At the time of writing this, the global markets are yet to price in the effects of the nearly $1 trillion package that the EU has promised to — let's face it — bail out sovereign governments of Portugal and Spain among others.
In parts, this inability to price in is directly a function of the substantive uncertainty about how the "announcement" to open the spigots of the financial system will indeed manifest.
As of now, this package is expected to be around 440 billion euros (Dh2 trillion) of loans from the European countries themselves, 250 billion euros from the IMF and 60 billion euros from an EU Emergency Fund.
Over and above these measures the European Central Bank (ECB) has issued statements that it wants "to address severe tensions in certain market segments which are hampering the monetary policy transmission mechanism and thereby the effective conduct of monetary policy".
In essence, the ECB will intervene actively in the secondary markets for sovereign and corporate debt and currency market as and when it deems necessary to stabilise the markets.
All of these interventions pose a number of unanswered questions.
One of the critical issues is how does the ECB determine what exactly constitutes as "unstable" market conditions?
There is active reporting across business desks that ECB will sell "unlimited amount" of US dollar to prevent the euro from sliding downwards — the near-Armageddon scenario for many who long believe the euro is in parity with the US dollar.
Is there an estimated value of EUR-USD that is deemed as appropriate reflection of the trade imbalances?
How is that exchange rate decided?
Within the euro zone the bond yield differentials (spreads) typically reflect the market's assessment of the relative value of the German debt versus the rest-of-Europe's debt.
The news of the present intervention has resulted in a decline in German bonds, thus a decline in prices and an increase in yield of German bonds.
Concurrently, one expects in the coming months for the Spanish, Portuguese bonds to have lowered yields. It is unclear, and perhaps entirely unlikely, that the mandarins of the ECB have any analytically rigorous way of defining what the average spread levels ought to be. Or if what the spreads on bonds ought to be at different time points on the yield curve, a crucial facet that bond desks across the world will monitor closely.
While the above might seem like technical concerns of little interest beyond the fixed income, currency world, a larger se t of questions continue to loom.
Most of the monies promised are from euro giants France and Germany, and for the time being they are seen as too big and too solvent to be questioned.
However, a minor issue of deflation has emerged. If much of the bailout monies is sucked from the larger monetary system to prop up debt with dubious values is deflation not inevitable? The cost of deflation on the countries like Greece which must pay back the debt is still unaccounted for.
Since, revenues from exports and taxes typically pay back the cost of debt re-servicing in presence of deflation, for fixed levels of debt, the amount of real capital that must be deployed will rise.
So, deflation will exert greater pressures on Greece and other troubled countries that any promise of a export driven growth will subside and eventually, as Yogi Berra says: "It will be déjà vu all over again".
All this aside, a new historical chapter is being written by the ECB before our eyes. Perhaps we appreciate.
This move to intervene directly in capital markets to bail out fiscal authorities across Europe has dramatically altered the fine equilibrium between regional fiscal balances and monetary policy.
Monetary imperatives
The political elite in regional capitals of Europe who have so far seen the monetary imperatives of the ECB as an unwelcome, if necessary, constraint on their powers will now see their fortunes tied directly to the mandates from Brussels (read: Berlin!).
Like feudal lords at the cusp of parliamentary democracy, the politicos will find that the ECB has virtually created an EU state more harmonised by finance than by cultural consensus.
To summarise, the financial elite has thrown a gauntlet at the political elite, either break up the EU or to go along with this supra-European agency that can issue debt, intervene in markets and affect unemployment in local regions. Diffident politics has been cuckolded by the imperatives of finance machismo.
