The euro has been the strongest currency this week. At pixel time it is up about 1.2%. The Dow Jones Stoxx 600 made new 18-month highs earlier in the week before consolidating in the second half of the week. Bond markets were mostly lower, though Greece, for obvious reasons, Spain and Portugal were exceptions to the generalization.
European officials also had a good week. Aid to Greece was approved, averting a more serious crisis. The broad strokes of the ECB taking on the responsibility of supervisor for important (nationally or systemically) banks has been agreed upon.
Yet there is still much to be concerned about. Some critics took the Federal Reserve to task for generally offering relatively optimistic GDP forecasts only to revise them lower later. European officials generally do the same. In particular, Spain and France’s official forecast are well above market expectations. As is now more widely appreciated, slower growth translate into deficit overshoots, requiring additional corrective measures.
In late 2011/early 2012, Draghi came out boldly. Quickly reversing Trichet’s ill-conceived rate hikes and offering not one but two long-term repo operations. Record financing sovereign needs and large sums of bank debt that need to be rolled in 2013 do not appear to have the benefit of a repeat. It is true that at the ECB meeting earlier this month, a majority may have favored a rate cut (reportedly blocked by Draghi and the German board members), but it is not the same thing.
First, given the low level of rates, it is not clear that another 25 bp rate cut would do much. Second, the key issue is less about the price of money and more about the availability of credit and collateral. Third, inflation has fallen about 2.2% in November form 2.9% at the end of last year. The ECB cut rates in July by 25 bp. This means that in real terms the refi rate is a higher than it was at the end of last year.
More austerity will be delivered next year. This cannot be do more to strain the social fabric in Europe. The former social contract is being dismantled and what replaces it is not clear or obvious. This in turn has political ramifications. Elections are scheduled for Italy and Germany, but other governments will see support erode under the weight of austerity. The Greek government seems vulnerable even though a large aid serving is upcoming. The game of more hoops to jump through more aid has not been broken.
It used to be said that Europe was built on the two pillars of Germany and France. This seems increasingly less true, even though Hollande claims that his victory in France was “one of the elements that enabled us to arrive at this result”, referring in general to the recently struck agreements.
In fact, France has lost its AAA rating by two of the major rating agencies. Although they are often referred to as American agencies, Fitch, is jointly owned by American and French companies, and is the only one has taken away its AAA rating, though the outlook is negative.
Germany’s Merkel plays the long game and seems to run circles around Sarkozy first and now Hollande. Hollande’s attempt to find common cause with Spain and Italy has not changed the agenda very much. Joint bonds are still not likely in the foreseeable future. A single deposit insurance scheme is no where in sight. France’s interest, through various government, is to get the German purse opened further. Hollande has very little to show for it.
We have argued that the debt crisis is so profound that the comity of Europe has been replaced by the cash-nexus. The creditor-debtor relationship within countries and between them seems to be the only thing that really matters. The real difference in material interests generates different visions for the future of Europe.
The creditors want European rules that secure their interests and prevents significant debt excesses. In what may appear to be a new form of debt prison for sovereigns, the creditors insist on a trade-off between solvency and sovereignty. The less solvent the more sovereignty one has to surrender to the committee of creditors (represented by the Trokia).
The debtors, with whom France shares much in common and has aligned, have a different vision. They want the creditors to support them to a greater extent because the success the creditors was achieved to a large extent by a transfer from the debtors. There are more debtors than creditors and in a one-country one-vote arrangement, the debtors can get secure some concessions. Outside of trying to foment a greater fiscal transfer union (the domestication of Germany?), the debtors do not appear to embrace a more compelling vision of the future of Europe.
We can talk of the de-leveraging taking place in Europe. We can talk about the lack of sufficient reforms among creditors and debtors alike. However, the most important failure may be this vision thing.
This piece is cross-posted from Marc to Market with permission