The Euro Is About to Get Killed

10/14/2011 11:15 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

With costly bailouts and a recession on tap, the common currency looks like a surefire loser, writes senior editor Igor Greenwald.

The bad news for France is that 19 foreign finance ministers are in Paris today to offer their two cents on Europe’s debt mess.

The worse news is that the solution, due in three weeks’ time, is likely to involve costly infusions of bank capital, which almost certainly means that Paris can soon kiss its AAA credit rating au revoir and start worrying about the $400 billion of Italian debt on the books of French banks. This equals 16% of the French GDP—about eight times the banks’ exposure to Greece.

Behind the scenes, the money arguments between France and Germany are yielding little beyond ever more fervent loyalty oaths at bilateral summits. Germany wants Greek lenders—many of them French—to take much hairier haircuts than were stipulated back in July, and also refuses to let Italy and Spain off the austerity hook by having the European Central Bank buying enough of their bonds to drive down the cost of borrowing.

That leaves Italy with little prospect of cutting debt below the current 120% of the GDP before it’s forced to sell another 200 billion euros ($274.6 billion) in bonds next year, at sharply higher yields than the retired debt.

The rising debt-service costs threaten to wipe out all the budgetary savings claimed by Europe’s least credible government, hastening the looming recession for good measure.

In Spain the biggest worry is private rather than public debt, but the danger is the same: austerity leading to a recession, leading to inability to roll over the debt at an affordable rate.

Hence the latest European sovereign credit downgrade, this one by Standard & Poor’s for Spain, which has many French bank stocks down 4% to 5% in early Friday trading.

Writing in the Financial Times yesterday, George Soros argued that European governments lack the resources to simultaneously recapitalize the banks and rescue debt-mired countries. His advice that they guarantee bank debts to keep the credit flowing and then instruct the banks to buy sovereign debt they could then shunt off to the ECB sounds like a shell game dictated by German taboos rather than realistic likelihood of success.

Economist Sony Kapoor retorts that only massive ECB purchases of Italian and Spanish bonds will end the “dance of death” between those sovereigns and the creditor banks.

But Germans have ruled out anything of the sort, viewing such purchases as a blank check. They may not come around until there are lines outside Italian and Spanish banks and blood on the trading floors.

All of which leaves the euro under long-term duress despite the bounce of the recent days, because the current dollar exchange rate isn’t compatible with European growth. Nor does it suit an economy trying to dodge debt blowups and an imminent recession.

Europe will need a much cheaper currency to defuse its debt bomb. And it’s likely to get it sooner rather than later.

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