The Final Act of ‘The Tragedy of the EMU’
I have been hard at work on a major paper and haven’t had a moment to blog. But I did want to comment on the European denouement. This final act will have many scenes, and we will likely see some significant plot twists along the way. But here is where we are at as the curtain rises:
-Here’s what hasn’t worked:
- Sweeping the problems under the rug – deferred “solutions.”
- Believing that the German electorate will merely roll over and bail out the entire EMU.
- Considering the Eurobond to be a viable option in the absence of fiscal union.
- Believing that fiscal union is a realistic short term solution.
- Moralizing about how the debtor nations need to take their pain and (Ireland and Portugal aside because they might and are small anyway) then expect them to impoverish themselves quietly.
-A Greek default and a return to the drachma is priced into the debt markets in terms of its direct impact. As to the indirect impacts – failing banks in Greece (less of a problem, they can recap with drachma) and elsewhere (more of a problem), it’s anyone’s guess if the markets are reading things adequately. The blow itself measured in the quantity of losses won’t be that staggering. The domino effect (counterparty issues among, mostly, EMU banks – but watch for unknowns) is quite another story.
-From my trader friend, Peter Tchir: “Greek bonds are dropping again. Yield is largely meaningless for Greece, but it is still eye-catching to mention that Greek 1 year bonds yields more than 100% at a price of 53.5% of par. With the 10 year bonds at 45% of par, the yield inversion is almost over, and the next phase is for the market to create a rumor that Greece is going to be trading “flat” (trading with no accrued is the final step before default).” The market is saying that Greece is toast.
-Spain is, I believe, the next great problem. Its problem is not sovereign debt – but its banks and real estate sectors are in total shambles. Much more like the U.S. in that respect. Italy is a 2012 issue unless things really go to hell in a hand basket…..which brings us to the core. The core and its woefully undercapitalized financial institutions is the real show. The rumored IMF internal study indicating $275 billion bank capital shortfall in the zone (which Lagarde swiftly denied) may be more accurate than the IMF wants us to believe right at this moment (albeit, they will initially recommend that banks have an “extended period of time” to plug the hole).
-The Euro is collapsing because of shock and awe to be sure. But the bloom that has kept the Euro strong vs. the dollar is now off the rose. The EMU is simply not strong enough to avoid jumping back into the developed nations’ race to the bottom on interest rates and currency value. Of course, since not everyone will be able to devalue at once, the far less stable EMU will be the – um – “winner” in that the ECB will continue to cut rates and the Euro will devalue vs. the dollar. (The U.S. already being at the zero bound and being much more of a reserve currency).
-In the end, this is Europe’s best and brightest hope: renewed competitiveness with a weaker currency relative to the “Chimerican” dollar, recapitalizing their core institutions, and lopping off the dead wood (Greece and maybe a couple more) that are too much of a burden to bail out. And it is all possible if the leaders in Europe roll up their sleeves and really do the responsible thing rather than just moralizing about it.
One Response to “The Final Act of ‘The Tragedy of the EMU’”
trending now • May 15th, 2012 at 6:22 am
Nice share…i like your title! 
Economy it's like a poetry….;)
