Europe

The results of recent elections in Greece and France have prompted me to review my analysis of the prospects for Europe. Last year I posited that Greece’s default would not cause shock waves in the global finances as it had already been factored in. I was hoping that the rest of Europe (possibly less one or two minor players like Portugal or Iceland) should be able to trade their way out of trouble, at the cost of a prolonged period of very low growth in all EU. I also predicted that Europe would lose international prestige and influence, with China, India and Brazil being the likely benefactors of this power shift.

The austerity pact signed in December 2011 appeared to confirm the political will to enact my scenario. The recent elections in Greece and France have changed all this. In Greece the centre-left coalition who had engineered the loans-for-austerity deal with Germany & Co took serious hiding at the polling booths. It looks like Greece will end up with some sort of left-leaning government with a populist program of spending their way out of the crisis. Of course this is precisely what Greece have been trying to do since 2004-2005 when the extent of their problems became apparent. Because they were already past the point where pro-growth policies could boost the economy sufficiently to service the country’s debt the recent spending fit only landed them in an even deeper hole. To me “growth, not austerity” is just another way of saying “we want more time at the trough before it all comes crashing down” and is rather self-serving on the part of the politicians. But, in my analysis, this really does not matter because Greece is toast and everyone knows it. All it means is they will sink with a bunch of leftists at the helm.

What however has a rather significant impact on the future of Europe is the political shift in France. The assumption had been that the “core” EU countries (Germany, France, UK) would anchor the painful transition to solvency; undersigning more loans for the weaker players, driving political processes ensuring the austerity deal is adhered to etc. Well, this concept is now history – France will not stand by Germany as the enforcer of fiscal responsibility. In fact Monsieur Hollande is likely to re-negotiate (meaning: dump) the austerity pact and loosen the purse strings in his own country. This is death knell to Germany’s efforts to introduce some sanity into the European finances. Given that Frau Merkel has used up all her political capital (and then some) to drive the December deal it is effectively game over for EU.

This forces me to re-adjust my last year’s predictions by a notch or two. I believe that the scenario of gradual stabilisation, followed by prolonged period of slow growth is no longer realistic. Not because the economic reality has changed that much (it has not) but simply due to the lack of collective political will to enforce it. One hanger-on and one “core” EU country have already baulked at the austerity pact (barely 6 months old!) and others will follow. We are no longer looking at a gradual economic recovery but rather at a break-up of the Euro zone and collective debt default. This scenario comes in a range of flavours – from a semi-managed political process to train wreck. I am not, at present, willing to speculate on which of them is likely to eventuate but will instead focus on the steps on the way to the inevitable end of the Euro zone.

Paraphrasing de Tocqueville’s quote there is no depravity a government will not commit when it runs out of money. Populist governments serve the interests of their electorate so we can expect a tidal wave of new taxes and regulation hitting the top rung of the wealth ladder. While I am ideologically opposed to progressive income tax desperate times call for desperate measures and some increases might be justified. But when the new crop of populist governments in Europe hit the proverbial wall of monetary realities things will get much more ugly. What my crystal ball shows are vindictive, envy-driven, Bolshevik-styled legislative attacks on “the rich”. Remember – as long as 51% of the electorate think it is a good idea to shaft the other 49%, democracy will facilitate it. This will lead to a mass exodus of the top social tier from Europe (much like from Russia in 1917). Then the governments will have “no choice” but to freeze the assets of those being targeted but trying to slip out. All social conventions of post WW2 Western World will be trampled in the process of de-possessing “the rich”. It will be like the “Occupy/99%” movement on steroids, getting the legislative blessing and going feral. But the problem is modern countries cannot function without strong, resourceful, inventive middle class so the decapitated corpse of Europe will wander aimlessly for a while before collapsing.

The international consequences of the collective default of Europe may be dear. It is one thing to cut one’s losses in the world of commercial finances but considering the sums involved, the sovereigns will intervene. We had a foretaste of it when an Iceland bank collapsed, taking the savings of the British subjects with it. Although this was a commercial failure of a free market entity suddenly the UK became agitated and pressured Iceland government into guaranteeing deposit refunds.  Looking into the future: if France owes China $100b in bad debts – how much is French Polynesia worth? What about the Greek islands in the Mediterranean? Chatham Islands? If you do not believe in the link between economy and wars think about the Weimar Republic. There will also be a lot of friction between the European countries over who owes whom what (and in which currency), who has “sold out” to China etc.

I believe the events will unfold quickly and before the end of 2012 we will see some signs of the approaching storm.

Europe – update (1)

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