Saved by Circumstance

In the 2006 film Apocalypto, set in Mayan Central America, our hero Jaguar Paw is saved from being sacrificed to the sun god by an unexpected solar eclipse. The Mayans take from this that their god’s thirst for blood is satisfied and there is no need for further sacrifices to him, letting Jaguar Paw go. In much the same way, the eurozone’s leaders have been saved from certain sacrifice at the hands of the markets due to the unexpected slowdown in the BRICs and the bond markets assume that there is no need for further worry or angst on the European front, wrongly.

Now, there were certainly signs of improvement before the BRICs slowdown became apparent, by the time of market reflection in late May, on the stock side things were looking positive for the eurozone. Both the CAC 40 and the DAX were at their highest levels for over 2 years and bonds remained stable. However, the reason I bring up the BRICs slowdown is because much of the investor money being pulled out of China and India is going to the last place imaginable 2 years ago: Europe. In a previous article I expressed concern about where all the investor money from the BRICs was going to go and what it might create, the answer it seems is a false sense of security among Europe’s high command.

We are now entering the time when big banks and investment warehouses make their bets for the rest of the year and Credit Suisse (whose market capitalization totals to nearly $1 trillion) has called a recovery of sorts in the eurozone. Given that every year we have come to expect a waspish observation from the bank about the trustworthiness of emerging market statistics, it was unsurprising that they announced a rethink on BRIC investments as well. In contrast, the bank is enthusiastic about European prospects, forecasting mild improvement in countries like Spain that were considered untouchable only a few years ago. How much difference a few years can make.

In their report on the eurozone, Credit Suisse make some good points on where the eurozone is headed, most interestingly pointing out that the size of the ECB’s balance sheet contracted by a fifth over 2 quarters. This is being taken as certain sign that the emergency measures used by the savior of the euro: Mario Draghi are beginning to be wrapped up. Merkel would be pleased by the report also, as it forecasts success for her at the ballet box come October, and her giving the troubled PIIGS some relief in the form of “soft” debt restructuring when it is more politically opportune. The report, in all its detail, serves as a magnificent snapshot of where the euro is today and makes perfectly justifiable points about what will happen to it in the near future. It stresses that all is not well in the currency but there is enough improvement to be more optimistic about Greek and Portuguese prospects than a few years ago. For all the PIIGS in fact, the programme of fiscal retrenchment is coming to an end, so much so that cuts will prove less of a dead weight in these countries than it is in the UK. Spain, according to the report, has successfully managed an internal devaluation, giving strength to a hale and hearty export sector, it is only logical then that all of the PIIGS can expect to follow in the same footsteps. Recently we also got PMI indexes for the eurozone that were slightly in the black, as manufacturing and services climb out of the dizzying lows they experienced at the height of the crisis. More than enough evidence then, that an easing of the pain in the eurozone will be turned into a full blown recovery by a fresh supply of emerging market bears piling in to make the most of a port in a more uncertain sea.

To be blunt, this is too good to be true, by a long way. Euro bulls are not looking past the bright statistics to reveal the bleak outcome, in Greece the current account deficit is getting smaller, but only because the populace don’t have the money to afford cheap imports any more. Greece, despite the eye-watering levels of austerity, will still need a further €11 bn of financing over the next 2 years. The markets should be braced for the populist posing that will follow such a deal, possibly wrecking the uneasy peace that has formed in the country. Both Spain and Italy are facing governmental collapse, the Spanish Prime Minister is strongly implicated in a fatal corruption scandal and the ruling Italian coalition could be sunk by Silvio Berlusconi’s intransigence on his recent conviction in court. Both of these could, potentially, cause bond market panic, casting new doubt over the euro area’s recovery.

Mario Draghi’s “do anything it takes” offer has given the eurozone leaders breathing space from market hysteria, but not a cure for it. The euro is essentially unchanged from its position in 2010. The much touted Finance Ministry and Banking Union, which abated market concerns back when a summit a month was considered too slow, simply have not materialized. The rift between France and Germany is still there, as is the endless bickering that comes with every single European summit. The banking union should have happened by now, as should some kind of mechanism for control over national budgets. With over a year of protection from the storm, all of the urgency and impetus that came with the height of the euro crisis has fallen away with PIIGS bond yields.

Even if all that eurozone leaders hope for comes true, that under the protection of the ECB, recovery takes off thanks to a surge in investment and exports, all eurozone countries will have to taste the bitterness of being stuck in the middle ground. The ECB cannot maintain its pledge forever, with recovery comes inflation and a rising bank rate. Soon enough the ECB will be forced to give up protection of the troubled member states, and if the rigorous institutions and reforms are not in place the ensuing calamity could bring the hammer down on not just the eurozone’s recovery, but the world’s too.

The simple fact is that the European situation, despite the stock market’s mysterious buoyancy, is not any closer to being resolved than it was three years ago. Once again eurozone leaders are faced with the choice of either cutting some nations from the heard to default and recover or go through bone deep reform to keep the system afloat as it is. They had best decide promptly, while they are still under the ECB’s protective umbrella, much better that than having to sacrifice whole economies when the sun god thirsts for blood once more.

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