Friday, June 29, 2012

Eurozone crisis atmosphere fades



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.


5 comments:

Dr William J McKibbin said...

I agree that we need to see "credible" and demonstrable austerity measures in place and active before the Euro-crisis is over -- likewise in the US in places like California, we need to see demonstrable austerity measures happening -- I am confident that a Romney administration will resist austerity through tax increases -- what is needed instead is a 40% cut in all government spending -- across the board would be fine with me, but however those cuts happen, they need to be in place and active within a year -- otherwise, austerity will fail -- Romney will get his chance assuming he is elected to prove that he is a fiscal conservative (or not) -- if Romney does not undertake savage cuts to government spending, then the only two courses forward will be tax increases or monetary expansion -- Romney will have to hold firm on austerity, or lose all respect from his own constituents and party -- that's a tall order, so I hope Romney is up for it -- otherwise, his election will be a farce.

PS: Watching Chief Justice Roberts fold on Obamacare provides a glimpse of what I fear from Romney -- does anyone else share that fear...?

PPS: Austerity will not work in the US or Europe unless the cuts are savage (as in 40% of government spending), so everyone should get ready to endure those cuts -- anyone who is not ready for huge cuts in government spending should admit up front that they were not fiscal conservatives afterall...

Dr William J McKibbin said...

PPPS: Savage cuts in government spending will require implementation at the point of a gun -- everyone should be forewarned...

Lawyer in NJ said...

Roberts showed what conservatives claim to love: judicial restraint.

When austerity includes commensurate defense cuts to entitlements reductions, its advocates will gain some credibility. As of now, that's Ron Paul and...no one....

Squire said...

We can’t grow out of our mess with 3% growth and 20% collected in taxes, both of which at this time are a big stretch of the imagination.

$15 trillion GDP x 3% is $450 billion in growth x 20% collected in taxes is $90 billion in central government revenue. A drop in the bucket.

We are not going to be able to increase debt enough as the effectiveness of more debt is now nil.

Cutting is going to be the only way. Unfortunately for me, I am unable to persuade my doctors to give me a hip and knee replacement earlier than needed. By the time I need it, medicare won’t cover it and I will be hard pressed to come up the dough.

Cutting spending will fail to meet expectations without structural reform: taxes (there is now a really good case for getting rid of the income tax because of the Obama Roberts new rule of law), healthcare (ditto), immigration (ditto), unfair trade, education, preference in hiring, energy, etc.

Squire said...

I am not of the class to be able to buy Spanish and Italian bonds. The yields are great and the bailout is designed to create capital gains. For now, Europe is saved. Two weeks? I will be out of my equity shorts at a break even if this surge of European optimism continues.