Round and round the EU goes as it searches for a way to resolve its self-made crisis. As predicted, the Germans and French leaked news to the press–via the Guardian–that a deal had been struck, which would provide the EFSF and the ECB with an equivalent of 2 TRILLION Euros for aiding and abetting the bailout and support of the European financial system. The early afternoon news story gave impetus for the equities to RALLY as well as a SELLOFF in the DOLLAR. The precious metals staged a late recovery after a very severe correction in the morning–GOLD was down almost $50 at its lows.
Later in the afternoon word came that the GUARDIAN story was TOTALLY WRONG which led to a very moderate correction in the EQUITY rally and DOLLAR selloff. It seems that there must be some legitimacy to the news story as the market moves have held up fairly well.
It seems that the bigger part of the story is being reported in Wednesday’s Financial Times in a piece titled, “FRENCH WARNING TO EURO SUMMIT.” Sarkozy has hit the panic button as France is faced with a possible downgrade of its AAA credit rating. The FT article quotes Sarkozy in a very existential statement: “ALLOWING THE DESTRUCTION OF THE EURO IS TO TAKE THE RISK OF THE DESTRUCTION OF EUROPE.THOSE WHO DESTROY EUROPE AND THE EURO WILL BEAR RESPONSIBILITY FOR RESURGENCE OF CONFLICT AND DIVISION ON OUR CONTINENT.”
This is as raw a statement we have heard from the FRENCH in many years so it seems that EUROPE has hit the breaking point. Sarkozy’s comment pairs well with another piece in the FT. Ian Bremmer, who I hold in very high regard, has an op-ed piece, “Germany Will Never Leave the Eurozone.” For Germany, the present discussion is a matter of determining how much value it has extracted from the EU and what cost will the Germans bear to maintain the present UNION. Bremmer argues that the benefits to the German populace have been so great that Germany is far better off remaining within the present structure. The fact that most of Europe is now so dependent on the Germans means that Merkel and company will be able to create a political entity in its likeness. Bremmer may well be right as Sarkozy’s statement is a reflection that French HUBRIS has been quieted.
President Sarkozy has believed that he has had the better of Chancellor Merkel for the last two years, as he rid himself of Axel Weber and got German acquiescence on the July 21 agreement that led to a 21% haircut on Greek debt and a ramping up of the EFSF. It seems that Merkel lost some battles but as the deadline for action nears, the Germans have solidified its hold on the European economy and ultimately fiscal policy. An aside: The German/French 10-year bond spread widened to 112 basis points. When markets reopen tomorrow it will be critical to watch this spread and see if it narrows, providing credence to a massive package.
Quick Hitter #1: Richard Koo of the Balance Sheet Recession theory had a piece on what Europe needs to do to avoid meltdown. Koo advises going NUCLEAR: “BIG TIME GUARANTEES” across the entire system to ensure that everyone survives. Lots of taxpayer money with FEW STRINGS ATTACHED. This is a very credible resource in the realm of credit crunches and the deleveraging process. One more voice advising the Europeans to not hold anything back.
Quick Hitter #2: Finally, we leave Europe for Mexico. In a story in tomorrow’s FT it seems that the frontrunner for the PRI‘s candidate for next years presidential election, Enrique Pena Nieto, is promoting a platform that calls for the use of foreign investment in the NATIONALIZED ENERGY SECTOR. The Mexican Constitution of 1938 prohibits foreign investment in the OIL Sector, which has meant that PEMEX has been a total government monopoly. For its part, PEMEX profits provide funding for more than 40% of the Mexican budget but the cost has been to the degradation of Mexico’s oil fields. If PEMEX reinvests its capital into development then the Mexican budget becomes stressed.
The Mexican Congress has prevented foreign firms from providing the needed capital, even though the present President Felipe Calderon had run on the promise of opening up the energy sector to foreign investment but Calderon could never muster enough support as he was not from the long governing PRI. Mr. Calderon was from the upstart PAN party and thus was not capable of challenging the long entrenched interests. Mr. Nieto, being from the PRI, might have the ability to amend the long-standing law against foreign investment, but it is still a long time till next summer’s election.
If Mexico ever opened up itself to the needed capital it would be very bullish for the PESO. It is early to invest but it is something worth paying attention to as I view Mexico as a very healthy alternative to any significant rise in the Chinese yuan. I will revisit this issue to explain why in another NOTES. But the key date to remember is January 1, 1994: NAFTA began and the CHINESE DEVALUED THE YUAN ON THAT DAY FROM 5.8 YUAN to the DOLLAR to 8.7 … The rest has been history.