By Tom Luongo - October 30, 2023

The leaders of the European Union met last week to discuss how to rearrange the deck chairs on their political Titanic. While the decisions to continue to monetarily support Ukraine and now Israel dominated the headlines, the real story is that what they have to get right is the new budget rules.

And that discussion is important in the context of continued tight monetary policy by the Fed and now the potential for fiscal sanity coming from Capitol Hill with new Speaker of the House Mike Johnson than it was a year ago.

In January, suspension of the Maastricht Treaty budget rules ends, meaning harsh ‘austerity’ comes back into play for the 28 members of the EU. In short, it means targets for budget deficits of no more than 3% of GDP and a debt-to-GDP ratio of 60% are the law of the land…

Unless you’re France.

This is the thing hotly debated during last week’s European Commission summit in Brussels. How do we, as the EU, engineer a soft landing on budget rules while not alienating what’s left of our investor base?

The rules were suspended originally because of COVID-19, as part of, in my opinion, the planned destruction of the European middle class. The point of COVID-19 from a EU policy perspective was to create a crisis that demanded a pre-ordained solution: integration of Europe’s finances under the control of the European Commission (EC) and the European Central Bank (ECB).

SURE You Are…

This was partially achieved by giving the EC limited taxing authority to issue pandemic loans under the €800 billion COVID recovery fund, the first tranche of which were called SURE bonds. The camel’s nose is now under the wall of the fiscal tent.

There is also a major push happening offscreen for these bonds to become indexed next to everyone else’s, i.e. to more easily sell them to Muppet investors, through the imprimatur of them being official and backed by the full faith and credit of the EC. Of course, the initial investors in them have lost their ass as the bulk of them were issued when the ECB was at -0.6%. (See Here).

The ECB just held rates at 4.5%. The bond math doesn’t work. So, the EU got the last big lot of blood and treasure after the COVID operation from its investor class, who are now sitting on massive losses. Some of these investors, of course, were the member central banks themselves.

Don’t believe me? A €7 billion 0.1% coupon SURE bond maturing in October of 2040 is now trading at a yield of 3.867%. Now that doesn’t look so bad until you grep the price of that bond, which is trading with a bid/ask spread of 0.54/0.55… or a 45% loss.

Well, when I say trading, I really mean quoted, because no one actually trades this hot garbage, certainly not with yields rising globally, inflation not tamed anywhere for anything that really matters, and the euro clinging to the cliffside of a precipitous fall against everything that isn’t the Japanese yen.

And the Bank of Japan is intervening daily to shift its monetary policy to defend the yen. And they will.

But don’t feel too bad folks, because the EU is so creditworthy you’ll get your money back in 17 years paid in full plus 0.1% compounded annually.

And they want these things listed as an index next to, you know, German bunds, UK gilts or US T-bills… Why? So people can laugh at them?

If these people actually had blood in their veins they would feel at least a modicum of pressure from the investors they swindled out of billions. But they don’t.

What they want now is to get more fiscal integration in order to reassure investors that their more perfect union will be that great bet for 2040.

This is why ECB President Christine Lagarde lobbied hard going in for more fiscal unity.

Ensuring a deal about the implementation of the Stability and Growth Pact would be an important signal of unity, Lagarde said — according to an official familiar with the conversation — observing that the bloc’s framework must promote both debt sustainability and investment.

EU countries are at loggerheads over how flexibly to enforce the fiscal regime, which normally limits deficits to 3% of gross domestic product. Such rules have been suspended since the onset of the pandemic, but are due to be reinstated at the start of 2024.

If you want to understand why . . .

[SNIP]