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Christian Hviid
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An Investment strategist with multi-billion dollar portfolio management experience managing active Absolute and Relative oriented strategies in Unified Managed Account and Separate Account settings. Cross functional expertise covering asset allocation, risk management, manager and investment due... More
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  • The ECB needs to stop the slow bleeding by either amputating or using new suturing technique 1 comment
    Nov 17, 2011 4:54 PM

    The European Central Bank is missing a huge opportunity to start putting the European economy back on track and stabilize the financial morass that is clouding Europe’s potential and for that matter the rest of the world.  With the recent arrival of Mario Draghi and the almost immediate interest rate cut, there is an opportunity to take the necessary steps to instill confidence in Europe’s ability to handle its crisis.  It is time for some bold action and the adoption of new techniques to combat the current crisis.

     

    If Europe keeps on going down its current path it is inevitable that global economies, markets and ultimately hard working people will pay a dire toll.  The time has come to reckon with binary choices: amputate or stop the bleeding.

    The first choice, to amputate, would entail allowing sovereign borrowers to default en masse given the unsustainable debt loads many countries carry.  This process would be painful and would have a long recovery period that could create more secondary effects than attempting to stop the bleeding.  We can all imagine the repercussions of allowing defaults to occur.  Stopping the bleeding would entail a pledge by the ECB to monetize debt which would allow for many positive outcomes if allowed:

    -          It would instill immediate confidence back into European sovereign bond markets.

    -          This would in turn lower cost of capital and uncertainty given the strong message to backstop the trajectory of the European economy much like what the US was able to do through quantitative easing.

    -          It would likely weaken the Euro vs. a basket of currencies which would make European goods and services more competitive globally driving up sales and for that matter taxes to pay back loans, etc. (Germany would be a prime beneficiary so they should have little reason to object).

    -          It would allow sovereign issuers to opportunistically issue long-term debt (10+ year maturities) to the ECB and go out and retire outstanding debt preferably shorter maturities and higher coupon tranches.

    Europe in essence is suffering the consequence of its own perilous policies and unsustainable spending through borrowing.  To borrow from what much of the Corporate Credit sector went through back in 2008 and 2009, European sovereigns can take some steps to extend their runway, attract investors and lower cost of borrowing.  Austerity measures at this juncture are unavoidable which will translate into subpar growth going forward for the European bloc.  However, the abyss can be avoided and countries can claw back and the global economy can be given a chance to find level ground to set foot on and move forward.

    Granted laws may have to be relaxed to accomplish what is needed but the European Union needs to adapt to the 21st Century to either be more unified than what recent behavior has suggested.  If the EU is to succeed then everyone has to keep the ship afloat, given the limited quantities of both life vests and rafts.

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  • Dear Christian,

     

    I do share your skepticism on what is going on in Europe. Trouble is, it is just too convenient for politicians to use the ECB or Germany as the scapegoats of the day. First and and foremost, politicians have to blame themselves. The Euro was a formidable PR and marketing exercise performed in 1997 and 1998 into which the population of weak-currency nations was lured with the bait of low north-European interest rates. How about that as a free lunch ? Trouble is, belonging to the golf club of one of the strongest currencies in the world carries a stiff annual membership fee, namely fiscal prudence. Consistent with bureaucrats' well-honed 3-phase "problem solving" approach, we are now in the "it is somebody else's fault" stage ("it is not a problem" and "is not a big problem" were the two previous phases, does the EU's nonchalance over Greece 18 months ago ring any bell ?). "A plot agreed by a few greedy hedge funds over dinner, "market speculators", Germany, the ECB, you pick. Also perfectly consistent with human nature is how the market is to blame only when things turn sour, nobody complained when the same market invested in PIIGS sovereign debt hand over fist ten years ago.

     

    OK, thank you for listening so patiently to my libertarian rant. Where do we go from here ? It is clear that we have a stalemate whereby everybody but Germany, Holland, Finland and maybe Luxembourg would love to socialise debt and losses. The EFSF was one of the key vehicles set up to do just that. The key issue at stake is not so much the Euro, European solidarity, the Unites States of Europe of any of that ______. The real point is that banks - notably the French ones - are just too exposed to the PIIGS and large enough to hold the entire system - first and foremost governments! - hostage. Who would care about Greece or Portugal otherwise ??? We can thank those megalomaniac politicians who encouraged banks to venture so aggressively abroad in fair weather. On the opposite bench, the virtuous countries - Germany in particular - set closer fiscal coordination as the pre-condition for any bailout. This is a perfectly legitimate request, after all it was politicians who went ahead and set up the EUR and left for later (ie. about 13 years later!) these trivial execution details. The other countries resist a German-led push towards fiscal coordination, which they view as a loss of sovereignty. One possible path could be as follows: Germany has one of the strongest credi standings and is pivotal for any bailout or guarantee, so it is under no hurry to move. On top of it, it set up a war chest of about 400bn EUR in 2008 to ringfence any bank which got in trouble. Not much thereof was used. France, on the other hand, has some of the most exposed banks and is fighting against time, since its own credit is under attack (spreads over German Bunds are now over 200bp) and any further hesitation could mean that some bank blows up AND funding becomes more expensive.
    Thus, Germany could wait for the market to keep turning the screw on France (via higher credit spreads) while the PIIGS implode. Then, sometime in February/March, France may be left with no choice but accept fiscal integration in return for bailouts and, by the way, some greater QE-style support from ECB. The weaklings would have to go along. If France keeps resisting, Germany could use that as a perfect excuse to quit the EUR, shifting the responsibility for this failure to France. It would be relatively easier for Germany to replace their EUR-denominated bonds with new ones in a denominated in a new DM than for anyone else to do the same with their new post-EUR currency. German banks could be ringfenced with the war chest above and only exporters would probably suffer (and under current circumstances are already suffering anyway). Germany might rejoin the EUR at some future date and a different parity. This arrangement could be portrayed to people all over Europe as a German problem rather than as a European problem.
    18 Nov 2011, 05:26 PM Reply Like
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