Passing The Buck- The EU Running Out Of Time

The IMF are informing China how to run their banks whilst President Obama is busy telling the Chinese government to devalue their currency faster and start acting like a “grown-up”. Meanwhile, Italy continues to have €1.9 trillion of outstanding debt and during the most recent 5-year bond auction, yields showcased severe market concerns. As 10-year Italian yields flirt around the dangerous 7% mark, the prospects look bleak. In August, S&P stripped the US of its Aaa rating; in Spain youth unemployment remains at obscene levels (45%); while even in the relatively solid Nordics (most notably Denmark) the banking sector outlook is dreary. Despite all of this, the IMF and the US are pointing the finger at China and criticising an economic framework that is ensuing consistent and impressive GDP growth.

As much as I would hope to see Europe succeed by means of an internal and organically constructed solution, I do not believe that the political figureheads (although quickly changing) or the indebtedness of the member states could feasible allow for this. Europe does not have one rotten apple anymore that can be bailed out by other prosperous and growing member states. Instead we have an entire bag of decaying apples. The only difference between these apples is the speed of decay. Greece, Ireland and Portugal have already rotted, Italy and Spain are decaying at a rapid pace and some fear that the mighty France (Aaa) might be next, after all the funding gap between Germany continues to widen reaching record levels. The rotten apples are unfortunately becoming the majority.

So how can we terminate this decay? Many consider the ECB as a possible solution. Although the ECB have seen their participation in the secondary bond market increase exponentially in the last 12 months, they have openly and strongly refused the idea of becoming the lender of last resort. The ECB has indicated that they will not start buying back bonds on the secondary market in unlimited amounts. Many people are putting all their eggs in ECB’s basket, but the ECB mainly driven by Germany, is keeping that basket well hidden under the table.

The ECB and the European Union needs investors to start believing in Europe again and quickly, with every passing day the likelihood of this diminishes and investors are off-loading European sovereign bonds from their balance sheets. Tough austerity measures have been introduced and citizens are feeling the pinch. In the great scheme of things these austerity measures are not changing investor sentiment and yields continue to push in the wrong direction.

The IMF is the only entity big enough and solvent enough to provide Europe with the much needed cash and investors with the much needed confidence. The IMF backed heavily by China, and other countries with impressive reserves, is the only credible solution to Europe’s woes. Europe’s options are limited and the future is bleak. If Europe continues shunning the IMF, it will almost certainly incur a lost generation. Let us accept that a system of excessive borrowing and spending has come to a halt. Let us recognize that no domestic European leader can reignite the confidence of investors - Not Mrs. Merkel, not Mr. Sarkozy and Not even the highly regarded Mr. Monti. But imagine if Premier Wen Jiabao stood side by side with Christine Lagarde and allowed a sudden and significantly large bond purchase of European Sovereign bonds. If in their speech they pledged their full support and reminded global investors of the underlying strengths of Europe – more importantly if this speech was followed by a significant purchase of European Sovereign Bonds. That would certainly see yields drop to levels where the word “sustainability” falls back in the European vocabulary.

So let us look to the IMF and ask them what we need to do in Europe to gain their pledged support. Let us acknowledge the position that we are in and let us pay the price accordingly. China and other countries with impressive reserves can help us out of this European crisis, but in return they will demand (and fairly so) that the multi-lateral institutions reflect the "new world". Allowing China status as a market economy under WTO several years in advance and reforming the IMF voting process seems to be a small price to pay considering the alternatives. After all nothing is free.