VTB: eurozone ‘a debtor’s prison with a German guard’

By:
Peter Garnham
Published on:

The eurozone debt crisis is going to escalate once the US elections are out of the way, argues leading Russian investment bank VTB.

Neil MacKinnon, global macro strategist at VTB Capital, says the vicious cycle of turmoil in the eurozone – which has seen every initiative to arrest the region’s debt crisis only offer brief respite – is finally going to come to a denouement after the US elections on November 6.

He says that markets during the past two to three years have always wanted to believe in both good news and that eurozone policymakers have got a silver bullet to cure the region’s problems.

The latest example of that is European Central Bank (ECB) president Mario Draghi’s – yet to be implemented – plan for outright monetary transactions, announced on September 6.

However, even that initiative is beginning to lose its lustre, with EURUSD struggling to hold above $1.30 despite the introduction of QE3 by the Federal Reserve.

 Escalating cycle of eurozone turmoil

 
Source: Bloomberg, IMF, VTB 

MacKinnon says the problem with the ECB’s plan is that it comes laced with conditionality, with the central bank demanding more austerity measures from peripheral eurozone nations if they want it to buy their bonds.

He says the problem with the eurozone is that the currency is trapped in a “1930’s-style gold standard”.

Indeed, MacKinnon believes there are lots of similarities between that era and now, principal among which are policymakers’ obsession with austerity and the fact the adjustment process is being placed on the deficit economies rather than the surplus economies in the eurozone.

“From an economic point of view, Germany should make an effort to save less and spend more because if the adjustment process is placed firmly and squarely on all the trade-deficit economies, you can never hope to catch up and improve their competitiveness,” he says.

“From my point of view, from an historical point of view, monetary union in its current format is simply not viable.”

MacKinnon believes a testing point for the eurozone is approaching in the coming months, but thinks policymakers have probably had a phone call from president Obama urging them “not to do anything silly” ahead of the US election that could spark turmoil across global financial markets.

European policymakers will, therefore, do their very best to give countries such as Greece more time to meet their budget targets until the presidential election.

Ultimately, however, they are delaying the day of reckoning.

“It is not a surprise that Greece misses its budget targets because it is trapped in a debtor’s prison,” says MacKinnon. “It is economics 101 that if you impose more austerity, aggregate demand goes down and your budget deficit goes up and you debt level goes up.

“This is really a debtor’s prison that is manned by German guards. There is no escape. The problem really is going to test monetary union in its current format.”

This article was originally published on Euromoney country risk.