So Much for the German ‘Miracle’

08/18/2011 12:27 pm EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

Austerity imposed on the leading European exporter’s neighbors and customers is coming home to roost, writes senior editor Igor Greenwald.

English speakers tend to think the markets are rational.

Culturally, we’re all (still) subscribers to the efficient markets hypothesis, which says that publicly traded markets reflect all relevant publicly available information.

Even as stock volatility has surged recently, mocking the notion (information was more or less static, but the prices jumped all over the place), there was the sense that the slumping European markets reflected the Eurozone’s apparent inconsistencies and illogic.

The Germans and the French are different. They didn’t pioneer the markets, and continue to view this import with deep-seated suspicion. Franco-German elites tend to view financial markets as adversaries imperiling their political plans and government policies.

So there was never much of a chance that this week’s summit between German Chancellor Angela Merkel and French President Nicholas Sarkozy would bail out the critically ill European banking sector, regardless of the hopeful buildup to Merkopalooza.

In Merkozy’s view, one doesn’t appease one’s adversaries; one attacks them. Hence the French ban on short-selling financial stocks, taking a page from similarly ineffectual decrees by Germany last year and the US in 2008.

And hence the most tangible result of the Franco-German summit: agreement to push for a tax on trading transactions.

Meanwhile, as to the goodies those the beleaguered market bulls had hoped for, there will, for now, be no Eurobonds issued on Germany’s credit. Nor any boost to the bond-buying facility widely judged insufficient to tamp down the interest rates demanded of Spain and Italy.

For a day, it seemed like Berlin and Paris might have won. European markets coughed up mere pocket change in disappointment.

But it’s now apparent that Europe’s problems are snowballing, as fading growth at its core leaves the periphery increasingly exposed to the worst of all possible worlds: a regime of austerity helping foreign banks, while domestic ones are sold ever closer to zero in the absence of debt restructuring and recapitalization.

As hedge-fund manager Ray Dalio wrote yesterday about the hard-pressed European rescue fund, “It seems like there is not nearly enough time between now and running out of money to arrive at Plan B.”

The clock is also ticking on the German growth “miracle,” with stagnant GDP data falling short of expectations, and Germany’s developed trading partners under siege.

France and the US are the top destinations for German exports, taking up more than 16%, and neither of those markets is thriving. Italy is Germany’s fifth-largest customer, ahead of China. So this is German-mandated austerity finally coming home to roost.

Auto sales in Europe are down sharply this month, as the sovereign credit crisis and related austerity undermine consumer demand. There is no good news from Rome for Mercedes.

“We were expecting sales to be weaker, but the Italian market running rate came in at the weakest in a very long time,” an analyst told Bloomberg. “Confidence is at a low in some of the key markets.”

I’d like to split the difference on the rationality of the markets. There is no rationality day to day, as traders fall under the spell of that release or that report, and high-frequency trading algorithms churn inventory.

But in the longer run, the trends tend to move in line with the developing situation, and the action in the European, Asian—and increasingly, American—stock markets keeps flashing recession alarms.

With governments in the US and Europe divided and weak, investors are no longer looking for a rescue from those quarters. And so the burden of cushioning the downturn and propping up demand falls disproportionately on the central banks, institutions able to conjure currency and credit out of thin air after a single vote by a small and mostly collegial panel of experts.

The Federal Reserve’s next move will be previewed a week from tomorrow, when Fed Chairman Ben Bernanke addresses the annual policy symposium at Jackson Hole, Wyoming.

The European Central Bank’s intentions can be followed tick-by-tick via the direction of Italian bond yields. Last week, these retreated back to an almost-manageable 5% after the ECB bought Italian and Spanish bonds.

Today, the yields remain quiescent, perhaps because growth is so weak that even Italian bonds are looking better than stocks at the moment.

But European bank stocks continue to take it on the chin. Let’s hope there’s something left to rescue by the time Merkozy get the message.

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