Europe; Coming Unglued

The financial media have, as usual, been watching a different movie.

The financial media have, as usual, been watching a different movie.

A friend recently said in reply to a comment, 'I think we're going to hell in a basket.' She is probably right but not for the reasons she thinks. My friend was referring to the consequences of Brexit. I am referring to the structural issues which are baked into the Eurozone and which are coming unwound at a pace which is very likely to accelerate throughout 2017. Standing close to an exploding bomb is never a good idea. The further away we are the better although it will take more than the English Channel and the political aspiration, if not commitment to leave, to save us from at least some of the backblast.

Political risk in Europe appears to be growing. The truth is, it never went away. It was simply subdued temporarily by successive ECB bailouts which have rescued (some) ailing banks but have done nothing to correct the systemic flaws in the Euro which have ruined southern European economies. Now, as political risk takes front and centre stage with Le Pen soaring in the polls the underlying economic risks which have been fermenting for years are at risk of ripping loose. The means of transmission are again, most likely to be the banks. You see, nothing has really changed.

We saw during the last period of Euro stress in 2011-12 that a sell off in bonds hit the balance sheets of European banks who tend to hold their own governments debt which increased their need for bailouts. In turn, that hits depositor and investor confidence which damage the banks even more creating a death spiral requiring direct central government intervention. As you may have guessed, the three countries with the banking sector most exposed to their own governments debt are Italy, Spain and Portugal.

With the ECB scaling back its bond purchases and the rising incidence of inflation yields have been rising. More importantly, spreads have been widening reflecting growing risk between member states.

Markets have so far placed a low delta on a Le Pen victory in France. Markets are being naïve. The French electoral system is designed to keep the door firmly shut against extremist parties but with the other candidates carrying baggage of their own her defeat is far from certain. Italy’s election meanwhile could result in a government under the influence of the Five Star Movement of the Northern League, both of which are committed to leaving the EU. Markets would not wait for an EU referendum result in these countries. Merely scheduling one will result in financial chaos. Meanwhile another Greek crisis similar to 2015 looks baked in when they run out of money in July.

Investors are hardened to serial crisis in these countries but are broadly complacent in their thinking that after a lot of fuss there will be another bailout and normal business will resume. Italy’s banks still hold 276bn in bad loans and the countries debt to GDP ratio stands at 134%. With 12% of the country’s bank assets being held in national debt there is a financial death spiral just waiting to be triggered. A small issue here is that Italy is the third biggest economy in the Euro block. That won’t be an easy fix.

Portugal meanwhile is back where it started with debt as high as it was in 2010. The 78bn Euro bailout there did not reverse economic trends. It did though, save the banks, for now.

The ever sensible and cautious Germans have been trying for years to neutralise this threat, first with a proposal to limit the amount of domestic sovereign debt that a bank could own. Germany failed. The second German proposal was adopted. That was to require that bank bond holders take a draw down, to zero if necessary, before government money could be used to bail out. Unfortunately, when Banca Monti Dei Paschi ran onto the rocks in December the rules were bent out of shape by using out of date stress tests and reimbursing debtholders saying they had been misled. That prevented a political fuss in Italy but has left the potential financial death spiral in place.

Other ideas, mostly based on the ‘bad bank,’ approach have circulated in recent years and include creating two classes of bonds, pooled together from the Eurozone countries, and divided into ‘safe,’ and lets call it ‘less safe.’ Loosely, that would be Germany plus one or two other countries and the rest. Unfortunately, the Germans are not big fans of either of these plans or any of their derivatives. The Germans in fact have been playing a quite crafty and streetwise game and who could blame them. German banks have pulled back their lending to non-German companies in the Eurozone over the past few years. Their appetite for shared risk is diminishing and the banks preference for keeping their money inside their national borders reflects this.

Germany itself has its own handcart of problems. Germany will of course work hard to keep the Eurozone together but it is not without its critics from both within and from outside. Germany is under constant criticism for having the largest trade surplus in the world, something that has not gone unnoticed by the Trump administration. It is ironic that Germany is the most powerful member of the very institutions that were imposed upon it in post war Europe. Indeed, the Euro was created years later in part to tie a reunified Germany to France and losing the Mark was the price paid for reunification. The trade off for Southern Europe in being unable to devalue was access to Northern European borrowing rates which allowed much needed structural reforms to be put firmly on the back burner.

Monetary union with fiscal union blocked potential wealth distributing mechanisms and acceptance of risk sharing required Southern Europe to gift their fiscal policies to Brussels. The Eurozone crisis and subsequent austerity measures have created fertile ground for growing resentment which has fanned the flames of populist movements which are gaining traction across the Eurozone. The refugee crisis and local political scandals have poured kerosene on an already politically volatile state. Growing recent civil unrest in France, (not much reported in the UK), and less violent demonstrations in Germany, reflect the heightened political volatility.

Political and economic structural tensions in Europe will continue to rise across the Continent in the coming months. They may well be contained and then abate. Protectionist rhetoric from Washington however complicates matters somewhat and are anathema to Germany’s export led economy. How the global economy, which has been designed and built around the free movement of people, goods and services reacts to fundamental changes driven by Washington remains an open question. Certainly, a much stronger dollar would be deflationary and wipe out the glimpses of inflation we are now seeing and that has a world of implications starting with Emerging markets and the $9tr of foreign dollar denominated loans which are ticking away.

With, for the moment, inflation at the gates and with bond yields rising in France and the periphery, the increased cost of debt repayments will do nothing to stabilise matters. Equities meanwhile have been skipping along without a care in the world. They may be about to stumble. For what it is worth, I firmly believe that the whole rotten construct is closer than most believe to coming completely unglued. Let’s hope that the financial boffins at the Bank of England are earning their money and are stress testing the banking and clearing system to destruction. It won’t be so very long before risk managers across the City are once again obsessed with counter party risk.

As a quiet postscript, those investment banks such as HSBC and Morgan Stanley who are making noises about moving some staff to Frankfurt and Paris, good luck. You are going to very much need it.

Alle ändern

Germany has closed it's border with Austria tonight to refugees. Poland and Slovakia remain open but we'll see how long that lasts. Clearly, there are limits to the Bavarian 'Wilkommen in der Hanglange.'

Perhaps Mrs Merkel and her Cabinet were surprised at the lack of European wide enthusiasm for her largesse and their appalling lack of team spirit in sharing the immense burden that Germany has shouldered. 

Perhaps though, her security service spoke to our security service and suddenly it's come as rather a surprise to discover that all of the tide of migrants are not quite what the media have portrayed them to be.

Quelle surpise! You mean Twitter, and the BBC sending Fiona Bruce from the Antiques Roadshow to Beruit for two days to interview one bloke who was photographed by an agency photographer selling biro's on the roadside with his daughter asleep in his arms haven't been telling us the whole picture? 

Expect a media about face within 24 hours, 'What were the Germans thinking of, putting us all at risk like that?'

Then again, Mrs Merkel might just have talked to some of the refugee agencies with decades of experience and learned that their policy is to keep the migrants within the region and close to home for when stability eventually returns to their various homelands. 

No one has greater capacity for organisation and logistics than the Germans. It is never though, Mrs Merkel, the first million people you have to worry about.

(As a quick aside, no family in the known universe is more disciplined about cross border mobile phone use than are the Crumble Kids, their dad being utterly paranoid about unforeseen big phone bills. Which company then, are all these refugees with? I want to sign up with them. If they have mobile signals in war zones in the Middle East and I can't get one in Compton in West Sussex they must be bloody good, and obviously as cheap as chips).

If there is a sudden rush of perspective and proportionality across Europe, does that mean that all the kids leaving for University this week and next will be able to return home at Christmas and find their rooms haven't been donated by their well meaning Mum's to a refugee family from Gaza?



Back after a parents trip to Auschwitz-Birkenau. It does make you think about many things…. Europe amongst them.

A visit to any of the camps is always going to be emotionally challenging. It does though, give pause for moments of reflection on many things, the current state of Europe and “could it happen again?” amongst them. Of course genocide has indeed continued to be inflicted on people across the world since 1945 and there seems to be no end, or sense, to the steady stream of racial, religious and ethnic murder and cruelty in the world. Growing divisions in Europe will not take us back to the 1930’s but the shadow of the Second World War is never far away and traditional cross border suspicions are again bubbling under the surface and are not helping; not one little bit.

Angela Merkel took office ten years ago in 2005 when Europe was enjoying the pinnacle of its success. German integration was complete, the Russians were picking themselves up off the floor, Europe was united with a queue of new entrants to the EU project and the global economy was blazing. The world though has very much changed. Europe is in crisis with many members blaming Germany for their problems. Few countries now want to join the EU and the EU doesn’t want any new members. Ukraine is plunging deeper into the abyss and fear of Russia is growing. US politicians are discussing arming the Ukrainians and storing arms for US troops in the Baltic States.

The combination of economic and political stress has led to an increase in nationalism. Those flames are being fanned by the actions of extremist Islamic terrorists. Germany then, finds itself in the unwanted and uncomfortable position of being forced to take a leading economic and political role. The good thing about that is there is no other country more unlikely to change a political problem into a military one. The bad thing is that institutionally, Germany is not experienced or adept in the handling of cross border crisis.

Reluctantly, probably the most important politician in the world today but with no easy options.

Playing in the Russians backyard and encouraging demonstrations was never going to have an elegant end. As is often the way with liberal minded democracies when shots were fired the Germans backed off and instead of supporting the Ukrainians they joined in with sanctions. Germany will not ever get involved in military action in the East but is now being forced because of its earlier political engagement to seek compromise and to cool the situation down, much to the chagrin of a number of US politicians.

Merkel’s US visit was designed to persuade the US to soften its approach to Ukraine but a deep rooted suspicion of the Russians and their intentions does not easily change in Washington and Putin meanwhile, has his own constituency to serve which will not easily accept Russia backing down without significant concessions.

Equally, the Greek situation is creating unease in Berlin. The Germans have massively benefited from free and open markets with more than 50% of GDP going to export. Growing nationalism and protection may come to threaten Germany’s dominant export position, especially if the Euro is threatened by a Greek default and expulsion with others following. Germany has been forced to adopt a tough public stance with Greece yet the new Greek government was elected specifically with a mandate to challenge Germany.

From a German perspective, they’ve been doing all the right things, including lowering their leverage ration from 80% to 76% of GDP in the last four years. The rest of Europe though has its foot on the floor and is accelerating toward the fiscal cliff edge. Of Greece’s $350bn debt, a mighty $210bn is owed to the Eurozone bailout mechanism. Germany’s share of that is some $57bn. The problem is not the burden which may be placed on German taxpayers, it’s the share which other countries have signed up to and their ability to pay. Italy for example has a debt to GDP ratio of 132.6% and so is borrowing to pay interest. But Italy’s share of the Greek liability is $37bn while France is on the hook for $42bn. France is well down the road of becoming a financial basket case with the state taking 60% of GDP and with a debt to GDP ratio of 92%, (Maastrict supposedly limited debt to GDP at 60%). The problem with these stats is that a Greek exit will be met with a storm of protests from voters when they figure out what the bill means for them and there is little doubt the political map of Europe will undergo further rapid change.

None of this is good for markets. Increasing numbers of strategists are going underweight US equities and overweight European equities. These people don’t learn quickly. In fact, they probably don’t learn at all or are so glued to their valuation models they just don’t see the storm clouds rolling in. True and transparent price discovery of debt instruments in Europe is currently non-existent. That will happen when a central bank quadruples its balance sheet over ten years as the ECB has done. This of course was a necessary requirement to save European banks which had become insanely leveraged into the 2010-12 peripheral debt crisis, (DBK @ 56x for example with $1.9tr of assets and only $36bn of tangible equity).

As I wrote at the time, the unwillingness to force speculative investors to take losses and to underwrite them would simply store problems for the future. The future has arrived but paying the piper is now going to have a political cost and not just an economic one. Of the two alternatives, allowing Greece to go and watching the whole experiment unwind at great cost to the German taxpayer, or appeasing Greece, and subsequently other countries, at great cost to the German taxpayer neither is particularly palatable. The problem with both is that Germany probably ends up stronger and that is as unwelcome in Berlin as it is outside. Germany will probably allow Greece to go, if only because the domestic political cost will be lower than allowing them to stay.

It will however, set in train a sequence of events that none of us can know the outcome of. According to a new McKinsey study, global debt has grown by $57tr since the crisis. Government debt has grown by $25tr and only in the UK, US, Ireland and Spain has domestic, (but not government), debt deleveraged. China meanwhile went postal and increased leverage by 4x and now has a debt to GDP ratio at a stomach churning 282%. Zero interest rates will not hold the wall forever and disruption from FX markets resulting from political breaks are one likely route to what we refer to as real “price discovery.”  You could though, just call it an almighty crash, harsh bear market and economic depression and it’s that last word, depression, that haunts historians and anyone else who has had a reflective thought at any one of the camps.

Man Up France FFS


Enquiring minds might find this table from SocGen of passing interest,


The standout lines are that the French and Belgiums earn more per hour than do German workers, which is a straight turnaround from 2000 when the Germans made more per hour. 

That of course suggests that the Germans suffered relatively poor wage gains but stayed competitive with low unemployment and strong exports.

Everyone else saw wages go up, and competitiveness reduce and now they're looking for German handouts.

 Except the UK where earnings per hour have fallen dramatically since 2008 which is demonstrative of the British taking their medicine.

Onlookers should remember, many things have gone very wrong in the UK but to our credit we started to face up to problems immediately after the crisis. There is a ton of unfinished work in the UK but at the time, the French swept most of their bad news under the carpet and hoisted a sign that said, "no problems here (especially in their banks), nothing to see, move along now." 

Guess what.... your problem, grow up, stop whinging and deal with it.


British / French Defence........ It's All About Germany.... again.

David Cameron obviously doesn't hold the centuries long held conviction that Frenchmen are there for Englishmen to practise shooting arrows at.

The ridiculous defence agreement with France, which David Cameron signed yesterday, brought back some memories of when your intrepid, and at that time much younger, writer played his own small part in the Entente Cordial.

In the far off halcyon days of the Cold War, when there was order in the world and we knew who our enemy was, I took part in an exercise in Germany called Tripex. The friendly forces consisted of a battalion of Jocks, (1 RHF), a US tank regiment, which carried the nickname "Hell on Wheels," and French Artillery. Working with the French was somewhat unusual at the time because they weren't NATO members and spent most of their overseas time skulking around the darker parts of Africa. They also had a presence in Berlin  given they were one of the Berlin powers, mostly as a result of three inebriated Frenchmen hitching a lift on a British Churchill tank in Normandy and accidentally arriving in Berlin at the end of the war.

The aim of the exercise, which was politically driven because it would have been suicide in practice, was for the battle group to punch a corridor through Eastern Germany to relieve Berlin should it again be blockaded. In reality of course, the undertaking would have been like A Bridge Too Far, only we would have lasted 20 mins against 3rd Shock Army rather than the full 3 hours of the movie.

Despite being an utter nonesense I expect it ticked a few boxes in Washington, London and Paris........ just as yesterdays agreement ticks a few boxes in London and more importantly for them, Paris.

The point of the agreement has nothing to do with military capability or sensible husbandry of reduced defence spending, because even stupid people in Whitehall know that the French can't be relied upon to do anything, with anyone or anywhere unless it favours their own direct self interest. Rather, it is to give the French an alternative to the Franco-German alliance that has bestrode Europe for the last fifty years.

In European terms, the winner from the recent financial crisis has been Germany. It's fiscal discipline, sense of common purpose and strategic industrial base has seen it emerge stronger than it's European partners. The geo political centre of Europe has moved from Paris to Berlin. Germany is not without it's own internal tensions and stresses but in geo political terms, they are in the driving seat. That worries the French.

This agreement then, simply expands France's options and is a starting gesture to diluting Germany's growing political influence over the extended EU.

So, sending some special forces to crawl about in the dark with knives between their teeth is a modern version of the old Tripex exercise. That however, didn't end quite so well.

Unsurprisingly, the Jocks and the septics rubbed along together just fine and the Americans soon learned to stop leaving their shiny new bits of kit lying around. That was until.................... until we had a couple of days off and were billeted in Sennelager Camp. Soldiers from various cap badges gathered in the huge NAAFI there and everything was going just fine until one very large septic knocked down the tower of empty beer cans that the boys from C Company had been diligently building all night. Then it all went off.

The instigating American immediately had a 5'6'' Jock hanging off his shoulders and bodies were soon flying in all directions, including one or two that went airborne, exiting through the windows. Tables, chairs, beer cans and the odd REME artificer were flying from one side of the room to the other as the whole place erupted in a bar fight worthy of a John Houston western.

Unremarkably, the French were nowhere to be seen.

After a while, the scenes of carnage and chaos quietened down with the arrival of the guard, some RMP's and some over enthusiastic barky, bitey guard dogs. Of course, the Jocks and septics suddenly became the best of friends and resumed drinking, swapping tales and kit.

Note to David Cameron, families fight but they're still family. For one thing........ they speak the same language.

Follow the bloody Germans..

You may or may not have been following the debt crisis in Greece. No matter, the broad brush summary is that the Greeks have been living way beyond their means and the clock is ticking against imminent debt repayments. To make those payments the Greeks must borrow money through bond sales which they can only do at a higher cost than other European governments may borrow money at. That premium prices in the additional risk of lending to the Greeks in case they default.

Intense discussions have been underway and at the end of last week the EU agreed to offer the Greeks assistance but only when the Greek government reach a point where the international markets are effectively closed to them.

The looming debt crisis has created a great deal of stress within the EU and the hard line attitude of the Germans has shocked not only the profligate Club Med countries but also the core EU states like France. The German government however has simply been reflecting a hard line German taxpayer view that they should not be put in a position whereby their hard work and productivity is exploited by idle tax evading beach bums. In fact an important result of last weeks negotiations is that the German government has sent a strong message not only to the rest of the EU but to their own people which implies that not one single German euro will be spent until all other avenues have been explored.

This hard core message of fiscal discipline has strong resonance for the average German voter.

Contrast this to the British voter, whoever he or she is and in fact it wouldn't be unreasonable to ask if they exist at all. If they do, they suffer from a collective virus of bovine lethargy given after all that the current shower of corrupt and incompetent muppets have done, there is barely a whisper raised in protest. The Cabinet must sit down not quite believing their luck - they've almost bankrupted us, financially and morally and they've got away with it - only a few points behind in the polls and growing in confidence as the election approaches. They're beginning to think they might actually pull it off; you can smell it.

So why is there such a dramatic contrast between the German people and ourselves and why does their government listen and ours don't? I genuinely don't know. I can only guess that people have simply given up, that they've decided that whatever their view is it won't make a blind bit of difference. That whatever actions citizens take They will still be there and They will keep on coming, no matter what, there is no way to finish them off. 


Even more sad, at times.......... I feel the same way.

What of the opposition? Just like many, many others I simply despair. No backbone, no courage, no idea. I sat next to a lady last evening who had every reason to vote Tory in May. I listened to her reasoned critique of Labour and then asked her about the Tories. "No way am I voting for them," she said, "I have no idea what they're policies are." Nor do I.

In fact, David Cameron rather reminds me of the captain of this ship.........(yes, I know we've all seen it before but it makes the point and me laugh at the same time so it's in..).