14th November 2011: Brokeback Europe Introduces “Hair of the Dog Political Policy”

The Globalization of The Brokeback Economy

Quote of the Day:

Ennis Del Mar: If you can’t fix it, Jack, you gotta stand it.
Jack Twist: For how long?
Ennis Del Mar: For as long as we can ride it. There ain’t no reins on this one.

Script from Brokeback Mountain

Macro Overview

The European Dream

• Like all pivotal societal achievements, the European Union started as nothing more than an idea, an idea which became a dream, a dream which became a reality. But dreaming is easy, implementing dreams is harder – dreams in design often become nightmares in development.
• Of course, we all know, immigrants in America had a dream a couple of centuries ago and the ideals of this dream were effectively drafted into print in the American Constitution. A document so powerful that, over two hundred years later, Americans today still abide by its principles religiously.
• But Europe is not a country. It is a continent, a continent with many diverse national identities. So a federal constitution is out of the question, instead, the European ideals were drafted in a series of broad confederal treaties. The Eurozone was going to operate under a monetary union, that part was clear, but if these treaties were to be effective they needed to be strict, clear and extremely well-disciplined, especially with respect to:

• •   Fiscal discipline
  •   Monetary discipline

• Anything other than this would open up festering wounds of national and cultural divisions that the EU was effectively trying to incrementally overwhelm with a new sense of continental identity in Europe. This was the New European Dream.
• The two items; fiscal and monetary union, were covered quite clearly in the Maastricht Treaty, Stability and Growth Pact and the EU Treaty. Paper promises are all well and good, but (as we have learnt from the balance of fiat currencies versus hard currencies of late – look at Gold prices) they have little intrinsic value – they must be backed up with a demonstrable record of discipline and credibility.

Discipline and Credibility of Fiscal Union in the European Constitution

• Well, I’m not going to repeat myself, but, to cut a long story short: there is little fiscal discipline within the EU and therefore little credibility. This is not an opportunity to point nationalistic fingers; this is a fault within the constitutional framework itself. The EU was a collective creation, this gaping policy hole is a collective, European mistake.
• Firstly, it is practically impossible for any supra-national agent (or any other entity) to objectively enforce any form of fiscal discipline of any weight on any government or regional fiscal body. Instead, the framework is a wishy-washy set of “guidelines” which, highly partisan, domestically-motivated political interests are expected to follow in good faith. It took a global recession to uncover the hidden fractures of this faith-based cohesion but, let’s be clear: right from the start, there were serious design flaws in the constitutional framework.
• A Debt-to-GDP ratio of more than 60% (the supposed limit of the Maastricht Treaty “convergence criteria”) does not suddenly appear overnight. It is important to understand that excessive debts and bloated deficits had been running in many European states for many years before the Sub Prime Crisis was just a twinkle in a Goldman Sachs Structured Products Salesman’s eye.
• I went through these fundamental problems in more detail in a comment I made: European Confederation – TIPSTER’s “European Consolidation Treaty”. Here I exposed the flaws of the current agreement and suggested ways in which this could be improved greatly to manage fiscal accountability. This is what I would call: political risk management. I’m a risk manager and the first rule of risk management is: make sure one is always aware of the risks one is taking – the rest is just a matter of calibration. Burying one’s head in the sand and praying is not an effective risk-management strategy – not with an investment mandate, not with a political mandate.
• In conclusion, the secret is out: EU is broken, it was broken from the start and it does not need a patch, it needs a complete fix from first principles. Notice, I’m not at all implying that the Europeans cannot implement their dream. I’m implying that, without a serious overhaul of the very fabric upon which the Eurozone is built upon, fiscal fractures within the EU will not go away, they will resurface again and again.

Discipline and Credibility of Monetary Union in the European Constitution

• So we understand how woefully insufficient the framework of fiscal union was – basically a disaster waiting to happen. But now we turn to the other part: monetary union and the discipline and credibility associated with it. Pretty simple, huh? A common currency, a single central bank with an extremely tight mandate: PRICE STABILITY ABOVE ALL ELSE. That should make this an open-and-shut-case, right?
• Well, try telling that to a German. The idea was, while the fiscal union part could be mercifully viewed as “work in progress”, the monetary union was supposed to be dependable, stoic, strict, unwavering and… well, yes, Germanic. There is a lot of talk about how “German” the ECB is and indeed there is ongoing debate about whether it should become more German in the future.
• A simple mandate of price stability (around 2%, if you will, no more thanks) would ensure that the ECB does not get entangled in matters of fiscal politicization and NO DIRECT MONEY PRINTING AND CERTAINLY NO MONETIZATION OF DEBT! Inflation is a prevalent predator in Europe, we know all too well where that has led Europe in the past. In fact, here is a little excerpt from the EU Treaty, Title VII, article 101 (yes, I read it, sad but true):

Article 101

1. Overdraft facilities or any other type of credit facility with the ECB or with the central banks of the Member States (herein after referred to as ‘national central banks’) in favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.

• Remember this is effectively part of a pretty clear transcript of what is the European equivalent of The Constitution. I’m not debating what the ECB should do. I’m simply expressing the consequences with respect to the credibility of the entire Eurozone dream if they do not adhere to Article 101. In fact the Germans, who have built their economy on the forthrightness of European Monetary Policy, have, quite simply, vetoed any notion of ECB peripheral debt monetization. Just in case you were in any doubt about the German position, the German Central Banker and head of the Deutsche Bundesbank recently said:

appropriation of monetary policy for fiscal policy purposes must come to an end.

• Pretty blunt, pretty clear, pretty honest, pretty well… German. ECB executive board member, Jurgen Stark remarked that the ECB can never become lender of last resort. So German monetarists are in close agreement about their stance. But they are not politicians, I think rift between the Euro-friendly German politicians and monetarists will intensify in the near future – as both seek to assert their case to the German public.
• It’s quite clear that, despite the “progress” made last week in Greece and Italy, Europe’s problems are only just beginning. It’s all very well putting an economist in charge of the country but solves neither the societal nor political problems at the root.

Short Term and Long Term Remedies: Print First, Ask Questions Later…

• Believe it or not there are still many solutions available toEurope- including temporary break-up/sabbaticals, revision of the treaties (as discussed above) and even collateralizing the EFSF with something less flakey than a mangy dingo with fungal skin condition. But I have now taken to calling the potential fixes “remedies” and not “solutions” because, honestly, if there was political will to see the solutions through, they should have happened by now. Preventatives and cures are being ignored, but best we can hope for is hair of the dog and some pain-killers.
• Of course, there is the possibility of just ignoring the German monetarists and printing money (as everyone outside Europe seems to want them to do). Careful what you wish for, that’s what I say. Not only will a significantly weaker Euro obliterate any green shoots of manufacturing recovery in America and Asia (can you imagine if the highly competitive German exporters effectively get a 10-20% subsidy on their exports with respect to their $-based competitors in China and the US), but the sheer volume of fiat trash in the global financial system will have second-round effects on global inflation pressures and, dare I say it, geo-political tension. By the way, for “growth recession” see political upheaval, social unrest and extreme investment risk.
• But perhaps Niall Ferguson, is right and European politicians will continue to talk tough on their discipline toward EU treaties but will, in actual fact, undermine it and the credibility of their constitution and the ECB, engaging in Quantitative Easing “by stealth” (is there any other form?). Harvard’s other prominent professor, Ken Rogoff, too thinks that the ECB will buckle under pressure and crank up the QE printing press. As ever with European politicians, it is more important to watch what they do, not what they say.
• Deception is a rather skeptical view of European politics but we should be used to this by now, there are any number of facilities “the Feds” have to disguise what they are actually doing – stealing wealth from prudent savers and lower to middle class families to prop up the rich and imprudent. America uses spaghetti-like complexity of “shell-games” to hide the true extent of their currency debasement. But, as usual, the magnitude of the fall-out to the questions of credibility and discipline, political forthrightness, moral hazard and equitability will be kicked down the road… and the price for that deception and procrastination will be that the risks associated with the answers to those questions will become evermore elevated.
• We’ve spoken before about hair of the dog monetary policy. Welcome to hair of the dog political policy. But if large populations of Europeans are at odds with each other over the mechanics of a resolution, when this severe bout of Euro-sclerosis eventually comes to an end, it’s hard to see how it will end gracefully.

Market Overview

The Future (Or Lack Thereof) Of the Eurozone

• The EU woke up this week with a slight hangover. After all, very little has changed fundamentally. The challenges described above all persist – if anything with greater looming presence than before. I’ll take you through a couple of really clever charts that ZeroHedge put up in their synopsis of the EU tragedy: Decision Time for Europe: The Definitive Presentation On The Future (Or Lack Thereof) Of The Eurozone. I’ll put a little commentary in Chart of the Day section today.
• I couldn’t help noticing that 5 year French-German CDS spreads hit an all time high… but that’s another chart for another story, which will be told another time…

Big Names Close The End of Earnings Season

• Some big names in the US issuing their numbers tomorrow – emphasis on consumer discretionary:

• Dell
• Wal-Mart
• Staples
• Home-Depot
• Microsoft

Big Names Kick-off The Macro Season

• Some critical, big submitting their preliminary GDP Growth Figures:

• Consolidated Eurozone GDP: France, Germany, Greece, Holland

Chart of the Day

Euro 7% Pulpit (Source: Zerohedge)

A great chart of how each of the peripherals have capitulated the moment they breached the 6-7% range.

As I write this Spanish 10 year yields have just risen above the critical 6% mark.

Euro Debt Distribution Profile (Source: ZeroHedge)

Notice that November, December and January is actually the calm before the storm in terms of debt and refi obligations in the Eurozone!

Long Term Euro Sovereign Spreads (Source: ZeroHedge)

Show how relative borrowing costs of Eurozone are now actually greater than they were before the Euro – despite all the monetization taking place.

Events

Macro Events:

Update:

• Japanese GDP in line and actually pretty decent (+1.5% QoQ is good for Japan)
• Russian GDP – slightly disappointing but basically in line
• Brazilian GDP – slightly disappointing but basically in line
• Portuguese GDP – slightly disappointing due to Q2 revision but basically in line

Alerts:

• Consolidated Eurozone GDP
• UK Inflation (CPI)

•   > France GDP
•   > Germany GDP
•   > Greece GDP
•   > Holland GDP

 

Corporate Events:

Results:

• Bouygues [EN FP], British Land [BLND LN], Dell [DELL], GoldCorp [G CN], Home Depot [HD], Microsoft [MSFT], Mitsubishi UFJ [8306 JT], Staples [SPLS], Wal-Mart [WMT],

Dividends:

• Starbucks [SBUX],

Reading, Links:

Germanic Monetary Policy:

• Germanic Monetary Policy #1
• Germanic Monetary Policy #2
• Germanic Monetary Policy #3