Can Merkel and Sarkozy turn the tide of markets?

President Nicolas Sarkozy and German Chancellor Angela Merkel Could Germany become banker to the eurozone?

It may be a heuristic rather than a cast-iron rule, but when markets turn against you, normally the best way to minimise losses is to cut and run as early as possible.

Hanging on in the hope that something will turn up is frequently the road to ruin.

So I was not surprised by the frustration and even despair I encountered when talking to bankers about last night's statements by Chancellor Merkel and President Sarkozy following their meeting yesterday with George Papandreou, the prime minister of Greece.

Their joint conviction that "the future of Greece is in the eurozone", unaccompanied by any new plan to make it so, was chillingly reminiscent of those statements we in Britain repeatedly heard from the then Prime Minister John Major in 1992 that the future of the British pound sterling was in the European Exchange Rate Mechanism (ERM).

And as luck would have it, tomorrow will be the 19th anniversary of the day that markets defeated politics, and the UK was forced to withdraw from the ERM - when the financial and economic costs of staying in the ERM became unbearably huge.

'Walk away'

Perhaps it is the memory of that trauma that has persuaded so many of the bankers, politicians and officials I speak to in this country that France and Germany are maximising the potential damage to the eurozone by refusing to acknowledge the economic necessity for Greece to write down the value of its public-sector or sovereign debt by somewhere between 40% and 60%.

John Major, seen leaving Number Ten Downing Street in 1992 Things came to a head between the UK and the ERM on Black Wednesday

One manifestation of the heavy tariff for delaying what may be inevitable is it is now conventional wisdom that Greece may have to leave the eurozone - whereas only a year ago, anyone making such a suggestion was seen in much of polite European society as in need of urgent medical attention.

It tells you all you need to know that the French president and the German chancellor last night felt compelled to say that they "are convinced" that Greece won't leave the single currency. But that sounded more like a bet than a pledge to make it so.

And although stock markets have bounced a bit overnight and this morning, we will have to see whether Franco-German-Greco solidarity that isn't backed up by hard cash succeeds in staunching the flow of money out of Greek banks, and the total boycott of lending to the Greek state.

This emptying of Greek banks' coffers has shown that both professional investors and ordinary people are not prepared to wager that the euro is forever in Greece.

On current trends, the European Central Bank (ECB) will end up financing every single past and future loan made in Greece, because when cash leaves Greek banks, it has to be replaced by emergency loans from the eurozone and Greek central banks.

Presumably some time before then, the ECB will say enough is enough - that were it to become the provider of finance to every nook and cranny of the Greek economy, its role of ensuring price stability would have been irreversibly corrupted.

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It is hard to see how the eurozone convoy can or will do a u-turn on the road to ruin, unless and until that convoy sees that it is minutes away from driving over a cliff”

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At which point, presumably, the rest of the eurozone would have to accept a Greek default and a much more significant reduction in the value of what the country has to repay than the implied 21% that has been allowed so far. Or it they are not prepared to do that, Greece would feel compelled to walk away from its debts and would tear up its membership of the euro club.

Road to ruin

We are experiencing something very similar to what happened in 2007-8, when it became increasingly hard for banks in the developed west to borrow and to lend, and that credit crunch transmuted into banking crisis, which transmuted into the worst recession since the 1930s.

Back then governments were paralysed from taking adequate action till the moment of acute disaster by a failure of imagination - they didn't really know what to do - which was combined with a belief that to bail out the banks would be to reward recklessness and greed.

This so-called moral hazard argument against rescuing those who have borrowed too much or lent too much is in play again right now - with Germany's reluctance to lend its ample financial resources to Greece and Italy, to keep them well away from the brink of collapse during this lending strike by commercial providers of finance.

But unlike in 2007-8, everyone knows what could be done to restore confidence in the eurozone: if Germany made a clear and unambiguous statement that it was prepared to underwrite the eurozone's public finance, real stability would return to the eurozone much faster than it has evaporated, so long as the over-borrowed members of the eurozone stuck to realistic commitments to cuts deficits.

That said, in describing the only real solution available, it also shows why it may be naive to expect a rapid end to the crisis - because the German people are understandably reluctant to mortgage their futures to nations, over whose expenditure and finances they have no direct control.

As Martin Wolf of the FT pointed out this morning on Today, this German fear of becoming banker to the entire eurozone even infects the capacity of the European Central Bank to buy the debt of Italy and Spain in sufficient quantity to prevent their sovereign borrowing costs from ballooning to potentially lethal levels.

Or to put it another way, it is hard to see how the eurozone convoy can or will do a u-turn on the road to ruin, unless and until that convoy sees that it is minutes away from driving over a cliff.

PS I will put some stuff out on UBS's $2bn rogue-trader loss later today, when I have found out a bit more about it.

Robert Peston Article written by Robert Peston Robert Peston Economics editor

Why aren't markets panicking about Greece?

Will Syriza succeed in persuading its eurozone and IMF creditors to write off some of their huge debts, or will it be forced to leave the currency union?

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  • rate this

    Comment number 12. favourite bit being this quote from Black Rock.

    "With limited supply and increasing demand exerting upward pressure on rents in the City market, investors can anticipate strong returns and considerable long term growth potential,"

    Total rubbish - there is no demand for City office space, there is mountains of supply and the returns are non-existent.

    A fantasy as bizarre as the EU's.

  • rate this

    Comment number 11.

    "Their joint conviction that "the future of Greece is in the eurozone", unaccompanied by any new plan to make it so"

    Nick: George don't worry, we will stand by you!
    George: Thank you (I think)!
    Ange: George, about those austerity measures...........

  • rate this

    Comment number 10.

    The problem is not the Eurozone but the psychology of 'markets'.

    'Markets' need things to gamble on & as the M&A business & normal insider trading opportunities are small they like to use the news media & their paid academics to provoke gambling opportunities. (A bit Marxist I know!).

    'Markets' have got so large they dwarf governments so in short they bully them to everyone else's disadvantage.

  • rate this

    Comment number 9.

    Yes - these fabulous politicians can turn the tide of markets - and our great grand-children will be finishing off the payments

  • rate this

    Comment number 8.

    The EU are simply doing what the capitalists do - lie, lie and lie again.

    Look at this story.

    Doesn't mention that the Tower was bought for £226m in 1998 and that it already failed to sell earlier this year for £300m.

    The desperation shown highlights the 'commerical property collapse' - thouroughly ignored by MSM

  • rate this

    Comment number 7.

    So a complete lack of political leadership in France and Germany. A restructuring plan in Britain that is so "difficult" it will take longer than WWII to complete. A budgetary timebomb in the US that bankers are hiding behind the Eurozone fiasco.

    This all seems to show the politicians really are not in control. The bankers and investors still call the shots.

    Time to take back what's ours.

  • rate this

    Comment number 6.

    I'll start the rumour that the Greek Generals have taken to studying economics. Seriously the crunch time is coming when the can comes to the end of the road. The big players have to decide if they want the Euro to continue (Greece alone leaving is not the end of it) or re-invent it for the big boys which will fragment the EU and possibly destroy it. Differing is not an option.

  • rate this

    Comment number 5.

    'Germany made a clear and unambiguous statement that it was prepared to underwrite the eurozone's public finance' Can't and Won't.
    Ange and Nick can talk all they like, Greece is dead on its' feet - as are Portugal, Spain, Ireland and Italy.
    Only £200bn UK banks exposure then - yet there are still some deluded fools who insist the banks are not to blame and we are going to see Economic Growth.

  • rate this

    Comment number 4.

    Robert, You appear to be writing in a more realistic manner now. Perhaps you should have a chat with your team about the spin inspired optimistic outlook as shown in this article yesterday:

  • rate this

    Comment number 3.

    Is the sky falling in Nicholas ?
    Don't be ridiculous Angela, the EU is completely safe with us two at the helm.

  • rate this

    Comment number 2.

    "the best way to minimise losses is to cut and run as early as possible."

    Not if you can outgun the hedgefunds and speculators which try their utmost to get the Credit Default Swaps to pay out. Easy for the EU if they try.
    (They will not if there is no Greek default : $80bn losses for hedgefunds)

    The EU should buy up the rest of the now cheap Greek debt and leave the hedgies high and dry!

  • rate this

    Comment number 1.

    "Can Merkel and Sarkozy turn the tide of markets?"

    Could King Cnut?


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