Imagine that a man (the "eurozone") experiences severe chest pains and looks like he is headed for a heart attack ("Lehman moment"). The protocol is well defined in these circumstances. Take steps to stabilize him ("inject liquidity via the ECB") and then address the causes with a program of diet, exercise and medical treatment ("longer term solutions such as balanced budgets, pro-growth policies, possibly closer fiscal integration, two-speed eurozone, etc."). Berating him about being lazy and overeating ("you lazy Greeks, Italians...") and making him get on the treadmill to work off his Thanksgiving feast ("more austerity and IMF monitors") while he is on the verge of a heart attack ("Lehman like financial crisis") is less than helpful under the circumstances.If the ECB was supposed to be the Emergency Room doctor, then yesterday's decision by Mario Draghi to rule out further bond purchases was like throwing the patient out on the street with instructions of "take an aspirin and call me in the morning."
What's more, the patient's family then gathered around to berate him for his bad habits over the years and forced him to get on the treadmill (the latest Grand Plan for greater fiscal integration) in order to lose weight and improve his health.
Heart attack time?
The markets promptly responded and Italian 10 year yields shot up an astounding 47 bps.
European stocks took a similar pounding in the wake of the news:
Euro STOXX 50
Fiscal policy does the heavy lifting
Instead of a combination of fiscal and monetary policy to save the eurozone, we now have to rely purely on fiscal policy. Will a new Brussels-on-the-Rhine, even if it were to be ratified by the eurozone governments, be able to do such heavy lifting without plunging Europe and the rest of the world into a deep recession?
There is a tool from The Economist that allows a user to specify economic assumptions, i.e. GDP growth, budget balance, interest rates and inflation, for a country's to see what is needed to stabilize national debt-to-GDP ratios. When I played around with it, getting from A to B looks a tough task once you assume the recessionary effects the combination of an austerity program and credit crunch. (If the tool below doesn't work, try this link instead).
The markets had been focused on ECB action to buy the eurocrats some time to fix the long-term problems. Now, we have a credit and liquidity squeeze occurring in the European banking system that is technically insolvent. These issues need to get addressed now.
As I write these words late Thursday night, it appears that the latest Grand Plan is already falling apart. Maybe Merkozy and the eurocrats can pull a rabbit out of the hat, but I am not optimistic.
The markets are going to take this very, very badly.
* In the past, I mistakenly referred to the December 9 EU Summit as the Marseilles summit. It is being held in Brussels. I apologize for the error.
Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.
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