Slovakia Passage of EFSF Initiates Relief Rally in Euro

The euro rebounded and the dollar came under renewed pressure after Slovakia passed the ESFS expansion a day ahead of the expected vote on Friday. The passage comes at the expense of the government itself, which collapsed earlier in the week when the initial ESFS vote was tied to a confidence vote.

While the ESFS bailout fund may now end up with additional fire-power, the details remain up in the air. Nonetheless, bailouts have proven over the last several years to be nothing more than a delaying action, as they do nothing to fundamentally alter the underlying problem. In fact, they may make things worse; as evidenced by the fact that Greece continues to teeter on the edge of insolvency despite multiple bailouts. The US economy too remains moribund despite a huge stimulus in 2009 and extensive and ongoing monetary easing.

The euro rebounded on the latest glimmer of hope that the end is not necessarily nigh. The dollar and gold retreated into their respective ranges as the need for a safe-haven was seen to have diminished; although arguably the greenback is no safe-haven at all. However, movements in all these markets have been generally tepid, amid persistent doubt that debt crisis can indeed be contained.

Now focus is truly on the grand Franco-German deal to save Europe. Details on this as yet undefined plan have been promised by the end of the month. The plan is widely expected to involve bank recapitalization and perhaps a final solution for Greece. They’ll call it a restructuring of Greek debt, but at best it will be a controlled default. Estimates of the haircuts that will be required on Greek debt continue to vary widely, but they’re all generally higher than the 21% haircuts that were promised just in July. Most current estimates are in the 30-50% range, although some still believe they may prove to be as high as 90%.

If the haircut is ultimately closer to that 90% then the low end of the range, the EU is going to have to do some serious recapitalization to prevent the European banking system from imploding. Where the money will come from remains in doubt, but as the ‘too-big-to-fail’ mentality continues to rule the day, they’ll find the liquidity somewhere. Much of it may in fact come from the Fed; and the requisite swap lines are already in place.

One thing we can be reasonably assured of, is that a massive liquidity-pump to save Greece and/or the European banking system and prevent contagion to core-Europe will elevate gold; both as a result of the heightened systemic risk and due to the resulting devaluation of fiat currencies.