Interesting conference call this morning from Credit Suisse (CS) on Europe and the outlook going forward. I'd say they do a nice job of breaking down the overall environment. In essence, they say the crisis is likely to deepen before forcing the hands of politicians in achieving what needs to be done. They offer four current scenarios for Europe with an 80% probability of the euro staying together in its current form:
(1) We think there are four scenarios that could play out by the end of the year: We see the probability of a "Grexit" at only 20% and the probability that the euro-area stays together in its current form at 80%:
(2) The euro-area stays together in its current form (80% probability)
(3) Greece leaves the euro-area without a complete euro break up (10% probability)
(4) Greece and one or two other euro-area countries leave the euro (less than 1% probability)
(5) There is a complete euro-area break up (10% probability)
Why won't Greece leave? CS offers five reasons:
(1) An exit of Greece would come at a very high cost to Greece: GDP down 10%, inflation plus 30%.
(2) According to recent polls, 80% of Greeks want to stay in the euro-area.
(3) Core European would face €220 billion ($272.60B) of direct losses from a Greek exit (and the indirect costs are clearly higher),
(4) A Greek exit would lead to €1.4 trillion ($1.73T) of deposit flight from the periphery and maybe as much as €1.8T ($2.23T) overall-forcing immediately a huge €2T ($2.47T) LTRO, a ECB deposit guarantee or capital controls.
So where to next? Ultimately, CS says there are five big hurdles that need to be resolved in Europe. We're through two out of five and CS says we're making progress on the others:
We believe there are five factors that needed to be addressed to resolve the European crisis:
(1) A return to growth. To some extent this is the most important issue. With growth, fiscal arithmetic becomes more sustainable and the political willingness to accept the pain of restructuring becomes more bearable (though clearly some pain is needed to force restructuring).
(2) A current account balance in the periphery. The net borrowing of the economy as a whole is more important, we believe, than the net borrowing of the government sector. On current exchange rates we fear a 3% to 12% fall in wages will be needed to restore competitiveness and reduce the current account deficit, but with wages being half of nominal GDP, that in turn makes the growth outlook worse.
(3) Questions over solvency need to be addressed (Greece and Portugal)
(4) Build a ring fence for the solvent. Being achieved slowly.
(5) Mutualization of debt. Mutualization works because in aggregate, Europe has lower government debt and fiscal deficits than the U.S.; the problem is the distribution of debt, not the amount of debt.
If CS is right, and I'd say it's probably not far off, the euro crisis is likely to persist unless markets force the hands of the politicians sooner rather than later. At this point, I just about hope they do. It's time for this crisis to come to an end...
Source: Credit Suisse