Thursday, October 6, 2011

Eurozone crisis update


This chart remains one of the most important ones to follow these days. It compares the level of 2-yr swap spreads in the U.S. with those in the Eurozone. U.S. swap spreads are still within the range of what is considered "normal," but Eurozone swap spreads remain dangerously high. Spreads of almost 100 bps mean that the Eurozone financial system and economy are exposed to an unusually high level of risk, because the market demands an unusually high premium for accepting counterparty risk in a swap transaction. The U.S. economy is not really suffering from any systemic problems, but the market worries that there could be some contagion from Europe. So we see caution in the U.S., but real fear in the Eurozone.


It may not seem like much, but I think it is important to note that Eurozone swap spreads have been relatively stable for the past month, as shown in this second chart. The first step towards turning around the escalating sovereign debt default situation is stabilizing things, and that may be what is happening. The ECB is stepping up its efforts to backstop the banking system, and national governments are pushing for bank recapitalizations. Austerity measures have been implemented quite successfully in Ireland, but they are still facing an uphill battle in other countries.

If we are to avoid an end-of-the-world-as-we-know-it scenario, then we will need to see some combination of aggressive measures on the part of the ECB, aggressive measures to recapitalize banks, aggressive and credible measures to curtail government spending, and most likely some form of controlled default or restructuring of Greek debt. If done right, these steps can defuse the situation and remove a gigantic source of the uncertainty that has depressed stock and corporate bond markets, and sent Treasury yields to historic lows, cash yields to zero, and gold prices to the stratosphere.

5 comments:

Dr William J McKibbin said...

"If we are to avoid an end-of-the-world-as-we-know-it scenario, then we will need to see some combination of aggressive measures on the part of the ECB, aggressive measures to recapitalize banks, aggressive and credible measures to curtail government spending, and most likely some form of controlled default or restructuring of Greek debt."

None of that is going to happen -- the "invisible hand" of capitalism is about to draw its sword on the southern flank of Europe...

David said...

Thanks for all you do. Your insights are greatly appreciated. Please keep up the great work.

Benjamin said...

"If we are to avoid an end-of-the-world-as-we-know-it scenario, then we will need to see some combination of aggressive measures on the part of the ECB, aggressive measures to recapitalize banks, aggressive and credible measures to curtail government spending, and most likely some form of controlled default or restructuring of Greek debt. If done right, these steps can defuse the situation and remove a gigantic source of the uncertainty..."

I think those are the steps to take, plus printing a lot more money to deleverage.

Capital is global and abundant right now, and probably will be for a couple generations. Deleveraging through growth and inflation makes a lot of sense--and is a lot better option than permanent Japanification of Europe and ther USA.

Mr. Kowalski said...

For those who doubt how serious this really is, may I present a BBC video done today:

http://themeanoldinvestor.blogspot.com/2011/10/dangerous-moment.html

jazs07 said...

@Mr Kowalski the involvement of the European Central Bank only shows how serious the problem is.

United States Financial Crisis