Sunday, September 18, 2011

The European Union: All For . . . Well, Let's Think About This

Like the middle of a horror movie, this weekend's inconclusive meeting in Poland of Europe's finance ministers revealed growing realization of how scary the EU's sovereign debt problems have become. The ministers couldn't agree on how to stop Greece's plunge toward white water. But did they did acknowledge the need to strengthen the capital positions of their banks. In plain English, this means they haven't figured out how to put out the forest fire. But they are leaning toward building firewalls around their own borders.

This subtle shift toward self-preservation is a small step back from Greece's outstretched hand. Just a few months ago, European leaders loudly, if not entirely convincingly, proclaimed all for one, one for all. Now, their eyes flick nervously from side to side as they maneuver to see who gets the hot tamale (read, the cost of yet again bailing out the Greeks). Private capital is vamoosing from the markets for the sovereign debt of weak EU member nations. The ECB has stepped in by buying, or lending against, the dodgy debt. But that can't continue indefinitely, as the ECB isn't supposed to be a bailout fund. Greece has repetitive failure syndrome when it comes to meeting the conditions for bailout monies from the EU. While Germany and France have thus far dispensed enough bailout funds to prevent Greece from technically defaulting, they can't continue writing blank checks forever.

Some of the finance ministers testily rejected suggestions by U.S. Secretary of the Treasury Timothy Geithner to increase leverage for pan-European bailout funding, and to apply greater fiscal stimulus. Of course, it's their money he wants them to spend, and their national wealth he'd put at risk. So he's not quite the hit as was, say, George Marshall.

What the EU would be willing to do--the $64,000 question--remains a mystery. Perhaps the ministers like it that way. Last week, the stock market rallied almost 5% on nothing more than gossip, whisper and innuendo about European intentions to do the right thing, or something like that. If a few leaks and whispers to journalists can turn the markets around like this, why spend any money on bailouts? Just keep gabbing to the financial press, prop up the markets, and wink at your constituents while gullible stock investors make you look good.

Europeans are very good at inaction. As long as the stock market responds so deliriously to talk therapy, expect the EU to yak ad nauseum. There's nothing like a free ride, and last week's stock rally cost the EU nothing. One might harbor suspicions about stock valuations based on politicians babbling. But, then again, as we know from the tech bubble and the real estate/mortgage bubble, markets love bubbles. The European sovereign debt crisis will bubble along until some unexpected singularity pops up and the bubble painfully bursts. Then, investors will once again learn that irrational hope doesn't translate into financial gain.

But, in the short run, the EU and other government officials, ever Pavlovian, will dangle faint glimmers of hope. Today's market is all government, all the time. Take government out of the picture, and the market tanks. Knowing that, the Fed will reincarnate the "Twist" at its meeting this coming week--not the dance (perish the thought of Fed Governors dancing), but a lengthening of maturities in the pool of Treasury securities held by the Fed. This maneuver is meant to make the yield curve undulate, with shorter term rates rising a bit while mid-length maturities drop. Whether it will actually stimulate the economy is open to question, but one suspects that the Fed's main goal is to keep stock investors giddy by at least creating the appearance of not sitting on its hands. (Parenthetically, the Fed's Twist will flatten the yield curve, and a flat or inverted yield curve is often taken by market prognosticators as a sign of an impending recession; but interest rates are now completely controlled by government fiat, and entrails aren't likely to mean what they used to mean.)

The G-20 is meeting toward the end of the week. This consortium of large economies provides the EU and the U.S. with another public relations opportunity to hint at succor for distressed EU member nations. While it's doubtful that the G-20 will offer more than vague expressions of concern, you can bet that it will do a little fan dance for the stock market to lure in those investors desperately seeking any straw to grasp. One could fairly observe that this silliness can't continue forever. But market bubbles last longer and rise higher than anyone might reasonably expect. And this is a government bubble. Politicians, being quintessential windbags, will bloviate as long as anyone is around to listen. So this bubble might last for a while. But when the government bursts--and all bubbles eventually burst--who will provide the bailout?

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