I went to a lunch this week where we talked about who is ultimately in control of things these days. Is it our governments? Or is it the markets? Most capitalists like to think it’s the markets. They are only sort of right.
Take Greece. It will go bust in the end. That’s just what happens when you have a debt to GDP ratio of over 150%: it costs you 25% plus to raise money in the markets; and your population considers paying tax to be an unusual lifestyle choice. But it didn’t go bust last year, last week, or even this week, as it would have had the markets had its way. And I’m not sure it even will this year. Governments have endless instruments in their armouries to postpone reckoning days. They’ve got opaque central banks through which they can do all sorts of incomprehensible things. They’ve got endless secret meetings. They have control of interest rates and, to a degree, currencies. They can change the rules on regulations more or less at will and, in the short and medium term at least, should they fancy it, they can go for full-scale financial repression and regulate the free flow of capital.
All this means that those who expect instant drama in Europe – beyond what we have already – are unlikely to get it. This week it looked like default was imminent. I suspect it’ll keep looking that way for some time to come. It is worth remembering – among all the talk about how much better off the core of Europe would be without the peripheral nations dragging it down – that if contagion and a wave of default meant that the core countries (Germany, France, etc) somehow went it alone, they would do so not just with a decimated banking system, but also with a much more expensive euro. That wouldn’t make their exporters look quite as good as they do with a cheap one. I’m wary of saying that Europe’s governments won’t allow Greece or the euro to fail – history tells us the market gets its way in the end – but they should be able stump up the cash and political will to keep it going for a while yet.
So when will Greece finally go bust? I discussed this over lunch this week with strategist Andrew Smithers (I’ve done a lot of lunching on your behalf this week). His view? The beginning of 2013. Why? Because 18 months is about how long it should take the lawyers to create a system for countries inside the euro to leave the euro. But that’s not the only significant thing that Smithers thinks will happen in early 2013. A new Chinese government will just have moved in and be getting to grips with its inflation problem (not easy) and a new US government will be having to make a decision about whether to deal with its budget deficit or not (both answers are bad for markets). Add it all up and you’ve got chaos. Smithers thinks the US stockmarket is 70% overvalued at the moment. He doesn’t think that will be the case by the end of 2013.