A tankist view of the euro crisis
- 26 October 2011
- From the section Business
In search of a metaphor in this crisis, I repeatedly come back to tank armour. An ultra-modern tank is almost impossible to kill because it is covered with a mixture of ceramic, textile and metal plating that is designed to disperse the incoming energy of an anti-tank projectile: laterally.
After it's done its job the armour does not look pretty, but it works - as long as you don't get hit again.
For all the criticism of the eurozone - the greyness of the political elite, the indecision, the bunga bunga etc - their strategy is not just "kicking the can down the road". It is about dispersing the energy of the debt explosion.
For velocity itself is important in the kind of collision we are talking about: over-accumulated debt impacting on real world growth. If you can slow it down, a debt explosion looks like just a long, dreary recession as people pay down their borrowings.
Now to the design of the armour: the complex system being - I will not say designed, but improvised - is composed of layers.
Layer one is the Greek debt write-off. This disperses the stress away from the Greek treasury - which can no longer control its ballooning deficits - and into the EU banking system. It takes down the Greek and Cypriot banks, but the hit it makes on the French, Belgian and German banks is - with one condition - survivable.
The condition is that it does not trigger default clauses in the insurance contracts numerous investors have taken out against a Greek default.
Right now, the politicians are trying to avoid this by declaring the write-offs "voluntary": many free market theorists are appalled, seeing this as a breach of the principles of derivatives markets.
However, if we suppose they pull it off, and no CDS meltdown takes place, then the stress is effectively transferred from Greece, to European Union banks to the global hedge funds and pension funds that hold the CDS.
Right now I would bet this works.
The second layer of armour is the 108bn euro bank recapitalisation programme: money from states, Far Eastern investors and the EFSF bailout fund (see below) will be used to shore up the balance sheets of the affected banks.
To visualise this, again, imagine a uranium dart hitting a surface that spreads the impact - in this case across a complex fabric of financial entities stretching from Dubai to Shanghai. The overhead cost in terms of destruction is, of course, shareholder value: French banks, indeed any banks taking the recap money, will see their existing share holdings diluted.
Again - this should work.
The deepest layer of armour Europe is trying to clad itself with is the EFSF. There is 726bn euros of taxpayers money committed, which translates into 440bn euros lendable. What they are trying to do is turn that into 1.4tn euros lendable - and the Brits want even larger - by getting, again, global lenders - including China, Brazil, the IMF and Middle East Money - to lend against the 440bn: once again spreading the impact laterally.
Here is the biggest problem - because to make this work you have to "anchor" the 440bn to something real. This can only be eurozone taxpayers' money. And the means of anchoring it become quite problematic.
If the world still accepted blithely the financial wizardry of special purpose vehicles, where E1 is turned into E10 on the five loaves and two fishes principle, it could simply be "declared" that 440 equals 1400.
But it doesn't, and can't. The easiest way to provide surety would be to let the European Central Bank do it: it is already buying tens of billions of Euros worth of debt short term to keep Italy and Spain afloat. But neither the rules nor the culture nor the leadership of the ECB will permit involvement. The Germans have specifically this Wednesday morning excluded ECB involvement.
The other option is direct taxpayer guarantees - which then show up on the books of countries, weakening their ability to borrow further.
At each level then, the EU response consists in taking a concentrated impact and spreading it out - across Europe, across the world, and over time.
However, in economics as opposed to inert matter, there is the problem of people not wanting to take the hit. Right now nobody wants to admit they are even putting themselves in line to take the hit: the German parliament, the kebab-shop phobic Italian right, the IMF, the Greek people. Everybody wants someone else to take the hit.
However the point of spreading the force of the impact is to avoid blowing up.
So here is the key question: does what they design today take the hit adequately?
It needs to take Greece out of its death spiral, save Europe's banks, avoid a CDS-triggered meltdown and swallow up the borrowing needs of Spain and Italy for at least a year. And it needs to be able to do this instantly, on - as sprinter Linford Christie used to say - the "B of the Bang".
And it needs to do so in a way that prevents repetition 18-months down the line. In tank terms - the vehicle needs to speed away out of range of the next impact.
But it can't. It is slowing down. Fundamentally growth is not going to rescue the entire eurozone because five of its members are trapped within an austerity programme in a continent whose whole economy is rapidly cooling down, and which needs fundamental structural reform.
Right now, we are close to the point of impact. The armour absolutely has to be designed right and it has to hold as the impact of a Greek default is felt.
If it does, there is one - guiltily unstated - fact to bear in mind: there is another tempting target - with equally shoddy armour and a similarly dodgy engine: the United States. If the Europeans do a deal today, there is a good change that the fissile matter in the global system gets focused on the US.
They used to say politics is war by other means: now it is economics that fits the epithet.
Brutal, tankist and about survivability.