Kiron Sarkar lives in London and Ireland where he works as a money manager. He occasionally attends the Scarsdales Equity idea lunches when he comes to New York, which is where I met him.



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.

Category: Markets, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

9 Responses to “Trichet/Sarkozy 1 Merkel 0”

  1. keithpiccirillo says:

    Yup, merely the half time score.

  2. arbitrage789 says:

    “…the biggest issue remains – the lack of capital of a number of European banks…”

    Bail out the depositors… and no one else.

    . . . . . .

    “No matter what measures the Greeks promise to abide by, they will not deliver…”

    Very hard to find anyone – – other than George Papandreou himself – - who disagrees with this. I suppose the bond investors are betting on a partial default, not a full one. Probably a good bet.

  3. Did anyone notice there are zero stats in this rant. I hope he is not also short the EURO. When he started his whining, the EURO was 1.18, but after Prime Minister Harper got the G-20 to agree to austerity measures the EURO has climbed back up to 1.43 exchange rate agin the USDollar. That’s all we need to know this hysteria over the EURO and its lesser countries is just smoke&mirrors to take the spotlight off the lousy fundamentals for the USA federal gov’t.

    The USD is down 25% since the Toronto G-20/G-8 summit. This has added $23 to a barrel of oil. The latter trimmed 1.5% off May’s GDP growth rate. And your boss is busy fund-raising for 2012 & playing golf…

  4. Greg0658 says:

    “And your boss is busy fund-raising for 2012″ .. this is “F-ing golden” .. and your wish list isn’t?
    or is that not needed – its sorta the club membership?

  5. TomO says:

    “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.”

    OK- someone help me with this. What I think he is saying that the financial world will end if European taxpayers do not surrender whatever amount of wealth foolish bankers demand of them, now and in the future. That the only alternative to financial Armageddon that exists is complete surrender to the very people that caused this problem, who must be made good in their entirety, multi-million Euro bonuses and all.

    Am I missing something? Has the sense of entitlement become so ingrained among financial market participants that the idea of economic serfdom for the great unwashed is just a given?

    This is a ludicrous as listening to all the right wing financial professionals complaining about deficits and taxes and government intervention in general. If it wasn’t for the government screwing small savers, the unemployed and working people in general to protect the financial services industry from the consequences of their own breathtaking incompetence, a lot fewer of these guys would have their 5, 6, 7 or 8 figure bonuses or even their jobs.

  6. blackjaquekerouac says:

    Do like Freddy Hutter on this one. To me however we need no stats vis a vis Europe since this story can be summed up in a single sentence: EUROPE HAS DONE NOTHING BUT TALK. “Kicking the can down the road” is charitable–and the DSK fiasco is proof positive is it not? Simply put Europe not in the immortal words of Cramer “been in the game” since day one. Throw in Fukushima and “welcome to the Game, folks.” A slowdown is to be expected at a minimum. We shall see if we are on the verge of a bloodbath as well (for this is no mere financial crisis oui, oui?) It is wrong to use the term “holistic” in order to explain why so many simply don’t get it? In a word-smithing sense of course it is–but clearly the “focus on the trees” has now been called out. As it is meant to be…c’est la vie.

  7. Excuse me? Europe is dropping pension age. Cutting civil service. Slashing wages & benefits. And what is the USA doing? Albeit debt ceiling has passed and is on life support ’til Aug 2nd … Congress spent three weeks laffing about Weiners pickle.

    Your so screwed…

  8. wally says:

    “Europe is dropping pension age. Cutting civil service. Slashing wages & benefits. ”

    A positive and proven means of guaranteeing a decade of no growth… or worse.

  9. Dennis954 says:

    I am curious to know who yanked Merkel’s chain. I suspect it is the German banks. Why should the banks and bondholders “voluntarily” participate?? They created this mess !! The EU governments should protect the depositors and inform the banks that they WILL take the haircut in a Greece restructuring. Default is just a matter of time. The sooner Greece’s debt is restructured, the less bitter the pill will be.