Thursday, October 6, 2011

Whither Europe?

I will post recent stock charts for the London Exchange (FTSE). Germany (DAX) and France (CAC). Stocks on each exchange took a beating in early August (US debt downgrade), and have been choppy since then. Yesterday and today they all moved up around 10% (charts from

England: up about 10%, yesterday and today

Germany: about the same

France: a similar story

And here is the S&P500 for the last week:

The S&P has also moved up about 10% in the last two days. Since most analysts assume Europe is driving the markets right now, what's up? Have the problems been taken care of?


1. Both the Bank of England (BOE) and the European Central Bank (ECB) announced quantitative easing/bond purchase programs today to inject further liquidity into the market.
2. There is clear recognition that European banks are poorly capitalized, though there is not an agreed upon plan on how to fix this. Germany's Merkel thinks sovereigns should fund this on a country by country basis. France's Sarkozy wants to use the new, almost approved funding facility, the European Financial Stability Facility (EFSF), fearing France might be downgraded, like Italy, and lose its AAA rating, if France had to provide new equity capital for its banks directly.
3. Trichet, in his final appearance as head of the ECB, said it might be possible to further lever the EFSF through market debt sales; but he said no to using the ECB.


1. Secretary Geithner told Congress in testimony today that Europe needs a significantly larger funding facility than the 440 billion Euros EFSF (2 trillion Euro figures have been discussed, which most analysts believe would be a "big enough bazooka" to handle weak bank capital and sovereign debt issues, if any form of market panic occurs). The ECB is the only entity with that kind of fire power, but Germans in particular strongly resist turning the ECB into a liquidity spraying machine (which is what our Fed did in 2008-9).
2. England and Europe's economies are slowing down. Greece, and today Portugal, announced they would miss their negotiated deficit targets for 2011.
3. There seems to be a complete absence of understanding of the dynamics of debt deflation: if the economy (Greece, Portugal,etc.) turns down, government revenues decline, and deficits widen. Cutting government spending to balance the budget takes demand/spending out of the economy; consumption and GDP fall, government revenues fall again, deficits and debt go up, debt service increases and you simply take matters from bad to worse. You just cannot get to budget balance through austerity when the economy is slowing. There has not been a single leadership comment in the Eurozone that recognizes this reality.


Europe is still a bomb waiting to go off. I do not think half measures will be enough to defuse the crisis. The ECB has the fire power to provide the necessary liquidity to the banks, as and after they recapitalize using a combination of sovereign and EFSF equity infusion, and to buy sovereign bonds, directly or indirectly, in quantities sufficient to convince the markets that no sovereign will be unable to find market funding. If Mario Draghi, incoming ECB head, were to announce that the ECB stands ready to provide whatever bank and sovereign liquidity is needed (which is what the US Fed did), the markets would quiet, and this crisis would be over.

Will it happen? It's possible, but very unlikely, at least until after the bomb has detonated, and the crisis has hit. For the ECB, for Angela Merkel, for the Bundesbank, unlimited liquidity provided by the ECB would appear to be a bridge too far. If a crisis hits, and the anti-debt monetization/austerity program is thoroughly discredited, a change may become possible.

As of now, I am not holding my breath. This crisis may still take more time to play out. When and if it blows, a new, more  generative order becomes possible. I honestly do hope this moment comes sooner rather than later, so we can finally deal with the deeply dishonest capital structures of our own banks.

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