Is there a solution to the EU Crisis?
Yes, there is a solution to the EU Crisis.
What is required in the solution?
The "failing EU nations" are in urgent need for liquidity to service their public debt. They are in urgent need because the interest margin for their debt is climbing by the day and quickly eroding their ability to service the debt. Hence the best way is to do what the French and the English have done, that is to quickly pass a "severe budget" and put the house in order before the rating houses or bankers can blink.
These "failing EU nations" need "emergency funds" in the form of EFSF (European Financial Stability Facility) to guarantee part or all of their debts so they can access that liquidity. The 440 billion euros in the EFSF currently is just not sufficient and no one is willing to step out to guarantee another 2 trillion euros.
The solution will need to address the following:
- Some emergency funds need to step out to provide the elusive 2 trillion euros guarantee needed to provide liquidity to these beleaguered nations. This is just a guarantee and there is no actual need to fork out that 2 trillion euros if the failing nations do not default.
- A control mechanism to ensure that the "failing EU nations" continue to be compliant to the prescribe set of rules and do not default. The solution should therefore include a schedule
- That ensure eventual compliance with the Euro Convergence criteria
- For regular compliance checks before disbursement of more funds
- For recapitalization of their financial sectors and strict implementation of an international capital and compliance standards replete with a complete set of standards for financial asymmetry risks.
These sets of control mechanism on the "failing EU nations" need to be implemented to ensure sustainability of such a solution. The time frame for the implementation of these sets of control mechanism may take up to mid-2013 [and possibly beyond] when the EFSF is replaced by the more permanent European Stability Mechanism.
- The eventual re-emergence of the "failing EU nations" with the "tranche 1 EU and euro nations". I have previously used the EU and Euros almost interchangeably but going forward they may be 2 very distinct entities especially when we have a 2-zone or dual speed EU nations.
What is the solution?
There needs to be an acknowledgement that there is a dual speed EU. The stronger EU nations need to move ahead towards nationhood and set up a treasury. The details on taxes will need to be negotiated, passed through the EU parliament and agreed by all the stronger EU nations. This new treasury will have the financial firepower to provide the 2 trillion euros guarantee needed to allow liquidity to flow back into the "embattled EU nations". The tranche 1 EU nations can bring back the liquidity that the tranche 2 EU nations need in order to put their house in order.
Lets consider the mathematics (based on the data as at April 2011) - lets assume that the nations below are tranche 1 EU nations
| | GDP in billions of USD | GDP % of EU 2010 | GDP per capita in PPP USD 2010 | Public Debts % of GDP 2010 | Deficit (-) % of GDP 2010 | Unemployment |
| 3,316 | 20.4% | 36,033 | 83.2 | -3.3 | 6 | |
| 2,583 | 15.9% | 34,077 | 81.7 | -7 | 9.9 | |
| 2,247 | 13.8% | 34,919 | 80.0 | -10.4 | 8.0 | |
| 783 | 4.8% | 40,764 | 62.7 | -5.4 | 4.4 | |
| 469 | 2.9% | 18,936 | 55.0 | -7.9 | 9.4 | |
| 466 | 2.9% | 36,100 | 96.8 | -4.1 | 6.8 | |
| 456 | 2.6% | 38,031 | 39.8 | 0 | 7.4 | |
| 377 | 2.3% | 39,634 | 72.3 | -4.6 | 3.7 | |
| 311 | 1.9% | 36,449 | 43.6 | -2.7 | 7.1 | |
| 239 | 1.5% | 34,585 | 48.4 | -2.5 | 7.8 | |
| 192 | 1.2% | 24,869 | 38.5 | -4.7 | 6.7 | |
| 55 | 0.3% | 81,383 | 18.4 | -1.7 | 4.9 | |
| Total | 11,493 | 70.5% | 34,373 | 75.3 | -5.8 | |
Source: Wikipedia on EU
The tranche 1 EU nations have GDP per capita that is almost as high as France and a GDP almost as high as US. Public debts is also quite low at less than 80% of GDP. It will qualify for AAA ratings if they can iron out the tax issues.
There is nothing new in this idea it is just a CMO (Collateralized Mortgage Obligation) model. Both tranche 1 and tranche 2 nations are paying interest for the loans. Tranche 2 nations pay more due to their lower credit worthiness. Besides that both tranches need to contribute taxes to the new EU treasury.
The divergent for both tranches is just a temporary phenomena. The 2 tranches are expected to follow their own Euro Convergent Schedule.
Once confidence returns to the European financial market, liquidity will return. With liquidity hopefully employment will return in time.
What will be the steps and possible outcome from this proposal?
One of the first form of tax for the new EU nation to raise revenues for the guarantees will likely be the financial transaction tax.
The other steps to recapitalize the financial institutions and to regain confidence in the financial soundness of its financial institutions will be to implement a sets of more stringent financial regulations and capital requirements.
All these extra taxes, regulations and capital requirements will greatly increase the cost of domiciling financial institutions in the EU zone. In order to avoid the flight of financial institutions to countries where the cost of domiciling is less onerous, the EU zone needs worldwide agreement to implement or adopt these taxes, regulations and capital requirements. As it is, HSBC is already making a very public case of the onerous burden of regulations and capital requirements has on its bottom line that reportedly can cost HSBC USD2.5 bn annually.
The nations in Asia and US will most likely be very unwilling to agree on any unnecessary burden on its financial institutions which will eventually pass the cost to the consumers given the relative elasticity of the demand curve for financial services.
What compels the tranche 1 nations to provide such a guarantee?
The reasons are already explained in my article titled "Putting The EU Crisis Into Perspective". They are the fear of contagion effects and the fact that they are already deeply exposed to the "failing nations".
On hindsight after reading the news reports from the EU committee, EU may have already started the process towards implementing this solution.
The next question is whether the people of Europe would accept more austerity programme to save their financial sectors. Would their elected representatives heed their calls to reject more austerity programme and reject forking more funds to save their financial sectors. Consider the case of Italy and Greece
Is austerity programme the only solution?
No, austerity programme is never a solution to the EU crisis. Saving was never a prescribed cure for a recession and EU's problems started because its economy is contracting.
The austerity programmes are always intended to be temporary measures intended to return confidence to the EU nation until the process of setting up a single treasury and forming a single nation is complete.
Once a single EU nation is created and confidence return to the single EU nation, Tranche 1 nations in the dual speed EU nation will be able to guarantee the debts of Tranche 2 EU nations and borrow further to embark on a fiscal expansionary policy.
Is EU turning its back on democracy?
The incidences in Italy and Greece certainly prompt us to ask the question whether there is a need for an elected government in each EU nation when the EU unite as a single entity. Only time will tell.
The opinions in this document are entirely the author's own and should not be construed as professional advice.
Important note: While every care has been taken in the preparation of this document. The author makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.
