Can Europe Avoid the Sovereign Sequel?
The difference between a mistake and lesson is the ability to learn from it.
The most intuitive positive surrounding the European debt crisis is that the sovereign sequel has been so scripted. How scripted was it? Minyanville first mapped it in February 2010, that they
should may have a back-up plan in place, if in fact there is one.
One thing for certain: there needs to be deeper fiscal integration (much to the chagrin of the German people) or a smaller Eurozone. My fear on the latter matter -- which is lock-step consistent with the first phase of the financial crisis -- is that if the EU kicks Greece to the curb, Portugal will come into the crosshairs. If Portugal is excused, Spain will emerge as the target, and so on and so on and so on!
As posited nineteen months ago, and equally apt today:
As the European Union and International Monetary Fund wrestle with how to address the sovereign mess, our financial fate can be drilled down to one very simple question: Will we see contagion, as we did with Fannie Mae, Freddie Mac, AIG (AIG), Bear Stearns, and Lehman Brothers, or will the current congestion be contained in the context of an evolving globalization?
The bulls will offer that corrections must feel sinister if they're to be truly effective. They're right, of course, but I will remind you of a salient point made by Professor Peter Atwater on Minyanville. If sovereign lifeguards saved corporations when the financial crisis first hit, who is left to save the lifeguards?
Continuing with our Five-Step Guide to Contagion, we offered:
We can talk about how the capital market construct forever changed, how our constitutional rights have been challenged, or how the lifestyles of the rich conflict with the struggle to exist. While those dynamics remain in play, they miss an entirely more relevant point for purposes of this discussion. (See The Declaration of Interdependence)
Social mood and risk appetites shape financial markets. One of the greatest misperceptions of all time was that The Crash caused the Great Depression, when the Great Depression actually caused The Crash.
It's been [over two years] since Minyanville fingered Eastern Europe as a modern day incarnation of a sub-prime borrower. The question is therefore begged, what if Greece is Fannie Mae, Portugal is Freddie Mac, Spain is AIG, Argentina is Wachovia Bank, and Ireland is Lehman Brothers? (Also read Eastern Europe, Subprime Borrower)
Contagion, by definition, arrives in phases and we must remember that Greece is a symptom of the problem, not the problem itself. Regardless of what IMF or Eurozone "cross border solution" we see, it'll simply buy time, much like the bearded nationalization of Fannie and Freddie pushed risk out on the time continuum.
Given the trending direction of social mood and the discounting mechanism that is the market, the perception that defines our financial reality must remain front and center in the mainstream mindset.
And finally, bringing this column full circle to modern day relevance, the "acceptance" of this inevitable evolution -- the comeuppance of untenable debt and the manifestation of risk gone awry -- is finally front page news and yes, the 34% two-month decline in Germany as well as deterioration in the Eurozone periphery has discounted this dynamic, to a degree.
In September 2008, we offered that the government invented fingers to plug the multitude of holes that sprang open in the financial dike. That imagery would again apply if there were viable fingers attached to a healthy and able arm.
While many dismiss the notion that Greece or Portugal "matter" in the global financial construct, I'll explain why they might. Concerns in the Eurozone could manifest through a "flight to quality" in the US dollar (up 5% thus far in September).
Those hoping for a stronger greenback should be careful for what they wish, much like the "lower crude will be equity positive" crowd learned in 2008. (See Oil of Oy Vey)
In an "asset class deflation vs. dollar devaluation" environment, a weak currency is a necessary precursor to -- but no guarantor of -- higher asset class prices. (See Hyperinflation vs. Deflation)
The hedge fund community currently has the carry trade on in size. If the greenback continues to strengthen, the specter of an unwind increases in kind. Should that occur, asset class positions financed with borrowed dollars would come for sale across the board.
In the meantime, as we edge from here to there, be on the lookout for the unintended consequences of European austerity initiatives, including but not limited to social unrest and the abatement of risk appetites. Risk management over reward chasing as we together find our way.
And so it is. The more things change, the more they stay the same. Let's just hope that policymakers have the wisdom and experience to learn from the past so that our global economy can emerge from the vicious cycle where investors get punished at the top and savers get roasted at the bottom.
As always, I hope this finds you well.
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Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at firstname.lastname@example.org.
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