Britannia Radio

TELEGRAPH   9.10.08
Who is going to bail out the euro?
Europe must pull together if it is to avoid further financial 
disaster, argues Ambrose Evans- Pritchard.

Better late than never. A half-point cut in global interest rates may 
not halt the slide into a debt deflation, but at least we can hope to 
avoid the errors of the Great Depression. The slump - remember - had 
little to do with the 1929 crash. What turned the mild recession of 
1930 into the sweeping devastation of the early 1930s was an entirely 
avoidable collapse of the banking system in both the US and Europe.

The culprit was tight money, made worse by beggar-thy-neighbour 
policies. The key levers of power in Western finance were held by the 
sorts of people who now think it is a good idea to drive our banks 
over a cliff.

Thankfully, wiser heads are in charge this time. Yesterday's move by 
the US Federal Reserve, the Bank of England, the European Central 
Bank (ECB), the Canadians, Swiss and Swedes - with Chinese help - is 
the first time in this sorry saga that the big guns have joined 
forces in monetary policy to arrest the disintegration of the credit 
system. The Fed and the ECB are no longer fighting. That alone is a 
massive change for the better.

However, the failure to offer a lifeline to distressed banks across 
the world earlier by cutting rates is unforgivable. The G7 bloc of 
economic powers is in recession or on the cusp, including Japan - 
where the Nikkei index fell by 10 per cent yesterday. American 
consumer credit is contracting at an annual rate of 7.9 per cent, the 
most violent squeeze on record.

The Baltic Dry Index measuring freight rates for shipping has fallen 
70 per cent since May. The whole nexus of commodities except gold, 
now a super currency, is in freefall. Oil has fallen by 41 per cent 
from its peak, copper by 38 per cent, wheat by 50 per cent. Few with 
their finger on the pulse of global commerce now think the threat of 
inflation is remotely credible. Tesco's Sir Terry Leahy says food 
prices are now deflating at two per cent in his stores.

My view is that Washington has done what is needed to prevent the 
collapse of the US economy. It has taken over the entire credit 
system, after all, surpassing Roosevelt's New Deal.

The US has guaranteed the $3.5 trillion money market funds. It has 
nationalised the $5.3 trillion pillars of the mortgage market, Fannie 
and Freddie. The Fed is accepting any junk as collateral at its 
lending window. This week it went the whole hog after panic hit the 
$1.6 trillion market for commercial paper. It is now offering loans 
without any security at all. The US government has become a bank. 
Yes, this is US socialism. What is the alternative?

The $700 billion Paulson rescue plan should put a floor under the 
colossal dung heap known as "structured credit". It is a bad plan, 
since it does not target the money on the recapitalisation of the 
core banking system. But it will help refloat lenders by raising the 
price of beaten-down securities somewhere nearer their true "hold-to-
maturity" worth.

An ugly recession is coming, as debt leverage kicks into reverse. The 
purge will be slow and punishing. Some 12 million Americans are 
already trapped in negative equity, but at least they can see where 
this might end. After much drama, the US institutions have risen to 
the challenge. The Fed, the Treasury, and Congress have managed to 
take some sort of coherent action. The jury is out on Europe, where 
the hurricane is now smashing the banking system.

Those such as German finance minister Peer Steinbruck - who thought 
the sub-prime crisis was just an "American problem" - have had a rude 
shock. The collapse of Hypo Real with ?400 billion of liabilities has 
made him face the unsettling truth that German banks have played a 
big part in this $10 trillion speculative venture undertaken by the 
whole global banking industry.

Europeans borrowed vast sums in dollars in the offshore money markets 
when dollar credit was cheap. This was leveraged by multiples of 50 
or 60 to fund whatever craze was in fashion - Russia, Brazil, 
infrastructure. The credit crunch has left these banks floundering. 
They have to pay back a lot of dollars, yet the underlying assets are 
crumbling. They are caught in a self-feeding spiral of 
"deleveraging". Even those European banks that stuck to stodgy 
investments are caught in a vice, since many rely to some degree on 
three-month loans for funds. That market is jammed shut. They cannot 
roll-over their loan books. This way lies sudden death, as Hypo 
discovered.

Who in the eurozone can do what Alistair Darling has just done in 
extremis to save Britain's banks, as this $10 trillion house of cards 
falls down? There is no EU treasury or debt union to back up the 
single currency. The ECB is not allowed to launch bail-outs by EU 
law. Each country must save its own skin, yet none has full control 
of the policy instruments.

Germany has vetoed French and Italian ideas for an EU lifeboat fund. 
The former knows exactly where that leads. It is a Trojan horse that 
will be used one day to co-opt German taxpayers into rescues for less 
Teutonic EMU kin. One can sympathise with Berlin. But sharing debts 
with Italy and Spain was implicit when they agreed to launch the 
euro. A shared currency entails obligations. We have reached the 
watershed moment when Germany has to decide whether to put its full 
sovereign weight behind the EMU project or reveal that it is not 
prepared to do so in a crisis.

This is a very dangerous set of circumstances for monetary union. 
Will we still have a 15-member euro by Christmas?