While more and more analysts are beginning to agree that the effects of the European Central Bank’s two three-year long-term refinancing operations have been fleeting, Ray Dalio and Bridgewater Associates have gone a step farther.
The fund argues in a recent note to investors that Spain is even worse off than it was before the ECB announced its two LTROs in December.
Dalio argues that the tenuous circle of fragile Spanish banks providing funding for the Spanish government which in turn supports the troubled banks is swiftly eroding, if not vanished already:
We summarize some key points
- Spanish banks have no desire to purchase more Spanish government debt.
- Foreign banks continue to sell Spanish sovereign bonds.
- The LTROs may have briefly brought down Spanish borrowing costs, but they did not translate into a thaw in interbank lending. Further, another LTRO would have “muted” effect, particularly since the last two were so recent.
The severity of these problems has left Spain in far more dire straits than before, even worse than it was before the LTRO. Dalio and his team believe that funding gaps will soon force Spain, the EU, and/or the ECB to take extraordinary measures to save the country and its financial system from economic disaster.
But policy action will be complicated:
- Dalio and his team believe that since the burden is being shifted to the public sector and domestic banks, we will be less likely to see the kind of private sector debt restructuring used in Greece.
- They also predict that EU leaders could soon tire of the slow progress of Spanish bank mergers meant to clean up Cajas’ balance sheets.
- Dalio believes that EU policymakers remain committed to ill-fated attempt to “save almost everyone” by using under-capitalised bailout funds like the European Financial Stability Facility.
- But they will also have to act in a much more of a hurry than they previously believed, given Spain’s predicament. This will show the inadequacy of currently budgeted resources to deal with the problem, and could pain EU leaders’ abilities to deal with crisis problems in a negative light.
- Ultimately, Dalio thinks, trying to save Europe without restructurings will prove to costly, and EU leaders will have to accept that more restructurings will be necessary.
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