Guest post by Peter Tchir.
The Bull Case
I had turned bearish on the situation in Europe last week, which had worked well until yesterday. I remain bearish, but there is an obvious and possibly realistic path for the bulls.
1) Spain, followed by Italy ask for and receive OMT and ESM support. The terms of which are generous.
2) Spanish bank recap goes ahead.
3) Budgets work, economies show signs of rebounding and markets reach new highs.
That is the bull case in a nutshell, and I had believed in it for awhile, but don’t see anything working out quite smoothly.
Restoring stability, while avoiding the contagion effects is a failed policy. This should be clear to majority of people by now. The bigger question is, what do the politicians need to do going forward? From Voxeu.
The EZ rescue strategy adopted in May 2010 failed to restore debt sustainability, avoid contagion, or reduce moral hazard. This column argues that a volte face is needed. The debt of Greece, Portugal and Italy – and perhaps Ireland, Spain and France as well – must be restructured to restore growth and end the crisis. All EZ nations should pay since their leaders’ decision to violate the Maastricht Treaty’s no-bail out clause is what brought us here.
Chancellor Angela Merkel has sent word that Germany cannot save the euro. She is right.
From the very start of the Eurozone crisis, it was clear that a domino game was under way and that a highly indebted German government should not be seen as the residual saviour. But keeping the euro will be costly and Germany will have to share the burden.
The solution will have to combine debt structuring and ECB lending in last resort to banks and governments. Angela Merkel needs now to lift the German veto.
In case you missed it over the US long holidays, here is the FT Wolf’s interview with Krugman.
So, I ask, will the argument of the column be that “it’s all over” for the eurozone?
“No. I don’t think they can save Greece but they can still save the rest if they’re willing to offer open-ended financing and macroeconomic expansion.” But this would mean persuading the Germans to change their philosophy of economic life. “Well, the prospect of hanging concentrates the mind; the prospect of a collapse of the euro might concentrate their minds.”
I change the subject to ask how he has coped with the shift from being predominently an academic economist to being the leading spokesman for the liberal cause. How did this happen? “Well, it was funny,” he responds. “I was doing a column for Slate and then a bit for Fortune, towards the end, and then the [New York] Times came along with this offer. It was 1999. We thought I’d be writing about the follies of dotcoms and stuff like that and then it turns out that it’s a much more awesome and ominous responsibility. It was nothing I ever planned.
“Really, the rough period was the first [George W] Bush term when it seemed like the whole world was mad, save me, or vice-versa, and it’s gotten easier.
“I have to say, though, that the economic crisis has played into the things that I was worrying about 15 years ago. It’s been almost alarmingly easy to figure out what to say. But it’s a very strange thing: it’s not at all what I was imagining I was going to be doing with my life.” (Full link here).
The “risk on/risk off” barometer moved back in the direction of “risk off” during April, as U.S. 10-year Treasury securities turned in the best investment gains (in U.S. dollar terms) during the month. The 2.8% jump in the value of the Treasury securities came despite the almost universal perspective on the part of professional investors that the 30-year bull market for bonds is finally sputtering to a halt and that eventually interest rates will begin to climb. Investors displayed a clear bias in favor of assets that not only generated income but also offered them security – in other words, bonds of various kinds were the only major asset classes to end the month in the black.
So the Euro is once again under attack. S&P delivered THE downgrade on Friday. Nothing unexpected actually, but of course not pleasant for the increasingly de united Eurozone. If the Euro survives or not, nobody knows, but one should definitely prepare for the worst. From PIMCO.
The risk of one or more countries leaving the euro – or indeed the euro breaking up into national currencies or new smaller currency blocks – is no longer something to casually dismiss. The volume of PIMCO client questions on this topic attests to this. The possibility is also no longer politically unthinkable. French President Nicolas Sarkozy and German Chancellor Angela Merkel contemplated the previously unimaginable last November when they said, “The question is whether Greece remains in the eurozone.”
So even if the euro survives this crisis intact, scenario planning is indispensable for investors. Indeed, even if no country actually leaves the euro, investors need to think about the implications, because the market will price in this uncertainty as the euro debt crisis evolves. As 19th century British Prime Minister Benjamin Disraeli famously said, “I am prepared for the worst but hope for the best.”
Remember the Teflon market? It sure seems 2012 started of in this “teflon” way. Markets are climbing the wall of worry, and nobody wants to miss out on the bull (nor the bear). Europe is still the main character in this debt soap opera. Some great insight on the Euromezz by Grant Williams of Things that make you go hmmm.
As we enter 2012, it is clear that Europe is still the focus of most people’s attention (although I suspect the gradual shift towards the Middle East is a trend that should and will accelerate in coming weeks) and I firmly believe that the continent is finally heading towards a resolution in 2012.
I suspect that resolution will NOT be pretty, will result in much upheaval and, ultimately, mean the end of the euro (at least in its current form), but from the ashes of that resolution we will find the clarity we need to move forward and put the past 2 years of ever-worsening headlines behind us.
Greece is done. Period. They cannot remain in the Eurozone – nor should they and, with the next bailout package (this time north of €100bln) being due in March when a whopping €17.5bln of Greek debt will need to be sold (although, between now and then, any of the 5 smaller auctions – starting with next week’s €2bln could tip the scales), it’s hard to see how they make it past that point. The Troika’s visit to Athens on January 16th will no doubt ramp up the rhetoric once more, but realistically handing ANOTHER €100bln+ to the Greeks would be both cavalier and stupid.
What would happen if the euro collapses as in collapses? Despite all the Economic effects, that wouldn’t be offset by the fees lawyers would collect, we could even get the blame game escalating into war. Below are Citi’s bullet points to remember should the political experiment fail, courtesy James Pethokoukis.
1. A break-up of the Euro Area would be rather like the movie ‘War of the Roses’ version of a divorce: disruptive, destructive and without any winners. A break-up of the 17-member state Euro Area, even a partial one involving the exit of one or more fiscally and competitively weak countries, would be chaotic. A full or comprehensive break-up, with the Euro Area splintering into a Greater DM zone and around 10 national currencies would create financial and economic pandemonium. It would not be a planned, orderly, gradual unwinding of existing political, economic and legal commitments and obligations.