Bulls and bears alike wonder when the next market bubble will emerge and pop. In recent years, major stock market downturns have come from bursting bubbles. Recessions, threats of war, terrorist attacks and other disturbances have caused market ripples. But the big gut wrenchers--the nosedives that wrecked your retirement--have come from the popping of asset bubbles. The gross over-valuation of tech stocks in 2000, the ridiculous real estate lending of 2005-07, those are the events that clobbered equities. What does the future portend?
Today, the mess in the Middle East grips our attention. Medieval atrocities by the Islamic State, a mosh pit with weapons in Gaza, mind-numbing slaughter in Syria and sectarian strife in Iraq appall and fascinate. But none of them will significantly drive down stock valuations. They just don't have the economic impact. The Ebola epidemic is now raging out of control in West Africa. But America's economic exposure to West Africa is miniscule. And the disease isn't likely to present a major threat to the industrialized world.
Is there an impending market bubble that could burst and dynamite the world's financial system? The answer is maybe, in Europe. The European economy is slowing. Growth is seen only on alternating Sundays. The EU stays afloat on a cushion of sovereign and bank debt--a lot of it. With Europe's slowing economy, it will be tough to pay down this debt and expedient to refinance by issuing even greater amounts of debt. Risks to larger members like Italy and France are rising. The EU is a financial and currency union without a unitary government. Thus, it is tailor made to borrow in bulk without governmental controls to interfere. We in America know from the 2007-08 mortgage crisis what happens when you bulk up on debt that can't be easily repaid. The vast amount of European debt presents potential systemic risk, just like the vast amount of American mortgage debt outstanding in 2007.
Exacerbating Europe's problems is the war between Ukraine and Russia. As Russia's direct involvement in combat is becoming increasingly clear, the war is likely to have ever greater impact on Europe. Sanctions by the West will probably be heightened, and Russia's retaliation will likely hit Europe harder than America. Europe's financial system could begin to totter as the EU is pushed into recession and capital flees the Old World. (Indeed, part of the buoyancy of U.S. stocks can be attributed to the arrival of capital now fleeing Europe.) A run on the Euro could be the straw that breaks the bubble's back.
The European Central Bank, as always, does a fan dance about how accommodative it will be. While it's become much more interventionist in the past couple of years, it remains constrained by its anti-inflation charter and the stolid, ever-frowning Germans. Maybe the ECB will save the day. Or maybe not.
Europe's economy, as a whole, is larger than America's. A tummy ache there could affect the rest of the world. if you're worried about where the next bursting asset bubble could come from, keep your eye on Europe.
Showing posts with label Italy. Show all posts
Showing posts with label Italy. Show all posts
Saturday, August 30, 2014
Tuesday, February 26, 2013
Politics Keep the Economic Crises Going
We are vividly reminded today that the economic crises bedeviling the world are political in nature. The election deadlock in Italy, with leftists likely to control one house of the Italian Parliament, and rightists and leftists apparently in a draw in the other house, is a vote against austerity and centralization of the EU's governance. Although the political nuances differ from Greece's initial anti-austerity vote last year, the Italian election, like Greece's, signals that numerous voters have yet to learn the words of the pan-European version Kumbaya. Another election in Italy may well be needed, or the country will be unable to stay on track to meet the EU's expectations.
In America, sequestration now seems almost a certainty. The arbitrary cuts imposed by sequestration were supposed to be unpalatable to either party, and would therefore incentivize both parties to cut a real deal. Fat chance of that in these days of political dysfunction. Truth is there won't be a real deal. That's why the Dems and Republicans kicked the can down the road when the fiscal cliff loomed and the debt ceiling threatened to descend like the Sword of Damocles. The government right now can do little more than bring its foot back for another kick. The one silver lining in the clouds is that the economy seems to be recovering to some degree. The better the economy does, the lower the deficit will be. We should hope and work for economic growth, because that is the only politically feasible solution to the budget deficit. The federal government needs to repair and upgrade infrastructure, adopt a pro-growth immigration policy, work hard to cut the growth of health care costs (perhaps the biggest expense in future federal budgets), and work toward supporting and expanding educational opportunities while reducing the cost of education. (Internet-based instruction may be a great way to educate at much lower expense, and should be encouraged and supported.) The current squabbling in Washington over budget cuts and tax increases is a game of musical chairs that no one can win. We have to take a different approach.
In America, sequestration now seems almost a certainty. The arbitrary cuts imposed by sequestration were supposed to be unpalatable to either party, and would therefore incentivize both parties to cut a real deal. Fat chance of that in these days of political dysfunction. Truth is there won't be a real deal. That's why the Dems and Republicans kicked the can down the road when the fiscal cliff loomed and the debt ceiling threatened to descend like the Sword of Damocles. The government right now can do little more than bring its foot back for another kick. The one silver lining in the clouds is that the economy seems to be recovering to some degree. The better the economy does, the lower the deficit will be. We should hope and work for economic growth, because that is the only politically feasible solution to the budget deficit. The federal government needs to repair and upgrade infrastructure, adopt a pro-growth immigration policy, work hard to cut the growth of health care costs (perhaps the biggest expense in future federal budgets), and work toward supporting and expanding educational opportunities while reducing the cost of education. (Internet-based instruction may be a great way to educate at much lower expense, and should be encouraged and supported.) The current squabbling in Washington over budget cuts and tax increases is a game of musical chairs that no one can win. We have to take a different approach.
Saturday, September 8, 2012
What's Behind the ECB's Unlimited Bond Buying Program?
It's kind of hard not to smell a rat in Mario Draghi's proposal for the European Central Bank to make "unlimited" purchases of sovereign bonds of troubled EU member nations. According to the proposal, the ECB will buy an EU member's bonds if the member requests assistance and submits to fiscal oversight by the EU. The latter, however, has been the problem with Greece. It doesn't want to submit to the EU's fiscal oversight. And when it did agree to terms demanded by the EU, it failed to comply with them. In return, Greece has been given break after break after break. It effectively defaulted months ago, but the EU papered the default over with a loan workout that forced creditors to sustain losses (which they may have recouped via credit default swaps, so the losses actually fell on the writers of the CDSs or their unfortunate direct, secondary or tertiary counterparties who held the ultimate risk of loss). Stated otherwise, the EU has supported Greece without Greece having to do the full austerity dance it was supposed to do.
The two countries that Draghi's proposal was aimed to help, Spain and Italy, insist that they will not submit to fiscal oversight by the EU (for domestic political reasons). If they really mean it, that means they won't get bond buying assistance from the ECB. Possibly, their hardline insistence that they won't ask for help (and thereby submit to central oversight) is a bluff, meant to get Draghi to drop the fiscal oversight condition. They could simply let market forces push their bond yields higher. That would shove the EU closer to the brink. Draghi might then drop the fiscal oversight condition when the markets threaten to go haywire. Of course, the bluff isn't really aimed at Draghi, who seems amenable enough to U.S. Fed-style money printing, but at the Germans and other northern Europeans of the frugal persuasion. The Greeks have proven themselves adept at brinksmanship with Germany and its economic allies. Spain and Italy have little incentive to be any more austere.
Germany may be wealthy enough to bail out Greece. But it can't bail out both Spain and Italy, which have much larger economies. So a move by Draghi to drop the fiscal oversight condition could lead to German withdrawal from the EU. That could be catastrophic. But writing blank checks to Greece, Spain and Italy could be catastrophic for Germany, and one can't expect Germany to knowingly sign up for a catastrophe. Mario Draghi may be playing a most dangerous game, and he'd better play it well or the abyss will beckon.
The two countries that Draghi's proposal was aimed to help, Spain and Italy, insist that they will not submit to fiscal oversight by the EU (for domestic political reasons). If they really mean it, that means they won't get bond buying assistance from the ECB. Possibly, their hardline insistence that they won't ask for help (and thereby submit to central oversight) is a bluff, meant to get Draghi to drop the fiscal oversight condition. They could simply let market forces push their bond yields higher. That would shove the EU closer to the brink. Draghi might then drop the fiscal oversight condition when the markets threaten to go haywire. Of course, the bluff isn't really aimed at Draghi, who seems amenable enough to U.S. Fed-style money printing, but at the Germans and other northern Europeans of the frugal persuasion. The Greeks have proven themselves adept at brinksmanship with Germany and its economic allies. Spain and Italy have little incentive to be any more austere.
Germany may be wealthy enough to bail out Greece. But it can't bail out both Spain and Italy, which have much larger economies. So a move by Draghi to drop the fiscal oversight condition could lead to German withdrawal from the EU. That could be catastrophic. But writing blank checks to Greece, Spain and Italy could be catastrophic for Germany, and one can't expect Germany to knowingly sign up for a catastrophe. Mario Draghi may be playing a most dangerous game, and he'd better play it well or the abyss will beckon.
Wednesday, November 23, 2011
The EU Sovereign Debt Crisis: Skipping a Few Dominos
A hooded figure of Death appeared at the Euro's door today, scythe in hand, beckoning insistently. Germany held an auction of 6 billion Euros worth of 10-year bonds (called "bunds") and sold only 60% of it. The German central bank, the Bundesbank, bought the rest. But that's like your right hand buying from your left hand. The German auction was catastrophically bad. And, who knows, the Federal Reserve may have contributed to the shortfall, by subtly putting pressure on U.S. banks to trim their Euro-denominated exposure (see http://blogger.uncleleosden.com/2011/11/sovereign-debt-crisis-skipping-few.html).
By contrast, the U.S. Treasury Department today sold $29 billion of 7-year Treasury notes, receiving three times as much in bids as it was offering (or close to $100 billion in bids). Even though the U.S. may be approaching another credit rating downgrade, the greenback remains a sturdy oak in a forest of blighted trees.
That the German bund auction went so badly means the European sovereign debt crisis is fastfowarding more rapidly than anyone anticipated. Next to topple were supposed to be Italy, Spain, France, Belgium, and Austria. Then, the Netherlands, Finland and Luxembourg would be at risk. But Germany was seen as the last bastion of stability, the wealthy uncle who could save the family if disaster struck. Indeed, the latest concept being proposed for salvation, the Eurobond that was to be backed on the entire EU, would be feasible only if Germany's creditworthiness was beyond question. That's no longer true. If Germany can sell only 60% of a bund auction, how could the EU as a whole sell a Eurobond auction?
The sovereign debt crisis has skipped the intermediate dominos and smashed directly into Germany. The German government continues its opposition to Eurobonds. At this point, that may be irrelevant because the viability of the Eurobond has been called into question. One naturally asks what else might be on the table. That's the really scary part. There is no Plan B. Germany has always been the fallback, the backup, and the backup to the backup. After Germany there's no one, not the IMF, not America, not China, not Russia and not Brazil.
The EU sovereign debt crisis is now proceeding at warp speed. That doesn't mean collapse is imminent. Experience teaches that the financial markets hear what they want to hear and need only one or two rosy press releases from prominent government officials to stage a relief rally. Time and time again, that's the way the EU has kicked the can down the road and avoided the moment of truth. But the EU's principal tactic has been to substitute new debt for old debt, offering promises to replace the promises that this member nation or that couldn't keep. Actual transfers of wealth to reduce debt doesn't seem to be on the agenda. But this paper-for-paper game keeps expanding the amounts of debt outstanding, and investors will eventually tire of playing (as they did with the German bund auction today). When that happens, the Grim Reaper will be waiting to collect his due.
By contrast, the U.S. Treasury Department today sold $29 billion of 7-year Treasury notes, receiving three times as much in bids as it was offering (or close to $100 billion in bids). Even though the U.S. may be approaching another credit rating downgrade, the greenback remains a sturdy oak in a forest of blighted trees.
That the German bund auction went so badly means the European sovereign debt crisis is fastfowarding more rapidly than anyone anticipated. Next to topple were supposed to be Italy, Spain, France, Belgium, and Austria. Then, the Netherlands, Finland and Luxembourg would be at risk. But Germany was seen as the last bastion of stability, the wealthy uncle who could save the family if disaster struck. Indeed, the latest concept being proposed for salvation, the Eurobond that was to be backed on the entire EU, would be feasible only if Germany's creditworthiness was beyond question. That's no longer true. If Germany can sell only 60% of a bund auction, how could the EU as a whole sell a Eurobond auction?
The sovereign debt crisis has skipped the intermediate dominos and smashed directly into Germany. The German government continues its opposition to Eurobonds. At this point, that may be irrelevant because the viability of the Eurobond has been called into question. One naturally asks what else might be on the table. That's the really scary part. There is no Plan B. Germany has always been the fallback, the backup, and the backup to the backup. After Germany there's no one, not the IMF, not America, not China, not Russia and not Brazil.
The EU sovereign debt crisis is now proceeding at warp speed. That doesn't mean collapse is imminent. Experience teaches that the financial markets hear what they want to hear and need only one or two rosy press releases from prominent government officials to stage a relief rally. Time and time again, that's the way the EU has kicked the can down the road and avoided the moment of truth. But the EU's principal tactic has been to substitute new debt for old debt, offering promises to replace the promises that this member nation or that couldn't keep. Actual transfers of wealth to reduce debt doesn't seem to be on the agenda. But this paper-for-paper game keeps expanding the amounts of debt outstanding, and investors will eventually tire of playing (as they did with the German bund auction today). When that happens, the Grim Reaper will be waiting to collect his due.
Wednesday, November 9, 2011
Italy: A Financial Run in the Making
If you ever wanted to see what a bank run looks like, you can watch the 1946 film, It's a Wonderful Life, starring Jimmy Stewart, or you can watch Italy. Greece's deterioration in the past few weeks laid the foundation for Italy's distress. As Greece was sucked down the drain, Italy began wavering, and then wobbling. Now, yields on Italy's bonds are skyrocketing, exceeding 7%. That's the range bond yields for Greece, Ireland and Portugal reached before those nations went down the tubes. Italy isn't literally a bank, and holders of Italian bonds can't go to the counter and make a withdrawal. All they can do is sell in the secondary market for whatever price is available, and lots of them are.
Rumor has it that the ECB is buying Italian bonds in an effort to stabilize the situation. But that would be a temporary measure. The ECB by itself is a wee bazooka, unless it starts printing money and that's not allowed by its charter. The EU has already announced that it has no plans to bail out Italy. Indeed, its bailout fund, the EFSF, doesn't have enough money to bail out Italy. Nor does the IMF. Nor do the Chinese or the Brazilians. Eyes will inevitably turn toward America. But the political situation here precludes a fiscally funded bailout for Italy. And the Fed, which has no compunctions about printing money, can't print Euros. Its bazooka uses different ammo.
Italy is on its own, and Jimmy Stewart is no longer around to step in and calm things down. It's up to Italy to persuade the fixed income vigilantes that it can pay its debts as they fall due. That's a tall order in this time of Euro-skepticism.
Compared to Italy, Greece has a small amount of sovereign debt outstanding. Yet Greece's problems were enough to knock down a major European bank, Dexia, and a significant American brokerage firm, MF Global. If Italy's bonds maintain their downward trajectory, it's entirely possible that more financial firms will fail. Sadly, we don't have enough readily available information about the bond holdings, derivatives exposures and counterparty risks of financial institutions to easily predict which ones might be in trouble. That lack of information exacerbates the potential for systemic risk. Volatility reigns supreme in the financial markets.
Rumor has it that the ECB is buying Italian bonds in an effort to stabilize the situation. But that would be a temporary measure. The ECB by itself is a wee bazooka, unless it starts printing money and that's not allowed by its charter. The EU has already announced that it has no plans to bail out Italy. Indeed, its bailout fund, the EFSF, doesn't have enough money to bail out Italy. Nor does the IMF. Nor do the Chinese or the Brazilians. Eyes will inevitably turn toward America. But the political situation here precludes a fiscally funded bailout for Italy. And the Fed, which has no compunctions about printing money, can't print Euros. Its bazooka uses different ammo.
Italy is on its own, and Jimmy Stewart is no longer around to step in and calm things down. It's up to Italy to persuade the fixed income vigilantes that it can pay its debts as they fall due. That's a tall order in this time of Euro-skepticism.
Compared to Italy, Greece has a small amount of sovereign debt outstanding. Yet Greece's problems were enough to knock down a major European bank, Dexia, and a significant American brokerage firm, MF Global. If Italy's bonds maintain their downward trajectory, it's entirely possible that more financial firms will fail. Sadly, we don't have enough readily available information about the bond holdings, derivatives exposures and counterparty risks of financial institutions to easily predict which ones might be in trouble. That lack of information exacerbates the potential for systemic risk. Volatility reigns supreme in the financial markets.
Sunday, November 6, 2011
The European Union's Only Option
The downfall of George Papandreou, prime minister of Greece, illustrates the European Union's only option for survival. Germany and France dictated the terms of the latest iteration of the bailout for Greece, which included tough austerity requirements and a 50% haircut for creditors. Both Greeks and creditors squawked, but ultimately knuckled under. Then, Papandreou threw a wrench in the works by calling for an ad hoc national referendum on the deal. Why he latched onto this misguided notion remains unclear. Whatever the reason, it threw the financial markets into a tizzy.
The prime ministers of Germany and France summoned Papandreou to be chewed out in Cannes. Most likely, George didn't get much time to work on his tan. Back in Athens, he called off the referendum. His next move was to maneuver for a coalition government, while his opposition called for snap elections. Germany and France stepped in again and made it clear that they wanted Greece to have a unity government that would implement the terms of the revised bailout.
Next thing you know, Greece is announcing that it has reached a tentative deal for a unity government. Tomorrow, Greek politicians will spar over who their next national leader will be. It won't be Papandreou.
What's happened in Greece was dictated by Germany and France. The Greeks weren't given a choice. They were told what bailout they would get and what governmental process they would use to implement it. In essence, Germany and France have assumed supervisory political control over Greece. This--the political unification of the EU--is the union's only chance for survival. Economically speaking, the EU's continuation depends on a transfer of wealth from the well-off nations of northern Europe to creditors of the more profligate EU members. The price of this transfer is political domination by the north.
Germany's been through this once before. When the Berlin Wall fell, prosperous West Germany unified with moribund East Germany. West Germany paid a very high price in bringing its formerly Communist sibling into the world of free enterprise. But the West Germans wanted unity and they were willing to pay for it. Now, Germans depend on the Euro Zone to sustain their prosperity, and they are gradually coming to realize their reluctant willingness to pay for the survival of the EU. The continued fecklessness of Greece and its government in dealing with the crisis has forced Germany and France to take charge. By the most contorted of processes, the EU is evolving toward political unity.
It's not inevitable the process will continue. Other nations are in trouble. Italy is the next target of the sovereign bond vigilantes. Interest rates on its bonds are rising sharply vis-a-vis German bonds, and it has recently agreed to be monitored by the IMF. Many Italians are irked by this infringement on their sovereignty. If Greeks and Italians feel put upon enough, they can simply leave the EU. That might seem highly irrational, since it could lead to the collapse of their financial systems and steep recessions. But let's not forget that twice in the last century Europe descended into horrific world wars that killed tens of millions of people. Europeans are eminently capable of highly irrational and self-destructive behavior.
No one knows all this better than the Germans, who were the most irrational and paid an enormous price for their self-destructiveness. That's why they're willing to pick up the tab now for the profligacy of their neighbors, but only if they can exercise political control over the spendthrifts. The question is whether Europeans, with their vast cultural differences--far greater than those between folks north of the Mason-Dixon Line and those to the south--can achieve the compromises and concessions needed for lasting political unity. The post-Communism breakups of Yugoslavia and Czechoslovakia tell us that Europeans don't always have a preference for political unification. Expect a bumpy ride in the financial markets while the EU works things out.
The prime ministers of Germany and France summoned Papandreou to be chewed out in Cannes. Most likely, George didn't get much time to work on his tan. Back in Athens, he called off the referendum. His next move was to maneuver for a coalition government, while his opposition called for snap elections. Germany and France stepped in again and made it clear that they wanted Greece to have a unity government that would implement the terms of the revised bailout.
Next thing you know, Greece is announcing that it has reached a tentative deal for a unity government. Tomorrow, Greek politicians will spar over who their next national leader will be. It won't be Papandreou.
What's happened in Greece was dictated by Germany and France. The Greeks weren't given a choice. They were told what bailout they would get and what governmental process they would use to implement it. In essence, Germany and France have assumed supervisory political control over Greece. This--the political unification of the EU--is the union's only chance for survival. Economically speaking, the EU's continuation depends on a transfer of wealth from the well-off nations of northern Europe to creditors of the more profligate EU members. The price of this transfer is political domination by the north.
Germany's been through this once before. When the Berlin Wall fell, prosperous West Germany unified with moribund East Germany. West Germany paid a very high price in bringing its formerly Communist sibling into the world of free enterprise. But the West Germans wanted unity and they were willing to pay for it. Now, Germans depend on the Euro Zone to sustain their prosperity, and they are gradually coming to realize their reluctant willingness to pay for the survival of the EU. The continued fecklessness of Greece and its government in dealing with the crisis has forced Germany and France to take charge. By the most contorted of processes, the EU is evolving toward political unity.
It's not inevitable the process will continue. Other nations are in trouble. Italy is the next target of the sovereign bond vigilantes. Interest rates on its bonds are rising sharply vis-a-vis German bonds, and it has recently agreed to be monitored by the IMF. Many Italians are irked by this infringement on their sovereignty. If Greeks and Italians feel put upon enough, they can simply leave the EU. That might seem highly irrational, since it could lead to the collapse of their financial systems and steep recessions. But let's not forget that twice in the last century Europe descended into horrific world wars that killed tens of millions of people. Europeans are eminently capable of highly irrational and self-destructive behavior.
No one knows all this better than the Germans, who were the most irrational and paid an enormous price for their self-destructiveness. That's why they're willing to pick up the tab now for the profligacy of their neighbors, but only if they can exercise political control over the spendthrifts. The question is whether Europeans, with their vast cultural differences--far greater than those between folks north of the Mason-Dixon Line and those to the south--can achieve the compromises and concessions needed for lasting political unity. The post-Communism breakups of Yugoslavia and Czechoslovakia tell us that Europeans don't always have a preference for political unification. Expect a bumpy ride in the financial markets while the EU works things out.
Saturday, August 13, 2011
Where Europe is Heading
Italy has just called for the issuance of Euro bonds that would substitute for the sovereign debt of individual EU member nations. An EU-controlled entity would issue these bonds in exchange for the sovereign debts of each member nation, and could impose continent-wide taxes to pay off the Euro bonds. Greece, badly battered by the debt crisis, shouted a heartfelt "amen" to Italy's proposal.
The UK seconded the sentiment, proposing fiscal union for the EU. Fiscal union is about effectively the same as the Euro bond concept. Why would Italy, Greece and the UK publicly talk up European unity? Because they can see the handwriting on the wall. Unity is, in their view, the only alternative to the septic tank.
Germany, on the other hand, is reaching for as much garlic as it can find, in the hope of warding off fiscal union. It would have to pick up most of the tab for true European fiscal unity, and the German electorate has yet to wrap their heads around that concept.
Europeans basically have two options. One is to unite. They would become something similar to the United States, with a continent-wide government controlling fiscal policy and having taxation powers. The current nations would become more like America's states, controlling local matters but subordinate to the bureaucrats and legislators in Brussels. While Europe would probably never be as tightly united as America under the Constitution (that is, after the Civil War and the adoption of the 13th, 14th and 15th Amendments), its survival would require greater union than achieved by the original thirteen American states under the Articles of Confederation.
Europe's second option would be for Germany and maybe other fiscally strong northern EU nations to leave the EU and strike out on their own, issuing their own national currencies again. Germany would probably strengthen economic ties with Eastern Europe, the Baltic republics, and the southeastern portions of the former Soviet Union (such as Ukraine, Moldova, etc.). These nations are of historical German interest, dating back even to the excursions of the Teutonic Knights during the Middle Ages. Southern European nations would be left on sidelines, muttering something about dancing with the one you brung.
Germany's chancellor, Angela Merkel, and France's president, Nicholas Sarkozy, meet on Tuesday, Aug. 16, 2011. With all this talk of European union, the media will fixate over their every smile, frown, and arched eyebrow. Merkel, more than anyone, will be the decider. Although she has talked the talk on requiring southern European nations to pay their own way, she has reluctantly slid down the slippery slope toward comprehensive EU assumption of the sovereign debt of member nations. It would be politically impossible for her to reverse course now (although she won't openly support Euro bonds because that would be political suicide). A change of political control in Germany would required for option two. That's not yet likely, although it's possible. Political turmoil there would translate into more stock market volatility in Europe and America.
More than anything else, Europe's response to its sovereign debt crisis will dictate the direction of Europe's and North America's economies and stock markets. Europe's recent piecemeal ban on naked short selling of bank stocks is akin to shooting the messenger. But the EU approach to its debt crisis has certainly been lathered with expediency. Next week, the EU may stir up a good deal of market volatility. The U.S. Congress can't do its share to screw things up, since it's thankfully out of Washington for the August recess. Keep an eye on events across the pond.
The UK seconded the sentiment, proposing fiscal union for the EU. Fiscal union is about effectively the same as the Euro bond concept. Why would Italy, Greece and the UK publicly talk up European unity? Because they can see the handwriting on the wall. Unity is, in their view, the only alternative to the septic tank.
Germany, on the other hand, is reaching for as much garlic as it can find, in the hope of warding off fiscal union. It would have to pick up most of the tab for true European fiscal unity, and the German electorate has yet to wrap their heads around that concept.
Europeans basically have two options. One is to unite. They would become something similar to the United States, with a continent-wide government controlling fiscal policy and having taxation powers. The current nations would become more like America's states, controlling local matters but subordinate to the bureaucrats and legislators in Brussels. While Europe would probably never be as tightly united as America under the Constitution (that is, after the Civil War and the adoption of the 13th, 14th and 15th Amendments), its survival would require greater union than achieved by the original thirteen American states under the Articles of Confederation.
Europe's second option would be for Germany and maybe other fiscally strong northern EU nations to leave the EU and strike out on their own, issuing their own national currencies again. Germany would probably strengthen economic ties with Eastern Europe, the Baltic republics, and the southeastern portions of the former Soviet Union (such as Ukraine, Moldova, etc.). These nations are of historical German interest, dating back even to the excursions of the Teutonic Knights during the Middle Ages. Southern European nations would be left on sidelines, muttering something about dancing with the one you brung.
Germany's chancellor, Angela Merkel, and France's president, Nicholas Sarkozy, meet on Tuesday, Aug. 16, 2011. With all this talk of European union, the media will fixate over their every smile, frown, and arched eyebrow. Merkel, more than anyone, will be the decider. Although she has talked the talk on requiring southern European nations to pay their own way, she has reluctantly slid down the slippery slope toward comprehensive EU assumption of the sovereign debt of member nations. It would be politically impossible for her to reverse course now (although she won't openly support Euro bonds because that would be political suicide). A change of political control in Germany would required for option two. That's not yet likely, although it's possible. Political turmoil there would translate into more stock market volatility in Europe and America.
More than anything else, Europe's response to its sovereign debt crisis will dictate the direction of Europe's and North America's economies and stock markets. Europe's recent piecemeal ban on naked short selling of bank stocks is akin to shooting the messenger. But the EU approach to its debt crisis has certainly been lathered with expediency. Next week, the EU may stir up a good deal of market volatility. The U.S. Congress can't do its share to screw things up, since it's thankfully out of Washington for the August recess. Keep an eye on events across the pond.
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