Relief rally as Eurozone liquidity issues fade; solvency and contagion still at issue
by ilene - May 10th, 2010 3:07 pm
Relief rally as Eurozone liquidity issues fade; solvency and contagion still at issue
Courtesy of Edward Harrison at Credit Writedowns
As in 2008, when global financial institutions were under attack, we are now facing a solvency crisis. This time the issue is Eurozone sovereign governments.
Make no bones about it, the EU’s trillion dollar gambit has worked and a melt-up is underway because near-term liquidity issues have been put to rest. But, this is not a liquidity crisis; it is a solvency crisis. And unless meaningful reform is taken in the Eurozone, this crisis will re-appear in due course.
Overnight, the Eurozone put together the European Stabilisation Mechanism programme, a hefty plan to provide fiscal support to any Eurozone government that runs into difficulty. While details are still coming into view, the euro and equity and bond markets have recovered tremendously. Meanwhile credit default swaps have fallen (see Marc Chandler’s pre-market summary here).
But, before we start popping the cork on the champagne, we need to realize that this stabilization mechanism and the developed market (DM) central bank swap lines only resolve liquidity issues. The genesis of this crisis is not liquidity, but solvency.
As I outlined in my last post on Germany (The Soft Depression in Germany and the Rise of Euro Populism), Germany has undergone extensive labour market reforms which Greece and Spain in particular have not. This makes Greek and Spanish labour forces uncompetitive vis-a-vis other countries also locked into the currency union, most notably Germany. The result, with the Euro well above its launch rate of 1.17 to the US Dollar, is international uncompetitiveness. Combined with extremely low interest rates, the result is a gaping current account deficit.
Unless the Eurozone attempts a beggar-thy-neighbour massive devaluation in the Euro, this closes off the export escape hatch for Greece and Spain. Therefore, in order to bring down enormous budget deficits and prevent national bankruptcy, the only option left is internal devaluation – across the board wage and spending cuts.
Ireland, which has faced similar pressures, is embarking on a path of internal devaluation right now to reduce their deficit. But reducing consumption demand at a point when the primary budget deficit is already double-digits still leaves the solvency question open. And Greeks have rioted to show the resistance to those kinds of measures.
My conclusion, therefore,…
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
Ilene is editor and affiliate program
coordinator for PSW.