Sunday, November 13, 2011

John Mauldin on Europe: Listen up City of Greensboro and Guilford County

"...the European issue is not a crisis of confidence,
as Merkel and Sarkozy, et al., keep telling us.

It is structural.

And until the structural issues are dealt with,
the problems will not be solved.

...Mediterranean Europe simply borrowed more than it could pay,
given the cash flows of the various countries...

...there is simply too much sovereign debt in Greece,
Ireland, Spain, Italy, Portugal, and Belgium.

...Debt cannot grow beyond the ability to service the debt...

...the cost of bailouts, present and potential,
is likely to be in the €3 trillion range, ...inconceivable in scope.

Greece has been told that they can write off 50% of their debt
held by private entities,
but not that owed to the IMF, ECB, or other public entities.

This means something more like a 20-30% haircut on total debt.

Sean Egan suggests that eventually Greece
will write off closer to 90%. is just a matter of time
before you have to do the same for Portugal and Ireland;
and are Spain and Italy close on their heels?..

That is a number that cannot be contemplated
in polite European circles,
as it is plenty enough to cause a serious banking crisis.

...Portugal will need at least a 40% write-off (probably more!).

The Irish are going to walk away from the bank debt
they assumed in the banking crisis.

...if Greece leaves the euro...
their banks will be insolvent, their pension funds destroyed.

...Amassing large amounts of debt is a national problem
that has as much to do with character as anything else.

That is true for families or for countries.

It is wanting to spend for goods and services today
and pay for them in the future.

...debt cannot be allowed to become the master of the budget
or the source for current spending,
again whether for families or countries.

...Greece and its fellow countries
have used debt to fund current spending
and now have run up against the inability to borrow more
at sustainable levels.

The easy answer is to cut spending.

But when you cut back spending, even borrowed spending,
it is going to affect GDP...

While on paper Spain looks like it may survive,
in reality it has significant problems in its banking sector.

If they move to insure the solvency of their banks,
their debts become unmanageable,
not to mention that their debt grows each and every month
from the rather large deficits they run
and seem totally unwilling to try to reduce.

...The “semi-autonomous regions” are in deep trouble,
and their citizens are leveraged due to excessive real estate exuberance.

Unemployment across Spain is 21%, and for the young it is over 40%.

The Spanish government has adopted the rather novel idea
that if it doesn’t pay its bills then its deficit will not be as large
and therefore they can get closer to meeting their targets.

Yields on Spanish debt are about 1% lower than on Italian debt,
but give them time.

...Italy is simply too big to save.

...The problem is a 10-year bond yield at 7%,
when your debt is 120% of GDP and growing.

...A drop in GDP while deficits rise
means that debt-to-GDP rises faster.

That means interest-rate costs are rising faster
than (the lack of) growth in the economy.

...this week we learned that Italian production was off 4.8%...

...The market realizes that if you grow debt by 5% a year,
it will not be but a few years until Italy is at 150%.

...Italy will need to raise close to €350 this year...

There is no retreat without default from such a number,
and the markets are saying, “We’ve seen this movie before
and the ending is not a happy one.

We think we’ll leave at intermission.”

The ONLY reason that Italian yields have dropped below 7%
is that the European Central Bank
has been buying Italian debt “in size.”

Any retreat by the ECB from buying Italian debt
and Italian yields shoot to the moon.

Europe, even Germany, is slipping into recession.

And now we are at the Endgame.

...when you are a country in recession and have to cut back,
it only makes the recession worse...

...Debt that was private debt and paid to European banks
(who lent to Irish banks) is now public debt.

And it is a punitive and crushing debt.

...The European Commission is trying to figure out
how to find €1 trillion to use to bail out southern Europe and Ireland.

They so far cannot,
and the market recognizes that fact
and that the needs are actually much higher.

...European regulators
allowed their banks to leverage up to 450 to 1 on their capital,
on the theory that sovereign nations in an enlightened Europe
could not default, a
nd therefore no reserves need to be kept for “investing” in government debt.

...banks borrowed massively and invested it in government debt,
making the spread.

It was an awesome free profit machine.

Until Greece became a road bump.

Now it is a nightmare.

France cannot afford to bail out its banks.

...France will want the Eurozone to bail out their banks,
and that means the ECB.

If France gets such a deal,
Ireland will certainly demand – and get – one, too.

In the “old days” of a decade ago,
a European country could simply devalue its currency
and adjust the relative value of labor that way.

But with a fixed currency there is no adjustment mechanism
other than reduced pay or large unemployment numbers,
which eventually translates into lower wages.

Essentially, the southern part of Europe
is on an odd sort of “gold standard,”
with the euro being the fixed standard.

And the adjustments are painful.

There are no easy answers if you stay with the euro.

And leaving is its own nightmare.

There is too much debt in many southern countries;
and while I have not yet mentioned it,
France is not far from having its own crisis
if they do not get back into balance.

And if they lose their AAA rating,
then any EFSF solution is just so much bad paper.

The banks and banking system are effectively insolvent.

The path of least resistance, for the ECB to find its printing press.

...the money to solve the crisis does not exist.

The only way to find it is for the ECB to print money and print in size,
enough to lower the value of the euro and make exports cheaper
(which gives southern Europe a chance to grow out of its problems).

But the choice is print or let the euro perish.

I see no other realistic solution, aside from massive austerity,
willingly accepted by Europeans everywhere,
along with the nationalization of their banks, etc...

...a lower euro means lower US and emerging-market exports
(Europe is China’s biggest customer!) to Europe
and more competition from Europeans
in what the rest of the world sells to each other.

It will be the beginning of serious trade issues
and ...will usher in currency wars and protectionism.

This will be a decade we will be glad to leave in 2020.


1 comment:

Harry "Harrying" Ferrari said...

Interesting post however i find the coincidence between the failing economic states of Italy, France and U.K are part of the coalition of the billing and Nato in Libya. Must be all that lovely Mediterranean coastline or sand which attracts them or maybe the freedoms of the empowered fanatics? Face it the West is bankrupt and was for some considerable time hence the need for socialism by nationalising the banks face it to remain top dog you need to innovate using old depredation tactics of old doesnt cut it anymore despite having the backing from the sensationalist and propagandist media, 2020 methinks is the new spacewar, were are the aliens when you need em?