Home > Uncategorized > 2011/12/07: ‘The Ecstasy & Agony’ on Europe Still a Mess with More Divergent Positions Than Meet the Eye

2011/12/07: ‘The Ecstasy & Agony’ on Europe Still a Mess with More Divergent Positions Than Meet the Eye

© 2011 ROHR International, Inc. All International rights reserved.

Rightful apologies to Irving Stone for reversing the word order in the title of his 1961 magnum opus on Michelangelo, but Ecstasy followed by Agony this seems to be the recurring cycle on these European ‘ultimate solutions’ for their Sovereign Debt Crisis. Whatever the hopes might’ve been after the extremely upbeat pronouncements by Chancellor Merkel and President Sarkozy on Monday, the typical cacophony of European opinion is chiming in as we head toward the more major late week (and undoubtedly into the weekend) decision horizon.

Even before the current dissension on several key points, there were flaws in the Merkel-Sarkozy plan we will explore below. However, on current form the typical naysayers among the northern European states are beginning to throw cold water on the whole idea that some sort of “grand bargain” is possible as early as Friday into this weekend.

In the first instance we’d appreciate it if the European powers-that-be (and the financial fourth estate) would stop referring to enhanced funding for the European Financial Stability Facility (EFSF) and its European Stabilization Mechanism (ESM) successor as those firewall entities having a sufficiently powerful “bazooka”. This is another prime example of folks forgetting the context of that characterization of massive funding for a rescue facility. It was used by US Treasury Secretary Henry Paulson to describe the necessity of a large rescue fund, as in (paraphrased) “…having a big enough ‘bazooka’ that its mere presence means it will likely be unnecessary to use it.”

And what was the net result of the US Congress passing the TARP (Troubled Asset Relief Program) on October 3, 2008? A straight down drop of over 2,500 points in the Dow Jones Industrial Average, along with similar moves in the other global equities prior to the markets stabilizing. So, maybe they should stop talking about this in terms of adefinitive cure for what ails the peripheral European sovereign debt markets.

And in fact, what Chancellor Merkel and President Sarkozy proposed at the top of the week doesn’t look like it’s getting a very friendly reception from the northern European governments. A key German financial official sounded very downbeat this morning on the plan to expand EFSF funding and powers. He also noted there would need to be further agreements on this in any event, which meant more meetings between now and Christmas.

Then there was Finland’s Finance Minister, who rejected the idea of majority rule in the operation of any bailout funds. This is another recurring theme in all of the failures to proceed with any “ultimate solution” or “grand bargain” on the European Sovereign Debt Crisis. The extremely contentious nature of getting the 17 member states of the Euro-zone, much less all 27 members of the European Union, to agree timely to the sorts of things that should rightfully require treaty revisions is a given. Not something anybody either in Europe or the rest of the world relishes, yet that’s the way it is.

All of which is in addition to the inherent contradictions in what Merkel and Sarkozy came in with on Monday after a long weekend of pointed negotiations and creative thinking. Unfortunately the creativepart of it seems to have been dominant, and not anything that was actually concrete.

Yesterday’s Financial Times included a story on the new fiscal rules they were proposing for the EU. It seems those are going to “…include a commitment not to force private sector bondholders to take losses on any future eurozone bail-outs”. That would be a major negative for the fiscal picture and government bond rating for the major European states; and goes a long way toward reinforcing the recent reversal on the country spreads of the German Bund from strong sister to extremely weak sister against the T-Note and Gilt.

It also goes a long way toward explaining the short-term rally in Italian and Spanish government bonds. Many folks have marveled over the degree to which that occurred with only limited European Central Bank intervention. Yet it is now clear there is a specific influence which has come into play in the form of that “no haircut” commitment; especially squeezing the bears.

All of which only highlights the contradictions still coming out of Europe. If Chancellor Merkel and her cohorts in Germany are so totally averse to a Euro-bond, how can they possibly sign on to the lack of any risk for the private purchasers of European government debt? That would seem to be a form of backing for a de facto Euro-bond. However, it seems that those future Euro-zone bonds will still include collective action clauses providing for potential ‘voluntary’ rescheduling of private debt.

In other words, if the public good were to warrant it, governments could still pull the same sort of stunt that they forced on the private holders of Greek debt. Standard & Poor’s has even allowed that a portion of their move to put the European Financial Stability Facility (EFSF) bonds on negative watch was due to the failure to trigger the credit default swaps (CDS) on the 50% ‘voluntary’ principal forgiveness imposed upon private holders of Greek government bonds. And in drawing the further inferences from that, it also noted that a lack of any bona fide hedging vehicle for these still relatively risky assets would be a disincentive for potential future buyers of European government debt.

So, just as we (among many others) had cautioned, the more fiscally sound northern European governments (which is to say Germany in particular) have indeed shot themselves in the foot. Aggressive opposition to the whole concept of Euro-govvies CDS has its consequences. It was interesting that right after the lack Greek government bonds CDS being triggered there were several major banks noting client inquiries on EFSF CDS. Yet they demurred from offering these products because they were afraid of government reprisals.

We had cautioned quite some time ago (March 2005’s 1970’s Redux: Son of Stagflation) that lax central banking and financial regulation were likely to create a crisis that landed us back in 1970’s style markets. At present that is not just about the volatility markets are experiencing; it is also about the degree to which they are once again ‘politico’-economic markets, with the emphasis on political meddling.

General Market Observations and Extended Trend Implications

These are of course very much in line with the updated technical projections and associated comments which we posted earlier today. We refer you to those for the general sense that the equities rally is a matter of hope over reason, along with the other asset classes not reflecting any great expectation of a real solution out of Europe. The current technical levels are also obviously the relevant price trend decision areas to watch at present.

Thanks for your interest.

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