I've been trying to think through the process of how this ends. There are some uncrossable lines that seem to point to the process that will follow.

First, Germany and the other financially sound nations will not handover the money necessary to support the Euro. Secondly, the other nations will not accept the political union necessary for intra-Eurozone fiscal transfers.

So my scenario for what happens goes as follows:

1. There won't be a big bazooka bailout that will give bond investors the confidence to continue investing.
2. Bond yields will rise, and at some point, one of the key players will have a failed bond auction. That is, one where they fail to sell enough debt to cover the repayments on their existing debt, and don't have the national reserves to pay it themselves.
3. The Eurozone facilities will have been exhausted at some point, so this failure will lead to a renegotiation of credit that may or may not be regarded as a credit default.
4. But then the bond markets will effectively cease lending to those countries deemed most at risk.
5. And then there will be a credit default event triggering bank asset write downs and payouts on credit default swaps.

What happens next?

The premises are far from certain.

Which premises? The ruling by the German Constitutional Court, and the estimate that voters in the EU won't vote for a transferunion are pretty solid. The Euro can't survive in its current form without them, so change is coming. The politicians don't seem to be able to embrace reorganising the Eurozone, so what happens next.

Can kicked down the road until a bond auction fails after the "firepower"has been used up - or what?

European Parliament, Brussels (12 October 2011): 'Preparing for Euro Breakup'



Start at 41m06s for Philipp Bagus's speech (Austrian economist); author of The Tragedy of the Euro and Deep Freeze: Iceland's Economic Collapse.

This could happen but is a huge dog. Thinking the politicians cant or wont come up with a short term fix completely misunderstands how Europe works.

I suppose that the underlying premise of my question is that the short term fixes have pretty much run their course. There aren´t any left. Very shortly, a problem will arise for which the "fix" is simply too expensive. ie The EFSF will definitely not be allowed to expand to $1trillion +. There are no circumstances when Germany will allow it to increase to that level, and France would lose its AAA rating if it did, so they´re opposed too.

Changing the charter of the ECB to create a Lender of Last Resort has also been ruled out by the Germans.

So at best the EFSF is leveraged to provide a first loss piece to a bond issue which then gets lent to the Greeks et al. Fine, but the Greeks need it all, and there´s nada left for the Irish, Portugese, Spanish or Italians. The Italians in particular are very vulnerable to a failed bond auction, so if the fund can't step in, and the Italians need $10billion to pay off maturing debt, from where does it come? The IMF? The IMF doesn't have the firepower to support Italy and is unlikely to get it from countries like China or Brazil. Will Germany stump up a bilateral loan? NB Germany´s public finances are not in great shape, and as the likelihood of a new recession increases. their debt dynamics are starting to look very weak too.

So rather than "Oh, trust them they´ll muddle through somehow", I'm more interested in the processes by which the thing behaves when the Eurozone governments find that the bond market will no longer finance their debts.

The consequences will be fascinating to watch from Peru, but I'm trying to work out what the risks are for things like the UK housing market. Does it collapse by 50%, or does Euro money escaping from civil war prop it up?

Nothing is ever ruled out, saying no is foreplay in Europe. I dont see how Europe is close to being out of short term fixes.

The consequences would indeed be fascinating. We would be living the chinese curse - in interesting times.

I agree with you that one should not underestimate the ability of Euro politicians to solve the problems, but I do think some possible solutions can be ruled out.

Turning the ECB into a lender of last resort is simply not possible under the German constitution, so there would need to be a referendum on a constitutional amendment, which would appear to be unwinnable given the political situation in Germany. Or the German government would have to merge with other national governments to create a "greater Germany", again pretty unlikely.

So the option to print money to solve the crisis doesn't really exist.

That leaves 3 options: Deflate so that more money isn't needed. Borrow from foreigners or Euro banks etc. Or default.

Deflation runs up against social unrest, and is crippling to GDP growth.
Borrowing is running up against lender's preparedness to lend
Which leaves default.

I'm not being argumentative, I simply don't see any alternatives that are implementable in the short/medium term that will avoid default. Maybe I will be surprised, and certainly it may be a few years before it happens, but I'm pretty fearful of the consequences for Europe if it happens.

Oh dont get me wrong I seriously doubt the ability of Euro politicians to sort it out.

What I dont buy is the idea that Germany will hold out in the way you seem to think is inevitable. They might do bit I doubt it.

If I was betting on this I would go for a way forward being found that goes against the German constitution but is claimed not to. Rather like the convergence criteria for joining the Euro in the first place it will all be a tissue of lies, sensible people will know its a tissue of lies but it will happen because they cannot prove it is fast enough to stop it or are bought off with something for their own special interests group. All the recriminations will come far too late and out brave leaders will throw their hands in the air, claim to be shocked, shrug their shoulders and say forget the past what matters is how we deal with the situation now, and its all someone elses fault anyway. Alternatively (or probably additionally) a vote of some sort will be forced through the German parliament (and others)

Chezlow, they are already working on thAt by modifying efsf so it could leverage itself without requiring immediate funding from Germany/France. In actuality, they are commited to unlimited liabilities as it is, and they've said as much. They still could change their minds but I think they recognize abandoning the euro is economic suicide in the short term at least.

Now they are just trying to figure out how to sell it without inciting general revolt.

Italy and Greece have already given up parts of their sovereignty by acquiescing to austerity measures so the other premise is pretty shaky too.

It's hard to imagine even now but I believe the course of least resistance is another step toward United States of Europe.

Europe and USA have massive debt issues. Isn't the only way out through inflation?

Why doesn't Europe keep the Euro and allow countries to have their own currencies?

I dont think you really understand that the EU knows what's best. Once this becomes clear to you then a choice of currencies makes no sense and the Euro must be the best option.

anyway everything is sorted now. Three cheers ...

Chezlaw,

Everything is not sorted. In fact this deal pretty much signals the end. I'm pretty sure history will point to this summit as the point when the Euro was given up.

Key points are:

The ECB has not been turned into a lender of last resort. Without this, the markets will pummel Spain and Italy, because there is a load of free money to be made if the Euro fails.

The EFSF has not been strengthened by very much. There is a commitment to exactly zero additional cash. Even leveraged 4x, when there is only $250bn to play with means that will only have $1 trillion of funding capacity. That's about a third of what the markets believe they need to protect themselves against the markets!

The bank recapitalisation is still subject to bank agreement. ie. The banks don't want to raise equity at less than net book value, and they don't want to accept the conditions that will be placed on them if they take government equity investment, so they are likely to reduce their lending in order to meet tier 1 capital ratios, which RBS estimated will produce $5trillion less credit over the rest of this economic cycle. And that means a major reduction in GDP growth or more likely exacerbating the coming Euro recession.

The Greek debt haircut has not been agreed by the banks. Their representatives have agreed, but individual banks still have to be persuaded to take a 50% haircut. Since some of them have protected some of their holdings with CDS, 50% may be less than they would get if they reject the agreement and trigger a default.

Plus, a 50% haircut in the privately held Greek debt still leaves Greece with 120% of GDP in debt in 2021, and this number is likely to balloon if Greek growth estimates are optimistic, or the populace rejects the austerity demanded by the EU.

In short, the can has been kicked down the road for maybe another 3 months. 3 months being the outer limit before there will have to be another agreement to increase the EFSF, and/or get the ECB to issue Eurobonds.

The market is going to slaughter the Eurozone.

<Gasp>

It was however another bullet and there will be plenty more.

There is only one bullet that will work. The European Central Bank must provide liquidity to Euro nations so that they can borrow as much money as they need.

Angela Merkel doesn't have the power to agree to this, so when this bailout fails, either she rejects the proposal, or her government falls and it becomes the central issue for the next German government, which knows that it will have to put it to a vote of the people - and I will give you 20 to 1 that the German people will not vote for it. The German constitutional court has made it crystal clear that the German Parliament does not have the authority to agree to the ECB being given these powers.

December will be Interesting! G20 meeting in November is timed about right to be in the middle of the process as Merkel and Sarkozy discover that this deal is falling apart around their ears

Lol, Italy bond yields back over 6%. twitter bondvigilantes "This isn´t even kicking the can down the road, this is dribbling with it"

We approach the endgame for the Euro pretty quickly.

Amazing.

France/Germany/Eurozone already committed to potential liabilities of 1 trillion+ (in practice, it's unlimited because they tied their own sovereign debts to ESFS.) They are looking for ways to commit even more. Governments in danger are surrendering sovereignty over their domestic policies to get bailouts. Both of your premises are getting shakier by the hour.

And yet, you keep insisting the end of euro approaches.

PS: The Fed and UK have already lent unwilling support. Japan will get involved too sooner or later. Actually they are already involved... quite busy propping up the dollar and euro for the past few months.

It has become an easy question. Will the EU change the charter of the ECB to allow it to act as a lender of last resort. Answer yes, Euro saved. Answer no, end of Euro in its current form.

France.Germany/Eurozone are not committed to potential liabilities of $1 trillion plus. They are committed to the ESFS for $440bn, and not one penny more! Germany point blank refused to increase it.

They are not looking for ways to commit even more. They are looking for ways to get other people to commit even more.

Governments in danger are trying to surrender sovereignty ... to get bailouts. Unforunately, their parliaments are baulking and not letting them do it. Berlusconi has promised to raise the pension age to 67,but nobody in Italy believes that he can deliver - he doesn't have the votes and his coalition is foundering.

The UK has ruled out allowing the IMF to invest in the EFSF leveraged fund on the basis that the IMF aids countries directly, not currencies.

Japan doesn't have the financial firepower to help much and since this agreement has just meant that they've lost a fortune on the existing EFSF bonds, they'll need financial guarantees before lending out their balance sheet; the Fed is helping euro banks get access to dollars, but demanding extra collateral for the privilege (using up Tier 1 capital so increasing the credit squeeze)You missed out on China, but as the Chinese Finance Minister said, "We're not dumb money" They will want something in exchange: more high tech, less IPR, less stress about human rights, more tariff free access for their products etc etc etc.

Honestly surprised at this gambit by Greek PM after the measures already passed the government.

Meanwhile, rest of Eurozone continues to beef up the various bailout funds.

And Japan intervened, again.

And CDS spreads have widened again, and Italy can't sell debt at less than 6%, and pretty much every commentator has said that the summit had failed to do enough.

Papandreou is unlikely to get his referendum, because it needs a 2/3 majority, so in practice this means a new election in Greece.

It really doesn't matter how much the bailout funds are beefed up. Unless they get the ECB to print the money to pay for government spending, the crisis will continue and get worse.

EU heading fast for recession next year, all growth forecasts being revised downwards. Italian finance minister worried that austerity measures will see the return of the Red Brigade and terrorism.

Austerity is not a politically acceptable option in most of Europe. That means the debts must be inflated away - and that can't happen if the ECB won't print the money. Northern Europe will not allow that to happen under any circumstances, so the irresistable force of austerity meats the immovable object of inflation - the only solution is a break up of the Euro. ie remove the problem, which is the common currency, then nations can sort out their different economic problems.

The question is not whether it will happen, the process has become inevitable. It is whether it can be done in an orderly fashion or not.

Very suprising and deeply interesting.

Whatever he was thinking its probably a good move for Greece. Once over the shock and some histrionics the EU will probably pay whatever they have to 'win'. Worst case for Greece is they go bankrupt and leave the Euro which isn't much worse than now (maybe better).

This stunt by the PM of Greece cost me a ****load in the market, he better get a clue.

Only explanation I'd thought of was an emotional tilt as he reached the end of his tether but maybe he had friends who made a bundle or he bankrupted someone he really hated (not you I assume )

Chezlaw,

The EU can't pay enough to win. They are going to lose. There is not even a shred of doubt about this, to believe otherwise is delusion. The issue is how they lose. And there are things that can be done to mitigate the disaster. The problem is that the politicians are so tied to the status quo, that they are suffering from cognitive dissonance, and so are making a bad situation catastrophic.

Greece is not the real problem here. The currency is the problem. It would be possible for a core of Germany, Holland, Estonia etc to share a single currency and have the ECB rechartered as a lender of last resort, but these fiscally responsible countries don't trust France, Italy, Spain, Belgium, Greece, Portugal inter alia, to not abuse the system.

Countries like Greece and Spain that are very recent democracies have had to develop corrupt political systems as a step on the way to being fully developed nations. Italy has been corrupt for generations and never even tried to eradicate the corruption which prevents them being trusted. They've run out of time to change. Their people won't vote for austerity to save French bankers, they'd rather go back to independence.

The future of the Euro has been crystal clear for a year now. It's over.

What is worth serious discussion is how much good can be saved, and how the duration of the crisis about to engulf Europe can be reduced to the minimum. How can we avoid the rise of extreme right and left wing governments in countries which will be seeing their living standards reduced by who knows how much (50% ? ).

Maybe they cant win but they can certainly 'win'

A 'win' in Greece for the EU will be anything they can claim is a victory. That means some deal they put together that is eventually passed by whatever method and they can claim is being implemented. I think the desire for that 'win' means the greeks have just improved the deal they will get.

I dont really have any idea what counts as a win or a lose or over what timeframe you measure it.