PIMCO’s Mohammad El-Erian has been all over the place this week.
Yesterday he arguably helped spark the big panic when he talked about cascading bank failures in Europe and warned that some weaker countries might take a “sabbatical” from the Eurozone.
First, this will hurt countries that sell into the euro:
It is certain that the Greek crisis will undermine aggregate demand and, therefore, trade flows – directly and, more importantly from a global perspective, by imparting an additional fiscal drag to other European countries.
This will strengthen the structural headwinds that are already weakening what has been a robust global cyclical recovery. It will also complicate the much needed handoff from temporary drivers of growth (government stimulus and inventories) to more sustainable ones (components of private final demand).
This is most consequential for countries that export heavily to the eurozone. Some are neighbouring countries, such as Norway, Sweden, Switzerland and the UK. Others are further away, such as Singapore and Russia.
Second, capital flows will be divided more sharply between winners and losers:
Several countries, led by the US, stand to benefit from a reallocation of capital away from the eurozone as investors react to both the deterioration in sovereign risk and the surge in volatility. As for the capital that flows just within the eurozone, there will be an even greater differentiation in favour of the solid core countries, particularly Germany.
And finally, this is going to leave a mark, politically
Over the next few months and years, we should expect politically driven changes to regulations that aim to lower the risk of contagion and dampen cross-border capital flows. And for the next few days, we should worry about cascading disruptions in the European banking system as interbank activities are undermined by renewed uncertainties about each institution’s exposures to peripheral European names.
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