Thursday, 27 October 2011

Just Lips service?

So the Euro is saved, for now. At 4am European leaders finally emerged from their talks to tell the fatigued journalists that after hours of very difficult negotiations, they had come to an agreement that will give the markets what they are demanding.

Perhaps it was the late hour, or the fact that the Polish presidency had closed the press bar at 11pm, but the journalists covering the summit initially greeted the announcement with scepticism. Many questioned whether the "bazooka" just unveiled really had the firepower to shield Spain and Italy from collapse. After all, this was not the first time the press had been held captive until late into the night in the Justus Lipsius building - or 'Just Lips' as I like to call it - to be told at the break of dawn that the euro would be saved. So in the end, was this just lip service? Or was this the decisive action the markets needed to see?

The agreement has three prongs:
  • Private banks holding Greek debt will accept a loss of 50% on their Greek bonds
  • The eurozone's main bailout fund (the European financial stability facility or EFSF) will be leveraged to €1 trillion.
  • Italy will implement reforms to bring down the country's staggering debt, including a lowering of the retirement age.
The agreement will not solve the euro crisis once and for all, and more meetings will be necessary over the coming months - particularly as concerns setting the closer financial union that will be necessary to prevent this from happening again. But as council president Herman van Rompuy noted as he was leaving the summit, “the deal was better than most people expected”. It certainly was a lot better than people in the press room were predicting early in the night.

The markets seem to share Van Rompuy's optimism. Stock markets rallied today and the euro shot up in value. But the devil is in the detail. For instance, that €1 trillion figure is not actually mentioned in the Eurogroup summit statement. It only says that the current amount can be leveraged four or five times. But where is that leveraging coming from? This is what got sceptical observers calling this a bazooka with no ammo last night.

The money cannot come from the European Central Bank – Angela Merkel was insistent on that. So instead it will come from special purpose vehicles. This will include the EFSF, but also the IMF and sovereign wealth funds. It is expected that much of that sovereign wealth will come from China. The first thing French President Nicolas Sarkozy did this morning after getting a few hours sleep was call Chinese president Hu Jintao. And the head of the EFSF will fly to China later today. The real convincing will have to be done at next week's G20 summit. In the end, China will probably agree to bail Europe out. Anyone want to start taking Mandarin lessons with me?

The banks themselves will also be going hat in hand to China to fund their 50% 'haircut'. If they cannot get the funding from China then they will have to be nationalised by their respective governments.

So much still needs to be ironed out over the coming weeks. Finance ministers will meet next week and set the details of this new arrangement. But for now, the markets have been calmed. But it remains to be seen whether last night's Eurogroup summit statement was just lip service, or the beginnings of a concrete plan that will save Europe.

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