Applied to the ‘solutions’ offered by eurozone summit, that scepticism was wholly valid but it missed the point: markets could rally without a eurozone solution. But it would be wrong to be complacent.
The eurozone’s 14th ‘crisis’ summit in 21 months resolved nothing and may have only bought a respite of a few weeks. The €106bn recapitalisation demanded from European banks covers no more than the 50% write-down of Greek debt held by the private sector and, inevitably, falls mainly on those who will be least able to raise capital from capital markets by themselves.
The write-down of Greek debt is inadequate to make it solvent but enough to encourage other countries to demand comparable terms. Nearly 40% of the €440bn in the EFSF has already been committed, leaving just €280bn to cover Italy, Spain, the banking system and (given the recent sharp widening of spreads against Germany) maybe even France.
Leveraging this with money borrowed from China looks like wishful thinking – why should they lend when the Germans won’t, unless it is heavily secured? Stretching it to cover partially future bond issues may spread it over €1trn but it would not cover existing bond issues and will, on current projections, run out in early 2013.
Moreover, guaranteeing 20% of a bond issue does not make the remaining 80% attractive, nor will it materially reduce the yield demanded by investors. The subsequent jump in the yield of Italian ten- year bonds to above 6% blew an immediate raspberry at the proposals.
Without growth, of which there is little prospect in southern Europe given the lack of competitiveness of the economies, in our view bailouts provide only an expensive stop-gap while insolvency remains inevitable.
The mantra of commentators now is to demand that the ECB implements quantitative easing, as if there was evidence that this would solve the problem. More importantly, it directly contradicts both Article 123 of the Lisbon treaty and an explicit prohibition by the German Bundestag when they approved the summit package. Quantitative easing by the ECB would precipitate a constitutional crisis.
It is inevitable that the eurozone crisis will continue to dominate markets. It did not prevent a market rally and markets should, in the medium term, be able to grind erratically higher without a resolution.
The banking problems of the eurozone are a long way from being recognised and quantified, let alone resolved, and will continue to undermine global markets. While it was right to add to equity exposure in early October, it is likely to prove prudent to reduce exposure into strength. Investors who missed the rally are likely to get another chance.
