Greece: Facta non verba
Greece has made some progress but not what is needed. There may be political commitment to austerity but there's no evidence they are going to implement it. Actions, not words, are required.
Hollande moving in the wrong direction
François Hollande is already re-lowering the French pension age; discussing making it harder to restructure the economy by enhancing the ability to hire and fire workers; and espousing aggressive personal taxation levels.
Political dynamics in Italy worsening
With 61 changes of government since 1945, the half-life of the Monti government could be nearing its end. If Greece's electoral disarray is added to Italy’s electoral disarray, the politics could become overwhelming—again.
Focus on Spain
I have written about the inevitability of an aggressive property boom being followed by a banking bust, and we are seeing this unfold. The recent independent audit test in Spain assumes the property market falls aggressively but also assumes an unrealistically high level of underlying profitability of the Spanish banks and that their core Tier 1 ratio at 6% remains acceptable because, under the new Basel III, that core Tier 1 would translate into a new core Tier 1 of 3%— way below where people would want them. We think the capital shortfall numbers still weigh over €100 billion, rather than the €50-€60 billion in the headlines. Observers are not taking matters seriously enough.
What lies ahead?
Is France “the dog that didn't bark in the night”?
- France: François Hollande feels empowered not to sail in the same direction as Sarkozy.
- Italy: If Mario Monti keeps following Germany’s plan, his political days are numbered.
- Spain knows their economy is heading into a tailspin.
- Germany: Angela Merkel is not yet hearing enough to make her blink. Austerity processes have just been put into place in Spain and Italy, so Merkel will first wish to see if they work. The German government would consider the European Redemption Fund and a Eurobill issuance process—and, by implication, a banking union—but only as a quid pro quo after sovereignty has been ceded.
I believe the situation is not yet sufficiently grave for Merkel to see enough ceded by other euro-zone members. While we expect a crisis to force the acceptance of loss of sovereignty, it is likely to take time. I speculate, therefore, that this crisis must bounce into France. When France is considered one of the PIIGS (Portugal, Ireland, Italy, Greece and Spain) nations, we will probably be close to the point when the German government must choose. Until then, Germany will simply continue to admonish the Spanish, Italians and others to “try harder.”
In my view, France's problem is its over-extended banks. There are several reasons why contagion could spread to France:
- Look at government deficits and the size of the banking industry, which are four times France's gross domestic product (GDP).
- Far more than Italy, France meets the criteria for serious problems. France’s current government outstanding debt is about 90% of GDP; the budget deficit is 7%-8%, like Spain; government constitutes 56% of GDP.
- Hollande's socialist policies of taxing and spending are likely to be unproductive in the medium term, and competition and free trade are likely to be replaced with State interference. This could exacerbate France's situation, ultimately requiring the European Central Bank or others to fund Hollande's government.
With all eyes on Italy, we may need to worry about what people are overlooking. In France, I think the direction of politics will not be European Union-friendly. Any element of financial stress would hurt the big French banks and, in turn, the big global banks. This is not a trifling challenge: As of January 1, 2012, BNP Paribas was, in terms of balance sheet assets, the world’s largest bank.
I'm concerned that we've only had temporary interesting policies—mostly from the central banks—when things have really deteriorated in the euro-zone crisis. With the euro at 1.25 against the U.S. dollar and the markets only 10%-15% off their highs, it's not yet been bad enough for the politicians to want to do the right thing—or do enough to produce an ultimate solution that will effectively address the issues. I believe the euro zone is still taking baby steps toward a United States of Europe.
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