Eurozone crisis inches closer to resolution

The IMF meeting in Washington on Sunday failed to reach agreement on how to resolve Greece’s bailout problem. Various options are on the table, which (indicatively) would involve a write-down of the net present value of creditors’ holdings by around 20%, five percent, or even “none at all.”

Presumably the different sizes of losses are linked to different probabilities and timings of future repayments.

All possible solutions to the crisis are not equal, though. As this opinion piece explains, if bailout monies came from the BRIC countries then Europe’s position as an exporter of capital (as it is currently) would reduce or even switch to it becoming an importer of capital. That would hit exports, damaging the recovery. Putting it simply, if BRIC countries bought the Eurozone debt, the value of the euro would rise. European exports would drop, European unemployment would rise (with implications for taxes and spending). BRIC employment meanwhile might rise (because BRIC companies became more competitive) or might fall (because Europeans bought fewer BRIC goods).

Foreign investors are not the same as domestic investors. And the different financial options on the table will have different impacts on the future ‘real world’ of trade and economic growth and prosperity.

So, the chosen (or rather agreed-upon) way forward will not only affect the balance sheets of the parties around the table — it will also affect growth in the eurozone economies going forward.

As an example of this we need look no further than the Fed’s Operation Twist last week.

The Federal Reserve bought long-dated treasuries and thus brought down long term interest rates, helping mortgage borrowers.

Other (unintended) consequences are that:

  • “The sell-off in global equities accelerated” — (investors expect a deeper recession)
  • Oil has fallen from $86/barrel to less than $80 — (global slowdown pushes ‘commodity’ prices lower)
  • Gold has fallen 8% — (selling in order to generate cash/liquidity in illiquid market — high correlations means nearly everyone has same opining on selling or buying; increased margins required for trading; and gold is also a hedge against inflation and inflation expectations have fallen)
  • Inflation-linked bonds have fallen — (inflation is expected to be lower, since long term interest rates are lower, recession expected)
  • The US Dollar rose by nearly 2% — (dollars needed to buy $400bn short term bonds sold by US government, damaging US exports)

“…piecemeal policy responses have been shrugged off. What we end up waiting for is a big policy solution and people are finding it hard to see where that comes from.”

The sense is that world leaders are failing to deal with the crisis, and that is creating a climate of fear in which ‘normal rules’ do not apply.

“Amidst the selling, the ‘core’ bonds sit like islands in the storm.” US 10 year bonds and German Bunds are near record lows in terms of returns, but clearly near record highs in terms of confidence that they will retain value. (The Bunds recovered in early trading today, on the back of signs that the Eurozone crisis is nearing solution, and better than expected German business confidence.)

Operation Twist has Investors Moving

‘Investors Wrestle with the Bear Facts’

“Gold Slides as Investors Scramble for Cash”


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