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Yesterday’s News: Things Fall Apart

Written by Brad McMillan, CFA®, CFP® | Jul 23, 2012 4:24:46 PM

There were no significant single financial events over the weekend, but there was continued fallout. The Financial Times (FT) led with “Deteriorating outlook drives Spain’s borrowing costs near euro-era highs.” Despite the bailout, bond yields are well above 7 percent—an unsustainable level—and appear likely to stay that way, according to the story on page B16 in the Wall Street Journal (WSJ), “Bailing on Spain’s Bailout.” Greece is also back in the news, on page 3 of the FT with “ECB raises pressure on Athens over debt collateral” and on page A8 of the WSJ with “ECB Adds to Pressure on Greece.” The European story is not over yet, and it may erupt back into the headlines in short order.

The U.S. picture in the press is a bit more mixed. The WSJ ran “Unemployment Rises in Six of 10 Battleground States” on page A3 on Saturday and “Price Check: Drought May Hit Grocery Tab” on page B1, but on Monday, page B1 had “As Homes Go, So Do Pickups,” which pointed out a recovery in truck sales and home sales. The weight of the coverage is still negative—note “Bleak jobs outlook raises heat on the Fed” on page 1 of Monday’s FT—but some nuance is creeping into coverage of the U.S. Maybe it is a leading indicator.

A major difference between the two continental currency areas—the U.S. and the euro—is, of course, the relation of the regions to the whole. We fought a terrible war to determine, once and for all (I hope), that the center holds the regions, not the other way around. In Europe, that structure is still being determined. A large part of Spain’s problems have resulted from semiautonomous regions that have spent as they pleased. For Spain to meet its goals, the regions need to be brought under control. On page A4 of Monday’s New York Times (NYT), the article “As Its Debts Mount, Sicily Risks Becoming the Greece of Italy” suggests that these regional problems are not limited to Spain. Besides Spain and Italy, Germany itself is made up of multiple smaller regions that once were independent countries, and we can see this scenario playing out in the political process of all three countries, making decisions at the national level more complicated, slower, and more constrained than ideally would be the case.

The problems at the region/country level are also being replicated at the country/eurozone level, with the same effects. What this means is that, while the U.S. had two levels to deal with, in Europe there are many more. I have written before about the enormous political and economic incentives in place at the national level to make the European project continue to work. As the process evolves, it seems to me that, more and more, these incentives do not necessarily apply at the regional level. If the European project does break, then the gap between the regions and the countries may well be culprit. We may be looking at the wrong places when we look at the country level to determine the future of Europe. Maybe we should be looking more at the regions.

One final point, also relating to the center versus the constituent pieces, is an opinion piece from page 7 of the weekend FT that I found extremely interesting: “Conservatives must fall back in love with the state.” Can you imagine this headline in a major financial newspaper from the 1980s? The 1990s? Even the 2000s (pre-2008)? I can’t. I have written before about the changing political incentives in place for both parties, and this may be another harbinger of things to come.