Perspectives on the Crisis in Europe
October 31, 2011
This week’s Outside the Box will be unusual. Rather than one essay, I give you a number of short ones, and links that are representative of the confusion that is Europe, along with a little history. As I noted this weekend, last week’s Eurozone announcement was short of details, and very little of the real work had been done. Merkel has to get her own country on board, keep the other nations that are in trouble from demanding haircuts, and keep the markets from trashing Italian and Spanish debt. Berlusconi has to figure out how to get the Italian budget balanced while staying out of jail and “balancing” his social calendar. Maybe he can dollar-cost average with a 70-year-old date? (Sorry, that was snarky, but it is so easy.)
Europe’s problems will visit shores all over the world. China will not come to the rescue, at least not cheaply. It is becoming increasingly unclear where they will get the money without ECB participation, but that is VERY euro bearish.
I don’t want to seem like I am piling on Euroland, but they are the crisis du jour. And it’s just a matter of time until it’s the US. Sigh.
And lest I forget again, let me say a special thanks to Joan McCullough for pointing me last week to Mike Masters, who was very helpful in understanding the intricacies ofcredit default swaps and their implications.
Another busy week and lots of airplanes. It will be my first time ever on Aer Lingus, as I fly to Ireland. This weekend will be fun, and even though I will do a few speeches, it will b a very different crowd than I normally speak to. No PowerPoints, just explanations of how the world works to average people – while professional stand-up comedians try and keep me honest! We shall see how that works.
Your keeping it simple analyst,
John Mauldin, Editor
Outside the Box
From David Zervos (of Jeffries and Company), writing this morning:
Seeing Greek bond investors take a 50 percent haircut, the 10yr BTP/Bund spread back to the August wides above 400 and the 10yr OAT/Bund spread north of 100 at the same time spoos have rallied 20 percent and CDX HY has fallen nearly 300bps over the past month is about as good as it gets for our “Fed Reflation vs European Detonation” view of the world. We are heading into the final few laps of the 2011 race with US equity indices up 2 to 5 percent for the year, European peripheral yield spreads at or very close to multi-decade wides, and European banks – many of which are down close to 50 percent on the year – about to be forced to raise heaps of capital. Those banks that cannot raise in the private sector, like the Greek and Cypriot ones which were lobotomized during the haircut process last week, will be forced into the EFSF vortex of pain. In there, ROEs will drop like a stone as executives are forced to delever and dilute. The only future allowable investments for these institutions will be in government-sponsored companies like the European version of Solyndra. When governments take over your capital allocation process it’s “game over” – this is all part of the longer term “European Detonation” trade.
Importantly, there is NOTHING in the EU plan from last week that should make anyone comfortable about investing in European sovereign credit – or European banks. The barber shop is now open – who is the next customer? And of course this is no ordinary barber shop, in fact it’s run by Sweeney Todd. The price that Greece is paying in austerity adjustment is heavy. The Portuguese, Irish and even the Italians and French are watching Athens closely. The Greek press and the Greek polls suggest that this debt relief is not being celebrated – rather it’s a time for more and more violent protests (see the Salonika parade cancelation – http://www.keeptalkinggreece.com/2011/10/28/unprecedented-thessaloniki-parade-cancelled-due-to-protests/ and the other protests –http://www.keeptalkinggreece.com/2011/10/28/national-day-parades-turn-into-protests-with-eggs-yogurts-and-black-flags-pcts-videos/ post bailout).
If your bankers were to cut your mortgage and credit card debt by 50 percent, you certainly would celebrate. But if the haircut came with a forced sale of your prized possessions, a 50 percent cut in your wages, a 50 percent cut in your pension, a repossession of your car and a loss of nearly all of your state benefits such as education and health care, then maybe you too would be throwing molotov cocktails on the streets. Welcome to Syntagma Square. Oh yes and all of this austerity is happening while inflation is running well north of 3 percent.
This is NOT going to end well in Greece. And it’s NOT going to end well for Europe. This barber shop is nothing more than the little shop of horrors and the Euro is the monster named “Audrey 2”. But enough with the Broadway show metaphors. The point is simple, steer clear of a complicated and caustic Europe, and stick with our homeboys in the USA. Their reflationary policies are much easier to trade.
As promised last week I wanted to spend a little time on Greek history because I think it is crucial to understanding how the next phase of the crisis will unfold. This history sets the stage for how the political tides will turn in Greece during the coming “EMU exit” phase of the crisis. The 28th of October – the day last week when the final details of the EU haircut/bailout meeting were released – was ironically a very important Greek holiday. It is the day in 1940 when Benito Mussolini presented the Greek prime minister/dictator Ioannis Metaxas with an ultimatum – allow Axis forces to occupy strategic parts of Greece or face war. Metaxas answer was a simple “oxi”. Oxi – pronounced oh-hee in Greek – means NO. This was the beginning of WWII in Greece. The Italians however never really fought hard against the Greeks – they were not particularly interested in battle. More than likely they all sat around having coffee together in the town squares. It was the German forces that ultimately came through Greece a year later and ravaged the country. And after the end of WWII, there was no reprieve for Greece – it became the center of the cold war battle. From 1946 to 1949, a British and ultimately US-backed fight against communism displaced over 15 percent of the population and generated more casualties than the German occupation. The Truman doctrine in 1947 was the beginning of US involvement in Greek government that would span 3 decades. For those that think the US will not take notice of a geopolitical crisis in Greece please reread Truman’s speech to a joint session of Congress in 1947 – http://ourdocuments.gov/doc.php?flash=true&doc=81&page=transcript. Importantly, Communism was outlawed in Greece in 1947 and communist fighters against the Axis in WWII were declared enemies of the state. The battle between the left and right in Greece divided the country for decades and tore the country to shreds. During the 50s 12 percent of the population left Greece (including my father who walked off a Greek naval ship in New London CT in 1958). Many of the communist fighters and their children retreated into eastern bloc countries.
Greece entered NATO in 1952, and the right wing was largely in control with strong American financial backing. The move to the right culminated in a military coup in 1967 that lasted until 1974. During that period, many of the remaining left wing sympathizers were imprisoned and/or deported. The fall of the dictatorship in 1974 opened up Greece’s entry into the EU. It applied for EEC membership in 1975 and entered in 1981. Also in 1975 Andreas Papandreau formed PASOK, the modern day socialist party in Greece. Further, the communist party was legalized and a new constitution that guaranteed individual rights and free elections was put in place. Importantly, it was not until 1975 that Greece even had a democracy post WWII. In 1981, PASOK took control of the government and allowed communist fighters from WWII to return from the eastern bloc to reestablish their estates. These fighters and many others that fought through the struggle with fascism were awarded generous state pensions. It was Andreas Papandreou in the 1980s who took Greece down the path of excess political patronage, excess debt and unsustainable budgets. It was a massive wealth redistribution process that not only came from within Greece, but more importantly from within the European Economic Community (the EEC).
Papandreou threatened leaving NATO and the EEC to secure constant funding from the West. In fact, in 1985, he blocked the admission of Spain and Portugal into the EEC until he was given nearly 30 billion in EEC funds. Jaques Delors finally caved! There is a constant and overriding theme in post WWII Greek politics: the world has used Greece as a pawn, and hence the world owes us. The Germans, the British and the Americans kept Greece from democracy and freedom until the late 70s. It suited their wartime aspirations. And while we in the US were going through the Reagan revolution in the 80s, the Greeks were still trying to right the many perceived wrongs from the WWII and Cold War battles. Much of Greece’s debt troubles can be traced back to reparations for the tragedies associated with those two wars. There are strong senses of entitlement, retribution and redistribution that have taken Greece down this path of excess debt for the last 30 years. The political culture of redistribution that came with freedom in the 1980s, morphed into a culture of unsustainable state entitlement.
With this political backdrop, the endgame for Greece is extremely complex. Austerity will not last in Greece, and the threat of exit will ultimately be used by the citizens of Greece to attempt to secure a continuation of the welfare state. The stakes are high, and Angela Merkel is no Jaques Delors. The next chapter for Greece will be exit, and the losses to Western creditors will be seen rightly or wrongly – in Greece – as just part of the payback. Good luck trading!
From Dennis Gartman:
Firstly, for example, the 50% “haircut” is apparently only going to apply to the Greek sovereign debts that the private institutions own; that which the “public” of government institutions own shall be left with the 21% “haircut” previous agreed upon. We are now being told that the €150 billion held by the “Troika” and the ECB will not be included in the “haircut.” As we understand the numbers, Greece had approximately €350 billion in outstanding debts, so already the haircut is far less than had been initially thought. The market was convinced as of late last week that Greece’s outstanding debts had been… or would eventually be… cut to €175 billion and at that level perhaps Greece could be made fiscally stable over time. Now, however, we see that Greece’s outstanding debts had been cut to €275 billion… far less than the market had thought. At that level, Greece will never be returned to solvency.
Two links via Bill King Reports:
China warns it cannot ‘cure’ eurozone’s debt crisis
China has stressed it will not be a “saviour” to Europe as President Hu Jintao embarks on an official visit to the continent that will take in this Thursday’s crucial G20 summit in Cannes.
The official Xinhua news agency, used to communicate Communist Party policy, said…”China can neither take up the role as a saviour to the Europeans, nor provide a ‘cure’ for the European malaise,” it stated. “Obviously, it is up to European countries themselves to tackle their financial problems.”
Merkel: Must prevent others from seeking hair cuts
[It’s too late, baby, now, it’s too late.]
Chancellor Angela Merkel said on Friday it was important to prevent others from seeking debt reductions after European Union leaders struck a deal with private banks to accept a nominal 50 percent cut on their Greek government debt holdings.
And from Reuters:
Italy at heart of crisis as borrowing costs climb
Italy’s Prime Minister Silvio Berlusconi talks to the media as he leaves a euro zone leaders’ summit in Brussels October 27, 2011.
By James Mackenzie and Valentina Za
(Reuters) – Italy’s borrowing costs jumped to record levels Friday, underlining its vulnerability at the heart of the euro zone debt crisis and skepticism about whether the struggling government of Prime Minister Silvio Berlusconi can deliver vital reforms.
The 6.06 percent yield paid at an auction of 10-year bonds was the highest since the launch of the euro, and not far from the level reached before the European Central Bank intervened in August to cap Rome’s borrowing costs by buying Italian debt.
Italy, the euro zone’s third largest economy, is again at the center of the debt crisis, as fears grow that its borrowing costs could hit levels that overwhelm the capacity of the bloc to provide support amid chronic political instability in Rome.
In a speech in Rome, Berlusconi insisted that Italy would meet its target of balancing the budget by 2013.
Tainted by scandal and repeatedly at odds with his coalition allies, Berlusconi has promised European partners a package of measures to spur Italy’s stagnant economy and cut its towering public debt, but has failed to convince markets made skeptical by his repeated failure to deliver reforms.
European leaders welcomed a letter of intent on reforms that he delivered to their summit last Wednesday, but emphasized that the measures must now be implemented.
“The interest rates that they are paying are punitive,” said Monument Securities strategist Marc Oswald. “Italy … is still the ‘bete noire’ of the whole euro zone problem.”
“They are still going to carry on having to pay higher yields unless they come up with reform plans and implement them. But anyone who expresses an optimistic opinion about that is probably looking through rose-tinted glasses,” he added.
France and Germany have expressed open exasperation at a succession of unfulfilled reform promises by Berlusconi, and fear the crisis in Italy could spark a wider emergency that would threaten the very existence of the single currency.
Even if a weakened government manages to pass the promised reforms, most will not come into force until mid-2012. Markets are unlikely to remain patient for so long.
In his speech Berlusconi took aim at the euro, calling it a “strange” currency.
“There is an attack on the euro which as a currency has convinced no-one, because it belongs to more than one country but does not have a bank of reference and guarantee,” he said, referring to reluctance by Germany and other countries to allow the European Central Bank to be used as a lender of last resort.
He later issued a statement saying his words had been interpreted in a “malicious and distorted” way.
“The euro is our currency, our flag. It is precisely to defend the euro from speculative attacks that Italy is making great sacrifices,” the statement said.
Berlusconi, who is facing two court cases for accusations of fraud and one for allegedly having sex with an underage prostitute, complained that he faced 37 judicial hearings between now and mid-January. He says leftist magistrates are persecuting him in an attempt to undermine democracy.
Speaking after Wednesday’s summit, French President Nicolas Sarkozy addressed fears that the crisis could spread to Italy.
“If we had allowed Greece to fall, and the speculation shifted on to attack Italy, the markets would then have said we will allow Italy to fall too, and that would be the end of the euro,” he said in a television interview.
As Italy sinks deeper into the debt crisis, tensions in the government have grown sharply, prompting widespread speculation in the press and even Berlusconi’s party that the government will fall, leading to an election in 2012, a year early.
“COALITION IS SOLID”
Berlusconi, whose ratings have been torpedoed by a mix of scandal and economic and political problems, rejected speculation that he might be forced into an early election.
He said his alliance remained solid with the pro-devolution Northern League party, whose leader Umberto Bossi has expressed open skepticism about the survival of the coalition.
“There is an absolute need for political stability and Bossi thinks exactly the same way I do. The pact we have with the League has never been up for discussion,” Berlusconi said.
“No credible political alternative exists.”
This week the League rejected plans to raise the pension age to 67, leading to tense late-night talks before a compromise was reached in time to take to the summit in Brussels.
The proposals, including an increase in the pension age, rules making it easier to lay off staff and provisions to place civil servants in special redundancy schemes, have raised fierce opposition from unions and skepticism about whether they will ever be implemented.
In Italy’s increasingly murky politics, there has been speculation that the package is part of a deal between Berlusconi and Bossi to take the government to the end of the year before triggering an election in the spring.
Friday, Berlusconi dismissed such suggestions and said an election campaign in the middle of the crisis would be “very seriously damaging to Italy.”