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Sunday, 7 August 2011

PIIGS

Or, if you prefer, Portugal, Italy, Ireland, Greece and Spain.


The acronym is not new and the parlous state of those countries’ finances has been known for some time.


We learn that The European Central Bank is holding emergency talks on whether to start buying Italian debt. Unfortunately, their decision is almost certain to prove too little, too late.


If the ECB decides to assist the Italian debt then, they will run out of money very quickly and remember that Italy only represents the ‘I’ in PIIGS. Clearly this would be the little boy putting his thumb to, highly temporarily, stop the inevitable flood from the dam. The ECB could of course, in theory, raise additional funds but no (effectively) bankrupt state could advance the funds. So the European markets will react on Monday with a big sell-off.


If the ECB decides not to assist Italy, this will result in the cost of borrowing for the Italian government becoming prohibitive, until the time that it inevitably defaults on its debt. The markets will therefore react with a massive sell-off of Italian debt (a possible source of profit for a very courageous/foolhardy investor), followed by a big downward trend in other European markets as this will be seen as not helping.


There is a possible, as yet seemingly unexplored option, that the ECB starts printing Euros (if you do it, it’s call counterfeiting and you would be punished). This would, at a stroke (remember that foolish expression) enable central banks to have more funds and repay any loans that are denominated in Euros. The high risk of this scenario is that the Euro would effectively be massively devalued (at least 30% against the US Dollar), the Euro zone would suffer substantial inflation and the standard of living would plummet. This would then be a typical scenario for revolution and war.


The EEC or ‘Common Market’ was originally formed to avoid another devastating war in Europe. This aim has been reached for 55 years but, the decision to attempt to share a common currency (the Euro) amongst many of the countries, without fiscal harmonisation, could well prove a step too far. An analogy could be football, where the common element is the ball (Euro) but the rules (fiscal measures) are different in each country. This system works as long as there is no game (interaction) between countries. Ludicrous but also very obvious that it cannot work.


Until all countries accept that levels of debt must be reduced (are you reading this Mr Obama) the brick wall that we are all heading in to is not receding, merely getting higher.

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