It is a quiet news night.
Any action is behind closed doors.
The papers are full of feature stories.
http://topics.nytimes.com/top/news/international/countriesandterritories/italy/index.html?8qa
Earthquake damage. 400 years of poor construction.
The death count is still under reported.
http://topics.nytimes.com/top/news/international/countriesandterritories/spain/index.html
Failure of Bankia from real estate defaults, bank runs.
Still dead like Franco.
Spain is going to need bankruptcy and foreclosure law.
It is not there at present.
Germany is not going to like the resulting defaulted bonds.
http://topics.nytimes.com/top/news/international/countriesandterritories/greece/index.html?8qa
Greece will leave the Euro very quietly. It may have already done so.
The government will simply meet its obligations with a new currency.
There is no initial need for cash. There are plenty of euro in the country.
the new currency will initially trade one for one. Taxes will be required to be paid in the new currency so it will have value. The new currency must be bought from those who have it by those who must have it. The store keepers will be glad to handle the transactions. Greek law banks will have to keep two books. Cash can be issued there as available. Euro will quickly disappear as trade will go forward in the less trusted currency.
http://www.telegraph.co.uk/finance/comment/9307591/Why-the-euro-will-continue-to-muddle-through.html
This is the view of the doctrinaire right.
9:37PM BST 02 Jun 2012
"The bursting of the US housing “bubble” unleashed a chain of events, each as complex and dangerous as the last. Underlying all of these, however, has been the urgent need to reduce leverage (debt) in the household sector, the banks and in governments.
To offset the impact of this huge adjustment, policymakers around the world, in particular central banks, have found it necessary to resort to “unconventional measures” – ways of trying to stimulate growth at a time when interest rates are already at historic lows. These have included policies such as the Quantitative Easing adopted in the UK and the US, and the more recent Long-Term Refinancing Operations (LTRO) by the European Central Bank, a huge injection of cash into the beleaguered European banking system. All credit.
In the summer of last year fears escalated once again, as a failure to reach any meaningful agreement over how to resolve the deepening debt crisis in Europe weighed on sentiment. In addition, confidence was further eroded by evidence of a renewed slowdown in the global economic cycle and weakness in China (an increasingly dominant driver of the cycle).
Equity markets fell sharply and investors flocked to the relative safety of government bonds – specifically the debt of the few remaining governments that were still considered to be close to risk-free – pushing the interest rates paid on this debt to ever lower levels.
The UK benefited from being outside the euro area. The interest rates that the Government has to pay on 10-year bonds has now fallen to just under 1.8pc, the lowest in more than 300 years. Not a good thing
However, interest rates for governments with the highest debt and/or deficit levels at the centre of the euro crisis, such as Spain and Italy, have continued to rise. In Spain, for example, the spread of interest rates that the government is now required to pay over the “safer” German government debt of similar maturities over 10 years has risen to 500 basis points, the highest since the start of the financial crisis. For Spain, these additional financial burdens come at the worst possible time. With very high unemployment and a continued deep recession, the higher cost of funding its deficit puts an even deeper burden on the already stretched public sector deficit. The higher interest rates weaken growth prospects, which, in turn, increase the size of deficit, putting yet further upward pressure on interest rates.
This dilemma is at the heart of recent political pressure on some of the eurozone countries to introduce policies to stimulate growth alongside deficit control. Not possible.
This makes good sense but finding the money that can help to boost growth is not easy and many of the region’s current problems stem from governments having spent money inefficiently in order to generate growth that was not sustainable. At the same time the focus on so-called “supply side reforms” – for example policy changes that increase flexibility in the labour and product markets – may pay dividends in the medium term but have ambiguous growth effects in the short term.
For a brief period through the first quarter of this year, the level of panic reflected in financial markets started to subside. The economic activity data out of the US surprised on the upside as the nascent signs of recovery in the US housing and labour markets gathered pace. The Federal Reserve, the US central bank, announced that it would maintain interest rates at the current 0.25pc until 2014, while China started to ease monetary policy to support the economy.
In the eurozone, the LTRO from the ECB, designed to reduce the risk of funding European banks, was seen as significantly reducing the systemic risks of a funding crisis in the over-levered European banking system.
Unfortunately, the optimism was short-lived. The lack of credible fiscal budget cuts in Spain coupled with the election of President François Hollande in France prompted concerns that the hard-fought compromises made to agree the new “stability” pact to reduce government deficits would unravel.
Meanwhile, in Greece, the rise in support for the Syriza party, a coalition of left-wing groups, rekindled concerns about the sustainability of the euro system as Greece threatened to renege on previous promises to cut its deficit further in return for more financial support.
While the election failed to build a stable government, the risk of Greece exiting the single currency bloc started to be talked about openly in government and policy circles, heightening fears that financial chaos and contagion would engulf the rest of Europe and beyond.
From an equity market point of view, it is important, and likely, that a rapid exit of Greece from the euro is avoided as such an outcome would expose itself and the rest of the eurozone to substantially increased uncertainty and financial market disruption. Greece would need to cut its spending immediately in order to balance its books, as it would be cut off from the existing loans. The benefit. Meanwhile, investors would panic, given the lack of a sufficient firewall to stop the fear of contagion and bank runs in other countries in the euro area.
A much more probable outcome after the Greek election, and a less negative one for financial markets, is a further protracted period of “muddling through”: the euro system holds together but with no clear resolution. This implies continued Greek EMU membership and ECB funding for Greek banks.
This is further growth of already unsustainable debt.
It also implies continued pressure on Greece, reluctantly, to implement reforms while the remaining eurozone countries very gradually deepen their policy integration. Such a scenario would continue to drag out the uncertainty that has characterized the crisis so far for quite a long time to come.
The good news is that in time it is likely that there will also be slow progress toward deeper policy integration (such as financial market and banking regulations, fiscal coordination and some risk sharing) in order to build the firewall necessary to make the euro area resilient to a possible future Greek exit.
As time goes by, bond yields in some of the periphery countries in Europe could moderate and equities could enjoy a reasonable, if unspectacular, rise. Cheap valuations would support the market as the current fears moderated but this would be somewhat offset by the continued weak growth picture.
Of course, it is also possible that, as part of this ongoing muddling through, eventually Greece would exit the eurozone, but over a longer period of time, as part of a more managed exercise.
Under this scenario peripheral countries would have received assurance that the ECB would intervene in bond markets to limit contagion, preventing a sharp rise in the cost of financing their government debt.
There would also be time for the eurozone to agree a bigger set of firewalls to convince markets that it has the wherewithal to get behind other vulnerable countries and prevent the panic from spreading. If the policy response was powerful enough, we could see a strong rally in equities from lower levels.
Whatever the outcome, it is clear that the uncertainty about the final size and shape of the euro area is likely to continue for some time. Even without the current political impasse, which is stalling an effective solution to the current crisis, many economies in Europe are likely to struggle to grow for a considerable period as they continue to delever their economies and claw back competitiveness.
Of course, this is not true for all economies. The UK has more policy and currency flexibility to help soften the impact of debt reduction as have other economies outside the euro area. Also Germany, while in the euro area, is benefiting from lower debt funding costs (reflecting its better fiscal trajectory) and an economy that is competitive at the current level of the euro and so is enjoying relatively low unemployment and strong growth.
Furthermore, financial markets tend to discount fundamentals pretty quickly and have reflected many of these drivers already. While the DAX, the main German stock market, is up more than 5pc this year so far, the IBEX, the Spanish stock market index, is down around 25pc. The Athens stock exchange has fallen around 20pc year to date but around 90pc from its peak in 2007. The FTSE 100 has fallen 2pc so far this year but ongoing concerns since the start of the financial crisis have reduced the stock market to the same level as it was in late 1997 (although it has risen and fallen sharply several times in the intervening years).
With high dividend yields (currently 4pc for the FTSE 100) and much bad news now priced in, investors who can have a long-term horizon and can stomach short-term volatility might find that future returns are better than they have been for a long time.
Peter Oppenheimer is Chief Global Equity Strategist at Goldman Sachs
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