We had a decent bounce in equities across the world in the last few weeks. We have a mild retrace at present which is needed to allow the indexes to push onward again soon. Pick your levels as entries to join the rally but keep stops fairly close given the issues we see all around us. Its the usual fair as far as technical patterns and trading goes which we are very familiar with i’m sure. The European mess deserves some comment here and now.The evolution of the euro story is key to understanding its resolution.
The real core of the problem is over indebted public finances which sit on top of structurally weak economies like Spain that over relied on public infrastructure and housing investment booms. Whether it be the PIIGS or even core states much of Europe is sitting on close to 100% or more of GDP as public debt. (Even France and Germany are not far from these levels although structurally they are better placed). Of the headline states Spain has one of the lowest debt to GDPs but structurally she is in a pickle.
Is it an unmissable irony that the solution proposed by the European states is more debt this time through the EFSF. The EFSF is simply a euro bond guaranteed by all 17 states. Its nothing more.. the EFSF debt then must be divided up and added to the individual debt of each country. This is really the same as each of the 17 states issuing their own debt just at a slightly better rate as the EFSF is guaranteed by all states so cast a triple A. It is no magic bullet therefore, no new capital in fact at all. And the borrowings will have to come from the same banks the fund is meant to be bailing out.. A desperate game of pass the parcel stuff.. If Asian banks would be prepared to create the new money needed on their balance sheets this would be preferable but it would still be yet more debt obligations for the European states albeit on a shared basis.
This is really desperate desperate ‘papering over the cracks’ stuff, imo. It is frankly comical. A modern ‘black’ farce of a comedy set around the theme of debt.
The insolvency of Greece etc is more intrinsically tied to the insolvency of the Euro banking system. Why? Simply as all the banks have created money from thin air to make vast margins yoy lending to these same states. Its been a very nice comfortable relationship in which the banks were happy as they make easy profits by lending to governments. The governments were also happy as they got cheap money they could lavish on winning votes by sustaining and increasing lavish social welfare schemes. All European public sectors expanded rapidly due to this comfortable relationship. But if the principle is not paid back the banks balance sheets implode and the comfortable bank/government relationship will be at an end with the implications this would have for all financial asset markets and corporate and consumer lending etc.
This game was effectively up when the productive ‘real’ economy of these countries was supplanted by this public sector spending. Once this occurred it was simply then the timing. Given the evolution of the problem therefore its impossible that more public debt can solve the problem. The euro Economy is around $14tr so another 1 or 2 trillion or so of debt would in theory be possible. But this would up the stakes considerably for all inc the euro banks whose balance sheets would need to grow considerably to accommodate this extra public lending. Of course they would be well paid for this risk. Remember the banks are already insolvent therefore their risk is no more than at present. Whats the difference between a huge insolvent client and a super huge insolvent client.? Not much if both would drive your bank to the wall of insolvency.
So the solution here is clearly to print money to allow debt write downs by the insolvent states. The ECB would print to recapitalize the banks, probably via a huge nationalization program. Or alternatively the ECB could take over the national banks herself and print to sustain loses associated with the purchases. In this case the initial and future printing would have to be large but only this will solve the problem for an extended period. Clearly there would be unintended consequences of such an action ie inflation and debasement of the euro but it is practically the only strategy that would work at this point in proceedings.
On the news today the ECB is digging its heels in and claiming to want to end bond buying. The ECB’s remit is to sustain GDP growth within a 2% inflation rate environment but it is also to maintain stability of the banking system. If i were a Brussels bureaucrat i would be reminding the ECB of their remit as regards to the European banking system. The IMF would be the only other show in town to recapitalize the euro banks.
Ultimately, in my opinion, the ECB will print and Germany will sanction the move. But this will only occur when a complete collapse is in the offering and all other options inc the EFSF have been exhausted. These events could ultimately provide the scenario for the final leg down of the cyclical bear, perhaps early to mid 2012.
Rich
Update: Just now we hear on the wires that Germany and Franc e have agreed to gear up the EFSF to 2 trillion Euros.
Such a number would increase the seventeen members of the euro area’s debt by around 15% on a pro rata basis. This ‘new money’ will have to be created by either the euro banking system, US banking system and or Asian and South Americans. A combination of all is also possible. In all likely hood it will be the euro banking system that will magic into existance the new digital money necessary to buy the 2tr mountain of EFSF bonds that will need to be issued. I’m on record as suggesting the EFSF would go nuclear.. That she was a ‘monster’.. the monster is almost here. The EFSF cannot work as this model is a model of debt on top of debt.. So when the EFSF needs a bail out then the ECB will be forced to print.. It will be interesting to see how the rating agencies rate the euro core’s bonds post the enlargement of the EFSF. The prospect of Italy increasing her public debt by an additional 15% is frankly impossible to imagine. All fun and games in the euro zone. Of course more magic money debases the existing money and therefore asset prices rise and inflation continues onward.
And Jim Rickards summing it up perfectly re ‘utility’ banks..
http://www.kingworldnews.com/kingworldnews/Broadcast/Entries/2011/10/16_Jim_Rickards.html
(4 votes, average: 5.00 out of 5)
Loading...