Here’s a helpful reminder, after ECB President Draghi’s latest attempt to jawbone markets higher and restore calm about the EU. Cut past all the talk, pundits, and spin control. Unless the 5 issues below are resolved, the EU in its current form is still a dead man walking.
As I’ve written for months, the EU and euro can’t survive in their current form. Forget all the verbiage written on it.
It all boils down to the following inability of the EU to reconcile the two conflicting fundamental needs of most debtor and creditor nations in the very limited time remaining before the sovereign and bank default dominoes start to fall.
1. Need To Centralize To Prevent A Repetition Of The Current Crisis
To get out of debt and be able to enact and enforce responsible budgets that keep the EU solvent, it needs to become a well run US of Europe with a fully empowered central bank, and the regulatory and police powers to impose and enforce rules of responsible economic management
2. Need To Cede Sovereignty In Order Allow That Centralization
However, to become the U.S. of Europe, 17 proud sovereign states with long and glorious histories, rather different attitudes about how to run an economy (in addition to other significant linguistic and cultural differences), and historic relationships that are not always amicable, must cede control over monetary and fiscal policy.
That means effectively ceding sovereignty and control over national destiny, or at least reducing it to a level similar to that of the American states. The balance of evidence strongly indicates that there’s little real will to do this. Germans and other northern funding states will not risk having slovenly Southern European attitudes towards economic policy and inflation imposed on them, nor are the GIIPs in any way ready or able to adopt the disciplined northern mindset towards spending and taxation, and related issues regarding social benefits.
3. Not Enough Time To Reconcile These Conflicts
Barring the advent of any new bold programs and lots of new money printing or debt that someone is willing to buy, the EU as we know it could have no more than a few weeks (early August?) until Greece defaults, given that is has utterly failed to keep most of the conditions needed to get the next tranche of bailout cash loans (as if it could afford more debt).
With Spanish and Italian borrowing costs at unsustainable levels, it’s hard to see how either would avoid default beyond a few weeks or months once a Greek default starts a wave of bank defaults and insolvency that radiates outwards and to banks and sovereigns across Europe
4. Currently No Source Of Interim Funding To Prevent Defaults While The US Of Europe Is Being Organized
The only way around the time constraints is a new and large source of interim funding. Are there any volunteers? Anyone?
5. No Credibility To Justify A Last Great Alliance of Lenders/Donors
To have the credibility to ask the world to lend/donate/print the trillions needed to tide it over for the next decade, the EU would have to behave like its united and knows what to do, and just needs 5-15 years of funding to keep the GIIPS and anyone else solvent while it organizes all the details needed to get the US of Europe functioning.
That’s where we stand with the EU sovereign debt and banking crisis.
The only thing that could save, or at least defer, the above scenario of a Spanish or Italian default that collapses the EU and euro would in essence be some combination of donations (likely in form of debt forgiveness) and money printing to keep banks liquid enough to continue functioning even though they’re insolvent zombie banks.
If the past years are any guide, that’s still a possibility, though a receding one. However it would only be yet another deferral of the inevitable, and as that realization has spread, each successive rescue buys less and less time.
A crisis on this level is in the hands of politicians and thus outside of my expertise.
Just stay focused on the following idea – the potential volatility ahead and room still to fall to March 2009 depths is still significant.
- It’s about 50% for the bellwether S&P
- The EURUSD is still 40% off its 2001 lows, and the EURJPY is around its all time lows. However for a currency that may disappear in its current form, these are hardly reliable long term floors.
That said, with so much fear surrounding risk assets and especially the EUR, these are ready to fly on short but violent short-covering rallies on any signs of positive news, and make more sustained gains on any longer term flow of positive news – or at least news that the end has been deferred for a matter of months.
The most likely form of such news/rumor is a new variation of an EU rescue or significant new QE 3 from the Fed.
What To Do
In short, this is a market for either very short term traders or very long term investors. The rest of us will likely do well to stand aside in the coming weeks.
Longer term, those whose wealth is based in the top ranked safe haven currencies, USD, JPY, or CHF denominated assets should take advantage of their relative strength to diversify into assets in healthier currencies.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.