Inadequate Euro agreement is a massive confidence trick, says Ignis economist Stuart Thomson
The agreement to save the eurozone will cause recession in 2012, rob France of its AAA rating, and represents a pyrrhic victory for Germany and the ECB, argues Stuart Thomson, chief economist at Ignis Asset Management.
The latest emergency European summit provided another trillion Euro package. To the extent that any agreement was reached, it was better than the unlucky 13th summit last weekend. The agreement is long on rhetoric and short on details but can be divided into four categories, all of which are inadequate. There will be an inadequate bank recapitalisation plan of €106bn, an inadequate Greek haircut of 50% of GDP, and additional but inadequate fiscal austerity from Spain and Italy. Finally, there will be an inadequate leveraging of the European Financial Stability Fund through a combination of credit enhancements and insurance leverage through a Special Purpose Investment Vehicle.
The aptly named SPIV spells the true nature of this policy it’s a massive confidence trick. Europe’s politicians are trying to sell PIIGS in a poke. We don’t believe that private investors will fall for it and private capital will continue to retreat from the peripheral economies.
The agreement represents a pyrrhic victory for Germany and the ECB. Germany was unwilling to fund the periphery without a substantial degree of economic control over the fiscal policies of its southern neighbours and has insisted that European treaties need to be changed. These treaty changes are fraught with political pitfalls and will require referendums in Germany, France, Holland, Finland and the UK.
The 14th emergency summit has kicked the can down the street and there will be a 15th meeting next month to flesh out the details of the package. We have no doubt that emergency summits 16 through 21 will take place through the first half of 2012.
2012 will be a year of recession in Europe. We expect European GDP to contract by 0.5%. Fiscal austerity and bank deleveraging means recessions are inevitable in the peripheral economies. However, the most important recession will take place in France. We expect French GDP to contract by 0.3% next year. The rapid deterioration in business and consumer sentiment over the past few months as well as the rise in unemployment and contraction in lending standards emphasise the downside risks for the economy.
Recession will rob France of its triple AAA sovereign credit rating. This will undermine valuations of the EFSF and its accompanying SPIV, raising the costs of funding in Europe and emphasising that the true triple AAA European economies are restricted to three members inside the Eurozone; Germany, Holland and Finland, and three members outside the Eurozone; UK, Sweden and Norway.
The Eurozone Con trick highlights excessive debt within the region. This debt is stifling growth, which in turn means that the affected countries cannot grow their way out of the current crisis and this debt will eventually have to be written off. This will take place through a series of sovereign haircuts. The next in line at the barbers is Portugal, but we expect it to be followed by Spain, Greece again, Italy, Ireland and Belgium over the next few years.
The Con trick also emphasises the shortage of safe haven bonds in the world of excess savings and increasingly repressive financial regulation. We recommend that investors remain overweight the bonds of these safe haven governments.
Stuart Thomson is chief economist at Ignis Asset Management