Better Days Ahead for Europe

05/15/2012 11:45 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

An obvious solution ignored for years now represents the last and best chance for preserving the union, writes senior editor Igor Greenwald.

“Europe is bankrupt and imbecile. Its wealth is a delusion, its science a fraud, and its art a mere shadow. The more I poke it, the rottener and more visionary all its stage conventions seem, and the more inevitable its quick and complete downfall.”

And: “Positively I sit here, and look at Europe sink, first one deck disappearing, then another, and the whole ship slowly plunging bow-down into the abyss; until the nightmare gets to be howling.”

That’s not some pundit forecasting the breakup of the Eurozone: hardly anyone writes this well these days. That’s noted American historian Henry Brooks Adams in letters dated 1897 and 1901, toward the end of the Victorian Age that marked Europe’s 19th century pinnacle.

While others celebrated breakneck progress and imperial glory, Adams saw growing trade rivalries pushing traditional powers into a series of unaffordable colonial wars. Two world wars sandwiched around a depression followed in due course, and then 66 years of unprecedented European prosperity.

What does all of this have to do with the Euro-record Spanish-German yield spread seen today? Only everything.

The point is, things change. Today’s consensus is tomorrow’s debunked delusion, and perhaps dogma again some years later.

Think Europe is the Costa Concordia or the RMS Titanic? Well, just who doesn’t these days? How much money will be made or saved by extrapolating outright collapse from current difficulties? Not much, I’d wager.

The time to be skeptical and bearish was two years ago, when Europe had just embarked on the disastrous policies that have now brought it low. The patient was only starting to be bled back then. Consumers hadn’t yet been squeezed to protect creditors. The negative feedback loop from higher taxes and shrinking spending hadn’t yet taken its toll on private enterprise.

And now? Greece can’t form a government simply because voters didn’t elect enough fools who’ll sign up for a rerun of the last two years. The alternatives may or may not be better in the short run, but at least they promise a longer-term recovery, whereas the current approach pretty much guarantees misery without end.

Voters in Europe’s second most important nation, France, have just elected a president who campaigned against austerity and for policies aimed at sparking growth. Right now, the bond markets are informing him he can’t. But, let’s face it: the European bond market right now is made up of a bunch of horribly overextended banks, and theirs will not be the last word.

More likely, the last word will come from Europe’s most powerful nation and its glue—Germany. Germany invented modern Europe with French help to get away from last century’s nightmares. Germany has zero interest in abandoning that project.

As for the cost of getting it back into working order, Berlin faces the same choice as ever: send the bill to its taxpayers, or finally let the European Central Bank become the buyer of last resort, giving the countries now being bled the necessary time to put their economies in order.

Only one of those choices stands much of a chance of keeping German Chancellor Angela Merkel in power past next year’s election deadline, and if she needed any proof of that, it’s been supplied by a virtual rout of her party Sunday in elections in North Rhine-Westphalia, Germany’s most populous and economically powerful region.

The left-of-center winner promised more spending. It seems to be a winning platform at the moment.

The European Central Bank’s fabled printing press has loomed as the likely solution to this crisis for so long that most market participants have always assumed it was only a matter of time before it made a lot of dodgy debt disappear into the ECB’s vaults in Frankfurt. The money machine sputtered into action long enough to stave off a banking collapse back in December, and as soon as it was idled again in March, the next stage of the panic began.

The obvious solution has been apparent for a year or more: the ECB caps interest rates for countries deemed to be making satisfactory progress on structural reforms, by pledging to buy their bonds in unlimited quantities.

Is that allowed under the Eurozone treaties? It’s not clear, but let’s be honest: Greece’s exit is definitely not allowed by the treaties, yet London bookmakers won’t even let you bet on that “impossibility” any more.

You’d think the recent Long-Term Refinancing Operations for the European banks would have broken any taboos, because it seems ludicrous to lend unlimited amounts to dodgy private banks, and not to struggling but fundamentally solvent sovereigns. The ECB has bought sovereign bonds already, of course, just not in the bulk needed to make a real difference.

But unlike two years ago, when there was a different path to explore, workable alternatives have now dwindled to slim and none. The choice is down to the ECB confronting the markets with unlimited firepower or speculators forcing politicians to try to raise revenue voters simply won’t approve—the new taxes further damaging the economy, shrinking future revenue to boot.

So: few remaining taboos, pressing need, no viable alternatives, political cover based on recent election results. This is not a disaster in the making; this is a Europe that is going to rediscover pragmatism.

Merkel and France’s next president, Francois Hollande, are both politicians who pride themselves on their common touch. They know which way the winds are blowing these days, both political and economic.

Expect a European pivot away from number-crunching public deficits and toward measures meant to revive demand, including higher public spending in Germany. This is a far better prospect than anything Europe had to look forward to in recent years.

The European economy has to this point endured a relatively mild recession. It can most certainly be saved, and there will soon be all sorts of life preservers in the water.

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