Insight: Euro has new politburo but no solution yet (Reuters)

PARIS (Reuters) – Europe has a new informal leadership directorate intent on finding a solution to the euro zone's debt crisis, but it has yet to prove its ability to come up with a lasting formula.

Forged in the fire of a bond market inferno, the shadowy so-called Frankfurt Group has grabbed the helm of the 17-nation currency area in a few short weeks.

The inner circle comprises the leaders of Germany and France, the presidents of the executive European Commission and of the European Council of EU leaders, the heads of the European Central Bank and the International Monetary Fund, the chairman of euro zone finance ministers, and the European Commissioner for economic and financial affairs.

Europe's new politburo met four times on the sidelines of last week's Group of 20 summit in Cannes, issuing an ultimatum to Greece that it would not get a cent more aid until it met its European commitments, and arm-twisting Italy to carry out long delayed economic reforms and let the IMF monitor them.

In a tell-tale recognition of the new ad hoc power center, members wore lapel badges marked "Groupe de Francfort."

U.S. President Barack Obama attended one of the meetings, getting what he joked was a "crash course" in the complexity of Europe's laborious decision-making processes and institutions.

"He proved to be a quick learner," one participant said.

Two people familiar with the discussion said he argued for the euro zone to make its financial backstop more credible by harnessing the resources of the ECB, but German Chancellor Angela Merkel and ECB President Mario Draghi resisted.

Obama also supported a proposal to pool euro zone countries' rights to borrow from the IMF to help bolster a firewall against contagion from the Greek debt crisis, but Germany's central bank opposed this too, the sources said.

The president referred obliquely to the debate at a news conference the next day, saying: "European leaders understand that ultimately what the markets are looking for is a strong signal from Europe that they're standing behind the euro."

Hours earlier, a television camera in the Cannes summit conference room caught Obama and British Prime Minister David Cameron discussing the issue while waiting for the start of the final working session.

Cameron, whose country is not in the euro, has called publicly for the ECB to act as the lender of last resort for the euro zone, as the Federal Reserve does for the United States, and the Bank of England for Britain.

When Merkel entered the room, Obama pulled her aside for a private conversation. An open microphone caught his opening words: "I guess you guys have to be creative here."

ON THE HOOF

The Frankfurt Group came about on the hoof to try to fashion a crisis response in something closer to the short timespan of frantic financial markets.

It seems destined to endure, not least because the growing imbalance between a stronger Germany and a weaker France means other players are needed to broker decisions.

Crucially, it aims to bridge the ideological gulf between northern and southern Europe, and between supporters of the orthodox German focus on fiscal discipline and an independent central bank with the sole task of fighting inflation, and advocates of a more integrated and expansive economic and monetary union.

The presence of IMF Managing Director Christine Lagarde gives the group greater credibility in the markets, as well as providing a reality check on what international lenders expect and the limits to their willingness to support the euro zone.

It all began with a blazing row at the Old Opera House in Frankfurt on October 19 that spoiled Jean-Claude Trichet's farewell party after eight years as president of the ECB.

As the fallout from Greece's debt crisis singed European banks and panicky investors dumped euro zone government bonds, French President Nicolas Sarkozy, who had snubbed the ceremony in honor of Trichet, flew in at the last minute to meet a visibly irritated Merkel.

Sarkozy himself said that day that France and Germany were at odds over how to leverage the euro zone's financial rescue fund. The French wanted to let the European Financial Stability Facility operate as a bank and borrow money from the ECB.

"In Germany, the coalition is divided on this issue. It is not just Angela Merkel whom we need to convince," Sarkozy told lawmakers, according to Charles de Courson, who was present.

At the Frankfurt meeting, described by one participant as "explosive," Merkel and Trichet firmly opposed the idea, which they said would violate the European Union's treaty prohibition on the central bank financing governments.

Germany insisted on that clause when the ECB was created because of its own history of fiscal abuse of the central bank that fueled hyperinflation in the 1920s and funded the Nazis' massive rearmament in the run up to World War Two.

As French officials tell it, Merkel is not so hostile to the proposal as her finance minister, Wolfgang Schaeuble, and the head of the German Bundesbank, Jens Weidmann.

The French are convinced that Merkel understands the ECB will have to be more centrally involved in fighting bond market contagion, but she cannot get it through her divided coalition for now. They see the ECB as the main center of resistance.

After hearing a chorus of Obama, Cameron and the leaders of India, Canada and Australia at the G20, Merkel acknowledged that the rest of the world found it hard to understand that the ECB was not allowed to play the role of lender of last resort.

But the crisis may have to get still worse before the Germans and the ECB relent, if they ever do.

LEGITIMACY VS EFFICACY

The Frankfurt Group has already had an impact in euro zone crisis management but like all informal core groups it has begun to stir resentment among those who are excluded, and it has yet to prove its ability to craft a convincing longer-term solution.

North European creditor countries such as the Netherlands, Slovakia and Finland, where public hostility to further euro zone bailouts is fierce, are already grumbling about decisions being taken behind their backs.

In Greece and Italy, there has been strong criticism of the perceived arrogance of "Merkozy," as the Franco-German duumvirate are increasingly nicknamed, in summoning their prime ministers to receive ultimatums.

German and French officials shrug off such complaints as inevitable, noting that EU partners are even more unhappy when France and Germany do not agree, since that paralyses Europe.

"There is always a trade-off between legitimacy and efficacy," said an EU official involved in the Frankfurt Group. "The euro area institutions were not designed for crisis management so we need innovative solutions.

"In an emergency like this, we have to have a structure that works," he said, adding that the presence of the European Commission and of European Council President Herman Van Rompuy guaranteed that the interests of smaller member states would be taken into account.

EU officials had held conference calls with the 15 other euro zone states during the Cannes summit "to keep them in the loop." The head of the EFSF, Klaus Regling, was secretly flown to Cannes to brief the leaders on the state of accelerated preparations to leverage the rescue fund, one source said.

Merkel long resisted French pressure to create more of an "economic government" in the euro zone, not least because she did not want Germany to be in a minority on issues such as bailouts, free trade or the EU budget.

She also did not want to alienate German allies and neighbors such as Denmark, Poland and the Czech Republic, which are not in the euro zone.

But recent problems in smaller countries that aggravated market turmoil -- Finland's demand for collateral on loans to Greece and Slovakia's parliamentary wrangling over increasing the EFSF's powers -- convinced her of the need for stronger leadership to impose order.

Whether the Frankfurt Group will be the forum that finally convinces Germany to accept a bigger crisis-fighting role for the ECB, or the creation of jointly issued euro zone bonds, remains to be seen.

(Writing by Paul Taylor; editing by Janet McBride)

View the original article here

Markets give up hopes for lasting euro zone solution (Reuters)

By Steven C. Johnson Steven C. Johnson – 1?hr?49?mins?ago

NEW YORK (Reuters) – After another week of confusion and turmoil in Europe, investors are ditching whatever hopes they once had for a conclusive solution to the debt crisis.

That may foreshadow a gloomy holiday season in markets, especially if wary investors opt to reduce risk in their portfolios and take refuge in U.S. Treasuries and the dollar.

Just weeks after it seemed leaders had drafted a master plan to solve the crisis, doubts rose about whether Greece would back a 130 billion-euro bailout.

Disaster may have been averted when Greece, under fierce EU pressure, agreed over the weekend to form a new government that would approve the deal and stave off bankruptcy.

But that did little to calm investors, who were already looking ahead to the next problem: Italy. Italian bond yields hit a euro-era high of 6.4 percent Friday, raising fears the country may soon need a Greece-style emergency bailout.

The Greek agreement "may spark a brief relief rally," said Alan Ruskin, head of global G10 currency strategy at Deutsche Bank. "But it won't last and we will soon go back to focusing on Italy."

"At the end of the day, it does seem like a grand plan is elusive at best," said David Ader, head of government bond strategy at CRT Capital Group in Stamford, Connecticut.

"We've seen one European bank and one U.S. brokerage fail. We know there are strains for French banks. We're wondering how long it will be before Greek default worries spread to Italy and Spain," he said. "In a situation like that, money managers are going to decide to simply take their risk down."

FLIGHT TO SAFETY

Investors are betting the market will see evidence of that as soon as this week, as flight-to-safety flows help boost U.S. Treasury debt, lift the dollar against the euro and weigh on stock markets around the world.

The biggest fear is that a disorderly default in Greece or elsewhere would ripple across the global financial market the same way the Lehman Brothers collapse did in 2008. That, investors fear, would probably be enough to plunge the global economy into recession.

"This is going to be pretty negative news for risk markets," said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "We are going to see a continued flight-to-quality tomorrow."

Benchmark U.S. 10-year note yields dropped more than 29 basis points in the past week and a half as worries about Europe overshadowed signs of economic improvement in America.

Ashraf Laidi, CEO of Intermarket Strategy in London, said he expected the euro to struggle again this week after losing nearly 3 percent against the dollar last week. By year end, he said it could fall below $1.30. It was around $1.38 Friday.

"This past week really raised some tricky questions," he said. "For the first time I can remember, the possibility that Greece really could leave the euro zone was being talked about in cafes and bars as well as on trading desks."

The weekend deal in Greece may stabilize things a bit in that it suggests Greece will keep the emergency funds flowing while making the tough spending cuts needed to get its fiscal house in order.

"What we had been afraid of was a stalemate. Now it seems the hard cuts will be made. I think equity markets will cheer this," said Michael Yoshikami, president and chief investment officer at YCMNET Advisors in Walnut Creek, California.

The cheering may not last long, though.

"These 24-hour risk-on rallies, I don't know how much longer people are going to be willing to do that," said Ader. "Sell-offs are getting deeper because the rallies are only short-covering moves. People are not getting long and putting on bets that everything is suddenly OK."

FROM GREECE TO ITALY

Deutsche Bank's Ruskin said the focus is likely to shift quickly from Greece to Italy in the weeks ahead, and that should mean more volatility and unwillingness to take on risk.

Italy's debt-to-output ratio stands at 120 percent, second only to Greece in the 17-country euro zone, and its borrowing costs are rising.

Prime Minister Silvio Berlusconi recently refused a loan offer by the International Monetary Fund and his government may be on the verge of collapse.

"Berlusconi says Italians are not feeling the crisis but that's because the European Central Bank has been providing high levels of liquidity at low interest rates and buying Italian bonds," Ruskin said. "That begs the question, should the ECB stop that to show them this is really a crisis?"

"I have to believe a lot of investors like me are thinking this could be the start of Italy week," said James Paulsen, chief investment strategist at Wells Capital Management in Minneapolis. "Italy is going to rapidly rise on investor radar screens and may be the bigger story."

(Additional reporting by Richard Leong, Daniel Bases, Karen Brettell in New York; editing by Bernard Orr)

View the original article here

Congress seeks debt solution, Obama goes to public (AP)

WASHINGTON – Racing the debt clock, Congress is working on dual tracks while President Barack Obama appeals to the public in hopes of influencing a deal that talks have failed to produce so far.

"We have to ask everyone to play their part because we are all part of the same country," Obama said Saturday, pushing a combination of spending cuts and tax increases that has met stiff resistance from Republicans. "We are all in this together."

In his weekly radio and Internet address, Obama said the wealthiest must "pay their fair share." He invoked budget deals negotiated by GOP President Ronald Reagan and Democratic House Speaker Tip O'Neill, and Democratic President Bill Clinton and Republican Speaker Newt Gingrich.

"You sent us to Washington to do the tough things, the right things," he said. "Not just for some of us, but for all of us."

As a critical Aug. 2 deadline approached, the chances that Obama would get $4 trillion or even $2 trillion in deficit reduction on terms he preferred were quickly fading as Congress moved to take control of the debate. At a news conference Friday, Obama opened the door to a smaller package of deficit reductions without revenue increases.

Obama's communications director, Dan Pfeiffer, said the president, Vice President Joe Biden and White House aides were discussing "various options" on Saturday with congressional leaders and House and Senate aides from both parties.

The White House held out the possibility of arranging a meeting with the leaders on Sunday.

House Republicans prepared to vote this coming week on allowing an increase in the government's borrowing limit through 2012 as long as Congress approved a balanced-budget constitutional amendment, which is highly unlikely.

In the Senate, the Republican and Democratic leaders worked on a bipartisan plan that would allow Obama to raise the debt limit without a prior vote by lawmakers. The talks focused on how to address long-term deficit reduction in the proposal in hopes of satisfying House Republicans.

A weekend deadline that the president gave congressional leaders to choose one of three deficit reduction options became a moot point after House and Senate leaders made it clear to the White House on Friday that they were moving ahead with their own plans.

In the Republicans' address Saturday, Sen. Orrin Hatch of Utah argued for passage of a balanced-budget amendment. He blamed Democrats for failing to embrace adequate budget cuts and said "the solution to a spending crisis is not tax increases."

An amendment that requires a balanced budget, he said, "would put us on a path to fiscal health and would prevent this White House or any future White House from forcing more debt on the American people."

The government said Friday it was using its last stopgap measure to avoid exceeding the current $14.3 trillion debt limit. Administration officials, economists and the financial markets have warned that missing the Aug. 2 deadline and precipitating a government default would send convulsions through an already weakened economy.

Obama had held five straight days of meeting with congressional leaders at the White House, but none of the three options he proposed — deficit cuts of $4 trillion, $2 trillion or $1.5 trillion over 10 years — were unlocking enough support to increase the debt ceiling by the $2.4 trillion Obama wants to make it last beyond the 2012 elections.

Essentially declaring those discussions over, Senate Republican leader Mitch McConnell said Friday: ""Now the debate will move from a room in the White House to the House and Senate floors."

In search of a deal, Obama has used a combination of private meetings with congressional leaders and high visibility press conferences, radio addresses and public statements in an effort to win the public to his side. His pitch is also aimed at independent voters, to whom he is presenting himself as a willing compromiser.

In a White House video distributed Saturday by Obama senior adviser David Plouffe to supporters, Obama is shown praising the virtue of compromise to a group Democratic, Republican an independent students. He noted that President Abraham Lincoln's Emancipation Proclamation permitted slavery in border states loyal to the Union, in an attempt to hold the nation together.

"Here you've got a wartime president whose making a compromise around probably the greatest moral issue that the country ever faced because he understood that `right now my job is to win the war and to maintain the union,'" Obama said.

"Can you imagine how the (liberal news outlet) Huffington Post would have reported on that? It would have been blistering. Think about it, `Lincoln sells out slaves.'"

He told the students: "The nature of our democracy and the nature of our politics is to marry principle to a political process that means you don't get 100 percent of what you want."

__

Online:

Obama address: www.whitehouse.gov

GOP address: www.youtube.com/gopweeklyaddress

View the original article here