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.