Why the euphoria was not justified

Allister Heath
MARKETS are hugely preferable to central planning – but sometimes capitalism’s finest get it spectacularly wrong. Yesterday’s deluded jump in stock prices – the FTSE is now back up to 5,713.82 – was a gross over-reaction to the Eurozone’s deal. A sigh of relief that the outcome wasn’t worse would have been understandable; but there was no justification for euphoria.

France’s President Nicolas Sarkozy summed up the day best when he launched a devastating attack on Athens’ dodgy accounting at the time of the euro’s launch, admitting that it was a mistake to allow Greece to join. I would go further: as many critics argued at the time, it was a mistake for anybody to join the euro. The entire single currency plan was misconceived from the start and now traps its members in a system plagued by cripplingly high exit costs.

But arguments about the looming political tensions as politicians seek to forge a transfer union without bothering to ask their electorate was not what the financial markets wanted to hear yesterday. They wanted some sort of “deal” and that’s what they convinced themselves they had got. It was not just UK and Eurozone equity markets that soared: the Dow and S&P are on track for the best monthly gains in decades.

The US rebound at least makes some sense. Third quarter GDP figures were decent at an annualised 2.5 per cent (0.65 per cent in UK quarterly terminology). The US economy is now bigger than it was just prior to the bursting of the bubble, an important milestone (the UK economy remains substantially smaller). The US double-dip recession all those forecasters kept predicting hasn’t materialised, though plenty of dark clouds remain.

But the rebound of European markets is not justified. The 50 per cent voluntary haircut on Greek bonds supposedly agreed after hours of meetings only applies to a group of private sector investors; governments and central banks that own 35 per cent of the debt aren’t losing a penny. In reality, the deal hasn’t been finalised. Even the haircut itself is dodgy: it is a reduction of half in the net present value of the bonds, a concept which requires contentious assumptions about discount rates.

The result is that – if all goes well, which it won’t – Greece’s debt to GDP ratio should fall back to a still unmanageable 120 per cent of GDP by 2020, back to the level it was just two years ago. And what are the €30bn of “credit enhancements” to the private sector contained in the fine print? We need answers. What is certain is that the bulk of the Greek banking system is now likely to be nationalised; and given the febrile political climate in Greece at present it is very doubtful that proper policies will be put into action. At best, Greece will be insolvent again in three years’ time, with another write-off required. It could happen much sooner than that.

The €1 trillion bailout fund remains equally opaque; no money has yet been raised. The idea is to construct an extremely complex set of mechanisms similar to the ill-fated CDOs with their debt tranches and the equally useless monoline bond insurers that rose to prominence during the sub-prime crisis. Insuring the first 20 per cent of losses on government bonds, one of the ideas mooted, would have failed to help Greece.

The Chinese will be tapped, perhaps to the tune of €100bn, to help leverage the fund – but it is vital that the full terms be made public. Until now, it was merely hypocritical of the EU to criticise Beijing for distorting the global credit markets by manipulating its exchange rate and accumulating excessive forex reserves. It soon may no longer be financially possible for it to do so either. The markets have been temporarily assuaged – but the euphoria cannot possibly last.

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