The official unveiling of a systemic crisis

One knows that there is something rotten in the world economy when the fate of a Greek PM makes headlines all over the world and for a whole week. Greece is not, and ought not to be, that important. But Italy is. And so is, from a global perspective, Europe. For some time now, Europe has been hiding its ills behind its (Hellenic) little finger. At long last, the truth (which I have been at pains to shout from the rooftops for more than 18 months) is now out: This is a systemic crisis that threatens not only the euro but the world economy in its entirety.

While Greece is insignificant, the eurozone, lest we forget, is the globe’s largest economy; a block that accounts for China’s single largest slice of exports, for one fifth of America’s exports, for more than $120 billion of Latin America’s exports, not to mention up to half of emerging Africa’s money-spinning trade (from fresh fruit and flowers to minerals). A deep recession in Northern Europe (which will surely result from the euro’s demise) is, thus, bound to unleash deflationary winds that will destabilise an already imbalanced global economy.

It is for this reason that all eyes have been, of recent, on the 27th October EU Brussels’ Agreement. For, as we all know, this is the Agreement that was meant to avert the euro-system’s collapse; a collapse that will force Germany to forge a new currency whose immediate appreciation will be the trigger of the recessionary forces mentioned just above.

Alas, while the world is looking, it is failing to see. Judging by the headlines, the world’s media, markets, political leaders and opinion makers were biting their nails until word came from Greece that a national unity government will be formed so that the Brussels’ Agreement can be implemented. It is as if the whole wide world was praying for the Greeks to give the Brussels Agreement a chance. And since Silvio Berlusconi announced that he will go Mr Papandreou’s way, similar hopes have been raised about Italy.

It is the purpose of this article to argue that the world’s prayers have been misplaced. That the anxiety to see Greece and Italy return to the Brussels’ Agreement fold is a sign of the calamity to befall the global economy. For this Agreement, as I shall be arguing below, is most likely to prove the euro-system’s greatest foe, rather than its cure. If I am right, the sights and sounds of a world agonising over the fate of the Brussels’ Agreement will be followed by the sights and sounds of a world readying itself for a major new twist in an already devastating Crisis.

On the pre-history and the three aims of the Brussels’ Agreement

This particular phase of the Euro Crisis saga began on 21st July when, in the midst of joyous celebrations, the last ‘final solution’ was touted. As some of us had indicated almost instantly, that agreement was doomed as it tried reluctantly to acknowledge one relatively minor problem (Greece’s insolvency) by putting so much of a burden on the shoulders of the problematic EFSF that a much greater problem was created (Italy’s and Spain’s liquidity-cum-solvency crisis). Lo and behold, the Italian and Spanish sovereigns were thrown in sharp turmoil two days later. During the summer, while on their holidays, Europe’s leaders knew they would have to go back to the drawing table come September. Indeed, by the time the leaves had turned brown, not only were Italy and Spain in the sin bin but, to boot, Dexia’s collapse had heralded the beginning of the unfolding of the eurozone’s banking sector. And when Secretary Tim Geithner and President Obama, aided and abetted by the rest of the G20, put it to the Europeans that they had a week to get their act together, Europe got into gear to produce what we now know as the Brussels’ Agreement.

Their task was to deal at once with three related problems: Europe’s collapsing banking sector, the problem with Italian and Spanish sovereign debt (and their potentially catastrophic effects on France’s triple-A rating which would, in turn, wreck the EFSF), and the derelict Greek economy. After days and nights of deliberations, the Brussels Agreement was patched together. On that night, after having read the preliminary document, this was my verdict:

Not one of these [nb.the eurozone’s three problems] was even remotely tackled last night. The banking sector required aggressive, compulsory recapitalisation at a central European level. It will not happen. (Not only is the sum set aside to feeble but, primarily, the bankers will be given multitude chances to wriggle out of losing control over their bankrupt banks through various means that will render recapitalisation a dead letter.) The EFSF-on-anabolic-steroids (which is what its private capital leveraged version will turn it into) that has been announced will neither lessen the burden on Italy (nor remove the dark clouds over France). Lastly, the Greek haircut is a mere empty shell of a number (50% is the rule of thumb agreed on in the early hours of the morning, just in order to have a number) since it is predicated upon a series of ludicrous assumptions and deals that deals with the bankers that politicians are nowhere near completing.

Now that the dust has settled, and new governments are emerging in Greece and in Italy, with the express purpose of endorsing the Brussels Agreement, it is time to take a closer look at what this Agreement is meant to do to tackle each of these three problems.

The Agreement’s First Aim: To re-capitalise Europe’s banking sector

After having, at long last, acknowledged, that Europe’s banks are in desperate need of recapitalisation, the Brussels Agreement allegedly set aside up to €110 billion for the purpose. This sounds reasonably encouraging, despite the low sum (which according to the IMF ought to be at least €200 billion; or three times that if we take into consideration the special vehicles that our wise bankers have created since 2009 and which multiply by a factor of around 5 the banks’ exposure to bad debts and assorted losses).

Ignoring for the moment the low sum allocated in the Brussels Agreement to the banks, the real cause of concern lies elsewhere. First, it lies in the stated target and, secondly, in the proposed means (by which the recapitalisation will be implemented). So, let’s begin with the objective of the exercise. It is, reportedly, to raise the banks’ capitalisation ratio to 9% over their assets/exposure. This constitutes a tragedy in the making. Let me explain.