Europe is partying like the good old days.  And why not?  It looks like the crisis is in the rear-view mirror.  But I don’t think that’s necessarily the case.  The reason is simple – the cause of the problem has not been fixed.  The fact is, Europe is an unworkable currency system.  There are no floating exchange rates between the economies and there is no fiscal entity willing to rebalance the imbalances that result from the trade issue (which is largely the result of the lack of floating exchange rates).  So what’s happened is that the periphery nations have borrowed from the core nations in order to finance their spending binges, but because they don’t create their own currency they have a real solvency risk.  So now we’re in a position where the governments are forced to cut spending in the midst of a balance sheet recession and the austerity is hurting growth without bringing the debt to sustainable levels.

The only reason we’ve seen a reprieve in the crisis is because the ECB has stepped up and implemented what is essentially a sort of ponzi by allowing the private banks to borrow at cheap rates and purchase government debts thereby reaping a profit.  The ECB thinks they’ve resolved the solvency crisis without allowing the periphery countries to print money.  But the reality is that the math just doesn’t work for most of these countries and while this sort of lending operation can alleviate pressures it does nothing to actually fix the problem in Europe which is at the highest level of the monetary system’s construction.   And when the core government’s realize that perpetual bailouts are the name of the game and the economies remain very weak we are going to see someone come to their senses – it will either be the citizens through revolt or the core governments through disgust.  But I have a very hard time seeing how this problem doesn’t continue to pop up time and time again in the coming years if not dealt with at the highest levels.

So how might it play out?  An excellent post from a European blog has the potential catalysts for the next leg of the crisis:

“The second Portuguese bail-out, although likely, is not certain. The Greek election is not legally due until 2013, despite the lack of democratic legitimacy of the present technocratic government. May be Hollande and Merkel will put their differences aside. Unfortunately, I doubt it…

It seems to me that all this creates an extremely fertile ground for “Crisis” to return to the front page of Europe’s newspapers as early as the second half of 2012Q2. Clearly, the timings of these events are uncertain at this stage. However, whether they are desynchronised or fall on the same week is irrelevant. All these events are likely to materialize and their interaction promises a substantial amount of political, financial and economic turbulence for the Euro-Zone. The chaos resulting from a Portuguese Bailout and from the Greek elections demands compromises, which would be difficult to achieve under calm and trusting conditions.

That being said, there is no reason why the EFSF/ESM, flexible and fully financed would not be able to interveneEven in the likely event that it does not, the ECB has a virtually infinite fire power, which it could use to stabilise markets. The issue is not whether the resources exist to rescue countries, but whether the political willingness is present to provide it in a prompt manner.”

Once again I am reminded of the old Minsky quote – “stability creates instability”.  And just when the ECB thinks they’ve stabilized everything it could very well be that they’ve destabilized everything….I could be wrong, but something just doesn’t add up here….


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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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  • VII

    The Honey Badger( SPX) doesn’t care about Europe. It gets bit and just keeps on going..nasty $&$&

  • Andrew P

    Infinite ECB firepower can kick the can for far longer than an individual bettor can remain solvent. It has been said many times before – the EuroZone will break when there is a political failure, not a monetary one. There does not seem to be any will among the people of the PIIGS to secede from the EuroZone. When the rubber hits the road, all PIIGS political parties, whether right or left, behave identically. Perhaps there is more will for independence among the stronger states of Germany and France. Or perhaps turning Brussels into a real EU Federal Government to save the EuroZone will induce the UK to leave the EU (assuming the UK itself is even in one piece).

  • In Accounting

    Loving your comments lately VII, and I agree on the honey badger remark. It’s astonishing how well the spx is going. After a great 2011 in treasuries I have finally relented and put on major exposure to spx.

  • Stephen

    LOL “major exposure” after what 30%+ coming into the end of the seasonally bullish season.I suspect “bit” is exactly what’s in store.You might wish to consider the maxim that rallies always need someone to sell to when they get overextended.Are you him?
    Sounds like we have some people believers in decoupling…good luck ith that. The chain with Europe in the middle as the main client for Asia goes…austerity goes relative strength to the dollar goes weakness into equity performance goes Asian manufacturing weakness goes US exporting weakness etc etc.Basically if Europe cannot pick up it’s end then Asia drops and then US drops.Period!

  • VII

    Then don’t buy until e erythin u know… Which the market knew 12 months ago is sorted out.
    I let the SPX tell me when I should sell the SPX. Not economic logic or decoupling discussions.
    I don’t opinion on that. My job is to make money not discuss decoupling scenerios I’m not smart enough to figure out. I’ll leave that to you. In the meantime if u have some stocks your selling today on the pullback I’m more then ready to be your greater fool.

  • Sormiou

    Talking about Europe and the return of “country risk” : it is actually quite ironic to notice that the Eurex exchange (main European derivatives exchange) will be launching a 10yr OAT bond (french bond) future on April 16th.
    There used to be an OAT future before the euro (so-called “Matif notionnel” contract trading in french francs at the time). But then the euro was introduced
    and you know, all of of a sudden there was no more country risk any more in Europe, just a single zone huuummm… so to hedge any interest rate risk in the zone everyone was happy to use BUND/BOBL future..not anymore obviously since last year and this french rates future rebirth is quite symbolic to me.

    And as I said on previous comments, considering the tone of the current presidentual election in France with the two leading candidates(Hollande and Sarkozy) willingly pretending to ignore the size of the budget/fiscal hole the country is in, there goes your S2 2012 / H1 2013 short, welvome OAT future !!!….

  • Martin

    Agreed Sormiou, no need to ban naked Sovereign CDS anymore on France. If you want to go short France and hedge your risk, there is a new product in town, aka OAT Future courtesy of Eurex (got to love the irony there…).

    Unintended consequences for European politicians meddling too much with the European bond market. Oh dear…

    So yes, welcome back OAT Future !!!



  • Stephen

    “if u have some stocks your selling today on the pullback I’m more then ready to be your greater fool.”
    Wrong tense you already were.You don’t sell when they are coming off you sell while they are still going up but fundamentally should not be.No interest in apissing contest my remarks were out of line in that I don’t usually make statements to influence other people because in this game it’s all about us as individuals and what we know and can stay with.Another word for discipline.
    Good luck and I’ll be buying from you later in the year ;)

  • VII

    If Europe and china are conned to the U.S growth and won’t decouple then why would we not assist them in any way possible?
    The fact a fire ther could burn our house is one more reason well help put it out.
    Further if china is slowing itself…. Self induced then why should u care about that which they’ll unwind.
    Chinas contracted 5 months straight. Would u rather buy the U.S when the ISM is 40 back in 09 or 60 back in 07?
    Europe…. What if they fix it?
    Your roadmap assumes the worse when they live in the home on fire. I suspect all this will get fixed. I don’t know how and I may lose a couple % getting stopped out or I lose more but even in 87 the market told u something changed prior to OCT. when it does change I’ll the second one out. But not because of a Mauldin presentation at the Montage in laguna beach on decoupling and 50 slides showing the decline. I’ll keep it simple…. When the SPX declines 7-12% as a warning I’ll worry. But it will give me a chance to getback to even.

  • VII


  • jt26

    I don’t see the Europe situation as being any different than the U.S.. What’s the probability of political failure of 16 “decision makers” vs. 1? From a random Gaussian POV, one could say the odds are 4X higher but, France/Germany/Italy have (surprising, even to me) been remarkably in synch. I think both blocks are at risk for a flair up as we go into U.S./French/German elections.

  • VII

    Stephen you don’t know what you talking about.
    There not coming off. There hitting support and responding like a bull market. Until this changes your making a mistake.

    It’s funny really. I made the same mistake. I lectured someone here. I don’t care what the SPX does. But it has NOT shown any signs to worry yet. NONE. until it does your watching eveything but the one thing which makes money.

    How is this lost on you if you know what your doing.

  • SC

    I’m “making a mistake”.Well I guess you hope that.However, I’m old and I’ve done this stuff countless times already and on balance I don’t make many meaningful mistakes. I’m not uber bearish equity here anyway as I’m aware that in the beauty contest as it stands there are limited options for people to throw silly money at because the central banks have done a AAA job of making values almost indicipherable .No, I just don’t take pennies when pounds are at an higher risk which of course is why I sold a multi decade property portfolio whilst people here in the Uk thought it was still the bees knees …LOL now that’s what you get when you don’t know what you are doing….. ;)

  • Larry

    @VII, what Long positions do you like/hold, if any, in addition to SPX? I have been buying DVY on the theory that if there is a downturn, the div-paying equities won’t fall as fast, plus the income is nice if we go sideways for a while. Any sectors or areas of risk assets look good besides the SPX?

  • Belex

    @ sormiou….why should Europens needs to worry about fiscal hole and that same hole is just great in US

  • scout

    I hope with all these grammatical errors that this is not indicative of the intellect of most investors reading this site.

  • Jose

    Good analysis. But Ireland just got back to recession mode. Let’s wait to see what will happen to the pro-euro mood in the PIIGS after a couple of years of recession nearing depression with no end in sight.

  • Texan

    Just a general observation….

    I know that central bank action has relieved the pressure on Europe, but it’s amazing how so many view the situation optimistically now vs a few months ago when just about everyone was saying it was going to blow up. Central bank can kicking is some powerful stuff!

  • B Ferro

    A bunch of south/Latin American countries blew up and defaulted in the 80s/90s and ppl freaked back then because like now, banks had a ton of that crappy paper on their balance sheets like they do today. Nothing ever really happened though and we all moved on. Could the same happen today with Europe?

    Also, what with China shifting growth internally does the Euro-zone trade surplus/deficit issue work itself out naturally as a result? Does it somehow turn EM-driven growth / export powerhouse and trade surplus nation into a deficit country as those exports slow and by default, reduce the trade deficits of the peripherals? Could the global economy, as it has always proven, be that dynamic and self-balancing?

  • JWG

    If the ECB is willing to use unlimited keystroke money to bail out European banks, the short term crisis is over. This will also ensure that structural reform will not occur in the Eurozone and that a long term crisis in competitiveness will be locked in.

  • Martin

    Hi Belex, there is a big difference that comes to my mind, namely that US citizens are taxed on their worldwide income and the US tax administration, the IRS, is pretty efficient when it comes to tax collection.

    Monti in Italy has accomplished more for Italy in 6 months than France in 10 years when it comes to structural reforms. By the way, Italy has still a primary surplus in its budget (doesn’t when the surplus is here to stay, but that’s another matter).



  • Larry

    Even if the short term EU crisis is over, Europe is still entering into a growth recession, or outright recession. How deep will this recession be? Will it be deep enough to impact 1) China’s exports, and (2) U.S. economic growth? I’m betting that it could reduce U.S. growth by 0.5% to 1.0%.

  • Old Dog

    I’ll continue to place my bets on capitalism, and fortunately capitalism is still thriving. I don’t think central banks are going to handcuff their own nations and push them into the pool.

    The political will is there. How many times will we continue to question it?