Wednesday, April 28, 2010

Europe is to big to fail...but

It is now obvious that Southern Europe is too big to fail. But it is not clear exactly who is supposed to fund the bailout. 

First of all, Germany can't guarantee all of the sovereign bank debt in the EU, and Brussels itself has no financial resources whatsoever. The EU is a club, not a country.

So who is the lender of last resort for Spain and Italy? 

Well, it's not the IMF. The IMF has limited resources. It can come up with packages in the $50 billion range for large countries, but this is too small for a country like Spain. The IMF has been a big help in the Baltics, but now we're talking about real countries.

As I have said before, the ECB has a EUR 2 trillion balance sheet. It is big enough, but politically, the Germans are not going to turn the ECB into a development bank without a fight. And they have a veto.

Which leads us back to the IMF. It is in everyone's interest that Europe does not have a wave of sovereign (and bank) defaults, plunging the world into an unthinkable crisis. Therefore, Greece has morphed from a eurozone crisis to a global crisis which includes the US, Japan, and China. 

I think it is necessary for the IMF to be dramatically recapitalized, and for it to access the debt markets like the World Bank. It needs a trillion dollar balance sheet. Simultaneously, Europe needs a regional IMF with serious resources as well. But time is of the essence.

Europe's Plan A is to bridge Greece into 2011 and to pray to the eurogods that Spain, Portugal and Ireland retain market access (doubtful). If that doesn't work, time is very tight, while an IMF recap and the creation of an EMF simply can't happen quickly. 

Before this is over, the IMF will be bigger and Europe will probably have an EMF. But not soon enough to forestall a series of crackups that could make Lehman look like a fender-bender.

Investment conclusion: good for Treasuries, the dollar, the yen. Bad for global equities, the euro, and any other investment that begins with the letters eur. Probably bad for sterling as well (they're in Europe).

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