AXA fears ‘fatal flaw’ will destroy eurozone
Analysts at the French financial group AXA see a serious likelihood that the eurozone will break in half or disintegrate, dismissing Europe’s €750bn (£623bn) rescue package for Club Med debtors as a stop-gap measure that misdiagnoses the problem.
By Ambrose Evans-Pritchard
“The markets are very nervous because they can see that there is a fatal flaw in the system and no clear way out,” said Theodora Zemek, head of global fixed income at AXA Investment Managers.
“We are in a very major crisis that has even broader implications than the credit crisis two years ago. The politicians have not yet twigged to this.”
Ms Zemek said the rescue had bought a “maximum” of 18 months respite before deeper structural damage hits home, with a “probable” default by Greece setting off a chain reaction across Southern Europe. “It would be the end of the euro as we know it. The long-term implications are at best a split in the eurozone, at worst the destruction of the euro. It is not going to end happily however you slice it,” she said.
The warning came as Spain’s authorities were forced to shoot down German media reports that Madrid was preparing to tap the rescue facility after ructions in the inter-bank market.
Carlos Oocaña, Spain’s treasury secretary, said smaller Spanish banks are struggling to roll over debts but denied that the country is seeking outside help. “The rumour is false,” he said.
Spanish banks increased reliance on funds from the European Central Bank to a record €86bn in May.
Berlin said Spain “does not meet the conditions” for the aid package in any case, even though the socialist premier Jose Luis Zapatero has already provoked a general strike by cutting public wages by 5pc. It is becoming clear that German demands for austerity across EMU are nearing the limits of political tolerance, and may prove self-defeating as 1930s-style wage deflation sets off a vicious circle.
Greece’s woes increased further as Moody’s downgraded Greek debt to junk status, saying the “macroeconomic and implementation risks associated with the programme are substantial”. The move is largely symbolic at this point since the European Central Bank has suspended its rating requirements for use of Greek debt as collateral for loans.
Greece is almost entirely shut out of the capital markets. Private investors are believed to have offloaded €25bn of Greek debt on to the ECB as it steps in to shore up the market, shifting the credit risk on to tax payers.
Axa said there was “no chance” that the EU’s €750bn “shock and awe” shield will succeed since it treats Club Med’s debt trap as a short-term liquidity crisis.
In the case of Greece the joint IMF-EU policy will increase Greek public debt from 120pc to 150pc of GDP by 2014, arguably making matters worse.
A number of ex-IMF officials have said the policy is doomed to failure since there is no devaluation or debt relief to offset the ferocious fiscal squeeze, and may endanger the credibility of the Fund itself. The IMF had floated the idea of a debt restructuring but this was blocked by the Brussels.
The strategy assumes that voters in Greece and other Club Med democracies will endure years of pain for the sake of foreign creditors. “It’s a pipedream,” said Ms Zemek.
Contagion from a Greek default would be harder to control than fallout from the Lehman collapse. “This has huge implications for banks. These bonds didn’t just disappear; they went somewhere, allegedly into French money markets and insurance companies, or on to French balance sheets,” she said.
The Bank for International Settlements said French and German lenders have $958bn (£650bn) in exposure to Greece, Ireland, Portugal and Spain, mostly in mortgage and company debt rather than sovereign debt. The distinction has become meaningless in Greece. The ECB has lent Greek banks €85bn, mostly in exchange for collateral in the form of Greek government bonds.
This has kept Greek lenders alive as they suffer a slow bank run, losing 7pc of their deposit base since last June as wealthy Greeks shift their funds abroad. The ECB support is equal to 20pc of their non-equity funding, according to Lombard Street Research.
Axa said the America’s currency union is successful because Washington has over-riding legal powers over the 50 states. “It is a precondition for the system to work but it doesn’t exist in Europe and the bond markets are starting to figure this out. We are looking at a noble experiment on the brink of failure,” said Ms Zemek.