Why Europe’s Fiscal Integration Still Spells Financial Doom

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Imagine you’ve mortgaged your house to the hilt in order to fill it with all the gadgets your heart desires. And imagine you have a big heart, with lots of desires. Your home has a comfy lounge with a large new HD television in front of it. There’s a plush recliner in which to park your weary behind. And all around the house are the accumulated creature comforts that enhance the quality of your domestic life.

Now imagine you’re forced to take a pay cut at work. Your job no longer provides you with enough income to support the interest payments on your mortgage. Your domestic bliss is still undisturbed. But in the back of your mind, you know that you’re living way beyond your means. Your lifestyle exceeds your financial resources.

Now imagine you’re the European Union – a vast army of faceless bureaucrats desperately trying to save its big 60-year project in social engineering. The private market – investors who buy government bonds – tells you its losing confidence that you can control your spending. More importantly, the private market tells you it doesn’t see how you’re going to repay the debts you’ve already accumulated in order to support your lavish, government-sponsored, Welfare State lifestyle.

What do you do to convince them you’re a good bet? You tell them that the answer to your problem is bigger government. That’s right! Your answer to a debt problem is to turn all the big national governments into one really big supra-national government, and give a few people control over everyone else’s money.

That’s basically what happened in Europe since we last wrote to you. All 17 countries that use the Euro agreed to greater “fiscal integration” in Europe. Even 10 or so countries not in the Euro agreed that it was a good idea. The lone exception was that island nation north of France, filled with cranky people drinking warm beer (their beer is warm…no wonder they’re cranky). The British politely declined to pledge their allegiance to a European superstate.

Today, then, financial markets will tell you whether private investors believe greater “fiscal integration” is the long-term answer to Europe’s debt problem. We can save you the trouble and tell you the answer now: Europe is still doomed. Friday’s deal is not an “all clear” signal for stocks (although we concede some people will read it that way and buy anyway).

The trouble is, no matter how you slice it, many of the world’s governments need money. If the private markets don’t give it to them, their central banks will have to do the job. This will lead inevitably to money printing and currency devaluation. The amount of money these governments require is staggering.

Industrialised welfare state governments will have to borrow some $10.4 trillion next year, according to the Paris-based Organisation for Economic Cooperation and Development (OECD). That’s a lot of money. Where will it come from? And with so much demand for new capital, doesn’t that mean the global price of money is going up, even if nominal interest rates stay low?

The countries doing the bulk of the borrowing are in Europe. Don’t forget America. (Which we’ll touch on in further detail in our second article for today about making the right stock investment decisions in this crazy economic climate). But how does Australia figure into this?

Well, the Big Four Aussie banks have to compete in the global market for funds. The banks might enjoy relatively stable credit ratings. This should make them somewhat attractive to foreign investors looking for a safe yield. But what we definitely know is that the cost of money is going up…and that the Reserve Bank of Australia doesn’t set the price of money.

That last little bit – that the RBA doesn’t actually control the price of money for Aussie banks – probably became clear to some people for the first time last week. The Big Four banks first ignored the RBA’s Tuesday rate cut. Then, they caved and matched it. But then, ANZ’s Phillip Chronican said this:

There’s a fairly tenuous link between the Reserve Bank cash rate and the cost of funds of a variable rate mortgage, and yet we’re all stuck in the same routine of waiting for an RBA cash rate move before we move. ‘We’ve all said it’s wrong, we’ve all said it’s a nexus that needs to be broken and we just thought it was about time somebody did something about it.

ANZ will begin conducting its own monthly review of interest rates. That review will not be based, we guess, on what the RBA says the price of money should be, but what ANZ must actually pay when it borrows money abroad. Thus you have a “decoupling” of bank mortgage rates from the cash rate.

This is going to upset a lot of people because it makes it crystal clear that the RBA doesn’t control interest rates and it doesn’t control the economy. The fact the bankers can’t control the economy like a finely tuned machine will upset the sensibilities of the technocrats and Keynesians who think they run things. It will also upset anyone who owns an interest-rate sensitive mortgage, which includes most Australian borrowers. The RBA has lost the ability to magically make things better by forcing the banks to effectively put more disposable income in people’s pockets through an interest rate cut.

Of course not everyone knows it’s a credit depression yet. But those who do know that the stock investment decisions they make in the upcoming months, could prove crucial to the future preservation and accumulation of their wealth.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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5 Comments on "Why Europe’s Fiscal Integration Still Spells Financial Doom"

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SV
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Erm.. you were the one who said monetary union is not working because every government has different fiscal policy. Now you are saying unification of fiscal policies is not good either. Is there anything the Europeans can do to please you (other than drop dead)?

Biker
Guest

Nice opening tying fears about home losses through unemployment to Europe’s troubles, Dan. A little disappointed you didn’t weave _China_ fears in there somehow, but you brought the article to a close neatly with the ANZ scare!
Inventive twist, after back-to-back interest rate cuts, with another two possible in early 2012. :D

Biker
Guest

And some more cheerful stuff for the festive season and New Year:

http://www.oecd.org/document/15/0,3746,en_2649_34573_45268687_1_1_1_1,00.html

Joe
Guest
The trouble is, no matter how you slice it, many of the world’s governments need money. If the private markets don’t give it to them, their central banks will have to do the job. You seem to have missed the natural conclusion beyond simple statements Dan. This is not a criticism as I suspect this was perhaps beyond the scope of your summarised commentary. The natural conclusion is that since so many countries need money because there is internationally so much debt, simple devaluations will not be the off-shoot of all the money printing. All nations cannot devalue their currencies,… Read more »
Joe
Guest
There’s a fairly tenuous link between the Reserve Bank cash rate and the cost of funds of a variable rate mortgage, and yet we’re all stuck in the same routine of waiting for an RBA cash rate move before we move. ‘We’ve all said it’s wrong, we’ve all said it’s a nexus that needs to be broken and we just thought it was about time somebody did something about it. Hmmm. Are we certain the RBA isn’t funding our banks because it is guaranteed funding and cheaper than the Money Market which we all know is pretty disfunctional at the… Read more »
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