Tags: Euro | Band-Aid | Problems

Europe’s Band-Aid Won’t Fix Euro's Problems

By Sean Hyman   |   Monday, 31 Oct 2011 08:44 AM

The European Union just put a massive Band-Aid on its problems.

EU officials are treating the symptoms and declaring victory rather than really treating the underlying disease that caused all of their symptoms.

So let’s take a closer look at the outcome of the EU summit.

They did use the magic word “trillion” and so that helped temporarily.

The two big things that came out of the EU Summit were:

1) That the EFSF fund would be levered up 4-5 times to around 1 trillion euros ($1.4 trillion).

2) The other is that France’s Sarkozy may be able to get China to help Europe out. China indicated that it “may” be willing to provide support if certain things were met like contributions from other countries and strong guarantees on the safety of their investment.

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There were other things that came out of the EU Summit such as an agreement that would try to get Greece’s debt to GDP ratio down to 120 percent by 2020. (Like that’s in great shape right?)

They also agreed to try to raise investor confidence in the banking sector by increasing the capital position of banks to 9 percent of Core Tier 1 by the end of June 2012.

But by increasing the capital required to be held by banks, it’s that much more that they can’t lend out too. Remember, there’s a compounded effect here too since for every dollar that they normally could free up in capital requirements, they can lend out 7-12 times as much. So that poses an issue too.

All of this initially sounds good to the retail investor at first when they hear about “1 trillion euros” set aside to deal with all of the junk and funk in the Eurozone.

However, when you realize that they’ll just be putting out an interim report on this by December 2011 which will then be finalized in March of 2012, you realize that it will be too little done, too late.

It’s just one more sign of governments acting too slowly and always being in “reaction” mode. Can a government ever see something ahead of time and act proactively? It seems not!

Therefore it’s for all of these reasons why I believe that the latest EU Summit has only treated the symptoms of the patient but not the root cause of the disease yet.

This is the real disease they have to deal with:

Europe has a monetary union but not a fiscal union. That’s a long-term problem. (At least the U.S. does have a monetary and fiscal union.)

They also have a divergence going on between the smaller economies and the larger economies. That’s not going to go away.

It’s hard to set interest rates that are good for Germany and expect them to be great for Greece and Portugal for instance.

So I still say that the euphoria that the markets has seen will be temporal and that this rally will fade just like the TARP and TALF rallies faded here in the U.S.

So my point is that in the near-term these Band-Aids cause some awesome “short-covering rallies.” But over time, investors realize that the effect of these programs will take T-I-M-E and the rally fizzles because the root, fundamental cause of the financial disease hasn’t been dealt with.

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Therefore, long-term I still don’t think the euro’s disease has been cured…only the symptoms treated with this trillion euro fund.

So the “risk-on rally” may last a short while longer where offensive currencies reign like the Aussie, Canadian and New Zealand dollars.

But it won’t be long until the “risk-off” trade is back on as investors go back on the defensive once the hype dies down and they realize that this program will take time to kick in.

Therefore, don’t be fooled. This thing has much further to go before it’s all over. The euro is not out of the woods yet.

About the Author: Sean Hyman
Sean Hyman is a member of the Moneynews Financial Brain Trust. Click Here to read more of his articles. He is also the editor of Money Matrix Insider. Discover more by Clicking Here Now.

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