I could not disagree more with your comments. You obviously believe that if the European leaders and technocrats make the right decisions, then calamity can be avoided. I think that it is far too late for that. Governments, their advisors and corporate allies have been making the wrong decisions for so long now that it simply is not credible that they could pull the rabbit out of the hat at the last minute. You complain about the “draconian” German response. They still have memory of the last time the printing press ran amok. The recent deal cooked up by Merkel and Sarkozy, the so called 50% haircut, is nothing of the sort in reality. As was pointed out by Dan Denning of The Daily Reckoning last week – why buy government bonds if the insurance you buy to protect against default (CDSs) is unusable because of government chicanery? I will concede though that most CDS purchases are most likely purely speculative in motive and I won’t be shedding any tears when speculators get scorched. The use of Credit Default Swaps for insurance was shown to be a poor strategy in the last meltdown because of the counter-party risk. Credit events are financial tsunamis and in the currently still over-leveraged financial world, a credit event will involve dozens of financial institutions. In the last meltdown, Goldman Sachs only got paid by AIG for the CDSs that AIG had issued to GS to cover mortgage defaults. They had made a huge business out of issuing CDSs but they had not bothered to set aside the collateral to cover payable events. Lloyd Blankfein strong-armed the former Goldman boss, Paulsen, who just happened to be the US Treasury secretary into paying them out with the taxpayer money that the government bailed AIG out with. This is just one of many examples of corporate power working hand in glove with state power. Goldman may well have failed without that “leg up” from a friend in government. Until the banks are forced to mark to market their sovereign debt “assets”, which has yet again been side-stepped because they have avoided a “credit event”, bankrupt businesses which should be allowed to fail will continue to operate and continue to misallocate capital.
I describe the world as still heavily over-leveraged. Some may argue with me on this because most data shows outstanding credit falling as the world deleverages. However, I would say that as long as financial institutions can get away without marking “assets” to market, we simply do not know the state of the balance sheets of many of the largest institutions operating today. In other words the levels of leverage may be approaching infinity if those institutions are, in reality, completely bankrupt as I believe many of them are.
You imply that Greece may not deserve austerity. A country whose citizens in the private sector simply do not pay their taxes and whose government hired Goldman Sachs to engineer their way through the small problem of disguising deficits and debt levels to gain entry to the EEC deserve all they get.
You also describe Italy as a victim. While it is true that Italy’s debt levels are much lower than most other European countries (private debt is 125% of GDP and government debt is 121% of GDP), the debt of the third largest euro economy is still $1.9 trillion. That is a huge problem because Italian sovereign debt is held by financial institutions all over Europe and they are very worried. The Greek haircut will have weakened the French banks even further. Banks have to raise money somewhere so they are selling Italian debt and so the yield rises.
It is simple arithmetic really. Debt is debt and it is a real call on the future. As long as the future comes round the outstanding debt will be there. It can be temporarily hidden, it can be obsfucated but when its time comes round it will still be there. Many people talk about debt relief. There is no such thing. Debt relief is a euphemism which simply means that the debt is passed onto someone else – usually the tax payer. So while one entity may be relieved another is burdened. The idea that spreading it out over millions of taxpayers will somehow mitigate the effects of the extra burden is a nice idea but someone will be worse off and therefore economically handicapped. In fact millions will be worse off. My point is that the perpetrators of the various money frauds are the ones who should pay. If they don’t pay they or those who come after will do the same thing again. The only way the whole show is being kept going is by the continuance of debt creation out of thin air by banks at the behest of government. More credit money was issued during the GW Bush years than in the entire period from 1776. The size of the fraud is beyond comprehension. It cannot be rectified except by deflation and bankruptcy. Real assets – the old fashioned capital assets like infrastructure, buildings which have a real use such as dwellings and factories, warehouses and silos, the means of production, farmland, machinery, mines and so on will find a level of value that reflects real economic output. I suspect many office buildings will struggle to find any value because we will come to realise that the vast bureaucracies of paper shufflers (including those in financial services) are simply nether affordable or sustainable. There will be new relativities of value. Food will probably become more valuable and dwellings less so.
You state that uncertainty in Europe makes US Treasuries at 2% look like a good safe haven. As if there is not a similar level of uncertainty in the US! The reason that US Treasuries are at such low levels is because the world is awash in US dollar “money” because the US created more credit than anyone else. It is so valueless that the Chinese thought nothing of spending $170 a ton for iron ore until quite recently. That was a six fold increase in 5 years. There are millions and millions of tons of the stuff in Australia, Brazil and Africa. The wonder is the extraordinary expertise to raise the capital, design the mines, the huge machinery, the rail and shipping infrastructure to deliver 350 million tons a year from Australia alone. That is a real business, yet mining companies with a few exceptions (like BHP and Rio) are midgets compared to the titans of the financial world. As the world deflates, which it eventually must continue to do despite the respite since March 2009, vast amounts of financial “assets” will simply disappear – they already have but it has not been acknowledged on balance sheets. When it is, those balance sheets will be seen for the frauds they are. As the dollars disappear so will the value of the dollar rise. The same goes for the Euro so there will be a ratcheting back and forth of currency values as first one economic zone deflates faster than the other. There are more dollars and more assets denominated in dollars so I suspect the last man standing will be the US dollar. It will buy an awful lot more than it does now when the dust settles and the howls die down. I have no idea whether this process will take decades, like Japan, or just a few years. I suspect the latter because the US is not a country where people like to sit around. At some point a realization will be made and there will be a year or two of brutal reduction. A complete re-calibration. Companies, institutions, governments will be broken up and assets will pass from weak hands to strong. Those without debt will be the strong hands. New leaders will appear. The can will no longer be kicked down the road but will be crushed. Bring it on, I say.
I thoroughly recommend reading Bill Bonner of The Daily Reckoning on this subject. He has been letting fly in his inimitable style just lately:
It is becoming clear that the Europeans will not get it together to save the Euro and avoid a major debt crisis. I guess we can hope that the next major crisis intervention meeting will produce results that prop things up for more than two days, but I'm not holding my breath. The European approach has been characterized by draconian hard money policies and a demand for austerity, whether deserved (Greece) or not (Spain). The result of these measures is the predictable Keynesian outcome of further depressed demand and higher unemployment. What was telling with this latest round of negotiations was the supposed capitulation by the banks to accept a 50% haircut on their Greek loans. Merkel and Sarkozy gave them a take-it or accept-the-consequences deal; the fear of another Lehman event was greater than the pain of the losses, so they took the deal to avoid a "credit event" that would trigger action on the largely unknown quantity of credit default swaps (CDS) that could unhinge other financial institutions. It seems that just about anything will be done to avoid the uncertainty associated with unmasking this unknown mountain of CDS exposure.
Interest rates on Italian 10 Year bond
It appears that Italy is the next victim of the self fulfilling promise of austerity under the Euro. Bond rates have been rising in Italy since early summer, but then in August, the European Central Bank (ECB) promised to buy enough Italian bonds to drive the prices back down. But they have been inching back ever since, with fear that Italy would be the next victim after Greece was out of the way. The big meeting with Merkel and Sarkozy was supposed to provide an answer that would calm the markets, as the ECB's debt purchases did in August, but this time it only took a day for the true implications of the deal to sink in -- that is was still too little, too late -- and rates are on the rise again.
Demand for more austerity seems guaranteed to cause deeper recession in the affected countries, less tax revenue, and less ability to repay loans in a timely manner, leading to higher bond rates, leading to more demands for austerity... you see where this is going.
So what does all this mean for us in the US? Although this mess is largely a European problem, as the Lehman event showed us, everything is connected these days. Right now, the uncertainty in Europe is making US treasuries at 2% look like a good safe haven. The danger is from the feared "credit event", when hedge funds and banks would be forced to reconcile their CDS bets. There is a good possibility that a significant default event, from even a small county like Greece, could cause some major bank or hedge fund to become insolvent themselves, and subject to default on portions of their portfolio. A sea of CDS bets could unravel in a tsunami of litigation and frozen credit. With today's global financial institutions, there would be no escaping the consequences of the global generalized bank run that would develop.
This is the scenario that must not be allowed to happen, that scared the bankers to accept their 50% losses on Greek debt. Perhaps this will be the model for future banking negotiations - capitulate or accept the MAD (Mutual Assured Destruction) consequences. Maybe it will work. After all, it kept us out of nuclear war for 60 years.
http://squashpractice.wordpress.com/2011/10/30/the-next-economic-crisis/