My Grand Recessional for Europe as It Dances Rings Around the Euro Crisis One More Time
European leaders pressed the case that a new fiscal accord will deliver the region from its two-year debt crisis, as Germany’s top central banker cooled speculation the European Central Bank will extend its role. (Bloomberg)
Europe, again, does too little, too late. The markets may dance a little to the news, but whatever lift the latest summit gives will give way as quickly as all the loftiness of previous "solutions" fell away. Here is why:
How to arrest a fall when dancing at a European reunion
To arrest a fall during any crisis (debt crisis or otherwise), you have to get far enough ahead of the falling victim to have time to intervene effectively. It's hard to stop a fall from behind. This is how I've advised people when selling their homes in a declining market. Always price below the current market, even though the current market price is already less than you want. Do so in order to sell quickly. If you don't, you'll end up following the market all the way to the bottom.
Time and again, I've watched people ignore that advice because they didn't have the stomach to take the initial loss. As predicted, they followed the market down one price adjustment after another to a much worse low than they would have taken if they had jumped boldly ahead of the market's collapse. Why? Because even a quick sale takes weeks to close, so the market value of the home will be worse at closing than it was at the time you priced it, causing the deal to fall through and the house to go back on the market. To get ahead of the fall, you have to take bolder action than what is currently needed.
Europe's slow approach to its own debt crisis is like a death march. European leaders consistently take a little less action than what it is needed even at the moment, much less what will be needed by the time each solution is executed. As a result, they never get ahead of the fall. The latest pact (described in the Bloomberg article quoted above) is no bigger a step toward recovery than all the steps taken so far.
This last weekend was like watching a slow shuffle of lemmings go over a cliff. Once again, the current plan throws the problems back to the individual national governments of Europe to come up with more money for bailouts. It promises too little money for the bailouts to work, and the individual nations still have to work out their cooperative efforts back home financially and politically. Some nations may decline to go along with the deal.
"I think [Friday's stock market gain] was a sigh of relief ... that at least the leaders are aligned in that they want to solve this thing, but now the heavy lifting comes in," said Kim Caughey Forrest, senior equity analyst at Fort Pitt Capital Group.
Leaders of the European countries involved in the deal will have to go back and convince their politicians to pass measures that will include "all the ugly stuff that comes along with belt tightening," said Forrest.
"It's going to be difficult to get this passed," she added. "Countries want to maintain their sovereignty and solve the crisis at the same time, so it's going to be a long slog.(CNN Money) The plan promises 200 billion more euros to the International Monetary Fund's euro relief war chest. This money is supposed to be coughed up by the sovereign banks of the various European nations and by non-European sovereign banks, but the size of the problem is so much greater than another 200 billion euros, which Europe's leaders are hoping to leverage into something more like a trillion-euro relief plan. And that is like watching Skinny Minnie dance with Heavy Harvey and try to throw him up into the air and catch him on the way back down. Good luck with either phase of that plan!
Stock exchanges and bond markets will soon realize that European leaders of the dance really don't have any tune to dance to. They have no short-term answer at all. The stock markets of this world keep hoping for a lofty aria to dance to at these meetings. They get excited that leaders are coming together. So, the stock markets' fickle bounce on Monday, if it they even have one, will mean nothing and will be short-lived.
By the time the 200 billion euros is fully approved and in place, it will be short of the amount actually needed. (Of course, I don't think bailing out banks is the right solution anyway, but I'm just saying this solution will fall short even as a bailout.)
The one good thing the plan offers is tighter budget restraints, but those restraints will be a long time in playing out, as budgets happen a year or more down the road. So, they, too, are too little, too late. Tougher budget rules will make for a more secure future if nations were fully solvent now, but they are not likely to stop defaults already in play due to past free-wheeling days.
One bit of good news for Europe is that China has now said it will now join the dance, though it has not publicly said how. It has the potential to be a sumo thrower, but nothing in the plan looks like any heavy lifting will really happen.
Economic predictions of market turmoil ahead
The ball may turn into a brawl next year. Forecasts everywhere indicate a slower economy for Europe, which means they will have less strength for their maneuvers by the time the maneuvers are in place ... IF they are ever in place.
Investors have already given the "solution" a mixed reaction while I was composing this article, so their mere "harumph" didn't take long to come. Austrian Chancellor Werner Faymann has also just cast doubt on the arrangement, telling the Salzburger Nachrichten newspaper that "The decisions don’t have enough firepower to have a sustainable effect."
"Sustainable effect" is the operative term there. As none of the previous solutions had any sustainable effect, this comes as no surprise. This tepid and uncreative response is what we've seen from Europe's leaders throughout the euro crisis.
The fact is, the world's leaders have no idea how to call the dance. The living have never danced it before. They are making up the steps as the go, and bumping people into each other. Britain has been more than jostled onto the sidelines and has said it is willing to dance no more. To make matters worse, the final steps of the pact are not even written yet, and it remains to be seen how individual nations will respond to their requirement of paying 200 billion euros. Nearly everything is still up in the air, except the markets, which are likely to fall flat in a hurry.
As I was in the midst of writing this article and just finished the segments above, the following news began to appear already online:
Some EU officials fear the lack of certainty about the real scope of the new deal could severely unsettle [the markets].
This nervousness is heightened by continuing arguments over the scale and nature of any intervention to shore up the eurozone and resolve the sovereign debt crisis by both the International Monetary Fund and European Central Bank. (The Guardian) Uh huh. The news unfolds exactly as I am anticipating almost faster than I can write down my predictions. The leaders have made a pact, but the nations they lead are still arguing over it. By the time decisions are finalized and money is in place, more bad news will have already swept over Europe, and its overall problems will, again, be too big for the current proposal. The primly dressed leaders of Europe are chasing the problem down a muddy slope and trying not to fall over themselves, rather than getting ahead of it.
The European solution to the euro crisis is nothing but a fancy dance that throws money in the air like confetti
Actually, it throws money made out of air. Supposedly the European Central bank (ECB) will not be doing any of what the U.S. Federal Reserve did by buying sovereign debt bonds, which it called "quantitative easing." By treaty it cannot. In practice, however, it will effectively be doing exactly what the Fed did.
Here's that part of the plan as I understand it based on the sketchy details so far: Since the ECB cannot buy sovereign bonds directly and create the money out of thin air to do it, as the U.S. Federal Reserve now routinely does, the ECB plans to give 1% interest loans to banks if the loans are backed in full with European sovereign bonds as collateral. In other words, if a bank buys sovereign bonds FIRST at 7% interest (or whatever the going high rate is), the ECB will loan the bank that same amount of money at 1% interest. In theory, that will create a much bigger market for those bonds and keep the rates down. If the bonds do not default, the banks in this example would take in 7% interest on money they borrowed at 1% to realize a 6% profit, and the ECB will make a 1% profit. Free money. Everybody wins! Yahoo!
Well, that or the entire dance floor collapses from the chaotic vibrations of so much nonsense:
The various banks that participate have only to front the money for the bonds before getting the principle amount back from the ECB on loan at 1% interest. So, all the bank risks is the 1% interest it is paying if it has to turn the collateral over in a default at the end of the party. It is hard to see how this loophole is any different than the ECB just buying the bonds directly, as you know these transactions are going to happen in endless circles of debt where the national banks buy as many bonds as they can with their own money, then get a loan to replace their money from the ECB, then go out and buy that many bonds again with the replacement loan, and get the money replaced again from the ECB. This APPEARS to be how the Europeans hope to leverage the 200 billion euros. In the end, it is the European Central Bank that gets stuck with hundreds of billions of euros worth of bad bonds as collateral if everything goes bad.
I wouldn't want to be out on the dance floor when all of that goes down.
These are the fancy money games -- the swirls and twirls -- the whole world is now playing in order for the nations of this world to pay their debts with money that doesn't exist. They pretend they can keep the downside risk of default from happening as they start printing money. So long as all goes well, this practice should insure a large supply of ready bond buyers for Europe's sovereign debt in order to keep the interest down, but if it fails ... Europe goes down more spectacularly than ever before! The collapse of the floor will pull the ceiling in on top of them, too.
What is unclear to me in the scenario above is whether the banks can reinvest the money they get from the ECB on loan at 1% into buying more bonds. If they can, what a feedback loop! It seems like a great gig if you can get it! And if you can exit the building before it falls.
My economic prediction
There is one simple think you can count on like clockwork in the midst of this chaos: The situation in Europe will deteriorate another notch before the pact is finalized in all details, so the pact will certainly falls short for having been too small a step. (Europe's leaders have decided to chase the euro downhill. You can bank on that.) Most likely that shortcoming will be seen before the plan goes into effect, and the pact will all fall apart before it even becomes real. If the plan does go through, ALL of Europe will become inextricably linked with the bad bonds of the low-ranking nations for an even more spectacular crash in the end when the music for this dance of musical chairs finally plays no more.
And the jury is in. The euro is doomed!
Well, that didn't take long! I posted the above article last night when Japan's stock market had bumped up a little, allowing that there might be a slight lift in the markets, but in the morning I waken to find there was no loft for the stock markets of this world:
NEW YORK (CNNMoney) -- Investors lost their enthusiasm for Europe's latest attempt to solve its debt crisis, with European stocks slumping, Italian bond yields rising and Moody's saying the euro area is "prone to further shocks."
...European leaders agreed to a new intergovernmental treaty at the end of a two-day summit Friday. But leaders have until March to hammer out the nitty gritty details and that's making investors nervous.(CNN Money)
The euro fell, stocks slid and borrowing costs for Italy and Spain rose as investors weighed the outcome of last week's summit that split the European Union, with Britain blocking treaty change and forcing euro zone countries to negotiate a fiscal accord outside the Union. (Reuters) With more details of the plan now seen, the view around the world is that Europe, once again, punts on its economic troubles. It doesn't HAVE until March to solve its problems!
Even the stock markets were not fickle enough this time to float any hope for the latest euro-crisis deal. Well before March, additional nations will have had their credit ratings downgraded, and the crisis to be solved will be far worse than the solutions set forward in this weekend's plan.
The problem with the euro has always been, in my opinion, that the nations of Europe will always act in their own self interest at the end of the day. The states of Europe do not have the kind of bond that the more united states of America have. The euro has always been a currency built over fault lines.
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