Wednesday, 27 June 2012

No mixing words – time for straight talking

Mervyn (black cloud of uncertainty) King told Britain’s law makers yesterday that the world is not yet half way through the financial crisis that began in 2008 and that Britain risked a downward spiral as businesses continue to put off investment due to the turmoil in the eurozone. No mixing of words there from the Governor of the Bank of England!

Why the strong tone? Of particular concern, as he put it, is the ‘ the position in Asia and other emerging markets’ and also the concern of his colleagues in the United States ‘...about what is happening to the American economy’.

Fair enough! It points to more QE on the way and indeed, all it needs is one more member on the MPC to tip the balance. According to the last set of MPC Minutes, any one of Charles Bean, Paul Tucker, Ben Broadbent, Spencer Dale or Martin Weale could do it. Those in the know think it will be Martin Weale of the National Institute but, who knows, in two weeks time they may all decide to go for it.

Mrs Merkel also chose not to mix her words yesterday. We now know for sure her position on debt mutualisation and eurobonds – only over her dead body. Well, this is not quite how she put it but she is quoted as saying that; ‘I don’t see total debt liability as long as I live’.

That sounds close enough and is not quite what the markets wanted to hear.

We sincerely hope the Lady has a long time to go, but is she saying that a fiscal union in the sense in which fiscal sovereignty is relinquished by eurozone members remains a pipe dream? Mrs Merkel’s position has always been that relinquishing fiscal sovereignty must precede debt mutualisation and eurobonds. The French President claims this is hardly a show of solidarity among peers and that without the latter the relinquishing of sovereignty is just not on. There lies an impasse. 

On the other hand, Mrs Merkel did refer to total debt liability in her dismissal of debt mutualisation, so could it be that some form of debt redemption fund of the kind discussed by Germany’s council of Economic Experts (or Five Wise Men), in which debt above 60 percent of GDP would be mutualised and redeemed over 25 years, is a still a runner?

Much is riding on this week’s EU summit which starts tomorrow after several pre-meetings, one of which remains for later today in Paris. The agenda for discussion has been set out in a document released ahead of tomorrow’s start. Titled Towards a Genuine Economic and Monetary Union, it contains what the President of the European Council, Mr Van Rompuy, described as ‘building blocks’ for reaching a common understanding among leaders on the way forward for the eurozone. To quote from the report, the following are the building blocks:

        An integrated financial framework to ensure financial stability in particular in the euro
area and minimise the cost of bank failures to European citizens. Such a framework elevates responsibility for supervision to the European level, and provides for common mechanisms to resolve banks and guarantee customer deposits.

An integrated budgetary framework to ensure sound fiscal policy making at the national and European levels, encompassing coordination, joint decision-making, greater enforcement and commensurate steps towards common debt issuance. This framework could include also different forms of fiscal solidarity.

An integrated economic policy framework which has sufficient mechanisms to ensure that national and European policies are in place that promote sustainable growth, employment and competitiveness, and are compatible with the smooth functioning of EMU.

Ensuring the necessary democratic legitimacy and accountability of decision-making within the EMU, based on the joint exercise of sovereignty for common policies and solidarity.
Among the proposals for discussion on banking and fiscal integration is one that relates to a Treasury function. This European Treasury would have the authority to force changes on national budgets of eurozone members to keep deficits on course with targets. If endorsed at the summit this would be a significant step in the direction of fiscal integration.

According to the authors, the broad architecture outlined in their report requires a decade to be put in place. Markets may be discounting mechanisms but they have neither that kind of vision nor patience. 

Recognising this, Mario Monti, who perhaps more than Mr Hollande, has become the arch-protagonist in the eurozone stage of dramatis personae, also chose yesterday not to mix his words. 

We commented in this week’s Market Tactics on his warning to leaders that the Thursday and Friday summit must deliver a ‘…clear medium and long term vision for greater integration’. Yesterday, he served notice to the great antagonist herself in saying he will fight for concrete measures to help growth and contain market turmoil.

But he went further by adding that he will not allow the summit just to give formal approval to pre-prepared documents. He wants a mechanism agreed that will help limit any sharp widening in the spreads or risk premiums over German debt and specifically on bonds issued by countries that respect EU budget rules. And not only that, he indicated to Mrs Merkel that she should not plan on going home on Friday at the close of the summit. 

Monti means business and is ready to keep the summit going through to Sunday evening if necessary to get what he wants. 

Markets anxiously await the outcome. Next week could be make or break for them. 

Mike Lenhoff
Chief Strategist


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