The fallout from the EU summit will be evident in the coming weeks but with solutions agreed only in principle this still leaves the eurozone in a vulnerable state. The article from ZeroHedge teases out the possibilities but the logical conclusion is for the euro to be devalued.

First of all the EU is limited to act when the market turns nasty on the euro crisis.

If I’m right, after a few weeks things turn south again in the capital markets. Then what?

– More LTRO. No – there is no more collateral. All of the swill loans have already been hocked.

– Cut ECB % rate. Doesn’t matter. It won’t change conditions in Italian or Spanish funding markets one bit.

– A spending plan of <1% of GDP. That won’t put a dent in the recession that is building.

– Brussels buys more sovereign bonds to avoid a catastrophe of Italian 10-year exceeding 7% (capitulation).Sorry. There are “wise men” in Germany who will simply not allow this to happen in the scale that is required.

– The ECB goes Defcon 1 and launches a E2T QE program. No – same answer as above.

– Merkel does a 180 and embraces Euro bonds. No chance in hell.

The US or China are going to start buying EU bonds? Lunacy – not happening.

-The IMF will come to the rescue? No way – the IMF does not have the resources to solve anyone’s problems.

There only possible solutions would be along the FX route, i.e.

1) Peripheral countries re-establish their legacy currencies. Spain will reintroduce the Peseta, Italy will bring back the Lira etc.

2) The Euro is split in two. There would be a Northern and a Southern Euro.

3) Germany leaves the Euro and re-establishes the Deutche Mark.

Although, the best solution of all is to devalue the euro.

These are possible outcomes. But I consider them to be unlikely. Too much effort has been taken to create and preserve the Euro for the deciders to throw in the towel anytime soon.

There is one currency option left. Devalue the Euro by 20++%.

This would make a difference. It would go a long way towards stabilizing the real economies of Europe. It would create inflation, something that is sorely needed to devalue the real size of Europe’s debts. Germany would agree to this as it preserves their export-competitive position within the EU, and improves it outside of the EU. The technocrats in Brussels would love it; it’s the only thing left that would preserve the monetary union.

Is this feasible? I say it is. It has happened twice before in history. In 1985 the world got the Plaza Accord that devalued the dollar and in 1987 we got the LouvreAccord that revalued the dollar. In both cases, the global central banks (CBs) and acted together.

With Plaza Accord, the CBs made a joint announcement on a Sunday evening that they would be selling the dollar against major currencies until such time as a meaningful devaluation had been achieved. It worked.

Would the US, China and Japan go for this?

The USA and China would absolutely hate to see a devaluation of the Euro. It would hurt their respective economies. But the deciders in China and Washington also know that a complete breakdown of the EU economy would lead to a global depression.

The timing of something like this is critical. Would Obama instruct the Treasury Department to intervene in the currency markets (via the Federal Reserve)? He would, if it happened in the next few months. The consequences would not be felt, in a meaningful way, by US exporters until after the November election. Obama also understands that if the EU goes belly up before the election, his chance of winning goes down. If the EU tanks, so will the S&P.

China and Japan would have some say in this in order for it to be successful. The CB interventions would have to be coordinated. If the UK and US go along with it, then Japan will be forced to join in.

China is a wild card. If China participated, it would be devaluing its own Euro reserves. It would cost China a few hundred billion dollars. But it would cost China far more if the EU went into the crapper for the next five years.

Source: ZeroHedge

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