Tuesday, 17 July 2018

Post-summit the EU must still face up to economic reality

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Anthony Peters, SwissInvest Strategist

From where I sit, the post-EU summit world does not look significantly less confused than the pre-summit world had done. I guess it would have to be an early observation that the recipe is only as good as the cook – or, in this particular case, the dozens of cooks – and we will have to see whether the grand words are followed with equally grand gestures. I have no problem following the causes for the relief rally which gripped markets on Friday, but I have seen too many failed European post-summit asset price bounces to feel comfortable that this one is any better than ones which have been and gone again.

Alex Moffatt of Joseph Palmer & Sons, a private wealth management in Melbourne, certainly has no axe to grind on European issues and therefore his dispassionate observation from the other side of the globe should be of interest to all who might be struggling to see the wood for the trees.

Foolish rush

He wrote: “Given the last treaty [Maastricht] has fallen apart at the seams, what makes us think that any new treaty cobbled hastily together will provide a solution to the individual problems of European nations and, even more to the point, be accepted by each of the 17 nations it will attempt to harness?” I am deeply concerned by the assertions which I receive from many European counterparts that the political will is here and that it would be futile to underestimate its power. I am worried because it is, in a large part, the slap-dash documenting of the intentions and rules governing the European currency union which brought on the crisis in which we find ourselves. The mistaken belief that political will can supercede economic realities in perpetuity does not appear to have been revised and hence I somewhat understand the position of David “call me Dave” Cameron who has grown up in the British political culture where pragmatism always outscores idealism.

If control systems are visibly failing, is the correct response to tighten or to loosen those controls? Ask a horseman

Reading the extensive coverage in the press this weekend – and many, many thousands of trees have died for this – it is clear that we have something of a problem. It is said there are three sides to the story in every divorce – her side, his side and the truth – and I sense that we are dealing with a similar matter here. London seems to believe that it has a role to play in Europe as the conscience of reason; the voice which perks up and attempts to prevent ideological orthodoxy from running off with the citizens’ tax money. The invisible Scotsman who abolished the boom and bust cycle and who saved the world took a significant stance in keeping this country out of the currency union and one which should have guaranteed him a spot in the Olymp which is Westminster Abbey. The fact that he blew his chances by getting just about everything else wrong which he could get wrong is another matter. Had he stuck with his pragmatic Presbyterian instincts rather than succumbing to ideological humbug, he would have been a hero and might in fact now still have been Prime Monster. Oh, for the what ifs!

Who is doing the buying?

Alas, markets will not judge the outcome of Brussels on the promises but on actions. Harry Wilson headlined in the Telegraph on Saturday with “Eurozone banking system on the edge of collapse” in which he summarises some of the signs of stress which are appearing in the system – ECB deposits are rising sharply as are interbank lending rates. However, the bit I liked best was: “UBS estimates eurozone banks could sell off between €3.7trn and €4.5trn of assets in the next three years.”

What I haven’t worked out yet is who is supposed to buy all these assets? We have already seen that many financial assets are trading below their intrinsic value – or default recovery value, if you so wish – but with a generic excess of supply over demand, this should not really be too much of a surprise. We saw a similar movement in prices in the period around the collapse of Lehman Brothers and untold dozens of other financial institutions in which the mark-to-market killed the firms and not  loan defaults.

When, in 2008 and 2009, SIVs and credit conduits were falling like flies, the excess availability in assets seeking parking places which weren’t there led to some serious give-away prices. However, one man’s once in a life-time bargain is another man’s terminal mark-to-market loss.

Investors, especially bank balance sheet managers, are trapped in an unhappy space where they will find themselves obliged to realise losses they haven’t really made. It might not be right and it might not be wrong but, like it or not, it is the way it is. In all probability, the agreements struck in Brussels will not be able to deal with the issues of deleveraging for so long as global lending capacity continues to shrink faster than borrowing and spending are cut – especially at a sovereign level – the deeper the crisis will become. If control systems are visibly failing, is the correct response to tighten or to loosen those controls? Ask a horseman. That is what Cameron appears to have done.  

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