Confusion Reigns In Europe
Via Blain's Morning Porridge,
Great story on Bloomberg this morning arguing Rajoy is waiting for conditions to get worse so he can garner easier terms for a Spanish Bailout. I get that, but the FT suggests a compromise whereby he can take a rescue with honor intact has been found.
Oh so many things I simply don’t understand creating confusion. Like why the European Union won the Nobel peace prize? Please! Or how the Euro Elites are apparently going to fudge a third Greek bailout (plus Cyprus and Spain) into a single ask when the Germans are apparently still saying no to anything (publically)? Although the EU says it’s in a “final stage of negotiation” on an Greek extension, well placed sources in Greece say a haircut of all debt to 20% has already been agreed in principal – hm.. that’ll impress Angela.
So, lots of stuff for the European leadership to contemplate as they head to Brussels for their latest Gabfest Thursday/Friday. What’s the betting on a late night Friday? Don’t worry about Europe - I’m sure they will reach a series of acceptable fudges.
I’m far more intrigued as to what markets will make of last week’s IMF admission austerity doesn’t work, and what scenarios may result. I suspect the world may be moving forward faster than we think – and as always, it’s all about politics! Although it didn’t take Sherlock Holmes to figure government spending multipliers are far larger than previously believed - will admitting it trigger a whole new wave of angst across Europe? Don't bet against it! If austerity doesn’t work, will something replace it? If so what? And what are the likely effects on bond and stock markets?
For economies tied to government patronage in a global recession, austerity was unlikely to work. But, because of the moral hazard / electoral trade off at the core of Europe, austerity was the only politically acceptable treatment the EU could prescribe. Countries that spent themselves into crisis have to be seen to be suffering while "unspending" themselves out! As the crisis has deepened, that simple dynamic has become increasingly complex.
Even though the IMF now admits austerity may be deepening the economic woes of struggling states, it's not a given Germany et al will agree to anything else - especially as Election year looms. For the Eu/IMF/ECB troika to step back and agree alternative economic treatments is going to remain long-term and potentially troublesome in terms of Northern European approval. So - don't expect anything sudden to replace austerity – it remains the only option today, but the debate has begun.
This is where it gets interesting. Enforced austerity is a lid on the pressure cooker, and some point it has to come off. For instance, have you noticed how the stressed Eurozone countries in the olive oil belt have become increasingly aligned - anti-austerity could further unite them. The political trick for southern Europe is about how far they can push Germany and the North. Under any scenario that pits France, Italy and Spain against Germany, you have to factor in the clear advantages Germany gains from within the Euro, versus the domestic strains if it becomes increasingly sidelined and the enormous potential costs of exit on the third axis!
That German dynamic is constantly moving as it becomes increasingly entangled in Europe (just look at the rising internal bop Target 2 balances owed to Germany!). At some stage it will lead to austerity being replaced. With what? Growth policies? In a Eurozone so diverse in terms of employment, productivity, and competiveness, growth policies have to be country specific. If the Euro has conclusively proved one thing it's that "one size fits all" monetary policies don't work for a union as unsimilar as the Eurozone. But entrusting Eurozone countries to repair themselves is utterly heretical to core Europe, raising the prospect of uncontrolled spending. Yet more airports in Spain anyone? Unlikely.
So what about something utterly radical - like simply cancelling government debt? See Gavyn Davies I the FT yesterday. He wrote: “One radical option which is now being discussed is to cancel (or, in polite language, “restructure”) part of the government debt that has been acquired by the central banks as a consequence of quantitative easing (QE).”
Recently a very experienced leading sovereign default lawyer explained to me and some colleagues a plan for a similar “European Deleverage Programme” that would see sovereign debt/and bank assets addressed simultaneously – radical and then it sounded very unlikely. But perhaps such a radical cancellation of European debt and monetisation is the only answer.
From a market perspective, it feels like the ground is shifting. What should investors be doing if austerity is becoming less invasive – that certainly keeps the European can kicking further down the proverbial road. That’s market positive!
And, if European governments are even thinking about thinking about something radical like cancelling debt – how will that effect current sovereign investments? Reducing supply should create scarcity, but printing money is an inflationary anathema to the Bundesbank! How will the central bank be recapitalised if it writes off its assets without money printing – why not when inflationary expectations are low? And what would it do to banks?
So lots to think about. Future looks very interesting.