Who will pay for the euro bailout?

As a deal to save the currency takes shape, Richard Bath concludes almost everyone will be ‘taking a haircut’

THE EURO

Analysts say the fundamental fact is that the bail-out is too little and too late, with the lack of trust making the euro’s failure inevitable. If they are right, it will radically affect the landscape of Europe.

In that case there will be two options. Some commentators believe Germany is preparing to leave the euro, with Dr Pippa Malmgren, a director of Deutsche Bank, recently alleging that Germany has been printing Deutsche Marks in anticipation of a return to the pre-euro currency. Yet while 70 per cent of Germans believe the euro is finished, the German electorate also appreciates that their country has prospered as part of the euro, with its exports growing rapidly, and that withdrawal from the euro would trigger a wave of sovereign bankruptcies in Germany’s major markets. Far more likely is the emergence of a two-tier Europe, with Germany, France and the Benelux nations at its core leading a hard rump of ‘upper’ nations.

At least some of the PIIGS will be jettisoned (Sarkozy pointedly admitted on Friday that Greece should never have been allowed to join the euro). In such a scenario, the Germany-led countries – including France and the Benelux nations – would finally match their monetary integration with a corresponding level of supranational fiscal and political integration, with shared taxes and fiscal policy. China would probably own the euro as it does the dollar, but it would be Germany calling the shots in Brussels.

EUROZONE LEADERS

Heads of the Eurozone nations have little room for manoeuvre and all are wriggling on the hook. Nicolas Sarkozy, with dismally low poll ratings, knows France’s banks are on the brink and will need huge amounts of taxpayer money. Angela Merkel remains Germany’s major political figure, but is constrained by the German public’s unwillingness to bail out the PIIGS (Portugal, Italy, Ireland, Greece and Spain) nations.

Most embattled of all is Italy’s Silvio Berlusconi, inset, who has so far managed to avoid any of the Greece-style reforms of his horribly indebted economy. However, judgment day can no longer be swerved: when Italy went to the markets to borrow money on Friday, the interest rate it was forced to pay rose from a punishing 5.86 per cent to a record 6.06 per cent – above the 6 per cent benchmark at which sovereign debt is generally reckoned to become unsustainable. Even at that rate there were few willing to lend: the Italian Treasury sought ¤8.5 billion in loans, but only ¤7.9bn was forthcoming.

Eurozone leaders know the pain is not going to be temporary. Even with the ¤100bn bail-out, Greece’s debt will be 120 per cent of GDP by 2020, the same as Italy’s now (anything above 60 per cent is reckoned to be unsustainable, even without the penal rates of interest Friday’s auction of Italian treasury bonds attracted). That auction showed Europe is on the brink, with heavily indebted but solvent nations now effectively unable to borrow against their assets.

THE BANKERS

Christine Lagarde, the French boss of the International Monetary Fund, believes many European banks are effectively insolvent and their governments do not have the resources to bail them out. Multiple bank collapses is the Armageddon scenario, which is why the bank shares which rallied on Thursday after the announcement of a deal slumped on Friday.

Trust is the issue, which is hardly surprising as the main bail-out fund, the European Financial Stability Facility (EFSF), is not sufficient to bail out Italy or Spain. There are complex mechanisms in place to try to ensure it won’t come to that, but the markets are wary of guarantees offered by nations whose own economies are under severe pressure. France, for instance, is a major guarantor of the bail-out fund yet its AAA credit rating is under threat as its banks own so much Greek debt, so its ability to make good on those guarantees is suspect.

Also, while the state-owned or state-backed banks have accepted the 50 per cent “voluntary” haircut (the willingness of Angela Merkel, above, to let Greece go bust led to a screaming match with Nicolas Sarkozy – it would have seen a 100 per cent loss for investors) some private holders of Greek bonds are less keen. This isn’t semantics: not only does it go to the heart of the CDS (credit default swaps) market which underpins the Eurozone banking system, but were the haircut to become compulsory, the European Central Bank, which has been the biggest purchaser of Greek debt, would be insolvent.

Even the recapitalisation of the banks by June 2012 to a 9 per cent core-capital ratio, and which has been lauded as a visionary move, is fraught with danger. Although analysts at Credit Suisse have suggested that as little as ¤20bn may need to be raised, the previous reaction of Europe’s banks in such circumstances was not to raise more capital but to stop lending, which would push Europe into recession.

THE WORKERS

Some Eurozone economies are close to the brink, but any new recession will have a huge impact on the living standards of all citizens of Eurozone members and beyond.

As the Irish found out when their economy imploded, the bail-out and the conditions that come with it – public sector cuts, mostly – will radically affect the people living in the PIIGS nations, although those taxpayers in the nations forced to bail out their banks (most notably France) will also feel the pinch. Germany has prospered under the Eurozone, yet there’s no appetite among its voters to simply bail out the PIIGS. Indeed, under pressure from her voters, Merkel is insisting that the feckless five undergo radical, painful reforms so that the workers who happily voted for decades of overspending share the haircut.

This has already caused riots in Athens (left) and, with the next tranche of cuts affecting Greek pensions, expect more of the same. That the reforms are being driven from Berlin is also exacerbating political tensions, with many Greeks pointing out that Germany still owes Greece ¤95bn for the gold looted from its treasury when Nazi Germany occupied Greece.

The powerful Italian unions are also promising an increasingly embattled Berlusconi a diet of blood and thunder, and there’s an uncomfortable appreciation at the Eurozone’s top table that a cut of GDP of 5 per cent or more within 12 months is the acknowledged tipping point for civil unrest.

For the Eurozone’s politicians, caught between a fiscal rock and an electoral hard place, there are few options.

BUSINESS

As the dust has settled on the bail-out deal, so the doubts in the business community have grown. “I’m very critical of this deal and the City is critical of it to a man,” says Jeremy Batstone-Carr of Charles Stanley stockbrokers. “There’s complete unanimity on that, which is why I’m surprised that the markets are so sanguine.

“This deal will impact on income and jobs because it’s deflationary and will push us back into recession.”

It’s not difficult to see why Batstone-Carr has such profound misgivings. Europe is so indebted that growth is the only realistic long-term exit strategy, yet the deal is the equivalent of moving personal debt from one credit card to another.

Although the bail-out figures being bandied around sound huge, they are nowhere near sufficient. Where most economists wanted a bail-out fund of ¤2trillion and a Greek bond write-down of 60 per cent, they’ve got far less than that.

Worse still, the bail-out fund is actually only ¤250bn, but is being leveraged by complex financial mechanisms so that it equates to four times that amount.

Without a massive injection of capital, the prospects for growth are poor, yet there are only two realistic sources for that amount of funding. While the deal assumes that the Chinese and Middle Eastern sovereign funds will provide an easy flow of good Samaritan capital – not least because the Chinese economy depends on exports to avaricious Europeans – analysts ask whether foreign governments which have already been stung by poor investments in the US and Europe will step in when the Germans are so clearly unprepared to do so. The only other option is huge levels of quantitative easing, which is anathema to a German public hard-wired with memories of the Weimar Republic.