If You Thought The European Crisis Was Over...

Via Mint Partners' Bill Blain,

Today’s big event was Italy's 10% auction. Buyers can’t ignore yield, and I suspect many were “encouraged” to participate. But a decent Italy auction doesn't change the brutal facts. Electoral fall-out blankets the Euro battlefield, but it was decisions made years ago that have brought us to this blasted heath. Markets are caught in...


On one side you have the disbelief on the Italy election (although why markets are surprised we cannot fathom) and all that entails about rising uncertainty on the Euro. On the other is the fact buyers need to invest. In the short-term expect the pressure to invest to win out – Italian and peripheral yields will consolidate and even tighten again. Risk off will quickly become Risk-on!

From there it becomes a debate about whether the Italy election was just another minor stumble that can be glossed over, or is it part of a more significant fundamental shift? I suspect market fears, uncertainty, and the global fundamentals will likely see the Euro crisis reveal itself again in four distinct ways in coming months:

  1. The Politics of Austerity
  2. Banks
  3. Sovereigns
  4. Renewed Unwind Fears

Austerity has failed: Listen to the language Bersani is using in Italy: trying to put together an administration based on reform and “easing of austerity”. 5-Star leader Grillo has made clear his anti-austerity convictions. Euro Elites must be having conniptions.

Austerity is the very core of the Euro Elites’ belief structure and anything less is heresy. But, across Europe from Hollande (in France) to Athens the political patience with austerity, and its increasingly apparent failure, is in the air. Austerity has done nothing to improve sovereign finances (actually increasing the imbalances in most cases!), and destroying economies with the resulting high social costs. Self-inflicted recession has not worked. There is no point in clinging to a failed ideology of austerity. The Euro Elites won’t accept that without a struggle.

So Europe needs a plan B – Growth… but a commitment to growth would require a much closer fiscal and monetary union akin to the United States of Europe to avoid moral hazard and free rider risk. It would also require yet another rejig of the ECB. There simply is not the bottom-up political appetite to support any of that. Sure, some of the Euro Elites would love to inflict top down “emergency/crisis” union, but it won’t happen because it would immediately crash against national politics!

If you fancy an academic explanation of failed austerity try this: http://www.voxeu.org/article/panic-driven-austerity-eurozone-and-its-im…

European Banks remain Rotten to the Core: If austerity has failed economies, it’s singularly failed to address the banking crisis. The US has spent the last 5-years deleveraging and recapitalising its banking system, and that is now paying off with growth in personal and commercial lending, restoring housing markets and seeding growth.

What did Europe do? Debated banker salary caps and the self-immolation of the financial system through a transactions tax! The Elites singularly failed to address bank’s previous fatboy lending practices – they remain essentially over-levered, over-regulated and dangerously exposed to European risk. Every policy response, like long term LTROs or even OMT, was a hasty panicked infusion of liquidity to keep the banks in pretend and extend mode. Draghi did a superb job keeping the illusion going.

But aside from that, all Europe has done to address the banking crisis at its core is make a series of promises about “save the Euro at all costs”. Talk is cheap. And has done nothing to make Europe’s bad banks safer. Instead, they became even more bloated and exposed to Euro risk!

Sovereigns remain in Crisis: The poor South is caught with the wrong currency – uncompetitive, unproductive and unable to deflate to compete. Even Ireland’s status as the poster boy of austerity is bogus – economic growth is largely on the balance sheet of tax sheltering multinationals.

The results of austerity are all too obvious – rising unemployment, social tensions, and electoral dismissal. Although some of the crisis economies have done much to try to restructure and redirect their economies, in the teeth of the Austerity gale it’s proved pretty much impossible. It takes years for economies to become as lethargic as the south has become, and it can’t be turned around overnight.

Renewed Fears for the Euro: The core tenant of belief of the Euro – austerity is failing. There is no easy way to redirect the institutions of the Euro to create growth. The bloated Brussels bureaucracy would be a highly imperfect tool to sponsor European growth – although I am sure they will tell us otherwise.

The ECB’s reluctant acceptance of its de-facto role of lender of last resort is heavily qualified by the need for countries to sign up to austerity prior to ECB OMT support – that is increasingly politically unacceptable in the wake of the Italy election. A new easier OMT will be required with all the national votes and treaty changes that will require.

If you thought the European crisis was over... it’s probably only just beginning. Sure, we may not see bond yields immediately rack back up into the stratosphere, but a period of further political panic and change is coming! What’s done cannot be undone..

And notice, yet again, I never mentioned Germany once in the above analysis.