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The
European Crisis is proving to be more of an unraveling than a contagion.
I have
long written that the European Monetary Union (EMU) constitution and Euro
currency should be viewed in the context of a risky bet versus a sound
regional monetary strategy. The odds of the EMU’s survival are
presently reflected in a plunging Euro, despite a historic and unprecedented
intervention. This indicates that the EMU’s existence in its current
form is now a bad bet.
The
good news is that this is becoming obvious and it suggests that the serious
governance flaws of the 17 year Euro Experiment may finally be addressed. It
took a crisis to see its first test, which has been the generally accepted
view of when the euro experiment would prove its viability. The established
momentum of the EU since its inception and its broad acceptance prove that
its survival is presently a matter of European preference with most Eurozone
members feeling it an absolute necessity. We’d therefore expect to see
the EU constitution reformed. What should concern investors the most however
is how the mechanics of what will be a ‘forced reform’ will
unfold. The highly visible process will have profound implications to the
stability of global financial markets and to a very tenuous global economic
recovery.
I see
the long standing philosophical difference between Germany
and France
to be at the core of this potentially very public resolution. During the
recent behind closed door emergency bailout negotiations, these differences
are reported to have come to the fore. Additionally, Frau Merkel and Monsieur
Sarkozy are very different personalities. Will Frau Merkel show German Steel
or as the German tabloid Bild proclaimed on news of the Euro bailout, become
‘schmucks’? Will Sarkozy the ever populist media hound prove to
be a true diplomat or display what Germans perceive as insulting French
arrogance? Unfortunately, the world must wait and watch while financial
markets will no doubt fluctuate wildly on the uncertainty of the outcome.
What
financial markets are oblivious to is just how crafty these two politicians
are. There is more going on regarding a European strategy than the media once
again fails to recognize.
For
the accompanying slide presentation see: Tipping Points - Commentary
WHY
THE EURO EXPERIMENT IS FLAWED
The
core issues with the Euro Experiment which need to be resolved are about a
workable governance structure. They can be summarized as follows:
1.
There
is no effective policing of sovereign fiscal authority.
2.
There
are no sovereign penalties for failing to adhere to the “Eurozone
Stability and Growth Pact“
3.
A
single currency does not allow a standard depreciating currency option with which
to resolve a sovereign growth or productivity failure without forcing a
devastating sovereign economic austerity shock.
4.
There
is no ability to effectively coordinate Monetary and Fiscal Policy
initiatives during a financial crisis.
5.
The
ECB is not empowered to monetize national sovereign debt. It is specifically
constitutionally banned from doing so.
The
International Herald Tribune outlines the issue as
follows:
Europe’s
consistent inability to move quickly enough to get ahead of the financial
markets during the Greece crisis is
shaking the
euro and the foundations of the European Union itself, as
critics of the euro have long predicted would happen. The question being
raised with increasing urgency is whether the European Union can fashion a
mechanism to speed decision-making before irreversible damage is done and the euro itself slips into history.
The
delays are inevitable, most experts say, stemming from the nature of the
European Union and its own institutional voids:
1
- No single government,
2
- No single treasury
3
- No effective fiscal coordination
4
- No mechanism for crisis management
Every
major decision on the euro must be negotiated among member states and
European institutions, a torturous process that also plays up political
fissures both within and among member countries. That breeds uncertainty and
even panic among investors, who already doubt that the Greek deal that the
European leaders finally sealed on Friday night will forestall an eventual
restructuring of Athens’
crippling debt.
“The
European Union is running behind events,” said Anne-Marie Le Gloannec,
a political scientist at the Institut d’Études Politiques in Paris.
While, for example, the United
States could “shock and awe” the
markets early in the global financial crisis with the TARP
bailout money and a huge stimulus program to restart the economy, there is no
single European institution that can do the same. By contrast, every decision
about Greece
has been a painful, time-consuming bargain among the different national
governments, with their own political requirements and concerns, and their
own views of economic virtue.
Let’s
briefly consider the leadership responses to recent issues through the lens
of the first three political altercations or ‘political dances’,
to see if we can get a clearer view of how this ‘forced reform’ I
mentioned above will unfold.
SCORING THE FIRST
3 DANCES:
1- THE GREEK
BAILOUT
Germany:
Takes the position this is a Greek problem and a matter for Greece
to solve without EU involvement as per the EU charter.
France:
Takes the position that EU aid should be given but with a plan on how
austerity plans will be implemented.
SCORING: Greece
has received $145B in financial support
WINNER: FRANCE
2- THE EU SHOCK
& AWE “TARP”
Germany: Once again takes the
position members need to solve their own problems but reluctantly is willing
to support a marginal scope of effort towards a bailout.
France: Wants and demands a
massive coordinated ‘shock and awe’ response to stabilize the
Euro and brutally punish speculators.
SCORING: A historic $1T bailout
intervention undertaken with unprecedented changes to the operation of the ECB
WINNER: FRANCE
3- GERMAN
UNILATERAL NAKED SHORT BAN
Germany: Unilaterally implements a
ban on naked short sales and on the shorting of specific financial
institutions.
France:
Completely rejects Germany’s position which makes German efforts
meaningless and only further weakens the Euro.
SCORING: Euro Collapses further
and global markets sell-off. Libor increases as does the Libor-OIS spread.
WINNER: FRANCE
FRAU
MERKEL
POLITICAL
REALITIES
1-
Chancellor
Merkel is in a tenuous political position. Ruling with a coalition, she lost
a critical election in North Rhine-Westphalia on May 8th, which
was the weekend of the summit negotiations. She is acutely aware that the
German people are decidedly against German financial support of spendthrift
countries, especially after German experiences with East German unifications
and the last 10 years of ‘belt tightening’ to make Germany
globally competitive. Frau Merkel is caught in what appears to be a nearly
impossible political position. She is politically exposed.
2-
German
banks are extremely vulnerable to defaults or possible work out plans with
troubled PIIGS.
3-
The
German economy has slowed dramatically and though not in a recession, further
weakness in the euro zone will have immediate impact on the German economy.
LIKELY
APPROACH TO ‘FORCED REFORM’
Germany
talks of ‘economic governance’
while France talks of ‘economic government’.
When you explore them you find there is a significant cultural difference. To
Germany the word government implies that an outside body would control
economic policy as opposed to governance that would convey the idea of
structure, framework and sanctions.
According to Stratfor:
"Germany now senses the opportunity to reform the euro zone so that
similar crises do not happen again. For starters, this will likely mean
entrenching the European Central Bank's ability to intervene in government
debt as a long-term solution to Europe's mounting fiscal problems. It will
also mean establishing German-designed European institutions capable of
monitoring national budgets and punishing profligate spenders in the future.
Whether these institutions will work in the long term - or fail as attempts
to enforce Europe's rules on deficit levels and government debt have in the
past - remains to be seen. But from Germany's perspective, they must."
MONSIEUR
SARKOZY
POLITICAL
REALITIES
1-
As
French President he does not face election until 2012. He is politically safe.
2-
French
banks are also heavily invested in PIIGS
3-
France’s
deficits have ballooned and austerity plans even remotely resembling those in
Greece would bring violent protests from notorious militant French unions and
workers.
LIKELY
APPROACH TO ‘FORCED REFORM’
It is
in Monsieur Sarkozy’s interest to fight for a US like Keynesian
solution with excess money printing. This would ‘kick the can down the
road’ and avoid an impossible ‘austerity cuts’ war with
French unions and workers. He sees what is happening in Greece as something he is likely to face in
8-12 months. The current increasing Credit Default Swap (CDS) rates for France also
reflect this concern by investors.
Ulrike
Guerot, senior research fellow at the European Council on Foreign Relations
(ECFR) suggests that Monsieur Sarkozy
would respond: 'what is so wrong with inflation of four percent? It will be
competitive inflation. But for the Germans, inflation at four percent is
evil".
Alexander
Law, chief economist at the Xerfi consultancy in Paris believes “France
and Germany will have to start speaking the same language or else the euro
will disintegrate. I think that France will end up agreeing with everything
Germany says, because they have to, but then they will simply continue to
flout the rules as they have done in the past".
THE
FORM THE CHANGES WILL TAKE
Having
played the schmuck, Germany is likely to win the dance finale. With the Euro
approaching its original 117 value or very near parity to secure German
support (who are going to be the big taxpayers behind successful ongoing
bailouts), Germany must feel ‘German Steel’ has been brought to
bear in resolving the EU crisis. Even a smart Sarkozy will know when it is
time to lose a hand to keep his winnings.
CRAFTY
POLITICIANS & SLY CENTRAL BANKERS
Now
the shocking truth – ALL THE HARD WORK HAS BEEN DONE!
Politicians
and strategists always wait to employ a crisis event to enact politically
difficult solutions. Whether “False Flag’ operations or just
opportune timing, history is replete with them. Experienced politicians wait
for the public to demand action during a crisis, and then make their move
just when the public is willing to accept any action rather than no action.
A
shrewdly crafted political strategy or a well coordinated plan of the central
bankers or circumstances; I will let you be the judge.
The
two major issues facing Europe have actually subtly been addressed and all
that is now left to do is to go through the public dance of appearing to take
actions to resolve the crisis. The two critical achievements that were
central to an EU survival solution were:
1-
A
massive devaluation of the Euro - DONE
a.
To
allow the EU to be competitive globally
b.
To
allow the southern Euro countries to regain some of their especially hurt
productivity due to a strong Euro
According
to Martin Wolf at the Financial Times:
"...
the story of the eurozone economy has, in consequence, been one of
divergence, not convergence. The rough external balance masked the emergence
of countries with huge current account surpluses and corresponding exports of
capital, notably Germany, and of others with the opposite condition, notably
Spain. In countries with weak domestic demand and low inflation, real
interest rates were high; in countries with strong demand and higher
inflation, the reverse was true. The result is not just huge fiscal deficits,
now that private-sector spending has collapsed, but a need to regain lost
competitiveness. But, inside the eurozone, this is possible only with falling
wages, higher productivity growth than in Germany (and so soaring
unemployment), or both."
Martin
Wolf’s concise description of the German economic machine is
enlightening:
At one
end is a powerful and highly efficient industrial export engine that
generates a large trade surplus with the rest of the world, including most
other countries in the eurozone. Instead of spending this new export wealth
on a higher standard of living, however, parsimonious Germans prefer to save
it, handing it over to thinly capitalized German banks that have proved
equally efficient in destroying said wealth by investing it in risky
securities issued, not coincidentally, by trading partners that need the
capital to finance their trade deficits with Germany. To prevent the collapse
of those banks, German taxpayers are dragooned into using what remains of
their hard-earned savings either to bail out their hapless banks or their
profligate trading partners.
Steven
Pearlstein writes on Germany in the Washington Post:
Normally,
what should happen to such a country is that, as a result of its trade
surplus, wages rise, along with the value of its currency, to reflect its new
wealth and productivity. That has the effect of making those exports less
competitive while encouraging workers to spend their increased income on
cheaper imports. And in that way, the system brings imports and exports more
into balance.
That
rebalancing, however, hasn't happened in Germany. It hasn't happened because
much of Germany's trade surplus is with other European countries with which
it shares a common currency, so the currency can't adjust. It hasn't happened
because Germans, by their nature, are eager to save and reluctant to spend
their newfound wealth on imported goods and services. And it hasn't happened
because the European Central Bank, driven largely by German economic
rectitude and fear of inflation, has followed a tight monetary policy that
has reduced growth and discouraged domestic consumption and investment.
But
that's not how most Germans see things. They look at the current crisis and
blame their spendthrift Mediterranean neighbors for
using the cover of the euro to rack up public and private debts that they now
cannot support. They blame hedge funds and other speculators for making a bad
situation worse and profiting from other people's misery. And they are
furious that they are being told by their leaders that they have no choice
but to bail everyone out.
What
Germans won't accept is that they wouldn't have been able to sell all those
beautifully designed cars and well-engineered machine tools if Greeks and
Spaniards and Americans hadn't been willing to buy those goods and German
banks hadn't been so willing to lend them the money to do so. Nor will they
accept that German industry was able to thrive over the past decade because
of a common currency and a common monetary policy that, over time, rendered
industry in some neighboring countries uncompetitive while generating huge
real estate bubbles in others.
The
danger of Germans misunderstanding the causes of the current crisis is that
it leads them, and the rest of Europe, to the wrong solutions.
Year
End 2009
2-
A
reconstitution of the EMU and specifically the role of the ECB regarding assumption
of sovereign debt – DONE (with the Euro Bailout)
a.
The
European banks still maintain leverage ratios over 50:1 and have not
addressed toxic assets like the US
b.
Europe
needed an immediate TARP-like solution to address a pending European banking
crisis that would never have been approved across the broad EU membership
without the cover of a crisis.
GEAB
LEAP E2020 in GEAB #45 report:
Without
knowing it, and without having asked their opinion, 440 million Europeans
have just joined a new country, Euroland, of which some already share the
currency, the Euro, and of which all now share the indebtedness and the joint
means to solve the serious problems posed in the context of the global
systemic crisis. The budgetary and financial decisions taken during the
Summit of the weekend of the 8th May in terms of a response to the European
public debt crisis can be evaluated differently according to one’s
analysis of the crisis and its causes. Without doubt, a radical unraveling of
European governance has just taken place: a collective continental governance
has just brutally emerged.
According
to Daniel Amerman:
What
happened in Brussels over the weekend was that the nature of money changed.
The nature of the euro changed, as the nature of the US dollar has fundamentally
changed, as have many other currencies over the last couple of years. This in
combination with radical, trillion dollar government market interventions has
also fundamentally changed the very nature of the investment markets.
The paradigm has changed, and everything most of us have is at risk because
of this. The paradigms that governed successful investment – and the
preservation of capital in the 1990s and the 2000s – are now obsolete.
With
both of these key goals now secured, (which would have never been achieved in
public debate) the public discussion over the wording of the reform can take
place. As mentioned earlier, the ongoing volatility of the financial markets
will give the politicians the cover to force these changes through their respective
sovereign political apparatus.
CONCLUSION
We
should likely expect the 27 member European Union to soon become more vocal
since any and all decisions will have a profound impact on their economies.
We’ll likely see the emergence of a couple of leaders to counterbalance
German and French parochial views and lead to a more collective, cohesive EU
view of itself as a political entity versus a bundle of disparate views.
What
this means is we may see the final emergence of a United Sovereign States of
Europe (USSE). This would be a blended version of US capitalism and Eastern
European socialism. You can likely expect Merkel and Sarkozy to be
strategizing to be its first President.
SOURCES:
(1) 05-16-10 GEAB N°45 is available! Global
systemic crisis – From « Eurozone coup d’Etat » to
the tragic solitude of the United Kingdom, the pace of global geopolitical
dislocation accelerates GlobalEurope
Anticipation Bulletin LEAP
(2) 05-14-10 Eurozone Rescue: Nuking the Savers to
Bailout Bankers Daniel R Amerman
(3) 05-15-10 ECB Abandons Independence and Prints $1Trilion to
Prevent Euro-Zone Collapse John
Mauldin
(4) 05-18-10 Single currency bloc plays
‘beggar-my-neighbour’ Martin
Wolf, Financial Times
(5) 05-18-10 Beggar thy neighbor: Martin Wolf is
singing from my songbook Edward Harrison,
Credit Writedowns
(6) 05-18-10 Germany, Greece and Exiting the Eurozone
Stratfor
(7) 05-16-10
“440 Million Europeans Have Just Joined a
New Country” John Rubino, DollarCollapse.com
(8) 05-19-10 The Irony Of The Euro Crisis: This Is What
The World Would Be Like Under The Gold Standard The
Pragamatic Capitalist
(9) 05-17-10 Here's Why Germany Really Can't Share A
Currency With The Rest Of Europe Vincent
Fernando, Business Insider
(10) 05-07-10 Greek Debt Crisis Raises Doubts About the
European Union IHT
(11) 05-19-10 Economic governance divides France and Germany
Reuters
(12) 05-21-10 Forget Greece: Europe's real problem is
Germany Steven Pearlstein Washington Post
Gordon T. Long
Tipping
Points
Mr. Long is a former senior group
executive with IBM & Motorola, a principle in a high tech public start-up
and founder of a private venture capital fund. He is presently involved in
private equity placements internationally along with proprietary trading involving
the development & application of Chaos Theory and Mandelbrot Generator
algorithms.
Gordon T Long is not a
registered advisor and does not give investment advice. His comments are an
expression of opinion only and should not be construed in any manner
whatsoever as recommendations to buy or sell a stock, option, future, bond,
commodity or any other financial instrument at any time. While he believes
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investment advisor, one licensed by appropriate regulatory agencies in your
legal jurisdiction, before making any investment decisions, and barring that,
you are encouraged to confirm the facts on your own before making important
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© Copyright 2010 Gordon T Long. The information herein was
obtained from sources which Mr. Long believes reliable, but he does not guarantee
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