Home > Uncategorized > 2011/10/24: Quick Post: Enjoying the Equities Rally? Go Hug a Commie

2011/10/24: Quick Post: Enjoying the Equities Rally? Go Hug a Commie

That’s right. There is a debt of gratitude due a select subset of the ostensibly anti-capitalist extreme wing of the global labor moment. It has to do with last week’s passage of the most recent in a series of Greek austerity package. While the current Franco-German negotiations on the broader European Debt Crisis rescue plan is now critical later this week (more on that below), none of it could have proceeded without the further Greek austerity measures.

And last week’s approval by the Greek Parliament was a distinctly fraught affair. For one thing, the vote inside the parliament building was an extremely close run thing. It required the dismissal and replacement of one deputy in order in the coalition to secure a majority vote. Dodgy parliamentary practice it best, but it worked.

The more visible and overt battle was outside the parliament building, where mostly peaceful protesters signaled their disgust Greece was basically being blackmailed into submission by the more successful Euro-zone states. Whatever one’s view on that, the even more troubling battle was the overt physical fighting between two key factions.

Was it the Liberals versus the Conservatives? Nope. How about the Socialists versus the Capitalists? Not that either. And what we are talking about here is folks who were actually aggressively attacking each other with projectiles, and even smashing each other with clubs.

It was the Communists versus the Anarchists. Sadly, right again. There are still anarchists out there in the world. The sort of people who feel so disenfranchised that they are happy to work to bring the whole system down. We thought we’d seen the back of these people at the end of the 1970s, but that’s obviously not the case.

So why is it that we owe the Communists this debt of gratitude? Quite simply, a long time ago the European Communists, including their Greek wing, decided to subvert the system from within. Rather than attempt outright violent revolution, they decided to enter the political process in order to take over the levers of power. Unfortunately for them, the current abysmal state of Greek finances and social fabric would seem to be a result of policies they ardently advocated.

We do not need to go into one of Dr. Arthur Laffer’s theories on the evils of excessive taxation to support unsustainable social services spending to illustrate the point that Greece lived beyond its means for way too long. Of course, there was also the intrinsically high level of EU regulation to restrain the economy. Europe has been living with its own version of Taxulationism for a long time.

Only natural then that there is an endemic tendency toward tax avoidance (legal and otherwise), and aggressive claiming of benefits that has produced an unproductive culture. For that we can condemn the basic communist theory and practice.

However, we should also thank them for defending parliament on the streets of Athens during the key Greek Parliament votes last week. Would the Greek police and army have been able to accomplish this without them? Likely so. All the same, it is good to see a previous revolutionary force defend the system it had decided to join long ago from the threat of pure anarchy.

And as far as the state of the overall European Debt Crisis negotiations, there does appear to be come progress; such as it may be. The rumors coming out of the Merkel-Sarkozy meeting are that the Germans are on board for the ‘insurance’ model for an expanded European Financial Stabilization Facility (EFSF). That is as opposed to the full ‘bank’ model the French had wanted, yet the ‘insurance’ model is something that Chancellor Merkel knew she could get passed through the German Bundestag later this week.

Or at least we all should hope, as along the way there was a twist. While the German High Court had ruled that only the Budget Committee would need to vote on the extended functions for the EFSF, the conservative parliamentary floor leader had insisted the full body approve the measures. We shall see.

The other contentious matter which is now seemingly close to reconciliation is the amount of the ‘haircut’ (writedown of the value) which the public sector distressed European sovereign bond holders will need to take. Of course, this has been an issue due to the significant amount of those bonds held by a particular private sector holder: the major French banks.

For obvious reasons, President Sarkozy had wanted much less of a writedown and more direct pan-European support for his country’s banks. The insurance model for EFSF goes some way toward stabilizing the overall system. Yet, it seems the trade off to secure German commitment was to require private sector holders to acknowledge losses of somewhere around 50%, as opposed to the current 21% that (to paraphrase Ms. Merkel) was a ‘dream’.

However, that raises two knock-on issues of some import. First, how prepared are the French banks (and others) to actually absorb that magnitude of loss? Maybe it’ll be all right for now, given the European stalling has allowed for some time to bolster balance sheets, and the IMF may be ready to sneak back in from the sidelines if necessary (maybe the Americans won’t gripe to loudly.)

More telling will be whether any overt implication this is being forced onto the private debt holders will be viewed as a ‘credit event’ (i.e. full default) by the credit rating agencies. That will trigger the exercise of the Credit Default Swaps on Greek debt, which may create a much more contentious and troubling short term interbank liquidity issue. No wonder that all the central banks (even the classically parsimonious ECB) have been putting forth the position that they will make plenty of emergency funding available to the credit markets if necessary.

After all, even if all the private borrowers do agree to the ‘haircut’, what if the sheer size of the writedowns causes one or more rating agencies to declare it a default in any event? Likely? Maybe not. Yet it is worrying that in the very short term horizon so very few government leaders and credit agency operatives hold the fate of market stability in their hands.

And in any event, this does not really appear to address any of the further problems that may surface if Italian or Spanish bond markets do not organically recover sometime soon. But that’s another tale for the next attempt to successfully ‘kick the can down the road’.

General Market Observations

All of the market observations remain much the same as previous. Even with the US equities up to new highs for the current rally, whether the December S&P 500 future swing up above the 1,230 area can push through 1,245-65 resistance prior to falling back below 1,215-10 is problematic. And none of the other asset classes seem to be reflecting that the equities extension of the rally is a sign of sustainable global economic growth. Please see those previous posts for that analysis.

Thanks for your interest.

  1. usikpa
    October 24, 2011 at 4:09 PM

    Surely, a rise of 1.2 points of the Chinese PMI can not explain all of that sudden end of the end of the world rally

    • October 24, 2011 at 9:03 PM

      More likely that it was reinforced by the over the top Caterpillar earnings with strong guidance. That goes to the “maybe China isn’t really softening” psychology.

      Yet, in the bigger picture it is less important than the overall deleveraging story. The focus coming out of Europe this week will change to how the agreed EFSF package will affect the banks, and soon rotate back around to the more telling US debt ceiling and fiscal reform focus. As noted in previous posts, the real key operator here is the CBO.

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