It won’t be a happy euro year

Its plus ça change, plus c’est la même chose this New Year in the eurozone as eurocrats fail to learn the lesson of last year: the fundamental flaw is the euro itself

The message from the Sarkozy camp is no longer so positive
Simon Miller
On 6 January 2012 13:50

New Years are meant to herald fresh hope, changes of direction and new energy but looking at the markets this week it seems that there will be scant differences from 2011.

Just as certain people who wear tin foil believe that the world will end this year, there seems to be an unassailable view in the eurozone that the currency union will remain intact no matter what the year brings.

The problem is that the markets just don’t believe them.

Of course, I am sure that the French will be hailing their latest debt sale as proof of the country’s ability to fund itself but a closer look at the result shows a distinct lack of faith in its stated confidence.

The €4.02bn of 10-year debt averaged yields of 3.29 percent, up from 3.18 percent in December and demand almost halved with a supply to ratio of 1.64 to one compared with 3.046 to one.

Simply put, the markets are pricing in a downgrade of France. Now, as the US downgrade showed, this is not the disaster it once was, as yields may not necessarily rise to a punishable rate, but the political pride, in this an election year, makes the thought unpalatable to French leaders. In addition, the US has the global currency which also offsets punishment by yield rate - a weapon France does not have.

However, the drop in take-up is a symbol of other underlying issues that all point to a market belief in euro-change.

Eurozone banks flung a record €455bn in deposits with the European Central Bank last night, a clear sign that banks are no longer trusting each other so are preferring to take a loss with the 0.25 percent rate offered by the ECB rather than run the risk of a default with a better rate elsewhere.

These record-deposits - three this week already – also points to what was feared and is now becoming a reality; a credit crunch.

A combination of a ludicrously short timescale to raise 9 percent in capital plus fears of contagion is simply leading to banks shutting up shop in terms of credit. As a result, a death-spiral where businesses go bankrupt when they cannot service debt, leads to banks holding bad debt, leading to even less lending and so on.

The eurozone is certainly heading towards another recession unfortunately.

And yet, its leaders are refusing to countenance that this was of their making and can be of their solving.

Today, Italian technocrat Mario Monti meets President Nicolas Sarkozy following his successful spooking of the markets by popping up unannounced in Berlin on Thursday. Apparently, there will be yet another communique to reassure markets that there is a credible deficit-reduction plan.

They just don’t get it.

It is the structure that is at fault. The system itself needs fundamental change if it is to survive.

Greece gets it.

With it struggling to push through austerity measures to meet conditions for a second bailout and trying to clinch a deal with private debt holders, Greek government spokesman Pantelis Kapsis put it quite simply: "The bail-out agreement needs to be signed otherwise we will be out of the markets, out of the euro. The situation will be much worse."

Now, there is a degree of pushing the actions to the benefit of Greece to ward off the worse scenario but at least the Greek government understands the fundamental problem with its situation and the likely scenario.

And so do the markets and banks.

Italian bank UniCredit, which saw its shares suspended on Wednesday after it offered a 43 percent discount on its enforced capital raising exercise bluntly spelt out this year’s risk in the prospectus: "The departure or risk of departure from the euro by one or more eurozone countries and/or the abandonment of the euro as a currency could have major negative effects on both existing contractual relations and the fulfillment of obligations by the UniCredit Group.”

So why can the politicians and eurocrats not see this?

Are they so embedded to the ideals of the eurozone that they refuse to countenance what the reality is?

With yet another Franco-German summit next week, I presume that the strengthened stability pact will be the sum of the measures – well that and yet another assault of the City through a Tobin tax – and that is not good enough.

What will it take for the eurocrats to understand that the fundamental risk to their union is the system itself? How much more damage will be done to the global economy by this dogmatic, blind adherence to an orthodoxy that is being proved flawed?

As S&P’s chief European economist Jean-Michel Six told French daily Le Parisien: "The problem more than anything is the way the eurozone functions, which leaves a lot to be desired.”

Simon Miller is the Editor of Financial Risks Today. He tweets at @simontm71

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