The big lesson of last week (and last year’s Greek crisis): The EU crisis is a financial crisis driven by political decisions.
To anticipate the coming weeks’ market movements, focus on what is likely to serve the policymakers’ priorities. It’s all about the banks, not the PIIGS. Always has been. Read on for details.PRIOR WEEK MARKET DRIVERS
According to most financial media, events surrounding the risk of Greek default were the prime market drivers.It’s All About Fear Of Greek Default, Right?
More specifically:GREEK DEFAULT THREAT TO GLOBAL BANKING, ECONOMIES, FINANCIAL MARKETS
The only thing that really mattered last week was the threat of imminent banking crisis posed by an imminent Greek default. All else last week was essentially irrelevant in influencing market movements.
Overall markets continue to believe the EU would, as it always has, grudgingly provide the cash needed to avoid a Greek default that in turn would likely spark another global banking crisis at least as bad as that ignited by the failure of Lehman Bros. bank back in 2008, which began the ongoing Great Financial Crisis.
While this consensus will likely prove correct, continued failures to reach agreement over the past weeks have undermined confidence in the EU’s ability to act before building uncertainty sparks a full blown global crisis, just as happened almost exactly a year ago.
Events toward the end of the week suggest that the brinksmanship and bargaining is ending, as dissent over the nature of further Greek bailouts has collapsed from fear that the banking system and thus financial markets cannot withstand anything that could be seen as a loss to Greek bondholders.
Here’s a short summary of why a default of Greece or any of the PIIGS risks causing a global financial crisis similar to that seen after the Lehman Brothers bank collapse.
- It would cause a spike in the perceived risk of all PIIGS bonds, as the assumed support of the EU is disproven. Thus yields of all PIIGS bonds soar beyond what these nations can afford to pay in order to reflect that risk, effectively locking them out of credit markets. The likely result would be:
- Both these nations and unknown numbers of large banks exposed to these bonds risk imminent insolvency unless provided ongoing credit or a bailout. Both core and peripheral nation banking systems in the EU would be at risk.
- Not knowing which banks are in trouble, but knowing that many could be, would be enough to cause a freeze in interbank lending, credit, as well as plunging financial markets, a run on banks, etc.
- The crisis would hit the US at almost immediately, because:
- Of the ~30% of PIIGS bonds insured against default, over half of that insurance is from US institutions
- US money market funds are heavily exposed to PIIGS short term paper, so a PIIGS default would cast doubt on the solvency of US money market funds and so these funds could face another run on their assets similar to that in 2008.
Thus toward the end of the week the EU showed significant signs of progress towards making sure Greece gets the cash needed to avoid default until at least July.
- EU Commissioner Michael Barnier told a British radio station that a restructuring is “off the table”, so no private bondholders will take losses at this time, avoiding a default and the crisis it would likely cause.
- That Germany had backed down on its demand that private investors bear at least some loss was basically revealed at Friday’s press conference on the results of the latest French-German talks.
Here’s the key to understanding the prime motivations of the decision makers so you can anticipate developments in the EU crisis and plan your trading/investing strategy accordingly.PROTECTING THE TO-BIG-TO-FAIL (TBTF) IS THE REAL GOAL
If you understand what best serves that goal, you can anticipate what will actually be done and plan trading or investing strategy accordingly.
As always, the first priority of policy makers in the EU, US and everywhere else is protecting the solvency of their banking system, not the PIIGS. Deferring a crisis until July is unlikely to help Greece, but it may be enough time to prepare a bailout plan for the affected banks. Regardless of what happens to the PIIGS, if confidence can be maintained in the banking system, the risk of crisis in the EU and US will be greatly diminished. If that can’t be done by July, then the cash is likely to be found to prevent Greece and anyone else from defaulting until September, or whenever.
In sum, until a banking rescue plan for the EU and US TBTFs is in place, PIIGS will be kept out of default if at all possible in the short term. Once such plans are in place, PIIGS will be abandoned, if the current loans-for-austerity is still in place. Political support for this approach cannot endure. Taxpayer suffering on all sides to bail out vital but unsympathetic fat cat bankers is politically unsustainable. None of the governments involved that has faced a national election has survived, with the exception (as of this writing) of Greece.
Indeed, the other likely scenario, and bigger risk, is that one or more of the current governments of one or more funding or debtor nations is replaced with a new regime with a specific mandate to renege on its unacceptably painful burden to fund bailouts or accept their conditions, before plans to keep banking systems stable are in place. If that happens, we have a global financial crisis.LESSONS FROM PRIOR WEEK FOR THE COMING WEEK
Viewed from this perspective, and suddenly otherwise inexplicable policy actions make sense.THE EU......
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DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING DECISIONS LIES SOLELY WITH THE READER. IF WE WERE SURE WHAT WOULD HAPPEN, WE WOULDN’T BE TELLING YOU FOR FREE, NOW WOULD WE?