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New Euro Order: The Empire Strikes Back

By setting up a Eur750bn package, the EU legitimately defends its currency but might simultaneously pave the way for even worses trouble. There is no example in history where any regulator or government could lean against the market forces for a long time. Previous "interventions" from central banks actually leveraged the market forces, never opposed them.

Why did the Euro fall in the first place? Technically some of the "hot money" loaded through carry trades over the last 18 months need exit the Euro as there is not much to hope for in terms of interest rates differential now that the ECB is also compelled to quantitative easing -just like the US and UK. The fundamental reason, is that the market has understood that the crisis leads to a long term structural recession in Europe. Unlike the US and the UK who can freely decide of their monetary policy, the Eurozone over-indebtedness materialises in regional discrepancies of credit quality. The European governments, who had tried to sustain their economies with public expenditure, have found a dead end. The structural deficiency is a fully independent central bank for 16 fully independent finance ministries. Following the Greek rescue all governments -not only PIGS- are forced to move into austerity budgets. Keynesians stop here. This means less earnings, less demand and less credit across the board. It means recession and, all of a sudden, the Euro appears massively overvalued.

The second error is to play against the market rather than using them. What the markets are in the process of doing is to rebalance massive discrepancies that the single currency has generated in credit quality across the Eurozone. Surely Eur 750bn is a lot of money but it merely represents half of what changes hand on the forex market -spot- in a single day. In addition, it concentrates all risks solely on the EU and the IMF. What might happen if the package is exhausted is beyond what my words can describe.
Leveraging the markets would instead consist of restructuring the PIGS debt with PIGS bonds collateralised with German or French bond (or a basket) and auction those bonds for whatever the markets will consider a fair price. Therefore risks would be disseminated over a very large number of risk takers and the credit quality of the PIGS would not contaminate the rest of the region.

By choosing to maintain the face value of their debt against the reality of the economic imbalances across the region (although pretty obvious) and by trying to do so against the market forces, the EU and the ECB have embarked in a journey no one ever came back from.


Comments: (1)

A Finextra member
A Finextra member 13 May, 2010, 09:39Be the first to give this comment the thumbs up 0 likes

Good argument well put.

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