Wall Street Journal
January 9, 2012
This much is already clear: 2012 will be dominated by a struggle between two powerful and opposing forces. On the one hand, there are the centripetal forces consisting of European leaders as they try to convince the rest of the world that their project to create "ever closer union" remains on track. On the other hand, there are the centrifugal forces represented by markets as they increasingly drive a wedge between countries, threatening not only the future of the euro zone but the global financial system itself.
As things stand, the centrifugal forces are clearly in the ascendant. Foreign investors have largely disappeared from euro-zone sovereign bond markets. Almost all the demand for an Italian 10-year bond last week came from domestic investors, raising fears about how much longer the country can continue to fund itself in the markets.
Similarly, U.S. and Asian investors have long since abandoned euro-zone bank-funding markets. Now the banking system itself is starting to fragment along increasingly national lines. This deglobalization of banking has been long anticipated, but the way that it is now playing out has ensured the centrifugal forces are being felt well beyond the euro zone.
Deglobalization is partly being driven by banks themselves as they deleverage to meet the Basel III regulatory rules. Unable to raise capital from markets and saddled with legacy exposures that are uneconomic at higher capital levels, European banks may need to offload €1.7 trillion ($2.16 trillion) of assets, more than 5% of the total, reckons Morgan Stanley.
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