It's The Economy Stupid: Euro Trash, Is It Time for Plan B???

Bridgewater Daily Observations

09/13/2011

Bridgewater Associates, LP

 

European Plans

 

As explained, there are three ways for the Europeans to deal with the funding gaps:

 

1) Transfer wealth from the "haves" to the debtors

2) Print money

3) Restructure the debt

 

There are also three types of plans that can be followed to set the mix of these things:

 

1. Plan A is the path that policy makers were on up until now and that they might still be on. It is the

one in which they a) collect whatever money that can be gathered from the "wealthy" countries

that have enough to "lend" to the debtor countries, b) get the ECB to do all the lending and bond

buying it is willing to do and c) hope that private sector investors will make up the difference so

that there won't be defaults. This was the plan that policy makers were so confident would work

that they did not make a good Plan B (i.e., a plan that would make everything OK in the event that

it didn't work). As it turned out the gap that policy makers (mostly the EFSF and ECB) had to fill

over the last year was over €400bn and the amount that they have left to fill the gap that is to

come is small, so it is now pretty clear that this plan is not working, so they need to put together a

good Plan B fast.

 

2. Plan B(1) is a plan to save the system without saving everyone from debt restructuring by a)

having each government take care of its own banks and key others and b) using EFSF funds to

protect those that are both systemically most important (e.g., banks via helping with

recapitalizations) and don't have governments that are capable of protecting them. We believe

that once stressed governments are motivated to take care of themselves, most will become

adequately resourceful (e.g., sell assets and structure deals) and that, while this plan is a bit

riskier than Plan B(2) over the short term, it is much safer over the long term. We previously

showed the numbers to convey why we believe that this plan can work and explained why we

believe that insolvent governments can go through restructurings without sinking the system and

without even sinking the euro.

 

3. Plan B(2) is a plan to save most everyone by leveraging up the EFSF and other government

money. For example, by recapitalizing the banks and having the ECB provide them with liquidity,

a lot of leverage can be created (because that's what banks do) in order to buy a lot of sovereign

bonds and other forms of credit. While some people ask how to get the money to recapitalize the

banks, that's the easy part (by using EFSF funds, selling off assets or borrowing against them,

changing the banks' capital structures, etc.).

 

While we believe that we will ultimately see a mix of the two Plan Bs come about, we believe that it

will look more like Plan B(2) than Plan B(1) because a) some types of lending and providing of

guarantees are conveniently not clearly wealth transfers, printing or write-downs, and b) policy

makers tend to favor short-term rewards at the expense of long-term consequences.

 

John Broussard

Assistant State Treasurer

Chief Investment Officer

State of Louisiana

Department of the Treasury

Ph:  225-342-0013

Fx:  225-342-9721

Email:  jbroussard@treasusry.state.la.us

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445 North Blvd, 7^th Floor

Baton Rouge, LA 70802

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