The recent EU heads of state summit was, as usual, a compete waste of time, with little of any substance achieved. Yes, a timetable to prepare a framework for banking union was sort of agreed !!!!, with implementation pushed back to “sometime in 2013”. The Germans are pressing for, in effect, an EU Budget Czar, who will have the ability to overrule the national budgets of EZ countries – not an appealing prospect for many EZ countries, in particular France. The game to date, played by countries such as Spain, Greece and, indeed, France for that matter, is to knowingly set a budget which has little, indeed, no realistic chance of being met, thereby delaying the imposition of even greater austerity measures. The German’s have understood this and want the practice stopped. However, to produce more realistic budgets, which comply with current budget deficit targets, will require further severe austerity measures which, given the recent IMF finding of the negative effect caused by fiscal multipliers, may well be self defeating – I wrote about this issue last weekend. The German finance minister is not prepared to throw in the towel and continues to press countries to adhere to strict austerity measures, though as months go by, the evidence will be clear that such measures are now probably self defeating, especially for countries such as Spain, Portugal and Greece.
Whilst nothing was achieved at the EU Summit, the announcement that the Spanish bank bail out would be delayed to “sometime in 2013” (after the next German general election in September next year was also mentioned !!!!!), fills me with alarm, I must admit. We had known that the Germans want to group together all bail out requests (which need to be put to a vote at the Bundestag), given the problems that Mrs Merkel is facing from rebellious coalition partners and MP’s from her own party, over further bail outs. However, to attempt to push such a vote (on banking bail outs) to after the next general election in Germany – the new target for Mrs Merkel ? – is highly dangerous, as she will discover pretty soon. The prospect of ECB buying short term debt and the establishment of the ESM has created a calm in the EZ, which politicians (including Mrs Merkel) have taken as an opportunity to delay having to take material decisions – however, the current calm will not exist for long, if they continue to pursue current policies. If the Spanish banking system is not fixed, the very obvious problems of the European (including the German) banking sector will become evident, yet again. Europe cannot recover until the banks are sorted out, plain and simple. Any delays, particularly given the fragile economy in numerous EZ countries, including Spain, will be disastrous. The basic rule is that economic/financial issues will always prevail over political considerations, something EZ politicians (including Mrs Merkel) have yet to understand.
OK, so we now have a situation where tough austerity measures, are (in certain cases) making the fiscal situation worse, but more importantly, there is growing resentment to such measures by the public in a number of these countries. A national strike has been called in Spain and Portugal for mid November and this weekend there was even a major protest march in London – far larger than expectations. Whilst not there as yet, I am beginning to feel that the prospect for the imposition of further austerity measures is coming close to its sell by date. As we are heading into winter, civil strife is less likely, though from Spring next year, the situation in the EZ could become explosive.
Two regional elections (in Galicia and the Basque country) are being held today. A referendum in Catalonia is scheduled for late November. It is thought that the Spanish PM will seek a bail out and I would be surprised if he can wait for the Catalan decision, before requesting assistance, though he is a compete ditherer. What conditions will be imposed on such a bail out – the German line is that they will be material – ignore the Spanish comments that they will be condition lite.
What would happen if an EZ country just said no to further austerity. Well, clearly they would not be able to raise capital in debt markets and almost certainly would have to default, creating a chaotic and systemic crisis, not only in the EZ, but worldwide, the likes of which none of us has ever seen. The German game is and should be to press EZ countries to become more responsible, but there is an increasing risk that they are overplaying their hand. After all, Germany has more to lose than others, in particular, as it has bankrolled so many EZ countries.
The recent EU heads of state meeting was interesting in that the relationship between France and Germany showed clear signs of (material) deterioration. Pretty obvious and particularly barbed comments were exchanged between President Holland and Mrs Merkel. President Hollande has sought support from the Mediterranean countries and it is increasingly clear that Mrs Merkel is ignoring President Hollande. This should not come as a surprise to anyone. The previous leadership of the EU was dominated by a pact between France and Germany, with France actually taking the political lead, as Germany did not want to be seen to be playing that role. That pact has ended – the relationship will be much different (and difficult) in coming years. Germany has become more assertive and is clearly the head of Europe, with France’s role diminishing – not easy for the French to accept. However, more importantly, domestic politics in both countries is forcing their leaders to take opposing views.
In France, in spite of his majority in the National Assembly, President Hollande faces an increasing euro sceptic faction within his Socialist Party, which is opposed to further austerity and, importantly, does not want political union. Indeed, in 2005, the planned amendments to the EU constitution were defeated in France. Mrs Merkel also has her problems – she faces increasing opposition from her coalition partner, the FPD and, in addition, from members of her own CDU party – they are opposed to further bail outs etc. She has had to rely on support from the opposition SPD to pass the measures which approved the ESM and the fiscal compact very recently and there is a real fear of increasing opposition to further bail outs from her coalition. Yes, the opposition SPD is more in favour of an united Europe, together with providing more support for the EZ, but seeking their support will come at a political cost to Mrs Mekel and one she is reluctant to pay. In addition, the Germans believe that France would be quite happy to have higher inflation, a looser monetary policy and a weaker Euro, completely the opposite to that proposed by Germany. These differences are irreconcilable.
President Hollande’s socialist administration does not want a budget Czar, let alone European political union, which Germany is pushing for. The French, who designed the EU, have created a bloated, unwieldy and a high spending, incompetent bureaucracy. Furthermore, over 40% of the EU budget is spent on the common agricultural policy, the main beneficiary of which is, you guessed it, France. The French want the EU to be what it is, a club of sovereign states with some joint rules, rather than the German vision of a supranational state. France has significant problems – it is heavily indebted and state spending is out of control. The economy is such that French businesses cannot compete and both the current account and trade deficits are deteriorating, unless domestic demand is curbed. The debt to GDP (around 90%) is ever increasing and the political will in France to limit, let alone cut spending is just not there. I don’t intend to set out all of Frances major problems (I’ve commented on them endlessly in the past), but believe you me, they are severe. In addition, the French generally expect the state to bail them out, rather than to rely on themselves – this time around, the money is not there. Furthermore, in times of stress, the French are also known to take to the streets. The contrast with Germany is so, so stark.
The French are not used to playing second fiddle politically to anyone and they had, in the past, been allowed to take the political lead in Europe , though from now, that option is no longer available. It is clear that the future political leadership will come from Berlin, Germany. That will prove to be a matter for deep resentment between the people of the two countries, though in particular, the political leadership in France.
The German position is clear – they are pushing for ultimately, political union in the EZ, though they understand that they need banking and fiscal union, in particular, ahead of that. Do not dismiss the thought that Mrs Merkel would quite welcome becoming the first political leader of Europe – not bad for a lady from the former E Germany. In addition, both Mrs Merkel and Mr Schaeuble are worried about a rebellion within their coalition partners and members of the CDU. The last vote on fiscal compact/establishment of the ESM required the support of the opposition SPD. The next may, as well. As a result, they appear to be becoming more and more politically cautious.
Having said all that, is the current German prescription credible – I think not. The recent calm, following the announcement by Draghi that the ECB will buy short term debt of countries that ask for assistance from the ESM/EFSF has been mistakenly interpreted by the Germans as an opportunity for them to be able to take the time necessary towards their economic and political goals for the EZ. In particular, the announcement at the last heads of state meeting that (Spanish) banks will not be recapped until “sometime in 2013”, is probably the stupidest mistake made by the Germans and, in effect, may well result in the crisis rearing its ugly head pretty soon. The result, if a crisis does occur, will require an U turn by Germany, which will be seized upon by its opponents.
The next crucial heads of state meeting is in mid December – I trust there will be some remedial action at that time. However, in a counter intuitive way, another crisis in the EZ, may well result in forcing politicians to come up with more positive action/policies – they only act in response to crises. I certainly hope so.
The game remains Europe and China. A number of analysts believe that the Q3 Chinese GDP data will calm down fears for the country – I have my doubts. The numbers flatter the true position and the new regime will face a dilemma in the New Year – I continue to believe that they will have to announce another stimulus programme. The US faces political uncertainty ahead of the impending Presidential elections, problems over the fiscal cliff and sharply declining corporate revenues and earnings – not an inspiring prospect. However, the US has proven far more adept at handling its economic and financial problems. However, the prospects do not look enticing.
As I reported last weekend, I continue to believe that US markets, particularly the NASDAQ, will under perform.
There are a multitude of reasons to be bearish, I must admit. There is a time gap between today and the next EU heads of state meeting in mid December, which is a real concern as, at present, no positive policies/actions are planned during that period. That does suggest that markets will become concerned and the risk is to the downside. A request for a bail out by Spain will help.
In particular, I believe that the recent strength of the Euro (which may pick up further, temporarily, if Spain asks for a bail out) will fade – I have increased my short. Oil remains around US$112/3. Seems far too high and whilst geo political risks remain, I would expect that prices will decline. A number of investors have bought the miners, in anticipation of better news from China. Whilst I believe that the Chinese authorities will be forced to act and introduce stimulus measures, I do not believe that will be the case until next year and I expect that the current rally in the miners will fade, indeed reverse. The financials sector may well face increasing pressure if the Spanish banking situation is not resolved – I reduced my long European financials on Friday, though retained my short Australian financial position. The economic and political situation in Japan seems to be deteriorating rapidly and I expect the Yen to weaken – yes, in the past, the Yen has traded as a flight to safety currency, though I believe it may not this time around? – indeed, I’ve put on a smallish short against the US$. Finally, I am getting increasingly concerned about France – the market has not yet focused on the country, but when it does………..French bond yields, in my humble opinion, should be trading at closer to Italian levels, rather than German.
Looks like being a tricky period, with increased volatility.
21st October 2012