Europe became a mess partly because of the Moral Hazard that resulted from the inefficient construction of the EU and the Euro. In simple terms, by being associated with Germany and France, countries such as Greece and Portugal had access to lower interest rates, compressed credit spreads and a sense that they could live their lives like the Germans.
This was sadly mistaken. As I read this week, Germany produces things that the Chinese buy.....Greece produces things that the Chinese sell! In short, the only area of competitive advantage was tourism, and since they no longer had the flexibility of cheapening their currency, they were constrained in promoting this.
So we ended up in a mess that has been well documented, but yesterday, the political leaders of the EU announced a breakthrough. The Euro rose and stock markets rallied. I think that this can readily be seen as being a relief rally.
Lets break this down in simple terms. Firstly, private sector banks will have to write off $100 billion or so in Greek loans and raise many billions in new capital....
Secondly, the EFSF will be extended to $1.4 trillion via an injection of equity and debt.
Onc this is done, everything will be rosy..........'ONCE' this is done......Of course, they have to raise the capital first......where is this going to come from??
Lets put it in context. $1.4 trillion is equivalent to over 30% of China's official reserves.
Now lets see who is going to be asked to contribute. The Japanese.....their economy is in a mess and they are faced with an earlier investment in the EFSF being devalued.....The Chinese.......What kind of influence are they going to demand......The Indians......How flattering to hand out the begging bowl to a country that can barely feed its own citizens.......
However, politics aside, on purely commercial terms, why would anyone invest (particularly debt) in the EFSF. Surely only because of confidence that France and Germany will stand behind it....It cant be an absolute guarantee....the electorate wont stand for that.....so it will have to be implied.......
Moral Hazard anyone??
Here we go again!! Will they get away with it??
Sadly, if they do it will be because they sell out to the Chinese and Indians. What a sad day for Europe...Our Grandchildren and their children and their children will all read about this in their history lessons.
