Evercore Pan Asset

European share markets have been plunging, just as we feared. They are led down by bank shares. US banks are reluctant to lend money to European banks. Some European banks are reluctant to lend money to other European banks. People are asking who will bail out any problem bank in the future, given the stresses and strains in some country finances.
 
The worst pressure point remains Greece. Rumours are circulating that Greece will soon not be able to pay all its bills. Greece is running out of cash. This, in many people’s view, brings much closer a Greek default. Greece, they say, will have to say to its creditors it cannot afford to pay them back all the money. There would need to be an accommodation, with agreement to repay less than the full amount in return for some basis for future borrowing.
 
This in turn would lead to European banks that have lent money to Greece having to write down the value of their Greek debt. These banks are then weaker, with less cash and capital available for other purposes. If it were just Greece, the problem would be containable.
 
Unfortunately for Euroland the markets are now very reluctant to lend money to Italy and Spain at rates of interest they think they can afford. The European Central Bank is buying up very large quantities of Italian and Spanish debt in an attempt to keep prices up and the interest rate down. Some led by Germany are worried by this, as they do not wish to print the extra Euros to pay for all the bonds they are buying, nor do they wish to send more of their tax revenue to settle the bill either. Last week brought a German resignation from the Board of the European Central Bank in protest over the policy.
 
Temporary relief came yesterday as the Chinese authorities said they would buy Italian debt to help out. I doubt they will do so on the scale needed. China seems to say she will buy European bonds to help talk the price up, but ends up buying gold without telling us, as she prefers a kind of money they cannot devalue by printing more.
 
Permanent relief from this crisis only comes if and when the individual member countries of the currency union have credible budget plans which produce affordable levels of borrowing. This has been made more difficult by the slowing of economies and the gloomy forecasts for future growth, scaling down forecasts of future tax revenues. Alternatively the Euro authorities have to get the richer countries to subsidise the poorer countries on a much larger scale. The European Central Bank has to print more Euros and send them to places like Greece to help pay the bills.
 
It does not look as if either solution will be put in place in time. We continue to recommend no exposure to European shares whilst the crisis unfolds. We have also cut exposure to shorter term high quality European bank bonds, as even these might feel the strains of this very tense time. 

As published in Investment Week, written 13.09.11.