Lighting the Euro Zone’s Christmas Fuse

For those who value apolitical conversation starters for seasonal parties, we offer a few notes on the Euro Zone “mess” which may go pyrotechnic within a few months.

 

The Substance:

 

Twenty-six European Union (EU) members voted to balance their nations’ fiscal budget within 0.5%, enforced by EU-imposed penalties.  Today, all but 3 countries are beyond that deficit level.  The U.K. vetoed this proposed change to the EU treaty, and if the measure were posed as a referendum it would be defeated almost everywhere.

 

Many Euro Zone (EZ) countries issued too much “sovereign” debt, and bond markets will take more only at deep discounts.  Collectively EZ countries will issue $1.1 trillion next year, but yields on some bonds are unsustainable if applied to much of the outstanding debt (e.g. about 7% for Italy’s 10-year, and 6% for Spain and Portugal).  It’s getting worse – S&P posted negative outlooks and probable downgrades for a dozen EU nations and many banks.  As well, EU growth will dive below 1% during 2012.  The key Debt/GDP ratios are: Greece 142%, Italy 119%, Ireland 96% and others 80% (UK, France and Germany).  Bottom line: the odds of sovereign default are; Greece 100%, Portugal 63%, Italy 41%, and Spain 40%.

 

EU banks hold $682 billion of sovereign debt despite offloading $86 billion in 2011.  The European Banking Authority (EBA) says EU banks need a $153 billion capital boost based on stress tests and the targeted 9% capital ratio.  Banks are struggling toward the target by selling sovereign bonds and business units and by avoiding making loans – actions which suppress growth.  Floating stock is more costly due bearishness toward Europe.  Some large banks have bankrupted and more failures are expected.  The banks face liquidity problems now and those may turn into solvency problems very soon.

 

Outlook and Themes:

 

The cultural contrast between austere northern nations and “club med” nations is a recurrent theme in EZ news coverage.  The fiscal budget austerity imposed will be followed by widespread kicking and screaming.

 

For Americans, the EU crisis may feel like a version of Scrooge’s Ghost of Christmas Future.  The misery of Europe’s runaway debt problem is palpable.

 

EZ leadership has presided over 5 crisis summits and 5 ineffective outcomes.  The history of failures justifies expectations of upcoming default.  The European Central Bank is unwilling to run the Euro press overtime and unwilling to buy sovereign bonds massively.

 

The European Financial Stability Fund (EFSF) has committed all but about $250 billion of its war chest.  Its replacement, the European Stability Mechanism (ESM) is slated to have $650 billion, but substantial funding will not arrive until mid-2012.

 

Alan Daley is a retired businessman living in Florida.  He follows public policy from the consumer’s perspective.

 

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