Europe’s End Game Is Afoot
If you aren’t prepared yet for the meltdown of the Euro, I suggest you get that way. Several notable events last week indicate the end game is afoot. Early in the week, Treasury Secretary Geithner, in an appearance at CNBC’s Delivering Alpha confab, said:
Now a few things about Europe, because that’s obviously such a dominant concern now. What they’re doing is very challenging. They’re trying to figure out how to build the architecture of a more complete fiscal, financial, monetary union. They’re trying to help countries in terrible crisis implement a set of reforms that can allow them to get the fixes for problems that took them decades to build up, and they have a terrible growth problem, and they’re trying to solve all those problems at once.
And I think it’s important that you saw the Chancellor of Germany say yesterday, Angela Merkel said yesterday, they are absolutely committed and they have the financial capacity, the economic capacity to do what it takes to hold this thing together. I think they recognize that they’re going to have to do more…..Europe has a tradition of much more indulgence, support for their institutions. They are much closer to ours, to their government. In just one man’s view. There is no chance that the major countries of Europe will let their institutions be at risk in the eyes of the market. There is not a chance. (Emphasis added)
One need look no further than an April interview with Fox News where Geithner stated categorically that the US would not lose its AAA credit rating to understand why his assurances about Europe provide no comfort. By the way, “problems that took them decades to build up, and they have a terrible growth problem, and they’re trying to solve all those problems at once” sounds a lot like the economy Tim Geithner is (mis)guiding. As for Europe’s alleged indulgence of their financial institutions, while that is likely true, one wonders how Geithner can know that, know the state of Europe’s economy and still believe that continued coddling of US financial institutions can possibly produce positive results.
Thursday, in a step widely applauded by the markets, central banks around the world, including the Federal Reserve, agreed to provide dollar liquidity to European banks through the end of the year. The markets seemed to take this as assurance that the central banks are staying ahead of the curve before European banks become even more reluctant to lend to each other. In other words, the market believes this is a liquidity problem and as long as the banks have access to short term funding, all will be okay. I take a different view. This is not a liquidity problem, it is a solvency problem. European banks are reluctant to lend to each other for good reason; they know what’s on their own balance sheets and assume – rightly – that the other banks have the same junk. As for staying ahead of the curve, I think they’re only trying to stay ahead of the arc of sovereign defaults that seems inevitable at this point. Geithner may not believe a default is coming but the Fed and the ECB are preparing for the worst.
Friday, Geithner headed to Europe to deliver a lecture on the wonders of fiscal stimulus and to recommend enlarging the EFSF, Europe’s bailout fund that even at its current size hasn’t gained the necessary political approvals. The response was as chilly as a Chicago winter:
“I found it peculiar that even though the Americans have significantly worse fundamental data than the euro zone that they tell us what we should do,” Austrian finance minister Maria Fekter told reporters after the meeting.
“We are not discussing the expansion or increase of the [financial stability fund] with a non-member of the euro area,” said Jean-Claude Juncker, the prime minister of Luxembourg and chairman of the group of finance ministers, according to wire reports.
Juncker was even more direct in rejecting Geithner’s argument that European governments should seek to stimulate their economies in the near term.
“We have slightly different views from time to time with our U.S. colleagues when it comes to fiscal stimulus packages,” he told reporters. “We don’t see any room for maneuver in the euro area which could allow us to launch new fiscal stimulus packages.”
Yep, sounds like Europe is unified – against doing anything recommended by our hapless Treasury Secretary. And why should they listen to the voice of failure? We used TARP to bail out our banks and while it did wonders for the bonus pool, it hasn’t done much to improve the economy. Mortgage lending only continues because of the continued existence – and taxpayer support – of Fannie Mae and Freddie Mac. What bank lending we have seen to corporations has been primarily in support of mergers and acquisitions that will undoubtedly mean more job losses as corporations continue to search for productivity enhancements in the absence of revenue growth. That isn’t a knock on the companies; it is what corporations are forced to do when the economic policies that are formulated and implemented by Geithner’s department fail to provide an economic environment conducive to growth. As for fiscal stimulus, which in this administration means permanent spending increases and targeted, temporary tax breaks, the ARRA may have permanently damaged that as a policy tool. Our own fiscal stimulus stands as a monument to the folly of substituting government largesse for the discipline of the market.
As I write this Greek finance officials are holding emergency talks in an effort to squeeze a few more ounces of ouzo out of their Big Fat Greek Budget so they can qualify for the next tranche of Euro loans. Apparently the Eurozone finance ministers weren’t placated by the recent imposition of an additional property tax in a country where tax evasion is the national pastime. It might seem hard to evade a property tax but that depends on the price of bribing the local property appraiser which in a country already mired in a depression is likely less than paying the new tax in full. About the only course left to Greek officials is laying off more public employees and that will probably produce riots and elections before budget savings.
The reception to Geithner’s remarks in Europe combined with the actions of the world’s central banks tell me that Greek default is only a matter of time and form. The question for investors is not whether Greece will default but what the response will be. One thing Geithner is right about is that Europe provides more support for their financial institutions – if by that he means when they get in trouble, they get nationalized. I expect Europe – either collectively or individually – to follow the model Sweden followed in its early 90s banking crisis. Some banks will be nationalized outright and those seeking government capital will have to write down bad debts first. Equity and bond holders will have to take their pain before taxpayers. That is as it should be and probably the only politically feasible course in most countries. European taxpayers – and Germans in particular – are not in any mood to pamper profligate countries or their bankers.
If this is how the European crisis plays out, the effect on the global economy might not be that severe. The key is prompt action that punishes the responsible parties – countries and bank investors alike. The Euro will likely be the relief valve as the crisis unfolds and I expect the US dollar to be a primary beneficiary. It is a bit ironic but the Euro crisis may be able to accomplish something at which Tim Geithner has failed miserably – attracting capital to the US. If Geithner and the other politicians would just stop issuing so many Treasuries maybe that capital could be put to good use.
If you’d like to receive this free weekly commentary by email, click here.