Euro war games shape financial strategy

On 13-14 September about 100+ movers and shakers took part in a conference and "war game" organised by the Breughel think tank, modelling solutions to the euro crisis. I am reliably informed this was not just a "what if?" but has - given the result - influenced crisis management in the non-war game world of Washington DC.

The full document is here. But the summary is: they saved the euro. Here's how.

In the war game the EU/IMF decided to expand the European Financial Stability Facility (EFSF) to between $3 trillion (£1.9tn; 2.2tn euros) and $5 trillion (£3.2tn ; 3.7tn euros). This was done by leveraging the 440bn euros supplied under the EFSF legislation going through European parliaments this week, plus match funding from the IMF. And by the ECB issuing "collateralised finance".

That is, by pledging around 700bn euros, they borrowed up to $5tn and then lent it to European banks and countries, starting with Greece. They got the money by mortgaging the assets of Europe basically, because $5tn is a lot. They mortgaged the EFSF money, and then the ECB borrowed money against the future tax revenues of Europe.

There were two interesting outcomes:

1. They saved the euro. Greece, Ireland et al stayed inside, now protected forever - certainly for the lifetime of the participants, who were mainly on the upside of 35 - by the wedge of money conjured from thin air.

2. It didn't solve the structural problems facing the periphery - but simply gave them more time to sort it out.

An account of the game reports: "The large new lending facility was seen by some players as free money for errant countries without sufficient conditionality."

This Breughel document is doing the rounds in Washington DC, and contains an uncanny blueprint for what might now be about to happen. However the term "war game" always summons up a defensive reaction in me. Not because I am against them: I am a bit of an addict. But they can be deceptive.

The Soviet high command shot and imprisoned staff officers who, between 1938 and 1941, argued that war game evidence suggested a mobile defence against a German blitzkrieg would be necessary. They relentlessly shaped the war game evidence towards the USSR's swift victory in a WW1-style "war of position". They did this by ignoring key facts.

Now, call me cynical but assembling 50 well-heeled types at Chateau Les Fontaines in Chantilly might not have given us the best hands-on understanding of how the actual people of Europe might take the issuing of $5tn of free money to once again save the banks.

Viz: the Germans and Finns might revolt against it, the Greek workers might take it and run with it, and Europe's trade partners/rivals might see it as a tad in breach of every global rule on the planet.

It was of course, Breughel the elder who painted this.