Thursday, 24 November 2011

Euro-Trillions. (Doomsday is coming)

Eurozone Public debt is heading towards Reinhart and Rogoff's magical (and somewhat mysterious) 90% of GDP, over $11 trillion which is, in short, a lot of cash. (I don't have specific numbers to be honest, but the numbers were based on estimates taken from here and here and partially also here it's worthing calling to attention how massively wrong the IMF's statistic's were, understating Eurozone debt by about 10-15% of GDP!).

Unsurprisingly (cough, as I predicted), the Commission has used this as an opportunity to promote integration.

Equally unsurprisingly, at least one National Government is cautious about ceding sovereignty to 'more Europe'. Perhaps a bit more surprising (but not really, given the context), the main national government opposing the move is Germany.

Nouriel Roubini, yet again finds himself the man of the hour after not just predicting in 2006 the (then) impending subprime mortgage crisis but also for warning, way ahead of the curve, of the serious risk of sovereign debt default in the Eurozone. Today, he has an interesting take on Europe's battalions of woes.

He makes the very important point that even if the ECB did take the leap of faith and start acting as a lender of last resort, that there's a good chance that someone in Germany is going to sue the ECB in the German Constitutional Court. Since the German Constitutional Court has a history of being jealous of the ECJ, the chances are pretty good that they would then win that case. Some ECB members could then face prosecution (urgh I saw this in a video a few days ago and can't find it now - readers, if any of you saw it, could you link it in the comments section on the blog?)!

Roubini's take is now that the most likely option is widespread debt-restructuring and a probable partial Euro-zone breakup. Other than 'nein' to all attempts at salvaging the Eurozone, its not clear what Merkel's response to Germany's failed bond auction will actually be.

The crisis is deepening day by day. Although French public debt looks not catastrophic on the face of things, the possibility of private debt being socialised in the event of peripheral defaults leading to bank insolvency is a serious threat (which, by the way, is what happened in Ireland which otherwise had been a very fiscally responsible country). French exposure to Italian debt is obscene. The data is a bit hard to pick through but from what I can make out, France is exposed to about half of Italy's externally owed sovereign debt according to the Bank of International Settlements.

At the same time, peripheral debt is either going to be taken on by Germany, the ECB, or Defaulted on. Right now, Merkel is effectively, forcefully insisting that it will be defaulted on. If it comes about, that will lead to massive payouts on Eurozone sovereign debt Credit Default Swaps and sovereign debt Derivatives (which Warren Buffet called in 2003, financial weapons of mass destruction- which could (and probably would) trigger a second financial crisis in the Eurozone, resembling the one that hit America after CDS's and CDO's on Sub-prime mortgages collapsed.

That scenario is sufficiently doomsday-esque that Merkel might, just might, be forced to pull back from it. But even if she does, there's no guarantee that ECB 'full fire power' intervention would actually save the situation. Since Euro-bonds are a more long term ambition anyway, there's no reason to think they are likely to make much impact in the short term.

The point of this post, other than to illustrate just how catastrophic the emerging and ever more likely doomsday scenario is, is to point out that one way of reading Germany's options is as a 'relative vs absolute' gains problem, common in the international relations literature.

Relative Gains become important when countries are more concerned about what happens to them relative to everyone else, as opposed to how well they do per se. For example, if Germany chooses a Doomsday scenario, even though salvaging the Eurzone would be better for everyone just because the costs of salvaging the Eurozone fall largely on Germany (note, Doomsday costs Germany even more, but it costs everyone equally) then it is making a relative gains decision.

An absolute gain decision would be if a country benefits from a decision, but not by as much as everyone else. Here, Germany would gain from saving the EU, but peripheral nations would likely gain even more. IF Germany went along with this, it would be making an absolute gains decision.

Realists in International Relations Theory tend to think countries, even the ones in the European Union, make decisions based on Relative Gains. Liberals think they make decisions based on Absolute Gains (at least on Economic Issues). This seems to me to be a possible test of that outcome.

Right now, things look good for the Realists.

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