Sun Post #2: Why Central Banks won't be able to stop the systemic risk crisis emerging in Europe

Those who have followed this blog over the past few years know there is one theme that we repeat ad nauseam: the 2008 Financial Crisis was an earthquake the depth and breadth of which none of us fully understand nor appreciate.

And that crisis is not over.

Yesterday Graham Summers of Phoenix Capital Research had this take on the current state of the Financial Crisis that emerged in 2008.

Summers believes events in Europe will escalate and that Europe will collapse before the end of the year and very likely before the end of the summer. When this plays out, the fallout will be worse than 2008.

And the world Central Banks will not be able to control the damage.

Summers thinks the Crisis coming from Europe will be far, far larger in scope than anything the US Federal Reserve has dealt with before.

He also thinks the Fed is now politically toxic and cannot engage in aggressive monetary policy without experiencing severe political backlash (this is an election year).

The Fed’s resources are spent to the point that the only thing the Fed could do would be to announce an ENORMOUS monetary program which would cause a Crisis in of itself.

Summers breaks down the key facts:

• According to the IMF, European banks as a whole are leveraged at 26 to 1 (this data point is based on reported loans… the real leverage levels are likely much, much higher.) These are a Lehman Brothers leverage levels.
• The European Banking system is over $46 trillion in size (nearly 3X total EU GDP).
• The European Central Bank’s (ECB) balance sheet is now nearly $4 trillion in size (larger than Germany’s economy and roughly 1/3 the size of the ENTIRE EU’s GDP). Aside from the inflationary and systemic risks this poses (the ECB is now leveraged at over 36 to 1).
• Over a quarter of the ECB’s balance sheet is PIIGS debt which the ECB will dump any and all losses from onto national Central Banks (read: Germany)
• It means we’re talking about a banking system that is nearly four times that of the US ($46 trillion vs. $12 trillion) with at least twice the amount of leverage (26 to 1 for the EU vs. 13 to 1 for the US), and a Central Bank that has stuffed its balance sheet with loads of garbage debts, giving it a leverage level of 36 to 1.

And all of this is occurring in a region of 17 different countries none of which have a great history of getting along… at a time when old political tensions are rapidly heating up.

As bad as the above points may be, they don’t even come close to describing the REAL situation in Europe.

Case in point, regarding leverage levels, PIMCO’s Co-CIO Mohammad El-Erian (one of the most connected insiders in the financial elite) recently noted that French banks (not Greece or Spain) currently have 1-1.5% capital relative to their assets, putting them at leverage levels of nearly 100-to-1.

And that’s France we’re talking about: one of the alleged key backstops for the EU as a whole.

The Federal Reserve, indeed, Global Central Banks in general, have never had to deal with a problem the size of the coming EU’s Banking Crisis. There are already signs that bank runs are in progress in the PIIGS and now spreading to France (see El-Erian’s comments in the article above).

Summers observes the EU is a colossal mess beyond the scope of anyone’s imagination. The World’s Central Banks cannot possibly hope to contain it. They literally have one of two choices:

1. Monetize everything (hyperinflation)
2. Allow the defaults and collapse to happen (mega-deflation)

If they opt for #1, Germany will leave the Euro. End of story. So even the initial impact of a massive coordinated effort to monetize debt would be rendered moot as the Euro currency would enter a free-fall, forcing the US dollar sharply higher which in turn would trigger a 2008 type event at the minimum.

Moreover, Summers observes the Fed is now so politically toxic that Ben Bernanke is literally going on the campaign trail to attempt to convince the American people that the Fed is an honest and helpful organization. Put another way, there is NO CHANCE the Fed can announce a large-scale monetary policy unless a massive Crisis hits and stocks fall at least 15%.

Finally if the Fed were to announce a new policy it would have to be MASSIVE, as in more than $2 trillion in scope.

Summers points out that the $600 billion spent during QE 2 barely bought three months of improved economic data in the US and that was a pre-emptive move by the Fed (the system wasn’t collapsing at the time).

So Summers concludes that given that the Fed will only be able to announce a large scale program in reaction to a Crisis, whatever it did announce would have to be ENORMOUS, a kind of shock and awe, attempt to rein in the markets.

Moreover, it would literally be THE LAST QE the Fed could hope to ever announce as political outrage from the ensuing Dollar collapse and inflationary pressures would likely see the open riots and/or the Fed dismantled (this has happened twice before in the US’s history).

In simple terms, the Fed’s hands are tied until a huge Crisis hits.

And then, if the Fed acts it’s going to have to go “all in” with a massive program. If it does, we will still experience a Crisis, as the Dollar would collapse pushing inflation through the roof as well as interest rates (which in turn would destroy the banks as well as the US economy).

In simple terms Summers believe that, this time around, when Europe goes down (and it will) it’s going to be bigger than anything we’ve seen in our lifetimes. And this time around, the world Central Banks are already leveraged to the hilt having spent virtually all of their dry powder propping up the markets for the last four years.

Most people believe the Fed can just hit “print” and solve everything, but Summers believes they’re wrong.

The last time the Fed hit “print” food prices hit records and revolutions began spreading in emerging markets. If the Fed does it again, especially in a more aggressive manner as it would have to, we would indeed enter a dark period in the world and the capital markets.

Country	GDP
European Union	$16 trillion
United States of America	$14.5 trillion
China	$5.8 trillion
Japan	$5.4 trillion
European Central Bank	$3.8 trillion
Germany	$3.2 trillion
US Federal Reserve	$2.8 trillion
France	$2.5 trillion
United Kingdom	$2.2 trillion

Banking System	Total Assets	Total Assets Relative to GDP	Total Assets Relative to Central Bank Balance Sheet
Europe	$46 trillion	287%	1,210%
US	$12 trillion	82%	428%

Summers insists this is not Doom and Gloom, it's reality.

Graham Summers isn't the only one with this view.

World renown investor George Soros is singing a similar tune.

Germany and its central bank are unlikely to lead the way out of the euro zone debt crisis within three months time, after which it will be too late, U.S. billionaire George Soros said on Saturday.


Speaking at an economic conference in Trento, Italy, Soros said that the euro crisis - which he defined as a sovereign debt crisis and a banking crisis closely interlinked - threatened to destroy the European Union and plunge it into a lost decade like Latin America in the 1980s.


The Greek crisis is liable to come to a climax in the fall. By that time the German economy will also be weakening so that Chancellor (Angela) Merkel will find it even more difficult than today to persuade the German public to accept any additional European responsibilities. That is what creates a three-month window," he said.

As I have stated many times, this crisis is far from over.

The Central Banks of the world will not permit the massive deleveraging  and destruction of debt that must occur for the capitalist system to repair itself.

So it MUST intervene.

Mark Zandi, chief economist at Moody’s Analytics, said yesterday that President Obama will not let Europe fail.

"Europe is the key swing factor. If Europe addresses its financial troubles, and keeps Greece in the eurozone, the financial markets are likely to settle and boost U.S. employers’ confidence. But if Europe slowly worsens, it will be a drag on the U.S. economy."

I tend to agree with Grant Williams who says

as we approach the endgame for Europe, the choice facing those empowered to make decisions about how it ultimately plays out is actually a fairly simple one—allow massive, widespread sovereign defaults and a continent-wide bank-run or print unlimited amounts of Euros... is anyone still confused about how this will all play out?

Europe’s ‘leaders’ will NOT arbitrarily choose to inflict the pain necessary to deal with the current debt crisis when they have the means to print free money at their disposal and the only impediment to doing so is an as-yet undetermined percentage of 81 million German citizens.

If Germany has to leave the EU in order for the moneyprinting to happen, then they will leave - either because they choose to or because the ‘Latin-bloc’ (which now includes France) forces them to. Either way, the end will come in a shower of confetti paper money.

There may well be a period of deflation or deleveraging prior to inflation taking hold, but with inflation the central bankers’ firehose of choice, we can be fairly certain that inflation is in our future.

Because the Central Banks MUST intervene, I believe tremendous opportunity lies ahead in terms of Gold and Silver, especially Silver.

I don't believe the world will return to a Gold Standard, nor should it. But there will be a tremendous flight to both Gold and Silver as this plays out, even while other commodities collapse.

And that represents a huge opportunity.

==================

Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.

The bailouts continue... you're just not hearing about them

A while back, US Republican candidate Ron Paul commented on the ongoing bailouts of Europe by the US Federal Reserve:

The Fed's latest actions in cooperating with foreign central banks to undertake liquidity swaps of dollars for foreign currencies is another reason why Congress needs enhanced power to oversee and audit the Fed.  Under current law Congress cannot examine these types of agreements.  Those who would argue that auditing the Fed or these agreements with central banks harms the Fed's independence should reevaluate the Fed's supposed independence when the Fed bails out Europe so soon after President Obama promised US assistance in resolving the Euro crisis.

And today the Wall Street Journal reported that former Dallas Fed Vice President, Gerald Driscoll has come right out and accused the Fed of bailing out Europe courtesy of "incomprehensible" currency swaps, and implicitly accusing Bernanke of lying that he would not bail out Europe even as he has done precisely that.

The Federal Reserve's Covert Bailout of Europe 

When is a loan between central banks not a loan? When it is a dollars-for-euros currency swap.

America's central bank, the Federal Reserve, is engaged in a bailout of European banks. Surprisingly, its operation is largely unnoticed here.

The Fed is using what is termed a "temporary U.S. dollar liquidity swap arrangement" with the European Central Bank (ECB). There are similar arrangements with the central banks of Canada, England, Switzerland and Japan. Simply put, the Fed trades or "swaps" dollars for euros. The Fed is compensated by payment of an interest rate (currently 50 basis points, or one-half of 1%) above the overnight index swap rate. The ECB, which guarantees to return the dollars at an exchange rate fixed at the time the original swap is made, then lends the dollars to European banks of its choosing.

Why are the Fed and the ECB doing this? The Fed could, after all, lend directly to U.S. branches of foreign banks. It did a great deal of lending to foreign banks under various special credit facilities in the aftermath of Lehman's collapse in the fall of 2008. Or, the ECB could lend euros to banks and they could purchase dollars in foreign-exchange markets. The world is, after all, awash in dollars.

The two central banks are engaging in this roundabout procedure because each needs a fig leaf. The Fed was embarrassed by the revelations of its prior largess with foreign banks. It does not want the debt of foreign banks on its books. A currency swap with the ECB is not technically a loan.

The ECB is entangled in an even bigger legal and political mess. What the heads of many European governments want is for the ECB to bail them out. The central bank and some European governments say that it cannot constitutionally do that. The ECB would also prefer not to create boatloads of new euros, since it wants to keep its reputation as an inflation-fighter intact. To mitigate its euro lending, it borrows dollars to lend them to its banks. That keeps the supply of new euros down. This lending replaces dollar funding from U.S. banks and money-market institutions that are curtailing their lending to European banks—which need the dollars to finance trade, among other activities. Meanwhile, European governments pressure the banks to purchase still more sovereign debt.

This Byzantine financial arrangement could hardly be better designed to confuse observers, and it has largely succeeded on this side of the Atlantic, where press coverage has been light. Reporting in Europe is on the mark. On Dec. 21 the Frankfurter Allgemeine Zeitung noted on its website that European banks took three-month credits worth $33 billion, which was financed by a swap between the ECB and the Fed. When it first came out in 2009 that the Greek government was much more heavily indebted than previously known, currency swaps reportedly arranged by Goldman Sachs were one subterfuge employed to hide its debts.

The Fed had more than $600 billion of currency swaps on its books in the fall of 2008. Those draws were largely paid down by January 2010. As recently as a few weeks ago, the amount under the swap renewal agreement announced last summer was $2.4 billion. For the week ending Dec. 14, however, the amount jumped to $54 billion. For the week ending Dec. 21, the total went up by a little more than $8 billion. The aforementioned $33 billion three-month loan was not picked up because it was only booked by the ECB on Dec. 22, falling outside the Fed's reporting week. Notably, the Bank of Japan drew almost $5 billion in the most recent week. Could a bailout of Japanese banks be afoot? (All data come from the Federal Reserve Board H.4.1. release, the New York Fed's Swap Operations report, and the ECB website.)

More and more balls are being thrown in the air.

The question remains... how long can the ponzi juggling act be maintained?

==================

Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.

Sunday Post #2: The European Debt Crisis Explained

Blogger Gonzalo Lira has produced an excellent post trying to make the European Debt Crisis understandable for the average joe.

It also succinctly explains why more Quantitative Easing is almost assured.

The European Debt Crisis: This is what happened

In 1999, the Europeans implemented a common currency, the euro. They did it in order to improve trade between the eurozone nations, and thus bind the European countries closer together.

This new currency was centrally managed—that is, there was a single issuer of this new currency. Which of course makes sense: In the United States, you don’t have 50 states issuing currency—you just have the Federal Reserve, issuing dollars for the entire country.

Same with Europe: Thus the eurozone - the zone of countries that had the euro as their currency. This new currency was managed by the European Central Bank - the ECB - out in Frankfurt, Germany. The ECB’s primary concern - like all central banks - was making sure that the currency it was supervising did not lose value. That is, it made sure that inflation stayed below 2% per year.

However, just like in the U.S., though there was a central bank - in this case the ECB -each of the member states of this European Money Union (from where we get the acronym “EMU”) - could issue its own debt.

So far, so good: The euro was printed and managed by the ECB in Frankfurt. The individual countries - pain, France, Germany, Holland - could each issue their own debt, and of course manage their own government budgets.

Now, the strongest economy in Europe is Germany’s. For our purposes, the reasons why of this don’t matter. What matters is, Germany’s cost of borrowing was the lowest of the eurozone.

This makes sense: If I make a million bucks a year, and borrow $10,000 for expenses and stuff, I’m going to get a pretty good interest rate from my credit card company or my bank. You know how lenders are: They lend you an umbrella when it’s sunny, then take it away when it rains. Since I don’t need to borrow the ten grand, all the lenders will trip over themselves to lend me money at extremely low rates, because they know I’m good for it. I won’t default on the debt.

Same with nations - and same with Germany: German debt was always cheap, in the 1%–3% range, because Germany was good for it. After all, it’s the fifth largest economy in the world, and the biggest within the eurozone, racking trade- and fiscal budget surpluses year after year. So who wouldn’t feel comfortable lending money to the Germans? Nobody - ‘cause see the Germans? They pay up - always.

But here comes the problem: Banks felt very comfortable lending money cheaply to Germany. Germany was a member of the eurozone. Therefore, lenders assumed that the other countries in the eurozone were going to be as good a credit risk as Germany.

So the banks lent money to the other, weaker countries in the eurozone at the same rates of interest as they lent to Germany.

Imagine you have a great credit rating - so the bank gives your kid a $100,000 consumer line of credit, just because he happens to live in the same house as you do. The bank lends your kid the money because it says there’s a “tacit promise” that if your kid doesn’t pay back the money, you will.

Crazy, right? Right - but that is the core problem: Countries like Portugal, Italy, Ireland, Greece and Spain - countries whose initials spell out the acronym “PIIGS” - could go into debt at the same rates of interest as Germany, just because they shared the euro as a currency.

The economies of the PIIGS were not as sound as Germany’s - but the lenders treated them as if they were. Not only that, the lenders assumed that, if any country got into trouble - i.e., if any one of the PIIGS couldn’t pay back their loans - the eurozone as a whole would be good for the debt.

This was great for the PIIGS. Because it meant cheap and plentiful loans, with which they could go out and buy stuff.

So they did: The PIIGS went into debt - too much debt  - while the banks gave them all the slack they needed. Which makes complete sense: If before 1999, these countries were borrowing at (say) 6% or more, and all of a sudden their cost of borrowing drops in half, what will they do? Go into debt!

Which is what they did - massively.

And what did these countries do with the debt? Create a false sense of prosperity!

This in a nutshell is what happened between 1999 and 2010, when the Greek crisis first erupted: During those “boom” years (which were really no more than junior going crazy with the credit card), the various countries of the eurozone went into massive debt, in order to both fund a social safety net, and cut taxes on their citizens.

In other words, something for nothing, bought and paid for with cheap debt. Kind of like America. 

Though they now don’t want to admit it, the Germans encouraged this over-indebtedness, by the way - as did the French. Why? Because with this false sense of prosperity, the over-indebted nations bought German and French goods and services. German and French banks were at the forefront of lending money to the PIIGS - which essentially made the whole scheme nothing more than vendor financing on a massive scale: I lend you money so that you can buy my products.

Just like a junkie setting up an addict, or a predatory credit card company giving you teaser rates, the Germans and the French - via their banks and government institutions—gave the weaker economies all the incentive in the world to go into massive debt, and then go out and buy German and French products.

It was bound to end in tears. As is happening now. It all goes to the issue that all these countries are over-indebted. And that overindebtedness is being reflected in the sovereign bond markets.

Let’s take a slight detour, to explain what this means.

What Are Bonds? What Are Yields? And Why Do They Matter?

A bond is a bit of paper that is traded, just like stocks. But unlike a stock, which is a piece of ownership in a company, a bond is essentially a promissory note: You lend me money, and I give you this piece of paper where I promise to pay you back. The bond has a face value, and an interest rate. The person who buys the bond at the market price collects the interest, and receives the principal of the bond on maturation. A person can own a bond, or sell it to someone else, just like a stock.

Corporations issue bonds, in order to finance factories, expansion, whathaveyou. And governments issue bonds, in order to finance various infrastructure projects, as well as their deficit spending.

With all bonds, there are three pieces you have to understand: There is the face-value of the bond, there is the interest that the bond pays, and then there’s the effective return-on-investment of the bond—which is known as the yield.

The yield of a bond is what everyone pays attention to. The yield on a bond is a percentage value: It is the interest rate of the bond, times the face value of the bond, divided by the current price of the bond. The yield is inversely affected by the price of the bond: The higher the price of the bond, the lower the yield, and vice versa.

So you see, it’s a seesaw: When the yield of the bond is going up, then the price of the bond is going down. When the yield is going down, then the price of the bond is going up.

Let’s see an example: Say I sell you a bond for €1,000, paying 5% interest per year. The bond is trading in the open markets at €900. So 5% times €1,000, divided by €900, equals 5.55%—the yield has widened, as they say in the biz. That is, the yield has gone up, since the price of the bond has gone down.

But say instead that the bond has risen in value, which of course can happen: Say the price is up to €1,100 per bond. So 5% (the original interest) time €1,000 (the face value), divided by €1,100 (the current price, gives us a yield of 4.54%. The bond’s yield is said to be narrowing.

Since bonds all have different conditions insofar as maturation, interest rate, etc., it is simpler and quicker to speak of changes in yield only: “The yield is rising” means that the price of the bond is going down.

Why is the price of a bond going down? Because investors think that the person who owes the debt—the bond issuer—is not necessarily good for the debt. That is, they think the debtor might default. So the owners of the bond sell it at a lower price, because they don’t want to have the risk of a default.

Why does a bond go up in price? Because the debtor might show signs that it won’t default—so the high yield makes it attractive for a buyer to pay more for the bond, thereby driving up the price, thus paradoxically lowering the yield of the bond.

So what does this mean for countries?

Well, when the yield of a government bond rises, it means that people are selling that country’s bonds. Take the above example of €1,000 bonds paying 5%. If the bonds are now at €900, the yield is at 5.55%, as per the above example.

Now, if the yield on that bond rises to 7%, what does that mean? It means that the bond is trading at distressed levels. Because for a €1,000 bond paying 5% interest to be yielding 7%, then the bond is trading in the €715 range. (The face-value price of €1,000 times 5% divided by a current price of €715 yields 7%.)

So say you’re a government, and you have to fund €1 billion for a bridge. You will issue bonds to finance the bridge, bonds that will pay an interest of 5% a year. In order to raise those billion euros, you have to sell not a million €1,000 bonds—you have to sell 1,400,000 bonds with a face value of €1,000.

And therefore, you have to pay interest on 1,400,000 bonds, instead of 1,000,000 bonds. And when these bonds mature—that is, when they have to be paid off in full—the government won’t be paying out €1 billion in principal: They’ll be paying out €1.4 billion in principal, on what was supposed to be a €1 billion bridge. Because bonds are paid full face value on maturation.

Thus a government’s cost of borrowing has risen. And it’s all expressed in the yield.

That’s why yields matter. And unfortunately, rising yields is what’s been going on with European debt: They have risen massively—because investors think there is a less likelihood that the bonds will be paid back in full.

Why does this matter? Because these nations are all relying on deficit spending: They spend more money than they bring in. So they need to issue more debt, in order to pay off their obligations, such as salaries, pensions, medical care, not to mention pay off the interest on the previous bonds they’ve already issued.

So in this situation, a country can get to the point where its bonds are selling at such a discounted value that it cannot issue enough bonds to simultaneously pay off their obligations and allow them to continue to function at their current level.

That is, countries can get to the point of bankruptcy—depending on how high the yields on their bonds rise.

Now, About Greece

This is what happened to Greece: Its cost of borrowing rose so much that they no longer had the ability to raise the cash to pay off all their obligations.

So starting in April of 2010, the so-called Troika—the International Monetary Fund (IMF), the European Central Bank (ECB), and the European Commission (EC, the executive arm of the European Union)—structured a bailout package, which was eventually passed through in June.

The bailout package of course had some conditions, which the Greeks agreed to in order to get the money—and which they then promptly failed to live up to.

The details aren’t that important for the purposes of this discussion. What matters about the Greek Drama is two-fold:

• One, Greece is a small economy within the EMU—about 2% of the eurozone’s GDP—so therefore its debts, while massive, were all-in-all manageable.
• Two, the bailout of Greece was supposed to be swift and decisive, and act as a signal to the markets that the Troika would defend the eurozone, and not allow any of its members to go bankrupt. In other words, Greece was a firewall, to protect the other economies.

But the problem was, the Troika dithered.

Why did they dither? Because it became immediately clear that the only way to fix the Greek situation was by debt haircuts—and haircuts were impossible, because they would bankrupt the European banks. And the American ones too.

Fear of a Credit Event

Part of any debt restructuring—be it a poor man’s bankruptcy, or the bankruptcy of a large corporation—is debt haircuts: That is, lenders get less than the 100% of the debt that they are owed.

Say I owe $10,000 to a car dealership for a new car I bought last year, and I go bankrupt. The dealer will get a percentage of the money I have left after everything (including the car) is liquidated. But they won’t get the full $10,000 that I owe them, obviously, because I’m bankrupt: I owe more than I have.

Same with nations: Greece owed more than they had—so Greece’s lenders were going to have to take a haircut. That is, they would have to take less money than they were owed.

This is what’s known as a “credit event”.

This was a problem.

If there was a haircut on Greek debt—a credit event—then the banks and insurance companies which held the debt (predominantly German and French banks) would have to write a loss on those loans. Huge losses. Losses bigger than their capital.

Thus these banks would go bankrupt, if there was a credit event in Greek debt.

Even if they didn’t go bankrupt, these financial institutions would have to sell off other bonds, in order to raise the cash to stave off bankruptcy.

This massive sell-off of sovereign bonds would have a contagion effect: In order to cover their Greek bond losses, banks would have to sell their Italian, Spanish and French bonds—at a loss—so as to raise the cash to stay solvent, which would in turn make Italian, Spanish and French debt toxic.

In other words, a domino effect.

Furthermore, American banks—which don’t own much in the way of PIIGS debt directly—have written a lot of insurance on those sovereign bonds: The famed credit default swaps (CDS). Bank of America especially has made a lot of money selling CDS’s on those debts in 2008, 2009 and 2010, as has JPMorgan.

If those sovereign bonds defaulted, those American banks would have to pay off these CDS’s—

—and thus they would go bankrupt too!

Everything is connected: A credit event in Greek bonds would trigger credit events in Italian, Spanish and eventually French bonds, which would bankrupt European banks as well as American banks—

—basically, a repeat of the 2008 Global Financial Crisis, only bigger, and without the happy ending.

This is why the Troika dithered. They talked tough, and they even put the gun to Greece’s head: Pass these austerity measures, or else no bailout money. But they never pulled the trigger and let Greece fail—because if they did, the European and American banking sector would collapse.

Since the Greek financial hole grew bigger between 2010 and 2011—because the Greek’s didn’t live up to most of their promises—a second bailout package had to be created.

Again—more dithering. This time, the dithering was because the Germans in particular feel that they are propping up spendthrift countries—and nobody likes to feel like the chump who’s paying for other people’s good times.

There is enormous political pressure on Merkel to not save Greece. The people pressuring Merkel don’t realize what will happen if Greece collapses.

So then last October 28, the Troika plus German Chancellor Angela Merkel and French President Nicolas Sarkozy finally came up with a “solution” to the Greek Drama.

“Solution” is used in the loosest possible sense of the word: In the weeks previous to the Oct. 28 announcement, the Europeans had been going around the world, hat in hand, asking emerging markets—especially China—to fund their bailout facility. They had been politely refused—because they’re not stupid: They saw that the bailout facility—the famed European Financial Stability Facility (EFSF)—was just a lot of smoke and mirrors, essentially throwing good money after bad.

Through some clever accounting tricks and some not-so-clever baldfaced lies involving accounting standards, the Europeans managed to cobble together a workable EFSF which could give Greece and potentially one of the other PIIGS a lifeline.

But in order to show that they were “serious”, the Troika and Merkel and Sarkozy insisted that the Greeks agree to a serious of painful austerity measures.

The big news, however, was that this second bailout of Greece included haircuts on Greek debt. The advertised number on the Greek haircuts was fifty percent! (Though when you looked more closely at the details, it was more like 20%.) The Oct. 28 deal stipulated that the haircuts on the Greek debt would be voluntary—“voluntary” as opposed to “forced”, which would have triggered a credit event)—

—but then on the following Monday, Georgios Papandreou, the Prime Minister of Greece, threw a monkey wrench into the Rube Goldberg contraption that is the Second Greek Bailout Package:

G-Pap called for a popular referendum of the bailout!

All hell broke loose.

The eurocrats famously do not like going to the public to ask for their support—they like to dictate instead. Why? Because they consistently lose the popular vote, to the point where they no longer bother putting things up for a vote.

For Papandreou to put the austerity package to a popular referendum meant that it would likely not pass—because no citizenry likes to be asked if they want their government to give them less services and entitlements (duh!).

Therefore, the Troika suspended the €8 billion tranche of the first bailout package that the Greeks were supposed to get in November.

Without that tranche, Greece goes bankrupt on December 15.

So Papandreou backtracked on Thursday, November 3, and said that there would be no referendum.

But the damage was done: The bond markets got so freaked out that they started looking at the next weak link in the European chain.

Enter Italy

In mid October, Italian debt was yielding about 3.5%—very respectable. Italy, furthermore, has a very large debt, but it is far from insolvent: In fact its government regularly meets its budget with a bit of a surplus. Balance of trade is okay, growth is low but in line with the rest of Europe. And aside from periodice sex scandals, the Berlusconi government is fairly competent and efficient.

Overall, Italy is in pretty good shape.

But it needs more debt to pay off previous debts, and to shore up its economy, which is in a recession much like the rest of the world’s. It’s debt load is growing, but strictly because its government is spending to prop up the sagging Italian economy.

Nevertheless, after the Greek fiasco, the bond markets turned on Italy.

On the Monday after the Greek Week (Nov. 7), Italian yields rose from their 5% level—then spiked on Wednesday to above 7.6%, which is potentially catastrophic. Why catastrophic? Because at those levels, no advanced economy can finance itself—not to mention the fact that certain derivatives require that yields stay below certain thresholds. If they remain above certain yield numbers for a set period of time, they are considered credit events—which triggers CDS’s, which lead to bank bankruptcies.

So those yields have to go down now—fast.

This crisis in Italy has led Silvio Berlusconi to resign, once austerity measures are passed. His resignation will likely calm the markets—for a bit.

What is striking is the inanity of the eurocrats’ response. They come up with vague and flimsy packages, and a lot of flowery rhetoric—you should have just heard Sarkozy, after the Oct. 28 deal, going all French Literature on the thing.

But the Europeans don’t seem to understand that they have a nuclear weapon at their disposal—which they refuse to use.

And that nuclear weapon in the European Central Bank.

Fear of Monetization

The easiest way to fix this entire debt situation would be for the European Central Bank to simply print up money, and go out and buy enough Greek and Italian debt to bring down their yields.

It wouldn’t even have to be very much—a mere €50 billion would do the trick. The fear that the markets would have of being caught on the wrong side of a trade against the ECB would be enough to keep the markets docile and quiet.

And this is where more QE is almost assured.

 You have to stabilize the patient, before you give him the treatment—not operate him for liver cancer while he’s still bleeding from a gunshot wound to the leg.

Having the ECB come in and decisely calm the markets—like the Swiss National Bank did a month ago—would be the best way to get the European house in order, and then implement the structural reforms and austerity measures that everyone agrees need to be implemented.

But the ECB isn’t stabilizing the patient. Why? Because the Germans are greedy.

If the ECB does a European version of Quantitative Easing, the Germans are afraid that their currency will weaken—which they do not want, because they are a creditor nation. If the euro’s value erodes, then Germany will have lost some purchasing power.

They are so afraid of the euro weakening—and thus the Germans losing a bit of their surplus—that they are making the other economies in the eurozone crash.

The Germans do not seem to understand that, if the nations of Europe go down, there will be no buyers for their goods and services—so they will suffer too.

Thus the ECB sits there, while this Greek problem becomes now an Italian problem—

—and soon a French problem: The yields of French bonds are rising precipitously, and already one French bank, Credit Agricole, is in trouble over the Greek Drama. It’s only a matter of time before the big French banks start tumbling—and then France itself—unless the bond markets are calmed.

So What’s Going To Happen?

At some point the Germans are going to come to their senses, and the ECB will start buying up European sovereign debt, calming the markets. Greece and a couple of other small and/or weak eurozone countries exit the European Monetary Union, go back to local currencies, devalue, and then rebuild their economies; say Greece, Portugal, Spain and maybe Italy. And finally, austerity measures are imposed, fiscal budgets are put on a sounder footing, and things right themselves in a few years.

==================

Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.

Wed Post #1: Print, Print, Print.

Two days ago it was Alessio "BBC Trader" Rastani's gloom and doom musings on Europe that garnered all the attention.

Today it is Attila Szalay-Berzeviczy, head of UniCredit global securities (Italy’s biggest lender) and former Chairman of the Hungarian stock exchange (pictured above).

Bloomberg is reporting that Szalay-Berzeviczy has written an OpEd piece in which he claims that the euro is “practically dead” and Europe faces a financial earthquake from a Greek default.

Sounds familiar, doesn't it?

• “The only remaining question is how many days the hopeless rearguard action of European governments and the European Central Bank can keep up Greece's spirits. A Greek default will trigger an immediate magnitude 10 earthquake across Europe. Holders of Greek government bonds will have to write off their entire investment, the southern European nation will stop paying salaries and pensions and automated teller machines in the country will empty within minutes. The impact of a Greek default will rapidly spread across the continent, possibly prompting a run on the weaker banks of weaker countries. The panic escalating this way may sweep across Europe in a self-fulfilling fashion, leading to the breakup of the euro area.”

Of course this is just "one scenario among many". Szalay-Berzeviczy offers this ray of hope:

• “It’s one scenario among many, one which may lead to the breakup of the euro area via a banking crisis. This can still be averted. It primarily depends on the Germans, and secondly on European citizens, especially on how much the Greek population can tolerate.”

All Europe has to do is print, print, print.

Pity they can't print more Gold and Silver too.

===============

Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.

Monday Post #2: More on Sovereign Debt

Some interesting comments yesterday on Bloomberg by ABN Amro Group NV Chief Executive Officer Gerrit Zalm.

• "Banks are seeking to retain their liquidity, making interbank lending more difficult, as funding from money and capital markets becomes harder to obtain. Interbank borrowing for more than six months is also becoming problematic because banks are reluctant to lend to competitors with big positions in weaker countries’ debt, for instance."

Fears are spreading rapidly that Europe is on the verge of experiencing a Lehman Brothers Moment, a bank credit crisis the likes of which plunged the world into financial mayhem in 2008.

At the heart of the issue is the arcane shadow banking system in Europe (just like it was in North America in 2008).

That system is so crucial to USD-crunched European banks and it is now apparent that it is not just Greece, or the PIIGS, that is the problem.  But now the entire Eurozone is at risk.

Everyone in Europe is completely dependent on the dollar generosity of the European Central Bank, and the various other regional central banks for liquidity.

It is clear that the US Federal Reserve will once again be forced to step in, "in size" and bail out the world.

You may recall that on August 11th, 2011, we posted on one of the news stories that flowed well under the mainstream media radar screen: the results of an audit of the US Federal Reserve conducted by the Government Accountability Office (GAO).

This was the first ever audit conducted of the US Federal Reserve in its 100 year history.

The audit indicate that the Federal Reserve dished out $16 trillion in emergency aid to U.S. and foreign banks, corporations and governments in what the Fed calls all-inclusive loans during the financial crisis.

$16 Trillion!

In all the Fed disclosed more than 21,000 transactions which it utilized after Lehman failed to push as much liquidity into the worldwide financial system as possible to stabilze things.

Fast forward to today.

This time it is far more debatable if the world believes that even the Federal Reserve is sufficient to prevent a rising global insolvency tsunami.

To have none other than ABN AMRO's CEO on the record complaining loudly about liquidity gives you an idea of just how serious this issue is.

The last thing a bank wants to do is give any indication of funding weakness.

Yet here is Gerrit Zalm talking about a dollar liquidity crunch and the difficulty European banks are having procuring the world's reserve currency.

If you think there are any doubts about QE3, let alone QE4, 5 and 6... think again.

==================

Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.

The Battle Royale begins

Make no mistake, the next couple of days are going to be nothing less than tumultuous.

Back in April 2011, little Timothy Geithner appeared on Fox Business (see clip above) and was asked directly about whether or not Standard and Poor's would actually downgrade the United States' triple A credit rating.

Peter Barnes: “Is there a risk that the United States could lose its AAA credit rating? Yes or no?”

Geithner’s response: “No risk of that.”

 Barnes: “No risk?” 

Geithner: “No risk."

In an absolutely stunning move, S&P went ahead and downgraded the US credit rating.

The Federal Reserve, the FDIC, NCUA and the OCC promptly issued a joint statement which basically said S&P could go f*ck itself with it's downgrade:

• Earlier today, Standard & Poor’s rating agency lowered the long-term rating of the U.S. government and federal agencies from AAA to AA+. With regard to this action, the federal banking agencies are providing the following guidance to banks, savings associations, credit unions, and bank and savings and loan holding companies (collectively, banking organizations). For risk-based capital purposes, the risk weights for Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities will not change. The treatment of Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities under other federal banking agency regulations, including, for example, the Federal Reserve Board’s Regulation W, will also be unaffected.

Next the US Treasury issued a hastily written statement which claimed S&P made a $2 trillion mistake with it's assessment and that "raises fundamental questions about the credibility and integrity of S&P’s ratings action." You can read the statement here.

The war is on.

Meanwhile, in Europe, Germany is balking about bailing out Italy. Debt contagion fears are running amok.

All eyes are now on the opening of the Asian markets on Sunday (3:00 pm on the West Coast, 6:00 pm on the East Coast).

Watch for a fierce battle to be waged against Gold and Silver to dissuade nervous investors from driving the prices up parabolically.

It should be an interesting night.

==================

Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.

Once again Jim Rogers succinctly summarizes the situation...

Rogers is talking about Greece. The key problem with Greece and why it matters to North America is that so many North American banks have huge exposure to Greek debt.  If Greece defaults, those banks lose massive amounts of money.

And in this segment below we see the root of the economic problem in North America... we're too busy blaming China for our woes as opposed to understanding why we can't bring the manufacturing of products we consume back to North America. 

==================

Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.

Has the unwind begun?

"The 2008 financial crisis was a financial earthquake whose depth and breadth we still do not understand nor appreciate."

Faithful readers will recognize this oft-repeated statement which I never tire of re-stating.

In Europe the continued insolvency of the PIIGS (Portugal, Iceland, Ireland, Greece and Spain) continues.  And as wrangling continues about how Greek bailout #2 is to proceed, the European Central Bank and Germany are at polar opposites on what to do.

And as the rancor over what to do heats up, Eurogroup President Jean-Claude Juncker has made some interesting comments.

The Eurogroup is a meeting of the finance ministers of the eurozone.  And Juncker has just attempted to deflect and redirect attention from the internal problems of Greece within Europe to the financial troubles of the United States.

How?

Well Juncker has continued the theme we highlighted yesterday with China's credit rating agency Danong and said that which no one wants to say publicly:

• "Not withstanding the euro zone's problems, the deficit and overall debt in the U.S. and Japanese economy are substantially higher than in Europe. The debt level of the USA is disastrous. The real problem is that no one can explain well why the euro zone is in the epicenter of a global financial challenge at a moment, at which the fundamental indicators of the euro zone are substantially better than those of the U.S. or Japanese economy."

As this blog has stated repeatedly... the defining issue of the next decade is going to be all about sovereign debt.

Not just in Europe, but all over the world... particularly in the United States.

==================

Email: village_whisperer@live.ca
Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.

The European Debt Crisis... explained?

==================

Email: village_whisperer@live.ca

Click 'comments' below to contribute to this post.

Please read disclaimer at bottom of blog.