The Temporary European Debt Solution & The Great Global Government Put

Pragmatist Capital has a good piece on the proposal to resolve the current European sovereign debt problem (here). For those who like to get straight to the point, you may just read its concluding paragraph below:

Conclusion: This is a step in the right direction. By recapitalizing banks and enlarging the EFSF they have set a nice sized rifle on the table. Unfortunately, this is just more of the same in greater size. Ultimately, none of these measures will resolve the true cause of the crisis which is rooted in the currency and the incomplete currency union. Until Europe resolves the imbalance caused by the single currency there is no reason to believe this crisis has ended. I still believe the ultimate resolution here will involve fiscal transfers of some sort directly to the sovereigns that resolves the lack of sovereignty issue. That likely means e-bonds or a central Treasury at some point. We are clearly not there though this statement buys them time.

For now, we can breathe a sigh of relief knowing that we aren’t on the verge of Lehman 2.0. Unfortunately, we can’t expect this to resolve the sovereign debt crisis as austerity will continue and the current measures do not attack the lack of sovereignty issue. All in all, this removes the worst case scenario, but virtually guarantees a muddle through scenario. If budgets worsen on the periphery we should expect to revisit this issue in the coming quarters and the crisis will once again ripple through the market forcing Euro leaders into greater action. Perhaps a true resolution is not far in the future. Unfortunately, it likely means more market volatility before leaders realize the true gravity of this situation.

I will summarize the main points as interpreted by the author, Cullen Roche as follows:

1. Greece Bondholders will take a haircut on the $120B Greek debt they own, but will also be recapitalized. This is really nothing more than a peace offering to those who want to see the banks “take a loss”.

2. Austerity will continue. Trade deficit nations undergoing a balance sheet recession will be forced into further budget consolidation which will continue to put downward pressure on growth and ultimately worsen the fiscal picture.

3. A larger EFSF will help to stem the bleeding and reduces the odds of a worst case scenario where we experience a Lehman type event. The leveraging of the EFSF ensures that Europe’s banks will not be allowed to fail and cause massive private sector contagion.

4. The ECB will temporarily enter markets in order to avoid catastrophe, but will not become the fiscal issuer required to resolve the crisis.

5. Europe needs a fiscal union of some sort, but not everyone is on board. This is a work in progress.

In a follow-up article, Cullen talked about the Global Government Put (here). To wit:

In the last few years we’ve witnessed unprecedented government intervention at every twist and turn. We’ve seen massive fiscal stimulus, endless monetary stimulus, QE2, Euro plans, etc, etc. It’s been an endless parade of government “fixes” that don’t appear to have really fixed anything. And if you’ve been an investor in this market, there is one clear cut lesson from all of this government intervention – don’t fade government intervention. If you’ve shorted government intervention in the last few years you’ve had your face smashed into the pavement time and time again.

He concluded with the advice that you should "know your government intervention. While all this government intervention might not be doing much for capitalism, the failure to understand it is surely detrimental to your portfolio’s well-being. Sadly, this is what “investing” has come down to in the day and age of the “New Normal”. Welcome to the global government put. Fight it at your own peril".