Europe Dithers, Markets Shudder

Merkel's isolation grows...

SOMEONE should tell Angela Merkel the story of Franz Ferdinand. The Archduke of Austria was assassinated on June 28, 1914 – nearly 98 years ago to the day – in Sarajevo by a 19 year old Serbian named Gavrilo Princip. Europe, already a political tinderbox, fell headlong into the Great War, writes Dan Denning for the Daily Reckoning Australia.

Surely Merkel knows this history as well as anyone. But we couldn't help thinking of the anecdote when we read her comment this morning. She replied to a seven page document by European Council President Herman van Rompuy which, among other things, argued for a Eurozone Treasury that would issue common debt. This proposal is backed by France, Italy, and Spain.

Merkel's reply was, 'I don't see total debt liability as long as I live.'

Hmm. Only the German Chancellor now stands between a fiscally integrated Europe that's able to borrow against Germany's credit rating for 'ever closer union'. The simple solution for centrists and Statists is to get rid of the democratically elected German Chancellor the same way they did in Greece and France. Watch out, Frau!

History and politics aside, markets are shuddering in advance of this week's European summit. Markets, in their natural collective wisdom expressed through price, know that deleveraging is deflationary for financial asset prices. Central bank and national government rearguard actions to lower the price of credit and replace private sector demand can stave off contraction, but they can't prevent it.

This is a brutal war of attrition in which the bankers give their friends on Wall Street covering fire to participate in risk free rallies in government bonds while shoveling the public a line of 'bulloney'. It's an effort to distort natural prices by lowering the cost of money. This confuses the price signals investors rely on to make their buy and sell decisions.

In a normal world with a normal market, today's price action is not that different from yesterday's price action...and tomorrow's won't be that different from today's. One way of expressing this statistically is through standard deviation. In a calm and normal market, daily prices don't radically deviate from the general trend (expressed here as a 50-day moving average).

But radical one-day swings in the share market – big variations from the average price trend – are becoming more common since the bursting of the US subprime bubble in 2007. Our argument here – and really the argument for incorporating trading analysis into your thinking – is that deleveraging coupled with high frequency trading and monetary instability makes big one day and one week price swings far more likely in the future than they have been in the past.

If we're right about that, you'll see more big spikes in price charts. Of course, the authorities in Europe and America want to prevent those spikes. Those spikes destroy retirement wealth. They also undermine confidence in share markets.

Without being a chartist, you can tell the share market has become less stable. Maybe this is a result of economic instability. Or monetary instability. Or maybe it's a result of the erroneous belief that more information, continuously processed by computers and brains, leads to better decision making. What this does do is leave us all constantly reacting, which leaves less and less time for real thinking.

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Formerly editor of Strategic Investment with Lord William Rees-Mogg, Dan Denning is an independent investment analyst now based in Melbourne, from where he edits the Australian edition of The Daily Reckoning. He is also author of the best-selling The Bull Hunter (Wiley & Sons).

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