Category: politics

09:55 – Wow. The EU crisis meeting this weekend degenerated even faster than I expected, with Merkel and Sarkozy literally screaming at each other, so loudly that it was audible over Ode to Joy down the hall in the main conference area. The problem, stated simply, is that Merkel and Sarkozy hate each others guts. Were it not for the critical nature of these meetings, they wouldn’t agree even to be in the same room. Sarkozy wants Germany, directly and indirectly, to pay essentially all of the costs of “rescuing” the euro. Merkel knows that Germany couldn’t afford to do that even if it wanted to, which it doesn’t.

The only significant thing to come out of the conference so far is a preliminary agreement to recapitalize EU banks to the tune of about $135 billion. That’s half of what the IMF said would be necessary, and even the IMF figure is based on rosy assumptions. And, if the last few months is any guide, rosy assumptions are highly unrealistic. My own opinion is that $1 trillion would be just a start on what’s needed.

Meanwhile, we’re in the middle of a huge run on EU banks. Individuals and corporations are withdrawing funds from all EU banks and moving them to perceived safety, often literally under their mattresses. No one–individuals, corporations, or governments–trusts EU banks any longer, and with good reason.

The level of writedowns that banks will be obligated to accept on Greek debt is a huge sticking point. The IMF and Germany are pushing for 50% to 60%, which is itself grossly insufficient. France, whose banks are hugely exposed to Greek debt, is insisting on no more than 35% to 40%. The bankers themselves, via the IIF, are saying that if the 21% “haircut” agreed at the 21 July summit must be increased it can be to no more than 25% to 30%. It’s gotten so bad that the EU authorities are now playing chicken, telling the bankers that if they don’t cooperate the EU is now willing to allow Greece to go into hard default, which means 100% haircuts.

There was never any realistic possibility that this summit would agree to any actions that had any chance of “solving” the crisis, but now it’s clear that nothing of any significance whatsoever can be agreed. It’s now as close to mathematically certain as politics can ever be that the euro will break up catastrophically, and it will be sooner rather than later. I’d bet good money that Germany is preparing, if not already fully prepared, to depart the euro and re-institute the D-mark under whatever name. Finland, Austria, and the Netherlands are probably planning to do the same, either with individual local currencies or as a part of a Northern-tier currency union.

What we’re watching is not just the collapse of the euro or even the breakup of the EU, but the destruction of the whole European welfare state.

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.

08:32 – It occurred to me that a few of my readers may be unaware of the weasely ways that governments try to make things appear better than they are by using phrases like “primary budget surplus” and “current account deficit”, both of which should be red flags. So let me explain it in personal terms.

Let’s say that you expect your household income to be $50,000 in 2012. Your expected expenses for food, utilities, insurance, car expenses, and so on total $49,000. Congratulations. You’re running a “primary budget surplus” of $1,000. (If your expected expenses had instead been $51,000, you’d be running a “current account deficit” of $1,000.)

But wait. By definition, these figures do not incorporate debt service expenses. You have a mortgage upon which you’re paying interest and principal of $1,500/month, or $18,000 per year. If you take that figure into account–which of course you have to, being a person rather than a government–your expenses now total $49,000 + $18,000 = $67,000 for 2012, but your expected revenue remains $50,000. You’re $17,000 in the hole. There’s no alternative to paying your mortgage, so your only options are to cut spending elsewhere or borrow an additional $17,000 to balance your books. In real life, of course, people cut the other expenses and governments borrow the money.

But it gets worse. Your brother-in-law retires next year, and you’ve signed an unbreakable contract to pay him $5,000 per month and cover his medical insurance costs, which total another $1,500 per month. Starting next January, you’re on the hook for an additional $6,500/month in expenses, or $78,000/year. So, at this point, you expect your actual revenue for 2012 to be $50,000, and your actual expenses to be $145,000. You have to come up with an extra $95,000 in 2012 and, not being a government, you can’t just print the money. Nor can you borrow it, because no one will lend to you. Your personal financial world collapses, but at least you can say you were running a “primary budget surplus”.

It gets worse still. Your sister-in-law retires at the beginning of 2013, and you’ve also agreed to pay her retirement and medical expenses, for an additional $6,500/month. And your company has announced that sales are falling and it will cut all salaries 10% across the board starting in January. So, as of 2013, your expected revenue is $45,000/year and your expected expenses are $223,000. How long can this go on? Well, the obvious answer is “not for long”. And that’s what nations are now finding out: eventually, you have to pay the piper.

Oh, yeah. Did I mention that many of your 50 adult children, such as California and Illinois, are deeply in debt, with no chance ever of paying what they owe? Technically, you’re not responsible for their debts, but you don’t want to see them go to debtors’ prison for life, so you’ll probably end up having to pay off their debts as well.