I have just been watching the Press Conference at the end of the European Central Bank’s meeting today and deliberately delayed my update on Europe to after it. Why? Because this was a particularly significant meeting surrounded by rumour and counter rumour and there was the possibility of it making announcements which would affect economic life in Europe maybe for generations. Fortunately it decided not to do anything particularly ground-breaking today and decided on what Sir Humphrey Appleby of Yes Minister called “masterly inaction”.
A Revealing Statement
In one of his answers Mr. Trichet did give something away quite revealing. You see he said “fully independent” and “liasing” as being the ECB’s role in the response to the Greek crisis. In my view you simply cannot be both you are one or the other. This sort of muddled thinking seems common to central bankers at this time as Sir John Gieve formerly Deputy-Governor of the Bank of England said some similar things recently( I wrote about this in more detail in my update on April 30th). So when they announce that they are independent my advice is to remember that what they mean by it may not be the dictionary definition.
What happened today to unsettle things?
There were several rumours doing the rounds for example that Italy was about to be downgraded and that US banks were refusing to lend in Euros. These sort of things thrive in such uncertain times and in a fearful environment some start to actually believe them. What was more realistic in my view was nervousness about the state of the interbank market and what might be happening there. Many eyes would have gone this morning to the LIBOR fixes (including mine) but in truth we were none the wiser afterwards.
Part of the nervousness had come from the way that bond yields had risen for the countries involved in the European sovereign debt crisis. I shall give closing levels for ten-year government bonds followed by the spread with Germany’s ten-year bunds. Greece 10.58% (+7.71%), Portugal 6.16% (+3.29%), Ireland 5.57% (+2.7%) and Spain 4.24% (+1.38%).
These numbers are particularly concerning for Portugal as she is being hit quite hard by these changes. We are back in a situation where offering the bail out money is likely to cost her as her three-year bonds are again yielding more than the cost of the bail out. I have wondered about this problem before and the European Commission is now saying that there is a special clause in its agreement for this and any losses will be subsidised by those who make a profit (according to the Wall Street Journal). So lets hope for their sake yields do not rise further elsewhere….
Also quite what the German Constitutional Court will say about subsidies to Portugal to help provide subsidies to Greece makes the mind begin to boggle I think!
Further Comment on the bail out
Having over this week analysed the so-called bail out for Greece I have come to the conclusion that it is in effect a bank bail out. I came to this conclusion earlier this week but I did not take the next step which I will introduce now. If I think this and if I assume that the designers of this plan are logical then there was a missing link in it which of course was some form of debt restructuring. One can only conclude that they felt that Europe’s banking system was not up to the shock.
However in the end I feel that it will be necessary and the delay caused by the plan to let Europe’s banks with particular reference to Greek, French and German banks off the hook will cause further pain to Greece. You see there are now two rather dark possibilities. One is that Greece’s population will realise that the bail out combined with austerity is not a long-term solution to their problems. The other is that Europe’s authorities are allowing their banks to recapitalise before they take the hit of a restructuring. This would certainly explain why Greek short-term bond yields are rising when there is an obvious carry trade available. Perhaps the main players already suspect the game and wish to avoid further losses.
My old tutor from my undergraduate days at the LSE (Willem Buiter) has taken this logic a step further and now concludes that there is already a plan for restructuring of Greek debt but not until 2011 when the debt has been transferred from the banks to other places including the taxpayer. I do not necessarily completely agree with this view but it is hard to discount entirely. If true it is a deeply cynical position from Europe’s politicians.
There is also a horrible possible irony here as what if a plan to bail out the banks is really helping lead to a freezing of interbank markets and therefore bank trouble and maybe failures?