Email of the day (1)
Comment of the Day

October 31 2011

Commentary by David Fuller

Email of the day (1)

On European periphery debt and moral hazard:
"Thank you once again for your great coverage. I am however in need of some assistance as to what is happening to asset classes at the moment. Whilst I can follow the thought process on your last audio of why we have seen a "melt up" in financial markets ie Armageddon was avoided, I am struggling to see the same bullishness in the following charts:

Italy Govt Bonds 10Yr Gross Yield
Spain 10 Year
EUR LIBOR 3mth - Euro Generic 3mth yields plus few equity markets have actually broken their 200 day moving average

"I always try and make my investment decisions based on objectivity and to drown out as much subjective noise as possible but I am struggling this time around! On top of the charts above, the question that I keep asking myself is what would you do in the shoes of the Portuguese or Irish finance ministers after seeing that Greece has received a "bailout/default". Would you carry on with the pain of austerity or try and write off some of your debt as well.? I can see there being a further wobble in markets before the good times roll again or if that isn't the case then load up on Irish, Portuguese, Spanish and Italian debt!

"Your assistance would be greatly appreciated."

David Fuller's view Thanks for a great email which makes some very important points.

Let's try and take it one step at a time. If market perceptions shift from Armageddon (my hyperbole for emphasis but people were very bearish last month) to Armageddon avoided, that is a big change capable of triggering a short-covering led melt-up, with the help of high frequency trading. It is more than capable of lifting markets at least once removed from the epicentre of concerns, but it is not a wand capable of turning suspect assets into collector's items overnight.Email 1 continued

Your resolve to remain objective is one of the keys to clear thinking and if we wish to know what someone else is going to do, it is not a bad idea to put ourselves in their shoes when pondering the question. However, Greece has certainly not escaped austerity. Instead, it has gone from a generally agreed hopeless situation to one that should just be manageable, and it has lost a considerable amount of sovereign control in the process. Other states hope to avoid that, although there will inevitably be more fiscal union in Europe over the longer term, as Fullermoney has maintained.

Italy appears to be in a much stronger position and hopefully Spain as well. Of these, Italy is the key in terms of European contagion, being too big to bail out. Arguably, it needs an emergency government capable of making some tough decisions on entitlements while also pledging state assets as collateral against its bonds. Incidentally, Italy's debt problems today are no worse than 20 years ago, although it no longer has the freedom to devalue.

Ireland is making good progress but I am not sure about Portugal although it is a very small economy.

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