On Italy, the script and a midsummer Knight's dream
Now here’s a question to tax the idle August mind: have markets divorced themselves from reality or has reality divorced itself from markets? Whichever it might be, current price action tells me that, in the words of that great market philosopher, Lawrence B Kingsnorth, “Same movie, different script”.
On one hand, we have a growing realisation amongst the political class that the solutions to most of the critical fiscal problems which the eurozone peripheral countries (and, less volubly, others too) are facing are not necessarily to be found in the prevalent political structure of liberal democracy at the same time as equity markets are on a mission with the S&P 500 again within a whisker of a post crash high and the Milan MIB index is now less than 3% in the red, year to date.
In movie terms, we are trying to make “No Way Out” with one part of the cast holding the script to “Cabaret” and the other acting to “The Way We Were”.
My old chum at Joseph Palmer & Sons in Melbourne, Alex Moffatt, highlights this in his own daily summary as he writes:
“The Italian Prime Minister’s comment that ’Bundestag control over EU debt policy threatens to bring about the disintegration of the European project’ has upset German politicians. One said ’we must make it clear to Mr Monti that we Germans will not shut down our democracy to pay Italian debts’”.
This lays a base for that rather uncomfortable political debate which I have pointed towards repeatedly in the past few years, namely the one as to how we can escape the public sector debt trap while fiscal policy is being made by elected politicians. Monti’s comments are not the first ones which have alluded to the incompatibility of the parochial political process with the primacy of collective fiscal action – and that does not only affect intra-member solidarity.
President Hollande has underlined his 75% marginal tax rate for the highest earners with the suggestion that the rich should be delighted to be given the opportunity to help the nation out of its predicament without necessarily acknowledging that you don’t make the poor richer by making the rich poorer.
More to the point, the frictional cost of redistributing funds collected through taxation may well suck most of the benefit out of the revenue. Has it ever dawned on you that if six civil servants share an office and each of them pays 20% in tax, then the total tax payments of five of them go to paying for the sixth one’s salary which means that the net fiscal benefit to the nation is 3.3% of their joint earnings. Of course I know that this is a massive and generally irresponsible oversimplification – no need to write to complain – but it could act as a starting point for a discussion on what kind of administrative structure we need and how we are going to finance it.
(The impending US presidential campaign between President O’Bama and Mitt Romney will in all likelihood end up pitching the contrasting philosophies of “spend, then tax” and “tax, then spend” against each other, albeit without either of the candidates addressing the more pressing question as to how to reverse and right some of the past fiscal excesses.)
Anyhow, back to my August question. Risk is king and both equities and credit are on a roll at a time when the political debate is, in my view at least, become sharper and not softer. German acknowledgement that a bond buying programme might be called for is not at all the same as an enthusiastic endorsement of the process and recourse to the Federal Constitutional Court will no doubt follow.
So far, none of the challenges to the constitutionality of emergency action taken by the eurozone authorities has been made to stick but I do have chums in Germany who believe that it is now only a matter of time until the judges in Karlsruhe decide for the first time that the rules have been bent as far as they can be without breaking and that enough is enough. Heavens help Eurozone risk markets on the day they do that.
Knight, life and Lehman
Meanwhile, on a happier note, I see that a lifeboat has been put in place for the rescue of Knight Capital. Common sense has prevailed in terms of assessing the value which Knight adds to the trading process in New York although existing shareholders are pretty much for the high jump.
That is capitalism at work at its very best. When Lehman Brothers was not saved by its peers, that was capitalism at work too and, without doubt, it went to the happy market place in the sky for a reason. Life is not a chain of positive outcomes, as much as we’d like it to be. But it is not a chain of negative ones either. I’m afraid I can’t see anything wrong with that.