Free Money in Europe
“More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness. The other, to total extinction. Let us pray we have the wisdom to choose correctly.”
—Woody Allen
Last week Evan and I attended a GaveKal conference in New York and the quote above, from Annie Hall, summed up the feeling in the room. Three potential risks for 2012 were outlined at the meeting:
- A breakup of the Euro and a resulting financial panic in Europe
- A recession in the US
- A Hard-Landing in China
GaveKal concludes that investors should worry less about the US and China, but more about Europe. The open question at that meeting was settled on Wednesday when 523 European banks drew down nearly $600 billion from the European Central Bank (ECB). Last week the audience was split on whether the banks would take the 1% three year loans—that’s been settled now.
These loans take a Lehman style bust off the table and solve the short-term banking crisis in Europe. It does nothing to address any long-term issues, but it buys time for Europe to reform itself or ditch the Euro.
Our concern over the last few months has been that killing off the Euro would be a messy business and one that would result in a lot of collateral damage in the stock market. That still may be how it works out, but these new three year loans from the ECB make an organized breakup more of a possibility.
Here’s a highlight from yesterday’s GaveKal report:
“Anatole argues that the ECB’s actions ironically pave the way for an orderly breakup of the Euro in a few years’ time. This is because the ECB is encouraging banks to borrow from the ECB at 1% and buy domestic government bonds at 5-7%. Buying domestic is a good hedge because in the event the union cannot be saved, the banks’ Euro liabilities to the ECB will likely become Lira liabilities to the Banca D’Italia or Peseta liabilities to the Banco de Espana. An orderly Euro breakup, by restoring the currency tool to less competitive economies, would ultimately be positive for growth in southern Europe.”
In other words, if more Italian government bonds are owned by Italian banks rather than French banks a return to the Lira could be more easily managed. Southern Europe has three years to bring its government bonds back from foreign owners and into the hands of Italian/Greek/Spanish banks. Then Italy, or the others, can go broke in a more peaceful way within their own borders.
One other reason to be slightly more optimistic about Europe is illustrated in the following chart.
There is no “European” economy. Broadly, there’s the booming North and the depressed South. The coming depression in the Mediterranean will hurt world growth, but growth in the north of Europe, the United States, and China will help avert a world-wide recession in 2012.
That’s our primary assumption for next year.
This will be our last note for 2011. Here’s hoping that you enjoy the holidays and that we all have a very Happy New Year.
Best regards,
Daniel A. Ogden
