It seems that nobody - and I mean nobody - was expecting George Panandreou to call for a referendum on the plan decided upon by the heads of state at the EU summit.
But in a crisis, events are fluid. Given that the structural economic and political situation is so fragile, anything can happen at any time. And mostly what can happen is not good.
One does not know what the exact catalysts will be that will prompt a collapse of the plan that was hatched at the EU summit last Thursday, nor exactly when they will manifest. The only near certainty is that this plan will fail for reasons that I have outlined in detail.
Paralysis In Europe
The very possibility of a “no” vote essentially halts implementation of the entire program decided upon at the EU summit.
- Without a debt restructuring deal on Greece, there can be no credible estimate of the amount of re-capitalization needed by European banks.
- Given the uncertainty regarding the nature of the financial crisis that could be triggered by a “no” vote (or its mere prospect), it is unclear whether the newly “leveraged” EFSF will have enough money to place a credible firewall around the other PIIGS.
- The “leveraging” of the EFSF depends upon attracting investors to buy massive amounts of bonds with only 20% principal coverage. Given that the Greek population may reject a deal to offer creditors a 50% haircut, it is understandable that investors might be a little skittish about buying bonds with only a 20% guarantee.
Can financial markets tolerate this kind of uncertainty for a few months while the Greeks organize a nationwide vote?
The most transcendent aspect of the Greek decision has to do with this: EU governance.
If entire populations are going to have to be consulted in order to get anything done in Europe, there is no way that anything will ever get done.
Drastic and swift decisions must be made in Europe. Such decisions will unlikely be approved by the populations of all EU nations – and certainly not with the speed required.
The risk of the referendum outcome in Greece is not the main problem, in my view. The problem is this: What if the bailout plan were put before a German referendum? And a Slovakian referendum, and a Finnish referendum, and etc.
If the Greeks can vote on whether to accept the EU bailout, why can't the Germans, Slovakians and Finns vote on whether to pay for the bailout on the terms offered? I expect exactly these sorts of arguments to come to the fore in the next few weeks.
If solving Europe’s sovereign debt crisis becomes a matter of direct democracy – i.e. national referendums -- the euro system will fall apart. Paralysis and gridlock will emerge as the populations of different euro area nations have competing interests and agendas. Furthermore, confronting populations in this manner only risks inflaming passions to a point of no return.
Greece Is Not The Issue
Back to Greece for a moment. I actually don’t think that the referendum is bad news per se. For historical and cultural reasons, I seriously doubt whether the Greeks will vote themselves out of Europe.
The way things were going in Greece, there was a serious threat of a violent and chaotic overthrow of the government. The referendum essentially takes that possibility off of the table. Furthermore, it places the responsibility for any negative consequences of the plan plainly on the shoulders of the citizenry. Folks will be less inclined to complain later as they experience the pain of austerity.
So the issue is not really whether the Greeks will vote for or against the plan. The issue is that the EU does not have a workable decision-making structure to deal with the sort of crisis that is confronted at the present time.
I have been clear in expressing my view that the plan unveiled at the EU summit was not going to work, no matter what. The plan was structurally deficient.
However, exactly how the program falls apart are details that are highly unpredictable. In this case, Papandreou has provided the first surprise. There will be others too come. When crises unfold, one must expect the unexpected.
The only thing that can be said with a high degree of certainty is that the plan agreed to at the euro Summit will fail.
On an intraday basis, the S&P 500 (^GSPC) broke beneath the critical support level around the upper end of the previous trading range at around 1,230. If the S&P 500 were to close below that critical support level in the next few days, it signifies that we are back to the status quo ante in which the equity markets (SPY, DIA, QQQ) trade in a wide volatile range awaiting resolution of the European crisis. In other words, it is likely that the upside breakout will have faltered and that the market will resume its previous pattern of sharp oscillation within a wide range.
I reiterate my prediction that within the next six months, the S&P 500 will test the 1,075 level and will likely break it on the way to the 950-1,020 range. Therefore, stocks such as Apple (AAPL), Microsoft (MSFT) and Intel (INTC) will be available for purchase at significantly lower levels.
On the other hand, short-sellers should be mindful of the G-20 summit on November 3-4. Leaders rarely fail to provide markets with assurance on occasions such as this. The typical pattern is for markets to rally into and immediately after such summits. This case could, of course, prove to be an exception. However, I will not be betting on that.