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Business Home > Opinion Analysis
Is the euro beyond salvation? Politics not economics to decide

(Reuters) / 27 June 2012

Indeed, it is because it cannot not raise enough money from the market that Spain has had to ask the euro zone to borrow up to 100 billion euros to recapitalise weak banks.

At that point, depositor flight into safer havens overseas would be rational. Greek banks, after all, have lost 30 percent of their deposits since the start of 2010.

European officials privately acknowledge that banks are a weak link in the current architecture of the single currency. The summit in Brussels on Thursday and Friday will seek to address the problem by setting out a road map to a banking union. But common deposit insurance, billed as one way of boosting confidence in the currency, seems a long way off.

Even without a pan-euro area guarantee for deposits, though, the EU and the ECB have the tools to stop a bank run and temper a bond buyers’ strike as long as the political will is there to deploy them.

The ECB could flood the banking system with cash to meet the demand for liquidity and fulfil its mandate to ensure financial stability. Less likely, it could start propping up bond prices again.

On previous occasions, ECB action came in response to significant government moves - it supported Italy’s bonds after a belated willingness in Rome to adopt austerity measures, while the injection of more than a trillion euros of liquidity followed a commitment by euro zone leaders to tough new fiscal rules.

For their part, euro zone governments could resort to their bailout funds, the European Financial Stability Facility and its embryonic successor, the European Stability Mechanism, which will have a maximum of 500 billion euros at its disposal.

To reduce the risk of a failed auction, both funds are authorised to buy the debt of a member state, in the primary as well as the secondary market, upon the request of the government concerned, which must agree to appropriate policy reforms.

A full-blown euro area-wide market run could quickly overwhelm the rescue funds, even if supported by the firepower of the IMF. Goldman Sachs estimates the combined borrowing requirement of Italy and Spain (rolling over maturing bonds plus financing the budget deficit) at about 300 billion euros over the next 12 months.

But even at that point the game need not be up for the single currency. Euro zone finance ministers have the authority to grant the bailout vehicles a banking licence that would enable them to leverage their capital by borrowing from the ECB.

All eyes on Germany

The question, again, comes down to the political will to resort to unorthodox measures in order to buy time - perhaps years - until a stronger institutional framework is in place.

Germany remains firmly opposed to giving the EFSF and the ESM a banking licence. “I regard that as monetary financing,” Jens Weidmann, the head of the Bundesbank, Germany’s central bank, said on Monday.

Weidmann said the ECB was running up against the limit of its mandate because the failure of governments to act was forcing it to step into the breach. Northern creditors point the finger for this “failure” at southern governments for not getting their house in order.

Capitals on the periphery, and many academics, say Germany must share the blame for its refusal to contemplate any form of debt mutualisation, such as commonly issued euro bonds, except as the culmination of a long process of fiscal and financial integration in the euro zone.

For a start, pooled bond issues or a debt redemption fund were unconstitutional, Merkel said on Monday. “I also consider them to be economically wrong and counterproductive,” she added.

But, in extremis, would Merkel and Weidmann want to go down in history as having signed the euro’s death warrant?

Markets are pricing in yet another disappointing summit this week, the 20th such “make or break” meeting in 2-1/2 years.

But the talks are likely to show that the will to preserve the euro is far from exhausted. Leaders are expected to agree to transfer responsibility for supervising their countries’ big cross-border banks to the ECB as the start of a long haul to a banking and fiscal union.

“While such a transfer would - in itself - not mark a fundamental change to the financial outlook, this concrete and verifiable step, coming as it does with an explicit cost to national authorities in terms of loss of sovereignty, could represent a clearer signal to financial markets of governments’ political commitment to further integration and resolving the euro crisis,” said Huw Pill, an economist at Goldman Sachs.




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