Eurozone Still in Crisis


‘Grexit’ fears give way to ‘Crexit’ optimism –

If today is Monday, then it is time to publish some recovering Eurozone articles in the mainstream media. Markets movements are based on myriad factors, which no one really understands; however, the drastic easing of monetary policy in the developed world has created trillions of dollars, pounds, euros and yen, and this money has to find a home somewhere.

When rising financial markets are used as an economic indicator, the assumption is that investors are betting on improving economic conditions. Under the new paradigm in the wake of the Great Financial Crisis, I believe that investors are merely speculating on increased money printing causing asset price inflation. Hence, improving markets in the eurozone do not indicate an end to the crisis.

This does not stop the author from asking and answering three questions and answering them based on distorted information. My answers are a bit different:

Is this optimism warranted or are markets overdoing it? Neither choice is an accurate representation of today’s financial position in the Eurozone. The markets are not optimistic but merely responding to more money printing as the adage, “Don’t fight the Fed (ECB),” instructs.

Are they simply shrugging off weak economic activity and slow motion political progress in Europe, and focusing on the signs of reinvigorated growth in the U.S. and China?  Monetary policy is distorting markets, and they are not pricing in the dismal European economic picture. There are signs of improved growth in the U.S. and China, but there are also signs that these economies will continue to plod along at a tepid rate. The consensus for U.S. fourth quarter growth is less than 1.5.%, and it is impossible to know what is really transpiring in China as economists are questioning the supposed rise in December exports.

Are markets just fatigued by the seemingly endless debt crisis and now underestimating the probability of renewed euro turmoil? Traders have a very short time frame, and the probability of a euro disaster within a few days is a low enough not to be a concern.

Not surprisingly, the author is very optimistic about Eurozone prospects. He has come to the conclusion that the markets are signalling renewed economic vigor ahead and an eventual exit from the crisis. His conclusion is based on rosy interpretations of several key facts.

Proposals on a single European banking supervisor were fleshed out further at the December gathering of EU leaders.  “Fleshed out” means that there is still no banking union. The two major sticking points are paying for resolutions and a depository insurance scheme. If the Germans decide to pay billions of dollars for these mandatory programs, it certainly will not be prior to elections in the fall. The rest of the core does not seem enthusiastic to participate in either of these schemes, too.

The de-risking and deleveraging of bank balance sheets has progressed, so that systemic banking risks have clearly diminished. My professor in Contracts Law once told the class that if someone uses the word “clearly” then it is most definitely not. While there has been some deleveraging, the author ignores its amplitude. Here is a chart showing the size of international banks. The Europeans have the largest institutions by far in terms of balance sheet to GDP. (Addendum: According to Phoenix Capital Management, the European banking sector has €46tr worth of assets versus a €16tr GDP)Bank assets to GDP

Claiming that these banks are de-risking is employing circular logic. Who do you think has been buying all of that PIIGS debt driving the rates down? If you believe that the debt is now safer because buying has decreased yields, then you also believe that the banks have de-risked. If anything, the gorging on shaky sovereign debt has increased the inherent riskiness of the Eurozone banking system.

Correspondingly, the decline of cross-border bank claims – which amounts to about €750bn since the third quarter of 2009 – has stopped and the deposit base of peripheral banks has stabilized. The reason that the deposit base has stabilized is because the smart money has already left. A significant signal here would be a few months of an increasing deposit base in the periphery. We are a long way from that phenomenon.

On fiscal issues, the new, more rigorous fiscal compact came into force at the beginning of the year and work on a time-bound road map towards enhanced integration is high on the agenda in the first half of this year. It’s one thing for politicians to make happy talk and for mainstream media journalists to repeat it, but I expect more skepticism from a sober, German economist. The original Maastricht Treaty provided that eurozone countries could not run deficits greater than 3%. Countries, starting with Germany believe or not, began flouting it almost immediately. France will miss its target this year. Spain will miss it as well, even though it does not have to count the cost of its bank bailout in its debt. Greece will miss its target because it is Greece, and it does not look too promising for Portugal.

The second clause does not require a response, because it is meaningless. If anyone knows what this means and why it is good news, please write me at my website:

“work on a time-bound road map towards enhanced integration is high on the agenda in the first half of this year.”

Although much of the progress is currently masked by the scars of recession, the data provide evidence that key macroeconomic indicators are now moving in the right direction. This is a case of cheerleading improvements in indicators while ignoring the amplitude of these changes. Did you know that wages still have to fall up to 35% in the periphery so that the PIIGS are competitive with Germany and the rest of the core? Apparently, neither does the author.

Actually, macroeconomic indicators continue to worsen in the periphery and have begun to do so in the core. Employment and GDP in the PIIGS, with the exception of Ireland, has been declining with no end in site and with them budget deficits have moved in the opposite direction.

Employees of the TBTF banks have a huge incentive to write and publish articles like these to drum up business in their firms. This is my unbiased forecast for the eurozone for 2013. The recession will continue and will deepen as the year wears on. Countries will have trouble meeting their planned budget deficits, but this will not reduce their creditworthiness as the ECB’s printing promise will keep bond yields in a narrow trading range.

Do not make same mistake as the author and other of his ilk confusing a temporary equilibrium with a permanent abatement of the crisis. While currently quiet, the current equilibrium is weak, and a tail event could easily change everything in a hurry. The biggest risk to the eurozone is not Italian or even German elections, but an unknown unknown destabilizing markets. Think of something like a debt crisis arising in Japan or a civil war erupting in Greece. In the meantime, expect more of the same.


Included at no extra charge, Nouriel Roubini’s Eurozone forecast for 2013:

The year ahead in the euro zone: Lower risks, same problems | The Great Debate.


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