Neils Jensen: The European Disease

Smoke and mirrors

So what does that mean? Three observations:

(i) One has to question the quality and sustainability of the €750 billion rescue package announced a couple of weeks ago. The vast majority of the funding originates from within the eurozone. As Dylan Grice at Societe Generale points out:

“…distressed eurozone borrowers are to be saved by more borrowing by … er … the distressed eurozone borrowers.”

Who do they think they are kidding? We are treated as a bunch of intellectual minnows who are not capable of seeing through the smoke and mirrors created by political leaders who refuse to accept that the euro in its current format is doomed. And when we rebel, we are deemed unpatriotic speculators who do not care about the greater good. It is precisely because we care that we speak up. Hedge fund manager Hugh Hendry hit the nail on the head last week in an interview on BBC’s Newsnight programme when he said:

“We can spread this over 20 years, or we can get rid of it over 3 years.”

(ii) This is no longer about Greece, which is just a symptom of much wider and deeper problems. It is not even about the PIGS anymore. No, it is about cross-European contagion risk which threatens the very existence of our banking system. It is this risk that Merkel and Sarkozy worry about when they say that Greece will not be allowed to go down.

European bank balance sheets are stuffed with non-performing loans which should have been written off in 2009. European regulators, however, allowed the banking industry not to come clean in a repeat of the policy mistakes made by Japan in the 1990s. As is obvious when looking at chart 4, German, French and British banks are all very exposed to Greece, Spain, Portugal, Italy and Ireland. The numbers are big enough to take the entire industry down. That is why the decision to bankroll Greece, Spain and Portugal was in reality a decision to save our banking industry.

Chart 4: The Risk of Contagion

Source: “Avoiding the Sovereign Avalanche”, Citigroup Global Markets, May 2010

(iii) The harsh lesson learned in recent months is that it is total debt which matters (see chart 5). Spain and Ireland were both very successful in cutting public debt in the years leading up to the credit crisis, but they somehow forgot to control private debt, a mistake for which they are now paying dearly. In fact, the rapid rise in public debt in recent years is not so much the cause of this crisis as it is the result of excessive growth in private sector debt over the last decade or so.