A series of orderly defaults among the eurozone's most indebted countries would trigger a deep and prolonged recession in the region and a double-dip in the UK, analysts at PricewaterhouseCoopers have concluded.
The region would fall into a debt-deflationary spiral, gross domestic product would fall by a cumulative 5pc. The debt restructuring could wipe €800bn (£686bn) from private sector wealth in the eurozone. The knock-on effect would be a second recession in the UK, with a 1pc fall in GDP in 2012 followed by a 0.2pc fall in 2013.
The accountancy firm goes further than Bank of England policymakers and Office for Budget Responsibility forecasters who in the past month have shied away from quantifying the impact of the various possible outcomes of the eurozone debt crisis. However, PwC falls short of measuring the possible impact of a total disintegration of the monetary union, concluding this to be unlikely.
Other scenarios examined are monetary expansion and a Greek exit from the euro, which were the most likely outcomes according to PwC, as well as a new currency bloc, which PwC said was less likely. PwC said that whatever happens over the coming weeks, the eurozone would be unrecognisable by the end of next year, and a "harsh adjustment to a new fiscal reality" will be unavoidable.
"Expect surprises next year. We are currently experiencing unprecedented levels of uncertainty in the eurozone," said Yael Selfin, head of macro-consulting and one of the report's authors. "The eurozone that re-emerges next year is likely to be very different to the one we know today and the implications for business within and outside this region are enormous."........
Very quickly, Standard & Poor’s is of course right.
The immediate eurozone crisis cannot be solved by punishment measures alone. There needs to be some form of joint debt issuance and a lender of last resort to halt "systemic stress".
It was well-timed to drop this bombshell on Monday night after the Merkozy fudge (though S&P made the decision earlier), since the duumvirate yet again failed to offer any meaningful way out of the impasse.
"Policymakers appear to have acted only in response to mounting market pressures, rather than pro-actively leading market expectations in a way that might have better supported and strengthened investor confidence. We take the view that the defensive and piecemeal nature of this response has helped expand the crisis of confidence in the eurozone."
IMF chief Christine Lagarde was equally dismissive of the Merkozy plan. "It’s not in itself sufficient and a lot more will be needed for the overall situation to be properly addressed and for confidence to return."
As S&P states, a credit crunch is taking hold, partly because of the EU’s pro-cyclical demands for higher capital ratios. Euroland’s incoherent mix of policies are pushing the eurozone into recession and therefore into deeper debt stress. "As the European economy slows, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, eroding the revenue side of national budgets."
There has of course been consternation in Germany, usually based on a misunderstanding of how rating agencies operate. They measure default risk, therefore members of a fixed currency union are inherently more risky. The US and the UK have used QE to inflate away some of the debt, and they have weakened currencies to act as a shock absorber. This is undoubtedly a form of stealth default, but that is not what S&P measures. It deals only with "credit events", and such an event is less likely for countries with a sovereign currency and central bank that can inflate (provided their debts are in their own currency). Furthermore, shrieking Europols commit the fallacy of comparing levels of public debt and deficit levels with the US. That evades the core problem, that the eurozone’s banking nexus is €23 trillion, or three times sovereign debt. This has become a contingent liability of the governments themselves, especially the AAA core.
"For countries in net external liability positions, including the eurozone’s peripheral economies, we see growing risks to the funding of their external requirements. In our view, financial institutions located in countries in net external asset positions (such as Germany) also face pressure where the quality of those assets is deteriorating. Deleveraging by European banks is intensifying, as they reduce their balance sheets amid worsening funding conditions, look to bolster their capital ratios, and address concerns about deteriorating asset quality among their borrowers. By our estimates, a sample of 53 large eurozone banks from 12 countries will face bond market maturities of an historic record of over 205 billion euro in the first quarter of 2012."
I might add that EMU banks have a loan-to-deposit ratio of almost 1.2 (like Japan before the Nikkei bubble burst), compared to 0.7 in the US. They are much larger in aggregate, much more leveraged, and mostly underwater already on EMU bonds if forced to mark to market. In essence, the whole eurozone is already insolvent. Face up to it.
(Yes, yes, before you all scream over there, Britain is insolvent too by the same yardstick. That is why it is useful to have the magical instrument of a sovereign central bank in such circumstances – and one willing to act – to conjure away the awful truth.)
Euroland’s crisis is not about Greek pensions or Italian labour laws, but about a vast and catastrophically ill-designed edifice of interlocking bank debt and sovereign debt. You cannot separate the two. The sovereigns are destroying banks, and the banks in turn are destroying sovereigns. The two disasters are feeding on each other. This will continue until there is a circuit-breaker, both to act as lender of last resort and to end the slump.
S&P does not pull its punches on this: "We will analyze the policy settings of the ECB to address the economic and financial stresses now being experienced by eurozone sovereigns. In particular, we will examine the potential impact these policy settings will have in both staunching the eurozone’s increasing output gap and ameliorating its currently dislocated debt markets."
In other words, Europe has been told that the ECB’s contractionary policies – if continued – will lead to downgrades. The agency is targeting the output gap.
The Europeans are entitled to ignore this as – in their view – the worst sort of New Keynesian and Anglo-Saxon muddled thinking. Fine, but you can hardly complain if you lose your AAAs from an Anglo-Saxon New Keynesian agency.
Take it on the chin, defy the world, and pursue your 1930s policies if you wish.
I think it was probably their complete and utter "failure to spot" the biggest financial meltdown our generation has ever witnessed, still "bigging-up" some of the worst offenders a short time before the arse fell out !
S+P was the agency being discussed here. I pointed out that their track record was considered less than good, by those better qualified to say so.
Nothing more, nothing less.
Is that clear ?
Actually, it isn't as S&P weren't being discussed. You just came flying in with the comment that they are "discredited" and "will they stop at nothing" when someone posted a link to a report which you did not agree with. Instead of actually "discussing" anything you went straight into the "schoolboy argument" by calling them names.
And that is something you would not have done if they had stated that "Everything was great in the Eurozone and there will be unprecedented growth in 2012". In other words, they said something you didn't agree with so must be "discredited" whereas every other credit agency is not.
BRUSSELS IS working on a plan to avoid a referendum, in Ireland or elsewhere, by adopting a special procedure to meet German demands for changes to the Lisbon Treaty.
With Europe under intensive pressure to calm the debt emergency, European Council president Herman Van Rompuy will urge leaders at a dinner in Brussels tomorrow night to support a limited change to the treaty which can be approved by a unanimous vote of heads of state and government....... sources briefed on private talks with Berlin and Paris said the amendments they were seeking could be made by rewriting a protocol attached to the treaty which sets out how Europe deals with countries which persistently breach budget guidelines.
Under article 126 of the treaty on the functioning of the EU, which gives effect to the Lisbon pact, government leaders have the power to replace the “protocol on the excessive deficit procedure” by voting unanimously to do so. Although the leaders must “consult” the European Central Bank and the European Parliament, this mechanism is seen as a back-door route to treaty change as the protocol has the same legal effect as the treaty itself. “The [Irish] Government was already empowered to make such changes when the treaty was approved,” said a high-level European official who is involved in preparations for the summit.
The Government is obliged under the Crotty judgment of the Supreme Court to conduct a referendum on any measure which exceeds the essential scope or objectives of existing treaty provisions. While the text of the actual proposal remains subject to negotiation, legal experts believe the kind of protocol change Mr Van Rompuy has in mind may not trigger a referendum.
“Altering the protocol doesn’t change the procedure set out in article 126. It merely changes the manner in which it is implemented,” said Dr Gavin Barrett, a law lecturer at University College Dublin.
Confidential paper from council president Herman Van Rompuy proposes empowering the commission to impose austerity
The European commission could be empowered to impose austerity measures on eurozone countries that are being bailed out, usurping the functions of government in countries such as Greece, Ireland, or Portugal. Bailed-out countries could also be stripped of their voting rights in the European Union, under radical proposals that have been circulating at the highest level in Brussels before this week's crucial EU summit on the sovereign debt crisis.
A confidential paper for EU leaders by the EU council president, Herman Van Rompuy, who will chair the summit on Thursday and Friday, said eurobonds or the pooling of eurozone debt would be a powerful tool in resolving the crisis, despite fierce German resistance to the idea. It called for "more intrusive control of national budgetary policies by the EU" and laid out various options for enforcing fiscal discipline supra-nationally.
The two-page paper, obtained by the Guardian, formed the basis for discussions on an interim report tabled by Van Rompuy, the European commission and the Eurogroup of countries that have adopted the euro, which is to be debated on Wednesday among senior officials in an attempt to build a consensus ahead of the summit............... The options outlined by Van Rompuy heavily emphasise the need for a new punitive regime overseen by EU institutions that would be given new powers of intervention. The proposals and policy options, if agreed, will be seen as seriously curbing the sovereignty of member states in setting budgetary, economic, and fiscal policy.
For countries deemed to be insolvent and in receipt of eurozone and International Monetary Fund bailouts but failing to meet the terms, Van Rompuy raised the prospect of drastic action, suggesting: "The granting of exceptional powers to the [European] commission (or another body) to take enforceable measures in the country concerned so as to ensure the stability of the euro area." It added: "In case of consistent non-compliance, political sanctions such as the temporary suspension of voting rights [in EU councils]" might be imposed......
As part of a German-led drive for a eurozone "fiscal union", Van Rompuy highlighted the potential for harmonising pension reforms, social security systems, labour market policy, and financial regulation: "Consideration could be given to use legislation to define minimum common features."........... Other "possible further steps" generating a "higher degree of economic convergence" in the eurozone could include reinforcing the commission's and the Eurogroup's rights of prior scrutiny "of all major economic reform plans" and sanctions if the commission's recommendations to individual countries are ignored. Van Rompuy also raised the possibility of using the EU budget to reward sound fiscal conduct within the eurozone – and to punish recalcitrants.
On the two most important rules governing the single currency – that budget deficits do not exceed 3% of gross domestic product and that national debt ceilings stay within 60% of GDP – Van Rompuy called for "stricter rules" and "extended capacity of the EU institutions to enforce them". Countries in breach of the euro rulebook could have to submit draft budgets "for approval" to the Eurogroup and the commission. The document said "a budget adopted not in line with the stability and growth pact [euro rulebook] could be considered in breach of EU obligations"............