Eye on the Market I November 29, 2010 J.P.Morgan Topics: The EMU unraveling; China and the Koreas heat up; the selloff in US municipal bonds Most of this week's note is on North/South Korea and China, but given yesterday's Europe headlines, here's an update. Germany is booming, with manufacturing and retail surveys at their highest levels since reunification. On the Ireland bailout, it might be seen as good news that there were no losses imposed on senior bank debt, and no automatic bondholder loss-sharing provisions for the future. However, both results might be temporary or beside the point. Last week's EoTM summarized our take on the market, economic, political and investment implications of the continued unraveling of the European Monetary Union. What would change our views? A full-scale German underwriting of the EMU problem. How likely is that? Wenn Schweine fliegen 'carmen (when pigs fly)..... A few things to keep in mind: 1. Bailouts don't change the level of debt that countries owe, it just shifts the creditors around. The latest steps remind me of the desperate attempts by US banks to lend more money on top of prior money during the late 1980s to Latin America, when Citibank chairman Walter Wriston's "countries cannot default" thesis was left in ruins. For everyone that said last spring that "Greece 2009 is not Argentina 2001", they're right; Greece's budget/trade deficits and debt/GDP were much worse. 2. GDP figures can be misleading indicators of risk. Greece, Ireland, Spain and Portugal (GISP) are small in GDP terms relative to Germany and France. But their banking systems grew to be very large (e.g., a 20% haircut on French bank exposure to GISP countries would wipe out French bank equity). Irish Finance Minister Lehinan intimated that Ireland asked to be able to apply haircuts to senior bank debt, and was told by the EU that it would make no money available if there were any haircuts, due to fears of contagion. What does that tell