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Posts Tagged ‘Sovereign Debt’

European Debt and Government Lies

Posted by Steve Markowitz on July 3, 2012

For a significant portion of the last hundred years a company’s stock value was determined by investors using its price to earnings (PE) ratio.  As the chart shows this ratio remained relatively constant at approximately 10-12, meaning that a company’s stock would sell for about 10-12 times annual earnings, until the 1980s s.  Towards the later 1980s this ratio began a steady rise ultimately peaking at nearly 45 to 1 before the meltdown.

As history judges the main cause of the 2008economic meltdown it will point to various asset bubbles.  This includes the Internet, Datacom and housing bubbles, all fueled by misguided interventionists’ policies of governments.

It is more than coincidental that the rise in the P/E ratio began about 1987, the year of a major stock market crash.  Shortly after the crash, the Federal Reserve panicked and intervened by flooding markets with liquidity.  Similar “corrective” steps followed the various sovereign crisis of the 1990s that occurred in South America, Asia and Russia, as well as when the Internet and Datacom bubbles popped.  These interventions stop the markets from cleansing themselves; i.e. rebalancing supply and demand.  The significant increase in money supply and low interest rate policies brought us to the current crisis now manifesting itself in Europe’s sovereign debt crisis.

The news from of Europe gyrates on nearly a daily basis.  One day it is negative with the next more positive, the result of supposedly interventions by European governments and their central banks.  However, given that European sovereign debt problems continue to grow after all of these interventions tell the real story.

Since the beginning of Europe’s sovereign debt problems these governments and their central banks have not been frank with their public pronouncements.  Their goal is and remains to maintain stability, a goal that would be negatively impacted by honest assessment of the challenges the continent faces.  This reality is explained in detail in an article by Eric Sprott and David Baker titled “Ministry of [Un]Truth that starts by quoting Eurogroup President Jean-Claude Juncker at a Brussels conference a year ago discussing the European financial crisis stating: “When it becomes serious, you have to lie.”  While refreshingly honest, Juncker’s statement indicates the inherent dishonesty in which governments treat the electorate.  This is pure progressivism!

Sprott and Baker offer examples of governments and bankers either misrepresenting economic reality or being oblivious to it, including the following:

  • Former Fed Chairman Greenspan down-played US housing bubble in 2004 and 2005.  How could he have gotten such a huge problem so wrong?
  • Current Fed Chairman Bernanke informing the US Congress in March, 2007 that: “At this juncture… the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained.” By 2007 the scope of this bubble was evident to many.
  • European Central Bank President Mario Draghi assuring the world in March of this year that “The worst is over… the situation is stabilizing.”  On a nearly weekly basis since this is been proven fallacious.
  • Spain’s Prime Minister Mariano Rajoy assuring the world in late May 2012 that: “There will be no rescue of the Spanish banking sector”.  Two weeks later the Spanish government announced a $125 billion bailout.
  • This past April JP Morgan CEO Jamie Dimon called press reports a “tempest in a teapot” concerning the bank’s derivative exposure.  That “tempest” turned out to be a $2 billion trading loss four weeks later.  A larger concern now relates to JP Morgan’s estimated $70 trillion in derivative exposures.
  • After Austria’s finance minister Maria Fekter called into question Italy’s debt she was castigated by the Italian Prime Minister who said: “The problem is that this is market sensitive.  …  It’s one thing if journalists write this but quite another if a eurozone minister says it. Verbal discipline is very important but she doesn’t seem to get that.”  Translation, governments must be dishonest to protect the people.

Sprott and Baker correctly conclude that the interventionists’ policies of Europe have failed and Western economies are once again weakening.  For example the bailout of the Spanish banks was announced on June 10.  Within one week of it Spanish bonds were again trading over 7%.  In addition, reason for the downward spiral is that Spanish banks’ assets include Spanish bonds that are depreciating in greater amounts than the value of the bailouts.

In late 2011 and early 2012 European central banks primed the pump with over €1 trillion being infused.  Much of this cash has been neutralized by more recent European economic turmoil.

As this Blog has proffered by many times an economic problem caused on excess debt cannot be resolved by adding more debt or moving that debt to other locations.  The writing is on the wall.   The excess sovereign debt will ultimately have to be repudiated before real economic growth can begin.  That will be a painful process that the disingenuous governments are attempting to forestall.  However, their sleight-of-hand will only create still more debt that will ultimately make its repudiation even more painful.  Until then, the politicians will continue deceiving the People.


Posted in Debt, European Union, Sovereign Debt | Tagged: , , , , , , , | Leave a Comment »

Spain/Europe Approaching Tipping Point

Posted by Steve Markowitz on June 10, 2012

What started with bubbles, particularly in the real estate markets, morphed into a larger international  banking crisis in 2008.  Interventionist governments including the United States acted quickly in bailing out the banks and other financially dysfunctional corporations and individuals.  These radical steps in essence bailed out reckless borrowers at the expense of more prudent ones were enacted in the name of saving the world from economic Armageddon.  Nearly 4 years later the worldwide economy is once again heading towards the brink.  Clearly these policies have failed.  But that will not stop the governments from throwing more good money after bad.

The inevitable and huge costs of the bailouts were hiding from the People by using printed money to purchase the bad debt.  This did not eliminate the debt, but instead increased and moved to it to various countries’ balance sheets.  These countries then went about selling bonds to cover this massive debt and forcing their commercial banks, especially in Europe, to purchase these toxic assets.  This has played a large role in creating the banking crisis raging in Europe. with Spain currently being at its epicenter.

Yesterday Spain announced it would accept a $125 million European bailout, the fourth and largest European country to require a bailout in the ongoing sovereign debt crisis.  It is unlikely that this bailout will be any more successful than previous European attempts to stop the economic bleeding.  Already the politicians are bracing for more problems.  After announcing the bailout, Spain’s Prime Minister Mariano Rajoy told The Associated Press: “This year is going to be a bad one.”  Given that 25% of the Spanish workforce is already unemployed, this is an ominous statement.

Jens Boysen-Hogrefe, Kiel Institute for the World Economy economist said of the bailout: “It’s a calming signal at a time when calming signals are badly needed.  The uncertainty is still high and bad news can pop up anywhere in the euro area.  This is not a final solution.”  Translation; the can has once again merely been kicked down the road a bit.

This weekend, Nouriel Roubini and Niall Ferguson published an op-ed in the Financial Times that put Europe’s economic crisis into proper perspective.  Roubini, an American economist and professor at New York University’s Stern School of Business, predicted the collapse of the housing market and subsequent massive recession before these events occurred.  Ferguson is a British historian who specializes in financial and economic history with specific expertise in hyperinflation and the bond markets.  These well respected experts stated in their op-ed titled One Minute to Midnight?:

“We fear that the German government’s policy of doing ‘too little too late’ risks a repeat of precisely the crisis of the mid-20th century that European integration was designed to avoid.”

“…….  Fixated on the nonthreat of inflation, today’s Germans appear to attach more importance to 1923 (the year of hyperinflation) than to 1933 (the year democracy died). They would do well to remember how a European banking crisis two years before 1933 contributed directly to the breakdown of democracy not just in their own country but right across the European continent.”

“But now the public is finally losing faith and the silent run may spread to smaller insured deposits.  Indeed, if Greece were to leave the eurozone, a deposit freeze would occur and euro deposits would be converted into new drachmas: so a euro in a Greek bank really is not equivalent to a euro in a German bank.  Greeks have withdrawn more than €700m from their banks in the past month.”

“More worryingly, there was also a surge in withdrawals from some Spanish banks last month.   ….   This kind of process is potentially explosive.”

“Germans must understand that bank recapitalisation, European deposit insurance and debt mutualisation are not optional; they are essential to avoid an irreversible disintegration of Europe’s monetary union.  If they are still not convinced, they must understand that the costs of a eurozone breakup would be astronomically high – for themselves as much as anyone.”

“Ultimately, as Angela Merkel, the German chancellor, herself acknowledged last week, monetary union always implied further integration into a fiscal and political union.  But before Europe gets anywhere near taking this historical step, it must first of all show it has learnt the lessons of the past.  The EU was created to avoid repeating the disasters of the 1930s. I t is time Europe’s leaders – and especially Germany’s – understood how perilously close they are to doing just that.”

Roubini and Ferguson are indicating that the European crisis is a game changer that will require commensurate game changing strategies.  The nickel and dime approach of kicking the can down the road cannot work.  Just as significant, time is running out for such halfhearted approaches.

Many financial experts agree with Roubini’s and Ferguson’s thesis that Europe will require decisive action, and sooner rather than later.  This includes financier George Soros and Nobel Laureate Joseph Stiglitz, among others.

The problem of excessive debt, not only in Europe, but in the United States as well, is the most pressing problem facing the world today.  Governments use of printing presses for problem resolution over the years has made many citizens oblivious to this reality, including some very smart people.  Just last week France’s new President Hollande incredibly lowered the retirement age in his country from 62 to 60 years old.  This will exasperate France’s debt problems.

In the United States debt has been growing at an alarming pace for the past 30 years with it significantly quickening under the tutelage of Barack Obama.  Instead of concern for this serious problem, many Americans focus self-serving economic and social issues.  Unless the Country is on stable financial footing, all Americans will be weaker and have less rights.

Economists John Mauldin said of the financial crisis in Europe that: “Europe has no good choices, only a choice among very distressing and expensive options.”  This same conclusion can be made of all countries with excess debt.  Sovereign debt is an immoral methodology whereby future generations are demanded to pay for the good life of the current generation.  Pulling the plug on this false economic high, like any addiction, is painful.

When a country deleverages, i.e. pays down its debt which ultimately must do, is an unpleasant experience.  Initially, special interest groups attempt to use political leverage to shield themselves from the pain.  This only can continue until a full-blown crisis hits.  That is the status of current Europe and other countries including the United States are not far behind.  Either a country takes corrective action, a difficult task for any democracy, or the cruel and unbending hand of supply and demand will enforce its own corrective actions.

Posted in Bailouts, Sovereign Debt | Tagged: , , , , , | Leave a Comment »

Europe’s Financial Crisis Coming to a Head

Posted by Steve Markowitz on May 26, 2012

It is hard to believe we are now approaching the fourth anniversary of Lehman’s failure.  This bankruptcy started a series of events that led to a worldwide financial meltdown.  Governments worldwide reacted with vigor, bailing out banks and other large firms, setting interest rates at historic lows, and significantly increasing the money supply.  While these actions may have avoided a more precipitous drop in economic activity initially, it is likely that the actions prolong the downturn and has led to potentially more serious economic problems going forward.

The governmental interventions since Lehman’s failure have not addressed the key issue that started the recession, excess debt.  Instead, the interventions took what was bad debt in the private sector and moved it to the governments’ balance sheets at significantly higher levels.  It doesn’t take a PhD in economics to understand that a problem caused by excess debt cannot be resolved by creating still more debt.

For over a year the world has focused on the economic challenges of Europe.  Initially this focus was on Greece and the possibility that it would default on its debt.  In recent weeks it has become apparent that Greece will default on its debt obligations and in fact may leave the European Union.  While these events are significant, it is the possibility of contagion at the larger European economies including Spain and Italy that is starting to become a concern.

Jim Cramer of CNBC’s Mad Money last week predicted a run-on Spanish and Italian banks within weeks, as posted in the video below.  Should this occur, the potential for at least financial anarchy in Europe is significant.  What four years ago began as a problem for the private banks including Lehman, has morphed into the more serious problem of sovereign debt in various European countries.

While governmental interventions of the past four years played a role in creating Europe’s current sovereign debt problems, the incompetent manner in which the European Union was put together by bureaucrats in political leaders played an even more significant part.  While the political arrangements between the European countries has been reasonably successful, the financial union was doomed to failure from the beginning due to its flawed structure.

For those interested in understanding details behind the flawed European financial union, posted below is a piece by David Zervos of Jefferies and Company.  The extent of the incompetence behind the flawed policies that led to the creation of the European Union is staggering and raises some interesting questions.  Who is responsible for this mess and will they be taken to task by the Leftist media in the same way that the bankers were attacked?  Given the extent of governments’ failings that led to the creation of the current economic maladies and the governments’ inability to fix the problem in four years, is it logical to expect these same folks to be any more successful going forward?

The Separation of Bank and State

By David Zervos

“The euro monetary system is flawed. It is a system that was cobbled together for political purposes; and sadly it was set up in such a way that each member state retained significant sovereign powers – most importantly the ability to exit the system and default on debts in times of stress. There is virtually NO federal power in the Union, as witnessed by the complete breakdown of the Maastrict and Lisbon treaties. In fact, what we are seeing today is that the structure of the monetary system is so poorly designed, it actually creates perverse fiscal linkages across member states that incentivize strategic default and exit. Our new leader of the Greek revolt, Mr CHEpras, has figured this one out. And in turn he is holding Angie hostage as we head into June 17th!

[JFM note: CHEpras is David’s tongue-in-cheek name for the 37-year-old leader of the Syriza Party, Alexis Tsipras, whose rhetoric does indeed resemble Che Guevara’s from time to time.]

“To better understand these flaws in the Eurosystem, let’s assume the European monetary system was in place in the US. And then imagine that a US ‘member state’ were to head towards a bankruptcy or a restructuring of its debts – for example, California.

“So let’s suppose California promised its citizens huge pensions, free health care, all-you can-eat baklava at beachside state parks, subsidized education, retirement at age 45, all-you-can-drink ouzo in town squares, and paid 2-week vacations during retirement. And let’s assume the authorities never come after anyone who doesn’t pay property, sales, or income taxes.

“Now it’s probably safe to further assume that the suckers who bought California state and municipal debt in the past (because it had a zero risk weight) would quickly figure out that the state’s finances were unsustainable. In turn, these investors would dump the debt and crash the system.

“So what would happen next in our US member-state financial crisis? Well, the governor of California would head to the US Congress to ask for money – a bailout. Although there is a ‘no-bailout’ clause in the US Constitution, it would be overrun by political forces, as California would be deemed systemically important. The bailout would be granted and future reforms would be exchanged for current cash. The other states would not want to pay unless California reformed its profligate policies. But the prospect of no free baklava and ouzo would then send Californians into the streets, and rioting and looting would ensue.

“Next, the reforms agreed by the Governor fail to pass the state legislature. And as the bailout money slows to a trickle, the fed-up Californians elect a militant left-wing radical, Alexis (aka Alec) Baldwin, to lead them out of the mess!

“When Alexis takes office, US officials in DC get very worried. They cut off all California banks from funding at the Fed. But luckily, the “Central Bank of California” has an Emergency Liquidity Assistance Program. This gives the member-state central bank access to uncollaterized lending from the Fed – and the dollars and the ouzo keep flowing. But the Central Bank of California starts to run a huge deficit with the other US regional central banks in the Fed’s Target2 system. As the crisis deepens, retail depositors begin to question the credit quality of California banks; and everyone starts to worry that the Fed might turn off the ELA for the Central Bank of California.

“Californians worry that their banks will not be able to access dollars, so they start to pull their funds and send them to internet banks based in ‘safe’ shale-gas towns up in North Dakota. Because, in this imaginary world, there is no FDIC insurance and resolution authority (just as in Europe), the California banks can only go to the Central Bank of California for dollars, and it obligingly continues to lend dollars to an insolvent banking system to pay out depositors. In order to reassure depositors, California announces a deposit-guarantee program; but with the state’s credit rating at CCC, the guarantee does nothing to stem the deposit outflow.

“In this nightmare monetary scenario, with the other regional central banks, ELA, and Target2 unable to stop the bleeding – and no FDIC – the prospect of a California default FORCES a nationwide bank default. The banks automatically fall when the state plunges into financial turmoil, because of the built-in financial structure. A bank run is the only way to get to equilibrium in this system.

“There is sadly no separation of member-state financials and bank financials in our imaginary European-like financial system. So what’s the end game? Well, after Californians take all their US dollars out of California banks, Alexis realizes that if the Central Bank of California defaults, along with the state itself and the rest of its banks, the long-suffering citizens can still preserve their dollar wealth and the state can start all over again by issuing new dollars with Mr. Baldwin’s picture on them (or maybe Che’s picture). This California competitive devaluation/default would leave a multi-trillion-dollar hole in the Fed’s balance sheet, and the remaining, more-responsible US states would have to pick up the tab. So Alexis goes back to Washington and threatens to exit unless the dollars and ouzo and baklava keep coming.

“And that’s where we stand with the current fracas in Europe!

“Can anyone in the US imagine ever designing a system so fundamentally flawed? It’s insane! Without some form of FDIC insurance and national banking resolution authority, the European Monetary System will surely tear itself to shreds. In fact, as Target2 imbalances rise, it is clear that Germany is already being placed on the hook for Greek and other peripheral deposits. The system has de facto insurance, and no one in the south is even paying a fee for it. Crazy!

“In the last couple days I have spent a bit of time trying to find any legal construct which would allow the ELA to be turned off for a member country. I can’t. That doesn’t mean it won’t be done (as the Irish were threatened with this 18 months ago), but we are entering the twilight zone of the ECB legal department. Who knows what happens next?

“The reality is that European Monetary System was broken from the start. It just took a crisis to expose the flaws. Because the member nations failed to federalize early on, they created a structure that allows strategic default and exit to tear apart the entire financial system. If the Greek people get their euros out of the system, then there is very little pain of exit. With the banks and government insolvent, repudiating the debt and reintroducing the drachma is a winning strategy! The fact that this is even possible is amazing. The Greeks have nothing to lose if they can keep their deposits in euros and exit!

“Let’s thank our lucky stars that US leaders were smart enough to federalize the banking system, thereby not allowing any individual state to threaten the integrity of our entire financial system. There is good reason for the separation of the banking system and the member states. And Europe will NEVER be a successful union until it converts to a state-independent, federalized bank structure. The good news is that our radical Greek friend Mr CHEpras will probably force a federalised structure very quickly. The bad news (for him) is that he will likely not be part of it! I suspect this Greek bank run will be just the ticket to precipiate a federalized, socialized, stabilized Europe. Then maybe we can get back to the recovery and growth path everyone in the US is so desperately seeking.

“Good luck trading.”

Posted in Debt, European Union, Sovereign Debt | Tagged: , , , , , , , , | 2 Comments »

Sarkozy Booted by French Voters

Posted by Steve Markowitz on May 7, 2012

This past weekend French president Nicolas Sarkozy was voted out of office and was replaced by Socialist François Hollande.  While Sarkozy is a center-right politician, his replacement by a socialist was not related to political differences.  The French people, like other Europeans, expressed their frustration with the ongoing economic problems of their country and Europe that have not been resolved after nearly four years of significant governmental interventions and efforts.

Hollande’s victory is the next step in the evolving European sovereign debt crisis that began with the worldwide economic meltdown in 2007.  In short, European countries piled on massive debt during the bubble years that they cannot afford to pay back.  Instead of writing off this debt, a requirement for insolvent companies in the private world, European leaders have attempted to create the illusion that the problem is resolvable with less drastic steps.

Within Europe there or two schools for problem resolution of the sovereign debt issues.  The one that dominated European politics since the beginning of the crisis took the position that through austerity the indebted countries could pay their debt back, although with some debt write-downs.  While politicians like Sarkozy pursued policies of austerity, the steps that they took were tentative and could not eliminate the debt, a requirement for renewed growth.  It has become clear that more drastic steps are required.  However, socialism is not the answer.

With the failure of the “austerity” efforts, Europeans are restless.  The French have elected their first Socialist president in 20 years.  Like Sarkozy before him, Hollande has promised voters that he will reduce the government’s huge budget deficit.  Unlike Sarkozy, Hollande has promised to do so by taxing wealthier French, thereby requiring less austerity.  However, any first-year student of economics understands that both austerity and higher taxes are contractive forces that ultimately reduces tax revenues and increases deficits.

Hollande’s election has ramifications that go beyond France’s borders.  Sarkozy had been an ally to German Chancellor Angela Merkel who promoted austerity to resolve European debt issues.  Hollande, on the other hand, wants to renegotiate European treaties.  This will likely place France on a collision course with Germany’s economic policies.  Germany’s experience with hyper inflation makes it unwilling to print money, part of the resolution suggested by politicians who want to end austerity.

When making his victory speech, Hollande said: “We will bring back Europe on a track for jobs, growth and the future.  We’re no longer doomed to austerity.”  While these words might seem reassuring, the United States has proven that governments cannot spend their way out of a recession that has been created by excess debt.

The problem for France, like other European countries, is their lack of competitiveness versus other European countries, specifically Germany.  While France’s trade deficit exceeded $90 billion for 2011, Germany had a trade surplus of over $120 billion.  If it was not for the European currency, the Euro, France’s competitive position versus Germany would have improved with a devaluation of its own currency.  This reality makes President-elect Hollande’s promise to create job growth a red herring.  Germany will not tolerate policies that increase the likelihood of inflation and it will not give France economic advantage at the expense of German citizens.  This creates a growing potential for conflict between France and Germany, the historic norm between the countries.

While the French election garnered most of the news headlines this past weekend, a similarly important event occurred in Greece.  On Sunday, Greece held its election and handed a humiliating defeat to both major political parties.  Neither received enough votes to govern and various fringe parties on the Right and Left gained significant votes.  Like the French, the Greeks are demanding problem resolution.  Unfortunately, I again that is not possible without the Greek debt be written down near zero and the country returning to its own currency.  However, even these required resolutions will inflict serious pain on Greek citizens, a reality that Europeans have not come to grips with.

The United States is not a mutant from fallout of the happenings in Europe.  President Obama and Nicholas Sarkozy had a close working relationship.  President-elect Hollande has already stated that he will fast-track withdrawal of his country’s troops from Afghanistan, i.e. he will place France’s interest first.

The events in Europe are starting to evolve more quickly.  They point to a fracturing of European politics and heighten the possibility of the breakup of the European Union.  While the problems of Europe surfaced with the worldwide economic meltdown, they were actually created by an ill-conceived union created by Progressive bureaucrats who understood little about national interests and economics.  Ultimately these two items will dictate how the politics and economics solutions in Europe play out.  European countries will individually evolve strategies to protect their national interests, with each country being concerned that others will gain advantage if they do not act quickly.  This has created a volatile situation that will quickly lead to a crescendo and lead to real problem resolution.  However, these forces are ultimately beyond the control of politicians.

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Standard & Poor’s Downgrades Spanish Debt

Posted by Steve Markowitz on April 26, 2012

The Wall Street Journal reported after the markets closed that Standard & Poor’s (S&P) downgraded Spain’s bonds two notches from A to BBB+.  This will likely lead to increased borrowing cost for Spain, a country that cannot afford to pay back its loans even before any increase in interest costs.

Before the 2008economic downturn hit, Spain had the highest debt rating of AAA.  Its continually sliding bond ratings is a similar theme that has hit many Western countries, including one downgrade the United States’ debt.

Spain and other highly indebted countries will not be able to repay a significant portion of their sovereign debt.  European governments are attempting to forestall this reality by printing money and bailouts.  However, as they kick the can down the road, each sovereign debt crisis is increasing in significance.  While Greece was a canary in the mine for sovereign debt problems, there are bigger one still to come.

Under more typical economic times, equity and bond markets worldwide would be reacting quite negatively to the sovereign debt problems.  However, the moral hazard has been broken with the myriad of government interventions worldwide in recent years.  As a result, equity markets are back to pre-meltdown levels and are likely becoming a new bubble that when popped, will cause other unintended consequences.

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Dutch Government Falls Due to Spreading Financial Crisis

Posted by Steve Markowitz on April 24, 2012

The sovereign debt crisis of Europe started in the smaller countries with most attention focused on Greece during the past two years.  It has since spread to the so-called PIIGS, Portugal, Ireland, Italy, Greece, and Spain.  Unfortunately, contagion is becoming an epidemic.

There are currently only four AAA rated European, in Germany, Finland, Luxembourg and The Netherlands.  However, even these countries are not immune to the growing sovereign debt problems.

The Wall Street Journal reported yesterday that the government of The Netherlands’ fell when it’s centrist Prime Minister Mark Rutte and cabinet resigned.  The resignation were caused by the government’s inability to agree to cutting its budget deficit from its current rate of 6% of GDP to 3%.

The Netherlands has been Germany’s strongest ally when it comes to the austerity Germany believes is required to address Europe’s debt problems.  The fall of Rutte’s government will at best strain this relationship.  This is not dissimilar what is unfolding in France where President Sarkozy is trailing in the polls.  He too has been an ally of Germany’s fiscal policies.

The word “austerity” is a ruse coined to mask the real issues behind the sovereign debt crisis unfolding in Europe.  At stake are the huge social benefits that Progressive governments promised their citizens over the decades.  Instead of paying for these benefits as they were incurred, governments worldwide borrowed funds to hide the true cost of these programs.  The source of the credit is drying up as lenders, i.e. bondholders realize the governments cannot pay their promised obligations.

This is not a dispute between capitalist and socialist or between rich and poor.  The issue is one of greed, plain and simple.  While interested parties on all sides will hide behind some supposedly nobler goal, at the end of the day it merely boils down to wanting the other guy to pay the bill.

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Europe’s Debt Problems Moving to Spain

Posted by Steve Markowitz on April 16, 2012

Earlier this year, the European Central Bank (ECB) came up with yet another Greek bailout plan.  Once again, the world rejoiced at the belief (wish) that the Europeans debt crisis was behind us.  However, the old axiom that there is no such thing as a free lunch has not been overturned.

Europe’s solution to its sovereign debt problem has been similar to America’s solution to the economic meltdown of 2008 that was also caused by excess debt.  Both have attempted to use still more debt to pay off the previous debt.  While there have been short reprieves from crises, they are shortly thereafter followed by still more problems.  In the United States, $5 trillion of additional government debt has not led to a strong economic recovery.  In the case of Europe, the sovereign debt problems nearly jump from one country to another.

Theoretically, the Greek sovereign debt problem has been mollified by a combination of a bailout from the ECB and austerity measures being implemented in Greece that calls for lower government spending.  However, the Greek people are fighting the austerity measures and it remains to be seen whether they will stand as elections change political leadership.  In addition, austerity measures lead to lower growth and decreasing tax revenues, which will likely exasperate the Greek debt situation going forward, a classic example of an economic death spiral.

While the Greek debt problem has been abated for the time being, the crisis has now moved to a much larger problem and economy, Spain.  The signs are eerily similar to Greece of just a few weeks ago.  Spain’s central government promised to its European brothers that it would cut its budget deficit to 6% of GDP for 2011.  It has had a huge miss with the actual number exceeding 8.5% of GDP.  Now, Spain is promising Europe that will make even more drastic spending cuts in order to cut its annual deficit to 5.3% of GDP for 2012.  Given their previous large miss, this is little more than wishful thinking.

The bond markets understand Spain’s real economic situation and have run up that country’s borrowing rates to over 6%.  According to many economist, at this rate a Spanish default is a real possibility.

Spain’s problem is similar to other southern European countries, excessive debt that cannot be paid back.  This Blog has not seen a scenario by any reputable economist that indicates how the debt could be repaid.  The problem is exasperated because these southern European countries are not competitive to the northern ones, including Germany, but unlike in earlier years, they now share a common currency.  That currency cannot be devalued to increase the relative competitiveness of these weaker countries.  Germany and the other northern European countries understand this reality.  However, their banks too would take a significant haircut to truly restructure (eliminate) Spain’s debt.  So the charade continues.

The issue boils down to when, not if, Spain and the other PIIGS sovereign debt will be written off.  This will ultimately be accomplished via a plan or crisis.  Either way, many investors are at risk and would do well to avoid investing in institutions who could be affected by the coming write-down of European debt.

As for the governments and central banks managing the worlds’ debt issues, they are being disingenuous to those they are supposed to be serving by not honestly stating the problem and the potential real solutions.  Nothing new here, that is what governments and bureaucrats do.

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Consequences of Europe’s Latest Bailouts

Posted by Steve Markowitz on March 8, 2012

The European Central Bank (ECB) has acted decisively in response to the ongoing sovereign debt crisis facing various countries.  That action included an additional €529 billion of printed money that is on top of the nearly €490 billion printed in December.  The money printing presses of Europe are working more efficiently than even the rapid acting presses in the United States.

The idea behind the ECB’s bailouts goes beyond the obvious, i.e. bailing out Greece who cannot pay back its debt.  However, the actual reason behind the bailout is to assist commercial banks in various European countries that hold Greece’s bad debt.  Once again powerful interest groups are being bailed out by Progressive governments.

It defies logic that a problem of excess debt can be resolved by creating more debt.  To believe this is akin to believing in alchemy.  At best the new debt kicks the can down the road when the problems will once again arise, but even larger.

The potential consequences of the ECB bailout is discussed in detail by economist John Mauldin in his piece titled “Unintended Consequences“.  Mauldin points out the following:

  • The ECB’s holdings of rather questionable debt that has increased fourfold in the past six months.
  • While the ECB has printed substantial amounts of money that has then been loaned at low rates to European commercial banks, these banks are not making loans to businesses.  Instead, they are buying European government bonds and earning the spread that may improve their balance sheets, but not stimulate economic growth.
  • The cost of short-term borrowing by the weak European governments substantially decreased with the ECB’s interventions.  As a result these countries have replaced their more expensive long-term debt with cheaper short-term notes supported by the ECB.  While on the surface this seems positive for the debtor countries, it is creating a dangerous situation whereby their debt will now mature in the nearer term.  This will create another crisis within a few years when the new debt comes due.
  • The bailout of Greece is not being unnoticed in the other problematic countries, including Spain, Portugal and Ireland.  This will likely lead to those countries asking for concessions requiring still additional European bailouts.
  • The ECB bailouts have placed draconian austerity measures on Greece that will further contract their economy making servicing the discounted debt more problematic.
  • Mauldin concludes that in unintended consequence of the European bailout is a higher likelihood that the European Union will be broken up.

As this Blog has proffered in the past, governments are not qualified to efficiently allocate capital (tax dollars), which is what they do when intervening with bailouts or picking winners and losers, such is with green energy companies.  John Mauldin more eloquently states this reality in the introduction to his Unintended Consequences” that is posting below.  Hold on and wait for the consequences.

“For every government law hurriedly passed in response to a current or recent crisis, there will be two or more unintended consequences, which will have equal or greater negative effects then the problem it was designed to fix.  A corollary is that unelected institutions are at least as bad and possibly worse than elected governments.  A further corollary is that laws passed to appease a particular group, whether voters or a particular industry, will have at least three unintended consequences, most of which will eventually have the opposite effect than the intended outcomes and transfer costs to innocent bystanders.”

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Spain Misses Deficit Number

Posted by Steve Markowitz on January 27, 2012

Earlier this month it was reported that Spain will overshoot its targeted budget deficit by nearly $20 billion.  Spain’s deficit target of 6% of GDP was a commitment it made to the European Union.  Instead, their deficit will be 8% for 2011.  Missing the target in theory requires Spain to take austerity measures that include budget cuts and tax increases.

Spain is not the only European country to miss the prescribe targets.  Previously, Greece, Portugal and Italy missed their deficit targets.  It is this lack of fiscal responsibility that the has created to the ongoing European sovereign debt crisis.  For too long member countries made fiscal promises that they had no intention to keep.  However, the piper must be paid and this has worldwide economic consequences.

The conundrum for Europe is that even if the affected countries install the required austerity measures necessary to bring them into compliance with Europe’s regulations, it will be an additional drag on their economies.  Cutting government spending and raising taxes are contractive forces.  However, not meeting the debt to GDP ratio will cause the bond markets to increase the cost of borrowing for the affected countries, increasing their debt ratios even further.

In Europe, there are no good solutions, only some less painful than others.  The choices are difficult, especially in democracies that have created so many dependent citizens.  This reality has led to significant economic news during the first month of 2012 including:

  • The Wall Street Journal reported that even though Spain has a huge housing glut, some of its banks are investing in building still more houses in order to avoid writing off bad loans.  This is an example of unintended consequences of government interventions and bailouts that will ultimately result in still larger financial problems down the road.
  • France and eight European countries suffered ratings downgrades.
  • Earlier this month Germany sold €3.9 billion (Euros) six-month bonds with a negative yield of 0.0122%.  In other words people paid German to take their money.  This bit of illogic shows the depth of the growing fears in Europe for sovereign and commercial banks debt.
  • The price of gold increasing by over 7% in January.
  • German Chancellor Angela Merkel stated her country’s unwillingness to spend more to bail out weaker European countries.  The end-game for Europe’s turmoil can only be temporary help up by German money.  Without it, the sovereign debt crisis in Europe will come to a head in a matter of months, if not weeks.
  • The Federal Reserve announced yesterday that they will keep short-term interest rates close to zero “at least through late 2014,” longer than previously indicated.  With this announcement Fed is stating its concern for the economy into the future.

As this Blog has proffered previously, the economic problems facing many countries today is not liquidity; the problem all of the bailouts and governmental interventions attempt to address.  The real problem is one of excess debt, both in the private and public sectors.  This debt must be paid back, often referred to as deleveraging.  It will be a lengthy and painful process.  Unfortunately none of the politicians running for the White House, or the man currently occupying it, is honest enough to share this reality with the electorate.  To them the prize of the Office is just too alluring.

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Markets React Manically to European Solution

Posted by Steve Markowitz on December 12, 2011

On Friday, European countries led by France and Germany announced their proposed “solution” to the significant problems affecting Europe that include sovereign debt issues and the solvency of many European banks.  The initial response from the financial markets was positive to be followed today by a very negative response.  This manic behavior is in keeping with the lemming mentality that exists in worldwide financial markets.  Instead of focusing on the long-term economic prospects and how they will impact corporate profits, the markets look to governments to create wealth.  This, coupled with artificially low interest rates invoked by governments, has cajoled investors into making investment decisions without regard to real market fundamentals.  This is a recipe for disaster for the importunate investors.

Europe’s proposed solutions to the economic challenges and merely kicked the can down the road once again.  In the original European Union treaty, member nations were given limits for their debt to GDP (Gross Domestic Product) ratios.  They ignored the limits and ran up huge deficits that were not allowed under the treaty.  The European Union turned a blind eye to this behavior during better economic times.  After the financial meltdown occurred, the strains of the debt became unsustainable for countries including Ireland, Greece, Spain, Portugal, and most recently Italy.

Making a bad situation worse, the deficit ridden European countries forced local commercial banks to purchase their own governmental bonds that are now risky investments.  This has put at risk many of the large European banks who are in danger of being insolvent.  The result is that should the Europeans not be able to get their house in order, the problematic countries and banks would freeze up simultaneously, creating a worldwide credit crisis.  For this reason, wealthier European countries including France, The Netherlands, and most notably Germany are caught in a dilemma with no good solutions.  To keep the European Union together, the wealthier countries are forced to take on debt responsibility of the poor ones.  The alternative is a breakup of the EU which would likely lead to a European-wide depression.

Friday’s proposed European solution in essence puts stronger teeth into the debt limiting provisions for EU member countries.  Should a country’s deficit exceed certain defined limits, the EU would then have the authority to severely sanction it.  The problem with this solution is twofold.  First, it is difficult to objectively define the debt limits as a percentage of GDP.  More significantly, each member nation must change their constitutions to allow the EU additional control over their sovereignty.  This is a best a lengthy process with no guarantee that voters in individual countries, especially the poor ones, will agree to the changes that will severely impact their ability to support expensive social programs.  It is this reality that the market is reacting negatively to today.

Governments worldwide have nearly universally used the same tonic in response to the financial meltdown of 2008.  This includes bailouts and interventions in efforts to keep markets from correcting the imbalances created during the bubble years.  While it is possible that the initial interventions forestalled a worldwide economic calamity, it is evident that succeeding interventions are becoming less effective with ever shortening durations of any benefits.

The European experiment initially created, and since maintained by governmental interventions, is a textbook example of how ineffective governments are in managing markets.  Europe is now approaching their endgame.  The problem of excessive debt cannot be resolved by still more debt.  Deleveraging (paying down debt) is painful and naturally contractive for economy activity.  Ultimately, Europe and other over indebted nations must face this reality.

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