Crunch time for eurozone

Countryman

The sharemarket's focus continues to be on Europe, where recent events suggest it is rapidly moving to a more aggressive stage of the debt crisis.

An example of this was news that the Spanish Government would seek up to euro 100 billion ($A124.47 billion) in international aid to shore up its troubled banks.

This pre-emptive move was designed to calm financial markets prior to the Greek elections, but it had the opposite effect.

In the days following the announcement, Spain's borrowing costs continued to rise, with the yield on 10-year bonds reaching euro-era record highs. So what is going on?

To put it bluntly, investors have had enough of the European Union's half-baked 'solutions'.

The market's reaction to the Spanish bank plan sends a strong message to the EU to get their act together quickly or risk a further deterioration in financial markets.

The Spanish bank plan fell short on a number of fronts. First, the sum of euro 100 billion looks optimistic. Several independent groups have estimated the total tab would more likely be in the vicinity of euro 400 billion once the country's deflating real estate bubble has run its full course.

Even the Spanish authorities have acknowledged that there could be another 35 per cent downside for the housing markets, which does not appear to have come into calculations.

Second, the plan involves the EU giving support not directly to Spain's banks but to the Spanish Government, which would then lend it on. So it's a classic reshuffling of debt, which does not alleviate pressure and ensures that market confidence in Spain will remain fragile.

This is a dangerous situation given Spain needs to access bond markets for large sums of money in the near future.

Third, the plan does nothing to address the fundamental problem of the trade imbalance within the eurozone.

Countries such as Italy are caught in a 'debt trap' where they have accumulated too much debt, lost their competitiveness and their ability to manage their finances under a monetary union (common currency).

So what happens next? The market's reaction to the Spanish banking plan suggests we are rapidly approaching the end game. The time is nearing that the EU will need to decide whether they want fiscal (debt) pooling of one sort or another or whether it prefers to see some countries exit the eurozone.

Germany is the key player (financier) and it has so far resisted change, because it is very expensive and a political 'hot potato'.

If we had to guess, we would expect a fiscal pooling of some sort but a decision will only come when the eurozone is pushed to the brink.

We suspect even Germany is beginning to realise that the massive costs associated with supporting a more unified Europe could be outweighed by the enormous relief as Europe breaks out of the vice that has squeezed the continent for the past two years and offers southern Europe a chance to break out of depression.

Information contained in this article does not consider your personal circumstances. You should consult a stockbroking professional before making any investment decisions. Sentinel may hold positions in stocks discussed from time to time.

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