Europe: Destruction, Courtesy of Short-term Thinking
I guess we have to get used to living in a “what have you done for me lately world”, huh? With high frequency trading, the 140 character Twitter world and attention spans about as long as a gnat’s, it looks like policy makers are increasingly being impacted by this societal change in the way we think. And I think there’s a bit of this going on in Europe as we speak and it’s having a massively negative impact on millions of people’s lives. Let me elaborate.
Every fix implemented in Europe thus far has been a band-aid on a gushing wound. And after brief periods of relief the negative long-term trends become acknowledged once again, the structural flaws reassert themselves and markets relapse. This has been the trend in Europe for years now and I don’t think it’s over yet.
As regulars know, I think the problems in Europe require long-term thinking. We need to fix the currency crisis that is causing the solvency crisis at the sovereign level. So we need one of two things to occur – a complete break-up of the Euro (very unlikely in my opinion) or a move towards some form of fiscal union (the likely direction). We have to return Europe’s nations to a state of sovereignty. Ie, we need to eliminate the solvency crisis by creating some form of supranational entity that can always procure funds like we have in the USA (see here for more on how the US states are like Europe’s countries and why US states are experiencing a funding crisis).
And one of the better indicators of persistent crisis in Europe over the years has been bond yields. And to view this short-term perspective just take a look at the 2′s versus the 10′s in Spain and Italy:
The 10′s have barely moved while the 2′s have collapsed. In other words, the long-term perspective on solvency has barely budged while yields at the short-end are cratering. What does that tell us? It tells us that bond vigilantes don’t think this crisis is close to being over yet. And given the lack of structural fixes, I think they’re right. The latest jaw boning from the ECB seems to have calmed markets for now, but let’s see if that buys them time to actually implement a long-term fix. If recent history is any guide, this is likely another case of short-term thinking for a long-term problem.
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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10 Comments
There is a lot of long term thinking, mostly by the nations who pay for the follies of the ClubMed. This thinking is centered around structural changes and complete overhauls of their economies as the one and only way to reach a self-sustainable business model.
Because the other option is that sooner or later the creditor nations will have to decide what standards of living they are prepared to fund the ClubMed, and for how long.
BTW, the recipes that -so far- worked to fund the US via money printing are not applicable to the eurozone. Not least because the US is one nation. While the eurozone is and will ever be a conglomerate of (so far 17) different nations, with different histories, languages, cultures… There will never be the United States of Europe. I hope.
“While the eurozone is and will ever be a conglomerate of (so far 17) different nations, with different histories, languages, cultures…”
Like USSR was a union of 15 Republics that used to forcefully added to the Russia Empire, and as soon as the right time came all those Soviet Republics split back into independent countries.
Those Europeans will have a hard time to melt into one single nation like USA.
I certainly agree with your point that the Euro needs some serious fixing, but it’s hard to accept this explanation for the recent divergence in the 2 year and 10 year bonds. The most obvious and simplest reason is that Draghi said the if and when the ECB will restart buying sovereigns that it will focus on the short end of the yield curve.
There have been lots of band-aids slapped on during this process, but looking at those charts the market never bet heavily on default happening 2-10 years out the way it is now. This summer and last the markets seemed sure the defaults could happen at any minute, but then post-LTRO they thought everything would be ok, forever. If not for Draghi’s explicit threat of curve manipulation, why the change this time?
To politicians, ‘long-term’ thinking takes them to the next election day. Acknowledging failure and making the difficult and necessary reforms won’t happen anytime soon because they’re afraid of losing their jobs. This applies whether we’re talking about the reforms required for the weaker nations or the question of integration or disintegration of the union (I’m in the latter camp).
We even see this thinking today in companies as they think on a quarterly or yearly basis, managing the stock rather than managing the company.
The incentives are all skewed toward short-term thinking. Change the incentives and we change the thinking.
Perhaps the reason the two’s are coming in is because that is where the ECB is buying or stated that it’ll buy. The ECB wants these two countries to come to it, cap in hand to ask for help and in return they will have to commit to more structural reforms with oversight from Brussels or Frankfurt. Why buy the 10s and let them off the hook so easily as they did with Greece. They buy the short end it only gives these countries a small amount of time in which to try and wriggle. The sword that hangs over them is the price of the 10s and if they don’t step up and agree to reforms that is what they’ll be refinancing at. The ECBis trying to lure them into to accepting the inevitable. the carrot is bringing the shorter end down the stick tis the spectre of the 10 year.
Just a thought.
Well,I think it was a “good thought”.
Moreover,not mentioned is a currency adjustment vis a vis Europes largest client base. It is not enough to suggest that fiscal unity is the answer because we are also where we are today because of European growth ,or lack of it.That may be partially explained by the balance of private and public sectors ,bit ignores the balance between European states and the external global market. Internal pain via austerity is by no means going to correct the European problem indeed a lot of movement in yields recognise that,but currency adjustment brings in the rest of the world and the overriding issue of global imbalances.
Agree with Nick, seems like this is the reaction the ECB is targeting and wants. Lower the short end; reduce near-term rollover risk. Europe will have to wait to be as desperate as the US to start flattening the whole curve (smiley).
If you go to YOUTUBE and query “ROGER BOOTLE” and Greece he makes a compelling scenario for a solution to the problem
The drop in short term Spanish debt is mainly due to the finalization of a “bad bank” scheme for the Spanish banks. Off course nothing is decided yet, but rumors keep popping up.
The ECB is not really known for its transparency, so it possible they will pull this one out if things get messy and if they can’t fix the transmission mechanism.
There was an article in the WSJ not too long ago about it, coincidently that was also when the market started to rebound in Europe like the crisis was finally solved.
To sum it up: Asymmetry of information is probably what drives this rally.
The main problem is NOT the monetary system. The main problem is the giant amount of debt. Both in Europe and the US. I see A LOT OF short term thinking in the US as well.