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Rescuing the eurozone: the right prescription?
March 8, 2012
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Rescuing the eurozone: the right prescription?

We view as a banking sector and government debt crisis what is really a balance of payments crisis

The tools being used to address the crisis are therefore badly-suited for the purpose

Only political will, not underlying economics, has so far stood between eurozone survival and collapse but…

…the ECB LTRO and official sector bailouts at best by time, at worst exacerbate the problems

Only restoring competitiveness in the periphery, not the ‘will of policymakers’ alone can make for lasting crisis
solution
Source: J.P. Morgan.
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Stresses in larger peripheral bond markets and the eurozone banking
system have eased
Eurozone government debt spread
Euribor-OIS spread
Basis points over Germany
Basis points
600
150
550
125
500
Italy
Spain
450
100
400
350
75
300
250
50
200
150
25
100
50
0
0
09
10
11
09
12
10
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Source: Bloomberg, J.P. Morgan. Data as of March 2012.
Source: Bloomberg, J.P. Morgan. Data as of March 2012.
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The balance of payments: how it adds up
Balance of Payments
=
Capital Account
Current Account
(net exports, transfer payments, net factor
income)
(Foreign direct investment, portfolio investment,
cross-border lending)
+
Source: J.P. Morgan.
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Iceland’s economy recovering from near-collapse
Iceland unemployment rate
Iceland 10-year government bond
Iceland real GDP growth
Share of labor force
Yield
Year-on-year rate
11%
10%
2009
Today
12%
2009
Today
10.6%
9.5%
4%
10%
9%
5.1%
2009
Today
2%
8%
7.2%
7%
6%
8%
0%
6.5%
6%
6%
-2%
5%
4%
-4%
4%
3%
2%
-6%
2%
-8%
1%
0%
-8.3%
0%
-10%
Source: Bloomberg, Statistics Iceland, J.P. Morgan. Data as of 2012.
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Peripheral eurozone economy continues to collapse
SIPI* unemployment rate
SIPI* 10-year government bond
SIPI* real GDP growth
Share of labor force
Yield
Year-on-year rate
18%
2009
Today
2009
Today
2%
2009
16%
14%
10%
14.8%
8.0%
8%
1%
Today
12.9%
0%
12%
-0.2%
6%
-1%
10%
4.3%
8%
-2%
4%
6%
-3%
4%
-3.1%
2%
-4%
2%
0%
0%
-5%
Source: Bloomberg, J.P. Morgan. Data as of 2012. SIPI is Spain, Italy, Ireland, Portugal.
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Past balance of payments crises have only been solved with major
currency devaluations
Currency devaluations in past BoP crises
Peak-to-trough
400%
360%
350%
300%
281%
250%
200%
150%
124%
115%
100%
59%
50%
27%
8%
Source: Bloomberg, J.P. Morgan.
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Argentina
Russia
Korea
Mexico
Sweden
Canada
Eurozone
0%
The eurozone’s design flaws
Main Criteria for an ‘Optimal Currency Area’:

Free movement of goods, capital and labor (YES/NO)

Flexible wages and prices (NO)

Cross-border fiscal transfer mechanism (NO)
Source: J.P. Morgan. Based on Mundell, R. A. (1961). "A Theory of Optimum Currency Areas".
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European support measures taken so far have failed to address the
underlying problems
Eurozone periphery* spread to German 10-year government bond yield*
Basis points
LTRO 2
1300
1200
Second set of bank
stress test results
released
Periphery
1100
€159 billion EFSF and
private sector support
package announced
1000
900
EFSF and ECB bond
purchase program
announced
800
700
600
Greece receives €110
billion loan
First set of bank
stress test results
released
€85 billion support
package for Ireland
announced
LTRO 1
500
ECB extends bond
purchases to Italy and
Spain
400
€78 billion support
package for Portugal
announced
300
200
100
Pledge of “determined and
coordinated action”
ECB extends liquidity
provision
0
Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
Source: Bloomberg, J.P. Morgan. Data as of March 2012. *Equal-weighted average of Portugal, Ireland, Greece, Spain, Italy.
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Apr-12
Eurozone lending growth still positive, but deteriorating
Eurozone lending growth
Year-on-year
20%
M2 money supply
Private sector
Household sector
Corporate sector
15%
10%
5%
0%
-5%
03
04
05
06
07
08
Source: European Central Bank, J.P. Morgan. Data as of November 2011.
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09
10
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Main elements of February’s Greek bailout package

€130 billion of official sector support over next three years

An extra €325m of spending cuts to close past budget gaps

53.5% haircut for private sector creditors with 90% participation

Interest rate cut on existing bailout loans

Public debt/GDP ratio target of 120.5% by 2020.
Source: J.P. Morgan.
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Have we got the maxim gun?
Source: J.P. Morgan.
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