Asset Allocator's Soapbox: Tony Yousefian

This week: Tony Yousefian, CIO at OPM Fund Management, asks if the €750bn bail-out fund is a short-term fix for the euro or a long-term solution.

Leaders have yet again had to lock themselves away in a room and bail out the banking system. This time the culprit was Greece. The result was a relief package of approximately $1 trillion dollars, which is bigger than the $700bn TARP program responsible for bailing out the banks in the wake of the Lehman Brothers bankruptcy. One of the immediate conclusions that can be drawn from this massive bail out is that no loss is too small to be socialised, and as a result there was a rampant rally in the Euro and wider stock markets.

It is interesting to analyse how they have arrived at this €750bn total. The Euro area governments, excluding the UK, have pledged €440bn in loans or guarantees. A further €60bn is from the EU budget (which includes the UK), with the balance from the IMF, which not only includes the UK but the Americans and the Canadians. As you can see, it is a truly global bail out package. According to our now ex-Chancellor of the Exchequer, Britain’s maximum liability is no more than £8bn - after all, the UK has a couple of much bigger problems to worry about and an additional £8bn on the national debt is neither here nor there!

One of the more interesting twists is the rewriting of the rules to allow the ECB to buy Government and Corporate bonds. However, this is not the same as quantitative easing, which took place in both the UK and the US. The ECB’s purchases will be ‘sterilised’, so for every Greek bond that it buys it will issue German Bunds to offset the new money. Other measures announced included the re-opening of ‘swap’ lines with the Fed to ensure a more steady flow of Dollars around Europe, as well as direct lending by the ECB to the banks on a three and six month timeframe. Interestingly these measures were all put in place during the last interbank lending crisis.

A long-term solution for a stronger Euro? Regretfully – no. These measures do not make for a strong currency. All that the Eurozone leaders have signalled is that they are only as strong as their weakest member, and there are quite a few of them – regretfully. The Euro will remain weak for quite some time as harsh austerity programmes have to be implemented by all the weak links, and that will stifle economic growth. Weak growth means we will see the ECB keeping interest rates low for a lot longer than we had previously expected, and that is not good news for a strong currency.

The EU members may well have averted a run on the Euro and another interbank lending crisis but this addresses the symptom, not the cause. The fundamental problem is that Greece cannot repay its debt. There is nothing in this package that makes their repayment more likely or which gives trade unions in Greece any reason to give up their rights to take industrial action or their pensions.

The good news for markets is that the ultimate responsibility for the debt is now being shifted from private sector owners to the ECB. Banks do not have to be concerned with possible loss, as the ECB will buy the bonds from them if they wish to sell, but Greece may still default.

Has the risk of ‘contagion’ been averted? Perhaps not. According to the BBC’s Robert Peston, although the package is big, it’s not that big. It’s just over one year’s new borrowing by the Eurozone members and a little more than 10% of Eurozone government debt. So it’s certainly not enough if investors were to lose confidence in the ability of some of the larger economies - such as Spain or Italy - to honour their debts.

Europe has bought itself some time and the best we can hope for is that the problem countries so elegantly referred to as the ‘PIIGS’ find realistic ways of restructuring their debt - before the issue raises its ugly head again. Meanwhile any rumours of a stronger Euro and higher interest rates in Europe in the foreseeable future are highly exaggerated.