Europe’s sovereign debt and banking crisis has now reached the point of no return. Recently, it has become abundantly clear that both Spain and Greece are now in a depression, which given their respective debt mountains renders servicing and repaying that debt impossible. The ECB is likely considering another helicopter drop of liquidity in the form of a further round of LTRO, but frankly all it does is buy a little time. Indeed, at this stage it is akin to giving a patient with two broken legs another shot of morphine; it dulls the pain for a few hours, but the excruciating pain of the busted limbs soon returns. More LTRO would make a very bad situation even worse, if that is possible. Europe’s banks, especially those in the south, are over-leveraged, and their governments have run out of buyers for their debt.
And so it has come to this. Europe must decide, and the choice is binary. Either each goes their own largely separate ways, or they bite the bullet and have a central treasury, which has the ability to issue their own bonds and collect their own taxes from the whole of the eurozone. Southern Europe wants the latter, for very good reasons (they are basically insolvent/broke); France wants it as well, because their national balance sheet also looks dreadful. However, the north (and especially Germany) is resisting, fearing that financial decisions made out of Brussels will be much more accommodating/liberal than those made in disciplined Berlin.
That said, the latter continue to weigh up the options. Now that a Greek departure from the euro is looking likely, it may be the case that relatively soon Greece will undertake to pay their debts off, but in (massively devalued) drachmas rather than euros. Under review by European creditors are the legal mechanisms whereby a country such as Greece could be made to pay in euros rather than drachmas. Under the Maastrict Treaty, how enforceable would contracts be in the event that Greece leaves the single currency? And if Greece takes this step (pay in drachmas), what is to prevent Spain (which is imploding in a fashion much like Greece) from taking the same decision, namely to pay their debts off in pesetas?
Frankly, if Germany has held out until now, it is unlikely to relent any time soon, notwithstanding the financial hit it will take should southern Europe debase their debts by paying in local currencies. Right now, the best bet is on a messy divorce within Europe.
