Albeit knowing the fact that global financial markets are prone to financial bubbles, the recent European sovereign debt crisis has been, due to its distinct features, not only successful in making a fool out of the financial gurus but it has also shattered the very foundations of financial markets and traditional finance’s concepts at such a drastic level which was surely beyond the imagination of even those having an extremely sceptical vision.
Sovereign debts, particularly those issued by the industrial giants of northern hemisphere, have long been considered as infallible by the financial community due to their strong economic and financial systems supported by the massive capital intensive infrastructure. That is exactly why despite observing the increasing vulnerability of eurozone due to the inability of Greece, Ireland and Portugal to refinance their debt in 2009-2010, majority of financial market players seemed unaware of what was about to come! And the first thrust of tornado was felt severely by the financial world when the 70 year old mighty US treasury debt, which had always been considered the most suitable proxy of Risk free rate (at least in the text books), was downgraded by Standard and Poor’s for the first time since its birth. Sadly that was just the “beginning of a new beginning” and US treasury debt downgrade has been proven the first domino after whose fall there was left nothing but a count. From Italy, Spain and Belgium to the mistakenly downgraded France, the major dominoes have continuously been falling and the world especially Europe seems unable to even preserve the very existence of eurozone, let alone to achieve recovery.
Tonnes of reasons can be provided on ex post basis to explain the fundamentals that exacerbate this crisis, however, in addition to putting blame on fancy words of “sovereign debt” or “debt to GDP”, the echoes of some not so easily forgotten words associated with the sub-prime mortgage crisis like real estate bubble, derivative securities and the role of rating agencies are also being heard during this emerging fiasco of European sovereign Mozart.
If we look at the importance of euro by analysing the data of COFER provided by IMF, we find it just behind the USD having 14.4 per cent share in the world reserves following 32.5 per cent share of USD. From July 2011 to December 2011 almost 10 per cent of euro’s worth has been vaporized against USD on a continuously compounded basis; against PKR this loss is approximately seven per cent. This is indeed a huge loss; however, it is no more than equivalent to peanuts if we compare it to the value which is at risk. After all we are talking about the world’s second largest reserve currency!
What would come out is very difficult to predict at least at this stage of time, particularly because of the unique Eco-Political nature of this crisis. Meetings by decision makers are being held on regular basis and the second week of December is considered as the critical week to save euro by enforcing stricter rules of fiscal discipline on the member countries. ECB is also expected to intervene by initiating massive buying of Italian bonds in an attempt to lower their yields. By the end of Friday’s meeting market participants will be able to know what the fate of MARKOZY plan is. Will all these actions be sufficient to recover from the crisis? There is a big question mark ahead of it. Otherwise to imagine the worst case scenarios, one should look at the suggestions, that have already been floated from the different corners of intellectual community, ranging from the voluntarily exit of nasty actors to save the remaining fraternity to the complete elimination of euro zone.
The writer is Chartered Financial Analyst and Financial Risk Manager. He holds a PhD in Finance from Paris Sorbonne and currently heading the Department of Finance at University of Central Punjab, Lahore