Sunday, June 3, 2012

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.

European Union
$16 trillion
United States of America
$14.5 trillion
$5.8 trillion
$5.4 trillion
European Central Bank
$3.8 trillion
$3.2 trillion
US Federal Reserve
$2.8 trillion
$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
$46 trillion
$12 trillion

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

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

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.

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Please read disclaimer at bottom of blog.


  1. Lehman was 70:1. The first problem is simply the sizes of these banks. Second, LTRO has encouraged bankrupt banks to further speculate on the debt of bankrupt countries.

    There's still a lot of garbage in the US banks too. It's moved off balance sheet, marked to fantasy, and banks take free money from the Fed to buy treasuries at 2%. How long will it take to recapitalize the banking system this way? Practically forever.

  2. Whisperer,

    While I agree that we're not done with the GFC and that we're about to see another set of domino falls this autumn/winter, I think the problems will not come from where you think.

    Europe is in a bad shape but not dramatic one and they still have lots of leverage to get out of the mess. Greece? Sure it's not great, but the troubles have been going on for months now and the banks as well as the countries have had plenty of times to get prepared, which they have done. Remember, Greece is only about 2% of the European GDP...

    What you're going to see there at the next european summit in June is another round of economical and political integration. See this article from the german newspaper Die Welt:

    The final objective, from Merkel's point of view, is to first make sure that the "club med" countries finally put in place the long awaited structural reforms that Germany did 10 years ago to ultimately authorize the Euro-bonds. Once done, the euro crisis will be over, as the borrowing costs of Spain, Italy, Ireland, etc. will go way down (no more risk of defaults then).

    Europe is going towards a more and more economically and politically integrated zone. Yes, not everybody is happy with that, but the truth is, the majority of the european population is in favour of that process. The ones you hear more on TV are the euro-skeptics, but they don't represent the majority.

    The next big blow will come from one of these three countries (maybe all of them at the same time?):
    - China, which has the mother of all bubbles getting popped right now.
    - Japan, which is soon to hit a debt wall
    - UK, with its over-bloated financial sector on the verge of collapse

    Another trigger could be again the debt ceiling drama coming from the US. Their political system is rotten and you never know how far stupid politicians can go to get their way.

    Have a look at the debt distribution (first chart of the article). Look at who are the two champions, and make your own conclusion...

  3. Great post Whisperer, and I totally agree that safety is now the investment buzz-word. Gold and the US dollar are going to be magnets in the months ahead.

    a problem with euro bonds

    "With markets bracing for further deterioration in Spain’s finance sector and a possible Greek departure from the 17-member euro area, Rajoy on June 2 added his voice to calls for a more robust “banking union” in Europe, lending his support for a centralized system to re-capitalize lenders. On the same day, Merkel toughened her opposition to euro-area debt sharing, telling members of her party in Berlin that “under no circumstances” would she agree to German-backed euro bonds. "

  4. I would not put too much stock in anything Graham Summers says or writes. His schtick has been to panic everyone all of the time no matter what is happening and it is almost all nonsense.

  5. Im beginning to wonder if its now beyond the ability of gold and silver to properly represent. Perhaps they may once we are beyond any financial reset, but.... how long will that take to happen? This is beginning to look as if its going to be an absolute shutdown and restart of the system.... It may very well be more about the paper 20s, 50s and 100s... than onces.

  6. Graham Summers is dead wrong on Europe as I already said above. Like many, he has no real clue what is going on and only sees destruction at every new turn. Like most people he is caught up in the drama and is unable to see into the deeper workings of what is really taking place.

    I am going to tell you what is happening though and hopefully you will relax a little once you hear it. It might cut some of the noise and make investing a lot easier too.

    Most Western countries are trapped deeply in debt right now. We all know that. There are very few means by which to escape the debt vice and this is especially true in democratic nations where the electorate determines the fate of politicians who try to actually solve the problems.

    When tax increases are proposed the people scream bloody murder and so they are nixed. So it is clear therefore that raising fresh revenues to keep the party going is not going to fly with the general public.

    The other solution is to cut program spending. This too is met with protests and a serious backlash. Few are prepared to give up social benefits, have less health care or see pensions reduced. Those voters get their way too and we have seen in technicolor how dramatic the public response to cuts is in countries like Greece

    So what is a government to do?

    You cannot increase taxes nor can you significantly cut spending without inflaming the masses. Both the escape avenues of revenues increases and spending reductions are closed. The public will not tolerate them.

    The only answer is devaluation.

    And so that is what we are getting. Just watch the Euro versus the dollar on any given day. You will see that as a general rule one rises and the other falls. The function inversly to each other.

    A crisis in Europe drives down the Euro....a crisis in America drives down the dollar. The trick is that both are in fact falling together but it is not obvious to any but a few economists. Both currencies are being devalued in tandem.

    Like a ping-pong game. This is how it is being played. But in order to be believable you must see a real crisis emerge on each continent at the appropriate time. It has to be real to draw in investors or get them responding with real money.

    In due course we will have the US Fiscal cliff on the radar and the dollar will plunge thus pushing the Euro back up.

    It is all drama and theatrics though. You are better off not even reading the news but trust me on this, can invest and make very good money once you get the basics of the principle.

    The European Union is not therefore at risk of collapsing any more than the dollar is at risk of hyperinflating to zero. Both partners need each other in order to carry out this shell game which is designed to accomplish just one simple goal.

    Debts will be defeated through a constant devaluation where real inflation runs at 7 percent or more compounded over the next several years. But you won't see it in the numbers. This is a true stealth devaluation and government numbers mask it very well. Nor will you see it in comparative currency pairs as all are taking a share of our buying power each day. It is almost invisible.

    The bottom line is that you will pay through a reduced standard of living that which none would accept paying through taxation or program reductions.

    So we will all get a little poorer as time goes by. Get used to it. This will not end until organic growth kicks in and we enter a new period of expansion. If you can begin to get an idea of what is actually taking place though you will not fear the future anymore.

    This is all just drama necessary to make ends meet and the EU is an absolutely essential part of that drama. It will not fail.

    Now go and get some popcorn, take a seat and try to enjoy the show. The fiscal cliff approaches and what a movie that will be!


  7. Respects to Farmer and others above. Interesting that Peter Schiff agrees with Soros and others on this one: I tend to a view between that given by Farmer and the apocalyptic: I think we will see the US and some European states in a very poor place in 12 months time, due in some measure to the fiscal cliff which F mentions above, for the US, and to catastrophic undeclared losses in EU banks, including the UK (both points mentioned above).

    Again I have to say: RELATIVELY speaking, one can see the attraction of Canada in all of this.


  8. Wrong: Canada has more debt per person than the US.

    The "Western World" will inflate there way out of this.=Yes.

    Canada will follow the US lead and evapoate everyones savings because as was pointed out raising taxes is not an option. I would be very surprised to see interest rates ride in my life time. Savers are screwed.

    GOLD will be the only safe haven from the great devaluation.