Auerback: Solvency Starts with the ECB
I thought I should highlight that Marshall Auerback was on Fox Business yesterday since he writes here occasionally. I wish it were more often! Marshall was on message regarding the euro zone debt crisis. His point: Additional liquidity is not a long-term solution to what ails Europe. It is about national solvency and economic growth.
I would add a couple of things. The euro banks have tremendous leverage. They are severely undercapitalised. So any national solvency questions immediately become bank solvency, bank run and bank failure questions. Dexia is the tip of the iceberg.
Now, Randall Wray wrote earlier today that he expects the Italian situation to come to a head – ending in an imminent default. As you know, I am more sanguine than that. You can read my thoughts on Europe and the global synchronised slowdown from yesterday. But the bottom line is what I said a couple of months ago: questioning Italy’s solvency leads inevitably to monetisation. The ECB won’t let Italy fail because, if you run through Italy default scenarios, you realise GDII awaits.
I expect fiscal austerity and continual bank liquidity to rule the day until we get the bank failures or a periphery government misses targets and bond prices crater. The ECB will not fully backstop national government bonds unless painted into a corner. At that point, I would anticipate a vigorous policy response to prevent another Great Depression – not that I would trade that call.
In short, with the policy response still ambiguous and the anti-growth fiscal austerity union now official euro zone policy, all of the risks are to the downside in European sovereign debt and in European equity markets. Until you get an ECB backstop, which will be euro sovereign bullish, you have to be underweight or zero weight peripheral bonds as a foreign investor and very cautious about equity exposure; euro banks, for example, are toxic.
Marshall’s video is below.