EuroSummit v20.0

  Yes folks-- this Thursday and Friday the European leaders will meet to solve the economic crisis for the twentieth time since early 2010, which since the last meeting {v19.0} has seen Spain and, as of today Cyprus, sucked into the vortex. This morning Spain formally asked for a banking bailout, and as the day progressed, so did Cyprus.

  I have complete confidence a solution will be found. After all, they were the last ninteen times. The markets will celebrate; stock markets will rise; fear will ease. Dom Perignon and congratulations will be passed around like dust in a Sahara sandstorm. People will turn the channel and catch up on Jersey Shore.

  It will look something like this: Spain's banks will get a bailout loan. Cyprus, too. There will be a "stimulus package" of about $150 billion {details coming "later"} and promises of stern response to any further crisis. In short, this will be nothing more than another bandaid and hot air on a system that has just lost it's foot to a landmine.

  Today a few noted columnists sounded the alarm-- many of whom have been doing so for years. George Soros warned that if the Summit was an utter failure, it could prove to be fatal to the Euro. Paul Krugman's article today was particularly dire, comparing today to not just 1937, but the far uglier year 1931, when a very similar situation which began with an Austrian bank called Kreditanstalt of Vienna went under and got the Depression really rolling. Here's the link to Herr Krugman's latest rant: http://www.nytimes.com/2012/06/25/opinion/krugman-the-great-abdication.html?_r=1

  This bandaid will buy time-- about a month or so. By mid August v21.0 will need to be crafted when they realize the amount allocated to save Spain is probably a fifth of what they really need and Italy begins showing signs of going under. Spain's economy will show further signs of economic decline, as will Italy. Portugal's economy will be literally imploding like Greece before it. Until such time as the powers that be realize that a Grand Reset is needed, this will continue. In the meantime, watch the price of gas. As it goes down, take it as a sign that the entire system is sicker and sicker as deflation sets in and demand recedes. I'm still sticking by my prediction that gas will go under $3.00/gal this year.

  One day soon enough {2013 is my guess} this farce will end very badly and very suddenly and we will all pay a dreadful price for the greed of bankers who were allowed to shred the laws enacted after the Depression to prevent just such an occurance via our under informed and over bribed politicians.

  Solutions you ask ? Unfortunately, nothing short of an entire systemic reset is needed here. The financial system is so complex, so overindebted in so many different forms that anything central banks and governments do will only delay the inevitable collapse of this bloated, diseased beast. My next post will be on what a sound financial system should look like instead of the one we currently have. Here's an article from Simon Johnson, former head of the IMF, on the complexity of it all: http://www.bloomberg.com/news/2012-06-24/u-s-banks-aren-t-nearly-ready-for-coming-european-crisis.html

Euro Faultlines

  This last weekend there were elections in a number of countries, with Greece and France amongst them. The Greek elections went as hoped, with the pro-bailout New Democracy Party winning. It's likely they're going to be able to form a government with PASOK and other pro-bailout parties. Champagne corks were heard near and far that Greece had saved itself from a terrible and sudden fate. My take is that Greece's timeline may not be sudden, but the terrible fate part is still unavoidable. Greece is going to literally run out of money in a few weeks; it'll be unable to pay Gov't wages. Unless there is a new bailout or a savior, Greece's date with The Keynesian End will come much sooner than they realize. I'm still standing by my prediction Greece will not see 2013 and be in the Euro currency. Today, the German newspaper Die Zeit reports that Chancellor Merkel today has nixed any further aid other than what has been agreed upon and refused to talk about another bailout package. When I was a kid, grandpa and his shotgun took a long walk with an old, sick horse and Valiant did'nt make it back from the walk. The kindest thing Germany could do is what my grandpa did.

  In France, President Hollande got a very nice Fathers Day present from his people in the form of a solid Socialist Party victory in Parliamentary elections. This election could very well have more implications than the Greek elections. It will make Hollande much less agreeable to Chancellor Merkel's approach; it will strengthen the Club Med nations' push to use the ECB as the primary tool to deal with the crisis. It appears that France has decided to align itself with it's Latin cousins and against their German neighbors. Unfortunately for France, this election will result in policies which are certain to hamstring France's economy. Amongst them are measures to punish companies that fire workers, reducing the retirement age, hiring 60,000 teachers and punishing companies that sell factories. These will certainly result in fewer companies starting up in France and a rush of firings before the new law comes into effect. Oh well.. once again Socialists must learn that simply passing laws does not mean that the finances needed for their laws will automatically materialize or that companies will keep their doors open.

  Thanks to the elections in Greece, the markets were expected to have a good day, and indeed started this way. But the Pain in Spain reared it's ugly head in the form of roaring interest rates on their ten year bond-- a sign from the market that the recent bailout is not nearly enough, and they're right. Spain's ten year bond reached 7.28%, though it did finish the day at 7.15%. Most market commentators know that when a nation reaches 7%, the end has come financially. To be sure, Spain reached this plateau months ago and wrestled it down-- and might be able to do so again. My make here is that at some point if this continues, certainly before it reaches 8%, the ECB will have to step in and begin purchases in order to buy time for a reformed bailout. I give it three weeks maximum before the ECB is forced to act. Here's Ambrose's take: http://www.telegraph.co.uk/finance/financialcrisis/9340073/Spain-pleads-for-ECB-rescue-as-bond-markets-slam-shut.html

Update Tues 6/19 5am: Spain just held a bond auction, and the results were brutal. A month ago, investors charged Spain 2.98% for 18 month loan. Today it went up to 5.074% for the same loan. That's really bad folks. Thursday Spain is going to sell longer termed debt and I suspect the result will be the same. It appears Spain has hit the wall and is essentially unable to borrow in private markets. A bigger bailout is needed. 

A Glimmer of Hope

  It appears that in Germany, there is increasing talk of passing something called the "European Redemption Pact", a fund that would be used to pay down excess debt in Eurozone countries. The specifics are that all debts in excess of the Maastrict Treaty limits, which is 60% of GDP and now totals a staggering € 2.3 trillion would be paid by issuing 20 year bonds (guaranteed by all EU nations and vast amounts of gold) and the money raised would be used to pay down these excess debts. The bonds would be paid down by a special EU wide tax.


  Several smaller German parties are on board with this; there is whispers in Berlin that Chancellor Merkel will drop her opposition to this so long as certain conditions are met. Some of this has to do with the other EU Treaty awaiting passage, called the Fiscal Compact, which mandates that EU states balance their budgets and actually has mechanisms in it to enforce this. Several German parties will not pass the Fiscal Compact without including the Redemption Pact. I can see a scenario whereby these two agreements are introduced hand in hand and could pass the various nations' Parliaments. Officials at Germany's Constitutional Court say that these two measures are both constitutional and would likely not be challenged. Passage of these two measures in the Club Med nations would be overwhelming as they would be the beneficiaries. 


  So far, Mrs Merkel's party, the Christian Democrats, are stubbornly against this, and not without reason. But the winds are beginning to change here; there is finally a sense of just how bad things in Europe really are and what a banking collapse would mean for all of Europe's people. Today's Italian Bond auction was absolutely brutal, nevermind it being inherently unfair that Italy has to borrow money at 6.2% and loan it to Spain at 3%. The matter is coming to a head very rapidly.


  The Eurozone Crisis has been festering for three years now with no real solution in sight. The two Pacts-- the Redemption Pact and the Fiscal Compact, enacted in unison, would likely be enough to solve the crisis-- as long as these nations honor their commitments in the Fiscal Compact and balance their budgets. We'll see. But for the first time in a couple of  years, I see a very real solution making progress. Hope springs eternal, no ?


Here is Ambrose's article on this: http://www.telegraph.co.uk/finance/financialcrisis/9330398/Debt-crisis-Germany-signals-shift-on-2.3-trillion-redemption-fund-for-Europe.html

Spain's Decaffeinated Bailout & Deflation

  This bailout was much different than the iron fist that they gave Greece and Portugal. In short, all Germany has agreed to do is to let the EFSF {Europe's underfunded rescue fund} to loan to Spain's bank restructuring fund, called the FROB. The FROB is backed by the Spanish Gov't. The EFSF loans are going to be superior to all other loans Spain has, meaning that if something bad happens, these loans get paid back first. It is at a pretty low interest rate, and so it does help Spain in the short term, sort of. It also does not force an austerity regimen or anything else onto Spain, a key demand of PM Rajoy.

  I see two problems here with this little operation. First is the amounts-- the initial pricetag is €40 billion, but almost nobody believes this. The likely total will be something like €200 billion, and in time maybe more. But the main problem here is that everybody who holds Spanish Gov't debt just went down a peg in the paying order-- it's called subordination. Spain also got downgraded by three notches yesterday by Moodys, after the bailout was announced. For investors holding Spanish debt, their investments just took a big torpedo. Some investors will have to sell their Spanish bonds because it is no longer above the A rating. Others will have to (or willingly) sell because of the subordination. Some traders will have to bail on trading Spanish Bonds because the downgrade means a higher margin requirement. Others will bail because Spain has essentially come out and said it needs help, a huge red flag. Yesterday China's Sovereign Wealth Fund, with a couple trillion Euro in their wallets, came out and said they're not going to be buying in Europe until radical steps are taken to change things. Another problem here is what is to stop the Spanish from borrowing to their heart's delight ? They can have their FROB borrow from the EFSF, and then have those banks helped by the FROB purchase Spanish debt. Yes-- a backdoor bailout. They will have to soak up a lot of Spanish bonds right away because of the wave of selling from the issues outlined above.

  Will this "unlimited line of credit" from the EFSF to the FROB work ? For a time, yes I think it will. But since only Germany, France and Italy are contributing to the EFSF now {and Italy's economy is also on the ropes lately} there will come a time when Spain will bleed the EFSF dry. 

  Yesterday Big Ben went to Congress and testified about the state of the US economy and gave hints on what he might do in the future. He said that at this time no action is warranted, but that he will be keeping an eye on matters. A few people have mentioned another Operation Twist, which I believe will do very little. Interest rates are already at historic lows; coming up with clever ways to lower them isn't going to do much good here. As the economy stalls and people's unemployment benefits end, there are just not many people who can borrow and spend. Because fewer are borrowing and spending, deflation is beginning to set in; the money supply is contracting. My guess is that Bernanke will do another Twist when the Fed meets later this month, and it will help for a few months. The markets will celebrate; the Dow and Gold will rally. For a little while anyways. The one thing Bernanke cannot do is to simply give money to the people, something he would dearly love to do. He can only manipulate the interest rates at which they get loans. Deflation's iron headlock is only beginning to show it's true power. 

Beware the VIX

  There are several very big problems converging together right now-- Brazil's economy has now stalled. India as well, and they are having serious problems controlling runaway inflation. China's manufacturing index has gone negative. Here in the US, job creation has stopped cold in it's tracks. And in Europe, Spain's economic situation is deteriorating very quickly, so much so that a bailout is now being openly discussed this weekend. The cost of rescuing Spain's banks is now between $75-120 billion, and Spain itself cannot possibly borrow this amount on the open market without immediately causing a bond crisis. The problem is, nobody has enough money to bailout Spain. These will send Spain's Bonds plummeting-- unless the ECB quietly steps in, which it appeared to have done late last week. Bank runs in Spain are accelerating; the yield of the German, US and UK ten year bonds are at record lows as people and investors bail on Spain and stash their money into what they consider safe havens. Worst of all, the VIX-- a measurement of volatility and sometimes called the Fear Index, is creeping back up again, nearing 30. When the VIX rises above 40, something is going badly wrong. During the Lehman crisis it went above 80. Ambrose's article today warns that global lending has contracted at a rate since the Lehman Crisis. Unless something is done on a grand scale, I look for the VIX to top 40 again by week's end. For anybody looking to measure the danger level in real time, here's a link to the VIX measurement: http://www.cboe.com/DelayedQuote/DQBeta.aspx?content=http%3A%2F%2Fdelayedquotes.cboe.com%2Fnew%2Findices%2Fquote.html%3FASSET_CLASS%3DIND%26ID_NOTATION%3D8941863

 Late last week I was convinced Bernanke would pursue another round of QE, but after a closer look, I'm not convinced reducing the interest rate on the US Ten Year from a record low of 1.45% to something under 1.2% would so much good. There is talk of the IMF stepping in to help Spain, and Bernanke himself could do so as well-- but doing either of these will be relentlessly attacked by the Republican opposition as a bailout of Spain instead of California. Look out for deflation and the continued sinking of commodities. For all who read this, if you see gas sink below $3.00/gal you should be afraid-- very afraid. Bernanke and the Fed meet again in a couple weeks; if the deflation train continues, I guarantee he'll so something. The problem is, we are now nearing what some call the Keynesian End Point and I fear that he has few options that will accomplish anything meaningful.