On Europe: "A Willing Lender Of Last Resort May Not Be Enough"

It is becoming clearer and clearer that some new policy option is required in Europe - but as JPMorgan's Michael Cembalest excellent cartoon description of the never-ending circular arguments among European leaders would put it - you would have to be a wide-eyed optimist to believe it will be a decisive one. Comparing the progress of the European Monetary Union with structural changes in the US around the end of the 19th century, it is arguable that more time is needed before judgment is passed but they may not get the chance. The resolution of a staggering EUR10 trillion in peripheral sovereign, household, and corporate debt may not wait. Durable unions are signaled by signs of wage convergence and unilateral transfers of wealth to smooth regional income difference - while a lender of last resort appears to be most people's solution, it likely will not be enough given the competitive divergences.


See the full reserch article below for the complete cartoon ridiculousness of the reality that is our European leaders


How long can this [ZH: FARCE] go on? It feels like a new policy option is needed (particularly in Spain, which looks terrible), but you would have to be a wide-eyed optimist to believe it will be a decisive one. Over the weekend, I reread an influential paper from the 1949 US Quarterly Journal of Economics which looked at how the US survived the Great Depression. A critical factor: US regional transfers undertaken by the US Treasury which were unilateral in nature, akin to a capital movement, a gift or an indemnity in international trade”. These unilateral transfers enabled weaker US districts to maintain a level of growth and consumption which would otherwise have been impossible. Other signs of the US monetary union becoming more durable are found in the gradual disappearance of regional wage differences (1st chart). If the hallmarks of a durable union include unilateral transfers to smooth out regional income differences, and signs of wage convergence, Europe could sure use a lot more of both. Just having a willing lender of last resort may not be enough.




From a political perspective, the European Monetary Union might deserve more time before final verdicts are rendered, as it’s only 10 years old. But from an economic perspective, they may not get the chance: the resolution of a staggering €10 trillion in Peripheral sovereign, household and corporate debt may not wait. The pressure is resulting in the propagation of views like this: the Italian newspaper Il Giornale wrote that Germany, not Greece, is Europe's real problem,

"because it is bursting with health and, as a result, is also causing its neighbors to burst. Germany has to adjust to the rest of Europe, not the other way around."

Ah yes, German growth is the problem. I am rendered speechless by this logic, and can only guess that it is a manifestation of combining insufficiently similar countries in a monetary but-not-fiscal union (see chart below). Even if post-election Greece remains in the Euro, none of the fundamental questions will have been answered. The idea that Italy would run a budget surplus before interest of 4% of GDP for 25 years (as per the European Redemption Fund proposal) is frankly ridiculous.

No one has any idea what will happen next, as the Europeans are making it up as they go. From an investments perspective, it makes sense to continue to watch Europe mostly from the sidelines and focus on other things.


Full Michael Cembalest analysis link.