EUROPE AT A TIPPING POINT?
Ambrose Evans-Pritchard recently wrote an excellent piece in the Telegraph covering the many risks in Europe. While the public goes out of its way to blame the U.S. they seem to constantly overlook the many mistakes Europe made during the past 10 years. I have long said that the U.S. is no more to blame than anyone else. In fact, you could easily make the argument that Europe is more to blame than anyone else. They essentially fueled the emerging market bubbles while amassing housing bubbles that nearly doubled those in other parts of the world – including the U.S. If the U.S. is guilty of anything it is guilty of being the biggest component of the global economy so its natural for the U.S. to bear more of the burden. And I am rambling….
Europe has undoubtedly played this global game of chess worse than anyone. I was very critical of Ben Bernanke in early 2007 for not cutting rates when the yield curve inverted, but that didn’t even compare to what Jean Claude Trichet was doing. The ECB and Jean Claude Trichet actually continued to target inflation and raise rates in the midst of the crisis. It was already clear that Europe was slowing and inflation was barely above the historical average, but the European Central Bank arrogantly assumed that they were contained from global problems. This could perhaps prove to be the greatest gaffe in central banking history. Did they not know they were more than 5 times more exposed to high risk loans than the U.S. or Japan? Did they really think their economy had decoupled from the U.S.? Pritchards writes:
Almost all East bloc debts are owed to West Europe, especially Austrian, Swedish, Greek, Italian, and Belgian banks. En plus, Europeans account for an astonishing 74pc of the entire $4.9 trillion portfolio of loans to emerging markets.
They are five times more exposed to this latest bust than American or Japanese banks, and they are 50pc more leveraged (IMF data).
With over 50% of S&P 500 earnings coming from abroad it’s hard to imagine how earnings can begin to recover any time soon with the impending weakness in Europe. Despite historic actions by central banks across Europe they remain well behind the 8 ball. In addition, UK housing prices, though nearly twice as bubbly as America’s, have only fallen 25% – about in-line with U.S. prices.
There are some incredle risks in this market and the majority of investors and pundits appear convinced that the worst is behind us. I believe Obama is exacerbating the issues and the problems abroad appear to be picking up steam. Owning equities at these levels carries substantial risks….
"but the European Central Bank arrogantly assumed that they were contained from global problems. This could perhaps prove to be the greatest gaffe in central banking history."
Rather *you* assume that slashing interest rates would help the situation. Perhaps Trichet and his brethren realised that cutting to Zero in these circumstances would be entirely pointless and, in effect, emasculate the power and impact of the Central Bank. Look at the BoE and Fed – they have both proved that the market sets rates and the Central Bank follows!
History has patience, we will not be in position to judge these actions for a decade (perhaps longer). By then, if Europe *doesn't* detangle through political meltdown, then I suspect the Euro will be a significantly stronger currency than the Dollar or the Pound (which will likely have ceased to exist and rather be a consituent of the common currency).
I have to disagree. Clearly, hindsight is 20/20, but the ECB's strict focus on inflation (when deflation was the real risk) was an incredible error in judgment. I don't think there is any question the Fed, B of E, and ECB could have significantly eased the credit stresses had they been more proactive. But you are correct – they are reactive entities which is exactly why their policy actions are often so destructive.
As for the $USD vs the Euro – I don't know. The Euro is about the enter a very trying time….
But we both know that the Bundesbank/ECB will take a decade of deflation ahead of even a *risk* of severe inflation – whether that be right or wrong.
Either way, time will tell my friend – great blog – keep it up
Thanks for the kind words.
Of course you are correct. I don't know what is worse – the single mandate of the European banks or the Feds need to try to fix every problem in the US economy….It seems any intervention is counterproductive in the long-run.
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