Evercore Pan Asset

A couple of weeks ago the “True Finns” party won a stronger position in Finnish politics. This has a wider significance, because their platform includes refusing to join in any EU wide bail out of Portugal.  The “True Finns” are not the majority in Finland, so they may not prevail on this issue. There are many possible permutations to form a government and its platform in the divided politics of modern Finland.  The EU may have some surprises in store for them which force them to accept the inevitability of a further EU bail out. The EU usually gets its way over these matters.
 
However, the True Finns position matters more to investors than their weight in the complex and sprawling world of EU politics. It matters, because the true Finns may be speaking for many other electorates in western Europe, frustrated at the inexorable rise in debt and spending around the EU with no end in sight to the rolling debt crisis. At various points the EU needs voter approval for its large project, or at least acceptance by individual member states of the discipline the EU is now trying to enforce.   It matters, because they may be right. You cannot solve a debt crisis by lending the debtors more.
 
The response of the EU authorities so far to the crisis in Greece and Ireland has been to offer short or medium term loans on cheaper terms than the market. This delays the urgency of the task of bringing the deficit down. At the same time the EU has demanded more rapid progress to bring the deficit down, requiring a combination of higher tax rates and lower spending than planned. The EU threatens fines if countries do not adhere to new targets.

This follows a long period when EU rules obliged each country to keep its stock of debt down to 60% of GDP, and to borrow no more than 3% of GDP extra every year. Many countries broke these rules, some by huge margins. No action was forthcoming.  If the new regime is tougher, the fines will themselves add to public spending and the deficit of the delinquent state. The loan agreements also give the EU some new powers of influence. 
 
The EU view is a combination of subsidised loans and a tougher regime for deficit control will do the job. The EU just needs to put all problem states under the control of its loan programmes. Time and better management will then resolve the difficulty. The markets and their participants take a very different view. They point out that Greece had to renegotiate its Spring 2010 loan as early as the autumn of the same year, to give it longer to repay. They price Greek debt in a way which shows a majority think Greece will in some measure renege on her debts, failing to repay all the capital or cutting the interest payments or both. They do not think Greece can easily get out of her problems, as the proportion of Greek tax revenue that goes in paying interest charges is on the rise. If a country – or an individual – does not control the quantity of debt, they can get into a debt spiral which becomes impossible to resolve by more borrowing, as they cannot afford the extra borrowing.
 
What Greece, Portugal, Ireland and the rest need is faster growth, to generate faster growth in tax revenue, to cut the proportion of the state’s income going on debt service. Higher taxes, spending cuts, and a high exchange rate they cannot individually influence is not a good recipe for success. Things may have been quiet for a bit on the Euro front. The German economic success and the move to raise interest rates has temporarily strengthened the currency. This does not mean the problems are over, or EU investments are suddenly good bets. The Finnish election will make the Portuguese troubles a bit noisier, and remind investors of the risks of investment in European sovereign bonds and in wider Euroland assets. European banks own many European sovereign bonds, and will be worried about the debt outcome in the problem countries.

 As published in Investment Week