Bill Jamieson A monstrous game of bluff

COMMENT

BILLJAMIESON | Executive Editor of The Scotsman

A monstrous game of bluff

Did we ever think the euro crisis had really gone away?

The hope was that the dramatic summer pledge of Mario Draghi, the European Central Bank President, to do “whatever it takes” to avert a continental financial crisis and collapse of the euro would defuse the ticking bombs within the single currency area. And so for a time it seemed to succeed. Greek and Spanish bond yields fell from stratospheric levels. The euro strengthened. The fear gauge relaxed.

But this was to overlook a key feature of Mr Draghi’s offer of salvation. It came with strings. The biggest string of all was that countries seeking the financial assistance being offered by the ECB needed to formally apply for it. This has not gone down at all well in the finance ministries of countries where help is desperately needed. Not only do they fear that such an admission would weaken what remained of their credibility in financial markets, but also that the admission would be taken as effective agreement to the imposition of austerity measures.

The ECB shows no signs of budging: it’s a generous offer on the table but them’s the rules. But now, looking at the hardening mood in Spain, Portugal and Greece, Mr Draghi’s bluff could be about to be called in the most spectacular fashion.

The eurozone crisis displays every sign of being about to re-erupt. In recent weeks figures from both eurozone member countries and from Brussels-based Eurostat suggest that major trouble lies ahead. Unemployment across the single currency area has risen to a new high of 11.6 per cent, while early readings of inflation in October point to price pressures remaining persistent with a 2.5 per cent year-on-year increase and little indication they are going to ease any time soon.

With external devaluation denied, internal devaluation is reaping a whirlwind of weak economic activity and falling wages across the weaker economies. In Spain, now with an unemployment rate of almost 26 per cent, this looks a truly toxic combination.

The stronger the downward pressure of recession the more difficult it is for governments to reduce their debt burden. The debt to GDP ratio of the currency union has now reached 90 per cent – and there is no sign this is going to be reduced any time soon.

Little wonder that in countries such as Greece, Italy, Portugal and Spain there is a deepening apprehension over escape hatches being closed and walls closing in. A full bail-out for Spain and perhaps another for Italy are looming on the horizon while Greece continues to be paralysed by 48-hour general strikes in protest at a proposed new wave of austerity.

All this lends growing credence to concerns that Mr Draghi’s bluff is about to be called. Eurozone policymakers are fearful it will be. The head of the Austrian central bank has urged the ECB to activate its latest bond-purchase plan, Outright Monetary Transactions (OMT), in order to prove its effectiveness. The fear is that market confidence in the OMT programme is ebbing. Spanish government yields are edging back up from the ‘lows’ reached in the immediate aftermath of Draghi’s original announcement.

“The Spanish Government, for which the OMT appears to have been tailor-made, has yet to make the application to EU authorities for a line of credit, which is the minimum condition it must satisfy in order to qualify for ECB bond-buying support.”

No takers

According to the rules that Mr Draghi attached to the OMT offer, there is no government’s bonds it is allowed to buy. Says Stephen Lewis, economist with Monument Securities, “The Spanish Government, for which the OMT appears to have been tailormade, has yet to make the application to EU authorities for a line of credit, which is the minimum condition it must satisfy in order to qualify for ECB bond-buying support.”

Of the governments currently subject to bailout terms, ECB officials have made clear that neither the Irish nor the Portuguese qualified for the OMT because they did not have full market access. The ECB, with a deeply apprehensive Germany breathing down its neck, is in no mood to play Lady Bountiful.

Relations between the ECB and the finance ministries of deeply indebted eurozone countries will have been further strained by an admission by the European Central Bank that it had miscalculated the ‘haircuts’ it applied to Spanish government debt supplied by banks as collateral for loans. The error arose in the classification of Spanish government securities – easy to shrug off as a minor administrative error but one that will have done nothing whatever for the reputation and credibility of the ECB.

The focus in eurozone deliberations has returned to Greece and in particular whether more bail-out money could be disbursed. But it seems the German Government is unhappy with the recent drift of events. How long can Greece keep going without more funds? While the Greek Government had earlier said that it would run out of money on 16 November, there is, says Lewis, a general assumption that it would be able to keep going, if necessary, until early December. Fingers are crossed that this is so, and that events in Portugal and Spain do not provoke a more immediate test of Draghi’s rescue fund conditions. n