Perhaps the EU (NYSEArca: EZU) is finally realizing that a debt
crisis can't be solved by issuing more debt. The proposals
emanating from their recent summit in Brussels will require massive
money printing instead, especially if the EU doesn't wind up
While EU leaders didn't state that they were going to start running
the printing presses at full speed, it is the only way they can
produce sufficient funds to actually implement their new policy
initiatives. They may not be willing to do so however. Until there
is an actual big increase in money printing, there is no reason to
believe that the EU will implement any of the proposed fixes for
its financial problems.
All the ideas that came out of the summit have been bandied
about before. Some, such as direct recapitalization of banks
(described as a "breakthrough"), had already been announced before
(perhaps it should have been called a re-breakthrough). This was
done in response to the EU's disastrous bailout of Spanish banks
that went through the Spanish government causing significant
downgrades to its credit rating and thereby raising its borrowing
cost significantly. A joint banking supervisory board is now going
to be added though. This seems sort of late in the game,
considering the teetering insolvency of many EU banks.
As a summit attendee stated, lending money directly to banks
means the loans won't have to be put on a government's books. He
should have followed up with, "at least not immediately". The way
Ireland got into serious trouble and required its first EU bailout
was that its banking system failed and the debt had to be assumed
by the government. The IMF now says it will need another major
bailout soon. As long as the EU is willing to commit unlimited bank
bailout funding this will not happen in other EU countries.
One new approach that did come out of the summit was a
relaxation of conditions for receiving bailouts. This was not
described as applying to all bailouts however. Only countries that
are "well-behaving" will not have stringent conditions applied to
them when they ask for a handout. This of course begs the question
of why a "well-behaving" country would need a bailout in the first
place. While this is an attempt to treat Spain and Italy better
than Greece, Portugal and Ireland, it will not work in practice.
All the previous bailout countries will demand that they be allowed
to spend more money and run bigger budget deficits. Since they
can't raise funds in the bond market, the EU will have to increase
the amount of their bailouts. This will require a continual stream
of additional payments from the EU. Where will the money come
The short answer is sharing debt through jointly issued
Eurobonds. Not that this can happen in the near future. First a
report on its feasibility will be issued in October. Then all the
EU countries will have to agree to it. Whether Germany (NYSEArca:
EWG) will be willing to do so remains to be seen (Angela Merkel
supposedly said that this would take place over her dead body).
Even if this eventually happens, and 2013 would be the earliest
that it would, can bonds that mix subprime borrowers and prime
borrowers be successful? The history of this is not encouraging.
This is what created the housing bubble and led to a massive
financial system collapse in 2008. The issuing of Eurobonds means
the entire EU could default as a single entity as opposed to just
the weaker members. That doesn't exactly sound like an improvement
over the current state of affairs.
One interesting note from the summit was the declaration from
Italian (NYSEArca: EWI) premier Mario Monti that Italy did not
intend to apply for a bailout. Greek and Spanish leaders said the
same thing just before their countries applied for a bailout. As
the French (NYSEArca: EWQ) say, "the more things change, the more
they remain the same". Perhaps the EU should adopt this as their
new motto. At least it sounds better than "bailouts are us".
Daryl Montgomery is Author of "Inflation Investing -
A Guide for the 2010s" and Organizer,
New York Investing meetup