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What’s in the water at Morgan Stanley? Its credit and equity strategists are negative on the market and now the bank’s economists are talking about the break up of the euro. And you thought FT Alphaville was bearish.
Here’s Joachim Fels in the latest edition of The Global Monetary Analyst (emphasis ours):
The financial backstop package for Greece and the ECB's climb-down on its collateral rules have clearly reduced the short-term liquidity risks for Greece. However, as our European economists have emphasised, long-term solvency risks remain firmly in place. More broadly, and more worryingly, recent developments significantly raise the (long-term) risk of a euro break-up, in our view.
The bail-out and the ECB's softer collateral stance set a bad precedent for other euro area member states and make it more likely that the euro area degenerates into a zone of fiscal profligacy, currency weakness and higher inflationary pressures over time. If so, countries with a high preference for price stability, such as Germany, might conclude that they would be better off with a harder but smaller currency union.
And because the Maastricht Treaty does not provide for the possibility of expelling euro area members, the only way Germany could achieve this would be by leaving the euro to introduce a stronger currency.
Of course, it hardly needs saying that support for the Greek bailout has been extremely unpopular in Germany — where a legal challenge to the deal has already been filed, according to the Telegraph.
As such, Fels is surely right when he says the risk of a German-initiated euro break-up is far from negligible.
But what are the signposts that would indicate that this bearish scenario – which would have severe consequences for financial markets – is unfolding?
Fels says there are three:
First, watch fiscal developments in other euro area countries closely: Our suspicion is that the aid package for Greece lessens other governments' resolve to tighten fiscal policy, especially in an environment of ongoing economic stagnation or recession.
Second, watch ECB policy closely: If the ECB turns out to be slow in raising interest rates once inflation pressures return, this would be a sign of a politicisation of monetary policy.
Third, watch the political debate in Germany: Support for Greece has been extremely unpopular and fears that the euro will turn into a soft currency abound. If the aid package for Greece, which so far is a backstop credit line, becomes activated, eurosceptic forces would receive a significant further boost. And, needless to say, if other countries also needed financial support, this would further strengthen euro opposition.
Full report in the usual place.
Related links: Greece "“ "?It's not that different' – FT Alphaville "?German domination of Euroland is a disaster' – FT Alphaville "?It is relatively clear that (in economic terms) the Euro does not work' – FT Alphaville
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