Friday, June 8, 2012

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. 


  1. Mr.K-I agree on Bernanke...which leads me to ask if he can't/won't attempt any wishcraft near election, what happens if France begins to wobble on top of Spain and possibly Italy? And, looking at China from the point of a housewife who isn't a trader, I figure that if credit tightens at ALL here, people will stop buying as many Chinese toys and throw-away items which would affect their economy.

    My question is what happens in the USA if China suddenly stops buying our bonds? I can't see a 'safe' haven of any type right now...not even cash. Stocks are suspect. Bonds may have a short-lived boost but there is a sword on a hair above them. And cash in a bank may, or may not, be safe depending on what is hiding on their books.

  2. Mr. K Another great blog. I followyour and check this site daily. Whats sad ifBernanke may be correct in giving the people the money to pay off bad debt. I am a conservative by nature, but honestly I seeonly two ways out of this mess right now. The first being a global debt jubilee and second giving money directly to the people so they can spend it. I actually think it could be done with an income tax holiday for a year. I know people will cry foul, but the current trend in bailing out banks and corporations is not helping.

    Business is also sidelined because of uncertainty and flush with cash. We have to sort out the divide in this country or we are doomed. I am a simple guy and old will retire next year and I am scared to death. No I will not rely on SS as I am frugal and have been all my darn life.

    Until this great nation comes together to solve our problems regardless of party affiliation nothing will get solved. I will not vote for Obama as his record is dismal at best and I know his track record now he is president. He had his chance and blew it. I am probably going to get flamed for this but that is ok.

    There are no simple answers anymore. One question if someone could answer it for me. I use yahoo and want to post but cannot here. I am an ole you know what and I do good to use a computer.

  3. Anon: This is a google affiliated site; you need a google e-mail account. When you sign in, you can then post as yourself instead of anonymous.

    As for your fears, they are all too well founded. The worst part is that our fate is unfortunately tied to that of Europe and Japan-- if either of these goes down in a big way {by this I mean their financial systems. I see this as a very likely outcome} then we will shortly follow. I've written two posts on what I think will be the worse case scenario-- over on the right hand side of this blog is a list of popular posts. "Update 5/23 and the Worst Case Scenario" and it's followup post "After the Crash" are what I think are likely outcomes. I've begun to develop a "Plan B" for me and the family as best as I can and would advise everyone to do so. As for a warning sign, you can watch the VIX-- anything over 40 is dangerous, anything over 60 means it's time to seriously think about heading for the hills. Here's a link to the VIX: