Europe faces a crunch from energy and austerity, and is vulnerable to policy mistakes, disunity and disinformation

Blain’s Morning Porridge Oct 10^th 2022 – Europe faces a crunch from energy and austerity, and is vulnerable to policy mistakes, disunity and disinformation

“The Euro will remain a tremendous success for Europe – up to the moment it collapses.”

This Morning: It’s too easy to write off Europe to the multiple threats of recession, low-growth, energy and inflation, but it has previously surprised us by its’ resilience! How will it fare with potential energy dislocation, fiscal and monetary risks and Russian disinformation? Can the Energy war be won?

Just how bad are things going to get in Europe this winter? A large number of market commentators predict the looming power cuts, recession, industrial and political strife will spell the end of European unity, inevitably leading to the unravelling of the EU while unfixable splits in the ECB lead to a collapse of the Euro. Doom and Gloom in bucketfulls!  This morning its headlines about the new Italian coalition coming off the rails. There is nothing like a story of imminent European collapse to excite the markets.

Hands up. I was once one of these nay-sayers, regularly on CNBC and Bloomberg explaining how the ECB was an unsteerable, top-heavy committee unable to agree common purpose or policy for a European polity comprising very different economies, how the European Sovereign Debt Crisis was irresolvable under the rules, how Greece, Portugal and Italy would crash out the Euro, and how a European sovereign credit crisis would force all the nations to abandon the common currency in order to bail themselves out. I pointed out repeatedly the divisions between national goals, and how German workers would never pay for Italians to retire early. For years I railed at the increasing behind-the-scenes mutualisation of European sovereign debt by Brussels.

But, some extraordinary things happened and Europe survived – and when the facts change I am willing to change my mind. Europe, the Euro, and the ECB have unique problems, but the EU has thus far proved far more resilient than the Brexiteering commentariat gives it credit for. When Europe looks cheap I am inclined to be a contrarian and see it as buy opportunity!

Mario Draghi demonstrated the ECB can do whatever it takes when faced with crisis. Even though Europe again faces multiple crises; energy, inflation and growth… and now Russia, I have an inkling difficult decisions will be taken, and the ECB will prove far more accommodative than disunity between Governments, and the current hawkish composition of the governing ECB board suggests.

Number 1 crisis is Energy.

Already there is clear division in Europe: Germany surprised its neighbours by using its debt headroom to raise €200mm of Energy bonds to price-cap rising energy bills. They have moved out of lock-step with Europe and seem determined to look after Germany first and foremost. No mention of solidarity with the rest. The nation’s energy reserves are at 91.5% of capacity, and it’s now struggling to persuade the electorate to be frugal with energy usage. To avoid power cuts, they need people to turn down the thermostats and a mild winter.

(Markets will be trading the weather this winter like never before – anticipating how a degree of temperature change impacts markets. A mild winter may not be on the Cards. La Nina in the Southwest Pacific means we could get a repeat of The Beast from the East in 2018 with a succession of cold easterly air masses hitting the UK. The Met Office most likely outcome is cold snaps, but generally wet, windy and relatively mild weather from the West.)

The EU is trying to “design” a similar price-cap across Europe – but its’ struggling. The plan is to establish reliable gas prices (in a volatile market?) with “reliable” suppliers, negotiating with Norway (who isn’t?), and decoupling gas prices from other power sources (like renewables, but also coal and nuclear.) In time honoured EU manner is says “it is paramount we have joint procurement of gas and avoid out-bidding each other.” Avoiding “fragmentation” (Ursula von der Leyen’s favourite expression) is critical.

Germany, the Danes and the Dutch (DDD!) are concerned the EU proposals won’t work. The risk is a price cap and global supply don’t necessarily align – the price is the price is the price. It could result in undersupply and power cuts. The problem is – without subsidy or assistance, most European nations simply can’t meet the costs of higher energy.

Number 2 crisis is inflation.

It looks like the ECB will agree to do “whatever it takes” to bring down prices, but the reality is most of Europe is going to be crushed by energy costs and negative growth recession whatever. The upshot is rising social tensions as inflation bites and wage demands soar. Raising interest rates are bound to further impact households and businesses. Higher rates can only make things worse – but Europe is hardly an overheated economy. The crisis is about supply chains, commodity prices and energy – addressing these through austerity looks a recipe for disaster in terms of social effects and protest..

Today’s ECB board is conservative, orthodox and hawkish – but if they raise rates aggressively, it’s difficult to see how they do anything except raise tension and accelerate recession.

Number 3 is Fiscal and Monetary Policy

In the wake of the UK Truster**ck currency and gilts crisis, how can Europe raise the necessary finance to address energy, avoid deep social recession and cure inflation when many nations have much worse debt fundamentals than the UK? And just to make that more difficult, there is no debt mutualisation within Europe. If Europe raises debt to finance an energy crisis, that debt is only as good as the poorest, least credit worthy member on a pro-rata basis.. (Complex stuff – but I have written about European debt many times, and will do so again!)

It all seems like an untie-able Gordian Knot – which is why something dramatic may have to happen to make it work… Like European Energy Bonds issued by the EU and financed by the ECB through the crisis. Unless it is very carefully and clearly communicated to markets how Europe is going to deal with the energy crisis, then expect wobbles which will rank alongside the UK two weeks ago. I suspect Europe will stumble into a solution – which I why I am waiting for the moment to buy!

Meanwhile, there is the additional Political concern of keeping Europe on track to win the Energy War with Russia. Russia is betting cold, hungry, poor Europeans will care less and less for Ukraine.

All of which begs the question: Who blew up Nordsteam?

The Ukraine war is about energy and who controls it, but the West can only win if the people are willing to accept and bear the high cost of the war in terms of the Economic damage that will be imposed this winter. If Russia can break the will of Europe, by forcing it to unwind sanctions in return for Gas, then it wins the war.

Yesterday I had a late post sailing lunch with some very dear chums and the sabotage of the Nordstream Gas pipelines came up. They absolutely assured me it was the work of the Americans – citing Biden’s promise to “put an end” to the gas pipeline if Russian invaded Ukraine, how the US Energy Department has already admitted to the attacks, and citing the film of US naval vessels and torpedo armed helicopters moving with . Proof irrefutable – apparently. All backed up by slick You-Tube videos and posts on Facebook they wanted to send me.

I’ve been mercilessly trolled for expressing the opinion the Russians are behind the sabotage of the Nordstream Gas Pipelines. I’ve been called an idiot (and much worse) for trying to rationalise how it can possibly have made sense for Putin to have destroyed his own assets, and cut off Russia’s ability to fill Europe’s gas needs in the difficult winter ahead.

Destroying the pipelines serves to highlight just how vulnerable energy insecurity has made Europe. But only 2 of the 3 pipelines have been destroyed. Gazprom has made clear the second Nordstream2 No 2 pipe is functional and can be reopened soon. I have no special insights or knowledge into what happened under the Baltic, but my conclusion is the sabotage is classic Russian Maskirovka distraction and propaganda.

NATO is well aware of Russian strategic doctrine to utilise: “social media, the internet, professional and amateur commentary, and political division to sow a “firehose of falsehood” to confuse and overwhelm the audience.” Russian disinformation propaganda is rapid, continuous, repetitive, and doesn’t care about consistency – if one leg of the lie is shown to be untrue, double up on the others, and keep doing so. It doesn’t have to be sophisticated or even vaguely honest. Overwhelm the doubts by throwing lie after lie till they stick. The three “proofs” the US sabotaged the pipelines depend on taking what Biden said in February massively out of context, falsely reporting what Energy Secretary Biden actually said last week, and using stock footage of US ships in the Baltic (where Nato has operated for decades.)

The best hope for Putin is persuading Europeans they are not fighting for Ukraine or themselves, but are being used as “useful idiots” fighting for the interests of the perfidious “Anglo Saxons”.

That’s exactly what’s going on here as Putin accuses the “Anglo-Saxons” of sabotaging the pipes to “destroy European energy infrastructure”.  My opinion is the Russians deliberately sabotaged the pipes as a “false flag” exercise – to shift the blame for Europe’s coming winter of power outages onto the Americans, building upon their narrative America has bullied Europe into supporting Ukraine.

Lest we forget – it was Russia that invaded Ukraine. As Putin says – who would benefit from proving it was the Americans? Russia; by blunting European support for Ukraine. Would the Americans benefit from proving Putin did it? Not really, we already know all about Putin.

Five Things To Read Today

BBerg – Meloni’s Ship of State is Heading for Choppy Waters

FT – Wall Street banks slash $34 bln from earnings forecasts for big companies

The Atlantic – Putin’s Regime Faces the Fate of His Kerch Strait Bridge

Guardian – Kwasi Kwarteng buckles up for an awkward first date with the IMF

WSJ – A Jittery Stock Market Heads into Earnings Season

Out of time and back to the day job…

Bill Blain

Strategist – Shard Capital