Europes Dominoes, teetering still

June 21, 2011

Global Macro

I sat through the demise of Bear Stearns in March 2008 and thought, OK that wasn’t too bad. But as the year wore on and Fannie and Freddie got into trouble and then Lehman Brothers started teetering I thought, “this is going to get ugly”. And to a certain extent it did but in my view it didn’t get really ugly until that day in Asian trade when the US Congress (I think – could have been the Senate) decided not to pass US Treasury Secretary Hank Paulson’s rescue package.

But the markets survived, eventually, thanks to Government’s throwing cash at their banks and to a lesser extent economies while Central Bankers dropped rates aggressively. In many jurisdictions to zero.

Please don’t misconstrue this next comment as saying that markets are always right or rule independently but I hoped this near death experience for the global economy would have taught politicians that dithering is death. It seems that perhaps Europe’s experience of 2008 and 2009 just wasn’t bad enough.

So it was with dismay yesterday that I saw the headline on Bloomberg that the Euro FinMin conference had broken up without agreement. What was truly interesting was the fact that Bloomberg and Reuters had diametrically opposed views as to what happened at the meeting but as European traders came back from the weekend we saw wholesale selling in Equities, Currencies and other asset markets.

Thankfully commonsense prevailed and Luxembourg’s PM Jean-Claude Junker made some conciliatory comments that the Greek Prime Minster had given undertaking’s to get the austerity package together. But is this worth the paper it’s printed on? Probably not. Bloomberg reports this morning,

Greek Prime Minister George Papandreou said it’s in Europe’s interest to find a solution to the country’s debt crisis after finance ministers left open whether they will give the country all the funds it was promised next month under its bailout deal.

“We are determined as a country, as a government, to be on track with the program, to move forward, to do what is necessary in order to put our country into a fiscally much more viable position,” Papandreou said in Brussels today. “At the same time, we do hope that the European Union will have also the similar will.”

My bolding but the threat, or message is clear. Importantly however Papendreou faces his own Parliament tonight, Asian time, so all bets could be off.

I understand the reticence of European policy makers to put good money after bad but they more they dither the worse it gets for others.

To wit, on Friday night Moodys decided that there weren’t enough bush fires in Europe and thought they should open up another front by putting Italy on negative watch for a ratings downgrade. Obviously I’m being satirical here because it’s not Moodys intent to make life harder for Europe but it does shine a light on just how deep and structural the problems with the PIIGS are (Portugal, Ireland, Italy, Greece and Spain).

Last week we had some hand wringing and teeth gnashing from commentators who said Greece was just 0.5% of the global economy and didn’t matter. We take an entirely different view as we strongly believe a Greek default will destabilise Irish austerity efforts and perhaps precipitate an Irish default. Rather more scary is the interconnectedness of global finance and the fact that while there are plenty of bonds to be defaulted on there is a multiple of leveraged bets on a Greek default in the Credit Default Swap (CDS) market. Someone, big US banks according to the BIS data, has been writing the insurance on Greece and other PIIGS so someone will have to pay the piper when the music stops.

But will it and when?

Which leads me back to Italy. This has been a rolling crisis, Iceland, Ireland, Greece, Portugal, Spain even the US’s fiscal position is being questioned and now Italy. So far the Italians have skirted the problems of the other PIIGS as they are rather more interested in the trials and tribulations of their leader Mr Berlesconi.

But in putting them on ratings watch Moodys has shone a light on something we all knew, that is, Italy is a big country with a lot of debt – $2,000 billion, or 2 trillion to be exact. Now a lot of this debt is held by Italians, so like the Japanese it is more easily rolled over than nations who are captive to global markets and the whims of traders.

But writing in the FT this morning Edward Altman and Maurizio Esento make the following observation,

Even today, despite low interest rates, the European Commission reports that Italy’s government interest payments as a percentage of gross domestic product are 4.8 per cent, second only to Greece’s 6.7 per cent and considerably higher than all other major European countries and the US (2.9 per cent). Even Portugal’s ratio is lower at 4.2 per cent.

In the past 24 hours the markets have ridden a rollercoaster as the outlook for the Greek situation has ebbed and flowed. 0.5% of global GDP is all that Greece may be but imagine if someone larger like Italy or Spain gets dragged into this mess. For now we don’t think so, let’s hope it remains that way.

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