Euro zone at risk of breaking apart says Pimco as markets realize the Brussels liquidity fix doesn't cover insolvency

Markets have come to realize that the Euro breaking up is a real possibility and not the product of an overactive imagination wielded by conspiratorial websites such as  Making a prediction on the breakup of the Eurozone is a fools game.  However, markets seem to believe in the possibility.  Pimco and Moody's among others have said specifically that it is a possibility, but probably not the most likely scenario. 

That seems reasonable.  However, it doesn't mean that some members who are currently part of the monetary union might opt out.  Portugal, Greece, Ireland, Spain and Italy are the first and most likely possibilities.  If they all opted out in lockstep, it would test the resolve of Abraham-Lincoln Trichet's monetary union and could be the first shot in an European economic civil war.  It could mean a review of the European customs union.  Via Pimco:
•Markets are concerned that Europe’s policy response to date decisively addresses neither the very real solvency concerns nor the path to regaining competitiveness in a fixed exchange rate environment.

•The challenges facing Europe were aggravated by the global financial crisis but are rooted in the framework of the Economic and Monetary Union (EMU).

•We think Europe will muster the political will to keep the monetary union intact, but there remains a residual probability that some societies may prefer to exit the union rather than face years of economic hardship.

...It is not clear yet how this important chapter in Europe’s history will play out. There are a range of possibilities: It is possible that the peripheral European economies will deliver on their ambitious fiscal adjustments and, in the process, regain the path of high growth and financial stability. It is also possible that adjustment fatigue will set in, growth will not materialize as expected, and the risk of some countries defaulting and possibly exiting EMU goes up.

Europe’s policy response to date has been to provide liquidity support to Greece and Ireland in return for very ambitious fiscal austerity measures. The objective is to buy time for these countries to grow into more sustainable debt dynamics and for banks with exposures to them to build capital reserves.

Markets are concerned that this response decisively addresses neither the very real solvency concerns nor the path to regaining competitiveness in a fixed exchange rate environment. Liquidity by itself – be it through a larger European Financial Stability Facility (EFSF), more purchases by the ECB, common Eurobonds or lower interest rates on official loans – is not sufficient to solve these long-term structural problems.

There’s also the risk that simply applying a liquidity solution to an insolvency problem may contaminate the balance sheets of otherwise financially strong countries. Moreover, constraints on EMU’s fledgling political integration and fixed exchange rates make for difficult policy choices that increase the risk of contagion.

Who is Jean-Claude Trichet


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