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September 9th 2011:  G7 must act to avoid 'Black Monday' crisis

 

There is little doubt now that G7 faces a crisis meeting this weekend as the European debt disaster continues to escalate. A bold approach is needed to save the Euro from collapse with a commitment to boost growth at all costs.

The latest body-blow for the Euro-zone and Euro comes in the form of ECB member Stark’s resignation. Officially this is for personal reasons, but there are strong reports that his departure is due to policy differences over the ECB peripheral bond buying programme. Stark was reported to have voted against the ECB bond buying in August’s council meeting so it was clear he had big objections to the plan. The inability to carry the bank Chief Economist with you into battle is clearly a very negative sign.

There are estimates that the Greek private-sector debt swap plans may have reached around 80% support oat today’s deadline with two prominent Greek banks still to decide on their participation. Although below the 90% target, such an outcome would provide some degree of relief. The markets simply are not buying the situation however as credit default swaps continue to widen with Greek credit default swaps above the 3000 basis point level as default is considered unavoidable.

Amid relief that the German Constitutional Court did not declare the original bailout to be against German law, not enough emphasis was placed on the fact that the court’s insistence on increased safeguards for parliament will make it almost impossible for Germany to be in a position to agree to Eurobonds even if it wanted to move in this direction.

Plans for the expanded EFSF have been approved in France only and the plans are threatening to stall in other national parliaments. Slovakia for example not likely to even start debate the proposals until December while the German government faces huge problems in getting the legislation passed. This leaves the Euro-zone political leadership in a state of potential paralysis and they simply can’t afford to carry on like this.

A rapid decision needs to be taken to let Greece exit the Euro with dignity and let it heal its severe wounds through currency devaluation and default. The process will certainly be very painful and there will be big losses for the French banks in particular, but if the bleeding is not staunched soon then the ultimate damage will be even worse.

There are grounds for optimism that Spain and Ireland can be saved while Portugal is a 50% bet at best to stay in the Euro over the next few months. The major concern will surround Italy as there will be an extremely high  contagion risk. The Euro-zone governments and ECB will need to pledge total support, as will the Italian government. This is the key battle that will need to be faced over the next few weeks. The longer the Greek decision is delayed, then the more likely it will be that Italy is also forced out of the Euro which would almost certainly be terminal for the Euro.

The Euro-zone as a whole will also have to face reality and pursue a much more growth-orientated policy of fiscal and monetary policy support.  Markets are not willing to accept that heavily-indebted countries can deflate themselves out of a debt trap and confidence will be given a much needed boost if there is a co-ordinated move to boost growth. It will be a very slow and difficult path, but the Euro-zone can restore some hope if it looks to boost growth which would also make the debt dynamics less terrifying.

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