Market Wrap | 16.12.11

I'm not usually a raging optimist but to me this feels a lot like the end of February 2009, where we seemed to be at a point of total pessimism - from there, the market bounced 44% over the next eight months. So, while five governments have recently fallen across Europe (Italy, Greece, Spain, Ireland and Portugal) and Germany could only sell two thirds of its own bond auction, you can be excused for being in the Eurogeddon camp. However, just like the US three years ago after the collapse of Lehman Brothers, Europe is now ready to act (in its dithering committee way) post its own Lehman experience (Greece). So, amidst all the Euro negativity I thought it would be different to raise some positive points about the common currency. 

Five reasons to like the Euro (compared to 17 currencies)

1. A common currency across 17 nations allows greater price transparency and lower transaction costs than 17 separate currencies.

2. Cross border trade and movement of workers is enhanced (although cultural/language differences are still big factors).

3. The Euro relies on minimum standards (sure some have been slack, or in Greece's case very slack, but this is similar to many struggling American states eg California). 

4. We’re seeing important, positive steps from key players in the Eurozone “debt trap” with countries like Ireland showing they can make progress with structural reform, Italy proposing to introduce a €30 billion package of new taxes and spending cuts and the Greek parliament overwhelming approving next year’s austerity budget (including more unpopular austerity measures).

5. ... and currently, its gross debt/GDP ratio of 89% is less than the US or Japan.

Let's put some numbers on it

Let’s first look at the baseline scenarios of expected growth in Europe, US, Japan and China. While the baseline scenario envisages a mild recession in Europe, the outcome of the other countries is reasonably positive. However, it’s also instructive to look at the upside and downside scenarios which we have in the following chart.

Our view (and let’s hope we’re right) is that the political will is now there to ensure that we, eventually, get enough firepower through the EFSF, IMF etc to quell markets and move towards a longer term solution.

The OECD has just released its latest outlook which contained some thoughtful analysis of the situation. It projected what would happen to major global economies under three scenarios.

• Baseline: Europeans muddle through, avoiding contagion. 

• Upside: Confidence building reforms are executed decisively allowing markets and banks to function reasonably well.

• Downside: Europe handles the crisis poorly, with contagion spreading throughout Europe and markets/economies reacting in a similar way to the GFC from late 2007 to early 2009.