The Eurozone crisis and America

http://blogs.wSportsJournalists.com/marketbeat/2012/04/26/sp-downgrades-spain-amid-growing-risks-over-government-debt/

S&P downgraded Spanish debt again, warned of further downgrades, and wrote "In our view, the strategy to manage the European sovereign debt crisis continues to lack effectiveness."

Spain is particularly bad right now. It is in a recession (that is sweeping across much of Europe), unemployment is 23 percent and economic growth prospects in the next few years look bleak -- even without the likely credit default that is eventually going to happen.

The timing of the downgrade doesn't make any particular sense, but it isn't saying anything everyone doesn't already know and SHOULD be focused on. With a large swath of Europe already in recession, and the increasing risk of sovereign debt default in several countries, which they have put off with half measures, but haven't fixed, I think this is going to blow up within the next year. Spain, and when you get to Italy, which is going to blow too, are Greece magnified to a scale that will affect the world.

The consequences for the U.S. economy, which is overloaded with debt, as well, and flailing around with ridiculously loose monetary policy to put off the inevitable here too, are going to be great. Our economy is an eggshell, and if Europe goes down, we go right down with it -- 2008 again, but this time worse.

Then, there is the fact that our policy makers understand all of this and have us way too involved with it already.

For anyone who doesn't understand that we are already knee-deep in this, thanks to our Central Bank, this is a good read from December:

http://online.wSportsJournalists.com/article/SB10001424052970204464404577118682763082876.html

Our Federal Reserve's balance sheet is already at an unprecedented $2.8 trillion, filled with garbage assets from its bailouts and U.S. treasuries that it loaded up on in through its feckless quantitative easing. It is a policy of shitting on the dollar and creating inflation to try to "stimulate" our economy. It has had very little effect, but has been very costly -- costs people will eventually understand better. They are essentially printing money endlessly and sinking us under a pile of debt that can only be alleviated by the dollar being debased at some point (hence my thread on gold).

At the same time, though, hidden off the books , the Fed has at least a $50 billion currency swap line (described in the WSJ link above) with the European Central Bank, being used to covertly bail out European banks, and by proxy putting us all on the hook financially for irresponsible European governments.

Aside from the fact that our central bank has no place covertly bailing out foreign banks, the way it is being done is disgusting. Because they don't want their fingerprints on it, they are essentially handing the ECB a blank check to give credit to favored banks (and it has been a corrupt process), and hopefully filter through by lending to EU governments that are trying to stave off default.

As S&P pointed out in its downgrade release, though, it, and other EU measures, has had the effect of spitting into the wind.

This is how deathly afraid our president and his Fed chairman are of what is happening in Europe, though. To the point that even with our own sovereign debt dangers, they are willing to use the relative safety of the dollar to try to keep propping up a house of cards that is going to fall.

For everyone overly focused on the elections in November -- if they can't stave off a collapse until then, this is the issue that WILL become the focus of the debates -- same as in 2008.

If they do get us past November, aside from the office perks, being president just isn't going to be fun over the next couple of years.

 

If Hollande gets elected (which he likely will), he will try to blow the Euro up. Angela Merkel doesn't have a lot of public support, and Sarkozy's support has been key in getting them to keep writing checks.

There won't be any unified European government. They are all so didactic about their sovereign rights. They will blow up the failed Euro experiment, but they will never allow their neighbors (they all hate each other) to have a say in their national affairs.

That doesn't solve the sovereign debt problems, though. The whole banking system is intertwined. They are not trying to save Greece and Ireland and Portugal and Spain and Italy for sovereign reasons. No one cares about those places. They are trying to save their banking system, to prevent economic collapse.

Deutsche Bank reported earnings today. As did Credit Suisse (which is managing slightly better). Things are ugly. Santander is beyond a mess. It goes on and on. The French banks have needed bail outs.

The sovereign problems are already causing a recession. Everything was predicated on endless economic growth, and when that ended in 2008, they found themselves in quicksand. They are doing everything to keep from falling in, but they are not going to be able to stop the inevitable.

A daisy chain of defaults, and it spells depression. The U.S. isn't an apple to that orange. Our banks are very exposed to it, our economy is too intertwined, and we have created our own fiscal mess that is only mitigated by the fact that our economy is so large that our credit limit is greater. We're doing everything wrong, though, by bringing us closer and closer to that limit and using monetary policy to try to avoid being fiscally responsible.

 

As an aside, Mike, I just remembered this post of mine from last year (edited out everything afterward since I overpost):

I didn't do that short play. I'm not sure if I could have. Soon afterward, the European regulators stepped in making it impossible to short their banks. I would have loved a play to short just Spanish and Italian banks at that time. It seemed obvious to me.

I just looked at that ETF. It is symbol EUFN. If I had shorted it in April, a little more than a year ago when I posted that, she'd have been sitting on close to a 35 percent return and the price is still sinking.

In any case, the key here isn't the sovereigns. It's the banking exposure. Italy is the 8th largest economy in the world. Spain is 12th or 13th. If they default, the exposure is enormous. And it spills over everywhere. This isn't Greece, which is tiny, by comparison.

 

Fiscal responsibility at the sovereign level is fairly simple in my estimation. It means not creating such a debt load that it drowns you. It means not predicating your spending policy on a false notion that economies grow endlessly, or that central banking can create growth (which comes with a very serious downside that puts off the consequences to the future).

That applies to Europe, it applies to everywhere else and it applies to the U.S.

In the U.S., given the unique role of our Central Bank, it also means not relying on a printing press that creates fiat money in order to inflate your currency and therefore artificially decrease your debt, in order to put off having to make spending choices. You can get away with that, the same way Greece and Spain got away for some time by increasing their debt load to 1.5 times their GDP. But when your debt is growing by $4 billion a day, as ours is, and you are not doing anything about it, what is happening to those European countries should be a cautionary tale.

That is fiscal responsibility. It's not some arbitrary value judgment. It's staying within your means, and when you exceed your means, as we have, not debasing your currency in an effort to continue to keep spending beyond your means because your leaders are too weak to tell people they can't have things we can't afford.

Because it does catch up with you eventually.

 

Everything you are saying is correct. But I think you are missing my point. We have centuries of sovereigns spending like drunken sailors and then just wiping away their debts. That is the history of nearly every European king and queen from the 1300s through the 1700s.

The issue isn't the sovereigns, though. It is who owns all that debt today, and the global interconnectivity of it all.

The reason the ECB is freaking, Germany is freaking, our Central Bank is extralegally funneling money to European banks. ... is that the exposure to that debt has enormous potential (greater than anything we saw in 2008) to drag down the global banking system.

And if that happens, worldwide economies will spiral out of control. In 2008, we had been living on false prosperity for more than a decade and then were dragged into recession. Today? We are looking at very fragile economies that will be devastated by a daisy chain of sovereign defaults by countries that large.

It's not due to the importance of those sovereigns themselves. It's due to where that debt is sitting -- in the global banking system.

 

Are you referering to what I said about the Federal Reserve's swap lines to bail out European banks?

Yes, it is extralegal. The Fed has no authority to bail out Europe.

Even Ben Bernanke isn't try to fudge that fact. He's just ignoring it and doing what he pleases, because he acts without much oversight (Congress has no oversight of his activities). When Ben Bernanke met with Senators in December last year to brief them about what was going on in Europe, after the meeting Lindsey Graham told reporters that Bernanke himself said the Fed did not have "the intention or the authority" to bail out Europe.

That same week, the size of the swap lines to the ECB ballooned by around $52 billion.

He is acting extralegally, and few people understand what the Fed is doing -- largely because they can act in secret -- and there is no one authorized to stop them.

I've said this before. The Federal Reserve exceeds even the CIA in its ability to act without oversight and cross lines.