2017/03/19 WEEKEND: Black Swans(?): Italy & Greece
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WEEKEND: Sunday, March 19, 2017
Black Swans(?): Italy & Greece
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This opening graphic notwithstanding, maybe in this case it is more so ‘gray swans’. After all, it’s not like Italy and to an even greater degree Greece are not on folks’ radar screens as potential global financial and economic problem areas. We have dwelt on their combined issues in recent posts, and they should likely be of more interest as the clocks tick toward certain key events. We have explored those at length in ‘European Kool-Aid’ observations from mid-February posts into the top of this month. Of course any observer of the overall global politico-economic scene is entitled to note that the sharp US partisan divide has also significantly worsened since Donald Trump’s November election victory.
And as a brief reminder for anyone who is still not attuned to what the term means, as originally reviewed our January 14th America’s Kool-Aid Crisis post, since the late part of the last century “Kool-Aid Drinking” has meant, “…extreme commitment to any idea or ideology to the exclusion of considering any other ideas might have merit.” The origin of the phrase in mass suicide of a religious cult is also explored there for anyone interested.
Yet the current ‘black swan’ (or ‘grey swan’ if you prefer) factor in this month’s vintage of European Kool-Aid is the intense focus on European elections to the exclusion of other critical influences. This is driven by the fixation on the populist parties’ fortunes, even though they are given almost no chance of success in actually winning to the degree necessary to form a government. This past week saw Dutch populist Geert Wilders’ Party for Freedom relegated to clear runner up status in Wednesday’s election. As noted previous and now reinforced by that slippage, French populist Marine LePen is also less likely than her previously slim chance to actually capture the French Presidency.
Yet all of that fixation on looming elections or more deferred votes captures most of the coverage in the political and financial press, and is reflected in the markets as well. There was an excellent column by the Financial Times’ John Authers this weekend on this outsized European market influence relative to actual potential for populist victories. His “Markets crude reading of populism distorts view on Europe” is nonetheless all about election calculus. That ignores some other critical developments…
Authorized Silver and Sterling Subscribers click ‘Read more…’ (below) to access the balance of the opening discussion. Non-subscribers click the top menu Subscription Echelons & Fees tab to review your options. Authorized Gold and Platinum Subscribers click ‘Read more…’ (below) to also access the Extended Trend Assessment as well.
NOTE: Given the likelihood the US economy will now get the structural reform that we (along with Mario Draghi and others) have been loudly complaining was not forthcoming since our dual It’s Lack of Reform, Stupid posts in January 2015, we need to adjust our view that a potential economic and equity market failure is coming. We previously referred you back to our December 8, 2015 post for our major Extended Perspective Commentary. That reviewed a broad array of factors to consider Will 2016 be 2007 Redux? While a continued regime of higher taxes and more regulation (i.e. under Clinton) might have fomented a continued weak or even weaker US economy, the tax and regulation changes proposed by a Trump administration that will likely be approved by the heavily Republican Congress now diminish the similar fears we had to what transpired in 2007-2008.
▪ …like the continued march toward problems in Europe and specifically the Euro-zone that will overtake the election calculus once they achieve critical mass. Even after the fizzle in the Netherlands, the elections and their potential outsized impact if the unthinkable happens in either France or Germany remain the headline (literally) fixation. Of course this is in part due to the (at the time) unthinkable polling missteps. If the Brexit vote had been UK REMAIN instead of LEAVE, and the US election had ended in a Clinton victory, none of this radical outcome speculation would likely be of anywhere near as much interest. Yet it is, and may be obscuring underlying problems which loom large.
Historic Antecedent
That would be what seemed to be less important developments while the US coalition was pursuing the 1st Gulf War from August 2, 1990 until February 28, 1991, and its aftermath. Certainly Iraq’s belligerent invasion and occupation of Kuwait was ‘the’ major issue. Yet beginning with the Yugoslavian confederation central government ignoring Slovenian and Croatian pleas for more autonomy within the country in 1990, the central government instead replaced representatives from Vojvodina, Kosovo and Montenegro with loyalists of the confederation’s domineering Serbian President Milošević.
While that early 1990 Serbian power grab within the federal system laid the groundwork for more active resistance, it was not until 1991 that Slovenia and Croatia declared independence, effectively ending the federal system. And there is a reason that political systems which fall into sectarian and regional disarray are referred to as ‘Balkanized’, referring to many historic instances in the mixed ethnic Balkans. Specific subsequent events in this case were so convoluted as to not allow for full review here.
Suffice to say that the initial phase of what became a distended ten year conflict began in earnest when the Croatian War of Independence began when Serbs in Croatia, who were opposed to Croatian independence, announced their secession from Croatia following Croatia's declaration of independence. So secession from a secession.
Let’s leave it at that for now, except to note major world governments were conspicuous by their absence in any attempt to resolve this budding internecine struggle. They were preoccupied by the event and aftermath of the 1st Gulf War to expel Iraq from Kuwait.
By the time they refocused on the Balkans, it was too late to intervene constructively to end what had already become an extreme ethnic and cultural conflict. For those who are not aware, this included ten years of the worst post-WWII instances of crimes against humanity, ethnic cleansing and rape. It led to establishment of a UN tribunal to punish the guilty, with many key Yugoslav government officials and others charged.
Current Election Obsession
All the fixation on the populist potentials in the upcoming European elections are the equivalent of the 1st Gulf War relative to the Yugoslav Wars being the equivalent of the other pressing issues in Europe that will soon become more critical. There are two items which we have explored at some length previous, yet about which there are telling further developments. Those are the next round of the Greek bailout (such as it is) funding, and the Italian bank rescue efforts focused especially on the plans for ailing Banca Monte dei Paschi di Sienna SpA (MPS.)
For anyone interested in much more background on each of those, we suggest two of our previous posts. The March 2nd Commentary: Trumponomics & Kool-Aid Coda post follows up on previous issues regarding the still fraught nature of further Greek bailout funding. That was the last update on prominent previous reviews of the pitfalls both on the Greek economy and negative nature of the bailout contributor demands on February 15th (Commentary: Greece (again)? European Kool-Aid) and February 22nd (Commentary: European Kool-Aid II.) As that suggests, there is quite a bit there, and it seems there is a key additional complication we explore below.
On the other front, our dissection of the Italian bank rescue efforts, and especially what in our view is a potentially very risky aspect of the MPS bailout plan, can be found in February the 26th WEEKEND: European Kool-Aid Redux post. Of course, the problem there is the degree to which the MPS bailout plan includes the first major bank ‘bail-in’ at such a large and prominent (Italy’s third largest bank) institution. Full review of those (so far unacknowledged) risks are covered extensively in that February the 26th post.
Italian ‘Euro’ Sentiment Shifting
And we will start with another aspect of that which we only ventured into tentatively in that previous analysis: the potential breakup of the euro currency union and with it the likely dissolution of the European Union. As noted in that February 26th post. “Yet while even hinting at the potential dissolution of the euro a few years ago would have been as daft as the March Hare referenced above, this is not quite as bizarre a thought as it once was.”
And the communication from Germany prior to this weekend’s G20 meeting (which we will discuss further below) highlights that it may finally be sinking in that its previously rigid lack of desire to compromise with EU compatriots on economic stimulus may be counterproductive... and that would be quite a sea change.
Yet for now, let’s build that insight from the grass roots level Italian sentiment. There was an excellent Financial Times article Italian debate on merits of ditching euro grows louder (our marked up version.) It draws some striking conclusions. The most prominent is at the end on the Italexit chances still being only 5% at present.
WWC Again!
Yet much like sentiment in other countries, the fear by the euro’s supporters is that it is gaining adherents at an alarming rate. Which is not surprising given the folks who are most disheartened by Italy’s Euro-zone membership are the same as the disgruntled elsewhere: the White Working Class or WWC. These are the same folks under-represented in the pre-Brexit LEAVE vote polling in the UK and prior to last November’s Donald Trump US election victory. And the reason for their disaffection which is driving the rising fortunes of Italy’s populist parties is much the same.
It is also nicely summed up in the FT article in the form of observations by anti-euro academic Professor Alberto Bagnai of Pescara University. While there is much else to commend the article, at its core are two factors. The first is the good professor’s rejection of the euro supporters scare mongering over potential for “…an inflationary spiral, higher interest rates and a contraction in real wages.” He doesn’t outright reject all of it; he just feels it will be less dramatic than the Cassandra’s suggest.
That fits right in with another point on the plight of the weakest links in Italy’s economic system: the lower and lower-middle class workers. As the article cites his views, “At the moment people are unemployed and their salary is zero, so the point is not what happens to their wages. The real problem is whether they can start working again.” Sounds quite a bit like what drove the UK Brexit and US election results. So it should scare the pro-euro camp quite a bit.
German Extreme Success an Issue
Yet at least part of the problem is once again Germany’s economic dominance of a currency union that intrinsically does not allow weaker cohorts from competing with a more efficient mercantilist juggernaut. Once again we must allow and respect that Germany undertook some very painful reforms even while the European and German economies were not so strong into the turn of the millennium.
The pyrrhic joke here is that Angela Merkel owes a good deal of her election victory and subsequent economic success to predecessor Gerhard Schroeder. Her 2005 election victory was due in some significant measure to the disgruntled who were then against Schroeder due to the economic weight of those structural reforms at the time. Yet it is now the case that Germany regularly runs trade surpluses (as we covered in the February 26th post they are at a post-reunification record level) while refusing to stimulate the rest of the Euro-zone economy.
And while Professor Bagnai’s view on this might sound a bit extreme, it is likely at least a sentiment shared by many others outside of Germany in both Europe and the wider world. The FT article cites his perspective as, “I’ve been saying this stuff for seven years, and little by little it’s becoming mainstream.” “Italy is wounded and the hegemonic powers – France and Germany – are buying it up piece by piece.”
And then he goes on to state his very politically incorrect conclusion, “This operation is almost colonial.” This goes toward supporting something we’ve noted previous (without necessarily agreeing): Some feel the Euro-zone is a ‘German racket’.
What Schäuble Said Then
And the Germans have a penchant for being their own worst enemy in how they handle such perceptions. As noted in that February 26th post, responding to further broad-based criticism over not using that post-reunification record trade surplus to stimulate its economy (and by extension the rest of the Euro-zone and global economy)…
(Also once again from the FT)“…German finance minister Wolfgang Schäuble (defending) Germany’s stellar finances as a source of strength in an ageing economy which will be absorbing a record number of refugees this year.” Our response at the time is the same as at present, “Once again, ‘Are you kidding?!’” As we noted back at the time, “…one would think Germany might see the wisdom in taking a more flexible position. At least in the near term; with the option to revert to more fiscal discipline later if desirable.”
What Schäuble Says Now
Yet it gets better as the Germans continue to formulate ways to not really do much for their Euro-zone cohorts. The lack of the typical strength in the anti-protectionist policy statements from the G20 this weekend is fairly glaring. While a good bit of that is based on the US position that it must finally start doing something about its trade deficit, there are quite a few other countries who want to see mercantilist players like Germany and China take steps to assist their trading partners.
While the issue of China with a singular national currency is different, the German benefit from euro membership is clear. As noted in “The ‘Friendly Poker Game’ Metaphor” just above the section cited above in that February 26th post we noted, “…does anyone doubt that if a powerhouse like Germany were out of the euro, the exchange rate of any ‘new deutschemark’ would be massively higher than what Germany enjoys within the euro? This is all while Germany refuses to entertain the idea that it might be to its advantage to allow a bit more fiscal easing…” Populist gains in Europe may be having an impact.
We liken this to the classical tactics for negotiating with a mule. For the uninformed, step one is to grab a short length of construction timber firmly in both hands. Step two is to hit the mule as hard as possible directly on the nose. Step three is now that you have the mule’s attention, begin negotiations. This seems to be how the rest of Europe, now with the assistance of the United Stated, is finally seeing some response from Germany.
Even so, this is what Herr Schäuble had to say coming out of a Berlin meeting with new US Treasury Secretary Mnuchin late last week (prior to the G20 meeting), (per the Financial Times once again), “…one of the reasons for Germany’s surplus was that the country doesn’t have its own currency and is not in charge of its monetary policy…" Well, in the service of not being specifically redundant we will channel tennis great and renowned hothead John McEnroe, “You CANNOT be serious!”
Are we supposed to all feel bad for poor little Germany that it is ‘stuck’ in that nasty euro, and because of that cannot do anything about that massive record trade surplus? In February we metaphorically referred to a lot of what was going on in Europe as tilting back toward slipping through the looking glass once again. This only reinforces our instincts on just how true that may be, along with another factor.
To that very same statement cited above Schäuble added, “…his country was doing its ‘homework’ and that there was a broader need to stimulate growth within the euro area.”
Breathtaking. After clearly expressing only three weeks earlier that were no funds available for any Euro-zone stimulus due to Germany’s need to fund services for the massive refugee population it has accepted, here’s the reversal. Or was it? There is a big difference between doing ‘homework’ and actually committing to fiscal stimulus for the German economy that might benefit trading partners within and outside the Euro-zone.
That may be a shift in the right direction. Yet it is not very encouraging that it took UK Brexit, the Trump administration’s more aggressive trade rhetoric and actual positions at the G20 and the continued rise of populism in Europe to get the mule to pay attention. And we still do not know whether it is going to follow up with any constructive steps.
MPS May Be a Key
All of this may be inconsequential in the near term if the Italian bank rescue manages to succeed. Once again, our most significant concern there is whether the (in our view) questionable Banca Monte dei Paschi di Sienna SpA (MPS) rescue plan holds up once the more radical steps are implemented. As also explored at length in that February 26th post, the contingencies now plaguing the rescue of the world’s oldest (founded 1472) and Italy’s third largest bank are nothing less than dizzying.
The various factors are so extensive that we suggest a read of that previous post rather than attempting to revisit them all here. Yet the most critical may be the whole idea that there will be a ‘bail-in’ (other limited examples also explored in that previous post), “…where a bank which is in trouble must receive some funding from a percentage of funds in depositors’ savings accounts along with losses of bond holders to qualify for state aid.” In other words, a partial (even if limited) confiscation of retail savings accounts.
While the triggers for populist revolts are hard to discern, the backlash against any such move by European financial authorities might be greater than they are expecting. And the populist tide rising in Italy is the reason that this not totally a Black Swan potential… more so Gray Swan, yet with still significant impact if the ‘bail-in’ is not well received.
Brief Greek Coda
And as a final note, there is a further complication in the Greek bailout dilemma: A United States that is a primary contributor of the International Monetary Fund finally objecting to the IMF pursuit of less than credible interventions. And guess who that now includes?
Greece, for all the reasons the non-European faction on the IMF board is already against moving forward with funding for the next tranche of Greek bailout funding without clear acknowledgement and action on Greece’s need for further debt forgiveness. That much became clear in recent discussions with the more budget conscious US administration.
There was an excellent FT article on IMF under pressure in Washington over Greek bailout (also our marked up version) on Friday. It is a very thorough review of the specific contingencies facing the IMF under the US regime change.
Most telling is that there has been a long running US Congressional aversion to funding an IMF that has strayed from its earlier principles under the influence of European rescue needs… especially in the case of the still forlorn Greece. We have already reviewed the still weak situation in Greece that is facing more problems under the new creditor demands in our March 2nd Commentary: Trumponomics & Kool-Aid Coda post. As such we refer you back to that follow up on previous review of the Greek situation noted above.
Sharp US Aversion
What is more striking now is the expressions from various US legislators questioning the cover that the IMF has provided the European political class at great expense, and with little chance of ever recovering the funds provided to Greece. The FT article notes the comments from conservative Michigan Representative Bill Huizenga who asserts…
“The IMF is supposed to be a lender of last resort, not a fig leaf of first resort for eurozone members.” He also states that the IMF activities in Greece have “…tarnished the fund’s reputation, prolonged Greece’s misery, and put off hard choices about Europe’s future that must be made regardless.”
IMF Still ‘Gaming’ the EU?
It all sounds very much like the ‘through the looking glass’ issues we have been highlighting again since late February. As we noted back at the time, that may have seemed misguided or even a bit harsh. Yet this additional US pressure is pulling the rug out from under the European pro-bailout faction on the IMF board. And in any event, as we noted in the extended bit of analysis in that February 26th post, it might be that the non-European IMF board faction is just ‘gaming’ the European Union.
As a diplomatic organization, the IMF might also be figuring that in can just play for a bit more time, and evidence. With so much sound and fury from the creditors (including a column in the February 9th FT by ISM Managing Director Klaus Regling on how the IMF analysis was ‘short-sighted’) regarding why they were not inclined to provide Greece more debt relief, it was probably not ‘politic’ for the IMF to dig in its heels in February.
As noted in that previous post, if Greece exhibits further weakness or even a lack of growth in Q1 2017, then the IMF will be within its rights to tell the EU creditors their projection of 2.7% Greek growth in 2017 is just not reasonable. It will be a case of giving the other side enough rope to hang itself, and possibly having a stronger case later for more Greek debt relief rather than fighting a theoretical battle now.
And lest anyone has forgotten, the Germans are demanding that the IMF participate as a requirement of the creditor nations providing further funding. Yet with the additional US pressure on the IMF to not go forward without further Greek debt relief the non-European IMF board faction is supporting, it is going to get very interesting. We suggest a read of the FT article and our previous post for anyone desiring more details.
▪ The Extended Trend Assessment with full Market Observations has been updated as of Monday morning. It was very important to wait in order to incorporate any of the reactions to the weekend’s G20 meeting as well as other negotiations underway now.
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