The next 6 months could be the most eventful since 2008: Greece’s resolution will overlap with the UK Exit threat at a critical time at global geopolitical and monetary fronts. Without the UK, the EU would cease to be a global geopolitical power.
Christian Takushi MA UZH on June 2nd 2015
As we have been saying since last year, the 2nd half of 2015 will see unprecedented action at the global political, geopolitical and monetary fronts. Political & corporate leaders as well as investors need to brace themselves for the likelihood of massive spikes in volatility. Brussels may surprise markets with a series of bold initiatives – starting with Greece this month – that will kickstart de-facto a reform process and partial re-negotiation of the EU Treaty. If the EU fails to act on Greece, the UK may exit and the EU project fail. Investors need to take action proactively. The surprising win of Mr. Cameron in the recent UK elections was a game changer. The EU can afford to lose Greece, but it cannot afford to lose Great Britain.
Markets are Greece-weary and think the EU is again in helpless crisis mode with late night talks to avert a Greece Bankruptcy or Default. But the dice has been cast. Economically Greece is de-facto a bankrupted and insolvent nation, that politicians have struggled to keep within the Eurozone. Greece can by no means repay her huge debt, even as she tries to get new loans from her three main creditors (EU, ECB, IMF) to repay due loans to the same three creditors. A bottom-less pit that gets only deeper. Unable to see the EU’s political and geopolitical concerns, many observers see Brussels simply as pathetically unable or incompetent to solve this problem.
To understand why the Greece Crisis will now be boldly addressed, you have to take the UK into account – plus France Exit fears down the road
Only after the sweeping victory of Mr. Cameron’s Conservative Party in UK elections on promises to uphold an EU referendum, Berlin has been able to convince the EU and IMF to turn the page on Greece. The EU will make a final offer to Greece that she has to accept: it provides a financing bridge into the 2nd half 2015 with massive debt relief (tied to painful cuts) or an orderly exit from the Eurozone, either way flanked with the biggest review of EU rules since Maastricht over the next 12 months. The constellation is finally perfect to move forward: The avoidance of contagion will allow weak Eurozone members to come to the table without losing face, but that is only the beginning. Berlin has won the implicit backing of the IMF and even a reluctant Brussels to prepare for an orderly exit of any member state unfit for the discipline of a common currency or the coming EU reforms. The fact is, the “eurosklerosis” is not just about Greece. All signs point to the IMF, Brussels, Paris and Berlin having reached an internal agreement. This week Greek leaders are realizing that Brussels and Berlin have made up their minds. Greece can no longer play a “game theory” poker. Will EU leaders bring resolution this Friday? They could announce it and give an OK to Greece. But, Brussels is a power-seeking political institution and as such it needs both territorial expansion and ever more powers. The latter can only be achieved peacefully via crises. Thus, it can only get more sovereign powers or force reticent members to agree to discipline under the urgency of crisis. The EU will move boldly, but solve the Greek crisis only in stages. EU citizens took the “sweet” bait of free movement and a common market, but the real goal of Brussels is a Federal Union with all sovereign powers.
Brussels’ rationale: Why solving something immediately if it can be drawn out for months or a year and get compounded with the next battle ground. The Greece resolution in stages will allow it to overlap with Mr. Cameron’s demands for EU reform. If Brussels behaves as it did versus Switzerland, despite the fact that the tiny nation was overwhelmed by job-seeking EU migrants, the UK could exit the EU, wrecking it. Thus, under the massive pressure of multiple issues – Greece resolution, Britain’s reform demands, youth unemployment in the EU periphery, lack of competitiveness, structural reforms, the rise of anti-EU parties, and last but not least immigration – Berlin can now convince Brussels and reticent EU nations that want to keep the status quo (they receive billions of Euros every month) that the time has come to reform the EU Treaty. Berlin and London know their citizens will only accept a reformed EU that doesn’t stand on treaties alone (we have seen they are mere paper), but clearcut incentives and “actionable” consequences.
The geopolitical map shows the World’s biggest military bases (source of chart www.telegraph.co.uk, commentary by Christian Takushi MA UZH) – The USA and the UK are on a league of their own in terms of conventional military power projection and deterrence.
Most observers know that economically the EU cannot exist without Germany or France, but they omit that the EU cannot exist geopolitically without the UK. Without the formidable military expertise, global logistics, fire-power (albeit greatly reduced) and serious nuclear deterrence of Britain and her unique strategic alliance with the USA .. the EU would become over night a geopolitical light weight with little power projection. On top of that, only London offers the market-depth and liquidity that the Euro needs to remain a global heavy-weight currency. Within a reduced EU Germany would have to exercise herself in even more restraint, which would induce Germany to exit – with other competitive economies leaving with her. Who can replace Germany as biggest payer; and let’s be honest, without those big payments, the lifestyle millions of Europeans got used to (as entitlement) over the past 10-20 years would evaporate.
If you read our Geopolitical Macro-Report on The Rise of Germany from July 19th 2014, you will know that Germany is the fastest growing geopolitical power worldwide. The only power trusted on all continents and welcome to most conflicts on the globe. Her rising weight can only be contained within the current EU thanks to the UK. In an amputated EU – and that is the EU without Great Britain – the colossal weight of Germany would increasingly overshadow almost every other area. Washington and Brussels want Germany to stay within the EU, so the slow-motion unanimous EU decision-making process effectively restricts German Foreign Policy. The US incursion into the internal politics of Georgia and Ukraine over the past decade was in part aimed at distancing Germany from Russia via a stand-off between NATO and Russia. A more powerful Germany needs more of Russia – and before 2013 they had become very close.
Politics, Economics and Geopolitics each play a role in analyzing EU strategy. To take important decisions in Europe based only on one or two of these three criteria is like betting on risks that can be diversified away, along a high likelihood of surprises. Even Greece poises a geopolitical risk to the EU. Amid growing destabilization of the Middle East, Europe needs a stable Greece. Turkey has been aggressively expanding its preeminence throughout the Middle East and on her own terms.
Economically the rationale is straightforward for Greece
How long can politicians be in denial of economic facts? In an indirect democracy, very long. Greece has been a bankrupted economy beyond remedy since 2010 and has only avoided default by creative statistics and new loans from the same old creditors that needed to perpetuate the problem. The macroeconomic solution for Greece is pretty straightforward: Greece should exit the Euro, default on part of its debt, trade with her own currency and devalue massively to regain competitiveness. In principle Greece could exit the Eurozone, stay in the EU or have the option to re-enter. I think the EU should forgive a significant part of loans granted to Greece after May 2010 to help Greece and avoid the annoying precedence of a EU member default weighing on future EU risk premiums. This is economically and politically “cheaper” for both sides. The economic solution has to compromise with the political EU reality.
Why debt forgiveness? In ethical and macroeconomic terms Greece was only the tip of an iceberg. It unfolded within a European context of widespread “twisting the numbers” to pretend being mature to join the EU. For Brussels this is a lesson in Governance, but also Financial Theory: You don’t get rewarded in hindsight for risks that were diversifiable and known to you. In fact by end of April 2010 the EU, IMF and ECB knew they were giving loans to a failed economy with no creditworthiness left. National accounting-wise a bottomless pit, Greece could only pay back by taking new loans from the same creditors. Everything it was loaned to after May 2010 was part of a “political deal” to keep Greece in the Eurozone and save European banks that had recklessly taken on Greek debt. The reform plans were doomed – drastic painful reforms only succeed where citizens realize their past bad choices (normally only at the abyss), assume responsibility and take charge of their future. I lived in the 1980’s in Peru when that imploding nation reached that edge of that abyss. Peruvians took charge of their destiny, because there was no one else to blame, but themselves, and no one to beg.
If you still want to be consequent and tough on Greece, prosecutors would have to cite all the EU political leaders that oversaw the entry of Greece into the EU. The rushed & premature entry of many economies into the EU (Cyprus, Greece, Portugal etc) was only possible thanks to the collective political & big-business pressure that shut down macroeconomic wisdom and common sense in Europe. “Greece” did not happen in a vacuum, rather in a tolerant environment conducive to manipulation: Did any state meet the Maastricht criteria without some creative accounting?
And here comes Geopolitics again: The EU needed territorial expansion to reach critical mass by all means, so the creative accounting was tolerated to allow as many countries as possible to join the EU. Nevertheless, even with an element of collective failure, the Greek people have to assume full self-responsibility for their past and future. You cannot be a 44 year old man and still blame your parents for your bad decisions and lifestyle. Otherwise you would have to give your vote to your parents too. You can’t have only rights and socialize your responsibility, as some US courts are allowing.
From Greece via UK-led EU reforms to the Future of Europe
For the reasons stated above Mrs. Merkel will partition the Greek solution in stages, so that it can overlap with the UK exit question. That powerful mix will force nations benefitting from the “status quo” to accept a partial redefining of the EU treaty. Thanks to the strong mandate by British voters to Mr. Cameron to renegotiate the EU treaty, Berlin can finally have what it has wanted since 2010, a reform of the EU without having to demand one. Britain has done it. It is badly needed indeed and time is running out. German citizens are increasingly unwilling to swallow the typical “threats used by politicians that without the Euro, nations in Europe would soon go back to war against one another”. The rise of the Euro-skeptical Alternative für Deutschland party (AfD) and its successful entry into parliaments of several Bundesländer, shows, Germans no longer want to pay ever bigger sums for millions of EU neighbors’ living beyond their means. Even worse, they will turn against Germany if it has to reduce the money transfers. Sounds familiar?
What now? Expect a clearer direction, a solution in steps, but no immediate closure
EU leaders will communicate the solution as a “work in process”. Even if they have reached a consensus to solve the Greece debt crisis, they will announce the deal as part of a bigger protracted process, so they can contain reaction by periphery nations and open the door to UK reform demands. This way Brussels can keep the uncertainty, crisis and pressure going, which they need in order to force reticent member states to accept EU Treaty renegotiations and also to exercise maximum discretionary powers. Something they’ve come to enjoy and use effectively since 2008. Why not a closure on Greece now that internal consensus has been found? Berlin doesn’t simply want a solution for Greece, Berlin wants to lay a framework to treat other governments that are enticed to use Greece’s skillful tactics to borrow, spend, borrow more and threaten with default. After all Berlin has become the creditor of last resort of EU member states and even of the ECB.
Berlin and London will seize this historic window of opportunity – their interests haven’t been this aligned since the End of the Cold War. They keep a safe distance to one another in public to appease other EU capitals. Britain and Germany are nations that thrive at challenges – nations of action, unafraid of pain and resistance. I’m convinced Europe will not be a boring place the next 12 months.
Keeping the EU strategic goals in sight – action and change is coming
Brussels will play along with Berlin and London, because of aligned interests in 2015. Without crisis and pressure, a flawed construction such as the EU would break down. With a powerful mix of overlapping crises, Brussels could come a step closer to a future Federal European Union (FEU) with a central government and nation-states left with mostly symbolic and subsidiary roles. For the first time in many years the interests of Brussels, Berlin, London and Paris are aligned with one another – and I’d be surprised if political leaders don’t seize this moment. Even Paris would be happy about a modest EU reform to stem the rise of the Front National (FN). Unfortunately Brussels will try to use fear as a tool again, but while it could work on the continent it may backfire in the UK and usher in the UK’s exit. On the continent EU leaders and many big businesses have for over twenty years effectively used threats such as “without the EU you’ll become poor, if we un-do the Euro millions of people will lose their jobs, if we don’t have a union, we’ll have war in Europe again”. And it works well on the continent. But does fear-tactics work in Great Britain? I’d say no. If fear would work on British people, they would have capitulated to the Nazis in 1940 – no one gave them a chance to stand up to the German war machinery. Paris and Warsaw had fallen within days of Blitzkrieg offensives. The Labor Party tried to use “fear” during this year’s general elections, and it backfired with fury. They said “if you vote for the Conservatives, the UK will be on course to leave the EU, which would be a disaster for Britain”. I believe it was this aggressive “fear” campaign by the Labour party that swayed millions of voters in favor of Mr. Cameron in the final weeks.
Many say nothing will change, hence markets could be surprised
Too many are tired of Greece and expect a “no solution”, but they underestimate two facts: First, unlike 2010-2012 the European Banking system would not suffer dramatically if Greece defaults totally or in part. The huge debt of Greece has de-facto been transferred to EU and worse case to German tax payers. Socialization of Greek debt. Second, a “no solution” would certainly reinforce the EU-fears of millions of British voters ahead of the UK referendum. Berlin, Paris and Brussels cannot afford that. There will be a decisive step towards some kind of solution this June. At the very least, viable scenarios will arise as a new framework. One thing is for sure, Greece-weary investors are at a place again, where policy makers can surprise them. Investors go from underestimating policy makers and their policy-making process (it is just noise, you cannot quantify it ..) to being driven by them.
The next 12 months will see a significant rise in volatility as economic, political and geopolitical forces converge
The near future will be loaded with questions about the future of the EU. Only a reformed EU treaty with full memberships and associated memberships makes sense, but politicians don’t want their citizens nor parliaments to have a say in the process. The period June 2015 to June 2016 promises to be eventful. Just consider one out of many issues. Can Brussels allow the UK to introduce quotas on immigration, while it says to Switzerland that the EU will never negotiate that? One of the biggest problems of the EU is that it offers too many transfer payments that “kill” self-responsibility. If redefined, the EU and Eurozone will reduce transfers while still keeping a certain degree of solidarity.
8 of the 20 global macroeconomic & geopolitical trends we are monitoring will overlap in Q3-Q4 2015, and I expect September to see a mid-term peak in global frictions. There will be tensions and frictions at diverse places: politically, militarily, geopolitically, monetarily and possibly more.
Considerations for investments (for qualified investors only)
We continue to suggest institutional investors to consider reducing USD exposure after its 33% rise trade-weighted. Many investors are again in herd behavior wanting to play a US rate hike vs bigger QE by the ECB. Fact is markets have discounted this already – US rates have already risen significantly vs European rates in relative terms. Add to it the Euro’s implosion in value vs the USD. Obsessed with carry-trade many investors miss the big picture.
The FED missed to begin normalizing rates in Q3 2014, believing the world and U.S. economies are too frail. A possible Euro weakness in the wake of Greece-Exit fears or deal-delay could be an opportunity to shift money from USD into Euros to balance currency exposures again. As we have maintained since last Fall, expectations by economists for European growth are too pessimistic. We maintain our view that US growth will rather disappoint in the 1st half 2015 just as EU growth will surprise positively until november 2015. And we keep our view that EU growth for 2015 will be close to 2%, and final readings between 2% and 2.5% should not be ruled out.
In that sense, institutional investors may want to consider increasing Euro exposure – of course depending on their strategic goals and risk budgets. If EU reforms begin to gain shape, the Euro could easily rally 10% to 20% over the next 24 months. There are of course other factors on the global stage that could counterbalance this, so we will update this continually.
Depending on the kind of solutions (simple postponement vs resolution) Brussels will communicate on Greece, this Thursday, Friday and Monday might see volatility and present opportunities. We also maintain our view that equities are highly vulnerable to a correction in the order of 20% to 50% over the next 24 months, specially over the next 6 months – investments are not just about valuations. Finally, institutional investors should consider some exposure to the VIX Volatility Index, ideally using USD cash or equity sale proceeds. In recent decades when equity markets sold off, the Volatility Index (VIX) jumped! The risk is of course that policy makers may want to interfere directly with bond, equity and volatility pricing. The market has grown used to policy makers setting asset prices directly. Thus, past correlations cannot be relied upon as in the past.
Looking into the future with all the information an data available to us, the period of 2015-2018 will see at least 8 out of 20 major global trends converge, unleashing more friction and tension to an already uncertain global landscape. The unprecedented confluence of geopolitical conflicts, economic imbalances, financial system vulnerability (debased paper-currencies), lack of trust in institutions, climate instability and extraordinary natural events will lead to unprecedented volatility in financial markets, distress and government interventions. Individual national governments and central banks will be overwhelmed, paving the way for a global currency reform and the rise of supranational institutions with sovereign powers. Investors and corporate leaders need to begin preparations for a much higher concentration of political power. They also need to stop looking at their performance in one reference currency only. We suggest European investors to monitor the performance of their businesses and portfolios in Euros, USD and Swiss Francs.
Source of market charts: CBOE and Bloomberg (analysis by Christian Takushi)
Christian Takushi MA UZH, Macro Economist, Wednesday, June 2nd 2015
Disclaimer and Warning: The opinions expressed here reflect the personal view of Christian Takushi and the current stage of his Global Macroeconomic & Geopolitical Research. His analysis and views are completely independent. The views of the independent specialists in Christian’s research panel and global network were also taken into account. Readers should be aware that global macroeconomic and global geopolitical research are highly complex and subject to sudden changes, even more so the analysis of the interconnection between global geopolitics, economics and financial markets. Our view may change within 3 to 6 hours following an event or data release, and we will notify and advise our clients first. This website will updated a few days later.
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