With a two-day hiatus on writing about our Macro Views (due to writing about the more important-at-the-moment topic of OPEC and oil) I am back on schedule today.
Moving from the East (India) we will continue East to West and talk about Europe today.
The major theme in Europe for the next six months or so, will be, elections. The importance of the election outcomes will determine the fate of Europe, the European Union and the Euro currency.
The United Kingdom leaving the EU (Brexit) was the first sign of voter dissatisfaction with the status quo of European (and global) trade, borderless migration of EU citizens and just a general distrust of the mainstream politicians that have been in power for generations. I suppose it is fair to say, "folks have just had enough" and were looking for change. Well, change they got. Now the hard part...the logistics of exiting the EU. Now for the UK, it is a much easier goal to accomplish than for a Euro nation because the UK didn't use the Euro currency and still retained it's own Central Bank and monetary policy. Not so for Italy, Holland, France, etc.
Well guess what time it is in Europe? (please don't give me the time on the clock right now in GMT). It is election time. I will run through some of the major elections (and a referendum) in Europe over the next few months as we think these are very important for global markets.
Italy - Sunday Dec 4, 2016 - Referendum
Home of fine wine, food, bicycles (I finally recieved my crashed carbon fiber (that was blessed by Pope Benedict himself) race bike back after 3months of repairs) and my maternal grandparents. Also home to a disenchanted voter base. On Sunday Dec 4th, Italy will vote on a Referndum to make dramatic changes to ammend their Constitution and the powers of parliament as they affect state, regions and administrative entities. I am most certainly not an Italian Constitutional expert but it sounds to me like the changes being proposed by PM Renzi and his left-leaning Democratic Party will actually give more powers to the PM. Anyone who has followed Brexit and Trump think this to be a good idea? I doubt it. Should a "No" vote carry the referendum, PM Renzi said he would resign. Where does that leave Italy? In a huge hole is my best guess. They already have had issues with at least one bank teetering on insolvency...just imagine what would happen if a hole opened up for the other, right-leaning political parties to step in and make the next move for Italy - a Italexit? Even if the right (the Five Star Movement) didn't get organized for months, the most immediate effect would be a "run on the banks", that being, depositors would be yanking Euros from Italian banks like crazy. So although a No vote on Sunday will not lead to Italy immediately leaving the EU, it would be a precursor and one that would provide immediate uncertainty. How the Bank of Italy and the ECB deal with it will be discussed at the end.
Germany - February 12, 2017 - Presidential Election
This is far less important an event as it is really the electors (current politicians) who will elect/nominate their candidate. Given Merkel's CDU/CSU party and the Social Democrats hold 75% of the house (the Bundestag), it is highly likely a mainstream candidate will be chosen. I don't think this is a major event but worth putting on the calendar.
Holland - March 15, 2017 - General Elections
Ok, this is a big and important one. The Dutch voters will elect 150 Members of the House of Representatives. Holland, like Germany, has had the typical, mainstream parties (Labour and People's Party for Freedom and Democracy) in power for a long time but there is a new underdog in the race. I don't need to mention this but we have seen this movie twice in the past six months and the underdog wins...Brexit and Trump. There is clearly a socio-economic movement afoot in western developed nations. Just two days ago, underdog Geert Wilders and his Party for Freedom (PVV) took the lead in the polls. If you have never heard of Wilders, go ahead and Google him but I can tell you he makes Trump look like Mother Theresa. Whatever you may think of him, his social views, his comments and anything else he stands for, I put aside because the only thing that matters to me, sitting here on Toronto St in front of my bank of monitors is, how to avoid losing money for the accounts we manage. So what if Geert picks up further steam and is actually elected to PM of Holland? He may not get a majority but who knows? Like Italy, his win would provide a massive uncertainty. And like Italy, there would likely be a run on the Dutch banks as depositors withdraw Euros. I will discuss shortly what the ECB might do to hold it all together.
France - April 23, 2017 - Presidential Elections and June 11 2017 - Legislative Elections
This may just be the biggest and most important of all of the European elections in 2017. First up is the Presidential elections on April 23rd, 2017. The three front runners are the newly elected Republican candidate, Francois Fillon, who just won his party's primary in an upset against a more moderate Alain Juppe, the winner of incumbent Francois Hollande's Socialist Party primary and...Marine Le Pen, the leader of the National Front. Like Geert Wilders, Marine Le Pen is a nationalist and a protectionist. Her message is beginning to ring through to the people of France as she is doing better than expected in the polls. I don't want to get into what is behind her recent popularity but she is clearly gettting through to the French voters. Again, like Italy and Holland, what the heck happens if Le Pen wins the day in France and they leave the EU? Remeber, we are talking about France, not Greece.
Before I conclude on what I think might happen over the next six months, I wanted to give you my views on part of the reason why this "populist" vote is rising up in the developed western world. Obviously, some of it is social. We all read the press about social unrest in Europe and the USA (so far in Canada, we have been somewhat immune to such domestic terrorism like we saw just a few days ago on the campus of Ohio State). Away from the social and immigration aspect, but not totally unrelated, is the more economic aspect to this movement and is best represented by modern day free trade. Modern day free trade was a socio-economic experiment that came into vogue about 30yrs ago. On paper, this seemed like a great idea and was well-supported by economic theories like that of Comparative Advantage which sates that one nation who produces something cheaply and in abundance (say wheat in Canada) should do so full-throttle while another nation that produces another good cheaply and in abundance (say autos in South Korea) should also do so full-throttle. So we would sell wheat to South Korea and they would sell us cars and the wheat and cars would cross borders without being taxed so consumers in both countries win...sort of. Where free trade and comparative advantage theory breaks down, as we are now seeing in this political movement, is that no one ever really thought about the socio-economic consequences when an entire town or city that used to produce cars (say St Thomas near London) abandons it car plant. The town and its people suffer enormously while wheat farmers in the mid-west are laughing all the way to the bank. I think the free trade experiment is starting to come home to roost and that is part of what is driving this populist political movement.
I am obviously not 100% sure that Le Pen or Wilders or whoever takes up the right in Italy will actually win the day and execute on leaving the EU and go back to their own home currency and central bank. What I do know, is the movement is gaining steam and if it does happen, look out below.
I have been talking to a friend of mine about the logistics of how the ECB or the central bank of France, Holland or Italy would support their banking system and save the day. I have no answers, unfortunately. You may say, "hey, it wasn't that bad in the UK, what is the worry?" The worry is, the UK used the Great British Pound as its currency and had its own central bank before, during and after Brexit. Not so for France, Holland and Italy. So if France votes to constitutionally leave the EU and there is a run on French banks, which central bank steps in to prop them up and what currency do they use to do so, Francs or Euros? Imagine the systemic risk amongst European and global banks if this were to happen. The Franc would get pounded into oblivion and a nation already on the fiscal brink, would become that much more so. This would likely mean the end of the EU and the Euro currency. I would envision that most every currency in the Euro Zone would get hammered hard, save for Germany where the Deutschemark would skyrocket. What I do know if this political movement does play out is...it would be a complete and utter mess for capital markets. Just the systemic risk in the banking system alone would be unreal.
How this would affect us here is an interesting question. It certainly doesn't look it today, but I think there would be a significant flight to the safety and quality of US (and Canadian) treasury bonds. European bourses would take a beating led by banks/financials on counter-party systemic risk. Gold would likely find some legs on the European currency weakness. Commodities would probably decline a fair bit on European economic weakness.
The sheer logistics of how the EU would be held together if this type of event were to unfold is mind-boggling. Dealing with a financial crisis when you have a functioning central bank and a currency is difficult as it is (USA 2008, UK 2016) but when you don't have a functioning central bank or currency, the solution is just a little bit clouded.
(Exhausted. I think that was the longest blog I have ever written. Apologies for the length).