Forget the short-selling ban, Germany’s plan to tackle budget transgressors (as outlined in Wednesday’s Handelsblatt), is what we should be REALLY worried about, according to RBS.
Before we get to that, here are the highlights of the draft document as seen by the paper:
1. Failing to comply with deficit reduction means temporary loss of EU Structural Funds.
2. Possible irrevocable loss of EU Structural Funds.
3. For serious budget failure voting rights in the European Council could be withdrawn.
4. As a last resort, a managed insolvency proceeding for bankrupt states.
Now, RBS’s Harvinder Sian thinks this plan would take the crisis to another level and would be a clear flag to get out of euro assets in general:
The last part is gunpowder, gelatine, dynamite with a laserbeam. To see this consider the most likely defaulter: Greece. If Greece can not manage the austerity then it will be pushed into a possible new insolvency proceeding, with markets back to trading recovery prices for bonds.
Government bond investors will naturally see that Greece is not that unique in EMU and that Portugal, Spain & Ireland also have large structural adjustments that look very tough. With a template and roadmap for default in place, investors (not just speculators) will begin to trade these bonds on a recovery price. That can be handled by ECB intervention.
The problem is the private sector debt that needs to be rolled. A decade of EMU has seen current account deficits in Southern Europe financed abroad. The total non-resident private debt in Spain & Portugal alone is EUR 1.5 tln, and the German proposal will make the crisis more self-fulfilling as this funding dries up. After all, it does not take great vision to see increased vulnerability for the periphery on an EMU exit clause. The banking systems will systematically weaken and the ECB balance sheet may have to be expanded with outright QE to avoid defaults, but even here avoidance of financial vulnerability by private investors can easily migrate to Italy, the rest of EMU and then as a global issue.
In short, the German exit-clause proposal, while superficially sensible, was something perhaps necessary a decade ago but would now take the crisis to another level. It would be another clear flag to get out of EUR assets in general. Like it or not, the destiny of Germany has been wedded to the Euro area, and there is no way to exorcise members without disaster.
However, Sian says we mustn’t panic just yet.
There is still hope:
Luckily, the German proposals are not a fait accompli, and will be presented to a EU working group on 21st May. The hope for markets is that Europe decides against the exit clause on reflection of its unintended consequences but clearly there is much to play for and investors to watch.
Game on, then.
What’s with Hannover and Generali De? – FT Alphaville
How the Wolf Pack is (already) playing the BaFin ban – FT Alphaville
Zwei linke Füße – FT Alphaville