Tags: Malpass | Europe | Fed | Tactics

Reagan Adviser Malpass: Europe Can Recover Without Fed Tactics

Thursday, 27 Oct 2011 07:59 AM

Encima Global head and former Reagan adviser David Malpass says Europe can recover more easily than it may appear.

"The bar for re-establishing confidence in Europe is probably not as high as it seems," Malpass writes in The Wall Street Journal. "A bold plan to cut government spending and sell government assets would work."

"Investors are looking for a home for trillions in idle Federal Reserve-generated dollars, and Italy's 10-year bond has a yield of 6 percent compared to only 2.2 percent for the U.S. 10-year Treasury."

Malpass says that as growth deteriorates and governments refuse to downsize, Europe will be tempted to go all-in, using overwhelming financial force to restore confidence to Italian and Spanish bonds and stabilize bank funding, perhaps using faster asset purchases by the ECB, enough to reduce bond yields in Italy and Spain.

"This is the approach the Fed used in late 2008 when it announced that it would purchase over a trillion dollars in mortgage bonds," says Malpass. "The severe downside was that the unbounded Fed purchases have opened a Pandora's box of taxpayer risk and market uncertainty that will last decades."

According to Malpass, an epic battle is under way in Europe and the U.S. over the size of government amid shrinking resources. The euro zone's path forward is clear but politically difficult.

"As nations, they need to cut government spending, sell assets and allow private-sector competitiveness," he says. "As a part of a union, the euro zone has to divide up the losses from past deficits, restore confidence in sovereign bonds, and create a system that won't let politicians borrow as much as they did."

"The alternatives—the current dilatory bailout or a faster path to default and the breakup of the euro—would be devastating for all."

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