Sunday, June 17, 2012

It’s Now ABOUT Germany, NOT UP TO Germany

EconoMonitor : EconoMonitor » The Euro-Zone Debt Crisis – It’s Now ABOUT Germany, NOT UP TO Germany

Satyahit Das:


"Germany’s guarantees supporting the European Financial Stability Fund (“EFSF”) are Euro 211 billion. As Spain could not presumably act as a guarantor of the EFSF once it asks for financing, Germany’s liability will increase further from 29% to 33%. France’s share also increases from 22% to 25%. Perhaps most interestingly, the liability of Italy, which is in poor shape to assume any additional external financial burden, rises from 19% to 22%.

The European Stability Mechanism, the replacement to the EFSF which is planned to commence in July 2012, will require a capital contribution from Germany which will push its budget deficit from Euro 26 billion to Euro 35 billion. If the ESM lends its full commitment of Euro 500 billion and the recipients default, Germany’s liability could be as high as Euro 280 billion.

Since 2010, the Euro-Zone has committed Euro 386 billion to the bailout packages for Greece, Ireland and Portugal. In June 2012, Spain is expected to request at least Euro 100 billion for the recapitalisation of the banking system, making the total commitment just below Euro 500 billion.

But the largest single direct German exposure is the Bundesbank’s over Euro 700 billion current exposure under the TARGET2 (“Trans-European Automated Real-time Gross Settlement Express Transfer System”) to other central banks in the Euro-Zone.

Designed as a payment system to settle cross border funds flows, surplus countries, like Germany, have been forced to use TARGET2 to finance deficit countries. Before 2008, deficits were financed by banks and investors. Since the crisis commenced, TARGET2 has been used to meet the funding needs of peripheral countries without access to money markets to fund trade deficits and the capital flight out of their countries.
Germany is by far the largest creditor in TARGET2. The Netherlands, Finland and Luxembourg are the other creditors with all other Euro-Zone countries being net debtors within the system.

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Fund manager John Hussman summarised the idea of Euro-Zone bonds neatly (http://www.hussmanfunds.com/wmc/wmc120528.htm): “This is like 9 broke guys walking up to Warren Buffett and proposing that they all get together so each of them can issue “Warrenbonds.” About 90% of the group would agree on the wisdom of that idea, and Warren would be criticized as a “holdout” to the success of the plan”

Germany’s TARGET2 exposure would also continue to increase, at a rate of Euro 80-160 billion per annum to finance expected trade deficits in the rest of Europe. The increase in exposure may be higher if needed to finance budget deficits of weaker Euro-Zone members and the weak banking sector. Germany’s TARGET2 exposure has increased by around Euro 237 billion or around 34% in the last 8 months alone.

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In the peripheral economies, continued withdrawal of deposits from national banks (a rational choice given currency and confiscation risk) may necessitate either a Europe wide deposit guarantee system or further funding of banks.

The amounts involved are substantial. Total bank deposits in the Euro-Zone total around Euro 7.6 trillion, including Euro 5.9 trillion from households. The euro zone’s peripheral countries, which are most susceptible to capital flight, have Euro 1.8 trillion in household deposits. In the first 3 months of 2012, Euro 97 billion of deposits were withdrawn from Spanish banks.

A credible deposit insurance scheme would have to cover household deposits (say up to Euro 100,000), which is around 72% of all deposits, in the peripheral countries. This would entail an insurance scheme for around Euro 1.3 trillion of deposits.

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Any European deposit guarantee system, provision of capital or further funding of banks would potentially increase Germany’s financial liability.

If integration is not undertaken or the partial solutions fail, then some European countries will need to restructure their debt and potentially leave the common currency. Germany would suffer immediate losses. A Greek default would result in losses to Germany of up to around Euro 90 billion. Germany’s potential losses increase rapidly as more countries default or leave the Euro-Zone. The greater the delay in default or departure the larger the German losses as their exposure increases.

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As Friedrich Nietzsche knew: “…hope is the worst of all evils, because it prolongs man’s torments.” Germany may not, as widely assumed, offer a safe haven in the European debt crisis."

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