Another European "Solution" Coming?, by Tim Duy: Financial market participants continue to digest what is viewed as generally good news coming out of Europe. Importantly, European policymakers appear to be aggressively moving toward what they see as an overarching response to the crisis. Edward Harrison at Credit Writedowns offers a possible three pillar policy path that has emerged in recent days. My summary:
- An IMF aid package for Italy and likely Spain, financed by the ECB.
- A credible, binding agreement for EU fiscal oversight. In return, the ECB would intervene more aggressively to support sovereign debt.
- A path to Eurobonds, assuming point 2 above.
Despite these optimistic signals, there remains room for plenty of disappointment in the days ahead. Notably, Reuters reports that German Chancellor Angela Merkel will not back Eurobonds or additional ECB intervention. This may be just internal posturing, but does speak to the high degree of internal resistance toward greater EU fiscal integration. Moreover, we have seen in the past the internal bickering yields responses that seem bold at first but quickly fail to stabilize the crisis.
And, when assessing the economic impact, what you don't see is as important as what you do see. What I don't see here is:
- A path to true fiscal integration, which would imply direct transfers from relatively rich to relatively poor member states.
- Similarly, a new path toward internal rebalancing. A commitment to stronger fiscal oversight implies continued pursuit of rebalancing via deflation in troubled economies. Moreover, as Paul Krugman notes, this will be attempted in the context of low inflation, which only exacerbates and extends the pain of adjustment. This path only ensures deeper recession.
- A coordinated, continent-wide banking sector recapitalization. Note that Moody's just placed European bank debt under review. Downgrades are almost inevitable at this point.
- An open door for stimulative policies to offset the demand contraction currently underway.
These are not small details. My fear is that European leaders think they can avoid these issues by enshrining fiscal austerity which, when combined with ECB intervention, will end the sovereign debt crisis. Confidence fairies will then fly to the rescue and fix the rest of the problems. To be sure, I think getting the sovereign debt crisis under control is critically important, but that alone will not stop the recession from deepening.
For those still expecting a mild European recession, I offer up Bloomberg's chart of the day - shipping rates from China to the US and Europe. The text:
Slumping shipping costs show exports to Europe from China are “falling off a cliff” as the euro- region crisis chokes off consumer spending, according to RS Platou Markets AS, a unit of Norway’s biggest shipbroking group.
The CHART OF THE DAY shows how the cost of hauling goods to Europe from China is falling faster than rates for deliveries to the U.S. The price for shipments to Europe is down 39 percent to $511 per twenty-foot box since Aug. 31, according to figures from Clarkson Securities Ltd., a unit of the world’s largest shipbroker. That’s more than double the 18 percent slide in the cost to the U.S. West Coast, measured in 40-foot units.
Not surprisingly, the appreciation of the renminbi has come to a standstill as Chinese authorities act to support exporters.
Finally, note that Portuguese bond yields are pushing higher in recent days, up 15bp to 13.60% today, above the highs of last July. It looks like market participants expect the next bailout will require some private sector involvement. Unsurprisingly, austerity isn't working. From Market News International:
The deterioration of Europe's debt crisis over the past months is hitting Portugal's banking sector and making it more difficult for the country to execute its fiscal adjustment program, the Bank of Portugal said in its financial stability report published Tuesday.
The central bank noted that in the past six months, the "materialization of risks" to financial stability have intensified "substantially," both internationally and inside Portugal. "This aggravation of economic and financial conditions has resulted in a deterioration of profitability in the Portuguese banking system," it added. "In the short term, this trend towards aggravation of risks is likely to persist."
The bank warned that the situation "is increasing the challenges confronted by the Portuguese economy, as well as by the Portuguese financial system, given that the adjustment of economic imbalances must now be carried out in a much more adverse context, particularly as regards the expected trajectory of external demand."
Bottom Line: European policymakers understand they need faster and bolder action. But the situation has many, many moving pieces. It is increasingly difficult to pull the brakes on this runaway train.