Last night I watched Man of the Year, a Robin William movie about a comedian who is elected President of the United States of America... now imagine that this happened in real life, it did, but in Italy not in America. I'm sure that the Beppe Grillo is a nice guy, but he's Italy's answer to Robin William (of course he's not president but you get the analogy -- what we have in Italy is gridlock).
The first thing is that the voters reaction to Monti and his chums should not have been surprising -- its always been the failure of democracy, that you can avoid the hard choices if you lie! The reality is that Italie (and a good chunk of Europe) are in deep trouble, that since 2011 the ECB has been buying off the market with a backstop debt buying program that has reduced the urgency to take action at the supernational level (where debt write-offs take place) and keep the focus on cutting wages and salaries at home (creating wage deflation) -- so that pension funds, banks and the establishment can continue, for one more day, to make believe that everything is OK.
Things are not OK and will not be until real actions are taken. As of right now Italy (Europe's second largest debt market -- Oops!) has 120% debt/GDP ratio, that's high and Italy is very important country within Europe -- around 11% of Europe's GDP. The cuts proposed by Monti & friends will ensure that the country recovers, in a decade (maybe) and this assumes that other play ball -- considering that the UK (which has its own currency) is in deep trouble, this is unlikely. Canada did very well in the mid 90s when the Federal Government cut expenses because the global economy in general, and America in particular were "on fire" with GDP growth in excess of 5% -- the world could carry Canada. This is not true today where GDP growth is much much lower (maybe even negative in Europe).
The hard choices that will be made over the next few months (with gridlock in Italy -- funds from the ECB will dry-up) will result in much sharper pain, but it may be much shorter too, and better distributed. There is no reason why only wage earners are suffering in this game, especially since capital is largely at fault here -- the road preferred by Morgan Stanley this morning is one that had no pain for bankers and investors. The odds of this being the actual outcome have shrunk tremendously overnight.
Sequestration, sounds bad and it is bad, it was a formula that was devised to create the most pain possible to ensure that both sides would sit down at the negotation table and find a better outcome. It speaks volume for the failure that is the US political system that such negotiations seems to be impossible. I am sure that both sides are to blame here, but being me I suspect that a greater share of the blame must rest with the GOP. It is a peculiarity of the American political system that elected officals in Washington owe almost nothing to the party under which they are elected. They raise their own money, decide to run on their own, often without any support from the central party, and face the risk of re-election every two years -- in primary were only the party faithful participate!
Things are so bad that the Senat and Congress are in recess for the next few days (actually 10 days).
What about Canada in all that, well we watch on the sideline. We are an export nation (mostly to the US) that have little control over the actions of our neighbour and wonder at time if they are insane. Then again here in Quebec, the language police has shown its true importance (BTW no joke here, there are language inspectors...) demanding that on/off switch in restaurant kitchen be covered with their French equivalent. Turns out once one restaurant spoke out, several other joined the protest. We look like a bunch of cretins, CNN and BBC thought it particularly funny, as did TF1 (France).
Aside from that the CAD continues to fall, predictions are that the CAD could go to 0.95 to the USD. Again an indication of how serious things are in the primary metals, and energy sectors in terms of slow down. What gave Canada legs for the past 6 years could be a real problem going forward. On the other hand manufacturers must be happy...
So yesterday we had a market correction, this morning the futures were up -- there's always an overshoot, but the reality is that the financial markets this morning woke up with a black swan event on their doorstep. The market doesn't know what to do or thing following the Italian elections. What kind of coalition will be formed? The market hates uncertainty, and is now forcing a re-evaluation of different risks.