Introducing the plan(s)

I find it only appropriate to begin posting the thoughts that honored me a place on the EPJ domain, which is about the current "bailout" of Europe. In my mind, the current discussion around the PIIGS, Germany and the rest of Europe is lacking a few vital connections, and is missing something that I think is blatantly obvious. The "bailout" is not one plan - it is two.

1. The "all-in" plan by the eurozone countries is viewed by many as a bluff. I support this conclusion for a number of reasons, but most specifically because their chance of bringing together the funds for it are slim to none, simply because the money isn't there to borrow - and there will soon be no money to borrow anywhere unless governments stop devouring credit. We see then that this is the official plan, which is completely impossible to carry out but did its job when it comes to preventing an imminent market meltdown.

2. The rational plan - maybe unbeknownst to most of those in charge - has been set in play by the markets. Regardless of how much Angela Merkel, Axel Weber, Claude Trichet, Nicolas Sarkozy and Wolfgang Shaeuble has realized about the state of the world economy, the second plan will play out, and at each and every decision the choice will be "the second plan" or "economic armageddon". I'm not ruling out that they choose armageddon at some critical point, I'm merely stating that this is how I think things will play out. So what is the second plan? Let's take a look at a few things that has come out of Europe lately, which could be seen as supporting my view :

• "We are merely buying time", said Angela Merkel a week ago.
• "In a market economy it is neither possible nor desirable to rule out completely the collapse of individual banks", Axel Weber of the ECB said recently.
• Nicolas Sarkozy has started talking about constitutional changes, to make each French government set deficit-limits at the beginning of their terms.
• Germany has banned naked short-selling, which means that even if you can sell government debt you own, you cannot make profit out of speculating that governments will go down.
• Germany clubbed a constitutional change in 2009, which has received suspiciously little attention. It is a plan to phase out government deficits, on the central and local level. In 6 years, the maximum allowed deficit will be 0.35% of GDP.
• The european parliament is discussing whether countries that do not comply with the stability pact rules will be stripped of voting rights.
• There is, for the first time, talk about an ejection mechanism to throw people out of the eurozone (however, this changes from day to day - today the official tune is "no one will be allowed to renege on their debt")

So what does all this add up to, besides what one could expect from panicking european leaders? What it actually adds up to is the answer to the $1 trillion question, namely "How does a set of almost-bankrupt countries bail out another set of bankrupt countries". Answer : They don't, and there we have plan two.

The first payment to Greece has been made, for them to avoid instant bankrupcy. This bought the german leadership time, maybe until the end of the summer. What do we think happens next time Greece asks for a handout? Someone is going to crunch the numbers and decide if Greece has strangled their budget enough. What happens if Spain or Portugal asks for a handout? Germany decides if their cutbacks are enough. My guess is that the $1 trillion bailout is in fact no more than $15 billion that bought time to prepare. In reality, Europe can only save itself by closing its deficits immediately, and unless we think Germany will go down with Club Med volountarily, this is how I see things evolving :

Every country has the choice of cutting their spending AT LEAST to the extent they have promised, and then there won't be any need for bailing countries out. If someone does not follow the plan however (with Greece being the prime candidate) this changes the game immediately. To "save the euro" suddenly changes meaning from "bailout" to "kick out". If Germany is honest about saving the euro, this is when someone gets the boot. This will send an interesting signal to the rest of the PIIGS, and to the markets :

The only way you get to borrow more money, is if you cut back the budget enough to prove beyond a doubt that your fiscal course is sustainable.

And in this case, you can just go borrow money from the market. Sure, there is the symbolic $1 trillion "package" available, except it might be a bit troublesome to fund it. I can easily see Germany - in the name of solidarity - asking that if one of the PIIGS needs extra money then sure, but the other PIIGS must cut their budgets even more to be able to help fund the bailout too. We're in this together, right? In fact, if Spain needs a $15 billion bailout, in return they may have to pay $10 to bail out Portugal. And if Portugal needs $10 billion in bailout, then we may have to ask Italy for most of that money. If Ireland needs money or if Greece again needs money, maybe Germany can cough up a few billions, but the rest will have to be payed by Spain and the rest of the PIIGS. You see where I'm going with this? This bailout is the end of all bailouts before it even started.

Hopefully, Germany is spending their time preparing for collapsing banks. Whether or not the rest of Europe is in on this is an open question, if Sarkozy (like rumours have it) threatened to leave the euro if Germany didn't cough up the money, then it wouldn't surprise me if Germany forgot to tell him how they see things playing out. Italy might in fact be in on it, because according to rumours, Italy is now increasingly using mark-to-myth for their banks. Also, the two names that have been mentioned for next ECB chief after Trichet are Mario Dragi (Italy) and Axel Weber (Germany). Isn't it comforting that Dragi used to work for Goldman Sachs?

By now some of you may think I'm pretty far out into conspiracy-land. Would Germany really consider throwing the rest of Europe under the bus? I ask you - what is the alternative (I see none)? But even if this isn't the intention of Germany, even if my plan two has never been explicitly "thought out" by any of the leaders of Europe - it doesn't really matter anymore. Plan two will be enforced by the markets.

To sum up - the game is by all means over, and unless we see a miraculous increase in political responsibility among the European leaders, there will be government defaults, bank defaults and countries kicked out of the eurozone. Avoiding this was possible perhaps in 2008. Now - it's inevitable. Armageddon comes if someone invokes the confetti solution, that has been promoted by, (among others) Ambrose Evans-Pritchard. I leave you with a quote from Karl Helferich - and when you hear these words again, you'll know what they mean :

"To follow the good counsel of stopping [the inflation machine] would mean… that in a very short time the entire public, factories, mines, railways and post office, national and local government, in short, all national and economic life would be stopped.”

If the ECB decides to buy unlimited amounts of government debt, run for the hills.