10/29/12 – Europe in the Hurricane

Posted by Brad McMillan, CFA, CAIA, MAI

This entry was posted on Oct 29, 2012 1:10:34 PM

and tagged Europe

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A metaphor I have used repeatedly to describe the European crisis is Hurricane Season, where individual storms brew up and slam into the mainland, with the consequent damage that implies. It is a good metaphor, which is why I use it, but it occurred to me as I looked out my window at a real hurricane that it was worth another look right now.

High winds continue to blow. Hurricane Spain spun in a while ago and simply stayed put, battering the markets. Just when the winds seemed to be dying down, Spain started to fragment into potentially smaller storms that could still cause wider damage. See “Europe’s Crisis Spawns Calls for a Breakup—of Spain” on the front page of Monday’s Wall Street Journal (WSJ). See also “Spanish Joblessness Above 25%, A Record” in the weekend WSJ and a similar article on page B3 in the New York Times (NYT).

Hurricane Italy is gaining strength again, after seeming to veer away from the mainland. Former Italian leader Berlusconi was sentenced to prison for tax fraud, as reported over the weekend; he then reversed a decision to remove himself from politics by threatening to pull his support from the governing coalition. The levees are starting to erode in Italy.

Greece also fits into the metaphor, as levees have collapsed there as well—in this case, levees of denial. A long-standing scandal involving a missing list of politicians with Swiss bank accounts bred another chapter, as an editor was arrested for publishing what seems to be another list of Greeks with Swiss accounts.

I could argue that the past couple of weeks have been the eye of the larger European hurricane and that we are now moving into the second phase of the storm—which might be worse. Indeed, Wolfgang Schäuble, the German finance minister, stated last week that “I’m not so sure that the worst of the crisis [in the eurozone] is behind us.” Nonetheless, the second phase of the storm is the beginning of the solution.

With the first phase, the problems have been revealed. Weaknesses in the levees have started to erode, flood zones have started to flood, and areas of people who refused to evacuate now have, by and large, become willing to leave. That is precisely where we are now.

Europe now has a pretty good sense of where the problems are—Spain and Greece, of course, but also France. Solutions have been tried, some of which worked (Ireland) and some of which did not (Greece). The institutional mechanics of dealing with these problems have notably evolved. The decision to bail out the Spanish banking system was made quickly and without fuss, and the European Central Bank is finally ready and able to act fully to contain the crisis.

Because the problems are identified, it now becomes a question of whether the countries are willing to actually solve them. Overall, the signs are good. Germany is actually probably willing to give Greece another extension, per “German Lawmakers Shift Toward Extending Greek Aid” (WSJ, p. A7). The French are starting to get serious, per “French chiefs turn up heat on Hollande” (Financial Times, p. 2). Greece is starting to address its own problems, as denial erodes per the stories mentioned earlier. Even Italy is making progress both economic and political, as Berlusconi is clearly on his way out.

The storm is not over, and we are moving from the eye back into the high-wind zone. That said, this is the phase that can and hopefully will lead to resolution, if the levees don’t break first.

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