The party that calls itself Europe is over.
The sovereign debt crisis afflicting its weakest members has ended the eurozone's political Ponzi scheme -- the proclivity to hand out entitlements today and run up a tab due tomorrow.
The continent's La Dolce Vita lifestyle will disappear along with subsidies; cushy civil servant jobs; six-week holidays; 30-hour work weeks, Freedom 50 retirements and its people's belief that the world owes them a living.
This is the Great Markdown in Europe. A more gradual one is underway in North America. Both are due to debts, deficits, demographics and democracy.
Europe's situation is compounded by its badly devised, decentralized and balkanized fiscal regime -- one currency for 17 out of 27 countries and a central bank in each nation state. This is like herding cats and unsustainable as last week's political upheavals revealed.
Two democratically-elected leaders in Greece and Italy were unceremoniously pushed aside and replaced by technocrats and the IMF.
Greece's prime minister was replaced by a de facto "bankruptcy trustee" whose job is to take orders from the IMF, in the hopes of turning around the bankrupt country.
Then Italy's playboy prime minister was replaced by a "soft receiver," Mario Monti. He's a tough-minded academic, with huge political and moral leverage across the European Union, who will make Margaret Thatcher look like Mother Teresa.
By the way, Italy is not a basket case like Greece, Ireland or Portugal. But its bonds are under siege, which could prove ruinous for the region, and this is not due to fundamentals but to trading games that can be halted as described below.
Here are some facts about Italy:
- Total government assets in Italy are slightly less than the total of its public debts.
- Italy could raise an estimated 45 billion euro by selling its stake in oil giant ENI, utility ENEL, Poste Italiane or aerospace conglomerate Finmeccanica alone and Monti loves privatizations.
- Offsetting Italy's high public debt, of 120 per cent of GDP, is its low household debt of 42 per cent. By comparison, the U.S. and Canada have public debts of 90 per cent and 80 per cent respectively, but their household debts are among the highest in the world or above 160 per cent of GDP.
By the way, the relatively seamless transition from elected to technocrats is a healthy and necessary way to circumvent short-term democracies which have failed to cope with this crisis. This is no different than a private sector "workout" where the CEO is removed from a failing corporation and is replaced by the bankers' representatives.
Those reforms are now in place and new leaders in Portugal, Ireland and Spain (in this weekend's election) are kowtowing to the dictates of bondholders and bankers.
But financial reform is necessary in order to arrest and cool off the world's hot money. These are hedge funds and others who have caused the sovereign debt contagion and profited from it by making self-fulfilling short-selling bets.
A fascinating set of remedies has been suggested this week by Leonard Waverman, dean of the Haskayne School of Business at the University of Calgary and former professor at London University.
He rightly suggests that the Euro crisis is similar to the Asian contagion in 1997 when speculators picked off one currency after another. The difference is that, in this case, there is one currency, the euro, but the similarity is that there are the bonds of 17 eurozone members to pick off. This permits a "classic run" because the bonds are substitutes for currencies that can be pummelled down in value for a profit.
"These one-way bets are yielding large profits to some at the expense of hundreds of millions of people," said Waverman.
It is time to put "sand in the wheels" of the "herd" through "capital controls." These include eurozone members mopping up embattled bonds and paying higher than market prices to destroy short-seller profit-taking; raising margin requirements to 50 per cent or more and imposing a Tobin Tax on trades.
It's interesting that in an imperfect currency union, the bonds of each country behave like separate currencies to market players. Waverman also notes that Malaysia was able to avert a currency run in 1997 by deploying such controls.
The European situation is considerably more serious than next week's "drama." The U.S. Congressional "super committee" is supposed to come up with $1.5 trillion in cuts and tax hikes by the end of the week, but they are also politically challenged.
Investors are assuming nothing will be accomplished. This means that the only big news will be if these American politicians actually agree to make cuts before the football games start on Thanksgiving Day.
But don't count on it. The Europeans stand a better chance of fixing their problems before the 2012 U.S. federal election because they have learned how to unseat the incompetents in between elections.
-- Financial Post
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