DAVOS- At a discreet farewell dinner in Davos for Swiss National Bank chief Philipp Hildebrand, a handful of guests including central bankers past and present were handed blank sheets of paper. Before they began eating they were asked to write down the probability, in their view, that the euro would collapse in the next five years, according to two of those present at the meal. They were also asked what likelihood they thought financial markets assigned to such an event. The result, announced at the end of the dinner, can hardly have helped the Europeans' digestion. On average the guests-from Switzerland, the euro zone, North America and Latin America-saw a 21 per cent risk of the 17-nation single currency breaking up in five years, one participant said. They concluded markets envisage a 35 per cent chance the euro will not exist in its current form. It was not possible to corroborate the figures with other diners who cited the private nature of the event. Some declined to reveal the content of the discussions at all.
The straw poll among current and recently retired policymakers reflected a wider mood of short-term relief tinged with longer-term doubt among the world's movers and shakers at this year's World Economic Forum session in the Swiss Alps. In contrast to pre-Christmas fears of an imminent breakdown, few now expect the euro to blow up suddenly this year after the European Central Bank flooded banks with cheap long-term money. "We know for sure that we have avoided a major, major credit crunch, a major funding crisis," ECB chief Mario Draghi told Davos delegates. Bankers concurred. In another hopeful sign, Greece says it is close to a deal in which private creditors would "voluntarily" accept a roughly 70 per cent write down on their government bond holdings as part of a second bailout package for Europe's worst debtor. The alternative to this "soft" debt restructuring would be a potentially chaotic hard default, which banks and governments are desperate to avoid if possible. Even if Greece is rescued again, much remains to be done to restore market confidence in the euro's long-term survival.
The gloom was felt most strongly in North America and Asia, where investors impatient with the complexity of the EU machine have lost trust and simply got out. High-level private meetings over four days in Davos helped many appreciate that progress is being made in Europe. Away from the media glare, a secret steering group of top European and United States policymakers, the ECB's Draghi and International Monetary Fund's managing director Christine Lagarde discussed how to strengthen financial defenses to protect the euro zone. The group, including finance ministers of France, Germany and the US, discussed a plan to assemble a combined warchest of 1.5 trillion euros by the time of the IMF spring meeting in April, one participant said. That depends on Germany agreeing to let a new 500 billion euro permanent rescue mechanism run in parallel with an existing bailout fund that has about 250 billion euros left after lending almost as much to Greece, Portugal and Ireland.
Chancellor Angela Merkel gave no clear signal of acceptance in her keynote Davos address, challenging the assumption of some policymakers and market participants that a doubling or trebling of existing rescue funds would restore real trust. Germany wants to be sure it has nailed down a new treaty on stricter budget discipline in the euro zone and a rulebook for the permanent bailout fund before it shows its hand on extra money, EU officials say. "Actually people are slightly more optimistic at the end of the week than at the beginning," British finance minister George Osborne, a member of the eurosceptical Conservative party, said.
Caution
Yet a note of caution is in order. Many delegates left last year's Davos too thinking the crisis was nearly over. This year, the mood was darkened by a bleak outlook for economic growth, with rising unemployment and deep recession in southern Europe widening a continental divide and making efforts to balance public finances even more difficult. Participants were most impressed this time by the decisive action of the ECB to shore up teetering banks. As a result, "there is not going to be a Lehman-style event in Europe," Canadian Central Bank chief Mark Carney said, referring to the collapse of the US investment bank in 2008, that triggered the global financial crisis. Markets had been baying for the ECB to step in as a lender of last resort to debt stricken countries, but the bank had fired its "bazooka" indirectly via the banks to avoid breaching its treaty mandate.
"The euro will continue to exist in its current form. It is highly likely that all countries will remain in. I think the odds are it just stays together," said Gary Parr, vice chairman of US-based investment bank Lazard Ltd. Parr said American skepticism about the euro zone's ability to mend itself was a mirror image of the subprime crisis of 2007-9, which was primarily felt in the US. In an informal show of hands at a closed-door session on global currencies, a majority of participants said they believed in the long-term survival of the single currency. Those who affirmed the euro would still be around in 10 years included a non-EU central banker and a top European regulator.
Worst over?
Market doubts about the euro focus on Europe's ability to rein in fiscal excesses at a time of slow growth and high unemployment, and a growing gap in economic competitiveness between northern and southern Europe. "The market says we may have confidence for six months but we are not sure we have confidence for 5 or 10 years," said Samuel Di Piazza, vice-chairman in Citigroup Inc's Institutional Clients Group. US Treasury Secretary Tim Geithner, on his sixth visit to Europe since last September, called publicly for the euro zone to increase the size of its financial firewall. Bankers who met Geithner said the fighting fund should be big enough to cover the borrowing needs of Europe's weakest debtors for the next three years to deter speculation and restore market calm. Italy, the euro zone's biggest worry, has 1.9 trillion euros of public debt, too big to be rescued were it to default.Many Davos delegates praised new Prime Minister Mario Monti's efforts to shake up the Italian economy, balance the budget and overhaul inefficient state structures. (Reuters)
