Back to Europe and the Euro.
To misquote President Clinton, it’s the math, stupid. OK, that’s a bit of an exaggeration, as there are political prescriptions that could change the outcome of this tale of woe. As I write this, everyone continues to celebrate the result of the most recent Summit and the alleged breakthrough for the European Union and the Spanish and maybe Italian banks. The announcement that the European Financial Stability Facility, or the European Stability Mechanism, will actually lend directly to the banks in Spain and Italy was a bit of an overachievement for this body and, as I write this, stock markets are surging across the world on the news and spreads are coming in a smidge on the periphery. But, as usual, no details, and I’m not buying it. My bet is that the bloom will come off this rose just as it’s come off following other Summits, promising coordination of fiscal policies leading to a mutualization of the debt.
I actually find these announcements increasingly strong evidence of the intractability of the problem. Fixes, even if agreed at a ministerial level, will take years to be transformed into law in the opaque, byzantine and ponderously slow political structure of the EU Constitution. Finland and the Netherlands have already said they don’t agree to much of what was agreed, and their vote is necessary. Do we really think, absent a true fiscal union, that sovereigns are really going to pay attention to what Brussels thinks when the rubber hits the road? I promise to be a virgin this time? Anyone buying that? Germany has made it pretty clear it’s not going to bankroll deposit insurance without common fiscal policy. Mrs. Merkel said “not in my lifetime” and I believe her.
So while members of the European chattering class continue to express confidence that the European community will muddle through and forcefully assert that those who publically worry about the future of the Euro are irresponsibly telling scary stories about the Euro; I still don’t hear any of them concretely articulating a politically viable way forward.
If a political Hail Mary doesn’t show up, and show up pretty damn soon, it will, indeed, be the math, stupid, and the end of the Euro will be in sight.
A couple of weeks ago, CREFC went to Washington as a nod to the fact that the United States government seems to be the big dog in the commercial real estate finance game right now but, in large measure, the industry’s eyes have been trained on Europe. I moderated a panel on the European debt crisis and its potential knock-on impact on U.S. domestic CRE markets and, indeed, worldwide CRE markets with Matt Webster, Global Head of Real Estate Finance at HSBC, Faisal Ashraf, Head of Commercial Real Estate within the Asset Finance Group at Credit-Suisse, and Steve Franck, Senior Director at Alvarez & Marsal Europe. All three of my panel live and work in Europe and have a pretty damn good handle on the slow but accelerating train wreck which is the European sovereign debt crisis. Make that the sovereign debt crisis, plus structural economic growth crisis, plus banking sector crisis plus political crisis. Then I went to Italy on vacation. Italy is a sort of microcosm of Europe. Let me tell you, being a member of the European community is a distant, distant abstraction. Don’t get me wrong, the Euro is popular, but the stuff that makes the Euro possible? Not so much.
Nothing said or heard over the past month (or days) has made me feel better about Europe and, indeed, the dialogue reinforces the notion that not only is a secular meltdown threatening in Europe, but it’s inevitable.
So in the first days of Q3, here’s why:
· The moderates won in Greece. So Grexit will be a tad slower, but I fear August and civil unrest that will close out options very fast.
· At the end of the day, this most recent Summit didn’t amount to much, really (although my 401(k) does really appreciate the temporary injection of confidence into the U.S. stock market). It’s again agreeing to agree but the famed Bazooka still looks more like a peashooter. Take a look at the great article in the FT on July 2 by Wolfgang Monchau. He gets it right when he says: (i) don’t count your chickens on collective bank supervision yet, the loss of sovereignty involved in such an agreement may be a bridge too far for France and many other European countries; (ii) direct bank recapitalization is not as easy as the Ministers saying "Voila" (this requires Treaty changes and already EU members are expressing doubts about the path); and (iii) the available money is simply too small by a substantial amount.
· Forget the banking crisis entirely and I’ll give you two data points that tell the whole story about Spain: (i) 25% unemployment rate and (ii) no control over monetary policy. That is the United States during the Great Depression before we went off the gold standard. And so how did that work out for everyone? There are also a lot of unemployed footloose young people who might well go into the street and burn stuff in August when it gets hot and ugly. Seriously, burning your stuff does not make you richer or better off.
· If Spain goes, Italy seems cooked. Italy’s debt is not sustainable and if it cannot borrow, and with its economy contracting, it’s running out of runway. Italian politics seem to be moving that way with Signore Berlusconi turning virulently euroskeptical from the confines of Palazzo Bunga Bunga.
· Last week, Italian long-term borrowing costs again approached 7% and Italy had to pay 3% to sell 6 month debt. Both the Spanish and Italian governments have essentially admitted borrowing costs at those levels are not sustainable. This week both came down a little. It’s not going to last.
· I listen closely to European establishment voices. Everyone expresses optimism. However, each presentation, to my ears, seems like a litany of facts which powerfully argue for a breakup, stitched, somewhat inelegantly, to an optimistic conclusion that it will not: I find it deeply gloomy.
· Does anyone seriously think that Europe is prepared to let Germany call the shots on fiscal policy? And what happens when sovereigns simply say no after agreeing to say yes? France, at least, is emotionally unprepared for poodle-hood. If history teaches us anything, true fiscal integration of disparate populations only comes out of the barrel of a gun. In some significant measure, the United States fought a civil war over national sovereignty. Putting aside the intractable problem of the multiplicity of languages in Europe and the almost complete absence of labor mobility, there is no way forward to fiscal union within the existing polity. Absent a fiscal union, there is no monetary union, absent a monetary union, there is no Euro bonds, there is no mutualization of the debt, there is no way out.
All the liquidity in the world, all the restructuring of the Greek austerity plan, all the accounting gimmicks to try to treat the Spanish bailout as neither a bailout nor Spanish debt, all the efforts to use €400 million of bailout funds to shore up a €15 billion pile of sovereign debt cannot fix a system which is irrevocably broken.
Just like the United States in the Great Depression, the way out for mortally wounded national economies is to debase the currency. That’s it. Nothing else will work.
So I continue to believe that the only way out for Europe is to restore national currencies, at least for the majority of the fiscally weak players. There’s probably an orderly way to achieve that outcome and get on with the business of creating jobs and creating growth, but I have little hope for that. One of these days, the Emperor is going to be found to be buck naked and a disorderly disaggregation of the EU currency community will occur. The riptide knock-on consequences of those events on world markets are untold. But we better start thinking deeply about what to do when it happens. Time to break the glass and do serious planning.
By: Rick Jones