Both writers point readers to the FAQ from S&P on the downgrades in Europe on Friday. Both hone in on one particular section. I’ll repeat it:
We believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers’ rising concerns about job security and disposable incomes, eroding national tax revenues.
There is absolutely no way to achieve economic growth while pursuing fiscal austerity. It just doesn’t work like that. The only other possibility is for Italy and Spain to re-establish their legacy currencies. That is S&P's unwritten, but clear message.
The point on legacy currencies made by S&P is actually an old one. Many have insisted that monetary union between north and south was a mistake. But for S&P to have put it on the table is very confrontational to existing EU thinking regarding the need for a breakup. European leaders have all along ignored the blogs and various MSM commentators. Their line has always been, “A breakup is unthinkable”. Not any longer.
I don’t expect “Merkozy” to change their stance on the single currency issue anytime soon. But others will. The message in the S&P FAQ will not be ignored. We’re going to see it in the MSM, and we’re going to hear about it from both the political and the financial sides of governments (and of course, the blogs).
The thought process of a resumption of legacy currencies won't start on Monday. Before this can be accepted as a viable option, things have to first get worse. Much worse. Liquidity has to dry up further. Bond spreads for Italy and Spain have to widen. Funding conditions for the banks have to get worse. Equities (especially bank stocks) have to be broadly declining. The economies of the region need to be in recession coupled with very high rates of unemployment. Declines would be most severe in Spain and Italy. Social disturbance would be on the rise.
Reading the S&P FAQ, you have to conclude that the conditions that would force a return of the legacy currencies will happen, and they will happen in the next twelve months.
There are some very substantial currency implications built into this line of reasoning. If you believe, as I do, that things have to get (much) worse before we see Pesetas and Liras again, then you might logically conclude that the Euro is first headed south against the crosses. EURUSD at 1.100 would not be out of the cards in this scenario.
But consider the end game for this. What's the value of a Euro if Spain, Italy, Ireland and Portugal were no longer part of the monetary union?
That price starts at EURUSD 1.6000. I look at this and wonder if the currency trade of the new millennium is taking shape.