What happens when “Exceptional Conditions” become the norm?
I am sure that question is on the minds of European readers tuned into the Mish Blog. Let’s take a look.

On June 6th it was announced that, Italy and Portugal Face the Wrath of the EU over their deficits. Italy is supposedly in a “soft recession”. Will that condition become exceptional if it turns into a “hard recession”?

To the ire of Italian officials, the European Commission agreed to launch disciplinary action against Italy for flouting EU budget rules. EC Officials also announced possible action against Portugal. The EC went on to say “The excess of the deficit over the reference value is not exceptional, as defined by the Pact … nor is it the result of a severe economic downturn,” conditions which may have won Rome a reprieve, the commission said in a report.

Enquiring Mish readers want to know if there is a clear cut definition of “exceptional” as well as clear cut timeframe in which exceptions MUST be addressed. I am not perfectly in tune with EC rules so if someone has precise rules and timeframes please Email them to me or simply post a response.

Here is the key question: How long can Germany play the “Reunification Card” as “exceptional conditions”? From now until doomsday? I mean really, how long can an exception last before it becomes the rule rather than the exception? What about France? What’s its excuse? Is France undergoing reunification? Is France undergoing a shortage of brie? I admit the latter would be a total and complete travesty of justice but to the best of my knowledge, there is no brie shortage in France. How long can a country with no perceptible “exceptional conditions” get away with playing the “exceptional conditions” card? I have no doubt now that Portugal will somehow be claiming “exceptional conditions” quite soon. I can’t wait to hear the excuse.

Is Italy even telling the truth about how bad it will miss EU stability pact agreements? Let’s take a look. Last year the Italian government reported a deficit of three percent of GDP, just meeting the EU limit. But Eurostat, the EU’s statistics arm, has refused to validate that figure. Brussels has forecast a budget deficit of 3.6 percent of GDP for Italy this year and widening to 4.6 percent in 2006. Italian Finance Minister Domenico Siniscalco admitted on Tuesday that the deficit would exceed the EU’s limit in 2005, remaining “under four percent”. Is there any reason to believe the Italian government over Eurostat? Somehow I doubt it. At any rate, someone please check my math: Is 4% under 3% or not?

Meanwhile, some people are worried about the spread of SARS or the Bird Flu Virus. The real question to be answered is this: Is anyone paying attention to the rampant spread of “exceptional conditions”? Whatever strain of virus it is, it seems to be impervious to anti-viral efforts. Take a look a Germany. Wow! If the US ever catches that strain of the ECV (Exceptional Conditional Virus) we are in trouble.

Then again perhaps the US has better news suppression techniques than the EU. I wonder if we already have that disease but it has been purposely misdiagnosed as “The Greenspan Conundrum”. Has the US center for disease control been alerted to this possibility?

Back in the EC, it sure seems that the biggest inflation hawks are now showing “mild symptoms” of ECV. I offer this as proof: “ECB Chief Economist Otmar Issing said on Monday a cut could not be ruled out, and Trichet himself, apparently inadvertently, fanned speculation by telling a banking forum in Beijing earlier on Tuesday the ECB would do all it can to bolster confidence.”
Quite frankly that is startling. Indeed, a quick look at Euribor futures (Interest rate futures in the EU) show them flat as a pancake for the next year. Given the time value of interest rate futures, that affectively means a rate CUT is now priced in.

Back on April 7, Jean-Claude Trichet said that “Rate cuts are not an option at the moment”. “Looking further ahead, the conditions remained in place for moderate economic growth to continue, Trichet insisted. Global growth remained solid, ‘providing a favourable environment for euro area exports,’ he continued.” Favorable environment for Euro exports? What about EU jobs? What is he smoking anyway? Let me translate the text of this speech for you in terms that everyone can understand.

Here is the Mish interpretation of what Trichet REALLY wanted to say: “Conditions in the EU are bad. They will remain bad. We do not really see a catalyst for growth in the EU until long after Germany and France change their labor rules and we really do not see that happening anytime soon. In the meantime and even AFTER reform, unemployment in Germany and France will rise. No pain, no gain. If a rate cut would stimulate sustainable economic growth, we would be happy to do it. As it is, rate cuts will do nothing but propel us deeper into the deflationary death trap that Japan went through. In short, cutting rates would just fuel bubbles in housing, exactly as the FED has done, but it will not do anything for lasting growth. Things will get a lot worse before they get any better but at least we are not lying to you as Greenspan is doing in the US.”

There, wasn’t that 100% understandable? The problem is that anyone who tells the truth would be fired or not reelected. People want to hear lies even when those lies do nothing but make problems worse. However, it now is readily clear that Issing and to a lesser extent Trichet, have both caught ECV. In light of that fact, I now confidently predict that the EU will soon be on the way to ZIRP (Zero Interest Rate Policy) next up after Japan. The nature of the ZIRP game is such that the last one to hit zero, wins.

Mike Shedlock / Mish/