Notes From Underground: For London it was the best of times and the worst of times

Today as Gordon Brown departed the scene, the Tories and Libs agreed to terms and will form a coalition after reaching a compromise regarding some contentious issues. Last week we wrote that hung Parliaments are not by definition bad outcomes. Stalemate forces compromise and often the result is more pragmatic policies and better solutions to difficult problems. In times of national emergencies, wide ranging political groups join together to promote the national good and the results are often successful as the nonsense of petty politics gives way to serious governance.

Britain faces severe budgetary problems and it will take a national consensus to make the needed tough decisions. We believe Nick Clegg got what he wanted from David Cameron as far as election reform and is now ready to get down to dealing with the budget. The Lib/Dems have always been more serious on the fiscal issues and now they will be tested while under fire. The European PIIGS have shed light upon shaky state finances and governments that fail to deal with structural deficits are going to be punished by market forces. Better to get ahead of the curve than to act like Brussels and pretend that if you admonish the bond vigilantes they will just go away. So to Britain’s new government we wish you GODSPEED.

While the political news out of  the U.K. was certainly positive, the “bad” news came from across the channel. There is great European anger aroused against the Brits because of their refusal to take part in €750 billion rescue plan. Jean-Pierre Jouyet, president of Autorité des marchés financiers, the French financial regulator, commented that Europe would think hard about coming to the U.K.’s help if there was to be a Sterling crisis. Jouyet said Britain would probably be targeted by markets because of their political difficulties. Right after Jouyet made these comments, the markets got wind of the TORY/LIB agreement and the POUND rallied against the EURO, YEN and DOLLAR. It appears that Jouyet understands very little about what the markets are saying, but that has been the point all along. European elites regard market forces with disdain and feel that crushing market forces is ultimately more important than incorporating effective economic policies. Jouyet also added: “There is a three speed Europe: the Eurozone; Poland, Sweden and other countries sympathetic to the EURO; and Britain.”

Anders Burg, the Swedish finance minister, added that the Brits should have joined the rescue as a responsibility to the Eurozone, as London is Europe’s financial center. The battle lines are being drawn and the continentals in Europe are declaring war on the Anglo-American model of capitalism. Jouyet is an idiot for his rhetoric will pressure the POUND in the near term at the expense of the European peripherals. The last thing Spain, Italy and Ireland need is a weaker POUND on the EUR/GBP cross. French Eurocrats complain about the POUND’s devaluation yet in their anger they attempt to drive it lower–and the pundits wonder why GOLD rallies.

Speaking of GOLD, we remain firm in our view that it is the fear of deflation that drives GOLD higher. The panic by Trichet and company this week in their efforts to halt a deflationary debacle has pushed GOLD to new highs. It is not inflation but the fear of deflation and the policy repsonses that scare the hard money crowd. It was interesting that Bernanke met with Congressional finance committees behind closed doors and we wonder what was discussed besides the FED’s reinstituted currency swap lines with several foreign central banks … HMMM.

In a bit of more bad news from Europe, Frau Merkel is under intense criticism for the financial package that was approved by the cabinet. BILD ZEITUNG, a mass circulation German daily, has been openly taunting the Chancellor over what is being called a“TRANSFER UNION.” German taxpayers have awakened to the fact that their hard earned EUROs are going to the profligate PIIGS after they have worked hard and saved and they don’t wish to bailout their “brethren.” The German economic powerhouse does not exist to suppliment the lifestyles of those who work little and play much. We can expect to hear more about this TRANSFER UNION in the coming days. Also adding to German angst is the specter that France has won the battle over ECB independence and has turned the BANK from an independent force to a political lap dog of the soft money crowd. The mood in Europe is not constructive, but as traders we caution that the Political Elite will ramp up the rhetoric and probably take action to halt the evil speculation against the vaunted EURO. Rational behavior is dying and long live 2+2=5.

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