Rescuing the eurozone: the right prescription?
March 8, 2012
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Rescuing the eurozone: the right prescription?
We view as a banking sector and government debt crisis what is really a balance of payments crisis
The tools being used to address the crisis are therefore badly-suited for the purpose
Only political will, not underlying economics, has so far stood between eurozone survival and collapse but…
…the ECB LTRO and official sector bailouts at best by time, at worst exacerbate the problems
Only restoring competitiveness in the periphery, not the ‘will of policymakers’ alone can make for lasting crisis
solution
Source: J.P. Morgan.
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Stresses in larger peripheral bond markets and the eurozone banking
system have eased
Eurozone government debt spread
Euribor-OIS spread
Basis points over Germany
Basis points
600
150
550
125
500
Italy
Spain
450
100
400
350
75
300
250
50
200
150
25
100
50
0
0
09
10
11
09
12
10
11
Source: Bloomberg, J.P. Morgan. Data as of March 2012.
Source: Bloomberg, J.P. Morgan. Data as of March 2012.
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The balance of payments: how it adds up
Balance of Payments
=
Capital Account
Current Account
(net exports, transfer payments, net factor
income)
(Foreign direct investment, portfolio investment,
cross-border lending)
+
Source: J.P. Morgan.
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Iceland’s economy recovering from near-collapse
Iceland unemployment rate
Iceland 10-year government bond
Iceland real GDP growth
Share of labor force
Yield
Year-on-year rate
11%
10%
2009
Today
12%
2009
Today
10.6%
9.5%
4%
10%
9%
5.1%
2009
Today
2%
8%
7.2%
7%
6%
8%
0%
6.5%
6%
6%
-2%
5%
4%
-4%
4%
3%
2%
-6%
2%
-8%
1%
0%
-8.3%
0%
-10%
Source: Bloomberg, Statistics Iceland, J.P. Morgan. Data as of 2012.
4
Peripheral eurozone economy continues to collapse
SIPI* unemployment rate
SIPI* 10-year government bond
SIPI* real GDP growth
Share of labor force
Yield
Year-on-year rate
18%
2009
Today
2009
Today
2%
2009
16%
14%
10%
14.8%
8.0%
8%
1%
Today
12.9%
0%
12%
-0.2%
6%
-1%
10%
4.3%
8%
-2%
4%
6%
-3%
4%
-3.1%
2%
-4%
2%
0%
0%
-5%
Source: Bloomberg, J.P. Morgan. Data as of 2012. SIPI is Spain, Italy, Ireland, Portugal.
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Past balance of payments crises have only been solved with major
currency devaluations
Currency devaluations in past BoP crises
Peak-to-trough
400%
360%
350%
300%
281%
250%
200%
150%
124%
115%
100%
59%
50%
27%
8%
Source: Bloomberg, J.P. Morgan.
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Argentina
Russia
Korea
Mexico
Sweden
Canada
Eurozone
0%
The eurozone’s design flaws
Main Criteria for an ‘Optimal Currency Area’:
Free movement of goods, capital and labor (YES/NO)
Flexible wages and prices (NO)
Cross-border fiscal transfer mechanism (NO)
Source: J.P. Morgan. Based on Mundell, R. A. (1961). "A Theory of Optimum Currency Areas".
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European support measures taken so far have failed to address the
underlying problems
Eurozone periphery* spread to German 10-year government bond yield*
Basis points
LTRO 2
1300
1200
Second set of bank
stress test results
released
Periphery
1100
€159 billion EFSF and
private sector support
package announced
1000
900
EFSF and ECB bond
purchase program
announced
800
700
600
Greece receives €110
billion loan
First set of bank
stress test results
released
€85 billion support
package for Ireland
announced
LTRO 1
500
ECB extends bond
purchases to Italy and
Spain
400
€78 billion support
package for Portugal
announced
300
200
100
Pledge of “determined and
coordinated action”
ECB extends liquidity
provision
0
Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
Source: Bloomberg, J.P. Morgan. Data as of March 2012. *Equal-weighted average of Portugal, Ireland, Greece, Spain, Italy.
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Apr-12
Eurozone lending growth still positive, but deteriorating
Eurozone lending growth
Year-on-year
20%
M2 money supply
Private sector
Household sector
Corporate sector
15%
10%
5%
0%
-5%
03
04
05
06
07
08
Source: European Central Bank, J.P. Morgan. Data as of November 2011.
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09
10
11
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Main elements of February’s Greek bailout package
€130 billion of official sector support over next three years
An extra €325m of spending cuts to close past budget gaps
53.5% haircut for private sector creditors with 90% participation
Interest rate cut on existing bailout loans
Public debt/GDP ratio target of 120.5% by 2020.
Source: J.P. Morgan.
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Have we got the maxim gun?
Source: J.P. Morgan.
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