Will Europe’s Democracy Problem Bring Down The Euro? (EUO, VGK, VWO, EEM, EPV)
Justice Litle: With Greece threatening to torpedo the latest rescue deal, Europe’s real issue is democracy. “They must be crazy… this is no way to run a country.” – Senior executive at a large Greek firm
For stock market bulls, the eurozone fix didn’t have to be long term. It just had to hold through Christmas (or at least Thanksgiving). The agreement to write down 50% of Greek debt seemed to accomplish that.
But then a funny thing happened: Greece threw a monkey wrench into the works.
In a surprise move this week, Greek Prime Minister George Papandreou called for a referendum (popular vote) on whether to accept the eurozone bailout, stunning France and Germany. The Greek government then revolted against Mr. Papandreou, calling for a no-confidence vote.
The net result: Total chaos. Will the rescue deal go through? Will the Greek government collapse? Will Greece be forced to exit the eurozone?
The outcome matters — to everyone — because markets have become so “headline driven” as of late, and Europe-driven in particular.
As the above chart shows, equities have been trading almost in sync with the euro. To understand the volatility swings, stock pickers have had to keep a weather eye on not just Greece or Germany, but obscure countries like Slovakia and Finland.
Many are infuriated with Prime Minister Papandreou, blaming him for wrecking things at the last minute (and causing markets to tank). But the episode goes to show how twisted Europe has been all along.
Papandreou called the referendum to try and appease an angry populace. Does Greece really want the bailout? Does it really want the euro? The people just aren’t sure, even though an exit could be fiscal suicide.
The other eurozone members, France and Germany in particular, are thinking about the bigger picture. As the German newspaper Süddeutsche Zeitung wrote:
As tough as it sounds, Greek politics is no longer just the business of the Greeks alone. … Greece’s fate also determines that of the other 16 euro-zone members. And if it’s true that the future of the European Union hangs on the euro, then the entire project is in jeopardy.
In other words, Greece can’t walk away without threatening a violent chain reaction… one that possibly topples Italy, or even Spain.
And yet, the Greek man in the street has known from the start that the real “rescue” is not for him — it is directed at the mega banks. The goal is to save the big financial players. Once that is accomplished, the hardships of the people are no real concern.
Greek citizens are not the only ones who know this. The Italians and the Spanish know it too. The deals are not for them.
This is why the bailout terms and rescue plans will keep getting tougher, and responses more hostile, until the math finally becomes impossible. Both sides are frustrated. It isn’t just that the sums grow astronomically large when Italy and Spain are factored in. It is also that Germany, the “deep pocket” of Europe, grows increasingly hostile as the checks get bigger.
In a very real sense, Europe has a democracy problem:
- The indebted populace (Greece & co.) is furious at the harsh rescue terms.
- The Germans are furious at having to mount a rescue in the first place.
- Both sides would rather call the whole thing off… but they can’t.
This is why Europe’s politicians have appeared so clueless. The only way to “save” the euro is to ram through a solution rejected by the democratic process. If such things were put to a popular vote, the euro would have dissolved long ago.
It’s too late now to simply ditch the euro, though, because a currency breakup would be horrendous. Those who argue against the referendum say Greece is playing with fire, and does not realize how badly it could get burned.
There is no straightforward way out. The big banks, loathsome as they may be, are still vulnerable. Businesses across Europe, deeply intertwined in cross-border currency transactions, are also vulnerable. To indulge the populace is (possibly) to invite catastrophe.
Europe has edged to the brink of disaster multiple times, caught itself at the last moment, and backed away. The habit of returning to the brink is born of Germany’s refusal to take the “nuclear” option: Some form of unlimited guarantee, coupled with “euro bonds,” that would be the fiscal equivalent of printing currency to monetize away the bad debt. (The mere thought of such horrifies the Germans.)
When Germany finally caves in to a printing press solution — if it ever does — the euro will fall sharply against the dollar, possibly to multiyear lows. This would lead to “risk off” all across the globe, as the USD and risk assets are negatively correlated. (When the dollar is rising, risk assets generally decline and vice versa.)
Of course, if Germany refuses to cave, Europe will continue its “edging to the brink” pattern until disaster finally strikes.
If a new disagreement from Greece doesn’t do it, then one from Italy will… or Spain… or a disgruntled creditor like Germany or Finland or Slovakia. When the wrong rescue deal fails, all the king’s horses and all the king’s men will not put the eurozone back together again. And that will hit U.S. markets too.
Either way, the timetable for the reckoning is accelerating…
Related: ProShares UltraShort Euro (NYSE:EUO), Vanguard MSCI Europe ETF (NYSE:VGK), Vanguard MSCI Emerging Markets ETF (NYSE:VWO), iShares MSCI Emerging Markets Index (NYSE:EEM), ProShares UltraShort MSCI Europe (NYSE:EPV).
Justice Litle is the Editorial Director of Taipan Publishing Group, Editor of Justice Litle’s Macro Trader and Managing Editor of the free financial market news e-letter Taipan Daily. Justice began his career by pursuing a Ph.D. in literature and philosophy at Oxford University in England, and continued his education at Pulacki University in Olomouc, Czech Republic, and Macquarie University in Sydney, Australia.
Article brought to you by Taipan Publishing Group, www.taipanpublishinggroup.com.