Europe is partying like the good old days. And why not? It looks like the crisis is in the rear-view mirror. But I don’t think that’s necessarily the case. The reason is simple – the cause of the problem has not been fixed. The fact is, Europe is an unworkable currency system. There are no floating exchange rates between the economies and there is no fiscal entity willing to rebalance the imbalances that result from the trade issue (which is largely the result of the lack of floating exchange rates). So what’s happened is that the periphery nations have borrowed from the core nations in order to finance their spending binges, but because they don’t create their own currency they have a real solvency risk. So now we’re in a position where the governments are forced to cut spending in the midst of a balance sheet recession and the austerity is hurting growth without bringing the debt to sustainable levels.
The only reason we’ve seen a reprieve in the crisis is because the ECB has stepped up and implemented what is essentially a sort of ponzi by allowing the private banks to borrow at cheap rates and purchase government debts thereby reaping a profit. The ECB thinks they’ve resolved the solvency crisis without allowing the periphery countries to print money. But the reality is that the math just doesn’t work for most of these countries and while this sort of lending operation can alleviate pressures it does nothing to actually fix the problem in Europe which is at the highest level of the monetary system’s construction. And when the core government’s realize that perpetual bailouts are the name of the game and the economies remain very weak we are going to see someone come to their senses – it will either be the citizens through revolt or the core governments through disgust. But I have a very hard time seeing how this problem doesn’t continue to pop up time and time again in the coming years if not dealt with at the highest levels.
So how might it play out? An excellent post from a European blog has the potential catalysts for the next leg of the crisis:
“The second Portuguese bail-out, although likely, is not certain. The Greek election is not legally due until 2013, despite the lack of democratic legitimacy of the present technocratic government. May be Hollande and Merkel will put their differences aside. Unfortunately, I doubt it…
It seems to me that all this creates an extremely fertile ground for “Crisis” to return to the front page of Europe’s newspapers as early as the second half of 2012Q2. Clearly, the timings of these events are uncertain at this stage. However, whether they are desynchronised or fall on the same week is irrelevant. All these events are likely to materialize and their interaction promises a substantial amount of political, financial and economic turbulence for the Euro-Zone. The chaos resulting from a Portuguese Bailout and from the Greek elections demands compromises, which would be difficult to achieve under calm and trusting conditions.
That being said, there is no reason why the EFSF/ESM, flexible and fully financed would not be able to intervene. Even in the likely event that it does not, the ECB has a virtually infinite fire power, which it could use to stabilise markets. The issue is not whether the resources exist to rescue countries, but whether the political willingness is present to provide it in a prompt manner.”
Once again I am reminded of the old Minsky quote – “stability creates instability”. And just when the ECB thinks they’ve stabilized everything it could very well be that they’ve destabilized everything….I could be wrong, but something just doesn’t add up here….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.