Friday, December 9, 2011

Are we close to the end?

I once read a comment about this blog which said that the analysis was good, but a shame about the market timing. I always keep this in mind now. As such, I ask you to approach this post with a great deal of caution. However, with cautionary note out of the way, I have to ask whether we are nearing the point at which the Euro crisis spirals out of control. There are flashing warning signs, but there also (temporary) fixes (again) being floated in the news. One serious indicator was an article in Spiegel, which describes the outflow of money from Greece:

With disarming honesty, the central banker explained to the lawmakers why the Greek economy isn't managing to recover from a recession that has gone on for three years now: "Our banking system lacks the scope to finance growth." He means that the outflow of funds from Greek bank accounts has been accelerating rapidly. At the start of 2010, savings and time deposits held by private households in Greece totalled €237.7 billion -- by the end of 2011, they had fallen by €49 billion. Since then, the decline has been gaining momentum. Savings fell by a further €5.4 billion in September and by an estimated €8.5 billion in October -- the biggest monthly outflow of funds since the start of the debt crisis in late 2009.

I also noted some similar, but less dramatic stories for the other 'at risk' countries, with money being moved into Scandinavia and (strange things happen) the UK, and out of Europe altogether. Today, in a story that has been effectively trailed by central bank interventions, another story appears suggesting that European banks are on the edge of crisis. At the moment, the wild card in the story is China. I discussed the possibility of China entering the picture when they had a stronger hand a while ago, saying:

The Chinese were seen as a hope, but they do not appear to be playing ball. However, I emphasise 'appear', as the Chinese will likely dive in if they can use the opportunity to strengthen their economic position versus the EU:

China had offered help in return for European support to grant it either more influence at the International Monetary Fund, market economy status in the World Trade Organisation, or the lifting of a European arms embargo [...]

Aside from these obvious benefits, there would be other repercussions. China's help would mean large scale purchases of Euros, which would see the Euro harden against the RMB, thus making European exports less competitive and Chinese exports more competitive. The shift in the currencies would see stronger competition from China, and those European manufacturers that are struggling already might well be pushed underwater where China offers direct competition. In other words, it is a short term fix, with long term painful consequences. 

There is (again) talk of Chinese intervention coming to the rescue, but it is still not confirmed. Bearing in mind my previous comment on China using the crisis as a bargaining opportunity, this interesting story comes from the Telegraph, which I will quote at length:

Hopes were further bolstered by improvements in the borrowing costs of Italian and Spanish government debt, which have soared in recent weeks on concerns about escalating risks. Yields on 10-year Italian bonds, which were recently above the critical 7pc level, fell 0.12 percentage points to 6.33pc while those on Spanish debt edged down 0.07 points to 5.71pc.
The rally came late in the day, as traders digested the news and after it emerged that China would consider stepping up its role in the crisis. According to Reuters, China's central bank has taken steps to create a new vehicle to manage two investment funds worth a total of $300bn – one to target investments in the US and the other focused on Europe.
"I guess they're hoping that China's going to be the white knight that rides to Europe's rescue," Joe Rundle, head of trading at ETX Capital, said. "I think in time China will probably step in and have an effect on Europe, but it's going to be very much on China's terms rather than European terms."

Chinese involvement has long been sought by the international community, as it has trillions of dollars at its disposal. For its part, China has long craved the freedom to invest in Europe and the US – but, to date, has met political resistance. However, the politics have changed now that stricken eurozone members hope to raise hundreds of billions of euros to cut their debts by privatising state-owned assets.

And the source of the story, this Reuters article (my emphasis):

The euro gradually strengthened on the summit news and was later boosted when a source, who asked not to be named, told Reuters China's central bank plans to create a new vehicle to manage investment funds worth a total of $300 billion, part of which will be focused on investments in Europe.
The euro rose to a session high of $1.3422 after the China news emerged from around $1.3380 beforehand to trade with gains of around 0.5 percent for the day.

It is curious that there is so much excitement in markets based on anonymous tip. However, provided that Europe will play ball, it is quite possible that China will finally intervene. Let's be frank - the European politicians are increasingly desperate, and will probably accede to nearly any vaguely acceptable demand by China (by which I mean demands which the public will not see as outrageous, rather than demands which might actually be outrageous). My best guess is that, right at this moment, China is dangling a bailout in front of Europe and playing some extremely serious hardball. As a note, the rumour of the Chinese bailout fund was probably an agreed leak by the Chinese government to wave the sight of potential 'salvation' in the face of Europe (using unofficial sources to float policy is not unusual in China, and leaves the Chinese government a line of retreat if they change their minds/or as need be).

The only other option open to the politicians is the ECB starting the printing presses. I would expect that, to turn the situation around, would probably require the greatest money creation exercise in history. However, alongside the latest package of measures, there is some talk (again talk) of the ECB turning the presses:

To further reassure bond markets so that investors continue to buy eurozone government debt, the condition that the private sector would automatically bear losses if the ESM was triggered has been dropped. At the same time, the European Central Bank (ECB) has committed to making up to €20bn of bond purchases a week and China has reportedly begun plans to create a $300bn (£190bn) investment vehicle to buy privatised assets.
Thomas Harjes, an economist at Barclays Capital, welcomed the announcements as positive news. "This may not amount to a single 'bazooka', but it does add up to a substantial package of measures," he said.
However, Louise Cooper at BGC Partners questioned whether it would be enough to settle bond markets. "These are positive developments but are not enough. We were promised the 'Big Bazooka' but got far less," she said. "Wasn't this supposed to be the week that saved the euro? Well, it didn't."

I would guess that the ECB is fully aware that, if they start the presses rolling, it will be ever harder to turn them off. You can imagine the special pleading, the 'social crises' that would be rolled out to get another hit of freshly printed money. If they do start printing, I do not think that it will be much more substantial than this mooted amount, and this is likely not going to be enough. As for the whole package, as the second quote above indicates, it is still unconvincing for many.

In short, there are potential avenues to stem the tide but these are still doubtful. However, each avenue will, in the long term just serve to ratchet the underlying problems upwards. They may delay a Euro road crash, but they will not solve the problems, but will just make them even worse in the long run. In the meantime, we can only look on and take guess at what events will bring.....but it is starting to look like crunch time.

Note 1: I would comment on the possibility of a Europe-wide downgrade, but this is (as usual) the ratings agencies following events. Their 20/20 hindsight is truly something to behold.

Note 2: A bit of a rushed post as I have a mountain of work to catch up on. However, with the 'events' taking place, I could not resist a brief post. Sorry not to respond to comments.


  1. You might find this interview interesting:

  2. I admire your economic analyses but there is more to this European melodrama than economics. Something that has been puzzling me for well over a year is why the Eurozone is playing this crisis out so slowly. A year ago fiscal union would have seemed almost unthinkable to many Eurozone countries whereas today it is a preferred option. They are playing out the crisis to achieve an objective and that objective is political union. When considering the economics we should not forget that the Euro was introduced to create political union. Here is an extract from an ECB paper:

    "So what does the future hold? Anyone who believes in the role of a single currency as a pace-setter in achieving political unity (Europe will be created by means of a single currency or not at all (Jacques Rueff 1950)) will regard the decisive step as has having already been taken. This does not provide an answer as to how the "rest" of the journey should be approached. " Europe: common money - political union? September 1999

    Sadly the British have little understanding of Franco-German history and seem unaware that when England was forming as a nation Northern France, Northern Italy and Germany etc. formed a single nation that persisted past 1600 AD. They want it back like the Scots, Bosnians or Basques want their nations back. It seems to me that our media are mistaking a fundamentally nationalist project for an exercise in internationalism. See The Eurozone, EU, Cameron and Crisis for further discussion.

  3. Hi Cynicus, I can't tell whether you were writing this post before or after the Eurosummit agreement announced on Friday. But I'm not sure that matters though: there have been Eurozone budget rules before which have been broken as soon as they became inconvenient, and the proposed new rules could well prove mighty inconvenient mighty soon.
    As for timing, I read recently (possibly in Robert Peston's blog) that huge amounts of Eurozone government debt need to be rolled over in 2012, quite apart from new borrowing. Good news: survive 2012 and things get easier. Bad news: if the markets know 2012 will be risky, anyone who can move their money to perceived safety will probably start to do so before the crunch comes - which would bring the crunch forwards. Hard to tell which crunch though: there seem to be quite a few variations to choose from.

  4. There is a nice quotation somewhere by a leading economist I try to find, but in essence he states that in Economics you may have a fully correct analysis but face humiliation because you are out on the timing; but when it does arrive, it is bigger and more devastating in impact that you ever predicted.

    I know that from experience to be very true

  5. Hi again Cynicus. You asked "Are we close to the end?" but on the basis that "there's a lot of ruin in a nation" it will be rather hard to say when the end was, let alone will be.
    But I'll venture a guess, in answer to your question, that the Eurozone crisis will return with renewed force in mid- to late-January.


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