Farrell: Germany's Southern Discomfort
Chief Investment Officer, Soleil Securities
Germany and France can't borrow or tax enough to cover all the debts of their southern neighbors.
In fact, it's borderline laughable that France is taking such a prominent position in that their total debt (80% debt to GDP, the same as Portugal's) and deficit to GDP (8%) is high as well.
If you wanted to be a pessimist, you would conclude one of two possible endgames:
One would be that without a spurt of growth that would be counter-intuitive with austerity being proposed, there have to be sovereign defaults or at least restructurings of debt.
The other would be to reflate your way out of the situation and print lots of Euros and the hell with fiscal discipline.
The latter is not likely with the German collective memory of hyper-inflation following World War I.
So without adherence to a severe austerity program, chaos could loom.
Will the Greeks (and Portuguese and Spanish) play along, or won't they?
Can they even if they might want to what with street protests and riots an almost daily ritual.
Would they prefer to drop out of the Euro game and devalue their own currency.
It's not like they haven't defaulted/restructured before.
And will the northern countries shoulder the burden without the bondholders of Greece etc. take some part of the hit. Bond buyers took risk seeking yield premiums to German debt and will Germany allow their economy to be taxed to keep those risk takers whole?
I would think any government that would allow that would quickly be a former government.
The European Central Bank is trying to take a stand and support the markets with recent purchases of debt. To offset (to sterilize) these purchases they are offering short term debt to recycle the cash they put into the economy when they buy bonds. That can only go on so long. Remember, when the Fed wanted to support the housing market in the US with purchases of mortgage backed securities, they committed $1.25 trillion to the effort, not a couple of billion. A bigger far more serious effort is needed.
The euro is taking the brunt of international dissatisfaction with the bailout program.
I think the euro continues to weaken.
A weak euro does not spell big trouble right away. German exporters (45% of that economy) will see demand for their goods rise.
You would think the same might be true of the southern countries, but at least half of their exports go to other euro zone countries, so there is no net effect.
The other side of that trade is that imports become more expensive so you could, in effect, import inflation. At the end of the day, ignoring short term benefits to some export focused countries, a weak euro (or any weak currency) is a sign of investor mistrust.
It tells you that doing business in Europe is not a good idea. Also, who wants to buy your financial assets if you might suffer losses on the currency exchange.
Another problem has reared its ugly head on the international scene in Iran.
Brazil and Turkey have brokered an alleged deal concerning Iran's nuclear output. The details aren't important. What is important is any muscle President Obama had behind a move towards tighter sanctions on Iran have been scuttled. That lunatic Ahmadinejad has used two emerging countries to completely outmaneuver Foggy Bottom and has left the State Department crew reeling. Russia and China are off the hook as to even weak sanctions being voted on. Short of military action, Iran's nuclear program will continue unchecked, indeed sanctioned, by the community of nations via Brazil and Turkey. Israel has to be looking in and wondering when they will be forced into action and take out the Iranian facilities.
This is not a good development.