Politics has been and will be the constraint on the latest iteration of Bailout Europe 4.0. We at the Global Macro Monitor really want to see Europe make it, for markets to rally, and for all to make money.
But the latest bailout announcement/rumor, which includes a Euro 600 billion loan facility from the IMF, which, by the way, exceeds the Fund’s total lending capacity, currently around $400 billion, doesn’t pass the political smell test. There are also rumors swirling of a Eurobond. As usual, the news has sparked a nut cracking short covering rally with S&P futures up over 25 points.
We see several political reality checks on the latest deal rumor because at the end of the day any large sovereign bailout is also a bailout of the major European banks. The public doesn’t want to hear about global systemic risk and we expect huge political pushback on this one. Imagine how this will play in the U.S. Presidential election as the Republican candidates are already on record, no bailout of Europe. Mitt Romney stated in a recent debate, “Europe is able to take care of their own problems.”
We see three major political constraints on the latest rumors:
1) 79 percent of Germans oppose a Eurobond;
2) Occupy _______ , which reflects global public opinion, will not be happy if taxpayers have to contribute more funds to the IMF to bailout European financial institutions, mainly French and German banks;
3) Italians will not be happy with severe austerity imposed by the IMF, which will require massive labor reforms, including cutting pensions and wages;
The financial rivets are popping and the latest rumors of new deals could buy some valuable time. But we’re beginning to believe it’s too late for Euro as we know it.
Maybe because there is no magic solution — x/ hyperinflation — as the true end game will be debt restructuring and the allocation of losses to those who caused the crisis in the first place — i.e., the sovereign borrowers and private lenders — as it should be, no? Reality is setting in and Europe is running out of illusions, delusions, and quick fix short squeezes.
We’re also beginning to conclude the best solution is that the less indebted core countries leave the Euro for a new common currency of their own – a northern Euro. This would allow the old/southern Euro with the highly indebted periphery to depreciate significantly, increasing the competitiveness of each country and effectively deflating their stock of debt in real terms. If Greece were to return to the drachma, their debt ratios would probably increase at least threefold and the recovery value of the bonds would likely fall to less than 5 cents on the Euro, if that.
The U.S., U.K, and Japan should also view what is happening in Europe as their Sputnik moment and motivation to get their own fiscal house in order. There is no doubt, at least in our mind, a version is coming soon to each of these countries. Sovereign risk is all about confidence and the lesson of the European crisis is that confidence is fickle and fleeting, here today, gone tomorrow. Nobody knows the tipping point.
Watch to see if this rally has legs, which we doubt it will. Our sense is the Europeans will view it as a gift of the Magi and use it to exit. Stay tuned.