Tonight I’m paying homage to Rudyard Kipling’s great poem, “If.” It’s a reminder of what the fourth quarter holds for global investors, and particularly traders with a much quicker reaction:
If you can keep your head when all about youAre losing theirs and blaming it on you,If you can trust yourself when all men doubt you,But make allowance for their doubting too;If you can wait and not be tired by waiting,Or being lied about,don’t deal in lies,Or being hated,don’t give way to hating,And yet don’t look too good,nor talk too wise
The issue of Europe is coming front and center and it will be important to be aware of the political dimension of the current economic malaise. There were three articles in the last week that require our attention. The themes aren’t new to the readers of NOTES but the fact that these articles have appeared in almost synchronized fashion should not be minimized. First, Ambrose Evans-Pritchard had a piece in the London Telegraph on September 24, “S&P Has Issued An Extraordinary Credit Alert on the Eurozone.” S&P is concerned because of the rise of the AfD, whose increasing political popularity in Germany is calling “… into question the euro bail-out machinery and queries the pitch for any form of QE…” Pritchard adds that the rise of the Alternative for Deutschland party has been “… able to galvanize the opponents of European ‘bail-outs,’ and of German taxpayers assuming contingent financial risks.” I have to give S&P a thumbs-up for having the vision to see the potential rise of a Euroskeptic party in Germany causing a potential blow to the credit rating of the sovereign debt of several European nations. The idea of a credit rating agency to invoke political analysis into an economic issue is unique–political economy in a world of econometrics.
In Monday’s Financial Times, columnist Wolfgang Maunchau also raised the issue of the rise of the AfD in a piece, “Germany’s Euroskeptics Sow the Seeds of Turmoil.” Maunchau notes the problem of a fringe party for Frau Merkel. It’s not that the AfD will become a parliamentary force in short order but more the fact that its increasing popularity is forcing the Chancellor to act in opposition to ECB President Draghi’s efforts to do more in terms of bailing out the debt-plagued peripherals and the entire European banking system. Maunchau wrote, “The AfD will bring some unhelpful clarity about the limits of Germany’s engagement. The rest of the eurozone might be in for a shock.” In his summation it states what is the most important issue which I have noted for several months: “The Afd only need to create doubt to upset this equilibrium. It does not need to win an election or become part of a government. Its strategy will be to test the limits of Germany’s commitment. That strategy stands a fair chance of success. And when that happens, it will wreak havoc.”
The greatest havoc could be pressure on Chancellor Merkel to call for a referendum on the entire European project (at least a non-binding vote). The problem for Draghi and Brussels is that no direct poll was ever taken of the Bavarian Burghers about the concept of German money guaranteeing the entire European financial system. IF a referendum was called it might give the authority for the Berlin government to actually step up and create a EURO BOND and a harmonized banking and fiscal authority. It was the highly respected Otmar Issing who warned in the FT last year that ECB bailouts backed by German taxpayers was a case of “taxation without representation.” A popular vote strikes fear in the hearts of the European establishment but to it may be the best way to counteract the rising popularity of the Euroskeptics.
Finally, in today’s FT Hans-Werner Sinn, president of the highly regarded IFO Institute for Economic Research, publicly advised Chancellor Merkel to stand firm in the defying the efforts of Mario Draghi to utilize the finances of the ECB to create a European-wide bad bank. In a concise summary of German economists Mr. Sinn writes in reference to the ECB‘s efforts at QE: “The ECB says these unorthodox measures are needed to combat looming deflation. Given that prices are still rising [albeit slowly–core inflation stands at 0.9 per cent] this seems little more than a fig leaf. Anyway, deflation is not a danger for southern Europe but an essential precondition for restoring competitiveness. This is nothing less than a fiscal bailout-something the ECB has no right to undertake, as the German constitutional court implied when it declared OMT unlawful.” If we can keep our heads and watch the blame game unfold in European politics there should be opportunity for a myriad of investments and trade.
The ECB meets Thursday and some analysts are predicting an announcement about increased QE or possible further cut in rates. I was wrong last month in saying the central bank would hold steady but again I will say the ECB won’t change its present position on rates or QE. The euro has dropped in value to 1.2590, which is close to what the French authorities had been wanting, while the ECB will be cautious about inciting further criticism from the Bundesbank and German financial authorities. The ECB‘s Asset Quality Review (AQR) is due in mid-October so it is wiser for President Draghi to preserve his fire power for a greater fight. If the AQR reveals that the European banks are in desperate need of a capital infusion, better for the ECB to use that as leverage against the German austerians,especially if it is German banks that are in need of a massive capital infusion. IF you can wait and not be tired of waiting we will find great opportunities ahead.