We’ve always held the end game in Europe will be the stronger northern countries eventually pulling out of the Euro. The path to the end game we do not know.
Sunday’s election in France, may, or may not, be the event that pulls the curtain and reveals the true nature of the Wizard of Oz. The Germans and their austere northern brethren will likely become increasingly isolated with an Hollande victory, in our opinion. This could trigger a political crisis in the north.
An orderly split of the Euro with the creation of a stronger northern currency must also allow for a mechanism that allows financial institutions and European companies in the stronger Euro a “cushioning mechanism” to fund and mark their assets in a devaluing weaker euro without severe balance sheet hits. This, of course, assumes an orderly transition, will be very complicated, and loaded with uncertainty.
It is tough to see, however, the north funding a “growth pact” which the European street is clamoring for and still difficult to imagine the Germans saying yes to monetizing bad sovereign debt. Make no mistake, direct central bank financing of sovereign debt which has no or few buyers is not quantitative easing in the U.S., U.K., Japanese, or LTRO sense. Evidence from history shows money demand becomes increasingly unstable during periods of monetization in a sovereign crisis.
We could be way off base in our view but throw it out there for our readers to contemplate.