The Euro Stabilisation Fund: some thoughts ahead of its annoucement

As there is much speculation and rumour this weekend I thought that after replying to a comment I would add one or two points to it and sit waiting for some more detail. As ever with the European Union(EU) we have a lot of political “hot air” and hyperbole. Sadly yet again this is preceding the plan itself as I notice that they are discussing the details of the plan today. I had hoped that they might learn from their previous mistakes in this area but it would appear that learning from experience is not one of their strengths. I would remind everyone that all of the plans from the EU so far have been preceded by grand claims and so far all of them have turned out to be failures. Otherwise this plan would simply not be required.

I am monitoring what is going on and waiting for some actual detail from the EU. I have for example spotted the words of the French President Nicholas Sarkozy ““When the markets re-open Monday, we will have in place a mechanism to defend the euro. If you don’t think that’s significant, you haven’t been to many EU summits.” However of course the hyperbole count from European ministers and officials has been nearly as high from their own previous failed plans and so far they have trumpeted plans which at best have disappointed….

I have two main initial thoughts. Firstly concerning the European Central Bank (ECB), that this weekend is likely to be very significant for it. If the deeds even remotely match the words they will be trampling on the ECB’s toes in one form or another and it was only Thursday afternoon it decided not to act on these subjects! So we are back to credibility issues. I think also that the issue of the ECB not having a fiscal partner in the way that the Fed has the US Treasury and the Bank of England has the UK Treasury and in particular the fact that this means it is limited in its ability to take losses will be significant today as they settle the plan. So here is my first thought if this plan is going to have a chance of working the EU should guarantee the ECB financially. I think using the European Commission would be a poor alternative. I do not want anyone to be in any doubt that guaranteeing the ECB fiscally would be a big step so it is quite possible that we will get a European Commission half-way house fudge.

The second is slightly uncertain because it is by no means absolutely sure that the UK will have a Conservative government. But if we do there has been circulating in London a draft EU policy and if you read it (and it turns out to be true) then they would turn this deal down. According to the Guardian newspaper “But the British relationship with the EU has changed with our election. We will never join the euro. We will introduce legislation early [I won’t pre-empt the Queen’s Speech with detail] to implement our commitments: any Treaty change transferring competence or powers would require a referendum; the sovereignty bill; and increased parliamentary controls on any use of ratchet clauses”

So there is much which may happen…

Causes of this

Several things happened last week which were significant.

1. World and particularly European inter-bank markets showed signs of freezing up and grinding to a halt. This is significant as it was this sort of thing which ending up in the failure of Lehman Bros.

2. The situation with European Sovereign Debt got  much worse on Friday. If we take the situation of Portugal then her ten-year government bond yields rose by nearly a full percentage point and are now at 7.05%. So she is now in a position this weekend whereby should yields remain at this level for a sustained period then she is looking like Greece in that she cannot afford to finance her national debt either at such price/yield levels.

3. As much a sign of our current problems is the way that stronger nations have seen their costs of borrowing fall as a “flight to (perceived) quality” has taken place. For example Germany’s ten-year bund yield is now 2.79% whereas up until very recently it had been solidly around 3.1%. So another measure of the problem is that investors are willing to accept 1/3rd of a percentage point less yield on such a perceived safe asset than they were only recently. A similar trend has impacted on US government debt.

4. Thursday nights “flash crash” has unsettled markets. You see many of the official explanations are inconsistent are partial. You cannot cause something by happening after it! Well unless we are in an episode of Star Trek….

5. A proliferation of claimed settlements of the European problem with the Euro has reduced faith in official credibility just at the moment it would be most valuable as a tool.

6. The impact of the planned removal of the extraordinary monetary measures undertaken by the world’s central banks may have been much stronger than any of them anticipated. If this is so it poses some potentially very disturbing questions and I shall return to these.