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I pass with relief from the tossing sea of cause and theory to the firm ground of result and fact

Monday March 12th 2012

"...I pass with relief from the tossing sea of cause and theory to the firm ground of result and fact ...”

Sir Winston Churchill
 
In the past few years the markets have endured a storm tossed sea, holding hard on the rail; watching in amazement as the debt dance in Greece ran ahead of other periphery nations.
Not until last week was any semblance of relief felt as the PSI bond swap was consummated. The wise heads at ISDA did mark the swap as a "credit event" and in doing so prevented the sovereign credit default swap (CDS) market from being torn to shreds. It is absolutely correct that a body with respected authority has called the situation for what it was... A DEFAULT.
However, as a new week in the financial funfair begins, can we really be confident that we have disembarked from the ship that carried across those waves of wrath and now stand on genuine firm ground? Last week Spotlight called the arrangement or PSI a "Debt Swamp" and our fear is that all we have done is exchange the waters for a marshy bog.
Suddenly the Forex markets exhibit less doubt over the Euro. All will be well. Still at a time when the call from the political power centres of the EZ...ah yes...Berlin...and Berlin is for more and ever "MORE EUROPE" i.e. closer integration at the fiscal level ... why is it we hear the financial power base of the EZ, that would be Frankfurt, cry that future policy has to be shaped by recognising that the Euro Zone is not a single nation such as the United States where "federal" institutions have been tempered by civil war and nearly 100 years of process.(the Fed was created in 1913).
Enjoy yourselves if for one moment one thinks that we have truly stepped from a sinking ship and planted our feet on terra firma...what we have is stepped onto  "turbatus terra" ... troubled land.
Troubles ahead:
France ~
The French Presidential Election is run over 2 rounds in April and May if no one candidate gets 50% + in April.
Of the leading candidates the current standing is Hollande 29%   Sarkozy 27% Le Pen 17% Barou 11.5%Hollande has stated he will renegotiate the fiscal compact. Similarly, as a left leaning politician will France really implement supply side reforms that it needs. if Sarkozy hasn't delivered how can anyone expect Hollande to do so? It is highly likely that France will seek to pursue as many protectionist measures as legally possible within the EU/EZ. The relationship between France and Germany runs a risk of being far from cordial.  

Spain ~
    ... going into May for a head to head runoff, the polls place the advantage with Hollande by 55:45.
Spain has suffered more than most in the EZ since the economic downturn took hold. We have to respect the fact that the Spanish government did not embark on a borrowing binge, however the general public did ...indeed as more was borrowed and spent at an individual level, so the public finances of Spain actually looked smarter as tax receipts soared.
Spanish households took on bigger and bigger mortgages and as demand outstripped supply so house prices rose 44% from 2004 to 2008. The prices peaked just as the property market fuelled by sub prime mortgages collapsed. Asset values are falling fast as the average price of a home in Spain has fallen by 35% since the peak of the market 4 years ago, according to the country’s economy minister Luis de Guindos.
De Guindos told "El País" as saying that “...finished housing sells at a discount of 35% compared to prices before the crisis...”.
This will unsettle many in Madrid as his view is far worse than official government data suggests! Standard & Poor’s, home prices in Spain are expected to fall well into mid 2013 due to lack of market activity in relation to the overabundance of housing stock on the market, estimated at 800,000 homes. What can be said for Spain when it is known that the numerous banks still hold on their balance sheet property and land assets marked at 100% of their face value...not a more likely 50% - 65%.Whilst PM Rajoy begs for more time in reducing the fiscal deficit the real fault in the Spanish system is within the banking structure itself. once again reality is being denied.
Portugal ~ 
We have left Portugal to last as it is now the nation that will be clearly in the cross hairs of the markets. Even with ECB accommodation the financing costs for Portugal are too high.
We are also concerned that setting Portugal a target for Debt:GDP is financial folly.   Look again at the ratio...DEBT divided by GDP. here though the denominator is falling faster than the numerator as austerity bites. So in effect, the level of Debt:GDP is rising as austerity deepens.
Of course Spotlight is not going to underestimate what the authorities are trying to do..."BUY TIME". It is hoped that in future Greece may book a primary surplus, Spain will manage the banks balance sheet deleverage and Portugal will perhaps with a 2nd bailout avoid the need for its own PSI deal.
We cannot see that happening and even if we allowed for the best case to pan out. What has been missed by European institutions and governments is that they are essentially applying central planning from Brussels, Berlin and Frankfurt and failing to allow the market establish "comparative advantage" by unleashing "entrepreneurial spirit".
We may see the ECB and EZ buy time...but time has a purchase price...sometime soon the price has to be paid and unless the national elements that comprise the economic union are completive and liberal, buying time will merely delay the day when the debt can is not kicked, but rattled by the hands that demand payment.
Stephen Pope

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