Europe's Tug-of-War Between Being European and Being National

By Peter Atwater  APR 24, 2012 11:05 AM

The eurozone is a monetary system "house of cards" without the foundation of meaningful fiscal integration.

 


MINYANVILLE EXCLUSIVE: This morning London's Telegraph includes this quote, attributed to the European Commission in response to current events from the continent: “Governments commit on behalf of states. Therefore commitments are not linked to one government. Governments change but commitments on behalf of states cannot be changed without discussion with European partners.”

With all due respect to the spokesperson from the EC, during periods of poor social mood government commitments do change and even more, during these particularly dour periods, national governments don’t play “Mother, May I?”  They take two steps and don’t even look back for permission.

Just ask Argentina’s president Cristina Fernandez de Kirchner.

But it is not just emerging market countries where political certainty is now in doubt.  What the past 72 hours have raised in France and in the Netherlands is the question of political certainty in Europe and whether even developed nations will honor their commitments.

The markets are right to be concerned.  From a social-mood perspective, the history is clear.  During periods of dour social mood, we vote elected officials out of office and we move to more extreme forms of government.  To me, all one had to do was to look at a chart of the benchmark French stock index CAC40 (^FCHI), which is arguably the best proxy of social mood for France.  It was no surprise that President Sarkozy now faces a run-off, nor was it shocking that Francois Bayrou, the centrist candidate, received the lowest percentage, nor that Marine Le Pen, the far right candidate, “surprised” in the polls.  To paraphrase an op-ed in yesterday’s Wall Street Journal  on the challenges now facing Richard Lugar’s re-election campaign, thanks to dour mood, France wants warriors, not statesmen.

And if mood doesn’t improve quickly, France and Holland will get them.  But with them will come more and more nationalistic policies.  The "us, everywhere, forever” social mood which brought the eurozone to fruition at the top of the markets is devolving into “me, here, now.”  And it is not surprising to see candidates on both the right and the left in France calling for changes to the Schengen Agreement and limitations on labor mobility in Europe.  And if the mood continues to fall, limitations on the mobility of capital goods and services won’t be far behind.  Further, as generosity is much more a function of the donor than the need of the recipient, support by the north to the periphery will falter as well.

Unfortunately, Europe is ill-prepared for all of this. Having been formed at the very top, the eurozone is the subprime of currency unions - a collective brought together when social mood was highest and underwriting standards were their weakest – a monetary system house of cards without the foundation of meaningful fiscal integration.

As if that weren’t bad enough though, European policymakers have, from my perspective, made two critical errors in their response to their crisis.  First, much like their American counterparts in 2008, they have tried to portray and handle events as a series of “one-off” unique occurrences, rather than the crisis in parallel it is. 

Second, rather than deploying real capital to the foundation of the system, they have relied heavily on unfunded guarantees and super senior debt that only adds to the complexity of concerns for private sector creditors.  Unfunded guarantees are bad enough when coupled with governments where the markets are certain of the willingness and ability of voters to honor them.  As we are now seeing, though, it is another thing altogether when that commitment is in doubt.

But that is the current state of Europe – a tug of war between honoring existing commitments to an integrated, collective Europe and mounting voter nationalism.

Still, no one should be surprised.  Iceland, arguably the harbinger of the New Century of the European sovereign crisis, clearly showed what happens to unfunded sovereign commitments when mood turns dour and nationalism mounts.

As I wrote over two years ago on the Buzz & Banter in The Ice(land) Man Cometh (subscription required):

...what is going on between Iceland, the UK and The Netherlands matters. The notion that a country can put out to public referendum whether to honor its existing contractual obligations is at a minimum deeply troubling. And in a world filled with [unfunded] guarantees I think it is important that [readers] realize that we have crossed the point where it is not only financial ability to honor guarantees that matters, but now also willingness. And if Iceland is any indication, public opinion is now going to drive willingness. …The financial pundits are likely to discount the message’s significance as it is coming from a small country most couldn’t find on a map. But I would not. To me the message from Iceland is really a message to all elected world leaders: “You had better think twice about helping those outside of your borders."

After the past 72 hours, I suspect that “thinking twice” puts it mildly.
Position in SH and JPM

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