Wednesday, August 1, 2012

“Sting Like a Bee”

Sydney M. Williams

Thought of the Day
“Sting Like a Bee”
August 1, 2012

George Orwell once said that most political speeches embody a defense of the indefensible. European Central Bank President Mario Draghi’s speech last Thursday at the Global Investment conference in London would seem to fit Mr. Orwell’s definition to a tee.

Markets thought otherwise. In the three days following his speech, the S&P 500 and the FTSE 100 rallied 3.6%. The DAX rose 5.7% and the CAC 40 was up 7.8 percent. Markets appeared to have heard only two sentences toward the end of his speech: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And, believe me, it will be enough.”

Markets ignored the warning passages from his speech: “There are some short-term challenges, to say the least [that] relate mostly to the financial fragmentation that has taken place in the euro area…The interbank market is not functioning. It is only functioning very little within each country by the way, but it is certainly not functioning across countries” and, later, “…regulation has to be recalibrated completely.” Not exactly words to warm the cockles of one’s heart, or to loosen the strings of one’s purse.

Mr. Draghi was hyperbolic in speaking of Europe, the euro and what’s going on. Describing the euro and the eurozone, Mr. Draghi’s said: “The first message I would like to send is that the euro is much, much stronger, the euro area is much, much stronger than people acknowledge today.” He goes on, “…The second message I would like to send today, is that progress has been extraordinary in the last six months.” Finally, he adds, “The progress in undertaking deficit control, structural reforms has been remarkable.” Why didn’t we know this?

To read most of Mr. Draghi’s speech is to drift through a land of fairy tales. “The euro is like a bumblebee. This is a mystery of nature because it shouldn’t fly, but it does,” he said. The metaphor of the bumblebee seems curiously inapt. Bumblebees do fly, but their lifecycle, other than the queen, is a year. And they sting.

In my opinion, the biggest problem Europe faces is the apparent refusal to recognize (at least publically) both the magnitude of the problem and its nature. GDP, in the first quarter of 2012 was flat for the eurozone, suggesting the area may be on the brink of a second recession, if not already in one. Unemployment rose to 11.2% in June, the highest level on record. Spain’s unemployment reached 24.8%. Italy’s unemployment was 10.8% in June, with national debt now exceeding 120% of GDP. The two countries have approximately $4.5 trillion in combined debt and GDP, which has been declining, of about $4.2 trillion. They are too big to save. Germany’s insistence on austerity condemns the PIIGS to slow strangulation. France’s preference for increased government spending would damn them to higher debt and deficit levels and much higher interest rates. (It is ironic that we accept without comment the inferred definition that “austerity” means starving the state, while “growth” means feeding the state, when real growth can only come from the private sector.) What is needed, and what does not seem to be on the near horizon, is an individual with the ideas, the chutzpah and integrity of Margaret Thatcher, one who believes in the power of the individual, the might of the private sector, the rule of law and the limits to government. Europe needs to stop spending money on unaffordable social welfare programs that have dominated the continent for the past few decades and concentrate on generating wealth. The only way to do that, without impoverishing the people, is to encourage entrepreneurship, via flatter and lower tax rates and less intrusive regulation.

The nature of the problem, again in my opinion, has to do with the fact that a common currency was implemented before political and fiscal union. It was easier to ask countries to agree on a common currency than to ask them to give up their sovereignty. Giving up one’s sovereignty cannot be easy for proud people whose heritage and history reaches back thousands of years. They may all be Europeans, but the differences between Basques and Tyroleans cannot be overestimated. Mr. Draghi can speak of all the progress at the “supranational” level, but the facts are that the euro has provided Germany a “cheap” currency and Greece, Italy, Ireland, Portugal and Spain an “expensive” one. The United States in 1787, with a bunch of refugees, had a hard enough time forming a union and, then 74 years later almost lost it. It is not that a United States of Europe could not be formed, but “wishes and fishes don’t make oceans.” Union will take time and will have to start within a political framework.

Yesterday’s Investor’s Business Daily had a front page article quoting a small rating agency, Egan-Jones, on the eurozone. Egan-Jones, while not a household name, was the first to signal the end of Enron, WorldCom and Lehman Brothers. Today, their outlook for Spain and Italy is dire. Their projections are for the GDP of both countries to contract by at least 4% annually through 2014. As GDP shrinks debt, as a percentage, rises making their fiscal positions increasingly precarious. What’s needed, in the opinion of the folks at Egan-Jones, is a restructuring of their debt – for investors to take a significant haircut by writing the debt down to manageable levels. That implies default, something no European official wants.

On a positive note, Milton Ezrati, a senior economist with Lord, Abbett & Co., wrote a piece published Monday in The National Interest. In that report he suggests a third way – the pursuit of growth through structural reforms that would liberalize labor markets, soften regulatory strictures and “adjust government spending with an eye to economic returns.” While the last sounds to me like an oxymoron, the first two make sense. In fact, Mr. Ezrati writes “the Italian parliament, under Monti [Prime Minister Mario Monti] has voted overwhelmingly to modify Article 18 of the country’s 1970 labor law, which imposes most of the Italian version of these restrictive structures.” (This is no small accomplishment. In 1992 and 2002, as Milton Ezrati notes, the Red Brigade murdered the leaders of Italian labor reform.) Similarly, Mr. Ezrati notes that Spain, Portugal and Greece have considered or are considering equivalent legislation.

Perhaps I am too negative on the prospects for the euro. I hope I am, for the markets are panting for good news. However, navigating a way out of the problems will be more difficult than the task given Theseus who had to find his way through the labyrinth in order to slay the Minotaur.

Abraham Lincoln began his 1858 “House Divided” speech with a sentence that seems appropriate in this instance: “If we could first know where we are and wither we are tending, we could better judge what to do and how to do it.” Wise advice to Europe’s leaders, who could use it.

The euro may have originally floated like a butterfly, but it has begun to sting like a bee.



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