What happened at the EU summit?
There’s an old saying that copper is the metal with a PhD in economics. Well, in my opinion, the stock market has a BA in Learning Disability. I need only remind readers of the fact that the S&P reached its all-time high in October 2007 after the credit markets froze and the CDO price index collapsed.
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More recently, every time there is an EU summit, the stock market erupts in euphoria: crisis over! The market is so bored with the euro crisis, and so totally uninterested in anything exogenous to its earnings models, that it will grasp at any straw that will allow it to go back to studying eps models and earnings “surprises”.
I see no information value in the market's rise on Friday.
So what did happen in Brussels? Not much, as far as I can make out:
1. An EUR 120 billion stimulus package using existing EU money. Yawn.
2. Direct EFSF/ESM bank recaps, once each eurozone member has surrendered its bank regulatory authority to an EU regulator yet-to-be-named. That will be a simple matter!
3. Something very convoluted about the ESM’s priority of claim at Spanish banks that is supposed to make bondholders feel better.
4. Allowing the EFSF/ESM to buy government bonds in the secondary market with an eye to reducing yields.
What didn’t happen?
1. No agreement about fiscal union, which is Germany’s precondition for eurobonds.
2. No mechanism to allow (or force) the ECB to buy government bonds in the primary market.
3. No (public) jawboning of the ECB for monetary stimulus.
4. No resolution of Greece, which is still trying to renegotiate its bailout.
I have to assume that the market’s euphoric reaction reflects the view or the hope that Merkel and Schauble have had a meaningful change of heart about Germany’s role in saving the eurozone. I see no evidence of this. It looks to me as if Merkel threw Monti these bones so that he would let her take off her earphones and go to bed. She didn't want a public row with France, Italy and Spain.
And, Merkel aside, there is still the small matter of the Bundestag (which has not yet passed the “fiscal pact”) and the Constitutional Court which looks fish-eyed at any loss of German sovereignty.
Once again, the EU has solved the immediate crisis (Spain’s insolvent banks) without providing a roadmap for any sort of final resolution. In my view there remain the following eurozone scenarios:
1. Breakup and chaos, as the PIIGS face daunting borrowing costs and default.
2. Fiscal union permitting the issuance of eurobonds co-guaranteed by the German taxpayer.
3. The ECB provides inflationary stimulus and refinances the PIIGS.
Germany does not want #1 to happen, and is prepared to discuss #2, but no one is jumping at the chance to permanently surrender their sovereignty to Berlin, and anyway it requires a new treaty. #3 is the best solution, but it is not under consideration, and it also requires a new treaty.
The spotlight now shifts to Athens, where the new government will shortly have to choose between massive mandated budget cuts (and riots) or eurozone exit (and riots).