Spain gets it right again

Spain has proven once more adept at reading the signs of an attack and going on the offensive. As everyone closes around Greece and France, Spain has passed a balanced budget amendment to its constitution. I expect it will do better than otherwise possible in the turbulence that is coming up this month and next. Indeed, with Spain's lower overall spending profile, the adjustment should hurt less than it does elsewhere.

It's not that budget retrenchment is objectively necessary, especially for Spain, with its low public debt. Nor is it that the current hysteria about deficit reduction is somehow right in treating Spain the same way as Greece or Portugal. Instead, the objectively good reason to move is that markets collectively are sloshing in a huge wave around Europe and don't really care about economic fundamentals any more. They care about political signals like this that identify a country as one of the winners.

Spain has decided it's going to come out of this crisis even stronger than it started. With such a big wave coming, whilst other countries are looking at it and wondering whether they can swim, Spain has just pulled out a surfboard. 

They may just pull it off. Whether it works or not, you've got to admire the balls behind that move.

Why are German banks hiding?

French banks are being pounded again today for holding so much Greek debt, but the other story this week (still) is that a number of German banks have decided to withdraw from the stress testing of the European Banking Authority.

To which my response is: are they smoking crack? The banking community has taken a big hit in trust over the last four years, and transparency is the way to restoring it. In order for regulators and the public to know the truth, stress testing has to show what is there. The response of the German banks, that telling the truth about what German banks are holding would exacerbate the euro zone debt crisis only serves to reinforce why German banks and their motives should be distrusted.

Although the UK banks are screaming about new rules on capital adequacy this week, at least they are designed to make the banks safer.

And why in all that is holy would anyone keep their money in such a place. If you're reading this and you're German, the answer is: you shouldn't. Withdraw your cash and put it in an institution that will be honest about what's on its books. Because however ugly it is, what you don't know will hurt you more than what you do.

Why? Britain and European passport controls.

The UK has always insisted on going its own way within the EU. Okay, we get it, and although I can't think of where that might actually have been a good thing (some Brits reading this will surely look at the euro zone crisis and laugh out loud, despite the fact that their mortgage payments are permanently higher to support the value of sterling), I can respect being eccentric if you aren't just making life difficult just to make a point. To wit:

Insisting on passport controls within the EU makes Britain (and yes, I'm looking at you, Ireland) look like a third-world banana republic with a huge chip on its shoulder. Grow up and let freedom reign already. I've just returned from a trip to Cambridge, a trip in which I spent three times more time in passport control than actually flying. There is a reason I won't be accepting many more invitations to the island anytime soon. It's a complete pain in the ass, even coming back into Schengen. And that's a shame. Because I'm going to tell my UK colleagues next time....let's just meet in Paris.

Switzerland pegs to the euro

Yesterday, the Swiss central bank announced it would intervene to prevent the franc from rising above 1.20 to the euro. What I want to know is how much money the main Swiss banks have planned in as ammunition. Because the markets will surely test it now.

I'd think twice about buying stock in Swiss banks at the moment.

A long roller coaster ride

Financial markets reacting in a manic-depressive manner under times of uncertainty. At the moment, when no one is really sure where the next wave of economic growth and recovery might come from, and where there are serious fears in the background (at least) that we are headed for a double-dip recession (showing the delusion of financial markets--if you were normal, you'd know that we've never gotten out of the one we entered in 2007). That's true of both Europe and America. Three things have been giving financial markets hope over the last year: a new bubble in technology stocks (particularly social media); a new bubble in raw materials (including gold), and taxpayer-financed welfare measure for banks and other financial institutions. 

That is a crappy basis on which to expect a recovery. The first two prospects are built on herd behaviour and inflated valuations which are exceptionally fragile. The last of these prospects not only has natural limits, but is hamstrung by a lack of political capacity. In the United States, the political landscape is so polarized that Americans are stuck with Cliffhanger Government for the foreseeable future, and may very well lurch from one debt crisis to another. In Europe, the EU and the Eurozone are proving equally incapable if not more so, of taking an authoritative decision on any way out of the crisis. 

As a result in Europe, the ECB has resorted once again to emergency purchases of southern European debt. As I've written in my post on the rise of General Trichet, that emergency action is coming with special powers, as witnessed by the humbling of Silvio Berlusconi. That's right. Berlusconi is a very difficult man to humble, in the light of corruption scandals, lawsuits and pressure from Brussels and other European capitals. but now we see where the real power lies. The ECB under Trichet has become very powerful indeed. How that will look in the fall is perhaps another story. The sources of the ECB's power are informal to a great degree, and a willingness to bend or break the rules to secure a greater purpose. That is a great part of Trichet's legacy, and what has kept the EU together over the last few years. What will happen once he passes the torch to his successor remains to be seen.

The roller coaster effect is sure to continue for two reasons: first, the combination of skittish markets, poor economic prospects in both America and Europe and political ungovernability in both areas mean that the world economy is in for a period of enhanced volatility for the next decade at least. To the extent that East and South Asia generate domestic demand that depends little on America and Europe, that volatility will decrease globally and provide America and Europe with new economic perspectives. But that is not going to happen tomorrow.  Until then, without a strong foundation or a government that works, financial markets will continue to freak out on an extended basis. Both positively and negatively. We saw that between the 1870s and the 1890s, when the world never really got out of recession, save for a few manias that collapsed into themselves.

Hold on to your seats.

Sovereign Default and Banking Collapse

In a recent stress test of selected European banks, the European Banking Authority made it known that it did not test what would happen if a country defaulted on its debt. Not Greece, not Portugal, not Italy and not the United States.

That means, at the least, that the official outcomes of the stress tests are useless. More seriously, it means that the EBA's official position on the possibility of default (that politicians are talking about amongst themselves very prominently) is that they don't want to talk about it. That is tantamount to reckless endangerment of the European financial system.

Given the obvious possibility of default, and the necessity of factoring it into stability scenarios, the only real question is: who is responsible for ordering the bank regulators to back off from the truth? Possibly, it is the bank regulators themselves who are shielding banks from the light of day. That would be bad enough. But it isn't likely that they could do such a thing without heads of government allowing or insisting that they do so.

Europe and its people deserve better. The EBA without realistic stress testing is, as my grandfather would have said, as useful as tits on a bull.

And the War Continues

It has been but a few days since European leaders agreed a new bailout for Greece and financial markets are already tightening the screws as if little had happened. This applies not only to Greece, but to Italy, Spain and Portugal as well. Why?

In a nutshell, the problems are simply to big and the resources are simply too modest to dampen future speculation against southern rim countries in the EU. The first set of problems lies within the affected countries themselves: there is still no sign from Athens or from Lisbon that they have adopted a new way of looking at things and will radically restructure their public finances. We are seeing emergency measures in Greece, but there is no discussion of what sustainable finances look like. As long as Greece and Portugal remain in the euro, and as long as the euro zone resists institutionalised fiscal transfers, sustainable will mean stingy. Tax collections will have to increase, social benefits will have to decrease, and public infrastructure will have to be sold off to private corporations. What little is left will have to go into regulating the private companies providing previously public services, if anyone is capable. The bottom line is: more for less and a loss of public control over the necessities of life. If I were 20 and Greek, and the country continued down this path, I would leave, period.

The second set of problems lies with Europe itself and the way it takes decisions. The response to the Greek crisis in particular has been a series of talks between France and Germany, long periods of German absence from discussions intended to heighten the sense of desperation by others, and German reluctance to spend much of anything. Of all the options available to it, Europe seems incapable of forcing real policy change in targeted countries, incapable of  kicking a country out of the euro, and incapable of agreeing on the fiscal transfers required to keep a country inside. Something has to give, and there will be changes yet to come.

The third set of problems is one that Germany seems intuitively aware of, and if so, is entirely right about: that if they continue throwing money at the countries that are now in trouble, they will themselves be pulled under water. German banks have been worried about the impact that a Greek default would have on their balance books (as have been French and British banks), but the other side of the coin is that ratings agencies have already started to warn that the credit ratings of Europe's more solvent countries would eventually be at risk if the problems in Europe's south are not solved. This is the reason why the European declaration stated time and again that under no circumstances would the arrangements be extended beyond Greece, and that everyone would strictly adhere to the budget and debt criteria. The word 'strictly' was used a lot.

Given all of this, there has been a lot of money spent, but it isn't by far enough to solve the euro zone's problems. The war will continue. Until Europe gets off the pot and does something real.