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Over the weekend, we saw one of the major risk factors in the world take a step back from the brink. Greece and Germany essentially agreed to disagree for the next couple of months, giving the Greeks enough rope to either weave a ladder down (the Greek version) or hang themselves (the German version).
Kicking the problem down the road
The coverage has been predictable. First, relief that a deal was cut. Now, the realization that nothing's really been solved; in many ways, the problem is worse than before.
In Germany’s opinion, Greece has backed down. Greece insists that’s not true.
A parallel I haven’t seen mentioned is that between Greece and Scotland. If you remember, the last existential crisis for the EU was the Scottish independence referendum. At the time, the question for Scotland was whether it was willing to pay a very real economic price for a political end. Greece and Germany are facing the same question, and that’s why the problem hasn’t been solved.
Economically, Greece should leave the eurozone. Politically, however, it would be a disaster for everyone if Greece exited. Thomas Sowell was right: “There are no solutions, only trade-offs.”
What does this mean for the U.S.?
First, we need to accept that Europe will continue to tie itself in knots for the indefinite future. Although there are signs of a recovery brewing, any economic progress will be delayed by political wrangling. We won’t see European growth take off any time soon.
Second, given the stakes and intractability of the problem, we need to realize that systemic risks have not gone away. In conjunction with the points I made the other day about how the U.S. markets are very expensive, in historical terms, the potential for systemic risk to shake the system is all too real.
Is Europe facing a Minsky moment?
Minsky moments don’t generally come out of the blue. There is usually some event that focuses investors’ attention on the underlying fallacy that's been driving the market higher. For the housing bubble, it was the realization that mortgage-backed bond pricing was essentially unknowable.
Right now, the very open question is this: What event would make the current pricing of stock markets seem ridiculous?
I would say that the underlying foundation of current equity values is low interest rates. The argument is that equities make sense because interest rates are so low. Why, though, are they low? They are low because of faith in sovereign debt. They are low because the central banks have made them low. They will remain low as long as central banks can continue to keep them there.
As I noted yesterday, a rate increase here in the U.S. won’t be the end of the world. Elsewhere, however, we have seen confidence collapse over and over again. A Greek exit could cause such a collapse in Europe, which would certainly echo through financial markets around the world. That’s why Greece cannot be allowed to leave, even though it would make sense economically.
If you're watching for a Minsky moment, this is the most probable candidate I’ve seen so far. We can expect more "solutions" that attempt to paper over the underlying problems. Let’s hope they continue to succeed.
