June 14, 2012

Redemption or Damnation for the Eurozone

News have emerged yesterday of a possible change of mind of Angela Merkel on the famous Euro Redemption Fund which could amount to 2.3 trillion euro.
For those unaware of what is this, let us point out it is not a bailout mechanism like the EFSF which has failed miserably so far to avert contagion.
The Redemption Pact covers all public debts of EMU states above the Maastricht limit of 60pc of GDP, roughly €2.3 trillion.
The idea is to put all the excess debt above 60% GDP in a bad bank and allow each country to pay it down over twenty years.
Each state would be responsible for its own debt and would be forced to pay it back by its own means in specific Italy would have to repay €960bn, Germany €580bn, France €500bn and so forth -- but they would issue bonds jointly in order to obtain the most favourable rating and interest rate.
The debt would be covered by joint bonds, paid for from a designated tax.
Officials at Germany's top court say it appears compatible with the country's constitution -- unlike eurobonds. There would be a fixed limit to costs and the fund would not endanger the tax and spending sovereignty of Germany.
Italy and other states would have to pledge gold and other forms of collateral equal to 20pc of their debt in the fund.
"The assets could be taken from the country's currency and gold reserves. The collateral nominated would only be used in the event that a country does not meet its payment obligations," said the proposal.
Germany would have veto power therefore would be able to ensure discipline in a way that it cannot do with the European Central Bank where it has just two votes.
The fund would entail sacrifices for Germany since it would no longer enjoy safe-haven borrowing costs and it would probably costs Berlin 0.6pc of GDP each year.
It seems a nice and fair plan in principle although I feel that some considerations are due.
It will certainly placate the markets for some time letting many States breath some fresh air for a while, but it will not address what is the core issue of the Eurozone a currency union without a fiscal and political union able to enforce common rules and it will exacerbate rather than mitigate the painful issue of austerity without growth. Countries will enslave themselves to a brutal plan of 20 years of debt repayment with no possible negotiation that will have to be enforced regardless of any consideration on the state of their economies. It will be for debtors the same of swapping the debt repayment from a bank to a shylock.
Austerity will become even more brutal on heavily indebted countries this will be only marginally relieved from the lower interest rates brought from the joint bonds.
It will be an insidious institutionalized indenture service for Club-Med and a de-facto seize of power of Germany who will keep on the hook the entire continent for 30 years.
Local politicians in Italy, Greece and Spain will become useless caretakers with no real budget power since a big chunk of it will go either as collateral or as repayment to the Redemption Fund.
The Redemption Fund in those terms will become the biggest CDS ever conceived where trash bonds such as the Italian, Greek and Spanish will be bundled together with German and given a triple A.
It will be interesting to see who will purchase those bonds at least until this fund will be attacked by speculation after some time.
Maybe it is a less painful measure in the short time for Europe than pursuing either an exit of indebted countries from the Eurozone or a closer and more disciplined union but it is again a less insufficient response to the core issues of the Eurozone. Can is being kicked down the road again.

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