Day: October 16, 2011

Sunday, 16 October 2011

10:18 – It would be amusing if it weren’t so disastrous. Back in late July, the EU authorities announced after the crisis meeting that Greek bondholders would have to take a “voluntary” 21% “haircut” (read writedown). That number has been climbing steadily recently, first to 33%, then 50%, now 60%. The reality, of course, is that there’s nothing voluntary about it. One cannot get blood from a stone. And, when the dust settles, the actual writedown is likely to be nearer 90% than 60%. Call it $450 billion, just on tiny Greece. And that’s assuming a “structured” or “organized” default. If Greece declares full default, which is not at all unlikely, the writedown will be 100%.

That’s what the EU is struggling desperately to avoid. They’ll do anything, including spending trillions of dollars of IMF (read US) money, as long as they don’t have to spend their own money. The problem is that when Greece formally defaults, holders of Greek debt, including European banks, will have to write down that debt to face actual value, which is to say nothing. Right now, they’re all carrying those worthless Greek bonds at full face value on their balance sheets. If they’d already written down the bonds to current face value, every bank in Europe would be bankrupt. Which, of course, means that every bank in Europe is actually bankrupt right now.

But it gets worse. A lot worse. When Greece defaults, investors’ attentions will immediately turn to the next dominoes, Portugal, Ireland, Spain and Italy. Those four countries are already bankrupt or nearly so as far as investors are concerned. The market won’t lend to Portugal or Ireland at all, and even with the ECB buying Spanish and Italian bonds to keep yields down, the yields on those bonds are now approaching the levels they reached before the ECB began to intervene. (Italian bonds were at 5.71% the last I looked, just short of the 6% panic level.)

Spain and Italy both need to sell tens of billions worth of bonds between now and the end of the year, just to roll-over maturing debt. When Greece defaults, selling those Spanish and Italian bonds will go from almost impossible to utterly impossible. Spain and Italy will be locked out of the markets, and will have no way to pay interest on current bonds, let alone redeem maturing bonds. In other words, they will default. And, although many have spoken of this as a domino effect, in reality what will happen more resembles an avalanche. As that tiny Greek snowball rolling downhill gains momentum and mass, it’ll take the rest of the EU economies down with it.

Of course, the EU does have one remaining solution. The ECB can simply print a boatload of new euros. And I mean “boatload” literally. They’ll have to print many trillions of new euros. Enough new euros to reduce the actual value of outstanding sovereign debt to a small fraction of what it is now. Right now, one euro buys about $1.35. To make EU sovereign debt sustainable, particularly among the PIIGS nations, the ECB would have to print enough new euros to reduce that exchange rate to one euro buying about $0.25, if not less. The result of that would be widespread defaults in all but name, as sovereign debts were paid off at $0.20 on the dollar. The standard of living throughout the EU would decline dramatically, but that’s going to happen one way or another. The euro is nothing but a gigantic bubble, and all bubbles eventually burst. Not that I’m suggesting massive inflation, which is the worst possible solution. But I think political realities mean it will be the only possible solution.

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