Friday, 21 September 2018

The trouble with ESM; all aboard the economic cycle

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Anthony Peters, SwissInvest Strategist

Do you recall the one we did at school where the hare never overtakes the tortoise? I seem to recall having been told at some point during the summer of last year that the Greek government and the bank creditors were very close to settling their differences and would imminently announce a debt-swap agreement.

Six months later they seem to have failed to have closed that tiny gap despite the fact that the French finance minister, Francois Baroin, assured us all that the negotiations are progressing at a steady pace.

Although I am trying hard to focus on something other than the European sovereign debt crisis – I add here that the economic downturn and the debt crisis may be closely related but they remain very separate events – it is hard to escape. I might be cynical but I can’t see what is in the deal for the lenders.

It is patently clear that unless Germany backs down and stumps up, the eurozone will be walking the plank, ’ere long. What she has to do is find an elegant way of, in the words of Heinrich Heine, publicly preaching water while secretly drinking wine

So they get 15 cents in cash – or near cash, as it will be handed out in the form of a short dated EFSF bond. The rest will be in paper issued by Greece which, let’s be realistic, has no more than a snow-ball in hell’s chance of paying that back either. The market might be a bit firmer in name but whatever upside there might be will barely make up for the administrative dog’s breakfast which the debt swap will bring with it.

This is not another Brady solution and I dread to think of what liquidity the exchange paper will have. Since the failure of the Greek 5-year bond auction two years ago come Thursday, I have recommended nothing other than to sell and I see no reason to change that point of view.

Meanwhile, in the background, the German government looks to have agreed to something. It has been announced that the ESM which was supposed to be created in order to replace the EFSF (which was intended to have only a two year lifespan) will be set up in parallel and by July. This will increase the eurozone “fire-wall” to €750bn without the EFSF having to be increased. Look, no hands!

However, the price which Germany has extracted is a more stringent wording of the “fiscal compact”. Well, kind of. Stuck in the middle of it is the inevitable escape clause which permits the breaching of said limits “in periods of economic downturn”. As the kids would have it in their SMS shorthand: “OMG”.

Mounting the economic cycle

Way back then, the invisible Scotsman, the Right Honourable member for Kirkcaldy & Cowdenbeath – who abolished the boom and bust cycle and who saved the world – when still Chancellor of the Exchequer, coined the phrase that he would balance the budget “over an economic cycle”. I am not sure whether an economic cycle is the length of one or of two pieces of string but whatever, he sailed through his period as guardian of the national purse with no consideration whatsoever for what constituted this cycle thing he was rabbiting on about. The only piece of string he ever laid his hands on was the purse string which he appeared to have thrown away. With the “periods of economic downturn” catch-all enshrined in the fiscal compact, I’d be tempted to suggest that it probably isn’t worth the paper it’s written on. Time to dig out Abe Lincoln again with his assertion that you can fool some of the people for all of the time and that you can fool all of the people for some of the time but that you cannot fool all of the people for all of the time.

Therefore it would seem that Mutti Merkel is beginning to cave in. The top line rhetoric remains tough and unless one digs a little deeper one might be led to believe that she has not. It is patently clear that unless Germany backs down and stumps up, the eurozone will be walking the plank, ’ere long. What she has to do is find an elegant way of, in the words of Heinrich Heine, publicly preaching water while secretly drinking wine. I have never questioned her serious and honest intentions of protecting German taxpayers from being cast as the eurozone’s free and easy open chequebook but the pressures which are now being exerted, not least of all by the IMF in the shape of Christine Lagarde, are affecting a subtle shift in her position which is in turn causing a barely visible but seismic shift in the structure of the eurozone bailout facilities. The commitment of the money to the two parallel funds is good but heavens help us if they are actually called upon and have to find and disburse the cash.    

However, to move to a serious and job-creating economic recovery is another matter entirely. In its global jobs survey, the ILO concludes that things remain miserable on the employment front with a third of the world’s working population either unemployed or working for less than sustenance incomes. Not surprisingly, the ILO’s chief economist blames the harsh austerity packages in the industrialised world for the high unemployment. He is quite right but I still struggle to get my head around the fiscally expansionary alternatives.          

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