Euro Crisis Risks Eliminated?

I still don’t think the Euro crisis has truly ended.  Yes, it looks like we’ve stumbled upon a temporary patch, but from a more macro perspective it’s hard to see that this is a real fix.  What remains unresolved is the lack of a permanent fix in the currency union.  The ECB has managed to bring private bidders back to the markets, but that’s all largely contingent on economic stability.

I am still having trouble with the basic math here and seeing how more fiscal austerity will generate enough growth to outpace debt growth.  It looks to me like we’re in a position where the governments on the periphery will continue to miss deficit targets and debt will remain extremely high, growth will stagnate and civil and political unrest remains the surest risk to causing an unraveling.

That said, I really like this Citi note on the risks remaining in Europe:

“The market seems ever more comfortable with the sense that the central banks have now effectively quashed the macro risks for the foreseeable future. It is certainly true that 2012 saw past ‘red lines’ shift significantly. As the German election has drawn nearer, Merkel has made considerable concessions on the
Greek bailouts and on banking union and recapitalizations. Even more significant perhaps is the shift in the ECB’s approach from the dogmatic Trichet to the much more pragmatic Draghi. Both have removed some of the constraints that threatened to break EMU not long ago.

But regardless, macro risk will never be far away in our view. It is Citi’s central scenario that there will be some form of sovereign restructuring in all five periphery countries by 2017, and Grexit in the next 12-18 months.

Granted, the kind of sovereign debt restructuring they envisage for countries like Italy and Spain is very different to what happened in Greece – comprising maturity extensions and coupon reductions, rather than large haircuts to principal. However, the transition towards that outcome will almost inevitably hold lots of uncertainties for financial markets. Restructurings may not occur this year, but any number of macroeconomic events could well tilt market expectations in that direction temporarily. Already this year, our economists believe the unsustainability of the debt level in Portugal will become increasingly apparent.

The immediate path towards bail-out programmes for Spain and Italy per se is not our principal concern. However, the reaction of the market and the rating agencies to the trajectory of several periphery economies implied by Citi’s forecasts creates significant downside risks in our view.

For instance, the Spanish government’s deficit targets of 4.5% in 2013 and 2.8% in 2014 are far more optimistic than Citi’s forecasts of 6.4% and 5.8% – largely due to our expectation that the economy will contract by 2.4% and 1.9% respectively over the next two years – far more than what is assumed in the Spanish budget. Based on current initiatives taken by the Spanish government, the European Commission
forecasts an even bigger deficit of 6.4% in 2014.”

This crisis is a long way from being over….


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Andrea Malagoli

    If anyone really believes the headline news and the continuing lies from the Central Banks, they will deserve what is coming …

    How can anyone think the European crisis is over, when all that has happened has been some shuffling of paper and (empty) promises around?

    There is still too much belief/hope that monetary policy can unilaterally solve anything. Monetary policy is only a time-buying tool, not a solution. It is just like trying to contain a flood by moving the water to different containment facilities … eventually someone has to find a way to dispose of the water altogether.

  • Nick

    Just shows that global markets are no longer discounting indicators (if they ever were), but just voting mechanisms for continuous easy money. Europe’s crisis is far from over as the economic data is still bad and no debt has been reduced, just changed hands. They have delayed the Euro default, but it will still happen.

  • A Droyd

    “Granted, the kind of sovereign debt restructuring they envisage for countries like Italy and Spain is very different to what happened in Greece – comprising maturity extensions and coupon reductions, rather than large haircuts to principal.”

    Is there any real difference (other than scale) between the two, for a total return investor?

  • Scott Krisiloff

    As long as the central bank stands willing to print doesn’t MR contend that there can’t be defaults?

  • Johnny Evers

    Does MR state explicitly that the central bank can print, or does MR limit itself to stating that the government can use the primary dealers to issue bonds?

  • Cullen Roche

    MR is just a set of understandings. The Fed could fund the govt’s spending if the system were designed in that way. That’s not a statement up for questioning. It is a statement of fact. Of course, that’s not what the Fed does at present….

  • Scott Krisiloff

    Isn’t a trillion dollar coin a mechanism for the Fed to directly fund the government’s spending in order to avoid default?

  • Cullen Roche

    If we minted coins to finance spending for the rest of eternity this would be a form of govt self financing. It would be full blown MMT. That’s not what I’ve been advocating. As Philip Diehl said, this would be a temporary fix for the debt ceiling.

  • Scott Krisiloff

    Ok, but in MR can the US government not default because it has implicit control of the Fed or because it can force the dealers to take down auctions? In that case why can European governments default if the ECB stands willing to buy their debt in a liquidity crisis and they can also shove government paper into their local banks?

  • Cullen Roche

    The ECB can always write the check. Just like the Fed. The govt’s in Europe are going bankrupt because Germany doesn’t want the ECB to write the check.

  • Scott Krisiloff

    Haven’t Draghi and even Trichet always been resolute in their willingness to provide liquidity in the event that there is a true funding crisis?