The end of the European dream

This weekend saw Marine Le Pen kick off her campaign to be France’s next president and move to the front of the opinion polls for the first-round election to take place on April 23. Nowhere is the disintegration of the European dream more stark than in France, where the whole concept originated. Trying to impose a currency that nobody wanted has resulted in the political left betraying its principles to “support” the people and the traditional right in betraying its role as defender of the nation. As a result, the two “natural” parties of government are imploding in front of our eyes. Nobody has a clue what to do next, or who to vote for.

But this is not specific to France. Italy’s political system has fallen apart since the 2011 “coup” against Silvio Berlusconi by unelected politicians chosen by unelected nobodies in Brussels. Greece could this week again enter the firing line as bailout negotiations loom. Portugal, which now has one of the world’s highest per capita debt levels, must endure interest rates that are twice the annual rate of economic growth, meaning that it is locked in a debt trap and on a near certain path to national bankruptcy.

To their credit, the British had the foresight to see that this ship is doomed and are getting the heck off. More nations will likely follow. The Netherlands goes to the polls on March 15 and may vote to break from the nutcases in Brussels. Spain and Catalonia are on the verge of parting company. Austria, the Czech Republic, Hungary and even Poland are starting negotiations for a common foreign policy. They are clearly not paying much attention to the foreign affairs bureaucracy in Brussels, but instead seem set on resurrecting the Habsburg empire.

This process of disintegration will have profound financial consequences. Germany has accumulated EUR 754 bln of Target II assets from the rest of Europe and knows these sums will never be repaid. Perhaps this is why it has encouraged a blowout in its current account surplus, which in nominal terms exceeds that of China. The result has been to suck out growth from the rest of the world.

It is my conviction that Europe’s financial Frankenstein monster has entered its death throes and the final blow will stem from a political crisis. I must admit that back in 2012 I thought such a denouement was close, but the technocrats threw so much money at the problem that a respite was achieved. My impression for a while has been that we are a lot closer to the end than most people think.

If I am right, it is worth considering the following checklist of financial effects which one would expect to be reflected in markets.

1) A rising and very high US dollar exchange rate as Europe’s “free” savings move to the US, leading the dollar higher.

2) High financial asset values in the US as excess liquidity moves from Europe to the US.

Done

an end)

To come

Done (but may be coming to

3) As excess liquidity leaves Europe, spreads open between Germany and the rest.

4) Since this is not a liquidity crisis, but a solvency crisis at least half of eurozone economies should see widening credit spreads (later spreading to the US).

5) Since many illiquid investments have benefited from excess liquidity created by the ECB to deal with a solvency problem, such assets will experience a return-to-the mean adjustment.

Starting

Starting

Hence, if I am right, expect illiquid investments to do much worse than the liquid ones as Europe’s stupidity ends with a massive destruction of wealth. Looking ahead at triggers, I am especially focused on the Dutch national election which is now only five weeks away.