How can overly indebted countries repay their debts without robust growth to provide the taxes? They can’t, and as growth slips—notably in Greece but also Spain and Italy—deficit reduction through “natural” means becomes literally impossible. European leaders are unwilling to admit that forced austerity undermines the avoidance of default. Italy and Spain need to raise over €200 billion over the next three years just to stay in place, and it seems logical that a Greek default will damage their prospects in the absence of growth.

The only tool on the table is the EFSF and we still don’t know how it will be used—leveraged to the moon or as a guarantor or possibly (despite German objections) as a bank. Whatever the form, it’s unclear if the EFSF will still need to borrow from the ECB, and in the end, the ECB may need another capital injection from national governments. The plans, so far, just don’t have enough cash. (Ironically, US banks are awash in cash and sitting on it instead of lending it out; maybe after European bonds go to a sufficient discount, they will buy there.) And yet, as far as we know—and things change daily—Merkel is sticking to the German stance that the German liability not exceed €112 billion and the ECB not be used to provide leverage to the EFSF.

The market is rewarding the euro for the appearance of decisiveness without regard for the quality of the decisions. A parallel might be the dollar rallying whenever the US invades somebody, not because FX traders are particularly bloodthirsty but because they appreciate decisiveness. Still, it’s shocking that the euro is rising and nobody is marching in the streets (of Paris, say) as the German parliament is running the decision-making behind the scenes. After all, it’s only an acknowledgement of what everyone knew in the first place—no Germany, no deal, the piper who pays calls the tune, etc.

Analysts are appropriately skeptical. Merkel may win in the sense that the proposals will be modest and limited, not the open-ended French model, but in the end, Greece is still going to default, banks are still going to struggle with liquidity, and contagion has not been averted. It’s hard to see the euro continuing to thrive and it’s almost unthinkable that it will surpass the 200-day under these circumstances. But the market is besotted with the euro, and you can’t argue with it.

USD/JPY76.16LONG USDWEAK10/13 /1176.81-0.85%
GBP/USD1.6016LONG GBPSTRONG10/11/111.56272.49%
EURO/USD1.3950LONG EUROSTRONG10/11/111.36012.57%
EURO/JPY106.25LONG EUROSTRONG10/11/11104.231.94%
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GBP/JPY121.98LONG GBPWEAK10/11/11119.771.85%
USD/CHF0.8783SHORT USDSTRONG10/11/110.91043.65%
USD/CAD1.0001SHORT USDSTRONG10/10 /111.02662.65%
AUD/USD1.0480LONG AUDSTRONG10/11/110.99345.50%
AUD/JPY79.80LONG AUDSTRONG10/11/1176.144.81%
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