Saturday, December 10, 2011

What Came Out of the European Conference.

The important decisions? The first was that Germany finally got France to go along with its view of how the future of Europe should look. There would be no more bailouts of any type without serious reforms. Sarkozy is in a bind. French banks are essentially so bankrupt that they are too big for France to backstop all alone and maintain its AAA rating. Plus, France's deficits are nontrivial and its ability to raise taxes with any real effect is rapidly dwindling. France needs help. Merkel simply held her ground. In the end, Sarkozy had to agree. To not do so would doom the European experiment and any French hopes for future relevance (more later).

The meetings between Sarkozy and Merkel and "announcement" give Sarkozy the political points he needs to demonstrate that he did not actually cave in. I am sure he in fact did get a few points in, here and there. But not the key points and certainly not what he was asking for this past summer. But he has elections coming up in five months. He can't appear to be weak when negotiating with the Germans.

Germany would have liked to have all 27 EU members agree to a major treaty change, essentially giving up some sovereignty to a new European entity (or the current one with more teeth) that could enforce budgetary controls on individual members. Britain could and would not agree. So, since we don't want to kick anyone out, Germany simply goes around the Maginot Line of the present treaty and says it will get an agreement from each individual country. They will each write into their national constitutions or laws binding rules that commit them to fiscal controls and austerity. If you want to be in the club you have to play be the rules. If you don't agree, you cannot be part of the eurozone and get access to the central bank and larger agreements on aid.

Each member has to take steps to help themselves before they can apply to the EU for help. If you want the ECB to buy your bonds and support your markets, then you need to get control of your fiscal situation. The carrot and the stick. The carrot is 1% financing for your banks, which can then buy your bonds at 4-5-6% (depending on the country). That makes it easier for your banks to get whole.

Remember, it is not just French banks. Almost without exception, every European bank has bought massive amounts of various European government bonds. Leverage of 30 to 1 is common. (This has the rather bizarre effect of making large US banks look conservative.)

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