The FT is out with a piece today saying the core (primarily France and Germany) will continue to push towards greater fiscal union in Europe, but ruled out the potential for Eurobonds.  This is more of the same from Europe where they impose austerity on the periphery and do just enough to keep the Euro from completely collapsing.  They are trying to kick this can right to the edge of the cliff, but I don’t think they have any idea how close they are to kicking it over.  The article says:

“Wolfgang Schäuble, German finance minister, made clear in an interview with Der Spiegel, that Berlin remains opposed to such a policy.

I rule out eurobonds for as long as member states conduct their own financial policies and we need different rates of interest in order that there are possible incentives and sanctions to enforce fiscal solidity,” he said.

Senior French officials also played down speculation that any firm announcement on jointly issued bonds would be issued after meetings when Ms Merkel comes to Paris on Tuesday. “Eurobonds would require a much more determined integration of budgetary policy,” one said. “We do not have that today. It could be a long-term project, but you cannot have eurobonds and at the same time national economic and budgetary policies.”

I keep saying Europe needs a bazooka.  QE of the sort that the ECB is attempting now is not enough.  If Italy’s budget woes remain this bad or worsen (high probability given their balanced budget amendment) the ECB won’t be able to keep the markets from pushing rates higher without altering their approach and targeting rates (which would also serve as a good bazooka).   But rate targeting would be the fiscal equivalent of a eurobond so I don’t see why they’re not moving in this direction now.

As I’ve said before, Europe has only two choices here.  They either move towards fiscal union or start breaking the union apart.  The only true fix to the monetary union is to create a fully autonomous state or states.  That means several autonomous states (as we had before the EMU, ie, dissolution of the Euro) or full speed ahead into a fiscal union.  There is simply no other sustainable fix.

So, while Europe continues to kick the can, the problems will continue to boil underneath the surface.  The economy in Italy will not improve, the budget woes will worsen, the bondholders will get antsy and the core will be forced to act.  This means we all sit and pray that the economic situation in Europe improves while leaders twiddle their thumbs and hope this bomb doesn’t explode in their faces.  But if and when it does explode, there is a very real chance that the markets will undergo a Lehman 2.0 type experience that will force Euro leaders to take out that bazooka.  They’ve said they won’t bailout Italy or implement Eurobonds.   But I don’t know if they’ll have much of a choice.  It’s just a matter of whether they’ll take it out before they actually need to or after they allow the bond vigilantes to leave a mangled global economy in their path….



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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • LVG

    Reminds me of 2007 when Bernanke said subprime was contained. I mean, this may have been the worst call in the history of economics:

  • Y

    “I rule out eurobonds for as long as member states conduct their own financial policies and we need different rates of interest in order that there are possible incentives and sanctions to enforce fiscal solidity,” he said.

    I like that he’s basically saying, “No, we can’t have eurobonds because then the system will stop doing exactly what it’s doing right now.”

    It’s all about incentives and sanctions. If they don’t keep the crisis going, how will Spain ever learn not to…run a pre-crisis surplus…or something?

  • Cullen Roche

    I think the one thing people have to realize is that a bazooka will still involve huge economic pain as they undergo austerity. It just rules out insolvency. Spain, Greece, Ireland, Portugal and Greece still get what’s coming to them. They just don’t take down the entire Euro with them….

    That’s what’s so scary here. Even the best case scenario is pretty bad….

  • Frenchy

    The last paragraph says it all about this weird situation we are in right now in equity markets. Everyone knows it’s far from over but it’s just not there yet so we don’t know where to put the money. I just wonder how long can the ECB keep rates low enough. Can it not buy it all if it wanted? What would that mean in terms of market reaction?

  • amateur

    Hi Cullen,

    Given the choices, or lack thereof, that you have laid out for European leaders, it would seem to me that the strength of the Euro may be suggesting that fiscal integration is the likely outcome. Your thoughts?

    Again, fantastic work on this site!

  • Cullen Roche

    I think the Euro is largely reacting to the fact that the ECB is ahead of the Fed in the cycle. Honestly though, I wouldn’t want to be long or short Euros here. The sentiment on this currency could change in a heartbeat if the market got a whiff of the idea that the ECB was backing down on their inflation concerns. There’s better sand boxes to play in in the FX world.

  • Jo

    Germany & France…..AAA countries still….right?

  • Mediocritas

    The primary problem with Eurobonds is that they’re a “one size fits all” solution and have the same fundamental flaw as the euro. One size *doesn’t* fit all. Without full fiscal union, eurobonds simply kick the can a little down the road and keep in place the same structural weakness in Europe by preventing sovereign states from floating relative to one another (as they should). Germany hates the Eurobond because it takes them back to where they were in the early days of the euro, being sacrificed to benefit the fringe. Germany has every right to reject eurobonds and I hope they stay strong on this.

    The most probable path I (currently) think will be followed is that the ECB get expanded powers (probably in the aftermath of a big collapse / scare) and it starts making solid command decisions regarding the influence of relative fiscal policy between states. It needs to pull out the bazooka (as Cullen puts it) and engage QE on a very big scale, I’d guess about double the size of QE1, maybe a little more. Like the Fed swapping toxic ABS onto its books, the ECB will instead swap toxic sovereign debt. The most important factor here (certainly from the perspective of Germany) is that the ECB does NOT follow a “no questions asked” approach and that it buys debt with constraint in order carefully set the relative yields of sovereigns.

    In essence, with a bazooka in hand, the ECB gains the power to blackmail member states into implementing disciplined fiscal policy. It can set prices to force members to take their economic medicine without pushing them so hard that they default. There will be a big philosophical fight about this as Europeans are VERY protective of whatever power they hold, but there really aren’t many other options if the euro is to be retained. Germany will accept this approach so long as it has a controlling say in the quantity and timing of open market operations (with the aim of setting prices). German economists will dominate I expect.

    In essence, this is much the same as the SDR-euro concept that I’ve floated in the past. Instead of controlling member currency weightings in the SDR-like euro, the ECB instead tries to control member nation yields (debt price). One of the main reasons we got into this mess in the first place is that member debt was artificially fixed at the same price for many years. The forced removal of that constraint led to a sudden shock and default crises as things returned to natural levels faster than market participants could respond, but with future management, the return to equilibrium can be slowed, shock-absorbed and stabilized.

    The billion dollar question now is, how long will this take to implement? If the realpolitik takes too long then the whole thing can blow up and there will be defections (not that this would necessarily be a bad thing). There isn’t much time here at all, we’re talking about weeks, not months or years.

    Regarding the value of the euro, I expect it to be volatile, but if the bazooka does indeed come out and we get a EU-QE comparable to QE1 (probably bigger), then I expect a carbon-copy response from the markets. Just as the Fed was seen to be monetizing debt, so too will the ECB (even if it’s just a swap in reality).

    Finally, remember the Fed’s role in all this. EU-QE will have to coincide with US-QE3 so predicting the relative value of the EUR to the USD is extremely difficult. If you want to play the EUR, don’t play it against the USD, choose something else.

  • Mediocritas

    To be consistent with what I’ve said elsewhere, if forced to make a call on USD-EUR, then my best guess is that EU-QE is the dominant factor, that US-QE3 is tempered by engaging the Fed-ECB swap line first, meaning that, in theory, the euro should fall against the dollar once QE gets underway. But as I said above, this is not a given. The extent of US-QE3 depends very much on what happens with CDSs in Europe (and what the ISDA chooses to recognize as a default (highly politicized)), and unless somebody can model the domino system of gross CDSs in Europe, nobody has a really clear read on this.

  • Wulfram

    Not only did Bernanke not see the subprime disaster coming, he actually had one of the option arm mortgages. It even exploded on him.

    Time: Do you have a mortgage?

    Bernanke: Oh yes we refinaned… We had to do it because we had an adjustable rate mortgage and it exploded, so we had to. ”

  • The Dork of Cork

    They are going to tax water consumption is Ireland…………… need I say more.

  • Anonymous

    The mercantilist and consumer nation mechanics of European failure:

  • Anonymous

    Sorry, my computer keeps losing log on name.
    El Viejo

  • effem

    It seems to me that the limiting factor on pulling out the bazooka is voter pushback in Germany. But isn’t the population 100% entitled to make that decision. If the Germany voters would rather have less wealth overall but a more “fair” distribution of wealth (i.e., not rewards the profligate spenders) isn’t that OK? The bazooka strategy implies that the current system should be saved at all costs – there is more to life than a simple wealth calculation.

  • Mercator

    This really is the children’s story, The Little Red Hen, playing out in real life. So, will the Little Red Hen (Germany) unconditionally share the harvest with the other farm animals, or, negotiate secured compensation going forward? Or do they just say, I’m getting off this farm and taking my harvest with me. Auf Wiedersehen!

  • ocean

    No one has suggested a tax on your tax?

  • El Viejo
  • Cullen Roche

    Sounds to me like the Eurobond idea is gaining some traction:,0,7602412.story

    Soros also has this whole thing dead right. We are moving towards a unified Europe.,1518,780189,00.html

  • Tom Hickey

    Just one good shock (Credit Anstalt)….

  • Martin

    The beggar-thy-neighbor policy is gaining traction. The Keynesians policies followed up by the FED and BOE is having its effect in Europe. The SNB interventions to lower the price of the swiss franc have been so far ineffective. The swiss are even contemplating waving the white flag of surrender: pegging the swiss franc to the euro, helping Germany taxing capital gains in swiss accounts belonging to its German investors at the rate of 26%.
    Without Euro Bonds, the ECB will have to start “monetising” as it won’t be able to sterilise bonds purchase in the secondary market for Italy and Spain, it is just too big. Thanks Cullen for posting Zulaf’s latest comments. When the ECB will start its own QE, you can expect Gold to reach another level, and some even more tightening on Treasury yields in the US, particularly on the long end of the curve, as the US, still in deflation, moves towards a Japanese situation.

    I am afraid Cullen, that the biggest threat (and we discussed it previously) relates to the political risk in Europe. It is playing out as we expected, unfortunately, fasten your seat belt.

  • Mercator

    Whatever the Germans decide to do, the devil will be in the details. Look for, “don’t take it personal, it’s just business”.

  • The Dork of Cork

    Well thats old news really , income tax & then Value added tax.
    But the water tax issue in Ireland is more of a class war thingy as middleclass people who live unsustainably in rural communting areas with private water provision wish to externalise their waste via taxing the urban poor which use efficient collective city water arrangements.
    You would think Ireland was Orange county recently – the state pravda gave out a amusing piece about water shortages in Ireland.
    I am enjoying the absurdity of the various contortions a society must go through to pay its betters – it wildly entertaining really

  • haris07

    Worry not, ECB will be dragged into money printing, if kicking and screaming. AEP nails it here.

    Bernanke will get to QE3 later this year too. Worry not, central bankers with moeney printing will solve all of the ills.

  • Cullen Roche

    Haris, you should know by now that QE is not money printing…..

  • Nils

    The markets and political realities dictate the decisions. There is no good solution.

  • Different Chris

    Yup, according to the same people who rated Credit Default Swaps that were worth pennies on the dollar as AAA…..

  • casanova

    I think the least resistant path will be chosen and that is debt monetisation in the EU. The fundamentals suggest that the Euro is and has been overvalued for some time and there is no reason for it to trade above parity to USD. I expect the Euro to trate at 1 or below USD in the not too distant future.
    It is a mystery to my as to why the EUR has been so strong. The only explanation I can come up is that China is playing a huge role in keeping the Euro high, for their own mercantilist reasons of course.

  • Different Chris

    (As usual) Very, very well stated.

  • Different Chris

    Hopefully the Germans will not accept the Eurobonds unless there is also an installation of some kind of mechanism to float rates, like a Cent. Tsy.

  • Bear

    Cullen, could you explain that:

    ” But rate targeting would be the fiscal equivalent of a eurobond ”

    Thank you

  • http://pragmaticcapitalism michael schofield

    At some point Germany just allows the piigs to collapse. I don’t see the Germans thinking spending the kind of money it would take to save the piigs would be worth it to them.

  • Mercator

    Gotta be difficult throughout Europe. The Germans did it again! They took the guns away from them, but they still found a way.

  • Bear

    US observers do not understand that building Europe is a process. There will not be a fine day when they all shout together “today we are making europe”. It is hugely complicated, it is a historical event.

    Instead of seeing each steps as another unuseful kick in the same can, one may see it as a new stone to the building. Germany will do all that it takes in order to save the system. But they have to manage the balance between the financial and monetary concessions they give, and the political advantages they obtain. In then meantime China helps on the markets.

    I think the young european generations won’t mind some loss of national sovereignty (?), the political problems will come from efforts to be made in pensions benefits and public sector austerity. Politically manageable with some time. In 1981 when a socialist president was elected in France, they tried a true soialist policy but had to stop the experiment after 18 months because of the markets. Europeans will scream and swear and curse, but beyond the drama and the unavoidable fingerpointing sessions they will eventually know what they have to do.

    The endgame should be a partially unified and germanized Europe. Scary in a way, but it is the way now.

  • Mediocritas

    I think that QE2 propped the euro to some extent. When eurodollar banks experience a run on eurodollars, they either have to sell dollar denominated assets, or sell euro denominated assets and convert to dollars, creating downward pressure on the EUR/USD. QE2 allowed eurodollar banks to raise reserves without having to engage the latter, hence helping to prop up the euro.

    Agree that the euro is overvalued.

  • Y

    Spain, Greece, Ireland, Portugal and Greece still get what’s coming to them. They just don’t take down the entire Euro with them….

    Word. They’re still stuck with a currency that’s overvalued for their purposes and severely restricted fiscal policies.

    Maybe a better way of paraphrasing Schäuble is, “We can’t have Eurobonds, because then we’ll be avoiding disaster instead of embracing it. As Finance Minister, I find this unacceptable.”

  • Mercator

    And to take that thought a little further… if Europe/Germany goes with “what’s fair” Mr. Obama will have someplace to go after the next election.

  • Different Chris

    Damn Cookie Monster keeps stealing all your cookies.

  • El Viejo

    Ok Ok I’ll give you two cookies for dat hat.

  • Oroboros

    Old, but …

    Italy calls for euro bonds, UK backs fiscal union

  • Oroboros

    Saturday, that is. Semi-old, in today’s world.

  • Mercator

    Amen Brother Bear. The can kicking has been a psychological process as well. Cut to the chase… the Germans have won! Now, what’s the political process to win acceptance without the rest of Europe losing face?

  • Ben

    Last time I checked, forced marriages usually don’t work and/or last. The best path forward for EU is to un-wind the Euro experiment in an orderly fashion, if possible, and the sooner the better. Unfortunately, I doubt that will happen.

  • http://pragmaticcapitalism michael schofield

    I sure hope you’re right, Bear.

  • Nils

    Seems like the Cookie Monster has taken to looting:

  • Michael Cullen

    Dear Cullen,
    I live in the beautiful city of Heidelberg, Germany, and have done since early 2005. I travel around Europe a few times each year. Recently I was in Brugge in Belgium, sitting outdoors in the market square, where hundreds were enjoying the sun and the coffee, and I commented to the waiter “just look at this; you wouldn’t think the Eurozone was in imminent danger of total collapse with a banking crisis”. He just looked at me as if I was a bit crazy. None of my friends in Germany, all well heeled, will listen to me, even when I put it in the gentlest terms. As for accepting what Michael Lewis wrote in Vanity Fair recently, forget it. After the first few lines, they would not read further. As for supporting the Greeks, Portugese, Irish, Italians, Spaniards; no way Jose. That’s where we go for our holidays.
    No, talking to them about this stuff (‘them’ includes my German wife) is only paralleled by mentioning to a American that the USA has a banking problem, or it is going into recession, or the stock market is about to go to hell. It is just unacceptable to them to hear or to read it. In Aussie vernacular “She’ll be right mate; what are ya on about!”
    So you see, Ms Merkel and her bunch are only a reflection of the underlying “head in the sand” people, who will wake up one day soon and say “What the hell happened!”, as if it was unexpected. I find this unrealistic attitude hard to believe; I have changed my view about people over the last few years; by and large they have a lot in common with cattle! Herd Nerds!

  • Cullen Roche

    Thanks for the info Michael. It’s always nice to actually hear from people living in Europe. I try to understand all of this as best I can, but I know I am writing about all of this from an American perspective so it wouldn’t surprise me if my perspective is flawed or biased in some way.

    Anyhow, I visited Germany last summer. What a place. Munich is a city I could see myself living in for a long time. I’ve never been been to Heidelberg. Anyhow, enjoy. Europe will still be a wonderful place no matter how this all turns out.