Italian financial reporter Fabrizio Goria summed up last week’s Merkel-Sarkozy-Monti summit aptly in his twitter message, “Can you smell the fear of Sarkozy about FrAAAnce?” as Fitch moved from rubbishing Portuguese outlook to investigating debt and deficit pressures bearing down on France’s AAA rating. Merkel’s uncompromising nein to eurobonds and ECB’s lender-of-last-resort lifeline shows the troika wasn’t holding any aces close to its chest after all, in keeping with this column’s expectations. All they had was a rehash of the same desperation tactics which, ironically, have failed to find support in Berlin. Most likely, France’s weaknesses will be exposed next as Merkozy gives way to Mermonti to talk up markets for the remainder of the euro’s endgame.
I feel it would be incrementally better for the euro if EU’s top leaders met less often. If I decipher Merkel’s position correctly, she has finally explained the paradox of her stance, at once promising safeguarding the single currency while ruling out the only measures guaranteeing immediate-term survival. If the setup must become a transfer union, which preserving the euro demands, it must first turn distinctly political. Such a landmark shift will no doubt stimulate special irony in the French left that bullied Germany into accepting the currency union in return for unification when Mitterrand and Schroeder decided the continent’s fate. Ironic because far from achieving more political muscle for France and less economic influence of Germany, it has concentrated both at unprecedented levels in Berlin.
More than the eurobond no, Merkel’s aversion to moral hazard is reflected in ruling out the ECB’s monetary faucet even as banks face a near-dry wholesale funding market, inter-bank lending is extremely stressed and billions in investor funds are fleeing Europe. With the ESFS initiative proving a non-starter, both sovereign and bank failures have become a real possibility. Germany’s central-role demands will require constitutional revisions and subsequent ratifications from all member states. It is not possible to reorganise at that level in time to prevent the euro’s immediate collapse. Sell the euro on rallies. Short with abandon. The 1.30 level will be tested a lot sooner than most had expected only a couple of months ago.
Europe’s hangover is now clearly showing in Asia, where markets have dipped four weeks in a row. Commodity currencies too have a pretty clear, depressed outlook as Mr Market prices in the troika’s failure to revive confidence amid growing doubts about American banks’ exposure to European debt. Downgrades, choked capital markets, split in the troika, enhanced possibility of bank-runs, Germany’s failed bond auction, all tighten the noose around the euro. Europe’s best possible future from here is a deep, protracted recession in ’12, made worse by strict austerity.
It’s best not to flirt with the market when volatility makes entering similar to catching falling knives. As soon as Merkel’s hints are digested across Europe, which shouldn’t take more than a few weeks, the euro-narrative will assume a definitive direction, bringing sense and correlation back to aussie, loonie, cable, kiwi, etc. But for now, discretion is the better part of valour, safe-haven dollar inflow and frantic euro-selling is assured, and risk aversion remains strongly entrenched. And before euro falls, it will bring down the façade hiding the financial sickness in France, and Humpty Dumpty will come falling down.
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