Fear premium, failure premium

What are the odds that this migration crisis in Europe could cost German chancellor Angela Merkel her job? What are the odds that 12 months from now, the European Union itself could be much smaller and much more German and French? What are the odds that financial markets have priced all this into currencies, stocks, and gold?

The week begins with more questions and answers. For investors, the key is asking the right questions now, and then thinking hard about the probabilities. Some of the questions are prompted by a conference I went to over the weekend on geopolitical forecasting. You’ll read more on that in a moment. But the other questions are prompted by events in Portugal and Poland over the weekend.

Before I get stuck into that, a reminder that former fund manager Charlie Morris was in on Thursday to talk to my colleague Nick O’Connor and me about why Britain should leave the EU. You can listen to the show here. In addition to immigration and Britain, Charlie had a bit to say on why gold enjoys a ‘fear premium’.

The chart above doesn’t show the ‘fear premium’ in US dollar terms. But I’d suggest that a ‘failure premium’  is building in the euro gold price. Gold, in euro terms, is up almost 6% peak to trough in the last 60 days. The migration crisis has added to doubts about the European Union’s ability to deal with big problems.

Speaking of which, plenty of people at the local level appear to be having the same doubts. Poland is pretty straightforward. The right-of-centre Law and Justice party won 37.7% of the vote in parliamentary elections. The incumbent Civic Platform party, which has governed the country for the last eight years, tallied 23.6%. The result is that for the first time since the end of communism in 1989, the socialists won’t have a voice in the Polish parliament.

But from Britain’s point of view, this is another central European state saying ‘yes’ to more nationalism and ‘no’ to more European Union. Poland, like Hungary and Slovakia, has a lot at stake in how Brussels (led by Angela Merkel) decides to handle the flood of refugees and migrants coming to Europe from the Middle East and North Africa. Judging by the results, the Poles would like more control of their borders and less scolding from Berlin.

That’s a huge simplification of the Polish election result, of course. The Law and Justice party has a little something for you if you’re on the left and a little something for you if you’re on the right. On the left, the party is for a bank tax and (weirdly) a tax on supermarkets. On the right, it wants stronger ‘social values’, reflecting Poland’s Catholic roots.

Mainly, this is Poland wanting to be Poland, and not Europe. You could say the same for Greece, Portugal, or even Britain. And because Poland’s economy has grown by 50% in the last eight years, it’s hard for the EU to use economic coercion to force political change in Poland.

That is not the case, apparently, in Portugal. I should qualify everything I say on this by admitting I know very little about it other than what I can read online. But what’s happening in Portugal looks a lot like what happened in Greece, with a twist.

EU ‘democratic deficit’ on display in Portugal

What’s happening is that when it comes to voting, a thin majority of people are against austerity and for more government spending. The twist is that Portugal’s constitution apparently allows its president to prevent the formation of a government if he’s not happy with the composition of the political parties in a coalition, or convinced they can form a stable government.

Are you following?

Recent elections in Portugal saw centre-left parties win a narrow majority of 50.7%. Those parties hadn’t yet formed a government. But Portugal’s president, Anibal Silva, has ruled out such a government on his own authority. Parties on the Portuguese left have variously advocated leaving the euro, leaving Nato, and nationalising the ‘commanding heights’ of the economy.

In a press conference explaining his essentially anti-democratic action, Silva said: “In 40 years of democracy, no government in Portugal has ever depended on the support of anti-European forces, that is to say forces that campaigned to abrogate the Lisbon Treaty, the Fiscal Compact, the Growth and Stability Pact, as well as to dismantle monetary union and take Portugal out of the euro, in addition to wanting the dissolution of Nato. This is the worst moment for a radical change to the foundations of our democracy… After we carried out an onerous programme of financial assistance, entailing heavy sacrifices, it is my duty, within my constitutional powers, to do everything possible to prevent false signals being sent to financial institutions, investors and markets.”

In other words, Portugal has already done so much to please its masters in Brussels, it would be folly, and therefore not permissible, for the people of the country to vote to change directions. What the EU wants, the EU gets. The ballot box be damned.

That, too, is a simplistic understanding of what’s going on. The ‘anti-austerity’ crowd really wants more spending and debt forgiveness. This may be a decision arrived at democratically. But exposes how easily democratic systems can be ‘gamed’ by an electorate willing to vote itself benefits.

It’s likely President Silva is trying to avoid what happened to Greece. When the Greek people rejected the financial terms offered by the EU in July of this year, the European Central Bank (ECB) froze lending to Greek banks. Greek banks then imposed capital controls on the Greek people. Thus were the people of Greece squeezed by the ECB until it hurt. Portugal can avoid that kind of financial/political extortion later by becoming more anti-democratic now.

Keep all of this in mind as you’re deciding whether Britain should stay in the European Union. When it was a project for a common market with the free movement of labour, capital, goods, and services, the EU made sense. Once monetary and fiscal union became goals, then it became about consolidation of supra-national power in Brussels.

That’s where we are now. And now, you wonder how much more member states can take before they’re in full rebellion. Thoughts? Post them below.

Category: Economics