While the broader equity markets and most cyclical commodities have held near their intra-day highs this afternoon, many investors, economists and market strategists have begun to dissect the details of today’s euro zone agreement.
One of the more thorough analyses of the outcome of the European Summit came from James Kostohryz, a contributor to Minyanville.com with nearly two decades of investment experience.
In a piece entitled “EU Deal: Woefully Insufficient,” Kostohryz argued that the new measures will fall far short of providing a sustainable solution to the European sovereign debt crisis. Given the level of detail he provided, GoldAlert has included his article in its entirety:
Expectations going into the EU Summit were extremely low. There was a sense up until late last night that the entire summit could collapse in acrimony.
Thus, the fact that the leaders agreed on anything is being taken as a relief by the market.
But when you look at the details, there was absolutely nothing new in this agreement that should have surprised anybody. And everything about this agreement serves to highlight the fact that Europe is headed for a major crisis.
1. The most important aspect of the agreement was opening the possibility of the ESM capitalizing banks directly rather than through loans to the sovereigns. However:
A) The possibility of direct ECB financing of the banks is conditioned on creating a centralized banking supervision regime which the agreement stipulates will be “considered” before the end of the year. Thus, the prospect of direct loans for the banks is neither immediate nor even certain.
B) The ESM has a limit of $500B – which is has not even raised yet. Suppose that the projected $100B is used for Spain’s recapitalization. Ireland, Greece, Portugal and banks from other European countries will also want in. (Ireland’s PM has been loudly saying that they want in). Thus, realistically AT LEAST $200B of the $500B will be devoted to bank recapitalization. That leaves a theoretical $300B to buy sovereign debt. That is peanuts.
2. The other aspect of the agreement is that the ESM will be allowed to buy sovereign debt. However, as pointed out above, this looks like a paper tiger.
A) The potential $500B (which is really $300B after subtracting bank recap funds) has not been raised by the ESM – and it may be very difficult to raise it. After all, who wants to lend to an entity that is “backed’ largely by Italy, Spain, Greece and Portugal? Within the ESM framework, the combined “guarantees” of the PIIGS are in fact proportionately more important than the guarantee provided by Germany.
B) As pointed out above, even if the $500B can be raised, it will not be nearly enough to capitalize European banks and serve as a bond-buying mechanism.
C) The possibility of the ESM getting financing from the ECB – the only way that the ESM could become credible in terms of size – was conspicuously excluded as a possibility. The idea has been flatly rejected time and time again.
D) The ability of the ESM to buy sovereign debt is hampered by all sorts of conditions. For example, purchases would be conditioned on the beneficiary countries complying with fiscal agreements. Well, there is no way that Spain can comply with theirs. So as of now, the entire exercise is mute.
In sum, the summit produced an “agreement,” and an agreement is better than a collapsed summit. But there are no real solutions here.
The Spanish and Italian economies are in the midst of a serious collapse in investment and consumption and this collapse will not be halted by this agreement. The consequence of this economic collapse is that neither Italy nor Spain will be able to meet any fiscal targets. These facts bring us back to square one. Unless something is done to halt the collapse of the Spanish and Italian economies, these agreements are futile.
Thus, within a matter of days or weeks, markets should resume their downward descent.
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