The Week that Europe Stopped Pretending: The Euro Has Essentially Broken Down

The euro has essentially broken down as a viable economic and political undertaking. The latest rush of events reeks of impending denouement.  The debt markets are pricing in for a global deflationary bust. Europe will have to restore shattered trust in the worst possible circumstances.

8:00PM BST 03 Jun 2012

Switzerland is threatening capital controls to repel bank flight from Euroland. The Swiss two-year note has fallen to -0.32pc, not that it seems to make any difference.

Denmark’s central bank said it was battening down the hatches for a “splintering” of EMU. It has cut interest rates twice in a matter or days and pledged to do whatever it takes to stop euros flooding into the country. Contingency plans are on the lips of officials in every capital in Europe, and beyond.

On a single day, the European Commission said monetary union was in danger of “disintegration” and the European Central Bank said it was “unsustainable” as constructed. Their plaintive cries may have fallen on deaf ears in Berlin, but they were heard all too clearly by investors across the world.

Joschka Fischer, Germany’s former vice-Chancellor, said EU leaders have two weeks left to save the project.

“Europe continues to try to quench the fire with gasoline – German-enforced austerity. In a mere three years, the eurozone’s financial crisis has become an existential crisis for Europe.”

Mr Fischer has the matter backwards. The euro itself is the chief cause of the existential crisis he discerns. Yet he is right that three precious years have been squandered, and that Europe‘s policy mix has been atrociously misguided.

The pace of fiscal tightening has been too extreme, made much worse by the ECB’s monetary tightening last year. This inflicted a double-barrelled shock on Southern Europe. The whole region was forced back into slump before it had reached “escape velocity”.

The window of opportunity offered by US recovery is slamming shut again. America’s dire jobs data for May – and the downward revision for April – confirm the fears of cycle specialists that the US economy has slipped below stall speed. America risks tanking back into recession as the “fiscal cliff” approaches late this year, unless the Fed comes to the rescue again soon.

Brazil wilted in the first quarter. India grew at the slowest pace in nine years. China’s HSBC manufacturing index fell further into contraction in May, with new orders dropping sharply and inventories rising.

We face the grim possibility that all key engines of the global system will sputter together, this time with interest rates already near zero in the West and average public debt in the OECD club already at a record 106pc of GDP.

“The world’s largest emerging economies are no longer in a position to carry the global economy through tough times, as they did during the ‘recovery’ years of 2009-2011,” said China expert Andy Xie.

The warnings from the bond markets could hardly be clearer. German 10-year Bund yields closed at 1.17pc. The two-year notes turned negative. British Gilts closed at 1.53pc, the lowest in 300 years. US Treasuries fell to 1.45pc, lower than at any time during the Great Depression.

The debt markets are pricing in for a global deflationary bust. Europe will have to restore shattered trust in the worst possible circumstances.

If deposit flight from Spain was €66bn in March before the Greek election tore away the pretence that Europe had solved anything, one dreads to think what it will be in April and May when the data come out.

Alberto Gallo from RBS says Spain will need an EU rescue package of €370bn to €450bn to bail out its crippled property lenders and limp through to 2014, pushing public debt to 110pc of GDP.

This would be the biggest loan package in history by a huge margin. Whether the EU bail-out fund could raise the money on the global markets at viable cost is an open question.

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