Europe’s big dilemma

Is anyone keen for a 50 per cent return on a two-year investment? If that sounds good, what would you say if this investment were backed by a sovereign government?

Ship it in, right? Well, perhaps not if it were backed by the Greek government. That was the return on two-year Greek bonds last night, 50 per cent. You don’t get a return like that unless almost everybody thinks you are going bust. And so it is, Greece is going bust.

We are on the verge of an economic collapse which starts, let’s say, in Greece.

Those hard-working Germans are hardly going to bail those lazy, tax-dodging Greeks out just to preserve the euro. This, in a nutshell, is the Euro dilemma. The efficient northern economies are loath to prop up the laggards of southern Europe.

Unless its members forge a radical commitment to stronger ties, politically and economically, the euro zone – at least in its present guise – is doomed.

Meanwhile across the Atlantic the bellwether US ten-year bond dipped to a record low yield of 1.984, lower even than in the depths of the financial crisis. The US treasuries market is a bubble, make no mistake.

Would you invest in the US government – drowning in debt and printing money like the clappers – for ten years for a mere return of two per cent?

Still US bonds, along with gold, are the safety destination de jour for international capital fleeing the prospect of another share market meltdown as the European economic union craters.

The plunging interest rates on bonds are, perversely, a big rally. That is, investors have been fleeing other investments to park their money in US treasuries (bonds, or government debt) actually force the price of bonds up.

On a bond, price is inverse to yield, so the interest rate falls if the price goes up.

The lower the yield, the safer is the investment. At least, that’s the perception. The US treasuries market has been a bull market for almost 30 years.

The point of all this is that investors are challenged for a safe place to put their money. Besides the rising spectre of recession in both the US and Europe (particularly in the wake of last Friday’s zero-growth jobs figures in the US), nobody seems to have a decent handle on what might transpire in Europe.

The variables are many, the list of possible outcomes countless. As uncertainty is anathema to share markets, the question for investors is, how long will this uncertainty in Europe last? What will transpire?

It’s a tricky one. Rather than delivering yet another opinion from an armchair critic, we have found a list of quotes from prominent Europeans themselves. This was put together by forex traders’ website Zero Hedge. And while it is a collocation of the most sensational quotes, as a body they tell a story:

1. Polish finance minister Jacek Rostowski: “European elites, including German elites, must decide if they want the euro to survive – even at a high price – or not. If not, we should prepare for a controlled dismantling of the currency zone.”
2. Stephane Deo, Paul Donovan, and Larry Hatheway of Swiss banking giant UBS: “Under the current structure and with the current membership, the euro does not work. Either the current structure will have to change, or the current membership will have to change.”
3. EU President Herman Van Rompuy: “The euro has never had the infrastructure that it requires.”
4. German President Christian Wulff: “I regard the huge buy-up of bonds of individual states by the ECB as legally and politically questionable. Article 123 of the Treaty on the EU’s workings prohibits the ECB from directly purchasing debt instruments, in order to safeguard the central bank’s independence.”
5. Deutsche Bank CEO Josef Ackerman: “It is an open secret that numerous European banks would not survive having to revalue sovereign debt held on the banking book at market levels.”
6. ECB President Jean-Claude Trichet: “We are experiencing very demanding times.”
7. International Monetary Fund Managing Director Christine Lagarde: “Developments this summer have indicated we are in a dangerous new phase.”
8. Prince Hermann Otto zu Solms-Hohensolms-Lich, the Bundestag’s Deputy President: “We must consider whether it would not be better for the currency union and for Greece itself to go for debt restructuring and an exit from the euro.”
9. Alastair Newton, a strategist for Nomura Securities in London: “We believe that we are just about to enter a critical period for the eurozone and that the threat of some sort of break-up between now and year-end is greater than it has been at any time since the start of the crisis”
10. Former German Chancellor Gerhard Schroeder: “The current crisis makes it relentlessly clear that we cannot have a common currency zone without a common fiscal, economic and social policy.”
11. Bank of England Governor Mervyn King: “Dealing with a banking crisis was difficult enough, but at least there were public-sector balance sheets on to which the problems could be moved. Once you move into sovereign debt, there is no answer; there’s no backstop.”
12. George Soros: “We are on the verge of an economic collapse which starts, let’s say, in Greece. The financial system remains extremely vulnerable.”
13. German Chancellor Angela Merkel: “The current crisis facing the euro is the biggest test Europe has faced for decades, even since the Treaty of Rome was signed in 1957.”
14. Stephane Deo, Paul Donovan, and Larry Hatheway of Swiss banking giant UBS: “Member states would be economically better off if they had never joined. European monetary union was generally mis-sold to the population of the Europe.”
15. Professor Giacomo Vaciago of Milan’s Catholic University: “It’s clear that the euro has virtually failed over the last ten years, even if you are not supposed to say that.”
16. EU President Herman Van Rompuy: “We’re in a survival crisis. We all have to work together in order to survive with the euro zone, because if we don’t survive with the euro zone we will not survive with the European Union.”
17. German Chancellor Angela Merkel: “If the euro fails, then Europe fails.”
18. Deutsche Bank CEO Josef Ackerman: “All this reminds one of the autumn of 2008.”
19. International Monetary Fund Managing Director Christine Lagarde: “There has been a clear crisis of confidence that has seriously aggravated the situation. Measures need to be taken to ensure that this vicious circle is broken.”
20. German Chancellor Angela Merkel: “The euro is in danger … If we don’t deal with this danger, then the consequences for us in Europe are incalculable.”

“Most of the individuals quoted above desperately want to save the euro.  They are not going to go down without a fight.  The overwhelming consensus among the political and financial elite in Europe is that increased European integration in Europe is the answer,” says the website.

The overwhelming consensus in Europe among the non-elite however is far different. Forgetting the tribulations of Italy, Spain and Portugal for a moment and looking simply at the Germany/Greece equation, the people don’t agree with those they have elected.

The Greeks don’t want austerity programs imposed on them by Germany and France. They already feel penalised by the European Central Bank holding interest rates high to combat inflation in Germany.

The deadline for the next restructuring deal, read bail-out, on Greek debt is this Friday. Over 90 per cent of investors have to agree to roll their bonds or E8 billion in bail-out funds gets blocked. Greece then stands to get thrown out of the EU and the banks face big losses on their Greek bond holdings.

Tonight there is a court decision due in Germany which will lend direction to how far the Germans will go to bail out their battling neighbours.

For a start, the rich countries will have to tip more money into the ECB for a bigger bail-out fund to buy distressed bonds in the likes of Greece and Italy. Overall, if the EU is to survive a far closer political union will be required – which means the northerners going guarantor.

No one likes standing up for other people’s debt, let alone paying it off. So the political impediments to a political compromise are high.

If it doesn’t work, the knock-on effect from toppling banks and governments will damage markets for some time.

It’s easy to say now that the French and German banks should not have lent money to the Greeks in the first place. But they did, and they will have to cop write-downs at some stage.

And here is further uncertainty. Many of the big European banks are more highly leveraged than their US counterparts, some to a similar degree to the 30x gearing of pre-Lehman levels. Hence the ructions.