European endgame

Europe came out with a shock and awe package of Euro 750 billion for the markets over the weekend. The markets heaved a sigh of relief and markets around the world rallied on Monday.

However, the problem is one of solvency not liquidity. Market participants are equating this to the TARP bailout program put together by the US government in 2008. The reality cannot be more different.

In economics, there is no free lunch! Someone has to take the loss when mistakes are made. In the case of the US, the mistakes were made by US banks and institutions and the losses were taken by the shareholders of those institutions. When the US government infused funds into AIG and Citigroup, it completely diluted away the earlier shareholders, eroding away the value of their holdings.

In the case of Europe the problem is with governments and not with private institutions (yet!). The Euro 750 billion package is a liquidity package. The question of who will tighten their belts to pay for the mistakes that have already been made is unclear. Strikes and protests in Greece and elections in the UK clearly show that voters are not going to bear the burden. Populat opinion in Germany clearly shows that other EU countries will not pay for the sins of their neighbors. Therefore the problem remains unresolved.

The liquidity package only defers the problem. The markets have clearly recognized that. Therefore the selloff is likely to resume. In today's volatile environment, even a trillion dollars only buys you one day.

For now, the US dollar remains the safe haven!