Greece must exit or manage a restructuring without the ECB

Outlook:

Traders say that China’s good CPI and the upcoming retail sales in the US, expected at 0.8% and thus on the high side, are supporting risk appetite. Does this mean that now it takes both China and the US to make the world safe for risk? It’s a bit lop-sided, with all the Event Risk emanating from Europe. Former TreasSec Summers has on op-ed piece in the FT saying nothing got accomplished at the World Bank/IMF (and G7) weekend meetings in Tokyo. The big problem is economists’ lack of a single coherent theory on what to do about the global economic crisis. The other big problem is adopting one of the two ideas on the table, boosting demand, but not making a big enough initiative or sticking to it long enough. The other idea, deleveraging, keeps creeping back to ruin progress.

Summers writes that alternating between the two ideas is a dangerous cycle. So far many governments and the IMF agree with Summers (of course they do) on choosing promoting demand, but still allow austerity to lurch on-stage periodically. Summers conveniently forgets the long history of European sovereign default, a cycle in its own right, the primacy of contract law, including the EMU’s founding treaties, and the right of voters to choose their own self-interest in democratic countries (Germany). Summers may have worked for the Dems but we imagine he would agree with Romney’s 47% comment. Let’s not let democracy or laws favoring voters and creditors (won over millennia) get in the way of an economist with a bright idea.

Elsewhere in the FT, editorial writer Gavyn Davies asks why we don’t just cancel the debt held by the central banks under QE? In the US, the Fed owns 10% of issuance and in the UK, it’s 25% (he doesn’t say how much the BoJ holds). Nobody in the private sector would be harmed. The reason is the “restraining effect” of bond repayment requirements, plus the possible inflationary effect. Well, with deflation the current worry, so what?

In fact, argues Citigroup chief economist Buiter, the eurozone experiment cannot survive without at least some debt restructuring, especially Greece’s €300 billion. The ECB can’t go along with that because it constitutes direct financing of a sovereign. Therefore Greece must exit or manage a restructuring without the ECB. Having a pan-EMU banking supervisor will help a lot, by breaking the “pernicious” feedback link between banks and government. Others need restructuring, too--Portugal, Ireland, Cyprus and possibly Spain, Italy and Slovenia. “Austerity fatigue in the periphery and growing bailout fatigue in the core mean that the ECB/euro system is the only Santa Claus capable of filling the solvency gaps of sovereigns and banks in the euro area. However, any attempt by the ECB/euro system to play this role on a sufficient scale to make a material difference would cause an exit of the strong, who reject the ECB as an open-ended Santa. The coming year will be a lively one.” Buiter’s argument is a little murky—he seems to be saying Greece will exit for sure and then Germany and other core countries will exit when it becomes clear that restructuring is needed in other countries and not just Greece.

In other words, the weakest and the strongest will both exit. This is not how we think the world works. Current thinking is that nobody exits, although Grexit has a 49% probability.

The EMU sanity check:

• IMF predicts a 80% probability of eurozone recession in 2013
  
• Capital flight/deleveraging credit contraction by $2.8 trillion in assets by end-2013
  
• German thank-tank forecast EMU growth at -0.5% this year and +0.1% next year.
  
• S&P cut Spain's rating two notches to triple-B-minus, one step over junk.
  

The calendar contains two big events this week, tomorrow’s second presidential debate and Thursday’s release of Chinese GDP. We also get Sept retail sales today (and a UN debate on the Middle East). Tomorrow it’s US CPI, the NAHB Oct housing index and the Treasury report on capital flows (plus eurozone CPI and the ZEW). Wednesday we get US housing starts and permits, plus overnight into Thursday, Chinese GDP, retail sales, industrial production, and fixed asset investment. Thursday brings the Philly Fed, the Conference Board leading indicators, a general strike in Greece and the start of the U Summit. Friday it’s existing home sales and utter exhaustion. Early in the week, several Fed officials give speeches. Next week, the Fed meets on Oct 23-24.

This is going to be an awful week. We already have a clue that die-hard euro fans are going to support the euro even if the news hits them over the head with a sledge-hammer. It doesn’t make sense, but the evidence is right in front of us in the form of persistent buying on dips. Bah.

	SPOT	CURRENT POSITION	SIGNAL STRENGHT	OPEN DATE	OPEN RATE	POSITION GAIN/LOSS
USD/JPY	78.76	SHORT USD	WEAK	09/04/12	78.46	-0.38%
GBP/USD	1.6065	SHORT GBP	WEAK	10 /10/12	1.5996	-0.43%
EURO/USD	1.2961	LONG EURO	WEAK	08/07/12	1.2403	4.50%
EURO/JPY	102.06	LONG EURO	WEAK	08/06/12	96.72	5.52%
EURO/GBP	0.8068	LONG EURO	WEAK	08/06/12	0.7943	1.57%
GBP/JPY	126.49	SHORT GBP	WEAK	10 /10/12	125.28	-0.97%
USD/CHF	0.9329	SHORT USD	WEAK	08/07/12	0.9686	3.83%
USD/CAD	1.0234	LONG USD	WEAK	10 /04/12	1.0229	-0.87%
AUD/USD	1.0206	SHORT AUD	WEAK	10/03/12	1.0351	0.17%
AUD/JPY	80.61	SHORT AUD	WEAK	10/03/12	81.05	-0.85%
USD/MXN	12.8271	SHORT USD	WEAK	07/30/12	13.2485	3.29%