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Europe Fighting the Wrong Battles Again with Dangerous Consequences



May 26, 2012 – Comments (0)

Here's an excellent analysis by Peter Tchir on the Europe situation.

Europe Fighting the Wrong Battles Again with Dangerous Consequences

A good point on the uniqueness of the Greek crisis:

Never has there been a situation where a country is in such deep trouble that it needs to default and virtually all of the debt is already held by entities which normally step in AFTER a default and currency devaluation.

How does one stop a bank run based on fear of redenomination?

Pan-European deposit insurance will NOT stop that flight of depositor money, unless it also ensures against forced conversion. That is a big risk to insure against, and may not be even remotely in the ECB’s mandate.

Anticipating what forced currency devaluation would really do is a new aspect to the crisis. It isn’t a liquidity or a solvency problem, it is its own problem. Politicians and central banks have to focus on this issue. I remain afraid, that like at so many other stages in this crisis, they will fail to understand the real problem, so their “preparations” will fail to stop this run and the crisis will escalate.

What will happen with the losses if Greece defaults? 

If Greece leaves, what is the ECB really going to do? Do they really expect Greece will pay them back at par in Euros with their new weak currency? That is stupid. Will the ECB print money to make up for the losses? That is one possibility, but given how stubborn Germany has been about austerity and how they hate printing money even more, I expect that the ECB would not print money to cover the losses.

If the ECB is going to take a loss and won’t print money, then they would have to go to their members and ask for more money. That seems highly unlikely, especially if Spain and Italy are busy trying to prevent a run on bank deposits. So, sadly, the plan seems to be to sell the bonds to the EFSF at either cost or par and let the EFSF take the loss.

Feeding more losses to the EFSF starts to fan the flames of contagion. The EFSF will have losses on its own loans, but now for the first time, obvious to everyone, the EFSF will be just a loss transfer mechanism.

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