A couple of days ago one of the European Union’s founders issued a stark assessment regarding the EU’s future. From the Telegraph:
The European Central Bank is becoming dangerously over-extended and the whole euro project is unworkable in its current form, the founding architect of the monetary union has warned.
“One day, the house of cards will collapse,” said Professor Otmar Issing, the ECB’s first chief economist and a towering figure in the construction of the single currency.
Prof Issing said the euro has been betrayed by politics, lamenting that the experiment went wrong from the beginning and has since degenerated into a fiscal free-for-all that once again masks the festering pathologies.
“Realistically, it will be a case of muddling through, struggling from one crisis to the next. It is difficult to forecast how long this will continue for, but it cannot go on endlessly,” he told the journal Central Banking in a remarkable deconstruction of the project.
The regime is almost certain to be tested again in the next global downturn, this time starting with higher levels of debt and unemployment, and greater political fatigue.
Prof Issing lambasted the European Commission as a creature of political forces that has given up trying to enforce the rules in any meaningful way. “The moral hazard is overwhelming,” he said.
The ECB has “crossed the Rubicon” and is now in an untenable position, trying to reconcile conflicting roles as banking regulator, Troika enforcer in rescue missions and agent of monetary policy. Its own financial integrity is increasingly in jeopardy.
The central bank already holds over €1 trillion of bonds bought at “artificially low” or negative yields, implying huge paper losses once interest rates rise again. “An exit from the QE policy is more and more difficult, as the consequences potentially could be disastrous,” he said.
“The decline in the quality of eligible collateral is a grave problem. The ECB is now buying corporate bonds that are close to junk, and the haircuts can barely deal with a one-notch credit downgrade. The reputational risk of such actions by a central bank would have been unthinkable in the past,” he said.
Prof Issing slammed the first Greek rescue in 2010 as little more than a bailout for German and French banks, insisting that it would have been far better to eject Greece from the euro as a salutary lesson for all. The Greeks should have been offered generous support, but only after it had restored exchange rate viability by returning to the drachma.
This insightful analysis doesn’t deserve much more than a giant Homer Simpson DOH!
There is a crisis coming, that much is certain. The political situation is extremely precarious, and the economic equilibrium is even more unstable. The chances of the EU continuing in its present form are extremely low.
The Target 2 imbalances which represent the lending or borrowing done by each country’s Central Bank with the ECB are expanding back to 2011 European crisis levels.
Otmar Issing is correct when he says one day, the house of cards will collapse.
But what I would like to point out is how you go about positioning for that collapse is important. Probably even more important than getting the timing right. Most traders will probably run out and buy European stock index puts in anticipation of a collapse of the European Union. I think this is a terrible idea.
All we need to do is have a look at the recent BREXIT fiasco to see why.
With the collapse in the British Pound, the FTSE 100 has become the best performing major stock index. It is up 10% in the last six months while the S&P 500 is down and the Eurostoxx 50 is up small.
The British stock market has moved almost tick for tick with the inverted pound.
I could easily see a situation where a full fledged euro crisis develops, but the Eurostoxx 50 screams higher! I am already long out of the money long term Eurostoxx index calls (Pretty Sure I am alone on this trade), but I am almost tempted to buy more.
Europe will rip apart in the coming years. Just be careful on how you bet on it. I think shorting the European currency is an infinitely smarter way to play it than assuming European stocks fall. Heck you could almost argue that long Eurostoxx calls is the true “EU collapses” trade… (and at the very least, it is probably the cheapest).
Thanks for reading,