So after another bad news week in Europe, I’m a bit gloomy about the future of the capital markets. As we try to run a business and help our clients, I’ve got this narrative running through my head about Europe. I keep running this movie back and forth in my head hoping it will help me tease out what will be in the last reel. Look, we try to make these blogs contain some bon mots of immediate utility. I’m not sure what follows has any immediate utility, but I hope someone will tell me what I’m missing here.
So, my narration runs something like this:
· All of Europe and, indeed most first world countries, are financially vastly overextended from years of profligate spending.
· 2008 ushers in an era of enormous uncertainty. Banks and markets shudder. Recessions, and economic dislocations follow.
· Things seem to stabilize and all take a deep breath.
· But sovereign debt continues to be issued at an astounding pace to keep the bread and circus gig going.
· In 2011, we have the first of many periodic Emperor’s New Clothes moments when the investor community discovers that the EU had unsustainable levels of sovereign debt.
· PIGS is coined.
· Greece, Portugal and Ireland totter. Italy and Spain look vulnerable.
· Banking sector shudders and credit contracts, again.
· Another cyclical recession looms and Keynes says “spend, dammit”. But the debt, mon Dieu!
· Repeat spend, borrow and pretend cycle.
· Bond vigilantes pounce, borrowing costs soar.
· Governments lean on “national champion” banks to soak up sovereign debt overhang and we pretend that there is no piper to pay for the flood of paper.
· Basel III seals the deal by encouraging banks to gorge on sovereigns and making sovereign exposure cost free from a capital perspective and vastly more attractive than silly old-fashioned lending.
· ECB floods the market with liquidity, everyone sighs with relief. Huh? So when does liquidity fix balance sheets? And by the way, the borrowing sector parks the cash at the ECB for a rainy day fund. Now that’s useful stimulus!
· Banks are chockablock with sovereign debt, bad commercial real estate loans and other impaired assets. Can anyone say mark to market?
· Another naked Emperor moment and bond vigilantes pounce again.
· It’s projected that Basel III will require the big banks to raise over $500 billion of fresh capital.
· The hell with Keynes, austerity is the answer, but since we loathe free market capitalism with its winners and losers, let’s mostly pretend to cut expenditures and just raise taxes! Viva fairness!
· Banks bloated on sovereign debt and on the teat of ECB liquidity tighten traditional lending. Interbank lending again dries up.
· Very little fresh private capital is raised by the banking community.
· Recession again.
· Some banks fail, governments step in. The equity is wiped out. So what private capital is going to catch this falling knife? No further chance to attract capital to the banking sector. It’s the governments, or nothing.
· Economies continue to erode; sovereign balance sheets continue to degrade, bond vigilantes pounce and pounce again. Greece…Portugal…Spain…Italy…what next?
· Talk of countries leaving Euro goes from frivolous to deadly serious. Greece is on the bubble.
· It is reported that major London printing concerns are ramping up to print drachmas.
· One cannot fix a truly broken economy without control over monetary policy – see Keynes. Germany, IMF and ECB will not play along.
· Bank runs begin and will not be stopped. Who wants drachmas? Bank runs can destroy the banking system of any country and with it, ultimately, the entire EU banking system. Takes a lot to trigger the first run on the banks. Each time panic ensues, the runs will be quicker and deeper (check the dollar recently).
· Recessions beget a credit crisis, which begets bank failures, which begets an “untidy” devolution of the common market, which begets a truly deep recession. Too much begetting going on and none of it any fun.
· European entropy. At the bottom of the cycle, what?
· Intolerable worldwide banking contraction as contagion infects U.S. and Asian banking systems.
· Worldwide deep recession, or worse.
OK, so maybe I’m being a tad over dramatic, but this is the litany of things running through my head as we try to manage a business that fundamentally requires the capital markets to function in an orderly way. Add to this European Sturm und Drang the uncertainty of the U.S. election, the famous fiscal cliff facing the U.S. at the end of the year, a possible hard landing in China, and there’s an awful lot to worry about. Maybe it’s self-inflicted (see Fox News or MSNBC, pick your poison). Maybe it’s the inevitable result of a Kondratieff Cycle. But it sure feels like we’re on the edge of a precipice and our persistent failure to address many of these problems may, I think, be the leitmotif of the time when looked at through the lens of history.
OK, I don’t want to get too philosophical here (nor too depressed). We’re just trying to make a living in a market where there seems to be a very high risk of something very bad happening. If all this were to happen, would it be the end of the world? Hardly, but it might be the end of the decade. So, for what it’s worth, can we please get some adult supervision here?
By: Rick Jones