Canada Facing EZ Contagion?

Blooomberg reports that Canadian Finance Minister Jim Flaherty says Europe’s debt crisis is creating “contagion” outside the region and policy makers must act while the situation can still be “stabilized”:

“Again today, we are staring a crisis in the face,” Flaherty said in the text of a speech he’s giving today in Toronto. “The crisis remains far from resolved.”

European leaders have spent two years struggling to prevent contagion from affecting the region’s largest economies such as France and Germany. Italy had to pay almost 7 percent to sell six-month bills at an auction today, and Germany failed to sell 35 percent of 10-year bonds on offer at a Nov. 23 sale.

“Ongoing uncertainty stemming from the European sovereign and banking crisis is leading to broader contagion outside Europe and global credit markets,” Flaherty, 61, said today. “If European authorities move aggressively and with decisiveness to address the crisis and restore financial market stability and confidence, the situation can be stabilized.”

Citizens in many countries face “dire consequences” without a quick solution, including more social unrest and major tax increases, Flaherty said.

Flaherty’s speech didn’t single out any countries or political leaders, adding that all Group of 20 countries have committed to boost economic growth and shrink budget deficits.

Debt Ratio

He touted Canada’s ratio of debt to gross domestic product of 34.9 percent, which he said compares with the Group of Seven average of 80 percent, citing International Monetary Fund estimates.

While Canada may offer additional stimulus measures if needed, the government won’t resort to “dangerous and risky new spending schemes,” Flaherty said. Canada’s federal and provincial governments must all aim to restore balanced budgets, he said.

Slower global growth led Flaherty to say Nov. 8 he would delay plans to balance the country’s budget by a year. The country’s cumulative deficit would be C$29 billion ($27.6 billion) higher between 2011 and 2016.

Canada’s two-year government bond yield rose 4 basis points to 0.953 percent at 12:26 p.m. in Toronto. Earlier today, the Canadian dollar touched C$1.0524 per U.S. dollar, the weakest since Oct. 5.

Flaherty is right to worry about Europe's debt crisis creating contagion as he saw the ravages that the 2008 credit crisis caused in the Canadian economy, especially in the auto sector. Publicly he is touting Canada's fiscal balance but privately he's nervous as hell because he knows the debt profile of the private sector is horrible and when the Canada bubble bursts, which is only a matter of time now, it will place huge pressure on government spending.

Meanwhile over in Europe, Reuters reports that eurozone states may ditch plans to impose losses on private bondholders should countries need to restructure their debt under a new bailout fund due to launch in mid-2013, four EU officials told Reuters on Friday.

Discussions are taking place against a backdrop of flagging market confidence in the region's debt and as part of wider negotiations over introducing stricter fiscal rules to the EU treaty.

Euro zone powerhouse Germany is insisting on tighter budgets and private sector involvement (PSI) in bailouts as a precondition for deeper economic integration among euro zone countries.

Commercial banks and insurance companies are still expected to take a hit on their holdings of Greek sovereign bonds as part of the second bailout package being finalized for Athens.

But clauses relating to PSI in the statutes of the European Stability Mechanism (ESM) - the permanent facility scheduled to start operating from July 2013 - could be withdrawn, with the majority of euro zone states now opposed to them.

The concern is that forcing the private sector bondholders to take losses if a country restructures its debt is undermining confidence in euro zone sovereign bonds. If those stipulations are removed, most countries in the euro zone argue, market sentiment might improve.

"France, Italy, Spain and all the peripherals" are in favor of removing the clauses, one EU official told Reuters. "Against it are Germany, Finland and the Netherlands." Austria is also opposed, another source said.

A third official said that while German insistence on retaining private sector involvement in the ESM was fading, collective action clauses would only be removed as part of broader negotiations under way over changes to the EU treaty.

Berlin wants all 27 EU countries, or at least the 17 in the euro zone, to provide full backing for alterations to the treaty before it will consider giving ground on other issues member states want it to shift on, officials say.

Germany is under pressure to soften its opposition to the European Central Bank playing a more direct role in combating the crisis, and member states also want Berlin to give its backing to the idea of jointly issued euro zone bonds.

German officials dismiss any suggestion of a 'grand bargain' being put together, but officials in other euro zone capitals, including Brussels, say such a deal is taking shape and suggest Berlin will move when it has the commitments it is seeking, although it's unclear when that will be.

German Chancellor Angela Merkel said after meeting French President Nicolas Sarkozy in Strasbourg on Thursday that there was no quid pro quo being set up.

"This is not about give and take," she said.

Euro zone finance ministers will discuss the ESM at a meeting in Brussels on November 29-30, including the implications of dropping collective action clauses from its statutes.

COMPLICATIONS

While most euro zone countries just want to forget about enforced private sector involvement, some are adamant that there must be a way to ensure banks and not just taxpayers shoulder some of the costs of bailing countries out.

Austria's opposition Green Party, whose support the government needs to secure backing for the ESM in the Vienna parliament, insists collective action clauses must remain a part of the ESM. It's also far from unclear whether the finance committee of the German lower house Bundestag would agree to such changes being made to the ESM.

Any changes to the mechanism would have to be approved by all member states and ratified by national parliaments before they can take effect, meaning fixed Austrian and German opposition could derail the push for changes.

Germany and some other member states were hoping to bring the ESM, which will have a lending capacity of 500 billion euros, into force as early as July next year, but disagreement over its structure could delay that.

In other words, more fiddling while Rome burns. Germany has to bite the bullet or it too risks sinking now that it has bought a first-class ticket on the Titanic. The endless political posturing will be met by more forceful selling of all European debt, including German bunds. In the end, the bond market will break Merkel and any other EU politician who adopts a hard stance against expanded powers for the ECB and a credible eurobond market.

Below, Nobel Prize winner Joseph Stiglitz talks about the risk of a recession in Europe and fiscal policy. He speaks from Helsinki with Francine Lacqua on Bloomberg Television's "Countdown."