What Would 'Decisive' EU Action Look Like?
“Buy the dip, sell the government policy induced rip.”
Those words were spoken to me by Larry McDonald in late May as we waited for the Greek elections and the meetings leading up to this week's EU summit. McDonald , author of the best seller “Colossal Failure of Common Sense” about the collapse of Lehman Brothers, rated stocks undervalued but said he would be a seller of all rallies until politicians and policymakers pulled out a bazooka, similar to events in 2008.
It's a theme many argue, waiting for some decisive short term action that will allow a big upside rally. Yet just a few days before another “crucial” summit, hopes should again be tempered, even without the rather inconclusive Merkel, Monti, Hollande and Rajoy meeting on Friday.
It's worth reminding ourselves what in market terms, “decisive action” might look like. This was the list that Larry put out.
1. Giving the ESM a Banking License
2. ESM Lending directly to Banks
3. European Wide Deposit Guarantee Scheme
5. ECB Quantitative Easing
Of the five, Eurobondsand then full ECB quantitative easing are the most unlikely and certainly then only in an emergency e.g. imminent euro breakup. So that leaves us with the first 3.
Right now there's still considerable uncertainty surrounding the future of the European Stability Mechanism, not least because deliberations of the German Constitutional court will likely delay ratification by Germany's Bundestag. Merkel set a June 28 deadline for a vote, it might now go beyond the July 9 target set for the ESM to be up and running. What happens will be a good gauge as to whether we're close to the point, as Monument's Stephen Lewis puts it, where “commitment in leading German political circles to European integration clashes with the principles of the German constitution”.
And this leads us to problems with the third idea: the European Wide Deposit Guarantee scheme. On closer inspection this path to banking union looks to be just fiscal union in another guise. As Lewis points out . “It merely substitutes a deposit guarantee fund for a fiscal revenue-sharing mechanism. All a fiscally profligate government then has to do is to stuff its banks, as buyers of last resort, with its own increasingly impaired securities and then appeal to the deposit guarantee fund for a bailout.” As a result it's highly unlikely to get approval right now.
Once again we are at impasse because any steps to improve the fortunes of the euro area means taking a meaningful step to full political integration. But are the sovereign European elite really ready to take steps that will end up in their political extinction and even if they were can they persuade the people of Europe to accept the democratic deficit it implies?
Until we start to see some clarity on these fundamental questions, many investors will believe it's far easier to stay on the sidelines and the core bond markets of Germany, Britain and the United States are likely to remain the preferred cash.