Investment Strategies

Fears Of Eurozone Demise Have Been Greatly Exaggerated - Citigroup

Tom Burroughes Group Editor 19 August 2011


note: As fears about the eurozone continue, this publication is
interested in different viewpoints, including contrarian ones. An
example below is from Citigroup chief economist Willem Buiter, who
argues that the EU has more banking and government firepower to
prevent default problems than some commentators and investors
imagine. As usual, this publication does not necessarily concur with
the views expressed, but lays them out as part of an ongoing debate.

former interest rate setter for the Bank of England and now economist
at Citigroup claims fears about the future of the eurozone are
overblown and that the single European currency will emerge stronger
from recent debt wrangles.

a note entitled Europe:
Fear and Panic Make Poor Counsellors
Buiter writes: “Europe never does things neatly, it seldom gets
ahead of the curve and often only does the right thing when all else
has been tried and failed. But it has considerable skills at lurching
from crisis to crisis. This sovereign and banking crisis is likely to
result in a stronger EU and euro area.”

Buiter admits
that he is taking a “contrarian” view in being optimistic about
the ability of EU policymakers, including the European Central Bank,
to fix the debt woes of countries such as Greece, Italy and Spain.
These worries, added to debt wrangles in the US, have pummelled
global equity and debt markets and propelled gold to record highs
above $1,800, although the metal has retreated in recent days.

EU and the euro area have the means to prevent disorderly sovereign
defaults even when the sovereigns are most likely insolvent (Greece,
Ireland and Portugal) and, in the case of Greece, already engaged in
a process that will lead to a selective sovereign default –
probably within a month,” Buiter, chief economist at Citigroup,
said. He was a member of the BoE’s Monetary Policy Committee from
1997 to 2000.

EU and the euro area also have the means to prevent fundamentally
solvent sovereigns (including Spain and Italy) from being pushed into
unwarranted defaults through a fear-driven denial of market access –
when the fear of default bootstraps itself into an actual default,
through soaring funding rates or complete loss of market access…
Fears of a downgrade from AAA levels, something that, since the US
downgrade, is causing problems especially for France, are a less
important issue.

can and in all likelihood will be addressed by additional
front-loaded fiscal austerity in France and Belgium,” he writes.

continued: “In recent days, the markets have seen turmoil and
indeed flashes of panic about euro area banks, including some of the
leading French banks. Hard information is scarce. We have seen no
evidence that any French bank is insolvent or even seriously
undercapitalized. It is certainly possible that the turmoil in the
sovereign markets of the narrow periphery, and now also of the broad
periphery, may have had capital adequacy consequences for some banks
in France and elsewhere in the EU. But even the most pessimistic
reading of the situation does not justify the panic and fear that we
are seeing. Much of this response appears to reflect bad information
and ignorance.”

Buiter argues
that France retains its AAA rating on sovereign debt and can borrow
from the markets and “recapitalize any bank that needs additional

the required capital injection were to be large, the French
government would probably have to credibly commit itself to
additional front-loaded fiscal austerity measures to convince the
markets that it remains committed to fiscal sustainability and the
defence of its triple-A rating. In our view, such a credible
commitment would no doubt be forthcoming,” he writes.

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