What a week. At the end of the previous week, the Germans signalled that they would take a tough stance on Greece, only for Mrs Merkel to completely cave in this week. Trichet and Sarkozy must have the biggest smiles on their faces – for how long though – never underestimate the Germans.
The Greek PM, reshuffled his cabinet, appointing a political opponent as Finance Minister. A confidence vote is to be called. This coming week, the Euro Zone Finance ministers meet – presumably they will agree (with the IMF) to transferring the next trance (E12 bn) of aid to Greece, which will need approval by the Euro Zone Heads of State, at a follow up meeting. This and any subsequent transfers of money are going to be a complete waste of money, though in the circumstances is the right thing to do, as the Euro Zone does not have a plan to deal with the consequences of a Greek default and, in particular, the contagion effects that will follow – essentially a number of European banks will be bust.
This is not yet a done deal. The biggest threats. Well, the Euro Zone Finance Minsters/Euro Zone Heads of State may not agree on a bail out package (unlikely), the German Parliament could vote against (a more serious issue, but on balance, also unlikely), the Greeks could reject the additional austerity measures (unlikely, as they need the money to pay their bills), the Greek Parliament could vote against the PM (less certain, but, following the cabinet reshuffle,unlikely) and the German Constitutional Court could well consider the further tranche of aid illegal, as its a fiscal transfer, which is specifically prohibited by the Euro Zone treaties (a real threat) and/or certain countries (such as Finland) may not approve a further aid package to Greece (all Euro Zone countries have to approve the additional aid package).
The biggest issue remains – the lack of capital of a number of European banks, which as we all know, is really the reason for all of this nonsense. Since the 2008 crisis, the Europeans have singularly failed to address this issue. Indeed, the Germans and the French have resisted moves to increase core Tier 1 capital ratios (last week, a number of the major French banks were downgraded). They will be paying far more attention to it now, as unless achieved, this very sorry state of affairs will continue.
What next. Well, the Europeans have to address the real issue ie the under capitalised banks. Basically, Governments have to provide the funds and/or act as a backstop, if the market cannot (as is likely) – not that easy to do at present, as their financial positions of a number of Euro Zone countries are stretched, but they will have to.
There is also the issue of bank bail outs being politically difficult.
The European Bank Stress Tests, due out in July, will be a complete waste of time, as they do not address the issue of haircuts (which are clearly necessary) on Sovereign bonds held by European banks on their banking books. The market will not be fooled this time – indeed, I was totally amazed it was, last time around.
There is a “sell by date” involved in all of this – in my opinion no later than the end of this year, but certainly not 2013, as the Euro Zone believes. The current situation is unsustainable.
No matter what measures the Greeks promise to abide by, they will not deliver, though from now on it gets tougher, as they will have the EU/ECB/IMF in Athens, verifying the numbers – the most recent data clearly shows that Greece has (once again) failed to deliver. The rest of Europe could not care a damn about Greece, I assure you. Indeed, my suggestion of handing over the country to the Turks is, quite frankly, the mildest suggestion around.
As a result, this crisis will pop up again. Moody’s, followed S&P, by placing Italy on review for a possible downgrade. Given the political situation in Italy (Berlusconi is coming under additional pressure – he lost a referendum recently – but there are few, if any, others who can take over as PM), the country is likely to be downgraded. Ireland is threatening to extend haircuts on senior bank bondholders – inevitable, in my view. Portugal cannot survive with its present debt load, given its anemic growth, but the population is not as vocal as the Greeks and the new Government will be given some time.
The biggest threat remains Spain. As you know, I believe that stories of “black holes” in provincial debt will emerge in coming weeks, following the recent elections, which resulted in a change in administration in most of the regions/municipalities. Spanish banks have not made adequate provisions and will come under pressure.
With a common currency and the freedom to move your money around, why would depositors not withdraw their funds from the banks of the peripheral countries and move them to “safer” banks in core Euro Zone counties. Off course they will. How do the banks in these peripheral countries survive – well they have to borrow more from the ECB, who are trying to stop reduce emergency short term financing to “addicted banks”. As a result, the ECB just takes on more and more risk and which, inevitably, will result ion greater and greater losses. Indeed, I would argue that the ECB is bust, if their assets and collateral is marked to market.
I simply cannot believe that this situation can last much longer.
One solution could be for the EFSF to buy peripheral country bonds at a massive discount (in Greece’s case 70%+) and, in effect, allow the peripheral Euro Zone countries to reduce their overall debt burden. In this way, at least, you are not throwing good money after bad – Euro Zone Governments a chance of getting their money back. OK, the ratings agencies may well call such a scheme a default, but at least the markets will understand that there is a comprehensive plan to deal with this mess – in any event, the market knows that there will be a default. A scheme of this kind, or something similar, will in my humble opinion, result is a major relief rally indeed. In addition, facilities will need to be put in place to recapitalise European banks, as a scheme of this kind will result in Greek banks going bust
- most likely a number of banks in other peripheral countries. The cost will be enormous, but what the alternative.
The simple issue is that further austerity measures will result in the economies in these countries continuing to decline, which will make the existing debt burden greater. These countries need positive economic growth. “Hair shirt” type measures are a complete nonsense – the Germans are disciplined enough to accept them – other Euro Zone countries are not – just watch your TV and you will see the riots in Athens.
The Europeans were stupid enough to agree to a currency/monetary union (without a political/fiscal union, including a transfer system + verification), which was fundamentally flawed right at the outset – there is no easy way out. They now have to take the necessary medicine and hopefully, not be quite so stupid again (some hope).
A number of people are questioning whether the current Euro Zone can survive. Clearly it is more than a little shaky – but how can you kick out Greece. If there is to be a restructuring, Germany + a few others will have to leave the Euro Zone and set up Euro2, rather than Greece and quite possibly others leaving, to avoid the scenario of the Euro denominated debts in these peripheral countries, becoming a much larger burden.
The ECB signalled a rise in interest rates in July – pure madness in my view, given the current situation. However, the ECB is more concerned about its image rather than economic/financial reality (as a recent Economist article pointed out). As a result, a rate rise in July is near certain (I still think there is a small chance there will not be a rate rise – however, the ECB has to come to its senses).
However, forget any further rate rises – which are still being priced in by the markets – it just will not happen. The Euro, well its bounced a bit this week, but in my view, has significant downside risk from now on. The prospect of wider interest rate differentials will no longer support it. Indeed, even if the ECB hikes rates in July, I think there is a fair chance that rates will be reduced in due course, quite possibly this year.
A number of you think I’m being a bit harsh on the Euro Zone – well, I have banged on, for a very long time, as to the impossibility of the Euro Zone currency union, as currently constituted. This crisis was inevitable. Basically, I’m just sticking to my original and long held views.
Best
Kiron
PS For full disclosure purposes, I’m short the European banks – Santander, BBVA, Credit Agricole and Societe Generale and the IBEX.
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