The Bewilderness

Waiting upon a butterfly, whose wings have already flapped

If you go out in the markets today, you are sure to meet a bear. And all the bears will be pondering the same philosophical question: if a bank fails, can it do so silently, or will the whole forest burst into flames?

All of the articles one reads offer the same handwringing condemnation of pusillanimous politicians and inevitable calamity. Yet, historians examining the same papers will come to radically different conclusions. What realistic choices do Eurozone participants have? They do not have control of the money supply. This belongs to the European Central Bank. They are unable to exercise full sovereignty. That was given away. All policy decisions require the unwieldy and unanimous commitment of all Eurozone members. Leadership and action are not words that could be associated, even remotely, with this set-up.

A radical response would be political suicide, entailing a dilution of fiscal responsibility and a further surrender of democratic sovereignty. The latter has been argued for by the bureaucrats and central bankers, pushing for even less accountability over budget and taxes from elected representatives. Such a move would usher in an illiberal confederation. None of the political classes have the courage to break with this structure, yet.

Since muddling through by consensus is the realistic policy response, criticism should flow from the ground chosen. Even on this narrower platform, the Eurozone members have proved to be a hapless bunch. Their play book is predictable and whatever firebreaks are built, only postpone the contagion. 

This does raise the important question: was the run on the € inevitable from a certain date? Would we have entered contagion without the pavane of promise from politicians, who feel dutybound to undertake the dance of the dead with their zombie banks? Could a proper accounting of sovereign debt after 2008 have averted this endgame? We will never know. 

It is the teasing out of structure versus action that raises an historian's game. Talk of economic determinism and a dysfunctional currency union ignores the ability of states to place politics over economics, even at great cost. Such arguments also dilute the responsibility of a political elite for the consequences of their mistakes (which we are all paying).

Now we are just awaiting triggers and that depends upon a butterfly, whose wings have already flapped.

Europe squanders its breathing space

The transfer union is off the table; Eurobonds will not be tolerated; it is doubtful that the EFSF can be enlarged.

What remains? A disorderly rout once the ECB's firepowers is exhausted. Or a European coup d'etat overturning parliamentary sovereignty and constitutions: political will overriding legal niceties designed to protect democracy. 

Soon, the EU periphery may face costly chaos or a bureaucratic technocracy with a representative figleaf.

And the band played the banks out...

History will record that political incompetence compounded economic disaster. The compunding is quite literal. By adding debt to debt, they increased the amount of interest to be paid back on outstanding principal. Banks losses were transferred to central banks. As countries toppled, these were transferred to the state. Soon, confidence in the state itself eroded: commercial risk became economic farce and then political disaster.

At what stage are we? Political action is now proving to be an accelerant, adding to the flames. The dishonesty of leaders, unwilling to allow banks to fail, has brought their whole project near the brink. We are not there yet, but soon, soon. Italy and Spain are the next tests.

Today, markets are dropping as the price of risk is reassessed. The more mendacious and deceitful the political class, the worse the economic outcome. (And that also brings us to the taxes heaped on the backs of the poor in the name of climate change: different trend, same moral sump). Evans-Pritchard is scared that a recession will commence next year. Backwards looking economic indicators suggest that it is already here and that the austerity of tightened state budgets will contract demand. Raising interest rate as the European Central Bank did recently will be seen as an act of malevolent madness. Further inaction and political chaos leaves any resolution of the contagion as close to zero. We can only watch the endgame play out, with national authorities acting unilaterally once a pain threshold is reached. The opportunity of collective action for the euro is now at an end.

Bailout sequelitis

Is the Eurozone nearer a resolution to the crisis of debt, default and devaluation. These are the three stages that all countries could potentially go through. The future of the € is mired in the political future of the European Union. The paymasters and the supplicants will need to sort out if they want a transfer union (a political union de facto) of if they wish to kill the Project off. Afterall, most of the political class in Europe love the travelling to an undefined destination but never wished to actually arrive.

Germany, naturally, balks at consigning its financiers (the German taxpayer) to a future of misery, bailing out other Member States. Yet we hear opinion after opinion from analysts, the ECB and endebted beggars that decisive action is required. Otherwise, contagion ensues. When examined closely, the actions demanded involve more money and institutional reform that will guarantee that flow of money. Will such actions prevent contagion or merely stave off the inevitable? The latter. All the actions desired appear to be bailout sequelitis. 

SO when Deutsche Bank argues that € hitting the wall = a 30% drop at least, we should prepare for the inevitable. Since the inevitable is here and earlier than expected.

Will contagion prove a self-fulfilling prophecy?

The Eurozone finance ministers are talking tonight on two issues: providing Greek with further finance and dispelling a possible 'contagion effect' across the markets if this fails. The argument is compressed into the next two days as poltical and financial effects combine. The Papandreou government in Greece is facing a vote of confidence which, if positive, will ensure parliamentary support for the austerity measures. To sweeten the pill and assuage the street, Papandreou is offering to curb some of the perks enjoyed by the political classes (ministerial immunity, political financing, gouging the taxpayer). In tandem, the Eurozone will make a bridging loan, to keep Papandreou's government afloat, although the IMF portion can only be disbursed if they are confident Greek finance is on a medium term foundation.

If these two hurdles are overcome, then the play will enter a new scene: to climax on July 11th. There, the ministerial jugglers will attempt a voluntary restructuring of debt (including private sector participants) without setting off a default event. Since the whole tiresome process hinges on Greek co-operation, I hope that the Parliament puts PASOK out of its misery and faces economic truths: your austerity program will not resolve your debt trap.

If there is a 'contagion effect', this may be viewed as a self-fulfilling prophecy. Market participants expect the dominos to fall, and act accordingly. Another blinding performance from Juncker and the Debt Junkies

Lehmans 2: European Cliffs

Draghi at the European Central Bank wishes to avoid the Greek default, that all now regard as inevitable. The cost of a Greek default is bearable on its own terms, if contagion effects are not taken into account. The ECB is scared that the destabilisation of a default event will suck liquidity out of the banking systems, leaving some dried up hag masquerading as a financial system.

The mess continues to drag on. Conditions in the periphery continue to deteriorate as the ECB compounds their misery with interest rate rises. No comment on the hairshirt devotion to an inflation target whilst national economies implode and the central bank volunteers for insolvency. Now the choice is deferred until July as two camps dance between a structured default and non-default. By the time they compromise, events may have rolled them over.

One day Greece will go 'splat' on the Euro windshield

Geoffrey Smith in the Wall Street Journal documents the build-up of the capital reserves with European bansk since the fall of Lehman Brothers in 2008. His article notes that a Greek default is unlikely to send any European bank into freefall. From a restructuring perspective, a Greek default will not cause significant problems for reserving in the European banking system.

The European Central Bank and its political bankers have consistently defended the system of bail-outs designed to prevent any default or debt restructuring in the PIGS. Their fear is defined by the experiences of 2008. They perceive the financial system to be too fragile for any further crisis of confidence, though this is an essential bug of market psychology. The sovereigns of the Eurozone are bucking the market. Josef Ackermann of Deutsche Bank exposes this fragility:

“The losses in many areas would be too high and could provoke a contagion impact,” Ackermann said in an interview... 

Greece cannot pay back its debts. If this truth is recognised, then banks may systematically fail, due to the risk of 'contagion', requiring further sovereign bail-outs and increased debt. Therefore, Greece must crucify itself to avoid this risk. As a story, it sucks. If 'contagion' from a confidence sapping event is that powerful, then the system will fail, as night follows day. If it is not inevitable, then pretending that a problem does not exist and extending its duration, may perversely bring about the outcome that the strategy was meant to avoid. The problem grows over time. 

Europe is not yet allowing its bugs to go splat! That day will come!

Tunisia pauses for breath, Mubarak clings to Egypt

The death toll of the Tunisian uprising was higher than reported, according to the United Nations mission in Tunis. Whilst the provisional government states about 350 killed and injured, the UN figure is double (including prisoners killed in state jails). Whilst a symbolic government of renewal has promised free elections in six months and has purged itself of RCD involvement at the behest of the protestors, the power of the police state remains in place.

The securocracy of Ben Ali has not been dismantled: low-level violence continues in many towns. The sources of trouble may be looters, or the disaffected police out of control. Whilst the military holds a protective ring, Tunisia will only be safe when the local thugocracy, abetted  by the former ruling party, is beaten, bribed and retired. A judicious mix of monetary incentive and violent examples usually does the trick for the remnants of a police state.

On Monday, hundreds of people ransacked and looted public buildings in violence which union officials said was instigated by members of the former RCD ruling party of ousted strongman Zine El Abidine Ben Ali. Mohamed Drbali, a member of a “regional comnmittee for the defence of the revolution” and trade unionist Sadok Mahmoudi, said police were nowhere to be seen during Tuesday’s protest while army tanks were posted near official buildings.

If a low-level backlash does not extend beyond isolated incidents like Kasserine above, then the self-styled revolution will develop. However, a taste for the "street" and a lack of response from the interim elite on grievances may herald a further wave of radicalisation. Mubarak's obstinacy further east may feed this desire to reject musical chairs at the top and riot for a new state of affairs, a world turned upside down and rendered anew: A police state more terrifying than the old.