In the coming weeks, months and maybe years, we'll continue to see assorted solutions to the EU crisis. Here are 7 criteria for quickly distinguishing which really help and which are the usual short term tranquilizers.
A. THE CHECKLIST
First, ask yourself whether the proposal address one or more of the following.
1-2. Reduce Debt Levels And Debt Service Costs To Sustainable Levels For Sovereigns And Too-Big -To-Fail Financial Institutions
That's the essence of the crisis and the thing that needs to be solved and prevented from recurring.
Arguably these could be broken down into further separate criteria, like:
- Break up the TBTF institutions
- Improve competitiveness of weaker economies so that they reduce more of their debt/GDP troubles by growth rather than austerity. In other words, they earn more rather than spend less.
However for simplicity's sake let's just discuss these two criteria together, because it was a combination of irresponsible management at financial institutions and failure of governments to supervise them well enough to prevent the financial sector from being able to threaten the global economy.
3. Need To Centralize Control Over EZ Budgets
To get out of debt and be able to enact and enforce responsible budgets that keep the EU solvent, it needs to become a well run US of Europe with a fully empowered central bank, and the regulatory and police powers to impose and enforce rules of responsible economic management
4. Need To Cede Sovereignty In Order Allow That Centralization
However, to become the US of Europe, 17 proud sovereign states with long and glorious histories, rather different attitudes about how to run an economy (in addition to other significant linguistic and cultural differences), and historic relationships that are not always amicable, must cede control over monetary and fiscal policy to a central body that not all nations would trust.
That means effectively ceding sovereignty and control over national destiny, or at least reducing it to a level similar to that of the American states. The balance of evidence strongly indicates that there's little real that will to do this. Germans and other Northern funding states will not risk having undisciplined Southern European attitudes towards economic policy and inflation imposed on them, nor are the GIIPs in any way ready or able to adopt the disciplined Northern mindset towards spending and taxation, and related issues regarding social benefits.
5. Need More Time To Reconcile These Conflicts
The EU as we know it could have no more than a number of weeks until Greece defaults, given that it has utterly failed to keep most of the conditions needed to get the next tranche of bailout cash loans (as if it could afford more debt).
With Spanish and Italian borrowing costs at unsustainable levels, it's hard to see how either would avoid default beyond a few weeks or months once a Greek default starts a wave of bank defaults and insolvency that radiates outwards and to banks and sovereigns across Europe
6. Need Interim Solution While The US Of Europe Is Being Organized
The only way around the time constraints is a new and large source of interim funding for the 5-15 years needed, be it gifts, debt forgiveness, asset sales, whatever.
Conversely, disregard any solution that involves piling on more debt to nations that can't pay back current debt load. That may buy some time, but not much.
7. Need Show Unity, Direction & Will
To have the credibility to ask the world to lend, donate, or accept the printing of the trillions needed to tide it over for the next decade, or, the EU would have to behave like its united behind a plan and just needs 5-15 years of funding to keep the GIIPS and anyone else solvent while it organizes all the details needed to get the US of Europe functioning.
Unless the proposal addresses at least some of these 5 issues, its effect on the EU and global market sentiment will at best be limited and temporary.
In order to quantify the proposal or overall level of progress:
- Assign 10 points for a complete solution to any of the above five. Thus 50 points means we've got a comprehensive solution.
- Assign 1-9 points for each item that is partially solved.
- DEDUCT 1-9 points for each item made worse by the act or proposal in question.
For example, a typical program like the Spain bank bailout (100/300/other bln euro version, whatever figure is current) would both earn points as a partial solution for criterion 5 (Buy Time) and lose points for making numbers 1-2 (Reduce Debt Levels & Service Costs). Thus far the bailout has done not calmed markets, so it appears markets deducted more points from 1-2 than they added for #5.
Using this simple method, we can grade each proposal, chart it, and chart how the crisis is easing or worsening.
I'm curious to hear from you all, open to suggestions of how to refine this EU crisis solution grading and tracking method.
At minimum, the goal is to be able to quickly evaluate each individual new action or proposal to resolve the EU crisis, which remains the primary threat to the global economy, and so be able to plot your own investment or trading strategy. For example, if markets are soaring over the latest rescue plan, but you see it either adds no net points or loses points, you can quickly start planning new entry points for short positions.
Ideally the checklist could be used to grade the overall status of the EU Crisis for each criterion and so have a way of assigning and overall figure to how good or bad things are in the crisis. I sense this checklist might still need some work in order to do that, though it's a decent starting point.
Special Note To Forex And Commodity Traders: Is It Dilutive?
Currency traders, and to a lesser degree commodity traders, need to also consider whether each proposal is potentially dilutive for the value of a given currency, particularly the EUR, decide over what period the market will recognize that loss of value, and plan trades accordingly.
Long term buy and hold investors of other assets denominated in these currencies have to consider these consequences over a longer term. Most investors tend to have virtually all of their assets tied to just one or two currencies. See the above mentioned book for a variety of lower risk, simple solutions to this lack of currency diversification.
Given that the debtor nations don't want to cut spending further, and the funding nations don't want to make further donations, EUR printing might at some point seem awfully convenient, whatever form it may take.
For example unless new bond buying programs are accompanied by bond selling programs, it's likely that the ECB will be creating euros out of thin air, as did the Fed in 2008 and beyond. For different reasons, those with most of their assets denominated in USD, JPY, and GBP (among others) also are risk of seeing their currencies suffer long term devaluation (for example see: 7 Charts Tell Why We All Need Currency Diversification).
Disclosure /disclaimer: The Above Is For Informational Purposes Only, Responsibility For All Trading Decisions Lies Solely With The Reader.