Call me stubborn perhaps, but I firmly believe the agreement is an awful one.  It doesn’t address the primary problems of the Euro Zone, doesn’t restore competitiveness to Southern countries, doesn’t address the problem of a lack of a true, unlimited lender of last resort and most importantly, probably won’t get ratified by the populations of the individual countries.

I may have read the markets incorrectly for today, but I am as convinced as ever that the problems have not been solved.  Watch this space, there is more trouble ahead. (Felix Salmon, amongst others, feels similarly.)

Prediction: Italian bond yields will be above 8% at some point before the end of 2012 or at least one country will have left the Euro.

“Renminbi” is the official name of the currency introduced by the Communist People’s Republic of China at the time of its foundation in 1949. It means “the people’s currency”.

“Yuan” is the name of a unit of the renminbi currency. Something may cost one yuan or 10 yuan. It would not be correct to say that it cost 10 renminbi.

A little confusing, but at least now you know.

There are too many political problems, too much fallout from the Euro and, frankly, too many good reasons not to do it. In some ways, Saudi Arabia may exert enough pressure in the region to make it work, but for the same reason I suspect some may be wary of Saudi gaining any more leverage.

I’d suggest that giving the limitations of the Euro structure, the ECB mandate and most critically, the failure of the Euro region to sufficiently meet the characteristics of an Optimum Currency Area (OCA), the problems we are having now were inevitable.

The timing of the event may have been uncertain, but the probability of it happening was pretty close to 100%. Yes, it’s easy to say that now and I wasn’t saying it before, but consider these three issues:

1. Banking crises happen all the time. Regularly.  This has been happening for hundreds of years as discussed in detail in the fantastic book, “This time it’s different” by Reinhart and Rogoff. Greece has had two banking crises since 1800, Denmark has had 10, somehow France managed 15 separate banking crises and the international financial centre, the UK, clocked up 12 over what is a relatively short period.  Before we get too Euro-pessimistic, the US managed an impressive 13 over that same period.
2. Sovereign default and financial crisis is a regular, recurring feature of our society.  Since 1800, Greece has defaulted/rescheduled debt 5 separate times (1826, 1843, 1860, 1893 and 1932) and has spent 50.6% of the period in default or rescheduling of debt. Spain has defaulted 13 times in the same period. While we’re at it, France has defaulted 8 times and even the Netherlands has defaulted once and spent nearly 7% of the period in default or rescheduling.  (same reference as above).
3. The Euro area does not have good labour mobility (language and culture differs strongly), does not have a fiscal union or lender of last resort and has economies with different characteristics.  This is not a system built to withstand sovereign debt or banking crises.

Now, ask yourself, is East Africa ready for a currency union?

Is the GCC ready for a currency union (pdf)?  More on this in the months and years to come I’m sure, on this blog and everywhere else.

The theory is that the insurer isn’t then exposed to changes in the term structure on interest rates, only exposed to illiqudity/reinvestment risk to the extent of mortality fluctuations, isn’t exposed to currency risk and certainly isn’t exposed to credit risk. Without complex margining requirements like some swaps and without the need to roll cash investments over, government bonds should allow ALM teams to sleep well.

Now, Solvency II is likely to adopt a swap yield curve rather than bond yield curve. There are some good reasons here, including arguably fewer distortions from temporary supply and demand imbalances, improved liquidity and so on. The same yield curve is used for liquid liabilities so the allowance for an illiquidity premium over and above the swap curve at some times, in some ways and for some products is still under debate.

But what should Greek insurers do in the meantime?

Frankly, Greek government bonds don’t remove credit risk and the huge credit spreads on these instruments will create huge funding gaps and variability in earnings unless a Greek govi yield curve is used to value liabilities as well. It’s not clear at all that Greece will stay part of the Euro, so German government bonds don’t remove currency risk. German government bonds in any case are show signs of nervousness as yields creep up.

The swap market is exposed to the same Euro break-up risks as bonds. Which banks will survive, what happens to currencies in the meantime and what does that do to long-term Euro swaps? What about Euro-Sterling swaps issued by Greek banks (I’m not sure if these even exist though).

All in all, it’s good to be involved in ALM in South Africa, and even the Middle East just at the moment.