Evercore Pan Asset

The two day Heads of government meeting in the EU was billed as yet another summit to save the Euro. They spent much of their time on a draft Treaty to beef up the Stability and Growth Pact. This was established years ago to try to prevent a debt crisis. Countries were meant to keep their stock of debt to less than 60% of their GDP, and annual borrowing below 3%. Germany wants to invent a new stronger version, with different numbers to reflect the reality that so many countries have ignored the old rules. They want to limit countries to a structural deficit of no more than 0.5% of GDP.

None of this is going to resolve the current Euro crisis. The refusal of the UK to join in meant they have to seek a new legal framework amongst the 17 members of the Euro, maybe including up to nine of the non Euro EU members. Even this is unclear, as Sweden and the Czech Republic need to consult their Parliaments about such an agreement, whilst the other seven have not finally committed. The participants are talking about reaching an agreement by the spring of 2012. It is possible they seek to get the UK’s permission to use the facilities of the EU to implement any such deal, as the 17 or the 26 would not legally be entitled to use all the facilities of the EU for this new scheme. People would still be entitled to ask why the new version of the Growth and Stability Pact should be better enforced than the old one. If they do intend to fine countries that are borrowing too much they will need to lend them the money to pay the fines.

It is difficult to see that the pledge to be tougher on debts and deficits in the future has any short term effects. The deficits of the southern countries remain obstinately high. A new set of rules does not change this. The south remains in heavy deficit on trade account with Germany and the north. The new agreement does not change this. There are still big issues to be resolved over how the running deficits of the south can be financed. They cannot print their own money, and they cannot devalue to cut the gap between imports and exports. They are all waiting for Germany to sanction more money printing at Euro level, or more transfer payments and loans within the union, to let it work. The Heads of government made little progress on finding the large sums needed to keep the system going.

In the real world outside the conference chamber the ECB lent more money to cash strapped EU banks, following its second interest rate reduction under the new leadership. The bond markets continued to play hard to get, forcing Italy to pay quite high rates for the money she needs to borrow. Italian 10 year yields remained above 7%, despite all the press releases. The US had plenty of demand for its Treasuries, showing the continuing flight away from the Euro by banks and investors.

We are watching to see if the Euro group are going to come up with some way of raising the large sums needed to defend the Euro, and to see if the ECB will find ways to put enough liquidity into the system so banks and countries can borrow what they need. So far they have not done so. The crisis rolls on. We recommend continuing to avoid Euro risk assets.