EU Break up? European Crisis worsening – if that’s possible

September 12, 2011

Australian Equities, FOREX, Global Macro

Get out of Dodge seemed to be the cry from market players on Friday night as Europe teeters toward a Greek default and the Euro Monetary Union is at its most tenuous since Sterling left the ERM back in the early 1990’s. On Friday a confluence of things came together to catalyse into a rush for the exits.

There were rumours of imminent Greek default over the weekend and the fact that ECB Board Member (and I think Chief Economist), Juergen Stark, resigned on Friday for personal reasons its said but many believe in protest over the ECB’s recent increase in the purchase of periphery bonds, and we see just how fractious things are getting in Europe at both a regulatory and political level. I wrote about these things Saturday but it’s worth reiterating some of the points here and extrapolating on them a little.

Indeed Stark told Bloomberg back in the middle of August that these bond purchases blurred the line between monetary and fiscal policy which goes to the core of the issue between the northern Europeans and the Southern Europeans (Club Med) countries. They are not happy with the effective fiscal transfer that the ECB bond purchases amount to. If there is a default, the ECB will lose billions – who will pay the bill? Northern Europe – so yeah, it is more Germany being bailed in than Greece and Spain, and now Italy, being bailed out.

So the market is rightly taking these pieces of European news as highlighting how the risks of a market seizure and or dislocation are growing. Indeed the story that Germany is getting ready to recapitalise its banks in the event of a Greek default is doing nothing to calm the nerves of the market.

As we learnt with Lehman Bros. There is no real way to have an orderly default when the tentacles of modern finance are so long and intertwined.

So it was to the G7 that we all turned hoping for a circuit breaker or some fresh impetus to resolution but unfortunately all we got was motherhood statements and hollow words.

Also from Saturday’s update I used our new favourite toy to see what they, G7, really meant and it feels a bit weak with verbal rather than actual support. The G7 did however say that central banks stand ready to support the banking system which after last Friday night’s moves could be pretty soon.

Are we moving toward resolution? Hopefully not this way. But I’m genuinely concerned about what is happening in Europe at the moment and this is genuinely more worrisome than at any time in the past 12-18 months.

Link

The reason I say this is that since the Treaty of Rome in 1957 ,which effectively established the EEC (European Economic Community) the forerunner of the EU, there has been a movement toward greater integration amongst first the core countries of Europe and more latterly the broader vision of a grand European Union which expanded east and south. The whole time this movement was supported by political will at a heads of state level which carried a slightly cynical at times individual national populations. There were hiccups along the way of course but generally European politicians have been able to take their populations with them.

This is not necessarily the case now as Angela Merkel and her party learnt at the elections the weekend before last. Equally the Finns are still holding out on any bailout without collateral in order to ensure that it does not become a Finnish bail in. As noted above the Bloomberg story that Germany is readying itself to protect its banking system also of concern. The Bloomberg article says,

After almost two years of fighting to contain the region’s debt crisis and providing the biggest share of three European bailouts, Chancellor Angela Merkel is laying the ground for what markets say is almost a sure thing: a Greek default.

“It feels like Germany is preparing itself for a debt default,” Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc in London, said in an interview. “Fatigue is setting in. Germany could be a first mover or other countries could be preparing too.”

Officials in Merkel’s government are debating how to shore up German banks in the event that Greece fails to meet the budget-cutting terms of its aid package and is unable to get a bailout-loan payment, three coalition officials said Sept. 9. The move capped a week of escalating German threats that Greece won’t get the money unless it meets fiscal targets and investors raising bets on a default.

Ring-fencing their banks and a hardening of rescue terms risk isolating Germany and unnerving global policy makers already fretting that the region’s political tussles are roiling markets and threatening growth. Underscoring the tone of weekend talks of Group of Seven finance chiefs, U.S. Treasury Secretary Timothy F. Geithner told Bloomberg Television that European authorities must “demonstrate they have enough political will” to end the crisis.

These nationalistic tendencies are absolutely understandable but they are a retrenchment from the common goal and union envisaged by the EEC’s founders and adhered to by politicians ever since.

The EU monetary union without fiscal consolidation was always going to have trouble in a recession but this Great Recession is throwing up more hurdles and problems on a scale that appear too large for the political classes to have their populations digest.

Europe is looking into the abyss and markets are right to be concerned. Risk reduction is a must for anyone except the most risk seeking or trading orientated investor. I have to think that the Australian Dollar, Australian Dollar crosses such as AUD/JPY and even AUD/GBP will come under pressure as will equities and a flight to safety in the USD and US Treasuries will eventuate.

 greg@lighthousesecurities.com.au

www.twitter.com/gregorymckenna

This blog is for information only and does not constitute advice. Neither Greg McKenna nor Lighthouse Securities has taken your personal circumstances, objectives or financial situation into account. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.

If you do need economic, investment or financial advice we are happy to help.

Please Email the team at Lighthouse at info@lighthousesecurities.com.au or Greg directly on greg@lighthousesecurities.com.au

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  1. Markets to bounce – thoughts on Merkel, Sarkozy and Papendreou | Lighthouse Securities - September 15, 2011

    […] this week I wrote …since the Treaty of Rome in 1957 ,which effectively established the EEC (European Economic […]

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