Thursday, December 1, 2011

Europe Explained by a Regular Guy

Wall Street economists just love to talk in jargon and show everybody how smart they are... consequently, most people, and most investors, tune them out and few American's really understand what the heck is going on over on the other side of the pond.

Well... it is a very similar story to America circa 2008 when our bank's collateral (mortgages) turned out to not be worth what people thought they were... only in Europe, the asset that is FUBAR is the sovereign debt of the EU members... the bonds sold by the various member country's departments of treasury.

Europe's banks are freaked out, and rightly so, about the potential for spreading defaults on those bonds... so they are in full flight, de-leveraging mode... and since they cannot (or won't) raise capital at these equity prices (some, like Bank of America are down 90%) they MUST work from the other side of the balance sheet - calling in loans and selling off collateral and seized assets.  What happens when the banks all try to sell stuff at once? The prices for that "stuff" collapses.... and if the "stuff" happens to be sovereign debt? Well, as asset/prices go down the interest rate for new debt goes UP! When you are on the razor edge, like Italy (forget Greece... they are off they edge and small potatoes, anyway) you go from "Everything's fine" to "my rectum thinks my throat's been cut!" in a matter of days... and what happens when the banks all call their loans at once? Liquidity - CASH - dry's up in the system, forcing down the prices for the stuff they are trying to sell to raise cash and deleverage in the first place... get it? The ultimate negative feedback loop.

And the response from The Powers That Be? Lend the banks more cash printed up over at the U.S. Federal Reserve... which had the effect of lowering the value of the US$ and raising asset prices.

This is a band aid over a festering, gangrenous wound. Italy's debt is such that any rise in interest rates and POOF! They won't be able to fund it any more (remember... Italy cannot print its own currency), and will simply have to default... And Japan makes Italy look like a pilgrim!

But wait! There's more! If you order now we'll throw in a U.S. pension system disaster right on time for the Presidential election! OR... an energy shock! Either way... you are gonna get something!

You see... the U.S. Fed is only to willing to do this despite the obvious draw backs because if they do not... and the markets continue crumble... it won't just be American Airline's that is defaulting on its pension obligations. So the U.S. Fed was willing to sacrifice the US$, at least a little bit, to buy the Europeans some time... with the risk that if it were to actually work the price of Oil could (though I doubt this very, very much) spike and put the kabosh on things in general.

Europe will have to shred its safety nets and generous pensions. Period. End of Report.


Anonymous said...

Two points Greg:
I feel obliged to point out that the starting point for all this shit was the 'innovative' gambling devices like CDO's that banks around the world bought from mostly US institutions. Whilst we could argue about whether the banks should have been bailed out by the gov'ts (I prefer what Iceland did) we would probably both agree that as a 'kicking the can' exercise it was unexpectedly successful. So far. Unfortunately most of those CDO's are still out there, ready to crush any signs of recovery.

Second point; there is flow of money and quantity of money. The money at play in an eonomy is flow times quantity. Normal flow is about six times - in other words every dollar circultes through some transaction that measures it 6 times in a year. If the flow slows down (because people aren't spending) then the gov't increases the quantity of money to compensate, in the hope that they can extract that money again when things pick up, and before inflation races away.

Altogether its a narrow path along a cliff face, with a plunge into depression on one side, the rockface of inflation the other, and falling avalanche of CDO's from above. Personally i'd be happy to see the whole sorry mess fall into the abyss so we can start all over again.

PioneerPreppy said...

So what happens when the cash isn't printed but simply added to the banks accounts to make them look good on paper?

If these banks simply use it to cover their own asses and perhaps play the market, thereby keeping the market up, since it is a zero interest loan. The cash never makes it into the actual economy so inflation is not an issue. There are no loans or any of the circulation Donal talks about.

The question for me is how long can they keep this up and what would be the final straw? Seems to me they been doing this stunt for years now and managed to keep it from affecting the little guys like us. Or am I missing some basic economic principal or something?

awashinoil said...

Increase retirement age at 70 ASAP.