It’s amazing how this has all progressed over the last few years. Excessive consumer debt was rolled up into excessive corporate debt and now governments are taking on the private sector debt at the very highest levels. Charles Ponzi would be quite proud.
I don’t want to get into too many details here as the full details of the eurozone bailout are not released, but we can come to some conclusions based on the early framework of the plan.
A few thoughts:
1) Let me start by saying that this plan has teeth. Sharp ones. Early reports are totaling the plan at $962B! Much of this is likely to have little long-term impact, however, the message the EU is sending in the near-term is is strong and markets will respond accordingly. When we covered shorts late last week it was due to this sort of risk. S&P futures are up 3% as I type at 2AM EST. The markets wanted this kind of shock and awe response. That is a near-term positive.
2) The Fed’s move to open swap lines should do a great deal to calm credit markets and provide liquidity. This is another near-term positive.
3) This plan breaks the Maastricht Treaty. I don’t care what loophole we refer to. The rules have been thrown out the window. The ECB will buy bonds on the secondary market and in my opinion this totally undermines the purpose of the EMU. The Germans must be furious over this whole situation (though they’re putting on a happy face and saying all the right things in public). In my opinion, the move to bond purchases is an admittal that the Euro is a broken currency even though most of the Eurozone leaders likely haven’t realized it. The currency now has one foot in the grave. The inherent imbalances caused by the single currency system will not be resolved by this plan and will therefore continue to exist. That is not good. This plan does not address the inherent flaws in the Euro as a currency.
4) The potential use of $285B in IMF funding is a gross misuse of U.S. taxpayer dollars.
5) There are rumors of further austerity measures in Portugal, Spain and Italy. Ultimately, this is the end game. If this plan does not result in lowering deficits then the plan is a failure. Unfortunately, I am having a hard time seeing how this will be anything more than a short-term fix for a long-term problem. We have a recent precedent for the current scenario in Ireland. Last week we wrote:
Ireland implemented harsh austerity measures in 2008 and these programs have done nothing to help matters. In fact, their deficit continues to go backwards. Since the government implemented austerity measures in 2008 their government debt as a % of GDP has actually INCREASED to 64% from 43.9%. Government deficit as a % of GDP has almost doubled. This is exactly what will occur in Greece as tax receipts will fall off a cliff and austerity measures will result in decreased aggregate demand and recession.
Without robust growth it’s highly unlikely that Greece and the surrounding nations have the time to grow their way out of this debacle. Particularly now that the sharks have circled. Deficits are likely to INCREASE in Portugal, Greece and Spain over the coming year as tax receipts will decline, spending cuts will reduce aggregate demand and debt levels will remain high. This is exactly what we’ve seen in Ireland and I would put a very high probability of a similar outcome in the PIIGS.
In sum, this plan does a great deal to reduce the near-term strains in the markets, but without attacking the structural imbalances within the Eurozone or altering the current flaws in the EMU this is nothing more than a very solid Pele-like kick of the can down the road.
Whether this results in a multi-month or multi-year rally is the trillion dollar question, but I am quite confident that this plan will not be the last we hear about Greek debt woes.