Euro Archives

Hard Times Ahead For Euro

Last week we rather briefly insinuated that the conditions of modern Europe carry some similarities to post WW1 Europe. Here is some more on that note, although its pre WW1 this time around. The Austrians are back in the mix:

“Austrian Finance Minister Josef Proell objected, telling reporters in Brussels that “countries committed to economic discipline that do the hard work and maintain stability” shouldn’t be forced to subsidize the fiscally weak.”

What a Grinch!

So what could trigger the onslaught in bond markets instead of battlefields? Germans will only pay for the fiscal irresponsibility of others for so long. Sadly, as soon as they stop, this will trigger the crisis that countries would have had years ago without German backing. This means it will not be difficult to paint the Germans as the wrongdoers.

Sure enough, that has already begun. A New York Times Opinion piece, which it seems no one will put their name to (for good reason) includes this:

“The worst offender has been Angela Merkel, the German chancellor who is showing herself, once again, to be a captive of opinion polls rather than the bold leader of Europe’s biggest economy.”

The Curious Capitalist website echoes the sentiment: “Germany has been at the centre of Europe’s mishandling of the euro crisis from the very beginning. Germany is expected to take the lead on policy in the Eurozone, and when dealing with the debt crisis, that leadership has sometimes been lacking. The misplaced reluctance of Chancellor Angela Merkel to support floundering Greece earlier this year allowed the contagion genie out of the bottle and spread the crisis to other weak Eurozone states.”

And the NY Times is back with a piece by Roger Cohen: “But how shallow, paltry and mean-spirited has this German reaction to the euro crisis been!” And all this is after the Germans have funded bailouts, and before they have actually abandoned the Eurozone’s delinquents.

No doubt the Germans know they could easily end up mightily unpopular if they do what is sensible and leave the rest of Europe to sort itself out. Angela Merkel, the German Chancellor, has it well figured out. She is likely to tag along with Europe’s requests for some time in order to make it look like she tried. In reality, she probably knows the efforts are doomed. That’s why she hasn’t committed her nation to the bailouts like a good politician should.

Kenneth Rogoff, who is quite the expert on these matters, has been working on the odds of debt restructuring for the PIIGS. “Greece will be very lucky to avoid restructuring, Ireland, Portugal — they’re just in denial, saying it can’t happen. They really haven’t drawn clear lines, they haven’t really said what they wanted to do, they haven’t really made choices.”

Here is the interesting part of his quote, as reported by Bloomberg: “Europe has “no credibility” in ruling out debt restructurings.” He is spot on. It’s not their decision. It’s the decision of the markets. That’s what governments of the world overlooked when they borrowed so freely to fund their welfare states. It comes at a cost. Now that pound of flesh is coming due.

But, like Shylock, the bond holders have got themselves in a pickle. The more they demand, the worse it will get for them when the inevitable restructuring occurs.

Courtesy of  the Daily Reckoning Australia

Thinking the Unthinkable
by Bill Bonner

This week, like the last one, was dominated by euro babel. Speaking in their various tongues, all at once, Europeans were talking nonsense. Especially Jose-Ignacio Torreblanca. The senior fellow at the European Council of Foreign Relations begins: “in an ideal world,” he says it is “fair and rational” for people to get what they’ve got coming… referring to the people who lent money to Irish banks. He even quotes the old Latin maxim: fiat iustitia, pereat mundus (follow the rules, even if the world should perish).

He should have stopped there. Instead, he misses the point he has just made. This time it’s different, he says. Why? Because “there is a good chance that in real life the eurozone could be killed…”

When the financial crisis hit in ’08, Europe might have let the chips fall where they may. But for nearly a century, elected officials have thought they could keep the chips from falling at all. Instead of merely consuming and redistributing the fruits of the economy; they pretended, by enlightened management, to increase them. Few people noticed the audacity of it. But in a downturn, government no longer lets wealth perish. It counteracts corrections with “stimulus.” And it doesn’t merely provide a stable currency, it manages a “flexible” currency system to help guarantee full employment and prevent debt crises.

By the 21st century, diddling the economy has become second nature…but much less effective. In the US, the fiscal and monetary stimulus of the early ’30s – equal to about 8% of GDP – had a powerful effect. One year later the US economy was growing at an 11% rate. Nearly four score years later, a combined stimulus effort of about 30% of GDP produced a response of barely 2% GDP growth. As for last week’s 85 billion euro Irish bailout, the market rally was over by tea time the following day.

The trouble with trying to get the outcome you want is that you end up getting the outcome you deserve anyway. Ireland guaranteed bank assets nearly 6 times greater than the nation’s GDP. Now, with unemployment at 20% and GDP down nearly 15% over the last two years, investors wonder how Ireland can possibly be good for the money. And they are beginning to wonder about Spain, Portugal, Italy and even France. Between them, French and German banks hold nearly a trillion euros worth of peripheral European nations’ debt. How long will it be before they go down too? The Irish bailout may cost about 100 million euros. Spain is ten times as big. These were “unthinkable” thoughts, said former Italian Prime Minister, Romano Prodi.

The periphery states benefited from the low interest rates of the Eurozone. With lending rates at 3%, instead of the 10% rate it had before it took up the euro, Irish property boomed. Irish banks were able to lend their way to insolvency. When the bust came, potential losses became real losses. But insolvent institutions do not become more solvent by borrowing more money. By the time the fix for Ireland is fully implemented, the Irish government will be deeper in debt – with a quarter of its GDP needed for debt service. At that level, they will be sunk. And you can forget about “growing” out of this debt problem. This year, for the first time ever, more Europeans will retire than join the workforce. Retirees are not producers of tax revenues. They are consumers of it. Besides, how will the Irish economy grow at all, with the government cutting back by 10% of GDP over the next 4 years, probably followed by another 10% cut when this one proves insufficient?

But that’s what happens. One manipulation leads to another improvisation. You pretend it’s a matter of principle, but you’ve already thrown out the “iustitia.” You’re just trying to get what you want, making it up as you go along.

The euro is a managed paper currency, like the dollar. Still, it is not managed enough for many Europeans. The Irish might revolt, leave the euro, and bring back the punt. In the old days of drachma and pesetas, Europe’s sunny countries could scam their lenders with shady currencies. There is even a proposal to introduce a new currency, known either as the “medi” or the “sudo” – designed to help Europe’s periphery states to manage their way out of their financial obligations. A weaker currency would lower the real value of debts, employment contracts, pensions and just about everything else.

“There will be no haircut on senior debt,” said Olli Rehn, the EU’s commissioner for economic and monetary affairs, still trying to keep the chips in the air. And why not? Because the consequences are unthinkable? No, he’s thought about them. He just doesn’t like them. But who cares? You can’t really manage an economy. You have to let it happen. Here we offer some constructive criticism: Stop worrying. What will happen if lenders suffer the losses they deserve? We don’t know. But we’d like to find out.

Bill Bonner,
for The Daily Reckoning Australia

Greenback Rises Against Euro and Yen

Since Bernanke announced his program to undermine the dollar, the old greenback has actually risen against its main rival – the euro. How do you like that? Bloomberg reports:

The dollar gained the most since August against six major counterparts as concern that Europe’s debt problem will worsen and military action in Korea will escalate boosted demand for the US currency as a refuge. The greenback rose against the yen for a fourth straight week, the longest streak in 20 months, after North Korea shelled a South Korean island and said “escalated confrontation” will lead to war.

The euro fell for a third week versus the greenback as investors speculated Portugal and Spain will be the next European countries to need a financial rescue. The US added jobs in November for a second month, data next week may show.

“The euro has further to fall against the dollar,” said Kathy Lien, director of currency research at online currency trader GFT Forex in New York. “If there is a war amongst the Koreas, the yen would fall off aggressively against the dollar.”

The problem with the euro is that it is too good for many Europeans. Everyone wants a flexible currency these days. That is, they want one that will act like a good dog…one that will “get down” off the furniture when it is told to do so.

Alas, all the currencies are unruly mutts. The dollar won’t go down, even though Ben Bernanke pulls the rug out from under it and gives it the old “bitch slap” with the back of his hand. And the euro won’t go down because the Germans don’t want it to go down.

Of course, this doesn’t make the Germans very popular with the Spanish…the Irish…and the rest of the peripheral crowd. They want a cheap currency so they can pay their debts. The Germans, on the other hand, cannot seem to forget the horrors of the Weimar days…when you could take a wheelbarrow full of paper money to the store and not be able to buy a loaf of bread.

The more you look at the European banking and sovereign debt crisis the more dangerous and insoluble it seems. Try to fix one part of the problem and you make another part worse.

The Germans don’t want to pay to bailout the Spaniards…and the Italians…et al. But German banks have nearly half a trillion euros worth of their debt.

The Irish taxpayer doesn’t want to pay to bail out the banks either. He’s already facing austerity measures that would choke and appall Americans.

Yesterday, the Obama team proposed freezing federal salaries – that is, leaving them 50% to 100% higher than private sector wages – for the next two years.

“We are going to have to budge on some deeply held positions,” said the decider.

His proposal would save…are you sitting down, dear reader…$2 billion by the end of 2011. Let’s see, that would cut the deficit by approximately 3 tenths of one percent…BFD – that’s shorthand for “so what.”

In Ireland, government workers already agreed to a pay cut. And now the Irish feds are supposed to fire 10% of their public workforce…with another 10%, probably, a few years from now.

How much austerity will the Irish be willing to take in order to protect banks from their losses? They could leave the euro…revive the punt…and shirk their commitments in the old-fashioned way – by devaluing their currency.

But wait… If the Irish opt out of the euro…the whole shebang could come falling down.

“If the euro fails, Europe will fail,” says Ms. Merkel, chancellor of Germany.

And if the euro fails…banks fail…companies fail…trade fails…and then US companies fail…US banks fail…

Who knows where this would lead? And only we seem to want to find out.

But what to do? A colleague gives us advice…below…

A colleague warns us:

“It’s time to save every possible penny. Next year is going to be worse than 2008 – a lot worse.

“Here’s why:

1. The euro is going to fail. Ireland, Spain, and Italy’s sovereign debt cannot be financed.Shares of even the biggest and strongest of Europe’s banks (Deutsche Bank) have begun to “roll-over.”

2. More QE in Europe and America will make it much more difficult for businesses to invest across borders. That will result in massive trade problems and could easily cause a global famine. Most people don’t realize how dependent the world has become on free trade for basics, like food. Here’s what agriculture prices have done since July when QE II began. Vastly higher ag prices are not bullish for financial markets or world order.

3. Housing in the US is going to collapse, again. The various games that have been played to prop up the housing market in the US have failed. Tax credits, etc. haven’t worked…and they never had a chance. I have good contacts in this industry and it is completely bleak. With foreclosed properties making up 25%-50% of the inventories, housing prices will continue to fall 10%-15% a year – or more. There will be no new net demand for homes for a long time. Several major homebuilders will go bankrupt, including the largest, Pulte.

4. Lots of major US corporations – see GE – have unsustainable debt loads. These companies will end up bankrupt and will fire at least 50% of their employees over the next three years.

5. Muni/State finance: You guys have seen all of the numbers. Probably half of the states and munis in the US are being run in a way that’s completely unsustainable. As these cuts are made it will have a big impact on the economy. See what happened to Cisco last quarter, all because of cutbacks at the local government level.

“The problems of 2008 haven’t gone away. We’ve just borrowed a lot more money to make people think everything would be okay. As the veneer wears off, there’s going to be a real panic; and this time it will be worse, because there’s zero trust and confidence left in the government or the bankers…

“If I were in your shoes, I’d make sure every business unit I controlled was being run in a very prudent way, with a big cash flow buffer. I’d make sure they were ready to cut overhead by 50% in 30 days…”


Bill Bonner,
for The Daily Reckoning Australia

China Ditching US Dollar For Euro

We all know the US flogs its debt to anyone willing to buy it. And up until recently, that’s been China. Very slowly, over the past twelve months China has been lowering its exposure to US treasuries. In fact, in the last twelve months, they’ve offloaded about USD$100 billion dollars worth. Some of this has been by simply not purchasing more bonds upon maturity. While some of it has been by turning those US dollars into precious resources. Instead of waiting for bonds to mature, it has used the cash to buy up natural gas stores, investing in oil rigs and even throwing money into companies with large iron ore mines. But now, it looks like China has more interest in the financially crippled Euro, instead of building up its supply of greenbacks.

In fact a former advisor to the central bank of China has been told by a top level Chinese central banker to convey to the European central banks the ‘confidence that China has in the region’s economy and currency.’ Why does it have so much confidence in the currency now? Firstly, Euro holdings are offering a far better yield than the US, which means solely as an investment, it’s make much more sense to go with the product that offers a higher return. Now you might be tempted to consider this a risky move by investing more money in the Euro rather than the traditional ‘international currency’ US dollars. But what if the central bankers understand something we don’t, or more importantly, America doesn’t get? And that is, America is no longer a sound investment. It could be that Chinese central bankers have decided that should the US fall apart financially, they no longer want to risk their US currency reserves, which is more than 30% of their total foreign reserves. From the very start of the ‘naughties’, China sought to grow its foreign currency interests.

What started out as a lazy USD$181 billion in 2002, grew to over USD$1 trillion by 2008. Of course, the US dollar/Yuan having a favourable exchange rate only helped these purchases… And now, China has passed Japan as the largest holder of long term debt in the States, currently holding a massive USD$843 billion. Coming in second is Japan, with a massive USD$800 billion of US debt and the UK has the third largest amount of American debt at USD$362 billion. Let’s be honest, none of these countries are in the position to pick up the debt as China slows down it’s buying of US debt. As I mentioned earlier, Japan is already up to the eyeballs in their own debt and so isn’t likely to go on a US bond buying spree. And the UK has promised fiscal austerity, so loading up on another country’s treasuries with a record low yield probably isn’t going to make much sense. See, during those boom times, when public debt didn’t matter, America knew that it could issue debt and would have a very willing buyer… China. That’s starting to change.

At the start of this year, the massive level of public debt held by China set off alarm bells with some US government officials. Even so, China still made another USD$30 billion in purchases before the Chinese government decided to start slowing the purchases down. There are massive implications for America now that China has decreased its holdings. Any reduction in holdings by China could see overall demand for American debt drop. If it hasn’t already. And think about it.

What if China becomes the world’s largest economy and shuns the US as an investment vehicle? Would you be inclined to follow China’s lead and dump US dollars and US investments too? A casual dumping of American Treasuries will inevitably lead to an even weaker US dollar. Which eventually can only encourage other investors, and countries to seek out a new reserve currency. Let’s face it, right now there’s no other country that can pick up the US debt like China can. But China’s new found interest in the Euro could be about more than just better investment yields. It could just be the next step in the shift of economic power.

Shae Smith Assistant Editor Money Morning Australia