This short-term fix won’t save the euro

Fill your boots! It’s the age of the bail-out.

Just as dozy lending to uncreditworthy borrowers was on the verge of bringing down the banking system (again), the world’s leaders locked themselves into a room over the weekend, and saved the bankers (again).

This time the dodgy creditor was Greece, and the bail-out was agreed by the European Union. Near enough $1 trillion this time – even bigger than the $700bn Tarp package that saved the banks after Lehman Brothers.

So – apart from a rampant rally in the euro and the wider stock markets, as they realise that no loss is too small to be socialised now – what does it all mean?

Why you can forget the euro as a hard currency

France’s president Nicholas Sarkozy must be feeling on top of the world right now. He’s managed to get one over on the Germans again. Forget a hard currency – Europe has now committed to the following:

1. The euro-area governments themselves (so this doesn’t include us here in Britain) have pledged €440bn in loans or guarantees.

2. A further €60bn in loans comes from the European Union’s budget (so that does include us).

3. And there could be as much as €250bn from the IMF (which again includes us, as well as all the American and Canadian taxpayers who might be wondering why their money is going on saving Greece).

Talking on Radio 4 this morning, Alistair Darling, who must surely have very mixed feelings about still being chancellor, said that Britain’s maximum liability is £8bn. We’ll see – I’m sure a lot of detail is still to emerge. But we’ll give that the benefit of the doubt for now. Britain, after all, has a couple of bigger problems to worry about than adding a further £8bn to our national debt.

On top of all this, the European Central Bank (ECB) has said, effectively, that it’ll step in as a lender of last resort, buying government and corporate bonds where it feels it’s necessary. This isn’t the same as the quantitative easing that the US and Britain have undertaken. It doesn’t yet involve money printing, in that the purchases are “sterilised”. In other words, for every cruddy Greek bond that it buys, it’ll sell a nice safe German bund to offset the new money. So it’s not pumping a load of free extra money into the system.

But there are other liquidity measures – the ECB will lend direct to banks over periods of three and six months, and there are new ‘swap’ lines with the Federal Reserve, to ensure a steady flow of dollars around Europe. These measures were all around during the last financial crisis, but they’ve been reactivated now after there were signs of panic last week in the inter-bank lending markets.

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The result of all this? Stock markets have taken off, of course. It’s a bail-out – what do you expect? And the euro has bounced sharply. Why? Because what the markets were worrying about on Friday was a complete disintegration of the currency. No wonder it’s up today.

This deal won’t save the euro

But in the longer run, this deal is not a solution. And it’s not good news for the euro. We’ll deal with the euro first. All of these moves, assuming they work, do not make for a ‘strong’ currency. As Marco Annunziata of UniCredit puts it, Europe has now decided that “member countries have to jointly put their resources at stake to support the weaker members.” In other words, the euro can now only ever be as strong as its weakest member.

And that will be pretty weak. Austerity programmes might be necessary, but they tend to stifle economic growth. Meanwhile, the ECB is likely to have to keep interest rates low for the long term as it shepherds all these weak economies through their hard times. That’s not a great recipe for currency strength, as Barclays’ currency trading team points out. The bank reckons that the euro will still fall to a $1.20 in time, and sees any bounce now as a good opportunity to get shorting again.

Then there’s the deal itself. The trouble is, there’s a fundamental problem which still hasn’t been addressed here. Greece probably cannot repay its debts. There is nothing about this package which makes repayment more likely, or which gives Greek trade unions any reason to give up industrial action alongside their pensions.

Good news for markets – bad news for taxpayers

The good news for markets (though not taxpayers) is that final responsibility for that debt is now being shifted from the private sector owners of that debt. Banks don’t have to worry about losing a pile of money because they can always dump this stuff on the ECB if they need to. But Greece may still default.

And the trouble is, that still poses a ‘contagion’ risk. As Robert Peston puts it on the BBC, the bail-out package is big, but it’s not that big: “€750bn is just over one-year’s new borrowing by eurozone members and a bit more than 10% of eurozone government debt. So it’s certainly not enough if investors were to start to lose confidence in the ability of some big countries – such as Spain or Italy – to honour their debts.”

Europe has bought some time. The best bet now is for it to look for realistic ways to restructure the debt of troubled eurozone nations, and get ahead of the problem, before the issue raises its ugly head again. Judging by past performance, I’m not hopeful.

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  • Tony Platts

    In the TV debates Brown criticised Cameron over the National Insurance issue saying by not allowing the rise to occur would thus take £6bn out of the economy which would threaten the ‘recovery’.
    Today he has committed us to an £8bn payment, to prop up the Eurozone.
    What effect will this have on ‘his’ recovery?

  • NVP

    so a light smack from mummy and the Euro is back in the garden to play in the mud again….

    forget equities – just as much fun in the forex markets this morning as traders enjoy this Volatility boost

    all this volatility is making a lot of traders even more rich


  • Peter Kellow

    Currencies must be coterminous with states.

    The euro experiment is the first time this iron law has been defied

    But the law will win

  • Stephen B

    Jim Mellon made a good point in his latest newsletter that there is no plausible scenario from which the euro can gain long-term strength. The Euro leaders have their careers invested in the Euro so as long as they are around (and Merkel will be around until at least next year) they will throw everything at propping up this ultimately doomed currency.
    One has to feel for the German people, as they have acted responsibly, worked hard, saved and paid their taxes. Their leaders have led them into a pact with totally different fiscal states such as Greece who now know that the more their protest, the more money the Germans will throw at them to keep paying themselves inflated wages and not pay their own taxes.

  • Keith G

    In the end you wonder where to put your money, Europe and the Euro is a no no, only a matter of time before the US debt goes the same way. The UK has a debt that is nearly as proportionately bad as Greece, so that’s not a good place to go. Japan is completely stagnate, China is into an over heating bubble. Fixed income debt around the world is stuffed, equities are going to get trashed. Gold might be OK but do you really want to put all your money into one asset like gold. Any suggestion what might be safe, let alone give any degree of return ???

  • Alex

    So the UK has had to come to this party because of some small print in the Lisbon Treaty that Brown signed us up to. Is there no end to his talents as an economic and financial genius?

    Why do the German people stand for this five card trick? Haven’t they got some law that says they don’t have to bail out other nations that have no financial discipline? If there are any German taxpayers out there who are happy about all this, perhaps they would care to comment.

    Meantime, has Cameron got the message yet? The UK should get out of the EU as fast as our little legs can carry us. The EU and the Euro are a busted flush and the UK, already shipping water big time will get sucked or suckered down with them.

  • Luke

    @Keith G: Physical gold

  • Stephen B

    RBS statement released not enamoured with the Bailout. US market doesn’t seem too impressed on opening either.
    Euro will be at parity with the dollar fairly soon, if it can’t put together a solid bounce after such a huge bailout.

  • Andy Dobbing

    Isn’t this just going to eventually have the effect of increasing the interest rates charged on German debt – after all its really just club-med debt in a German flag?
    Also this a vast reaction and without some real teeth behind it, it opens up the way for the club-med countries to let everyone else pick up the tab; not to mention letting the current bondholders off scot free with high interest rates and no risk.

  • Keith G

    @Luke, Yeah and Gold mine stocks, but not everything into one asset class, is there anything else …… tins of baked beans ( aka food ) is possibly another option.

  • jj

    I don’t know why there is so much worry about private and govt debts when they are in fiat currencies.It isn’t like there are any promises to pay back in real goods.Govts have no limit on how much fiat currency they can provide for no cost.The worry is if you have your savings in these currencies or promises to be paid back in those currencies,because they will always be devaluing over the longer term.

  • gareth evans

    Currency reform is needed. The bond market and “income tax” are just a scam to suck money out of the nations and transfer the wealth to the banks.

    Time to bin the debt-based, 18th century money system; it has no place in the 21st century.

  • Alex

    Keith. Land or Forestry would probably be a more practical option than raiding Tescos for baked beans.

    There are a few forestry companies, TREE, Phaunos Timber Fund, that you can buy with a retail broker.

    Failing that you can always by some farmland. It is allowed in your SIPP.

  • michael

    Wasn’t that long ago that euro-bigwigs were complaining about the euro’s strength. Hopefully this haircut will stop them complaining for a while but to regain competitiveness, it needs to be heading under 1.17 against $. Would be very handy if someone could explain to me why IMF & ECB want to maintain its strength? Is it because foreign creditors have the ear of the IMF now & don’t want to see the real value of their investment fall?