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Plus
ça Change.....
Another
month, another Euro area country in the hot seat... Italy already
had issues thanks to the buffoonery of its former Prime Minister and
it’s now the target of bond vigilantes. No real surprises and no
mystery about the steps the euro area countries have to take. What steps get
taken and how forcefully is the issue as it has been for months.
It’s still all politics.
Unless
the EU fixes everything in the space of the next two weeks plenty of tax loss
selling should be expected. Notwithstanding that, we’re finding
the buying in the bulk material space and strengthening oil price
encouraging. There are clearly those that expect a resolution in
Europe.
Economic
numbers closer to home continue to improve, if slowly. Manufacturing has been
a pleasant surprise and China is promising to be a bigger importer.
Outside of the bulk materials and oil though, it’s still gold stocks
getting the most traction. Volumes overall do continue to be
light As we move into December and tax loss selling intensifies we may
start seeing the volumes required to clean up share overhangs. If
that happened in addition to some debt resolution we could still see a decent
yearend/ early 2012 rally. Stay tuned.
So
who wants to play poker with Angela Merkel? Not us. Ok, it’s not just
about Merkel, but the country she is Chancellor of is more than ever calling
the shots in Europe. Many, not just Germans, think that is the
way it should be. Germany has low risk bonds and high(er) growth so its ways are considered the solution for
all, particularly by Germans.
There
is some truth to this but Europe’s problems will not be that easy to
solve. Every country in Europe can’t suddenly become an export
powerhouse unless there is a country somewhere (other than the US)
conveniently running massive trade deficits. Other structural changes in EU
countries internal markets need to come first.
In
the past two weeks the debt crises have claimed two national political
leaders. Before the next election cycle in Europe is over it’s
all but certain to claim at least a couple more.
The
two latest victims were of course the leaders of the current basket cases du jour, Greece and Italy.
Of the two, we definitely have more sympathy for Papandreou, the former
Premier of Greece. He’s been vilified far and wide but he
wasn’t the architect of Greece’s many problems. He got
elected after the mess was made. If anything he was the whistleblower.
Papandreou's
surprise announcement about a referendum on the austerity package sped his
demise. It may have been one of the worst timed political maneuvers of recent
memory but we can understand the motivation.
The
amount of unrest in Greece shows most of its citizens are not invested in the
austerity program. Greeks are sick of being asked to make
sacrifices. Whether that is a realistic complaint or pure cynicism on
their part is beside the point. The country is a democracy. If the
populace isn’t willing to support the program it won’t
work.
Papandreou
obviously knew this and there was a lot of sense in the idea of forcing
Greeks to make a choice they would have to stick to. He made it clear
the question would have been framed as a vote on the EU. The idea was
sensible; it was the timing that was crazy.
The
high level of danger in the Eurobond markets doesn’t allow for
democratic niceties right now but the underlying issue is not going to go
away. Austerity required to fix the problem will be long lasting
and in many cases severe. The fact that its required and fair as
most would argue for Greece doesn’t mean it’s going to be
popular.
Papandreou’s
referendum call was a tactical disaster but it showed more political courage
than he got credit for. Even at this stage of the crises it’s not
clear most Greeks understand how stark the choices facing them really
are.
Backing
down on its austerity program would mean expulsion from the Euro and a
complete loss of borrowing power. Debt default and the currency
adjustment back to the Drachma would bankrupt the entire Greek financial
sector and many industrial companies as well.
Many
Greeks act like they are seeing some middle ground solution no one else
is. Greece’s new Prime Minister Papademos
is looking for a three month mandate to push through austerity
measures. His predecessor had his bluff called by Chancellor Merkel and
the position of most northern European countries has hardened considerably in
the past two weeks. There is open talk in the north about amending the
EU treaty to make it easier for countries to exit. Everyone knows which
country would be the test case.
The
market’s hatred of uncertainty will dog Greece until it passes measures
that will satisfy the rest of the EU. This looks more possible now than
it did a couple of weeks ago.
Europe
is playing a dangerous game but it was right to call Greece’s
bluff. There is still a confidence vote in the Greek parliament to get
past but indications are that most parties will back Papademos.
Markets
turned on Italy almost as soon as the Greek government fell. In
this case no sympathy is required. Unlike Papandreou, Italy’s
former Prime Minister Berlusconi held his position longer than anyone.
He had no one to point fingers at about the lack of progress on reform,
though it didn’t stop him from trying.
Berlusconi
had his bluff called too, and had to be dragged off the podium by his own
coalition members. New Prime Minister Mario Monti
is working to craft an interim government that will have the main task of
introducing austerity measures Berlusconi dithered on.
Italy
has one of the world’s largest and most liquid government bond
markets. That gives Italians minute by minute readings on the
market’s opinion and it’s anything but positive. Yields
reached all-time Euro era highs as Berlusconi departed and Monti’s arrival hasn’t helped much yet.
He and his new technocrat cabinet have to be very convincing.
Italy’s
situation is scary because it’s in the “too big to fail”
camp. It’s not Greece however. At 120%, its
debt to GDP ratio is far too high but that ratio has been relatively
stable. The country was running structural surpluses until the Credit
Crunch struck. The combination of revenue increases and spending cuts
required in Italy should be far less severe than the other PIIGS.
Italy
needs austerity measures convincing enough to bring bond yields down.
Even working back to a structural surplus won’t solve things if bond
yields get out of control. The ECB has been buying Italian bonds but
this is a stopgap and perhaps intentionally so. Like Greece, northern
Europeans are not willing to commit too much to Italy until it proves
it’s serious about solving its problems.
At
the end of the day, Europe is still capable of dealing with these issues if
politicians are willing to be bold. Like the US, the EU can issue debt
in its own currency and the ECB can buy unlimited amounts of it. If
it’s pushed to the wall Europe can start up the printing presses.
Northern Europeans insist this will never be allowed to happen but the
ability to do it is there nonetheless. If even northern European bond
yields started to explode we suspect the reticence about printing Euros would
dissipate.
Unlike
the US however, doing this will only solve half the problem. Most European
economies have structural issues that need to be fixed so that their growth
rates can increase. Ultimately, real growth combined with spending
restraint is the only way to permanently bring down debt/GDP ratios across
the continent.
This
is as much a generational issue as anything. Europe has extremely
restrictive labour laws designed to protect long
term workers. That is coupled with monopolistic practices that cover
virtually every occupation. These are designed to protect existing workers
and make it all but impossible for new entrants. In Italy’s
case, making changes to these practices has been more contentious than
deficit cutting.
Politicians
have spent decades buying off interest groups to cement coalitions and stay
in power. The web of protections and regulations this created is a huge
drag on growth. Solutions will have to wait for the passing of the more
immediate debt crisis but Europe’s job is not done until they deal with
this.
The
European debt crisis has reached a new level. Greece has a new
government that must prove it deserves EU money and Italy has one that must
prove it doesn’t really need it. At best, that will take a couple
of months. The markets have moved to a higher level than
August-September but are going sideways again. This should continue
until it looks like some Euro resolution is at hand. Italy’s bond
yields, currently 7%, should be a good proxy to track.
Gold
will continue to be supported by uncertainty. Base metals appear to
have stopped falling. China is promising more imports but its strikes
that are the big support for copper. Strikes or not, copper
inventories are dropping which bodes well if the world can avoid a recession.
Of
equal interest is strength in bulk material stocks and oil. These
markets are trading like they expect stronger growth. Pundits have
predicted weaker economic stats for months but they have yet to appear.
That doesn’t mean it won’t happen but it hasn’t yet.
Economic
stats continue to be better than expected. If Greece and Italy can get their
act together there is room for a year-end rally after tax loss selling is
done
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