45-09-06-11-EOTM-European-Minifigure-Union - September 6,...

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Topics: The debt crisis in the European Monetary Union as seen by a 9-year old, and US recession risks 1 September 6, 2011 For the last 2 years, if the Eye on the Market had a single dominant theme, it was that a common monetary policy does not by itself create a durable monetary union; that European asset markets were not adequately pricing in the risk that the European Monetary Union could fail, or require massive transfers to save it; and that austerity with no FX devaluation is doomed to failure . During this time, our skepticism about the EMU and European asset markets has been rewarded at every turn. For those interested, here’s the latest grisly news of the week…. European manufacturing and new orders surveys are generating the worst readings since May 2009 (particularly sharp declines in France and Italy); German growth fell from 5.0% in Q1 to 0.5% in Q2 Both Italy and Spain struggled in August to attract interest in their public debt, and now both countries face much bigger auction schedules in the fall. Spanish and Italian banks also have large funding needs which are likely to be a problem if their respective sovereigns cannot borrow from the debt markets. Asian buying is critical; Spain relies on Asia for 5x the demand they get from the US. Current IMF and bilateral EU borrowing facilities are not big enough if Italy needs to access them. EU bank shares have plummeted due to funding concerns, as the IMF and EU argue about capital adequacy of EU banks Italian government bond yields rose by 0.5% yesterday as Italy struggles with ECB demands for a zero-deficit plan 1 by 2013; the ECB does not appear to be in a rush to restore stability before the Italian plan is “fully confirmed and implemented” The IMF-sponsored Greece adjustment program is in shambles 2 , for all the reasons we expected it would be Imbalances at the root of the region’s problems have not improved fast enough (see chart). Without an FX devaluation to close the gap, the periphery is consigned to a self-reinforcing cycle of low growth and austerity. While many see the EMU as an integration project, it has resulted in the largest growth and employment disparities in decades (see charts on page 5). This saga has been going on now for 24 months, making it the Berlin Alexanderplatz of Sovereign Debt Crises. However, I think we’re moving closer to the end-game, which begins and ends in Germany. German political parties likely to run the Bundestag after the next elections are in favor of socializing these problems through Eurobonds, if necessary. But the German public generally opposes Eurobonds (see chart), perhaps since the potential cost of a permanent fiscal transfer union rivals the cost of German unification and post-WWI Versailles reparations (see EoTM August 6, 2011). The end-game is mostly about who pays for the accumulated, unrealized losses of the last decade, and who finances the
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This note was uploaded on 02/08/2012 for the course ECO 51844 taught by Professor Sabet during the Spring '11 term at FIU.

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45-09-06-11-EOTM-European-Minifigure-Union - September 6,...

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