...or a better question, has CB activity and the promise of more (devaluation competition) created a risk-on situation starting in December? Is the market anticipating a 2009-like "recovery" thanks to "Helicopter Ben" and friends? We've paused at current levels for the past 2 weeks...
Long-term, the EMU can't solve its crisis without 1) a fiscal union;
and either 2a) transfer payments (e.g., a euro-investment fund) from competitive to non-competitive countries, and measures to move competitiveness among members to parity; or 2b) deflation in non-competitive and/or inflation in competitive members.
So far, only #1 has been acknowledged as necessary (by Germany, not so much the rest), but the last big meeting in December suggested half-measures, at best, to accomplish this goal ("enforcement mechanisms" suggested are a joke). #2 has had lip service paid to it by Italy, et. al., but we're still waiting to see large portions of their economy/professions opened up and state owned assets sold off. Acknowledging the problems, of course, says nothing about the political feasibility of implementing their solutions.
Michael Pettis has written
ad nauseam about
competitiveness being the root of the crisis (see also,
Italy's lack of competitiveness). His intro is spot on: "Europe’s underlying problem is not budget deficits or even unsustainable debt. These are mainly symptoms. The real problem with Europe is the huge divergence in costs between the core and the periphery – in the past decade costs between Germany and some of the peripheral countries have diverged by anywhere from 20% to 40%. This divergence has made the latter uncompetitive and has resulted in the massive trade imbalances within Europe."
Before the euro,
as Milton Friedman noted: “the various countries in the euro are not a natural currency trading group. They are not a currency area. There is very little mobility of people among the countries. They have extensive controls and regulations and rules, and so they need some kind of an adjustment mechanism to adjust to asynchronous shocks—and the floating exchange rate gave them one. They have no mechanism now.” "Canada and Flexible Exchange Rates," Q&A section, pg. 419-20, (ht
bondvigilantes.com). In other words, without the ability to devalue, the EMU needs to institute transfers from competitive to non-competitive countries, and/or enact measures to equalize competitiveness. Good luck to them (as a whole and individually) on being able to pass either of those measures.
As far as efforts to increase competitiveness, e.g., in Greece,
a senior IMF official is quoted as saying these measures face "'unprecedened [sic] delays' in the proper implementation of fiscal and structural reforms linked to the first 110bn euro bailout programme. Instead, 'horizontal austerity measures are constantly being adopted that are leading nowhere, whilst further wage and pension cuts are unjustified because the only way to improve competitiveness is through growth-creating market liberalisation, the opening of closed professions and productive investments.'" In short,
no one will do what is necessary, unless and until the SHTF.
Short-term,
IP continues to decline:
However, the latest flash euro/German/French PMI figures are on a 2-month bounce which I think may continue. What matters at least as much, if not more, is whether Italy and Spain will follow; so far they have not.
Further indication that all will not be well in Italy and Spain are deleveraging trends. Bank loans have been shrinking the last few years in
Spain and are now trending downward in Italy (
pg 23). Also troublesome for social stability as well as an economic indicator is high and rising unemployment in Spain, Greece, et al.
What about the short-term?
Near-term potential for catastrophe is on the decline...
EUR 2-yr. swap spread
3 mo. EUR basis swap
However, the potential for crisis and contagion remains.
Deposits continue to flood out of Greek financial institutions. Likewise, Italian residents have been withdrawing deposits from domestic institutions since the end of 2010 (
see page 23). Further, which should come as no surprise,
Spain's banks have overvalued property on their books by almost 50%. The most imminent cause for concern, however, is Greece securing its next tranche of aid before its March 20 EUR14.5 bond redemption. Receiving that tranche will depend on a number of factors.
What must happen for Greece to receive the next tranche before March 20?
First, a new loan package must be negotiated between Greece, the EU and IMF. That must be completed before the offer (as the result of the ongoing negotiations) can be made on the PSI (tentative deadline is February 13). Greek Finance Minister Venizelos stated he wants this completed by February 5th. These negotiations have been complicated by the demands of Germany. (
see Germany requires Greece to hand over control of budget for a period of time before releasing next aid tranche due to poor performance to date;
Greece declines Germany's demands to hand over budget control).
Second, a deal must be reached with Greece's private creditors (only 3/4 of whom are participating in this "voluntary" restructuring) to exchange their bonds for those worth ~70% less. As that will not be enough to bring Greece's debt/GDP < 120% (which is unsustainable anyways), public sector creditors (i.e., ECB and NCB's) will have to take a haircut, too. But only the private creditors must have this completed
by February 13.
But what, exactly, will a deal to write off an insufficient amount of debt do when completed and combined with an agreement for a new Eur130 billion loan, which we already know is at least Eur15 billion too small? Risk on? Maybe in the very short-run, but I have a feeling this obviously insufficient deal will be enough by itself to cause problems not too far down the road...and the moral hazard of which may cause issues in Portugal sooner rather than later.
Also interesting to note is the rhetoric of the negotiations -
Greece to default and exit Euro if it doesn't get a new bailout.
Will moral hazard become the next stage of the crisis?
Do rising Portuguese yields signal market anticipation of Portugal feeding on the moral hazard? In other words, why would Portugal go through the same foreign-imposed pain as Greece and get worse treatment? If Greece gets a writedown on its debt, why shouldn't Portugal?
I don't put alot of stock in to the
Portuguese PM denying that his country won't want the same treatment...
Also interesting to note that the
Greek PSI model won't work in Portugal...
Ending with a Quote:
"While many claim that a Greek default is priced in, we don’t buy that, as we apply the “no such thing as one cockroach” theory. By itself a Greek default isn’t a disaster. The problem is that it will drive borrowing costs for the other GIIPS out of range risks starting an avalanche of sovereign and/or bank defaults from the banks holding those bonds."
http://seekingalpha.com/article/322851-u-s-dollar-forecast-what-everyone-needs-to-know
