dragweidFrankfurt, Rome, Paris, Berlin, London & Washington: the forced march of two opposing philosophies

Here’s a point that may have escaped you. Probably you know that eurozone sovereign nations have joint and several responsibility for the zone’s debt. But the amount each country is liable to cough up in the event of a euro default is based on their size and gdp track-record, not their own current debt problems.

This brings with it all sorts of unpleasant ramifications. France alone, for example, is responsible for 20% of the debt…a relatively modest €160bn. But its own national debt is €2.1 trillion…and its economy is in recession….and the recession is getting worse.

However, it’s the Italian debt responsibility that should terrify everyone with a functioning brain. It is nearly 18% – €140bn – and has a spiralling debt problem of its own at €2.3 trillion….and the economy is a joke.

Whereas France is paying €50bn a year interest on a debt that is 93% of gdp, Italy is paying €108bn a year in interest on one that is 137% of gdp.

This obvious disaster waiting to happen was what prompted ECB Chairman Mario Draghi to mention the Frankfurt Unmentionable three days ago: purchasing ezone sovereign debt bonds. The German Bundesbank will have its beady eye on all things Draghi: it will have noted that the Italian bond yields fell, which is of course what Mario wanted. Herr Weidmann will be watching further progress closely.

Bankfurt intransigence about the use of QE remains dogged, and in some ways one can see why; but in others, the BB does appear to be mad. For instance, Mario Draghi knows full well that if Italy goes bang, the game’s up. The balance sheet of the ECB is shrinking when it ‘should’ be expanding (given Draghi’s promise to bring in QE) and this must mean that the Chairman’s hands are still tied.

The sane German fear is that Germany will wind up with almost all the ezone debt responsibility. The insane German response is to imagine it can avoid that anyway. Merkel lied to the German people last year, and everyone in the élite knows it. One has to assume that Kleine Geli is bracing herself for an Italian default because Jens Weidmann thinks that is better than QE just making the debt bigger, and the currency more compromised.

I don’t understand why they think this can fly. It’s now an open secret in Rome that the Italian legislature, whatever its final form might be, is aggressively secessionist. But Italy quitting the euro after defaulting is no solution, because the other ezone members will have to share out the area’s debt proportionately.

Spain (itself the subject of more recovery bollocks than the rest of Europe put together) already ‘owns’ 12% of the eurodebt. How will the markets react to that going up to16%? That all depends on how much of Spain’s parlous position comes to light in the coming months. Portugal, Ireland and Greece are also jointly responsible…they’ll cope by putting out bromides for a while. I doubt if the markets will just sit on their hands about it.

My view remains what it has always been: Italy is the key weakness in the chain, not Greece. And once Italy sinks, bond market attention will turn to France. Rates must and will go up if the Berlin/Bankfurt axis continues to insist on restricting the ECB balance sheet.

This is far from being a certainty. Merkel herself shows signs of grasping the difference between certain collapse soon and almost certain collapse in the end. On the other hand, she’d probably rather deal with a total eurozone debt responsibility of €800bn rather than €2.5 trillion.

The point is, she’ll have to throw her considerable weight (including the fridge) behind Draghi pretty quickly, or yield contagion could get out of hand.

The German government is damned if it does, but facing Gotterdämmerung if it doesn’t. I still think that plans are afoot and in place in Berlin to leg it out of the euro and go back to the Mark. Not only would this then make German eurodebt responsibility more doubtful, it would also leave other ezone strugglers with an incredibly cheap euro…ie, devaluation – which is what ClubMed so desperately needs.

Even here, the argument follows that without the implied German guarantee, eurozone sovereign debt yields would go up into hyperspace – and the debtors would all default anyway. On the face of it, I don’t see that as a bad thing: from the start of this farce I have consistently argued for debt forgiveness: this would effectively force a debt write-off.

But because we live in the mad world of globally linked banking and global marketing, the contagion effect would be swift and headless. Given its ludicrous dependence on banking service exports, British banks would collapse in short order – in fact the UK itself would default….followed remarkably quickly by the US unless Obama got a grip. And there are two chances of that happening.

However, it is in nobody’s interests (least of all Asia’s) for all customers to be penniless. On a broader scale, the creditors will be forced into debt forgiveness. And who knows – at long last, there might be both real banking reform, and a rethink about mercantile globalism.

I’m sure that will happen in the end. I’m extremely doubtful that it will happen this time around. But we are at last going to see change on a scale very few people are expecting.

Connected from previous Slogposts: QE – saving the world by making it worse