Wednesday, November 24, 2010

The Myth of Contagion

Another good article this morning from Ambrose Evans-Pritchard in the Telegraph. He actually seems to have a reasonably good grasp of what is going on in Europe at the moment, which makes a change from most of the commentary I read.

However, I want to specifically address the idea of "contagion", which anyone that has followed the Greek and Irish bailout stories will have heard as a key reason for the bailouts. Here is a good example, I have pulled out they key quote:
The problems of Ireland's banking system pose a risk of contagion to other Eurozone countries, European Central Bank Governing Council member Yves Mersch warned in a newspaper interview released Wednesday.
To banish this contagion risk, other governments must make the reforms needed "to gain market confidence," and appropriate structures must be set up for the Eurozone as whole, Mersch said.
This "contagion" is not something that can be averted with the application of more money. In reality, the bailouts are fuelling the crisis, because now the market knows that by exerting enough pressure on the bond market, credit spreads will widen to a point where the EU/IMF will intervene, pouring liquidity into that economy via the bond market.

This is not a malicious attack on a currency or economy, but rational behaviour. The fact is that the Greek, Irish, Portuguese and Spanish economies are all in serious trouble, and while Portugal might conceivably be saveable with a third bailout, you can forget it with Spain, it is FAR too big to bail. In fact, as Evans-Pritchard points out:
Saxo Bank said the EU's €440bn (£370bn) bail-out fund would lose its AAA credit rating if Spain needed serious help.
This would require Germany & France to put more money in, which for Merkel in particular would be very hard to explain to voters. She is already rowing hard in the other direction, with her insistence that Irish bondholders must pay for the Irish collapse. Morally she is right perhaps, but it is a very damaging thing to say and suggests to me that she has already given up on actually saving the Euro area as it stands, and is positioning Germany for the future.

The "contagion" is unavoidable, it is a consequence of a single currency and single monetary policy, neither suit any of the countries in the Euro. The bailouts, just like the whole Quantitative Easing debacle, are making everything much, much worse.

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