Sunday, June 17, 2012

Europe sounds the All-Clear

Boy, that’s a relief! Just a few days ago the eurozone was about to blow up, and now they’re sounding the All-Clear. I feel so much better now. Mario Draghi has a bank rescue plan, and Greece will accept the bailout and stay in the zone.

Tomorrow the stock market will rise, yet again. Watching the stock market during this crisis has been fascinating: stocks are so screamingly cheap that the market will grasp at any straw to rally. Any news is good news, even bad news.

Now let’s go back to reality. Actually, Europe hasn’t won the war.

First of all, the “Draghi Plan” as described in today’s NYTimes is a long-term solution to an immediate problem. Yes, of course it would be nice if the eurozone had a single bank regulator, and yes it would be nice if the eurozone were able to create a credible deposit insurance scheme. Someday, who knows, all of that may come to pass. But right now, there is no reason why a rational bank depositor in any PIIGS bank would not be in the process of moving his money not only out of the country, but out of the eurozone.

Draghi is seeking some basis to continue lending to the insolvent banks in the PIIGS. He needs a solvency fig-leaf to justify continued lending to bankrupt banks, and the dirty secret is that every PIIGS bank is insolvent if its government bond portfolio is marked to market.

Next, the Greek election. Let’s assume that New Democracy and PASOK form a coalition and agree to continue the austerity plan “with modifications”. This assumes three things: (1) Merkel will agree to renegotiate; (2) the IMF will agree to renegotiate; and (3) there is some possible deal that can stave off a Greek collapse.

It’s point #3 that worries me: it is not clear that there is any way to solve the Greek problem. Greece is not merely insolvent in the sense that she can’t repay all of her debts; she is insolvent in the sense that, even if she repudiates every penny of her debt, she still cannot pay for (or finance) her imports. Greek government revenues are collapsing, and the Greek current account deficit remains large. Greece is a basket case that needs foreign aid; her debts are worth nothing. Greek exposure should be marked to zero at every eurozone bank including the ECB (and the IMF).

Finally, in more good news, the Socialist Party is reported to have won a majority in the French Parliament. Hollande and his leftists appear to hold all the reins of government. We can expect to see the Socialist's "growth plan" soon. (Keep an eye on French bond yields.)

France is now off the austerity reservation, and is no longer Germany’s partner in resolving the eurozone. France and Germany are at odds on the central policy issues. France is seeking to isolate Germany in the hope that she can force her to capitulate to the have-nots. The idea is that France will win, Germany will lose and have to pay reparations to Europe again (for being successful). 

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