According to Italian Prime Minister (and former Goldman Sachs adviser) Mario Monti, Europe must be saved by July 1. Monti, an accomplished economist and the man once responsible for setting Italy's financial policies as chair of the country's Treasury committee, warned last week that if he, French president Francois Hollande, Spanish prime minister Mariano Rajoy, and German Chancellor Angela Merkel cannot come to an agreement on the terms for greater financial integration in the eurozone at this week's EU summit, the "vicious circle"--wherein governments are forced by public outcry to abandon austerity measures causing the bond market to lose confidence in their sovereign debt, which subsequently pushes the countries closer to the brink and precipitates a further deterioration in public opinion--will be perpetuated. Monti believes that Europeans are becoming fed up with what they perceive as ineptitude on the part of policymakers, leading many to question whether it woudn't be better to dissolve the currency union once and for all. To illustrate the point, Monti noted that the Italian parliament is already becoming increasingly anti-Europe.
While it conveys an appropriate sense of urgency, the problem with Monti's "this week is the deadline, failure is not an option" approach to the summit, is that is sets the market up for disappointment. Monti's warning serves as an implicit guarantee that some kind of resolution will be reached by the end of the week. In fact however, the situation has become so complex--the moving parts so interdependent-- that it really isn't even clear what needs to be discussed or resolved.
For instance, one of the issues supposedly under discussion is a "'new market-friendly policy mechanism" to help out countries under attack - provided they had complied with EU demands for fiscal discipline." While Monti stopped-short of specifics, what he means (and what Francois Hollande has explicitly recommended) is an automatic program in which the European Stability Mechanism (ESM) will purchase the sovereign debt of Italy and Spain when yield spreads between those notes and comparable German debt widen to a predetermined level. It makes little sense to discuss this at the current juncture however, because the ESM doesn't even exist yet. Although EU leaders have promised the fund will become operational on July 9, "so far only France, Greece and Slovenia have fully completed the ratification." On top of this, article 8(4) of the ESM treaty makes contributions mandatory:
4. ESM Members hereby irrevocably and unconditionally undertake to provide their contribution to the authorised capital stock, in accordance with their contribution key in Annex I. They shall meet all capital calls on a timely basis in accordance with the terms set out in this Treaty.
Effectively, this means that countries accepting ESM assistance must still make their promised contribution to the fund. Theoretically then, this means that Italy and Spain will be providing the money for their own rescues. This demonstrates how convoluted the topics under discussions have become and illustrates why the problems are so deep-seated as to make any sort of resolution unlikely in the short term.
Even if European leaders are able to determine exactly what needs to be discussed--a few concrete measures that do make sense, such as region wide deposit guarantees, are on the agenda--German Chancellor Merkel will undoubtedly make negotiations difficult. Merkel has already said the idea of the ESM buying sovereign debt is "not up for debate."
Adding to the confusion, Greece's foreign minister and outgoing finance minister will attend the summit to ask the Troika to renegotiate the terms of its 130 billion euro bailout, a discussion which will no doubt be negatively impacted by the fact that Greece's prime minister and incoming finance minister have canceled their plans to attend due to eye surgery and nausea respectively.
Somehow, Mario Monti expects European leaders to craft a road map to save the eurozone in this chaotic environment over the course of just two days. This is a lofty, and likely quite unrealistic goal. Unfortunately, Mr. Monti's words are being taken quite seriously and the market now expects significant progress. If the past is any indication of the future, investors shouldn't expect much from the meeting. Sell into any strength this week, or short S&P 500 (SPY), Nasdaq (QQQ), long dollar, long volatility.