The European debt crisis to date is playing out like a chess match. This parallels the discussions at Alhambra. The on going saga is still progressing toward structural changes in southern countries and recapitalization of banks. At this stage in the game southern countries face a choice, structural reform within the context of the a single currency or structural reform outside of the Euro. The former is more palatable as aid from the north eases the pain on the country and less palatable because competitive issues remain. The catalyst to stay within the Euro will depend on the north’s willingness to redistribute their competitive advantage back to countries like Greece. The north faces the choice of aiding countries such as Greece and keeping the advantages afforded them by the Euro or cutting the periphery lose and risking a banking crisis.
In either case these countries need to strengthen the capital position of their banks. This entails the selling of assets, mainly foreign operations, in order to strengthen their core capital. This process involves the repatriation of capital. In the short run this gives strength to the Euro. We expect the Euro union to stay intact as the costs of disbanding are high for both sides. The capital repatriation strengthens European banks and prevent “good” capital from leaving. Once this leg of the saga plays itself out, our expectation would be a weak currency policy from the ECB.
Politics continues to play a large roll. Reform and progress is slow, but all indications are that the path is the same. We continue to monitor the situation for indication that the long term goals have changed.