Europe’s Falling Dominoes

11/07/2011 11:17 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

Silvio Berlusconi and George Papandreou won’t be missed, but their successors are unlikely to fare any better, writes senior editor Igor Greenwald.

Do Europe’s odds grow appreciably better with two fewer jokers in the deck?

Investors seem to think so. They bid up global equities Thursday on news that Greek Prime Minister George Papandreou was on his way out, effectively deposed by Germany and France after calling for a referendum on the restructuring plan they negotiated a week earlier.

Papandreou is to give way to a coalition government whose sole goal will be to secure the promised aid and pave the way for new elections in February. Greece getting back on the path of permanent austerity removes the risk of an imminent default, with its nightmarish implications for the European banking system.

Italian Prime Minister Silvio Berlusconi, perhaps the only European leader with less credibility than Papandreou, doesn’t seem likely to outlast him by much, if at all. Italy’s depressed stock market jumped early Monday and the downbeat global tone improved, all on speculation that the scandal-ridden strongman would resign rather than risk losing a vote of no confidence.

That could open the way for a government by technocrats tasked with pushing through the budget and pension reforms demanded by Italy’s partners. And that, in turn, might get the European Central Bank to buy more Italian bonds, taming the punitive interest costs that are eating up all of Italy’s projected budget savings.

The trouble with that line of reasoning is that new leadership in Athens and Rome would merely ensure that Greece and Italy stay on the self-destructive austerity track that’s already depressed Greece, and threatens to plunge Italy into a recession at any moment.

German prescriptions for Greece have the economy contracting by 7% a year and mocking the government’s revenue-collection goals. In Italy, a similar dynamic may be taking hold. The spending cuts now on the table are likely to weigh down the economy for years. Yet, unless borrowing costs plunge the way the way they never did for Greece, Italy is unlikely to end up any better off two years later.

Instead, of course, Italy’s ten-year yield is up to a record 6.53%, nosing into the danger zone that prompted Greece, Ireland, and Portugal to seek bailouts. Any improvement in the wake of Berlusconi’s departure is likely to prove temporary, more so if the next Italian government actually makes the cuts Berlusconi keeps promising.

And in the meantime, the bond insurance scheme designed to replace bond buying by the ECB remains on the drawing board.

Europe may have already run out of time, as economic weakness spreads from the periphery to the continent’s core. Germany’s industrial juggernaut is markedly slowing. France is raising taxes into the teeth of an economic downturn. Danish prospects are wilting amid a credit crunch.

And if Europe’s core sneezes, the likes of Italy and Spain figure to catch pneumonia in a hurry. Spain’s socialist government is likely to lose to the conservative opposition in two weeks’ time, the latest casualty of popular discontent that has already replaced the governments of Ireland and Portugal.

The notion that caretaker governments in Italy and Greece will somehow succeed where their predecessors failed in the absence of popular support seems far-fetched. And popular support is so questionable that Europe panicked at the prospect of a Greek referendum.

No wonder gold keeps going up. There are no obvious exits out of this mess that don’t involve a lot of pain, followed by lots of freshly printed money.

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