Kermit the Frog. Throughout his illustrous career running The Muppet Show, Kermit was able to rally the troops, and inspire them even under dire circumstances. When all looked lost, the diverse crowd all trusted Kermit and banded around him because they liked him, believed in him, and wanted to make him proud. But that's fiction. If it were real, Fozzy bear would be back stabbing Kermit and Scooter would be on Fox selling some political soap opera threatening to undermine his boss.
Who are the best and the brightest and why don’t they ever want to lead? The U.S. and Europe could use some leadership right now, but heroic pep talks about Herculean battles are lost on anyone in a suit working on a tax payer salary in Brussels and Washington.
Kermit the Frog could have done a better job.
Europe keeps looking worse with every passing month. The market has given European leaders numerous chances to come up with some short and long term policy mix to keep the eurozone in tact. Today, it looks like at least one country, Greece, will leave the euro.
The increase in European sovereign bond yields last week suggests that Europe’s fiscally stronger sovereigns — mainly France — are reaching their limits in terms of supporting their weaker neighbors, particularly as the region heads into recession. The International Monetary Fund forecasts higher unemployment in nearly every major EU nation next year. Barclays Capital economists said they expect Italy and Spain need an external financial “shield” of 500-800 billion euros to protect themselves from destabilizing market dynamics. That’s bigger than the U.S.’s Troubled Asset Relief Program launched in 2008. It is also bigger than QE2. The question is, where is the leadership that will make it happen before credit costs are so high, a major economy like Italy defaults instead of Greece.
Capital injection from the European Financial Stability Facility, the European Central Bank, and the IMF are unlikely to be the big “bazooka” the market is hoping for. Ultimately, whether a solution is reached largely depends on developing a more coherent vision of the post-crisis landscape from European political leaders. That means politicians will have to actually do something. So far, they are playing a long and boring game of chess. We might be approaching check mate.
On Friday, Barclays economist Julian Callow wrote in a report to clients that borrowing costs are going to continue rising even as the economy slows. “We look for a greater divergence to emerge between growth in northern and southern Europe,” he says. Germany, the powerhouse of Europe, might be lucky to grow 0.3% next year, down from 1%. “Financial conditions have worsened significantly across most economies, and particularly in southern Europe. This can be seen just by looking at government bond yields,” he says. The ten year GDP-weighted average euro priced government bond yield is now at 5.29%, the highest since 2002. The toxic correlation of sovereign and bank borrowing rates implies that the rise in government financing costs will be felt in terms of higher bank lending rates.
The present crisis in Europe is a leadership crisis. Those who know what to do, cannot convince others to do it. No one wants to make sacrifices to their social status. This lack of decision maker powers now means that Italy, the third largest bond market in the world, is facing a short term funding crunch. Like the U.S., Italy needs short term cash to pay for government obligations, such as government pensions and entitlement programs. The lack of leadership threatens to undermine the future of the euro, a currency that was created to unify the continent politically, a continent that has been the source of some of the most violent wars in human history.
Ireland, Greece and Portugal are already out of the public markets. Spain and Belgium are rapidly joining Italy in facing a credit crunch. And what’s worse, much worse, than that, is that the eurozone banking system is following suit, writes Tim Worstall, a fellow at the Adam Smith Institute in London and a frequent Forbes contributor.
Banks are finding that they simply cannot refinance the debts they need to in order to fund their lending. Thus the supply of credit, the money supply in the wider sense, is contracting and contracting at a fearful rate in some countries.
The U.S. might be in better shape in terms of credit, but in a leaderless Washington, the August debt ceiling increase was not enough. At the rate the country is going, politicians will have to raise the debt ceiling again in 2012, preparing plot point 2 as Act III of Jersey Shore plays out in Congress.
Barclays economist Troy Davig said on Friday that the failure of the Joint Select Committee on Deficit Reduction, or the so-called Super Committee, a scramble is now likely in Congress to determine if it can piece together a package that will preserve some short-term fiscal stimulus. In particular, the payroll tax cut and unemployment benefits for the long-term unemployed are two important factors shaping the near-term outlook. “Our baseline assumption is that both of these provisions will be extended. However, we see an elevated risk that they will expire, which would result in a drag to disposable income growth and likely shave about 1.5 percentage points off consumption growth in the first quarter and about 0.5 percentage points in Q2 next year…”
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