Kicking the can down the road. Who isn't kicking the can down the road?
Everyone loves procrastinating. Despite several warnings by world financial authorities of the cost of inaction, European policymakers continue to lag the debt, credit and economic cycle. This is somewhat troubling since the announcement of the Debt Rescue Plan in October brought much relief in terms of funding costs, and concrete actions to solve sovereign debt and bank credit issues would have allowed for cheap bond re-financing operations.
Quite frankly, we had thought that European policymakers would have broken their “slow-moving” reputation and surprised market participants with forceful actions. Instead, they are behaving as expected and world central bankers need to buy them time. Political dithering is acting like a cancer and unfortunately, the patient keeps refusing treatment.
The net result is a possible funding crisis as the liquidity response needed to counteract fiscal constraints, banking and housing deleveraging forces is delayed. As we are writing, Europe is probably in recession.
Canaccord Genuity Portfolio Strategist Martin Roberge notes that while history contains few analogies of mind games between financial markets and politicians, the break of the pound sterling in 1992 offers a possible roadmap to investors. On October 8, 1990, the British Conservative government decided to join the European Exchange Rate Mechanism (ERM), with the pound set at DM2.95. However, the country was forced to withdraw from the system on "Black Wednesday" (September 16, 1992) as Britain’s economy could not cope with an unsustainably high exchange rate.
The pound sterling plunged to DM2.20 under the weight of speculators and interest rates jumped from 10% to 15% in an unsuccessful attempt to stop the pound from falling below the ERM limits. In the end, the government caved in and withdrew the pound sterling from the ERM. Equities lost nearly 20% from June to August 1992 with investors forcing the break of the pound. However, upon the capitulation by politicians, the U.K. stock market recouped all its losses by December and soared 45% over the next year. Also, the S&P 500, which had been trapped in a range for about two years finally broke to new highs in 1993.
Obviously, the ongoing chicken game between European politicians and financial markets is much broader in scope and spread globally compared to the 1992 British experience.
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