October 06, 2013

Euro zone turns from financial to political crisis

LONDON (MarketWatch) — A political crisis in Italy threatens fresh elections. The Portuguese government takes a hammering at the polls.Austria sees an upsurge in far-right and anti-euro parties. Germany drifts on without a government. Far-right parliamentarians are being arrested in Greece.


Hey ho — just another weekend in the euro zone. And yet, there are only so many storms any ship can weather, no matter how determined the captain and crew might be to keep the vessel afloat.

The markets have grown complacent about the crisis in Europe since European Central Bank President Mario Draghi made his pledge to do whatever was necessary to keep the euro EURUSD -0.44% afloat last summer.

But crisis never went away — the reckoning was just delayed with some heavy-duty painkillers.The real problem this time around is not the bond markets.

It is the political backlash against austerity and recession, and that has the potential to be far more serious for the investors who have been piling into European equities in the past few months. Phase One of the euro crisis, from 2009 to 2011, was essentially a financial crisis.

The bond markets refused to lend any more money to profligate peripheral governments, at least until the ECB promised to print enough money to pay them back if necessary — in the same way the Federal Reserve or Bank of Japan will print the money if it needs to.

It could always be fairly simply fixed by the ECB taking on responsibility for those debts. The only real surprise is that it took so long.

Phase Two was always going to be a political crisis, as people grew angry at the austerity, unemployment and bailouts, which appear to be all that the single currency offers anyone.

That is going to be a lot harder to solve — and it is only just getting going.Italy will be the center of the next storm. Former Prime Minister Silvio Berlusconi has withdrawn his support from the moderate coalition led by center-left leader Enrico Letta.

A confidence motion is scheduled for Wednesday. If the government falls — and Berlusconi seems quite happy to force that result — Italy will face its second election of the year. Keep in mind that last time around the anti-austerity parties, made up of Berlusconi’s center-right and Beppe Grillo’s Five-Star Movement, won a combined 56% of the vote.

It was only because Letta’s party won a fraction of a percent more than Berlusconi that he was able to form a government at all. Will the anti-austerity parties do better if fresh elections are called before Christmas?

Well, the Italian economy shrank by another 0.3% in the latest quarter, even as the rest of the euro zone finally started to expand. It is hard to believe the anti-austerity parties cannot pick up even more support.

Across the border in Austria, the euro is no more popular. The governing coalition of the center-left and right just about hung onto power.

But the far-right FPO, which wants to end euro-zone bailouts, scored 21% of the vote while the new Team Stronach, which wants to pull Austria out of the euro, got 5.8% in its first election campaign.

To the South, in Portugal, the government took a drubbing in local elections and looks unlikely to receive a fresh mandate to push through more austerity.

In Greece, the government has been arresting parliamentarians representing the neo-Nazi Golden Dawn, a party that has now risen to around 15% in the polls.

In Germany, supposedly the rock of stability in the euro zone, there is little sign of Chancellor Angela Merkel being able to actually form a government despite doing well in the election. The opposition SPD speculated this week it may be 2014 before a new administration is formed.

The strong showing of the anti-euro Alternative for Deutschland party will only make Merkel nervous of more bailouts. Indeed, Francois Hollande of France is the only strong leader around — which shows just how bad things are.

It is no surprise that the voters are fed up. Despite the boasting about a recovery from some of the euro-zone’s leaders, many of the figures are shocking. In Greece, retail sales are down 14% year-on-year, according to figures released this week.

That speaks of real hardship. In Italy, per capita gross domestic product is down from £36,000 in 2011 to $33,000 in 2012, according to World Bank figures.

Poverty has doubled, and now covers 14% of the population according to the country’s statistics institute ISTAT (it defines poverty as hitting four of nine criteria, such as being able to afford to heat your home).

It found that 16.6% of families could not afford a protein-based meal such as meat every two days, up from 6.7% two years ago. For a G-7 country such as Italy, those are terrible figures.

Things are just as bad in Spain, despite talk of a recovery, youth unemployment is now 56%, meaning someone under 25 is more likely to be out of work than to hold down a job. Old left and right divisions are gradually being replaced by pro- and anti-euro dividing lines.

Grand coalitions are emerging, as in Germany and Austria, that combine the old enemies of left and right to defend the euro against populist parties that campaign against austerity and the single currency. The trouble is, unlike the financial crisis, the political crisis is going to be a lot harder to fix.

If the euro is associated only with rising unemployment, increasing poverty, and endless government austerity, one of the anti-euro parties will break through eventually.

Investors globally have been pouring money into euro-zone equities in the last few months, attracted by cheap valuations, and tentative signs of stability and even recovery.

In the short term, they may well be right to do so. In the medium term, the euro crisis is merely taking a pause for breath. As it turns into a political crisis, it will be back with a vengeance — and second time around it will be far harder to fix.

marketwatch.com

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