Monday, April 18, 2011

Greece, US Money Supply and the S&P Downgrade

 I'd like to cover a few things here today, with the first being Greece. The originial EU rescue of Greece envisioned a three or four year aid package, after which time the situation was supposed to stabilize and Greece was to return to the bond markets. It was a terribly flawed plan to begin with, and the markets saw it as such. Today the Greek 2 year bond hit an unbelieveable 20% interest rate (see chart above). In short, the bond markets have even less faith in the Greeks to repay, and rightly so. The amount of money the Greek government owes is staggering, and it still needs to borrow every month to make ends meet. Simply put, even if Greece were to outrightly default on it's debt, they would still need to borrow money each month. To it's credit, the government of Greece is making budget cuts and increasing taxes, but it's not nearly enough to meet the commitments it's made to it's people. Good ole fashioned corruption is a large problem to boot. For the last year.. even last week.. EU bureaucrats have constantly maintained it's faith that Greece would pay it's debts and come out of this. But last week, there were reports circulating that Germany was drawing up plans to deal with a Greek default, despite denials from German Finance Minister Wolfgang Schaeubel. These rumors set off the latest deterioration in Greek bonds-- not that it mattered much as nobody was going to loan Greece money anytime soon anyways. Greece has consistently missed budget goals set out by the bailout terms, and their accounting methods are questionable at best.

This has happened before in recent history.. Latin America in the 1980's to be precise. At that time, US Treasury Secretary Nicholas Brady came up with what were known as "Brady Bonds". These were bond options given to the creditors of these Latin nations-- most often, these involved the creditor taking a straight up haircut on the debt while the other option involved extending the debt in order to lower the yearly payments. These Brady Bonds were guaranteed by a special issue of US 30 Year Zero Coupon Bonds. For the most part, this was a success.. most of the nations who took these did indeed pay them off, with the exception of Ecuador, who defaulted on their Bradys in 1999. The other Latin nations.. Mexico, Brazil, Colombia and Venezuela among them.. went on to get their fiscal houses in order.. Brazil especially. It can be done.

My guess is that by the Ides of May, we're going to see what the End Game is in Greece, and I'd wager that it will be some form of Brady Bond deal guaranteed by either the ECB, the EFSF, the IMF or a combination of these. But will this eventually succeed with Greece this time ? My concern here is fourfold: first is that in today's world, there are credit default swaps written on Greek debt.. and as soon as this plan is announced,  there will be a deluge of these hitting the books of the banks that wrote them. Also, much of Greece's debt is to itself in the form of pension funds and Greek banks (which also have credit default swaps written on them), and these will also take a nasty hit.. thus crippling the Greek economy further. Third, the Greek government will be forced to finally live within it's means as it will have no real access to credit for some time-- and this will mean deep cuts in Greek government spending on social and medical programs, another kneecap to Greece's economy. Fourth-- and most seriously-- if Greece were to get such treatment, you should expect Ireland and Portugal to line up pretty quickly shortly thereafter. The problem here is that Euro banks are unbelievably overleveraged and have written credit default swaps on Irish and Portuguese debt as well as Greek-- many banks {especially Irish, Portuguese and Greek banks) will not be able to survive these dual torpedoes, especially given that these economies will begin to seriously contract, forcing yet more businesses and mortgages to go belly up. In the case of Portugal's debt, much of it is owed to an already crippled Spanish banking system. As for Greece, they have a restless population prone to riots and a military establishment prone to throwing out incompetent civilian governments. Is there a chance it winds up as rosy as what happened in Latin America ? For the bankers, the answer is probably no. As for these nations ? Time will tell. One thing is certain-- for the people of these nations, lean times are a'comin.

Onto the next topic du'jour-- the United States's economic problems. Today the rating agency S&P downgraded the US to a negative outlook, though the US did keep it's AAA rating. It was a bold step-- and one which the Obama Administration was forewarned about last Friday. This weekend, Treasury Secretary Tim Geithner went on a media publicity blitz, reassuring anyone who would listen that things are just fine. When somebody important stands up and tells you that "all is well !!" you know it's time to panic. Panic time has not yet arrived.. but day by day the Day of Reckoning draws ever nearer. My last post details the dual deadlines facing the US this summer-- raising the debt ceiling and the end of QE2. My guess-- a deal gets done to raise the debt ceiling, but QE2 does indeed end-- for a while anyways.

The downgrade was not too shocking or upsetting to me.. it was long overdue as a matter of fact. But an article I read today on ZeroHedge did rattle me.. more accurately, a chart. Here is a chart of the US Money Supply published last week: {above}

This is the total supply of money in the US. This year, it has rocketed upwards.. action not seen since shortly after the Lehman disaster. Indeed in 2010, the overall money supply had more or less stabilized. In my last article, I posted an opinion from Lee Adler, who wondered aloud what exactly is spooking the banks into hoarding this much cash into their vaults. While the obvious answer is thatQE2 is whats causing this, we must remember that this chart does not include the QE2 money, which has put another $400 billion into the system.. in other words, the US has printed about $900 billion so far this year. Most commonly banks hoard money like this in order to be able to absorb some big losses they see coming down the pike.. this is what happened in the 2008 spike, and Adler believes it might be the case again. But I'd like to offer another opinion-- they're hoarding it so as to be able to purchase US Bonds when the Fed halts QE2 in June. Whatever the answer is, it appears the banks are aware something big is about to change.


  1. We can see that a hyperinflationary depression is on its way. Maybe by design? After all the crisis coming could be averted if the Federal budget gets much closer to be balanced on can only be done by huge budget cuts. Their smoke and mirrors games leading the stupid masses to believe they are doing their job. Well a 1990s Russian collapse is in order here and desired by the leadership. Default of foreign held US Treasuries and a new issuance of currency. Only tho other countries like Russia and China may want war with us, after all we cheated them big time. For the lack of balancing the Federal budget they (US Government) literally destroy the world. Armageddon does not sound so far fetched.

  2. Hi Mr K " they're hoarding it so as to be able to purchase US Bonds when the Fed halts QE2 in June." I think this is an excellent hypothesis. Also you are spot on the Greek and PIIGS crisis. It is swept under the rug for now, but not dead at all. Your idea about how Latin America was handled may be right, but IMHO a Hail Mary at best. The chart on money supply is downright scary. Great for my PM holdings, but this will cause terrible inflation in the things we need like gas and food.

    I am also looking at energy now that Libyan oil has ceased to flow. As for Japan check out my blog and Nathan's Economic Edge for some scary stuff.

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