Daily Market Reports | Nov 25 2011
By Greg Peel
London's FTSE was down 0.2% while Germany's DAX fell 0.5% and France's CAC was flat.
There's a slight irony in the notion that trading in Europe's stock and commodity markets overnight should be light given Wall Street's closure for the Thanksgiving holiday. The world still looks to the US as ultimate determinant of market direction, yet for two years now Wall Street has done little more than respond to events in Europe.
The world does tend to see “Europe” as a homogenous entity which is why it has become so frustrated with European inaction. Since the GFC, the US, UK and Japan have all implemented policies of emergency quantitative easing in order to prop up their vulnerable economies, while on the other side of the coin China first applied enormous fiscal stimulus before pulling on the reins and after its own initial fiscal and monetary stimulus was implemented immediately after the GFC, Australia has had no need to do anything out of the ordinary since.
As is often noted, all post-GFC policy managed to achieve was to transfer the global debt problem from the private sector to the public sector but this was indeed the intention. In the US, government investment in the banks and General Motors has both saved those institutions and, in some cases, even delivered the American people a profit, while AIG is slowly on its way as well. Fannie and Freddie remain the only real basket cases. The UK undertook similar actions and is now at least relatively stable. Both economies, and the global economy, would probably be in a much healthier position right now if Europe had done the same thing. But it didn't, and still hasn't.
The world might see a single entity in “Europe” but Europe is anything but. The UK actually forms part of “Europe” by being one of the twenty-seven members of the EU, but it is separated by the fact it did not sign up to the eurozone. Indeed, only seventeen members did. In retrospect it should have been one in all in or nothing. Actually, in retrospect the common currency was extraordinarily ill-conceived.
The years 2007-11 have shown that the ECB is not a central bank at all. All the ECB can do is set interest rates for the euro with the single mandate of controlling inflation. It has no mandate to apply monetary policy in response to economic growth, which is why both in 2007 and in 2011 the ECB shocked the world by increasing its cash rate when all about were lowering theirs. A central bank, as we know it, must apply monetary policy with consideration given to the government's fiscal policy, such that the two are not at odds. That's fine if there's only one government, but not in case of seventeen governments with the right to completely individual fiscal policy, as well as another overriding EU “government”, and another ten non-euro governments which are also involved.
The GFC has shown the eurozone to be a complete and utter failure.
The ECB does have the power to place certain limitations on eurozone member fiscal policy, and arguably one of the most important of those is limits on public debt to GDP ratios. Yet by 2010, the only eurozone member with a ratio inside those limits was mighty Luxembourg. Every other member, including Germany, had breached those limits. Some, like Greece, by a considerable margin. The breaches began long before the GFC, when the world was a rosy place. The ECB was asleep at the wheel.
Realistically, it's time to call the eurozone experiment for what it is – a failure. Admit defeat and move on. Unfortunately, nine years on, that would be akin to untangling a bowl of spaghetti into individual al dente strands without breaking any. It would be difficult to achieve even if times were good. It would be dangerous to attempt now, unless it were the only remaining solution.
And right now, the markets are beginning to assume that it is the only remaining solution. That is, unless the eurozone goes the other way and reinvents the ECB into a proper central bank. This would mean introducing a common euro bond and providing the ECB with the power to act for “Europe” as if Europe were truly homogenous.
Last night, that's what the French president and the new Italian prime minister were trying swing the German chancellor towards. But they failed. Merkel remains resolute: there will be no euro bond and no extended powers for the ECB. Why not? Well just imagine if the Australian federal government had the power to take all of Western Australia's mining royalties away for redistribution to NSW and Victoria (let's just forget the GST for the moment). IF NSW and Vic were in deep recession, WA would have to be cast into recession as well when otherwise Western Australians might have been able to live high on the hog. Now imagine Western Australians had the power to vote against such a plan by ousting the state government.
And there you have Germany. Merkel wants to move the eurozone towards greater fiscal union in the form of a uniform fiscal policy before any consideration can be given to a more powerful ECB. Fine in theory, but years in implementation. Meanwhile, no one outside Europe is prepared to provide funds to save Europe. This is particularly the case when the ECB could have saved Europe anyway. Wednesday night's disastrous German bond auction was indicative of a world beginning to concede that the eurozone is on its last legs.
Last night Merkel, Sarkozy and Monti agreed to only one thing. They will stop airing their disagreements in public. That probably is positive in terms of dampening “headline driven” global market volatility, but it also implies that the world might head into 2012 in the dark.
Oh and Fitch downgraded Portugal to junk last night. Otherwise, market movements were immaterial.
The SPI Overnight is up 4 points.
It's a half-day on Wall Street tonight.
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