Firewalls , The Color Of Their Money and other Fables From Davos !

http://blogs.telegraph.co.uk/finance/jeremywarner/100014410/europes-firewall-demands-just-keep-growing-and-growing/

Europe's firewall demands just keep growing and growing

Britain is edging towards agreeing its $30bn share of the $500bn of extra funding demanded by the IMF for eurozone bailouts, a sum so large that it will require parliamentary approval.

That's the clear message I've taken from a speech made by the Chancellor, George Osborne, to British business leaders here in Davos. I may be jumping the gun a bit, but it seems to me, listening to other European policymakers gathered for the World Economic Forum annual meeting in this Swiss Alpine resort, that the conditions he listed are quite likely to be satisfied.

*     *     *     *

A little context. By general agreement, the eurozone crisis isn't going to abate until a credible firewall is put in place, big enough to end uncertainty and convince markets that even countries as large as Italy and Spain are adequately backstopped against speculative attack.

The IMF reckons that approximately €2 trillion is needed to do the job, a figure which by the way is also being bandied around in private meetings here in Davos by our late lamented former PM, Gordon Brown. Neither David Cameron nor George Osborne will put a number on it. The arithmetic would work something like this: €1 trillion would come from existing European bailout facilities, €500bn in additional loans from the eurozone countries, and €500bn from the IMF, to which the UK would contribute €30bn.

Of course, these are only standby monies. The hope is that once markets are convinced that the commitment has been made, it won't actually be necessary to use any of it. Or as Francois Baroin, the French finance minister, told Davos participants; "The higher the firewall, the less it will have to be used, because of its deterrent effect".

Unfortunately, there is a world of a difference between what Brown and the IMF want and what's possible in practice. Enhanced bailout faciliies are one of the things on the agenda for Monday's meeting of European heads of state. Olli Rehn, Europe's monetary affairs commissioner, sketches out the numbers something like this; the new permanent bailout facility will have lending capacity of €500bn, to which can be added the remaining €250bn of lending capacity in the existing but termporary European Financial Stability Facitility.

By the way, the permanent facility was meant to replace the temporary one. Germany hasn't yet agreed to fold the two together to create the bigger fund. But even if it does, we are still a long way short of the sort of sums the IMF thinks necessary. Germany has meanwhile made clear that it sees no need for extra money, a message repeated by Wolfgang Schaeuble in Davos on Friday. "No firewall will work unless the real underlying problems are solved", he said. First let's have austerity and structural reform, is the German view: then perhaps we can talk about bigger firewalls and other forms of debt mutualisation.

Mr Osborne set out a series of conditions on Friday that need to be satisfied before he'll agree extra IMF contributions. First, they cannot be made specific to eurozone bailouts. Well, that's easily satisfied, even though everyone knows that in practice, that's their purpose. Second, further eurozone bailouts must be subject to full IMF conditionality. Again not a problem. Third, extra contributions must be agreed by the whole G20. Now that could be an obstacle because the US, knowing it could never get enhanced IMF support through Congress, has already said no. Oddly, this exception already seems to have been accepted, so perhaps what Mr Osborne is talking about is the G20 minus one, or the G19.

And finally, the UK chancellor wants to see the colour of the eurozone's money before he will contribute more. Again, he's not specific about how much. But the working assumption is that despite what it says, Germany will eventually crumble and agree to cough up more. Germany has repeatedly attempted to draw a line in the sand throughout this crisis, and repeatedly been forced to breach it. As the crisis intensifies, it will do so again. Germany has to be dragged again and again to the cliff edge before it will act.

In any case, all the Chancellor's conditions appear quite flexible, allowing him ample scope to agree provided there's general international support. The justification essentially goes like this – that if an extra €30bn of contingent contributions to the IMF is what it takes to make the eurozone debt crisis go away, then it is a price worth paying. Remember, this is theoretically just standby money, which if the firewall works as hoped, will never be drawn.

I've got two concerns. I'm not convinced that even €2trillion is going to be enough given the downward spiral in debt dynamics Europe now finds itself in, where economic contraction increases the size of the debt burden regardless of measures to fix deficits, which in themselves are contractionary. It's a vicious cycle.

But my main concern is the same as that of the US administration. This is a crisis the eurozone is easily rich enough to solve itself through collectivisation of the debt burden and fiscal union. Why should comparatively poor countries such as China and India be expected to contribute to the bailout of relatively rich ones? Morally, it's indefensible.

The great firewall debate is set to run and run.