Forget fundamentals for now, for markets turn on a dime simply based on whether the Federal Reserve or European Central Bank signal that they will deploy their weapons of mass construction, or not. Understandably, economic conditions have deteriorated, and the European debt crisis is slowly dragging the major members into the fray. But to witness a euro rise of only 1.5 cents today after Mario Draghi assured salvation, is extremely telling in itself, and the underlying message is that we're beyond normal repair. In addition, those pesky euro zone rules about printing money are still alive and well, and overcoming those obstacles is no easy feat. Having run out of ideas, such as China saving the euro, which no one talks about any longer, while China is trying to save itself, Mr. Draghi used his last bluff -- and a bluff it is. The stakes are raised, but now the ECB must show its hand.
European Central Bank President Mario Draghi said policy makers will do whatever is needed to preserve the euro, suggesting they may intervene in bond markets as surging yields in Spain and Italy threaten the existence of the 17-nation currency bloc.
Maybe Mr. Draghi was prodded by the article "Europe is sleepwalking towards imminent disaster, warn top economists," while taking into account the increasing odds that Spain, and then Italy, will be shut out of the credit markets.
"The sense of a never ending crisis, with one domino falling after another, must be reversed. The last domino, Spain, is days away from a liquidity crisis," said the economists. They include two members of Germany's Council of Economic Experts and leading euro specialists at the London of School of Economics, all euro supporters. "This dramatic situation is the result of a eurozone system which, as currently constructed, is thoroughly broken. The cause is a systemic failure."
How can one be a euro supporter when the "systemic failure" is derived from a defective currency system? "Thoroughly broken?" Was it whole while the deficiencies had not surfaced? The experts never cease to amaze the common folk, and there's more common sense at your local coffee shop than at any think tank. But there's plenty of optimism, and Peter Berezin, managing editor of Bank Credit Analyst Research, was quoted by The Economist and offered a rear view from 2021, while pointing out that "things had to get much worse before they could get better."
In the end, the common currency survived. Indeed, over the past five years, growth has accelerated sharply and debt levels and borrowing spreads have continued to come down… While it was hard to imagine during the dark days of 2012, European stocks have outperformed all other major markets over the past decade.
For everyone's sake, I certainly hope that Mr. Berezin is right, although in 2021 nobody will remember, and his story implies that the healing will only start in 2016. Meanwhile, the capital exodus out of Europe continues, which was the main concern harbored by the former President of the ECB, Jean-Paul Trichet. Inflation was never his focus when rates were increased in 2011, as pointed out numerous times.
US prime money market funds cut their exposure to eurozone banks by a third last month, according to a new report from Fitch, underscoring how the crisis in Europe is rattling investors and triggering heavy outflows from the region. The 33 per cent fall in the month to the end of June, compared to May, reflects increased risk aversion to the eurozone but also comes as European banks have become increasingly cautious about relying on money market funds for short-term financing.
Mr. Draghi's other stimulation was certainly Moody's downgrade of Germany's outlook, and that in itself may loosen the German politics of resistance, leading to the acceptance of D'Artagnan's motto: "All for one, one for all." Yet, and not surprising, the conspiracy theories surfaced, although the U.S. and Japan have already been downgraded.
"It is striking that the negative developments in the U.S. and Japan are ignored by the rating agencies, but that Europe will be written down despite visible progress in fiscal reforms." Folker Meyer Hell, chief economist at Bremer Landesbank.
Desperation always clouds the mind. In closing, here's a simple observation. Aside from the fact that Debt/GDP ratios are meaningless, and it's the ability to service the debt that truly counts, Spain's official Debt/GDP ratio is only 68.5%. That's exponentially better than the euro zone's average of 85%, and Greece's "whatever percent." But if the markets are still pricing Spanish 10-year debt at 6.94%, even after Draghi vowed to save the euro, it only means that market participants don't believe that the Spanish Debt/GDP ratio is real, and must be much worse. The 5-year (6.58%) and 2-year (5.62%) notes are telling the same story, and the fact that tax revenue is sinking fast does not help the cause. Food for thought.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
