Europe: Crisis Unlikely Over

August 14, 2013

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Bridgewater recently pondered a perfect storm in Europe, breaking down numbers, and listing five catalysts. Meanwhile, Felix Zulauf is also concerned. He noted that European bank writedowns are expected to be over one trillion Euros, while the EM has committed only sixty billion to bailouts.

The depositor haircuts in Cyprus showed investors and depositors who would likely be the targets the next time a crisis erupted.  Few of the structural issues have been dealt with, although a reduction in trade imbalances between Euro countries, and a positive fiscal balance in Greece, does show progress.

In 2012, I was quite pessimistic on the Euro staying together.  Some of this pessimism was due to history, some if it due to moral hazard.  However, the data point I mistakenly overlooked was in the polls.

This past spring the WSJ showed that even in Portugal, Italy, Ireland, Spain, and Greece, the public supported the European monetary union at a staggering rate of 60-70%. Evidently, the only politicians the people distrust more than Germans are the local politicians.

However, perhaps this merely needed more time to play out. The polls are still supportive of the EU, but they show a clear trend:

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Support has fallen most notably in France (-7 to 62%) and Spain (-11 to 52%).

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In a study of 245 unions covering 1948 to 1997, where 128 of the unions disolved, Niktsch (2004) showed:

“…departures from a currency union tend to occur when there is a large inflation differential between member countries, when the currency union involves a country which is relatively closed to international trade and trade flows fall, and when there is a change in political status of a member.

Germany’s inflation rate has diverged from the rest of Europe; in fact, they are working on a housing bubble of their very own.

Other risks include the sudden rise of a fringe party. Nazism came on abruptly in the 30s, and Niktsch confirmed political transitions as a threat to monetary unions.

As for stocks, European equities are quite inexpensive and have recently outperformed U.S. market. The time to buy is when everyone is negative and that’s certainly the case now.

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Timing is everything though, better opportunities may be available on corrections.

Interestingly, in Sweden, where the public is most positive, they are busy blowing a housing bubble, and thus, at risk of a banking crisis.

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