I'm Keeping My Fingers Crossed for a Quiet Summer

But be prepared for something else
Wednesday, June 27, 2012, 12:01 AM
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I am hoping for a quiet summer so that all of us north of the equator can enjoy the warm, lazy months of July and August in peace and quiet. But I am concerned that this may not come to pass.

The daily drumbeat of bad news from Europe covers all fronts and is relentless. Rumors abound, confusion reigns, downgrades happen weekly and sometimes daily, unemployment is up, the economy is slipping, and it is entirely unclear if anybody there knows what to do.

Even as the stock markets somehow magically finding their footing on each new rumor turning back at each critical zone of support, while gold continues to languish, I find myself increasingly bearish as all the new data comes in on both the unfolding European credit crisis and the slowing global economy.

Here's the troubling information out of Europe:


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I am hoping for a quiet summer so that all of us north of the equator can enjoy the warm, lazy months of July and August in peace and quiet. But I am concerned that this may not come to pass.

The daily drumbeat of bad news from Europe covers all fronts and is relentless. Rumors abound, confusion reigns, downgrades happen weekly and sometimes daily, unemployment is up, the economy is slipping, and it is entirely unclear if anybody there knows what to do.

Even as the stock markets somehow magically find their footing on each new rumor turning back at each critical zone of support, while gold continues to languish, I find myself increasingly bearish as all the new data comes in on both the unfolding European credit crisis and the slowing global economy.

Here's the troubling information out of Europe:

Spain Poised for a Cut to Junk as Default Swaps Near Records

June 26 (Bloomberg) -- Spain is poised for a downgrade to junk by Moody’s Investors Service, according to investors who sent the cost of default insurance for the nation’s biggest banks and companies close to record highs.

Credit-default swaps on Banco Santander SA, the country’s biggest bank, jumped 23 percent this quarter to 454 basis points, compared with an all-time high of 474 in November. Banco Bilbao Vizcaya Argentaria SA rose 26 percent to 477, approaching May’s record 516, while phone company Telefonica SA surged 70 percent to a record 540 basis points.

Moody’s downgraded 28 Spanish banks yesterday including a two-step cut for Banco Santander and a three-level reduction for BBVA, a week after it lowered Spain’s rating to Baa3, on the cusp of junk. The country remains on review for another cut by New York-based Moody’s after it sought a 100 billion-euro ($125 billion) international bailout for its banks and on speculation losses from its real estate industry will worsen.

“There’s more to come if Moody’s downgrades the sovereign as we expect in the next few weeks,” said Suki Mann, a credit analyst at Societe Generale SA in London. “A one-notch move to Ba1 will likely see all the country’s banking system in junk territory, with the possible exception of Santander.”


Surging credit default rates and widening spreads were the exact early warning indicators that most clued me in to the imminent crisis back in early October 2008. Here we are seeing the credit default swaps on Spanish financial and a utility company (!) blow-out in anticipation of a downgrade of Spain itself.

The thinking here is that if Spain is downgraded, its borrowing costs will rise and its ability to help out its major companies diminishes -- and, as the market logic goes, therefore the cost of insuring the debts of those companies goes up.

Right on cue, and serving to really drive the point home in case anybody was wavering, we have this news:

Spain's borrowing cost soars

Jun 26, 2012

(AP) MADRID - Spain's borrowing costs soared in a pair of short-term auctions Tuesday as investors worried that the country would not be able to manage an expensive rescue of its ailing banking sector.

The Treasury auctioned 3.1 billion euro ($3.9 billion) in the two maturities, just above its target range, and demand was strong.

But the cost was very high - an indication that investors are concerned that the Spanish government will be stuck with huge expenses after a European bailout of its fragile banking system.


While it is a good thing that demand was strong, the issuance was a very small one, at only 3.1 billion euros and the doubling and even tripling of the rate of interest  in just one month's time was a very bad sign.

However, even with a tripling I think that the rate of interest is not nearly high enough given the risks involved here. Have the purchasers of this debt already forgotten how quickly the Greek situation unfolded and the massive haircuts that landed on the holders of Greek debt?

I suppose that these investors (assuming there is anybody beside central banks and other sovereign governments bidding for this paper) either have already purchased CDS protection on these positions or are planning on being able to dump out of their holdings quickly if the need arises. Of course, everybody always thinks that.

Along with the news from Spain comes this from Italy:

Italian borrowing costs spike at auction

Jun 26, 2012 (Barcelona) - Italy sold 3.91 billion euros worth of 2-year bonds, near the top range set for the auction. Borrowing costs soared to the highest level seen since December, rising to 4.7%.


Italian yields are not yet in danger territory but are also definitely heading in the wrong direction.  Italy is also facing a recession and rising unemployment, and cannot afford to be paying 4.7% interest, which far outpaces its economic prospects.  When a country is paying a higher rate of interest than its underlying economy is growing, the debt burden is growing.  That's just simple math.

Taken together, the news out of Italy and Spain indicates that the crisis is once again on the verge of tipping into a new and more dangerous arena where the next phase of the crisis will be played out.

Hope Is a Terrible Strategy, Yet I Am...Hopeful

There are two reasons that I think we can safely make it through the summer despite all the bad news emanating from Europe. The first is that this entire crisis has been unfolding very slowly and we might expect that trend to continue for a while longer. Also, Europe tends to shut down in August for holiday, and so there might not be the quorum necessary to really turn the heat up another notch on this crisis.  So perhaps all of this just continues to limp along, neither getting better nor really worsening, like a gathering thunderstorm sliding slowly closer. 

The second reason I am hopeful is that neither July nor August are the most likely months for a financial crisis to strike. For some reason, possibly linked to the same biological impulse that causes squirrels to bury nuts in the fall, humans are most prone to scurrying away from stricken banks (and financial markets) while urgently clutching their wealth in the month of September:

The cruelest month of the cruelest year

Jun 25, 2012

Most readers of this blog are familiar with the path-breaking work of Carmen Reinhart and Kenneth Rogoff on financial crises. Fewer have heard of Luc Laeven and Fabian Valencia, but they too have contributed richly to the raw material of crisis economics. Labouring away at the International Monetary Fund, they have assembled a detailed database of 147 banking crises from 1970 to 2011.

They recently published a new working paper detailing some of their latest findings. There's lots of fascinating stuff in here but what leaped out at me was a chart showing the likeliest months for crises to begin.

The frequency with which the world goes to hell in September seems hardly random.

Unfortunately the authors provide no explanation for this beyond observing, "An interesting pattern emerges: banking crises tend to start in the second half of the year, with large September and December effects."


So from a betting perspective, the odds favor a quiet summer and an explosive September. Adding fuel to the Mayan 2012 prophecy camp is the observation that December is the second most likely month. I've always known that fall is the preferred season for financial and banking crises to arise, but now have the data to confirm that idea.

While there's really no good reason for the European crisis to wait even another minute to swing into the next phase of this financial drama, it will crack when it's finally ready, and that may be a couple of months yet.

So I am prepared for the crisis to erupt at any minute, but hopeful that we will have until September.

Meanwhile, Back In Greece

All eyes are now firmly fixed on Germany and Spain and Italy, but I am finding that Greece is worth keeping in plain, daily view because it provides something of a roadmap for the other countries that are in danger of following in its footsteps.

On an abstract level, what is happening in Greece is fascinating. On a human level, it is devastating. Greece is experiencing a full-blown economic meltdown ,and there is much to learn from it.

Here's how an economy just comes to a stop:

Greece’s ailing economy grinds to a halt

Jun 19, 2012

Last week, Medical Service Limited, a small Athens’ supplier of medical equipment that can no longer afford to pay its employees, received what should have been a blessing: an order from one of the city’s hospitals for a heart monitoring machine.

But after thinking it over, Yannis Stamos, the company’s co-founder, turned the customer away. Filling the order would have meant reaching into Medical Service’s own pockets to cover the €35,000 cost of such a machine, since Greek banks have stopped lending and the company’s German suppliers now demand pre-payment in cash.

Even if it could foot the bill, Medical Service would then have to hand over thousands of euros in sales tax to the Greek government within a month – long before any hospital is likely to pay.

“It’s a terrible situation,” Mr Stamos says. “Everything is frozen. The economy is dead, and no one is paying anyone.”

Medical Service is but a snapshot of what is happening to businesses across Greece as the economy’s gears grind to a halt. After sputtering through four years of recession, most commercial activity has all but ceased over the past six weeks as the country endured two nail-biting elections with its future in the eurozone hanging in the balance.


With an absolute lack of cash flow, plus the onerous state taxes required to be submitted regardless of whether any cash has yet been received on a sale, plus a complete lack of faith in the ability of counterparties to pay up, has caused the Greek economy to just grind to a halt.

Once a dynamic like that gets going, it is really hard to reverse. What this means is that Greece will be in an economic free-fall for quite a while. Honestly, its only real option at this point is to go off the euro, go back on the drachma, and let a rapid inflationary spiral burn the rot out of its system.

Unfortunately this means that things will get worse before they get better, and things are already pretty bad:

Dread and Uncertainty Pervade Life in a Diminished Greece

Jun 14, 2012

Anyplace else, they might be signs of progress: Traffic moves faster on once clogged streets. Cigarette smoking has dropped sharply. Far less garbage heads for landfills each day.

But this is Athens, and the statistics are grim reminders of a middle-class society in rapid decline. Many fear that elections, including voting scheduled for Sunday, offer no clear route out of a deepening political and economic crisis. From its wealthy northern suburbs to the concrete blocks of downtown, there is a sense of an endgame in Athens.

“It’s the last days of Pompeii,” said Aris Chatzistefanou, a co-director of “Debtocracy,”a provocative 2011 documentary about the Greek crisis, as he stood, drink in hand, outside a cafe in Exarchia, a thrumming graffiti-filled neighborhood whose night life remains a rare pocket of defiant joy amid the unremitting gloom.

“There is a depression in the Greek people, in all my friends,” said Giorgos, who has put off plans to open a frozen yogurt shop. “They keep saying: ‘I can’t take it. There’s depression about our jobs, depression on the news, depression about the economic situation, depression in our family, depression and fighting among friends.’ ”

He had just returned from a day trip to Munich, where like many people in the heavily indebted countries, he had opened a bank account. “I don’t want to transfer all my money, but if something goes wrong here, I don’t want to be poor just in one day,” he said.

In the Athens Metro, posters that read “Apocalypse,” advertising a staged rendition of the Book of Revelation on the island of Patmos, capture the air of desperation. In the gleaming Eleftheroudakis bookshop downtown, copies of “Living in the End Times” by Slavoj Zizek, the Slovenian cultural critic, are on prominent display.

A clerk said books on economics and do-it-yourself guides were selling briskly, as were escapist thrillers and philosophy, especially works by Arthur Schopenhauer, known for his pessimism and his conviction that human experience is not rational or understandable.


Well, at least we learn from this that some things sell really well even in a completely depressed economy. I was taken by the reference to the works of Arthur Schopenhauer selling well. If you recall, I featured a quote from him in the Crash Course.  But note also the strength of escapist entertainment and do-it-yourself guides.  From this we might learn that there are always jobs to be had, goods to sell, and opportunities to be found no matter how bad things get. My recent trip to Las Vegas (this past weekend, to present to a professional organization) was a bizarre experience where I was surrounded by ordinary people dropping extraordinary sums of money, mainly on their credit cards, according to the service staff I talked to.  Economic stress?  What economic stress?  There was none to be detected in the crowds at Vegas.

I fear that the people of Greece are closer to the beginning of their period of adjustment than the end, and they are growing despondent and desperate.

But they are not alone.  The government of Greece is also desperate and some of the measures recently enacted by the Greek government (at the behest of the international banking cartel) were increased taxes and tax collection efforts.

And that is an example of something I have been predicting for a long time, namely that...

The Rules Will Change

Skipping to the other side of the globe, Japan just recently took a good, hard look at its own books and realized that its demographic wave had finally swamped the ship of state and that new money would be required to keep the government afloat.

And not just a little bit, but a lot. Enough to cause Japan to pass legislation fully doubling the country's sales tax:

Japan's lower house approves doubling of sales tax

Jun 26, 2012

TOKYO — Japan's lower house voted Tuesday to double the country's sales tax to 10 percent over three years in a bid to rein in a bulging national debt as an aging population burdens the country's social security system.

The bill passed easily by a vote of 363-96, with support coming from the two biggest opposition parties. The bill must still pass the less powerful upper house to become law, which is expected.

It calls for raising the sales tax from 5 percent to 8 percent in 2014, and then to 10 percent in 2015.


This is an example of why I propose that any purchases be made early in a crisis rather than later. Further, any tax advantaged investments should be considered 'at risk' of similar treatment. When the chips are down it is quite usual for governments to try everything first before actually cutting spending.

And it is easy to understand why. Cutting spending is always deeply unpopular with the affected portion of the population which tends to limit political careers and, just as bad, spending cuts also translate into economic weakness. That just tends to exacerbate whatever the problem was in the first place and often no gain results as the reduced spending is offset by reduced economic activity and therefore tax receipts.

The bottom line here is that Japan is clearly entering a new and more desperate phase of their own struggle, and I predict that they will discover that doubling taxes will not result in a doubling of tax receipts.  Instead they will find that people will avoid paying taxes one way or another (either by buying less or going underground), and that the economy will shrink as a result, putting a further strain on government finances.  


Yes, I, too, am tired of how long all of this is dragging on, and yet at the same time, I am grateful. The time has been an invaluable gift to myself and many others.

A complete mystery to me are the folks in Greece who still have money anywhere in the Greek banking system, but that applies equally well to the people of Spain and Italy. I know that if everyone took their money out, the system would crash, because fractional reserve banking cannot withstand depositors withdrawing more than a few percent of their funds.  So I am somewhat sympathetic to the idea that it appears selfish to pull one's money in an attempt to preserve one's wealth.

At the same time, I note that the very wealthy and well-connected have pretty much already removed all of their funds a long time ago, and so I am slightly more concerned that the appeal to patriotic duty is most heavily marketed to those who can least afford the losses. When it comes right down to it, as long as I was completely assured that everybody was going to share equally in the risks and losses, then I might be persuaded to consider leaving money in the system.

However, that is simply not the case.  And so, in a world where the elites take very good care of themselves, I think everybody else should do the same for themselves. Nobody will ever pat you on the back for taking massive losses in a vain attempt to help sustain an unsustainable and insolvent system. While it may serve to hasten the demise of the banks involved, logically it makes the most sense to take your funds and put them to good use while you can.

When the European system enters the next phase of this crisis, I am still anticipating systemic banking effects up to an including a bank holiday that spans the globe followed by a coordinated set of central bank actions to pump massive amounts of thin-air money into the system.

In this environment I find the current weakness of gold to be a rather odd development but a welcome one for those seeking to add to their holdings. I am not even remotely considering parting with mine here.

Silver is a different story though as I expect the next global downturn to be quite unkind to all sorts of industrially useful metals and other commodities. At least in price. For a while, and just over the short to medium term.

Over the long term, say five years or more, I have few doubts that all the efforts at printing will finally do what they always do and plunge the world into a most destructive period of inflation that will have to be serious enough to wipe out forty years of excessive credit creation. At a minimum.  An overshoot would not be out of the question.

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