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No magic bullet for what ails the euro zone

People hold signs as they protest at Sant Jaume square in central Barcelona June 17, 2012.

ALBERT GEA/REUTERS

Equity, bond and commodity markets weren't exactly delirious with delight at the prospect of co-ordinated intervention by the world's major central banks to prop up stumbling economies and keep credit flowing in the wake of the Greek election. But the mere fact markets reacted positively Friday to something the banking magicians might have up their sleeve – including more financing for Greece – marked quite a change from the way they have behaved of late when policy makers have actually done something.

Last week, for example, European leaders finally came to grips with their Spanish dilemma, promising at least €100-billion in bailout money for Spain's sad sack savings banks. But the euphoria stemming from that decision lasted for about 10 seconds. Analysts quickly cast doubt on whether the money would be enough to stop the slow-motion run on bank deposits – it won't be. They also pointedly noted that the deal merely enables Madrid to borrow money at considerably cheaper rates than are currently available in a bond market gripped by worries of impending euro doom. Not surprisingly, grumpy bond players drove up yields on Spanish and Italian debt to levels their treasuries simply can't afford, especially after Spain's credit rating slid toward junk territory.

Similarly, the Bank of England's aggressive moves to flood the financial system with cash and give banks more incentives to boost lending only added to concerns about Britain's flagging economy, the health of its banks and, ominously, the potential for a euro land catastrophe to rain havoc on the global financial system. Faced with that grim possibility, not even the promise of more pump-priming by central banks or vows of allegiance to the euro by newly elected Greek politicians can keep the bears at bay for long.

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The harsh market response is actually a good thing, because it means people are becoming more realistic about prospects for Europe and the rest of the world, argues hedge fund manager Michael Yhip, president of Toronto-based Garrison Hill Capital Management. "That is rational. What's hurt a lot of investors is irrational behaviour, the positive skew that people want to take on this."

The simple fact is that there is no magic bullet for what ails the euro area. "This is a project that's going to move a lot slower than the markets are going to like," Mr. Yhip says. "And it's not because they want to move slowly. It's because they have to move slowly. Is that going to cause financial turmoil and dislocation? It absolutely will. So to expect otherwise is unrealistic."

So get used to several more years of Sturm und Drang in global markets. "We're not going to get back to a normal investing climate for at least five years," the former debt and derivatives banker adds between sips of Perrier. "And when I say normal, I mean one where you're not living in fear of the next iteration of the euro zone crisis or the next financial or monetary crisis."

No wonder investors are still fleeing European stocks and bonds for the dubious joys of U.S. Treasuries and gold. Withdrawals from European bond funds tracked by the folks at EPFR Global climbed in the latest week to their highest level in six months, while equity funds suffered net outflows for the 10th time in 12 weeks.

Those staying put have flocked to German bunds and Swiss government bonds yielding negative real returns. It would probably be cheaper to rent a storage locker.

"If you're a European investor trying to invest in stocks and bonds, it's a complete losing proposition," Mr. Yhip says. "You're going to lose money in stocks and you're going to lose money in bonds. And it's not small amounts of money." Indeed, those stuck with Italian or Spanish sovereigns are down 20 to 30 per cent in just two years. And equity holders have suffered even steeper losses.

Anyone wondering why the euro crisis should matter if the bulk of their portfolio is in nice safe Canadian blue chips need only listen to Bank of Canada Mark Carney's increasingly strident warnings. A crumbling Europe means a slower China, which translates into weaker commodity prices and lower earnings for Canadian producers. Corporate profits across Canada are now expected to rise by as little as 5 per cent this year, before taxes, compared with 15 per cent in 2011.

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"Canada is by no means an island in the financial world," Mr. Yhip points out. "If Mark Carney has no power to raise interest rates 25 basis points, it gives you an idea of what he thinks of Canada's ability to withstand a full-fledged euro crisis."

Under the circumstances, it makes perfect sense to be sitting on cash, where you can safely remain for the next several years. If you're not invested, "then this [crisis in Europe] is an interesting intellectual exercise. It may affect your job in the real world, but it won't affect your portfolio."

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More

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