The impossible triangle

It's coming down to the crunch.  The Eurozone is caught in its version of the "Impossible Triangle" in international finance: among states you can have unrestricted trade in currencies and/or fixed exchange rates (or, in this case, a single currency) and/or sovereign financial and monetary policies, BUT YOU CAN'T HAVE ALL THREE AT THE SAME TIME.  Something has to give.  So what will it be?

EUROPE: Changing The Rules In The Middle Of The Game:

I have been writing for a very long time about the changes needed to the EU treaty if Europe is to survive. Specifically, last week I noted that Angela Merkel has made it clear that the independence of the ECB must not be compromised. This week Sarkozy and the new prime minister of Italy, Mario Monti, agreed to stop their public calls for such changes (at least until their own crises get even worse, would be my guess). And Merkel has called for a new, stronger union with strict control of budgets as the price for further German aid for those countries in crisis. In seeming response: 

“The European Commission on November 23 proposed a new package including budget previews at EU level, the establishment of independent fiscal councils and growth forecasts, closer surveillance of bailout recipients and a consultation paper on Eurobonds. There is also a growing consensus among EU policy makers on the need for the adoption of fiscal rules in national legislation. However, it is far from clear whether EU countries would accept the implicit loss of sovereignty this would involve and agree to treaty changes enshrining legally enforceable fiscal oversight at EU level. The German Chancellor, Angela Merkel, is willing to support a change in Germany’s own constitution if the EU Treaty change to that effect is agreed first.” ( www.roubini.com)But this means a major treaty change that must be approved by all member countries. Note that Merkel wants the treaty change first, or at least the language, before she takes it to German voters, which will certainly be required, since what she is suggesting is not allowed by the present German constitution. Without the changes stated clearly and explicitly in advance, it is unlikely, as I read the polls, that German voters will go along. Merkel has made it clear that any proposed changes will be limited to fiscal issues and central control and not touch on the ECB’s independence. She is adamant against eurozone bonds and putting the German balance sheet at risk (see more below). 

But will the rest of Europe go along with what would be a major alterations of their own individual sovereignty and their ability to adjust their own budgets, no matter what? And agree to all this in time to deal with the current crisis? Such changes will be controversial, to say the least. And they would require, if I understand, the yes votes of all 27 European Union members, or at a minimum the 17 eurozone members.

Unfortunately (?), some, but not everyone, are panicing:

On Friday, Standard & Poor’s downgraded Belgium’s credit standing to AA from AA+, saying it might not be able to cut its towering debt load any time soon. Ratings agencies this week cautioned that France could lose its AAA rating if the crisis grew. On Thursday, agencies lowered the ratings of Portugal and Hungary to junk. 

While European leaders still say there is no need to draw up a Plan B, some of the world’s biggest banks, and their supervisors, are doing just that.  “We cannot be, and are not, complacent on this front,” Andrew Bailey, a regulator at Britain’s Financial Services Authority, said this week. “We must not ignore the prospect of a disorderly departure of some countries from the euro zone,” he said. 

Banks including Merrill Lynch, Barclays Capital and Nomura issued a cascade of reports this week examining the likelihood of a breakup of the euro zone. “The euro zone financial crisis has entered a far more dangerous phase,” analysts at Nomura wrote on Friday. Unless the European Central Bank steps in to help where politicians have failed, “a euro breakup now appears probable rather than possible,” the bank said. 

Major British financial institutions, like the Royal Bank of Scotland, are drawing up contingency plans in case the unthinkable veers toward reality, bank supervisors said Thursday. United States regulators have been pushing American banks like Citigroup and others to reduce their exposure to the euro zone. In Asia, authorities in Hong Kong have stepped up their monitoring of the international exposure of foreign and local banks in light of the European crisis. 

But banks in big euro zone countries that have only recently been infected by the crisis do not seem to be nearly as flustered. 

Banks in France and Italy in particular are not creating backup plans, bankers say, for the simple reason that they have concluded it is impossible for the euro to break up. Although banks like BNP Paribas, Société Générale, UniCredit and others recently dumped tens of billions of euros worth of European sovereign debt, the thinking is that there is little reason to do mo

Evidently, the French banks are convinced someone MUST save them.  Denial?

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