“It’s interesting to note that 20 years later we have realized we have succeeded in creating a more stable foundation for that economic and monetary union, and in so doing we’ve advanced political union and have attended to weaknesses that were included in the system.” Angela Merkel,  9^th December 2011

The weekend headlines blared a mixture of adulation and success: Resurgent Germany, Shrewd Sarkozy, Britain Isolated. In fact Germany is far from resurgent, Sarkozy is more reacting to events rather than leading solutions, and Great Britain’s refusal to submit to fiscal control from Brussels is hardly a surprise given that she is not a member of the Monetary Union.

Had the agreement for fiscal union been reached prior to the launch of the Euro that would have been extremely favorable news; and the fiscal controls, had they been made to work would likely have muted the breadth and depth of the current Eurozone crisis. But alas, we are not living in 1991. It is 2011 and the promised reforms are just that: promised, they still are subject to debate and ratification by each member nation. And then there is the question of sanctions against members who violate the proposed fiscal rules. If the enforcement mechanisms are too stringent, no national government will ratify the fiscal proposals. If they are too lax, the agreement will be toothless and incapable of serving as a bulwark against some future crisis.

But the real story is that the proposed agreement does not address any of the urgent and important issues that the Eurozone is facing right now. These stresses threaten the continued existence of the common currency. Last week’s entire exercise, and the posturing before, during, and after therefore must be judged as a lost opportunity of significant dimensions

• None of the structural problems relating to pensions and entitlements spending in a large number of countries has been adequately dealt with;
• At last count, large European banks are undercapitalized to the tune of over EUR 120 Bn. Moody’s Investors Service downgraded the three largest banks in France on Friday and said there was a “very high” probability that the French government would be forced to step in to support them if conditions worsened.
• Fifteen out of Seventeen EU countries were placed on negative Creditwatch last week by Standard and Poors.
• Greece, Ireland, Italy, and Portugal and Ireland cannot fund themselves at economical levels. Spain is arguably close to the borderline as is Belgium. Over the next 12 months the aggregate funding requirements for these countries amount to EUR 1000 Bn.
• The EFSF is broken and no credible mechanism yet exists to replace it. Announcement of the formation date of the ESM as being in 2012 in place of 2013 does not make money available sooner until the ESM is actually funded. No updated funding plans were announced in the wake of the recent dud China funding effort launched in spectacularly disastrous fashion by Klaus Regler, the EFSF honcho.
• There is no relief for countries suffering with austerity. The solution, according to Merkel and Sarkozy appears to be More Austerity!!. As we have said in the past, the track record of these programs is not good, and that reflects cases where countries were able to devalue their currencies. In the present scenario no Soft Exit from the Euro for the PIIGS and other sufferers is being countenanced by the Euro Leaders. It is only a matter of time before large scale social unrest erupts in one of these places and/or the austerity programs are abandoned.
• The IMF is washing its hands of this mess. In fact, there may no longer be any legal or politically palatable way to re-engage the IMF after this episode. Similarly, the US is adopting a hands-off approach.
• One recurring theme of this crisis in Europe (and North America) was also played out yet again in that it was obvious that there is no political will to force banks that made all of the bad bets to pay for their oversights.
• The other recurring theme is that markets have again been asked to wait “another three months” for the next installment of this sorry saga.

Looking at the list above it becomes apparent that there are actually more and deeper problems on the boil now than in the late Fall when the crisis seemed to be close to a blow-off phase.

The Euro Leaders are likely taking comfort from the fact that there has been a muted to slightly positive market reaction to the announcements of last week. The reality is that what they are really admiring is the market reaction to the efforts of the Euro spin doctors hired to generate false headlines, and not developments that are substantive and likely to contribute to renewed and durable confidence in Eurozone economic management or the Euro itself.

Being suspicious of free markets, what the current Euro Leadership does not recognize is that markets do not necessarily follow a rational path in reacting to information and do not process it in a temporally consistent and predictable manner. Recovery Partners believes that although a measure of calm has returned, it will prove temporary. This is because the ongoing failure of the Euro politicians to implement appropriate measures with enough speed and force to counter market pressures that are threatening the Euro’s survival is risking evaporation of what remains of the opportunity to turn things around. This is the fourth kick at the can this year. Each time anyone has looked for substantive progress, they have been left wanting.

For now, the relative calm in the markets is therefore more a reflection of year end book flattening and position squaring behavior rather than a true reaction to last week’s efforts of the Euro people to fix the problems. In a sense, it appears that a Prozac Bubble has formed to shield the markets from bad news in what is supposed to be a happy time of year.

Unless something intervenes to prick this Prozac Bubble, we will have to wait until the New Year to fund out what Mr. Market really thinks about the latest Euro-wheeze. Whatever the timing, in our opinion the reaction won’t be pretty.

Happy and I’m smiling,
walk a mile to drink your water.
You know I’d love to love you,
and above you there’s no other.
We’ll go walking out
while others shout of war’s disaster.
Oh, we won’t give in,
let’s go living in the past.

Once I used to join in
every boy and girl was my friend.
Now there’s revolution, but they don’t know
what they’re fighting.
Let us close our eyes;
outside their lives go on much faster.
Oh, we won’t give in,
we’ll keep living in the past

Ian Anderson, Jethro Tull

This entry was posted on Monday, December 12th, 2011 at 7:37 pm and is filed under Banks, Bond Market, Crisis, EU, IMF, Sovereign Debt. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.