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The media would like us to believe that the Euro-zone is in the hands of Germany. It certainly looks that way. Twice in the course of a month, Frau Merkel pulled her weight and got what she wanted from everyone in the EU. It happened first, at the end of 2011, after the Euro Summit of 8 and 9 December, when she succeeded in imposing her rules of the game to the whole of Europe: strict fiscal discipline and austerity. Growth that had been a French and Italian concern was firmly put on the back burner. Even firewalls to defend Euro-government in distress (including additional funds to the International Monetary Fund and the European Financial Stability Mechanism) took second place. Moreover there was a short-lived moment of euphoria. The media made a show of the 26 countries pulling together around Merkel's disciplinarian cure for the Euro while one major member of the Union - the UK - opted out with a flourish. Cameron claimed he vetoed Merkel's proposed amendments to the Treaties of the European Union to "protect the interests of the City". Of course the City is important for the UK: it accounts for 10% of national product. But the City begged to differ and several bankers publicly complained that they risked losing markets in Europe. Regardless of what City bankers had to say, the British bulldog found itself out of the European ring. The British generally rejoiced, the media trumpeted that Britain would build a Europe outside the Euro. Conservatives crowed and welcomed Cameron as their new hero. At the recent European Summit held on 30 January the scene was repeated, with Frau Merkel once again calling all the shots. This time 25 governments agreed to move ahead with strict budgetary discipline rules, handing over stray governments to the Judge's rules at the European Court of Justice. 25? Yes, once again, the UK pulled out and this time it was followed by the Czech Republic. The Germans didn't mind - actually nobody minded because the Czechs were deemed unimportant by everyone and the UK's position was nothing new. Liberal views (so dear to the Conservatives in the UK and the Republicans in the US) that the government has tostay small and that budget discipline is the key to restore confidence in the markets won the day. Keynes was once again buried. Short shrift was given to the concept that in recessionary times when the private market consumption and investment has collapsed, you need at least one player in the economy to kick start growth. And that player can only be government precisely what the Germans don't want to hear. Yet only with the resumption of growth is there a fighting chance to increase tax revenues and eventually achieve balanced budgets. Sure not now, not as long as the recession is on-going, but
in the future. And one should never prospect political measures such as modifying the European treaties when confronted with a market that demands immediate solutions. Frau Merkel's solution - a change to the European Treaties requiring close fiscal discipline and coordination is necessarily slow. If she has it her way, there will be plenty of time for the Euro to crash before European treaties are adopted. Because in the last quarter of 2011, there were forces at work to make the Euro collapse: all those speculators betting against the Euro. Result: a huge credit crunch had developed and European bankswere scrambling to shore up their reserves. The last thing they were thinking of was to lend to business. Clearly a recipe for disaster and depression. In these attacks against the Euro, American credit ratings agencies have so far played a key role. They have regularly issued warnings and downgrades at the most delicate junctures, precisely when a moment of silence would have been desirable. For example, just before the December Euro Summit, all three major agencies announced that they were putting the Euro-zone members who still enjoyed a a Triple A rating "under surveillance". That means of course Germany and France. And small wonder: the German economic model, depending as it does on exports, will necessarily slow down as the recession deepens in Europe and demand for its exports inevitably plunges. The handwriting is on the wall. By the end of 2011, the credit crunch that was paralyzing European banks was already felt in Asia, where loans and support to business acquisitions slowed down or even froze. If Germany cannot sell to Southern Europe on which it has imposed austerity and cannot sell to Asia because European banks have seized up, who are the Germans going to sell to? The Russians? They're facing an economic slowdown. The Americans? Come on, the Americans have still to come out of their own slow-moving recession and solve their unemployment problem... Since the Euro crisis is exquisitely financial, it requires financial measures to solve. Not amendment to treaties. Sure, in the long run, Frau Merkel is right: close coordination of fiscal policies and measures are required for the stability of the common currency. But in the short run something needs to be done right now. By early 2012, the clock was ticking and on 13 January, Standard and Poor's downgraded France and Italy's credit ratings. Actually nearly all Euro-zone members got downgraded, except for Germany, Belgium, the Netherlands and Luxemburg - but for the first time a "negative outlook" was given to Germany. Time is running out! Or is it? Good question. And to answer it one needs to turn to the ultimate big player on the Euro scene:
the European Central Bank. Mr. Draghi, the savvy Italian who is the new head of the Bank, has asked for euro-zone governments to make an effort and produce a "fiscal compact". That is what he expects. On 30 Janurary, at their Euro Summit, 25 governments certainly came as close as they could to satisfy him. Everyone talked about the "fiscal compact" even though the time needed to achieve it are not in line with financial expectations. We're talking her in terms of several months, perhaps years, and nothing in the immediate. Surely the European Central Bank cannot hope for more from the European political class. They have given their best in the last four months, in particular Italy and Greece, both with "technical" governments in charge. Read: technical experts instead of politicians as ministers - although this is more true of Italy than Greece where the political class hasn't lost its grip on the government. Italy in particular (and it is by far the larger economy, the third in the Euro-zone after Germany and France) has gone to great pains to adopt belt-tightening measures, and so have Ireland, Portugal and Spain. On the other side of the barrier, the Czech Republic,Sweden and Hungary have joined the UK in showing how little they cared about Europe. They might yet change their mind, but for the time being, they have opted out, saying they need to "consult with their parliaments" - diplomatic language to say that they won't commit themselves to anything. Of course, Hungary has problems of its own: its debt is rated junk and the government appears determined to curtail democratic freedoms, muzzling the press and attacking the Hungarian Central Bank's independence, much to the dismay of the European Union, ill-equipped to deal with wayward members...But Hungary is not in the Euro and its problems are marginal to the more central issue of a possible Euro collapse. Yet the European Central Bank so far hasn't moved...much. But it must be recognized that it did something important before that fateful December Summit: it indicated to Euro-zone banks that they could consider the ECB as their lender of last resort. Loans were given outover a three-year timeframe. The latest numbers indicate that Euro-zone banks have taken ample advantage of this offer, to the tune of over €400 billion. Accordingly it took what amounted to "quantitative easing" measures for private banks. That's certainly a big step in the right direction, and in principle it should relieve the credit crunch. Unfortunately, so far the banks have used the cash to strengthen their reserves rather than lend to entrepreneurs. So business still suffers... The real issue is that European Central Bank will still not buy any bonds from Euro governments in distress. It is still off the books for so-called "constitutional" reasons. The Bank is not allowed to do this. So far, the Bank is reported to have bought some 200 billions worth of bonds (that's peanuts compared to the trillions spent by the Federal Reserve). But it has always re-balanced its purchases in the following weeks, in order to avoid any accusation - that are coming especially from German quarters - of indulging in "quantitative easing" the way the American Federal Reserve does. In other words, the European Central Bank is still toeing the German Bundesbank line of refusing any quantitative easing to relieve governments in difficulty. That's the fashionable term for resorting to the money printing press and it is something the Germans won't hear about, in the
misplaced fear that this could cause some sort of hyper-inflation. Germans are obsessing over the hyperinflation they suffered in the 1920s and that brought Hitler into power. But times have changed: If anything, we're headed towards deflation and recession - and even the Fed's generous quantitative easing has not had any noticeable inflationary impact in the US... Add to the mix the role of the American credit rating agencies, and you have a recipe for disaster. The solution? Two major steps, one easy, the other not. 1. The European Central Bank should act as a central bank normally does, and "act as a lender of last resort" to governments; it should be allowed to engage in quantitative easing as appropriate and whenever needed; that's the easy step: once the ECB pulls out its bazooka, speculators will scramble for their lives... 2. American credit agencies should be taken off the books of whatever Euro-zone government structures where their rating is still used as a reference for investment (usually pension funds). This is something that is already proposed by America's banking regulators: that all references to credit rating agencies should be removed from regulations and be replaced with a formula based on a company's cash flow, leverage and volatility of its stock price to assess the riskiness of corporate debt. American banks have until February 2012 to comment on the new proposal before final rules are issued by the competent Federal authorities (the Federal Reserve, the FDIC and OCC). Likewise, Europe should move forward on this chapter. There are suggestions that a new Eurozone credit agency should be created to substitute (or better compete) for the American ratings agencies, since they are even discredited in their own country. Of course this is not an easy step the Chinese have already done so and created their own agency but it certainly hasn't yet attained the required credibility to be effective beyond China -. The process is undoubtedly delicate and time-consuming and complex (like Merkel's cure for the Euro). Nevertheless, it should be started. It has even been suggested that the United Nations get involved in the credit rating process. There is little doubt that the American credit rating agencies absolve a useful function: anyone who wants to tap the bond market - whether private (say a corporation) or public - needs a credit report for the would-be investors. The trouble is that American rating agencies maintain relations with customers on both sides of the barrier: the bond sellers and buyers and it is difficult to see how they can remain independent. Italy on January 16 opened an investigation of the practices of two of the major agencies (Standard and Poor's and Moody's), accusing them of spreading the news to the markets before informing the concerned authorities of changes in their credit ratings. The way out might be to get credit ratings through an international institution that is above any suspicion, like, for example, the International Monetary Fund. It makes no sense that the Eurozone economic well-being should be in the hands of American credit agencies (whose customers are the speculators attacking the Euro). And it makes no sense that the Euro-zone has a common currency that no one, and least of all the European Central Bank, is willing to protect...
Claude Nougat, a graduate of Columbia U. School of Economics, has specialized in financial market analyses and worked in banking (Citigroup). She has worked 25 years for the United Nations, as a project analyst at Food and Agricultural Organization in Rome (1979-2204) She ended her career at FAO as Director for Europe and Central Asia. Since then she writes (she is the author of the Fear of the Past trilogy published in 2011 (available on Amazon, Barnes & Noble, iBookstore and Sony Store). She maintains a blog on which she often discusses and updates economic issues, including the Euro crisis since it began 2 years ago with the debt scandal in Greece: http://claudenougat.blogspot.com.
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