The implications of the crash of 2008 have made one thing very clear. China has emerged as the engine of growth in the world. The US became the land of sub-prime loans, and Europe is the land of finely dressed paupers. The Europe of today is not the Europe of old.
When the economic crash came, it took a second Marshall plan, with the US pouring trillions of US dollars into European banking subsidiaries, helping to prop up the western economic system.
The reality is that European bankers did not have the capital to cover the trades they held on their books. Risk management is Risk management. You only have to look to the rogue French trader for context of the risk management controls in place during the build up to 2008.
A full two years have passed, and the only area in the world where the economic storm is still unfolding is in Sovereign European finances. The US has many economic issues of its own, but let’s be honest. The US Treasury, with access to the Federal Reserve system as it stands today, has a self funding structure unlike that to which the EU has access.
The EU understands it doesn’t have access to real capital on the scale that the US Fed/Treasury do. Ergo, they’ve raised their deposited capital to 10 Billion Euros from its earlier 5 Billion. Yes, those are real numbers.
The E.C.B. said the increase in capital to €10.76 billion, or $14.2 billion, from €5.76 billion, the first such increase in 12 years, would help it to better offset risks as the volume of its financial activities grew.
“The capital increase was deemed appropriate in view of increased volatility in foreign exchange rates, interest rates and gold prices as well as credit risk,” the E.C.B. said in a statement.
The ECB is running at triple digit leverage internally. While they can try to print money, they do not have a US Treasury equivalent bond. It is each state for itself. This is what is causing a run on the yield in their weaker states. The lack of a Euro bond to support the overall EU governments borrowing needs. The triple A rated states of Europe do not want to subsidize the overall borrowing costs of the less rated ones.
If you look at the bail out of Ireland, so far the only money that has been disbursed is to the Irish Retirement funds. In fact, Europe is trying to get everyone, including the IMF, involved. It’s quite simple. Europe is not properly capitalized to keep up the lifestyle it demands. There is no quick solution to a shortage of an estimated 5 trillion or more of new real capital. That is my estimate.
So now it is China’s turn to pour its cash reserve resources into buying European bonds from the failed economic states that make up the EU experiment. They are expected to purchase up to 6-18 Billion in PIIGS debt in the near term. This is happening exactly as Switzerland places Portugal on the do not buy list.
This action was taken in such a way as to apply their debt for margin on swaps. It’s a very intentional slap in the face, and one not needed when the real volume of trading in their bonds in Switzerland is considered. It was, however, a very public form of disavowing a struggling financial neighbor, and one that will not be forgotten.
If Switzerland, which needed capital from the US Federal Reserve, is intentionally preying on its weakened European sisters, things will get interesting quickly. This is the same Switzerland which lost $30 Billion dollars buying Euro’s, while shorting themselves last year, so anything is possible.
If Switzerland is intentionally affecting the bond markets by having their banks short the debt, and then a pulling of the swap markets for effect, it won’t last long. These kinds of events heat up quickly, once the actions become noticeable.
Ironically, it appears that the Irish collapse happened about the time that Switzerland was putting Irish debt on the do not buy list internally. As a Zerohedge article by Bruce Krasting pointed out, this smells.
The European bluff and bluster of 2008, was to cover up the fact they were broke. Every international action taken by the two world economic super powers (US & China) since has been to prop up the floundering, and now failing, European state.
While the US provides currency swap lines with the ECB, China is bidding up the bonds of European states that can’t sell their junk debt in the open market anymore. The jig is up, and Europe is the epicenter for the reality of tomorrow.
You only have to look to the “REAL” actions taken by the US Federal Reserve during the crisis. While US Banks, Insurance, Money Markets companies & Automotive industry’s were going BK seemingly overnight, the US Fed was pouring Trillions into Euro institutions to keep them alive.
We are not talking about Billions in loans, we are talking about Trillions in liquidity provisions. The amount provided was equal to the US national debt at the time. This is not an insignificant amount of liquidity. There was no nation but the US, which could have provided it to the world at the time. Not China, Not the Middle Eastern Nations. Only America could.
So how does Europe fix its finances? It has to do to its banks what the US did with GM and Chrysler to name two… It has to kill the equity holders of the banks. It should convert the Junior debt holders to equity, and only the Seniors continue to stay on the bond side of the balance sheet. This is why these bonds were rated SENIOR when they were issued.
The system needs a reset. Debt needs to be converted to equity if the system can’t afford to continue to roll its debt.
It will be interesting to watch reality unfold in Europe in the next year or so. They have had their Bear Stears moment, but they have not had their BIG WEEK yet.
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Very interesting Jack. I have only concerned myself about all these aspects of macro finance in a real world setting last year and this scares the heck out of me. Thanks for explaining these things in a simpler way.
Jeffrey, Thank you for making me think about the Euro bank structure. While everyone is talking about the Sovereign issues, their banks have to roll the same amount of debt this year. A trillion here, and a trillion there, and pretty soon we are talking real money.
The EU appears, via the white paper, to be getting ready to force the cram down and recapitalization. If they can pull that off, they can free up enough liquidity for their own debt rolls.
I would argue this is their game plan. Gain control of the Banks, force a resetting, and pray that the market will return to buying their debt cheap. They will need the Euro bond rolled out at the same time, in my opinion.
Very interesting article. Thank you. As a German I am deeply worried about the situation. Unfortunately nobody wants to listen to me right now. Do you know the story about Cassandra? When she kept warning about the end of Troy and nobody did listen? That’s how I feel at the moment. All I hear these days is: “You’re wrong, wrong, wrong. Economy is doing good. Boom years are ahead of us. Crisis is over.” The media coverage is optimistic as it gets – for 1 bad story you hear about 10 good stories right now. Those idiots even wrote articles about a boom in birth rate. But if you take a look at the numbers – you just see that the birth rate was just higher than 2009 – still much lower than 2008, 2007. It’s a joke but the ordinary person is believing it.
Unemployment statistics are “faked” in Germany. Everybody knows that. If somebody works 1 hour a week and is still looking for a job, he won’t be counted in the statistics. And there are millions of other cheap tricks to let the statistics look good. But still: the message is out: “Germany is booming – lowest unemployment since 1991″. Somebody from East Germany told me recently that this reminds him of the last days of the GDR.
Besides being concerned about the situation in the EU, I am also looking to China. May be I am the biggest bear out there. I don’t know, guys. But the situation in China scares me.
Did you read the article about the rising inflation in China?
http://www.smh.com.au/business/world-on-high-alert-as-china-inflation-soars-20110102-19d0l.html
1) Food price.
2) Coal price / Iron ore price.
3) Inflation.
4) Export situation.
5) Housing market bubble.
Do you think China can manage this?
Hi Clara,
I want to start off by saying that I love Germany. I lived there for a year in my youth. While I no longer can fake the language, I miss many aspects of living there.
I believe that Germany can/will leave the Euro at some point during a major inflection point. I expect that the DMIII rises to replace the Euro in the Germanic economies. To me, the Euro is a piece of paper from the Brussels/France side of the economic equation.
I honestly believe Germany will be in better shape with a new floating SDR type of currency, than held hostage to the Latin economies needs for cheap funds. I believe we are in a push comes to shove moment, and Europe is not going to stay the version we have grow up with.
As to China, No I do not believe that China handle the balancing act that is going on. Their need to export deflation (read unemployment) to their trading partners, to stimulate jobs growth in China, is higher than then their fear of inflation is yet.
However, once inflation expectations take hold, it becomes ugly quickly. I believe China is loosing control of their inflationary issues. You can not institutionalize 200 years of capitalism into 30 years of growth. They do not have the check’s and balances we have developed to handle situations like this.
I expect that China needs a war, to rally the people sooner rather than later. Inflation is ugly when the people expect it.
Japan’s CB owns 20% of their GDP in debt.
US FED owns about 7% of the US GDP in Debt.
There is no signs of hyperinflation in either of those economies, only signs of slow devaluation. China, however, has everything necessary for a hyperinflationary event. They have expectations of inflation plus they have the largest bubble in human history for misallocation of assets. Think of the worlds largest shopping mall with no stores, no roads to it, and its still under construction in a field.
They are building empty cities, because top down orders said to. They consume 40% of the worlds concrete. Carlos the Concrete guy needs to fear their bubble popping.
The hangover from this, will probably take them generations to unwind. Hard commodities are about to become a hard sell. However, they stay a buy, until China pops. If you look at the BDI index it sure looks like that could be happening now.
Best,
Jack
I am portuguese myself but born n raised in America. I do not have the benefit of studying the economy but I did pay very close attention when I was there visiting family this year. It was over the summer before all the news started heating up. Similar to you I was upset as soon as I started hearing Portugal mentioned in the media as I could not help thinking…”great, now we’re gonna get a slew of uninformed opinions from people who don’t give a shite about the country.” And folks in the media did not disappoint.
Portugal has a lot of fat to cut, and the social consensus to push it forward. Talking to a bus driver I heard about how he was sick (no worse than a severe cold) and he got to take leave from work for three months while getting payments from the government higher than his salary. Even he thought the system was in dire need of change. The country’s problems can indeed largely be solved by getting its own internal finances and incentive systems right, we just need a chance to do so before the international financial system pulls the plug.