The EU non-event3 min read . Updated: 02 Jul 2012, 10:10 PM IST
The EU non-event
The EU non-event
The last day of the week, the month and the quarter lived up to all the things that this column discussed last week: rumours, summitry and manipulation. Again, India had a leading role to play in that. As the editor of this newspaper wrote, almost the entire media went gaga over the fact that Prime Minister Manmohan Singh had assumed charge of the ministry of finance. They extrapolated that into a resumption of reforms without an iota of logic or past performance to back up that optimism. Since when has somebody’s questionable achievements two decades ago become more important than his non-performance in the last eight years? Similarly, financial markets celebrated the new deal from the summit of the European Union (EU) leaders. It had all the hallmarks of another exercise in “smoke and mirrors".
The tactic adopted by the EU leaders and the media was the oldest trick in the game: hide the details in fine print or omit them completely. The ability of European financial mechanisms (there are many of them) to directly fund European banks in distress was a game-changer if it came with no riders. But, it is predicated upon the willingness of EU governments to agree to a common banking supervisor. Whether EU nations would be willing to cede the powers of their banking regulators over to a common continent-wide regulator, what powers and responsibilities would such a regulator have, etc., are open and important questions. Can a continental regulator order the winding up of a national banking entity? It could be a long while for such questions to be answered precisely and fudge might be along the way for the year-end deadline to be met.
Then, there was a lot of excitement over the announcement that European governments would not claim seniority over other creditors. The euphoria over this “breakthrough" was punctured neatly by Gavyn Davies who blogs for Financial Times: “The markets initially became excited by this, but should not have done. There is very little change here. The statement ‘reaffirms’ (a word which in effect implies ‘this is not new’) that the Spanish bank injection, made by the EFSF (European Financial Stability Facility) and then transferred to the ESM (European Stability Mechanism), will not gain seniority status over private debtholders. Careful observers knew that already, since it has always been the intention, stated in the preamble to the ESM treaty. The key point is that there is no general change intended for the seniority of ESM debt, so this problem is not alleviated." (Source: http://blogs.ft.com/gavyndavies/2012/06/29/more-questions-than-answers-after-the-summit/#axzz1zTZoq09J.
The full post is essential reading for those who see a “game-changer" in the Thursday EU summit.
For those who are not interested in going into details, there is another way to achieve enlightenment. The euro zone problem was and is one of too much of debt and too little of growth. On top of that, due to their unwillingness to recognize the problems for what they are, euro zone leaders precipitated a bank run in the troubled countries. Now, last week’s agreement appeared to tackle the problem of “bank runs" in crisis countries. Even if the agreement is taken at face value, it solves a problem that developed later, while original problems continue to fester. In fact, that financial markets were willing to bid up the Euro on this news was faulty on two counts. It jeopardizes European growth. Second, it fails to recognize that bank’s capital needs are a moving target. Weak or no growth can turn “good" bank assets “bad", requiring further capital infusion, if the bad assets are recognized. Further, it is a sad commentary on the US economy and on the market judgement, in general, that a vague summit declaration was enough to send the dollar weaker.
As Prof. Charles Wyplosz wrote (http://www.voxeu.org/article/one-more-summit-crisis-rolls) after the summit, the crisis rolls on. Then, why was the financial market reaction disproportionately enthusiastic on Friday?
It was the month-end and quarter-end for “long-only" funds. Performance reporting is due. Hence, it was imperative that asset prices were pushed up as far as possible on the last trading day. For governments, it was another opportunity to squeeze and scare short-traders off their short positions lest they exposed economic and financial market fundamentals for what they were. In recent years, squeezing short-sellers, banning short sales and slapping legal suits have been deployed to prevent bubbles from deflating.
Hence, the world of finance and economics has not become a safer and better place after the EU summit. Financial market reaction has not only been unfounded but also excessive.
V. Anantha Nageswaran is an independent financial consultant based in Singapore. Comments are welcome at firstname.lastname@example.org
Also Read | V. Anantha Nageswaran’s previous columns