Friday, June 29, 2012
The Eurozone members have not yet solved its fundamental problem—excessive government spending—but as these charts show, they have significantly reduced the threat of a near-term disaster. The ECB's liquidity injections have been sufficient to keep financial markets liquid, allowing financial markets to play their traditional role as a "shock absorber" for the physical economy. Liquid markets permit risk to be transferred from the risk averse to the risk lovers, and there has been lots of that going on in the past two years.
The biggest risk that the Eurozone has faced was the collapse of its banking system, since Eurozone banks held the bulk of the PIIGS debt. Eurozone banks have lost some 85% of their valuation in the past five years, which means that shareholders have effectively absorbed a huge chunk of PIIGS debt losses. Recent steps taken by the Eurozone members will make it easier for banks to recapitalize and continue functioning. In other words, the losses that have occurred as a result of PIIGS countries having borrowed beyond their means and squandered the proceeds of their loans are being spread around. The losses occurred in an economic sense a long time ago, and all of the sound and fury in Europe for the past few years has been about who is going to have to write those losses off on his balance sheet. Well, it's slowly getting done, and that is good, even though the PIIGS have yet to make meaningful cuts in their spending.
We haven't seen the end of this crisis, not until we see credible austerity measures coupled with supply-side growth remedies. But the panic edge is off, and financial markets continue to function. This gives the Eurozone more time to stumble around looking for the right solutions. And it gives the rest of the world some breathing room, and time to continue growing.
UPDATE: A chart (below) of the latest figures for Spanish 2-yr yields and the Vix/10-yr ration. This reinforces how the fears in Europe are driving fears in the U.S, and how both have declined on the margin. We're not out of the woods yet, but recent improvement is encouraging. Buying time and maintain liquid market can go a long way to mitigating the magnitude of the Eurozone sovereign debt crisis.
Posted by Scott Grannis at 8:50 AM