For months in a row, the core propaganda meme seeking to drag lambs into the ponzi, has been one of "ignore Europe - it is irrelevant." Naturally this "narrative" was primarily spread by expendable C-grade media elements whose careers will promptly terminate once this latest episode of artificial "decoupling" is over, as we have been warning for months (at a cost to the S&P of over 200 points [15]). And judging by today's US Trade Balance, which came in at a whopping $47.8 billion on expectations of $45 billion, the widest gap since June, which was driven due a plunge in European exports as the European economy is shriveling in the grips of what is about to be a doozy of a recession, it may be time to polish those resumes as the inevitable decoupling approaches with every passing hour. Yet one of the best comments on what Europe really means for the world comes from none other than Bank of America. While we have discussed previously that BAC is doing its best to crush the market and to precipitate QE3, thus like everyone else, always having an agenda in its message, what it is saying is spot on. And it is as follows: "Europe matters, according to the most oft-heard arguments, because of its size and the euro’s reserve currency status. The Euro area’s systemic relevance (both in trade and financial terms) means that its governance crisis is a global menace. This narrative portrays Europe as a self-contained shock emitter, with the rest of the world cast as innocent bystander. Rather, much like the Lehman bust, the current Euro area crisis may be a symptom of faulty globalized finance. Europe is rightly being held to account for fiscal mismanagement, but there may be bigger cracks in the background." Spot on, and it gets even worse, which we urge everyone who still doesn't grasp the linkages between Europe and the US to read on.
From Bank of America:
Hot topic: Europe will remain a global issue
The European crisis remains center-stage but markets are no longer the proverbial deer in the headlights. With hints of normalization in capital flows to emerging markets, investors have become more discriminating. The latest currency moves summarize the prevailing sentiment: greater appetite for LatAm returns and a pass on EMEA assets (Chart 2). This pattern conveys both caution with exposure to the Euro area and optimism on the back of the recent improvement in the US macro data; thus we highlight LatAm’s good fortune, being relatively safe from European ripples and influenced by a more dynamic US.
But while not necessarily dismissing the risks in Europe, this pattern suggests markets may no longer view the fallout from the ongoing crisis as having global repercussions. Confidence in the potential for a US decoupling is rising. And a global shock that does not engulf US financial markets can hardly live up to its name. According to the IMF, the US accounts for about one-third of both global stock and bond market capitalization. But in terms of turnover, the clout of US markets can reach two-thirds of the global total. So if the European hurricane is downgraded to a tropical storm on US shores, it is also likely to be rated as a moderate nuisance in many parts of the world.
Arguing for less anxiety on the US exposure to Europe are better economic momentum and greater policymaking efforts to redistribute liquidity. The expansion of FX swap line agreements, the ECB’s offer of unlimited long-term refinancing, and the European Council announcement that EU and other countries would channel resources to the IMF have improved the actual and prospective liquidity situation in Europe. But are these factors enough to restrain the global reach of the European crisis?
The bigger picture
Europe matters, according to the most oft-heard arguments, because of its size and the euro’s reserve currency status. The Euro area’s systemic relevance (both in trade and financial terms) means that its governance crisis is a global menace. This narrative portrays Europe as a self-contained shock emitter, with the rest of the world cast as innocent bystander. Rather, much like the Lehman bust, the current Euro area crisis may be a symptom of faulty globalized finance. Europe is rightly being held to account for fiscal mismanagement, but there may be bigger cracks in the background.
A fundamental issue is the international allocation of liquidity. Liquidity crises are typically generated by solvency concerns. In a global context, however, this raises questions of international cost sharing. In practice, the IMF is the institution with the legitimacy to dilute the burden across its members and channel official liquidity to troubled parts of the system. But what works well when the Fund’s client is a smaller EM economy sputters when the troublemaker is a large advanced country. Who will pick up the tab? Berlin is not the only capital pondering this. As Obstfeld (2011) describes, “the problem of allocating fiscal burden ramifies into every facet of the debate over international liquidity”.
Still flying blind?
When markets turned on Italy during the summer, it not only marked the point of no return for European policymakers, it also laid bare the limits of the international financial system. Italy’s gross financing needs for the next three years reach €750bn, more than double the amount the IMF disposes of. As a result, the current crisis-fighting framework remains ill-suited to deal with persisting crises in Italy and Spain. The Fund is on course to receive almost €200bn in loans, but with the EFSF still out of its depth, the backstops are not ready to be activated. Are they about to be tested nonetheless?
Our Euro area team thinks it is unlikely Italy will request a full-fledged loan package from the IMF over the next few months. If it remains committed to reform, the Italian government will be able to count on the ECB and on precautionary lines from the IMF. But downside risks remain significant. Italy is not only exposed to its own program implementation risks but also to those of Greece. And we remain concerned about the outlook for the Euro area’s weakest link. Greek political risks have been mostly pushed back to 2Q, but the saga of the unyielding Greek austerity effort continues.
All this points to the need to keep reinforcing the safety net. Recent improvements in financial markets did not stop ECB President Draghi from claiming that swift deployment of backstops are “urgently needed”. And given the scale of the crisis, work on the containment tools is likely to require further involvement from reluctant outsiders.