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Euro Summit Failure Underscores Need for Sovereign Default

The euro fell to $1.310 by 2:30 pm in New York on Monday and continues to be assailed on two fronts. Investors clearly remain unmoved by the outcome of the weekend summit meeting and this has money leaving the euro in favor of safer destinations. In addition, the European Central Bank’s back-to-back interest rate cuts [1] have also eroded support for the euro.

Summit Meeting Underwhelms Eurozone Watchers

Once again, a lot of talk came out of Brussels as the 17-members states scheduled yet another meeting to discuss the sovereign debt crisis. And once again, the rhetoric fell tragically short of establishing a firm course of action.

In the end, the Eurozone brain trust failed to provide a compelling argument to convince investors that a credible plan was in the works to prevent the crisis from spreading to the larger economies including Spain and Italy. One has to wonder how many more opportunities can be squandered before the Eurozone finds itself past the point of no return.

The main outcome of the weekend meeting was the establishment of another fund, this time to be administered by the International Monetary Fund. Eurozone central banks will provide 200 billion euros to the IMF which is also expected to make available another 300 billion euros.

This new fund will be in addition to the existing European Financial Stability Fund. The EFSF currently contains about 500 billion euros but much of it is already committed to existing bailout plans. This leaves the EFSF woefully underfunded to save the larger economies now teetering towards insolvency.

The fact that eurozone officials continue to print money in anticipation of another round of bailouts makes it clear that the problem is still being perceived as a liquidity issue. The reality, however, it that the lack of liquidity
is the result of a debt problem and a corresponding lack of confidence. Investors are unwilling to buy Greek debt at a rate Greece can afford; and until confidence is restored, Greece and a handful of other countries following Greece’s path will continue to rely on bailouts to cover their deficits.

The only way to break this dependency is to invoke a reset. These countries must be forced into a controlled default that involves a writing-down of sovereign debt. The cash now being set aside would be better served to minimize the impact a write-down would have on debt holders including the banks forced to accept a reduced payout.

To simply hand billions of euros over to these countries may deal with the symptoms, but does nothing to address the ailment.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Scott Boyd

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