Why the Europlan will work
Published:Friday | May 14, 2010 | 12:00 AM
The €720 billion of government-backed loan guarantees by European Union (EU) governments and, even more important, an open-ended commitment to buy European sovereign bonds by the European Central Bank (ECB) will do the trick.
It will provide the time needed for Greece, Spain, Portugal and others to put together sustainable fiscal programmes and breathing room in terms of lower interest rates and financing of upcoming debt repayments.
Don't bet on the euro unravelling internally any time soon, though external euro weakness will continue for a while longer.
Of course, the fiscal support is offered conditionally, and if these conditions are not sufficient or are not met, the problem will no doubt re-emerge, but not before any impatient speculator has become insolvent.
I always remember sitting on the dealing floor of JP Morgan's Singapore dealing room as news of the first International Monetary Fund (IMF) package to support Thailand in the summer of 1997 hit the screens.
I recall the dealers picking up their hand-held calculators in unison.
Within seconds, some-one shouted out, "That's just three months' im-ports!" and within seconds another shout reverberated around the room: "Sell!"
One of the things I have learned observing the dynamics of speculative attacks over the past 20 years is that speculation is a costly activity. Invariably, they are selling the risky, high-yielding asset, and buying the safe, low-yielding, asset.
It is the reverse of the seductive carry trade. Consequently, speculators focus on those opportunities where there is potentially a large windfall in a short period of time, and if the bet goes wrong, the resulting losses are modest.
Billy Ray Valentine would have said: speculation is for high-return, low-risk activities.
Attacking narrowing exchange rate bands when the exchange rate is already at the floor is a classic example.
The point of the size of the loan guarantees, and the further commitment by the central bank to buy euro-denominated bonds of eurozone members, is that they have made speculating against eurozone credits today a low-return, high-risk venture.
A euro-sceptic would say, with reason, that they have merely turned eurozone credit risk into euro inflation risk.
A euro-optimist would respond that as they are merely replacing liquidity that has disappeared and there is no current evidence of inflation, this is a risk worth taking.
And, the authorities can always sell back the bonds once inflation re-emerges.
Reality will tread a tight rope between these two perspectives.
What should have happened was that Greece offered to swap existing debt for new debt, backed by eurozone loan guarantees, with a lower coupon that effectively gave creditors the 25 per cent-plus haircut implicit in the price of the debt they hold, and the condition of the loan guarantees was a fiscal stabilisation plan that would have been easier to achieve with the 25 per cent-plus haircut in debt levels.
The plan would be further backed by the ECB carrying out a bear trap by buying up eurozone bonds for as long as it takes to squeeze speculators out of the trade.
Without the haircut, the Greeks will find a stabilisation programme harder to achieve, though it would still be possible to achieve if bond yields are contained.
The ballet is that the more bond yields are contained through EU action, the less pressure there will be on the Greeks to pursue the stabilisation plan, potentially resulting in euro inflation and a re-emergence of the Greek problem.
The Germans see this clearly and demand institutional change. There is the irony: commitments to protect the creditors in full, in the short run, will merely undermine them in the long run.
Perhaps the institutional solution is the establishment of a voluntary, sovereign bankruptcy court that would help countries restructure their debt, with the help of conditional support of others, which might improve the restraining effect of market discipline in the first place.
Professor Avinash Persaud is chairman of Elara Capital Plc, chairman of Intelligence Capital Ltd, emeritus professor of Gresham College and senior fellow, Caribbean Policy Research Institute.