The great convergence trade of the 1990's was between interest rates across the EU for those countries that were joining the euro currency union. The last five years have been the unraveling of this trade. The risk across countries is now more pronounced and risk premium have shown marked differences between the creditor and large debtor countries.
The reverse of the convergence trades shows the biggest problem in financial markets is fragmentation. To eliminate the continued crisis, there will have to be a solution to the fragmentation problem. The banking behavior in the EU is a perfect example of fragmentation. German banks have cut their exposure to periphery EU countries by 300 billion euros. This is a decline in their EU portfolio outside of Germany of close to 50%. French banks have decreased their lending to non-core EU countries by 200 billion euros or over 30 percent. There is a credit crisis for corporates and other borrowers in risky sovereign countries.
The solution of throwing more money at the issue through broad-based monetary expansion without structural changes is counter-productive. It is not how much money is in the system but where the money goes.
Governments are engaging in financial protectionism through setting up barriers to international lending. Countries want to keep bank lending at home. This should be expected given there has been the socialization of bank liabilities through government support. Why help other countries out of their financial difficulties? The role of the EU and the ECB should be to focus on the fragmentation issue. The OMT program is headed in the right direction.
The reverse of the convergence trades shows the biggest problem in financial markets is fragmentation. To eliminate the continued crisis, there will have to be a solution to the fragmentation problem. The banking behavior in the EU is a perfect example of fragmentation. German banks have cut their exposure to periphery EU countries by 300 billion euros. This is a decline in their EU portfolio outside of Germany of close to 50%. French banks have decreased their lending to non-core EU countries by 200 billion euros or over 30 percent. There is a credit crisis for corporates and other borrowers in risky sovereign countries.
The solution of throwing more money at the issue through broad-based monetary expansion without structural changes is counter-productive. It is not how much money is in the system but where the money goes.
Governments are engaging in financial protectionism through setting up barriers to international lending. Countries want to keep bank lending at home. This should be expected given there has been the socialization of bank liabilities through government support. Why help other countries out of their financial difficulties? The role of the EU and the ECB should be to focus on the fragmentation issue. The OMT program is headed in the right direction.
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