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CFO – 3RD QUARTER – EUROPE ON THE EDGE OF A TAILSPIN, three scenarios to watch

10 October 2011

We know it is going to be a long hard slug out of this financial crisis.  Slow growth in Japan, Europe and USA will slow deleveraging for governments and consumers for years to come.  Growth options are just limited.   Despite all the venerable intents to zoom in on exports, the reality is such that a good part of the export game has already been shifted to the emerging markets.  And are they not keen to protect their exports:  Their exchange rates have weakened from 3 to 10% against the US dollar since the beginning of the year (with the notable exception of China at +3.4%).   At best, the roadmap to sustained economic recovery will be a slow process.  At worst, the forthcoming European debt crisis could derail and push it into a tailspin of economic damage. 

The stakes are clearer and riskier than ever in Europe.  Three issues stand out.  First there is a solvency issue with Greece, a liquidity problem with Ireland, Portugal and to some extent Spain and Italy, and a banking crisis in the making.  A frightening number was published by John Hancock last week:  today the total debt of the three largest banks in France reaches a staggering 250% of France’s GDP.  The European Financial Stability Fund, with funds estimated at Euro 440 billion, will look rather insufficient to deal with this soup of solvency, liquidity and banking stress.  Yet we know the cost of an extensive bail-out is a fraction of the cost of breaking up the Euro. Solving the bail-out issue remains the priority in the very short term.  Second, the true proportion of the gap between monetary union and loose fiscal policies, in part at the origin of this mess, is coming to light: large imbalances in labour costs, budget deficits, national debts and current accounts amongst European nations have been allowed to grow over time and are now threatening the very monetary union.  Third, it is awfully painful for depressed countries to restore competitiveness.  How far can austerity dig in, wages fall and jobs disappear without breaking a social contract in these countries?

Thus the ideal package would fix 3 things: 

1. The bail-out:   Currently short of reassuring financial markets

2. Some sort of fiscal union in Europe: Currently under tortuous negotiations

3. A roadmap to country competitiveness for depressed nations:  Which remains hard to sell.    

Under crucial time pressure, what can we possibly expect from European politicians to deliver?  At the minimum, failure to sort out the bail-out between sovereign debt and banks could deal a nasty blow to the world economy, or even create a tailspin:  tipping the USA into a double-dip, slowing Asia and so on.  Leaving the fiscal question untouched would condemn the European Union to an uncertain economic future.  Leaving out the small troubled countries would tear off cohesion in the European project. 

The words of Churchill resonate:  ‘Want of foresight, unwillingness to act when action would be simple and effective, lack of clear thinking, confusion of counsel until the emergency comes, until self preservation strikes its jarring gong -these are features which constitute the endless repetition of history’.

Europe is on the edge of biting a large bullet, with consequences ranging from a muddled economic mess to a full banking crisis. 

A storm is approaching.   Hang on.

André Du Sault.

Posted in CFO & treasury, World economy.

Tagged with , , .

6 Responses

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  1. Paul Piché says

    I agree with your comments and expect the worst, as we have not heard much from France’s problems because they are preparing election in May 2012.
    But when election will be over, the truth will emerge, and then, the worst could happen

    • Andre Du Sault says

      Good point. The election does provide hell of an incentive to fix the short term problems. Will it be some patching, or true repairing before the 2012 election?

      • Jerry says

        That’s rellay thinking out of the box. Thanks!

    • Darvin says

      Grazi for mainkg it nice and EZ.

      • Bellary says

        ΑΝ ΔΕΙΤΕ ΠΟΣΟΣΤΑ ΜΕΓΑΛΥΤΕΡΑ ΑΠΟ ΑΥΤΑ,ΘΑ ΕΙΝΑΙ ΠΕΙΡΑΓΜΕΝΑαπο τους φινανσιαλ ταιμς,3 μαιου1.ΝΔ-ΠΑΣΟΚ μαζι παιρνουν 30-35%2.πολυ μεγαλη ανοδος της αριστερας3.ευρυ αντιμνημονιακο μετωπο δεξιας-αριστερας,μαλλον τσιπρα-καμμενο εννοει4.μικρη η πιθανοτητα εξοδου απο το ευρω5.πανικος στις αγορες για σταση πληρωμων6.πιο ευκολη η αναδιαπραγματευση του χρεους παρα η εφαρμογη των μετρων.7.θα γινει κοινωνικος πολεμοςσας βαζω σχεδον ολοκληρο το αρθρομπας και σκασουν οι παπαγαλοι νδ-πασοκGreek elections: Be aiafrd, be very aiafrdPosted by Masa Serdarevic on May 03 17:37.Greece goes to the polls this weekend. And it looks like it’s going to be messy. The potential for the wrong result to wreakhavoc in the markets on Monday morning is real.The outcome is very difficult to predict due to the incredible fragmentation of political support within the country and the riseof marginal parties. Many of these are deeply opposed to the austerity measures, the euro and the EU/IMF programme. As aresult, mainstream parties have been dragged away from the centre.The most recent indications are that the two major parties that form the bulk of the current ruling coalition, New Democracyand Pasok, can together scrape in about 30-35 per cent of the vote.Clearly support for the left is much stronger than for the right, but support for the bailoutprogramme is low on both sides of the political spectrum. Moreover, the communists (KKE) and Golden Dawn on the far rightare in agreement that Greece should leave the euro.However, the risks of trying to renegotiate the Memorandum of Understanding with the IMF pale into insignificance comparedwith the challenges the new government, whoever it is, will have in implementing austerity measures. Some 3bn-worth ofspending cuts must be made immediately, and another 12bn are slated for 2013-2014.As a result, argues the global economics research team at UBS, the biggest risk is for a temporary suspension of officialsector financing, with worrying social consequences:If Greece does not fulfil its commitments, we think it is entirely possible that the IMF, and in turn the EU, willsimply refuse to make the next payment. However, it is unlikely in our view that payments would stop altogether rather, they might be postponed until Greece fulfilled its obligations. This could generate considerable tension,with the Greek government quickly running out of cash and being forced to stop paying salaries and pensions.Social turmoil would almost certainly follow.The markets, they argue, are unprepared for such a scenario (our emphasis):The restructuring of Greek debt earlier this year appeared to many people to mark the end of Greece’s ability toupset other European markets. Even a temporary suspension of official sector financing could thereforebe very damaging to European markets as they consider Greece’s alternatives in the event that officialfunding were cut off permanently.The likelihood of Greece leaving the euro is relatively small, the UBS team argues, as voters are generally in favour ofkeeping the single currency, but the taboo of discussing an exit is gone. Such talk, and the implications for a euro-exit forSpain and Italy, could send the markets into a spin.Underlying all these concerns are more fundamental issues of social turmoil in Greece. As austerity drags on, support forboth Communists and the far right is rising, making it more difficult for moderates to hold on to power and make thenecessary compromises. If the new government after is unable to pay wages its employees and pensions to the retired,voters may plump for increasingly extreme options. Earlier this week Venizelos’ was reduced to appealing to voters not toallow neo-Nazis goose-step into parliament , but there’s a good chance they might.

  2. Kaley says

    So that’s the case? Quite a revletaion that is.

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