Europe End Game
December 10, 2011 Leave a comment
So the EU has taken the first steps towards fiscal union. Economists, ever ignorant of actual history, are repeating a mantra that currency unions and fiscal unions must go together and if they don’t a currency union is doomed. So the stock markets are happy and the can has apparently been kicked again.
To a degree, this can kicking is significant. As long as the periphery countries engage in actual serious austerity, then it is highly likely that the ECB will monetize bonds right around significant rollover dates and actual default of the insolvent can be pushed back. And since this perma-austerity means that Europe is now going to head into a deep recession/depression, it is likely that the price manifestations of monetary inflation won’t appear. Why stock markets think this is good news is baffling. It is good news for debt markets and for the euro currency (short-term) — but not for equities.
What this can kicking does do is really change the politics. Greece is now basically irrelevant. They will agree on some default – when default is deemed to be non-contagious. Greek bonds are probably a good speculation here. They are already pricing in a large default – and the profit would arise from this taking a bit longer than people think. Once they default, Greece is again irrelevant.
Italy is now being run by ECB and Goldman Sachs. The technocrats will wear out their welcome – and, most likely, screw things up. But for now, Italy was weary of bunga-bunga Berlusconi and is glad to be rid of him. Short-term, Italian bond rollovers will be “taken care of” (read monetized to some degree) and very short-term Italian debt (less than two years) may be OK – in small doses. If/when Italy defaults; the Italian equity market is really really cheap already. The only thing it isn’t pricing in is perma-austerity and the nationalization of banks. But still – I’m in wait/watch mode.
France is now the AAA country on the chopping block. If they lose that – via having to nationalize a bank probably – then all bets are off for everything. Avoid French banks via any channel – via French equity indices, French government debt, US money market funds, companies with callable loans, etc. When the ratings agencies do move on this, things may be different. But that is for the future. French elections (April 2012) also play a big short-term role. If Sarkozy is re-elected (35% chance); then things remain the same. If the Socialists are elected (55% chance), then the whole euro negotiation stuff rolls back to square one and, best case, we get to relive Groundhog Day (all the euro can-kicking since May 2010). Worst case, the markets say “enough” – and force the crisis endgame in a disorderly way. If Marine LePen is elected (10% chance); then watch out below because everything will become disorderly fast. IOW – there is no real positive outcome here — so this election uncertainty is likely to weigh on markets until April.
Spain actually looks OK here. They really don’t have much government debt – far less than the US. They do have a serious housing bubble that hasn’t burst yet and that could be a problem for large parts of the economy. But Spain also has very large financing exposure to Latin America and that can really be a positive for many companies (including banks). I kind of like the Spanish equity markets here – if I can avoid the Spanish banks/housing stuff.
Germany is in the catbird seat for now. Or so they think. Everyone else in Europe will have to undergo serious government austerity if they want bailout/fiscal transfers from Germany. And the morons in the US seem willing to bailout the eurozone if the Germans hesitate (which is bad news for the US – but not for Germany). However, Germany has relied on exporting to the rest of the eurozone for its economic health. That is going to disappear with austerity — and fast. German companies that export to the non-eurozone seem to be the best positioned for now. But if the US does bailout the eurozone via the IMF, then the DAX is the place to be. Germany will NOT pull out of the eurozone. At least not first. Any rumors to the contrary are complete and utter BS. It won’t happen – for a host of reasons.
The fiscal union pulls the UK into the political problem. The continent despises the Anglos and the institutions of the eurozone fiscal union seem like they will be the same institutions as the broader institutions of the EU. That presents a real problem for the UK. The eurozone could easily vote for increased taxes on things that mostly affect the UK (eg Tobin tax) and use that to fund their fiscal transfers. If that happens, the UK will have to seriously consider dropping out of the EU — which will in turn ignite trade wars and protectionism a la the 1930’s.
Likewise, the US is now to a lesser degree pulled into the problem via NATO. Eurozone “austerity” means that Euro defense spending will go from anemic to nonexistent. The US already carries NATO on its back anyway but these changes would make it obvious to even the moronic in the US. Unfortunately, “moronic” is what the powers-that-be ASPIRE to in the US – and no one except Ron Paul is talking about ending NATO subsidies or ending an alliance that has ceased to serve any actual function.
In sum, I do suspect that this can-kicking does “work” in the sense that it delays/hides the sovereign debt crisis and removes it from the headlines for awhile. Markets still need to price in a serious deep perma-recession in Europe – but that is a different dynamic. I think volatility is likely to drop a bit going forward. But equity markets will not be rising from here. An ugly slow steady grind-down in the first half of 2012 is the most likely scenario IMO. If the austerity actually works – and Europeans reduce government spending/entitlements and allow for semi-free markets again; then Europe is going to be a far far far better buy at the trough than the US is. We in the US have not even begun to face those problems and our longer-term outlook is currently just as bad as Europe.
Minnow Among Sharks 