spotfxtrader

IMF warns US, eurozone deficits a threat to stability

The International Monetary Fund warned that Washington and debt-ridden European countries are “playing with fire” unless they take drastic steps to reduce their budget deficits.

The warning came as the IMF cut its growth forecast for the US and said the risks facing the global economy have increased since April.

It said the euro area’s worsening crisis, signs of economic weakening in the US and overheating in the developing world all pose fresh threats to global stability.

“The global economy has turned the corner from the Great Recession. However, securing the transition from recovery to expansion will require a concerted effort at addressing diverse challenges,” the IMF said in its World Economic Outlook update.

World growth this year is expected to be 4.3pc, a downgrade from 4.4pc in April, prompted predominantly by a sharp reduction in America. US GDP is now forecast to grow at 2.5pc this year and 2.7pc in 2012, compared with its prediction in April of 2.8pc and 2.9pc respectively.

“For the US, it is critical to immediately address the debt ceiling and launch a deficit reduction plan that includes entitlement reform and revenue-raising tax reform,” it said.

Jose Vinals, director of the IMF’s monetary and capital markets department, added: “If you make a list of the countries in the world that have the biggest homework in restoring their public finances to a reasonable situation in terms of debt levels, you find four countries: Greece, Ireland, Japan and the United States.

“You cannot afford to have a world economy where these important decisions are postponed because you’re really playing with fire.”

The IMF had already downgraded its forecasts for UK growth to 1.5pc from 1.7pc in April, which was itself a downgrade from 2pc in November.

It added: “Downside risks due to heightened potential for spillovers from further deterioration in market confidence in the euro area periphery have risen since April. Market concerns about possible setbacks to the US recovery have also surfaced.

If these risks materialize, they will reverberate across the rest of the world–possibly seriously impairing funding conditions for banks and corporations in advanced economies and undercutting capital flows to emerging economies.”

With Greek two year paper ‘yielding’ 27%, the question of a Greek default is no longer a matter of ‘if’, but ‘when and in what form’. Minds are being focussed on what happens to the Euro area, and the Euro itself. Now that we know that the French banks (as signalled by Moody’s downgrade of Crédit Agricole, BNP Paribas and Société Générale) are on the hook for large chunks of Greek debt, the idea of wider contagion must be scaring the shit out of the imbecile euro politicians who have foisted this doomed experiment on the European people.

The question is who wants to be holding Euros while they sort the whole mess out…

from zero hedge

As if insolvent European private banks were not enough to worry about (and with banking assets of 461 percent of GDP in the UK, 178 percent in Germany, and 820 percent in Switzerland, there is more than enough to worry about), a new study by Open Europe has found that at the heart of the insolvency argument is none other than the only hedge fund that is even worse capitalized than the US Federal Reserve: the European Central Bank. “With Greece forced to seek a second bail-out to avoid bankruptcy, Open Europe has today published a briefing cataloguing how the eurozone crisis could drive the European Central Bank itself into insolvency, with taxpayers likely to pick up a big chunk of the bill. The role of the ECB in the ongoing eurozone and banking crisis has been significantly understated. By propping up struggling eurozone governments and providing cheap credit to ailing banks, the ECB has put billions worth of risky assets on its books. We estimate that the ECB has exposure to struggling eurozone economies (the so-called PIIGS) of around €444bn – an amount roughly equivalent to the GDP of Finland and Austria combined. Of this, around €190bn is exposure to the Greek state and Greek banks. Should the ECB see the value of its assets fall by just 4.25%, which is no longer a remote risk, its entire capital base would be wiped out.” It seems that in crafting “prudent” capitalization ratios courtesy of Basel 1 through infinity, the global NWO regulators totally let the ECB slip through the cracks. The finding also confirms what we have been saying all along: there is no way that any form of voluntary or involuntary phase transition that will require the ECB to mark down assets that it has on its books at par (yet are worth 50 cents on the dollar) can ever occur: such an event would result in the immediate insolvency of the European lender of first and last resort, and, in turn, the unravelling of the Eurozone.

From Open Europe:

“The ECB’s attempts to paper over the cracks in the eurozone may have temporarily softened the impact of the crisis, but have exacerbated the situation in the long-term. The ECB has dug itself into a hole and now we are seeing that there is no easy way out.”

“Huge risks have been transferred from struggling governments and banks onto the ECB’s books, with taxpayers as the ultimate guarantor. There’s a real risk that these assets will face radical write-downs in future with eurozone governments and banks teetering on the edge of bankruptcy. This amounts to a hidden – and potentially huge – bill to taxpayers to save the euro.”

“The ECB’s wobbly finances and operations to finance states have landed a serious blow to its credibility. It must now seek to become the strong, independent bank that electorates were promised when the Single Currency was forged.”

Key points from the report:

– In parallel with the IMF’s and EU’s multi-billion euro interventions, the ECB has engaged in its own bail-out operation, providing cheap credit to insolvent banks and propping up struggling eurozone governments, despite this being against its own rules. The ECB is ultimately underwritten by taxpayers, which means that there is a hidden – and potentially huge – cost of the eurozone crisis to taxpayers buried in the ECB’s books.

– As a result, the ECB’s balance sheet is now looking increasingly vulnerable. We estimate that the ECB has exposure to struggling eurozone economies (the so-called PIIGS) of around €444bn – an amount roughly equivalent to the GDP of Finland and Austria combined. Although not all these assets and loans are ‘bad’, many of them could result in serious losses for the ECB should the eurozone crisis continue to deteriorate. Critically, struggling banks in insolvent countries have been allowed to shift risky assets away from their own balance sheets and onto the ECB’s (all the while receiving ECB loans in return). Many of these assets are extremely difficult to value.

– Overall, the ECB is now leveraged around 23 to 24 times, with only €82bn in capital and reserves. In contrast, the Swedish central bank is leveraged just under five times, while the average hedge fund is leveraged four to five times. This means that should the ECB see its assets fall by just 4.25% in value, from booking losses on its loans or purchases of government debt, its entire capital base would be wiped out.

– Hefty losses for the ECB are no longer a remote risk, with Greece likely to default within the next few years – even if it gets a fresh bail-out package from the EU and IMF – which would also bring down the country’s banks. We estimate that the ECB has taken on around €190bn in Greek assets by propping up the Greek state and banks. Should Greece restructure half of its debt – which is needed to bring down the country’s debt to sustainable levels – the ECB is set to face losses of between €44.5bn and €65.8bn on the government bonds it has purchased and the collateral it is holding from Greek banks. This is equal to between 2.35% and 3.47% of assets, meaning it comes close to wiping out the ECB’s capital base.

– A loss of this magnitude would effectively leave the ECB insolvent and in need of recapitalisation. It would then have to either start printing money to cover the losses or ask eurozone governments to send it more cash (via a capital call to national central banks). The first option would lead to inflation, which is unacceptable in Germany, while the second option amounts to another fully fledged bail-out, with taxpayers facing upfront costs (rather than loan guarantees as in the government eurozone bail-outs).

– The ECB’s actions during the financial crisis have not only weighed heavily on its balance sheet, but also its credibility. First, as a paper published by the ECB last year noted, “The perceptions of a central bank’s financial strength have an impact on the credibility of the central bank and its policy”. Secondly, by financing states, the ECB has effectively engaged in fiscal policy – and therefore politics – something which electorates were told would never happen.

– Worried about the risk of these potential losses being realised, the ECB is vehemently opposed to debt restructuring for Greece and other weaker economies. However, continuing the ECB’s existing policy of propping up insolvent banks – and intermittently governments – would be even worse for the eurozone as a whole.

– The ECB’s cheap credit has served as a disincentive to struggling banks to recapitalise and limit their exposure to toxic assets in weak eurozone economies. This creates moral hazard for banks and governments alike, at times even fuelling the sovereign debt crisis, while transferring more of the ultimate risk to taxpayers across Europe. Therefore, in its attempt to soften the immediate impact of the financial crisis, the ECB may in fact have exacerbated the situation in the long-term, increasing the cost of keeping the eurozone together for taxpayers and governments.

– Moving forward, the ECB must return to its original mission of promoting price stability and a way has to be found to get ailing banks off the ECB’s life support. This should include a winding-down mechanism for insolvent banks.

The “Game Over” Redux
Submitted by Tyler Durden on 05/19/2011 21:01 -0400

Back in November, we posted a piece by Knight Research titled “The Game Is Over” in which the firm’s strategist Mark Lapolla presented his thesis why he believes that “the structural and cyclical terms of global trade have finally reached their tipping point. This will catalyze a wholesale change in sentiment and a historic repositioning of risk assets. The emerging market global growth story is over.” And while the article came out just as the barrage of $750 billion in daily POMOs courtesy of QE2 was starting and hence masked the true state of reality, now that QE2 is finishing, it is only appropriate to bring Mark back up front, as the imminent and very violent convergence of the rosy myth that is the stock market, and of the underlying miserable reality, is about to wake up all those who have been dozing under the Printer Piper of Eccleslin’s soothing tune, and Lapolla’s thesis is about to see its first validation. In essence, while we have heard much from those who claim that the end game will come as a result of hyperinflation, Lapolla is convinced in the opposite: namely that the end will be not a bang but a hyperdeflationary whimper. In order to refresh readers with his thoughts, recently Lapolla conducted an interview with the master questioner Kate Welling in which the Knight strategist laid out his uber-bearish case in more gruesome detail than most can stomach. Below we present the key points from his interview, as well as the full thing subsequently.

In a nutshell, and this won’t come as a surprise to anyone, Lapolla believes that “the game is over because there is no collateral… When consumer debt is rooted 75%-plus in residential real estate and residential real estate is impaired, easy Federal Reserve monetary policy simply cannot make it to Main Street. The transmission mechanism is broken. There is no conduit. ”

Lapolla’s observations on the secular shift in the employment structure:

What’s going on here is very simple. John Maynard Keynes wrote a letter entitled, “Economic Possibilities for our Grandchildren “in 1930, in which he coined the term “technological unemployment.” He said it’s a term nobody has heard of, but you are going to be hearing a lot about it. Of course, he was writing about the use of technology to supplant labor in the factory… Any way you slice it, nominal wages, real wages, hourly wages, the duration of unemployment — all of these measures imply that we have a growing structural fracture in the labor markets.

On the irrelevance of week to week and month to month micro fluctuations in the jobs numbers:

Right now, the full employment gap is running about 11 million jobs. That’s a shocking gap and, although this is very difficult to quantify, we have a sinking suspicion that — while a number of the jobs that are being created right now might in fact be “good jobs” – they’re being filled by over-qualified labor no longer able to wait for jobs at compensation levels similar to what they had before. Now, in the very long run, this might work itself out, but in the short run it doesn’t do anything to change the outlook for the consumer. What it does is suggest that people are going to have to shift down the way they live and the way they expect to live — perhaps even further than they already have. Thus, the propensity to save in this country has to continue to rise — which (although not in the short term) is very bullish long term — whether that’s captured in the aggregate data or not. So as you’ve gathered, we are very different from consensus, first and foremost, when it comes to the secular structure of labor and credit in the U.S.

On the previously discussed topic of Squatter’s Rent (discussed extensively here):

There are roughly six to seven million folks who are no longer paying on the mortgages on their homes, so if we do some really simple arithmetic, it suggests in the aggregate as much as $100 billion of annualized consumer income is being freed up to find its way into consumer spending elsewhere in the economy, instead of going towards the satisfaction of housing debt…, the real question is if, or when, does the foreclosure mechanism begin to kick back into gear and then accelerate? At this juncture, there really isn’t a tremendous amount of evidence that it’s going to accelerate. Let me give you a tangible example. We know someone who has lost his job and is in a home with a $1.45 million mortgage. The house is on the market at $1.3 million, which we guess is the degree to which the home has been written down on the books of the mortgage holder. The property taxes on the home are about $20,000 a year, so he has been expecting an eviction notice or a foreclosure proceeding for almost 18 months. Yet his property taxes have been mysteriously paid every year. What is going on is clear: If the bank or whomever holds that mortgage note were to foreclose, the house’s liquidation value is prob¬ably about $900,000. So they would have to take a further $400,000 writedown on that mortgage. Which makes paying $20,000 a year in property taxes, look like a relative bargain.

On Europe’s state of suspended animation:

Europe right now is still kicking the deflationary can down the street; trying to postpone and prolong the inevitable. Meanwhile, they’re trying to cover their tracks with verbiage claiming they’re pursing mandated fiscal and monetary austerity policies and monetary policy. But the ECB’s bump up in rates of 25 basis points isn’t material. And all of this is intensifying the deflationary pressures on the periphery countries. So Europe is in a state of suspended animation, where the deflationary pressures are spilling out but even the sort of modest financial restructuring the United States is trying is still being resisted. It’s clearly not a stable situation.

On the “China” question:

I think the China situation, how¬ever, is profoundly obvious and profoundly simple. The idea that the free world is placing its hope in a repressive, communist regime employing command and control economic management while violating trade protections and human rights everywhere is absolutely astounding, amazing. I would suggest that, in itself, should be a sufficient warning flag. But let’s be a lot more specific. I actually see the situation in China as very analogous to the U.S. in 1929 and Japan in the 1980s….I’ll just tick off eight similarities between China circa 2011 and the U.S. before the Depression. 1) Massive disparity of wealth, income, and education. 2) Rapid industrialization and displacement of labor. 3) Opaque and misleading economic and financial data. 4) Massive build-up of leverage across the “rising” class. 5) Bubbles in both residential real estate and fixed asset/infrastructure development. 6) Accelerating and uncontrolled growth in disintermediated credit. 7) Expected transference of economic growth to domestic demand. And, finally, an accelerating price/wage spiral. Nonetheless, to China’s credit, they have a booming economy which has drawn the attention, admiration and certainly the economic aspirations of the world. The irony is, despite its hubris, China appears to have lost control — and has done so by doing everything it could to avoid that. Essentially, in its own zeal to placate its masses with rapid growth, China has created a tide of inflation that threatens it with wide-spread social unrest. But if it crushes speculation and clamps down on credit, it risks a deflationary collapse that would also threaten social harmony. The upshot is that China no longer controls its own destiny. The free markets do. As an aside, I would suggest that in the not-too distant future, when this all unravels, there will be downside as well as upside for the U.S., particularly as it relates to what we were talking about before, the way the U.S. has benefited from the value of intellectual property versus scale.

On China’s Lewis Point (discussed extensively here):

If there was one thing that pushed us over the edge to publish it last November, it was our belief, now confirmed, that China and an increasing number of other emerging markets are caught in a price/wage spirals that they’re not going to be able to control through monetary, fiscal or legislative policy. These are an inevitable result, not only of the credit boom, but of the manufacturing engine they’re living by. This is the great differentiator between the U.S. and China. The reason a systemic inflation cannot happen here for a long time and why it is happening in China is simply this: When labor is in the business of manufacturing goods (as opposed intellectual property or services), labor has a call on rising finished goods prices. When commodities prices begin to increase and manufacturers attempt to raise finished goods prices, wage rates must go up or labor’s value is necessarily diminished. This is the dynamic traditional U.S. manufacturing businesses faced decades ago, and now, in China, it has reached epic proportions. We’ve seen 20% to 30% wage increases by the government on the low end and by contract manufacturers such as Foxconn (FXCNF), which does the Apple (AAPL) iPhone, on the high end. It has raised wage rates, almost 30%. China bulls believe this wage inflation is good for workers and so ultimately is going to help China accelerate consumer demand as an engine of their growth. Nonetheless, it hasn’t and won’t, for a couple of reasons. 1) Savings rates actually are rising in the major city centers. 2) China’s consumer confidence numbers and research on the ground in China both show that labor has never been less secure than they are now, which seems paradoxical. One would think that China’s new¬found international power, along with higher incomes, would make Chinese workers feel all is right with the world. The problem is that the cost of living is growing even faster. Without getting too technical, China has probably crossed over what’s called, in academic theory, the Lewis Point, where the movement of labor from agriculture into manufacturing reaches a peak and begins to taper off as manufacturing labor begins to reconsider whether life in fact wasn’t better back on the farm.

On the link between inflation and money:

Increased money supply is not a causal factor for inflation. It’s like suggesting that a bartender is a causal factor for alcoholism. In reality, reserves, whether they exist in the system’s books or not, are always available. Credit creation cannot really be controlled. If you and I want to create a loan between ourselves, we can do it. If a bank wants to create a loan, it can do it. The only thing that can mitigate that ability is regulation of the banks. However, if we consider the off-balance-sheet and shadow banking mechanisms, there really is no way to control that credit creation. The only way the Federal Reserve can influence credit creation is by raising or lowering short-term rates. With that said, we’re at the outer bound, at zero, and what we’re finding is that demand for money is not increasing as the cost of money goes to zero — which is not unlike what we saw in Japan. What is happening, however, as ever when the cost of money stays this low, is that speculators are inclined to speculate because the cost of speculation on leverage is negligible.

The reason why, in Lapolla’s opinion, the Fed has failed in generating systemic inflation (and why the Fed will keep coming back, and doing the same wrong things over and over until everything finally breaks)

The reason [we don’t have systemic inflation] is that the labor markets are fractured. So, at the end of the day, what we’re having now is an asset inflation again, an echo. We’re not seeing the seeds or leading edge of wage/price inflation, the true driver of damaging systemic inflation. Asset inflation resolves itself in one way, and one way only, and that’s through asset deflation. So we have ongoing asset deflation in the residential real estate market. We have ongoing asset deflation in the commercial real estate market and we will ultimately have asset deflation across China and Asia.

On what would happen to the global economy if the dollar were to collapse versus the euro and commodities:

Global deflation and depression are what would happen.

On what self-cannibalizing HFT algorithms means for volume and for the markets in general.

Doesn’t it necessarily imply that there must be real inefficiencies in pricing on the table, for long-term investors, if everyone is totally focused on the short term? So, suggesting that “the game is over” has implications across the board. It has implications in terms of the way asset allocators think about investing, the way their money managers think about deploying capital, and ultimately about the way corporate managers think about deploying shareholder capital. We in effect are in this very awkward “teenage” stage where we’ve just had this fracturing shock, the credit crash, the exposing of all the financial hubris and misallocation of capital. We haven’t even moved to credibly addressing those issues in Europe and we’re still holding onto the notion that the emerging markets — which are just getting their first taste of capitalism on the back of reckless credit expansion and speculation — can somehow become the engine that overwhelms the massive deleveraging of the developed world. It’s a preposterous notion. I’m not being fatalistic. This is the way history moves. In 30 years, it will be clear to people, looking back, that this is the final chapter of the old story in which finance, financiers, leverage and short-term trading ruled the world.

On what the “sequel” is:

We’re moving towards something that, by definition, is going to have to address the real structural issues — in the U.S., fractured labor markets, still-excessive credit and unsupportable levels of debt tied to homes, a rising propensity to save, bleak expectations for wages and investment returns. From our vantage point, it’s only a question of timing. But it’s entirely possible that there won’t be an asymmetrically positive outcome for the globe. “Growth” is not a fait accompli. In fact, there can and probably should be periods, lengthy periods, of virtually no growth; of consolidation and pruning. So we would reject the notion that growth necessarily has to happen. Very marginal, just population-type, growth could in fact be the order of the day, and that implies a re-pricing of risk capital across the board.

Lastly, his investment advice:

Those who are bit more speculative, we’re encouraging to pick a spot where they will buy the U.S. long bond, if not zeros on the U.S. long bond, as rates start to move closer to 5%. It’s likely to have very high, equity-type returns, in short bursts.

From Der Spiegel

German bund futures rose to an almost one-month high after Der Spiegel reported that Greece is considering withdrawing from the euro region, prompting investors to seek a refuge in Europe’s benchmark securities.

The futures contract expiring in June climbed 0.6 percent to 123.76 as of 6:20 p.m. in London. Greece isn’t considering abandoning use of the euro as its currency, the Athens-based Finance Ministry said in an e-mailed statement today. Such reports have been repeatedly denied by Greece in the past as well as by governments of other European Union countries, the statement said.

Greece is lobbying for easier terms on the 110 billion euros ($164 billion) of bailout loans as speculation of a default mounts a year after European leaders set up the unprecedented emergency fund to prevent the nation’s debt woes from spreading.

“Some sort of Greek restructuring was priced in the market, but the thought of them leaving the euro-zone never really was,” said Anthony Cronin, a Treasury trader at Societe General in New York. “If there’s something that happens over there this weekend, you’ve got to be properly positioned for it.”

The euro fell against all of its 16 most-traded counterparts, extending its two-day loss as much as 3.1 percent, the most since May 2010. U.S. Treasury notes reversed earlier losses as investors also sought U.S. government debt as a haven.

Debt Burden

EU leaders agreed in March to create a permanent rescue mechanism for the euro area, the European Stability Mechanism, or ESM. The ESM, which becomes effective in mid-2013 after a temporary facility expires, will make loans to fiscally strained governments under strict conditions. When governments can’t cover their debts in full, the ESM’s loans may be paid first, before private bondholders.

Even under cuts imposed as a bailout condition, Greece’s debt is forecast to climb to 159 percent of gross domestic product in 2012. The nation’s economy is forecast by the government to shrink for a third year in 2011, before returning to growth in 2012.

Greece’s possible exit from the euro area isn’t being discussed in the EU, said Steffen Seibert, German Chancellor Angela Merkel’s chief spokesman. “This isn’t on the table and hasn’t been on the table for the German government and isn’t a topic at the European level,” he said by telephone today.

Since exit is the sensible option for the people of Greece, this denial by Herr Siebert could signal an outbreak of common sense…

After a pro EU piece the other week, (and by pro EU I mean anti Europe – his suggested most favourable outcome for the crisis being the introduction of a debt union, i.e. an outcome which would amount to the crushing of any democratic opposition to the EU Superstate), Mr Münchau appears to have seen the error of his ways….

As we’ve been saying all along, the ‘system’ is non-linear, and as it has now become totally unstable, the chances of the crisis being resolved in anything approaching an orderly manner are extremely slim. After considering his earlier piece pretty contemptible, I do like his description of EU decision makers as ‘serially incompetent’. I would venture that that description universally applies to the political classes throughout Europe and the US, with very few exceptions.

Ultimately he suffers from the delusion that the whole edifice could be managed if only good decisions could be made. The only good decision would be not to have attempted the creation of a superstate founded in subterfuge in the first place.

By Wolfgang Münchau

Published April 24 2011, 19:51

I was uncharacteristically optimistic last week, and had planned to end my informal series on eurozone crisis resolution with a benign scenario. The eurozone would survive in one piece; there would be no blood on the streets, just a once-and-for-all, albeit reluctant, bail-out, accompanied by a limited fiscal union. But as several readers have pointed out, my scenario is prone to a very large accident. I accept that point. Last week, we caught a glimpse of how such an accident may come about. My benign scenario looks a lot less certain today than it did a week ago.

The week began with the strong showing of two parties in the Finnish election, which are advocating a partial Portuguese debt default as a condition for a rescue package. The results triggered a renewed outbreak of the financial crisis, as eurozone spreads rose to near record levels once again.

The most disturbing news, however, was a revolt within Angela Merkel’s increasingly fragile coalition. It looks as though the German chancellor is on the verge of losing her majority over the domestic legislation of the European Stability Mechanism (ESM), the long-term financial umbrella for the eurozone. She may have to rely on the opposition to ratify the ESM, which may come at a heavy political cost. The Bundestag already postponed the vote on the ESM until the autumn, hoping to keep it clear from the controversial decision to pass the Portuguese rescue programme in May.

As opposition to the ESM mounted, German officials fell over themselves to be quoted by various newspapers pronouncing that a Greek restructuring was inevitable. Even Wolfgang Schäuble, finance minister, talked about the possibility of default. Some wily speculators unleashed the rumour that Greece would spring a surprise debt restructuring. The rumours prompted a criminal investigation. Another week in the eurozone’s debt crisis!

A monetary union is at a natural disadvantage when it comes to the handling of crises. There is no central government that takes decisions, which makes communications hard to control. What is less forgivable is the serial incompetence of the eurozone’s decision-makers, as exemplified by the perpetual eagerness to declare the crisis over the very second financial market pressure subsides. Not only do they know little about financial markets, they have surrounded themselves with policy advisers who know little too.

Their ignorance is an ideal breeding ground for quack solutions. One such is immediate default. German Christian Democrats and Finnish isolationists spent the last week trying to convince themselves that a Greek debt-restructuring would save them a lot of money.

That belief is premised on two false assumptions. The first is that a voluntary restructuring could solve the Greek debt problem. It can work in limited cases, but not when countries are insolvent. Greece, however, faces no short-term liquidity squeeze, because it is supported by the European Union and the International Monetary Fund. There is no need for any restructuring, voluntary or involuntary, right now. But Greece may need to impose a “haircut” in the future to ensure debt-sustainability. The ideal moment would be when the country achieves a primary surplus, probably in 2013.

The second wrong assumption is that the Greek banking sector would survive a restructuring unscathed. This is a conditional error. If you believe that a voluntary restructuring would be sufficient, then the Greek banking sector would indeed survive. But it would surely not survive a large and involuntary haircut. The European Central Bank would face a haircut on its direct investments of Greek government bonds, and, more importantly, much of the collateral posted by Greek banks would vanish. On my calculation, the cost of a Greek default to the German taxpayer alone would be at least €40bn ($58bn), including recapitalisation of the ECB. A bail-out would be cheaper.

A premature Greek default would change everything. As would the failure by the EU and Portugal to agree a rescue package in time; or an escalation in the EU’s dispute with Ireland over corporate taxes; or a ratification failure of the ESM in the German, Finnish or Dutch parliaments; or a German veto for a top-up loan for Greece in 2012; or the refusal by the Greek parliament to accept the new austerity measures; or a realisation that the Spanish cajas are in much worse shape than recognised, and that Spain cannot raise sufficient capital.

Then there is the downgrade threat for French sovereign bonds. I recall asking a French official about this, and getting the smug answer that the rating agencies could hardly downgrade France if they maintained a triple A rating for the US. That was before last week. By extension, France must also now be in danger. A downgrade would destroy the logic of the European financial stability facility. It is built on guarantees by the triple-A countries. Without France, the lending ceiling of the EFSF would melt down further.

The list of potential accidents is long, but they share a joint theme – serial political crisis mismanagement. We saw another glimpse of that last week. If we go down the route of premature default, and allow the True Finns and the true Germans to run the show, the eurozone as we know it will be finished.

As reported in the Telegraph by Emma Rowley.

http://www.telegraph.co.uk/finance/currency/8427703/One-in-seven-chance-that-nations-will-abandon-euro.html

‘One in seven’ chance that nations will abandon euro

The risk is roughly one in seven that Europe’s ongoing debt crisis will push member nations to abandon the shared currency, raising the spectre of the “effective end of the euro area,” the Economist Intelligence Unit has warned.

Attempts to restore investors’ confidence in debt-laden nations’ ability to honour their commitments could see the weaker eurozone members grow ever wearier of the demands placed on them, according to a new report from the research body.

Meanwhile, those countries whose finances are in better shape could lose patience with propping up other member nations, in this worse case or “ultimate risk” scenario.

The pressure on politicians from voters at home to leave the shared currency could then become “irresistible”, resulting in either stragglers like Portugal or Ireland or a robust economy such as Germany deciding to leave, before other members follow suit.

“This scenario posits that sooner or later, the cement that has held European countries together for decades cracks and the progression towards ever-closer union comes to a spectacular halt,” said researchers, who gave it a likelihood of 15pc.

The report’s central scenario – put at a 50pc probability – is that the eurozone will muddle through the crisis, with the most indebted countries accepting the harsh reforms needed to cut their deficits and stronger members reluctantly offering enough support to contain the crisis.

However even this relatively benign resolution of the crisis expects some countries to default on their debt, with Greece seen as the most likely. The least probable scenario, put at a 10pc likelihood, is that the eurozone will undergo a resurgence as countries manage to rein in their public finances, researchers thought.

The European Central Bank is on Thursday expected to raise interest rates to fight inflation across the eurozone, but there are fears it will make conditions even harder for the struggling periphery.

There was no mention of the probabilty that the politicians responsible for this will face any criminal charges for their unconstitutional and anti-democratic actions in attempting the euro project in the first place. OK, I added that last bit. But these people are wholly culpable for the extensive misery the whole euro project has caused to millions of people across the continent.

But raising interest rates in euro land is the correct thing to do to prevent hyperinflation and maintain sound money. The peripheral countries will be forced to leave… the 15% probability assigned to this outcome is wishful thinking.

If (when) rates rise, the Euro (i.e the Deutschmark in disguise) will rapidly strengthen.

this time from Bill Bonner in the Daily Reckoning…

Another thing taking a beating today is Europe’s periphery debt after the Portuguese voted against austerity. To put this into perspective, there are only two ways to go. When you borrow too much money from the future, you either have to pay it back or you go broke. The Portuguese were trying to pay down their debts, by cutting “services.” But it’s harder to cut services than you might think. Modern democratic welfare states are built on a fraud — that the government can give people more in services than they pay for. Typically, the government takes the extra money from groups that are politically weak — such as the next generation, which doesn’t get a vote.

Citizens don’t like it when the government tries to cut back. And when a majority of voters are on the taking end of the exchange — getting more from the feds than they pay in taxes — it’s very hard (maybe impossible) to impose “austerity” measures.

What the Portuguese election is telling us is that many governments will go broke before they pay down their debt. At least, that’s what it implies…

Portugal’s government is on the verge of collapse after opposition parties withdrew their support for another round of austerity policies aimed at averting a financial bailout.

The expected defeat of the minority government’s latest spending plans in a parliamentary vote Wednesday will likely force its resignation and could stall national and European efforts to deal with the continent’s protracted debt crisis.

The vote comes on the eve of a two-day European Union summit where policymakers are hoping to take new steps to restore investor faith in the fiscal soundness of the 17-nation eurozone, including Portugal.

The governing Socialist Party’s parliamentary leader Francisco Assis made an 11th-hour appeal for opposition rivals to negotiate changes to the latest austerity package and ensure the government’s survival. Prime Minister Jose Socrates, who heads the government, has said he will no longer be able to run the country if the package is rejected.

But opposition parties say the center-left government’s latest austerity plan goes too far because it hurts the weaker sections of society, especially pensioners who will pay more tax. The package also introduces further hikes in personal income and corporate tax, broadens previous welfare cuts and raises public transport fares.

The leader of the main opposition center-right Social Democratic Party, Pedro Passos Coelho, said late Monday that the political deadlock made an early election “inevitable.”

As in Greece, the austerity policies have prompted numerous strikes, with train engineers set to walk off the job during the morning commute Wednesday.

Portugal’s plight stems from a decade of miserly growth. While growing at the tepid rate of 1 percent a year, it ran up debt to finance its western European lifestyle.
Bloomberg reports Portugal Faces Lawmaker Vote Threatening to Push Toward Election, Bailout

Portuguese Prime Minister Jose Socrates will today face a vote in parliament against his deficit-cutting plan which threatens to push the country toward early elections and the need for a European Union bailout.

Lawmakers will discuss the government’s so-called stability and growth program of austerity measures at 3 p.m. in Lisbon. The opposition Social Democratic and Communist parties both pledged yesterday to table resolutions against the plan.

“If parliament decides on a motion against the stability and growth program, that means the government is not in a condition to make commitments internationally,” Socrates said on March 15. “That would mean a political crisis. In my understanding, the consequence of a political crisis is the worsening of the financing risks of our economy and would lead Portugal to request external intervention.”

Portugal is going to fail. Wednesday is as good a day to do it as any.

Thus, sooner, rather than later, another bailout is coming. However, it will not be Portugal who is bailed out, but rather German, French, and UK bank that lent money to Portugal.

Eventually Greece, Ireland, and Portugal will default, even though pretending otherwise may continue for a while.

I repost this article,  which was posted in zerohedge.

From Alasdair Macleod of FinanceAndEconomics.Org

We have already passed the point of no return on our journey into hyper-inflation for many paper currencies, and investors seeking to protect themselves from currency debasement should understand why. This opening statement is valid even if we ignore today’s abounding systemic risks.

There is a simple reason why monetary inflation becomes an exponential phenomenon. As currency is debased, an increasing quantity of money is required to achieve the same real-money effect.  For example, if the quantity of money is increased 25%, the initial benefit to the issuer is a tax of that amount on the holders of previously-existing money stock.  To achieve the same tax in real terms for a second time requires a further expansion of 31.25% of the original monetary units, and continuing with subsequent 25% expansions on increasing totals we obtain our exponential series of monetary inflation.

In practice, the realisation of the loss of purchasing power a currency suffers depends on how quickly it is transmitted into the general price level, and this can vary considerably; but eventually it is reflected in prices. So we need to consider the likelihood of an improvement in government finances sufficient to eliminate reliance on funding through the printing of money, which is the root of this evil. It is here that governments have great difficulties, which lie generally in the nature of government bureaucracy.

In government departments, there is always a complex and expensive structure designed to ensure compliance with the wishes of the executive, and to ensure that public money is properly used. This is why boxes are ticked; why it is so important to employ gender and race equality officers to ensure a department complies with government policy. The process, therefore, overrides the result, and nothing can change this. So when a government restricts public spending, there is no cut in bureaucracy; on the contrary, often more bureaucracy is required to administer the cuts and monitor the results.

The consequence is that restraint in public sector spending always feeds through disproportionately to cuts in services, leading to public outcry. And this is precisely the problem faced in Britain today. The Coalition government has adopted a hard line on public spending, following the profligacy of the previous socialist administration. This corrective approach is creating uproar, not only from users of government services and civil servants, but also from the intelligentsia who fail to properly understand the true cost of public services. So Keynesian economists are providing the public with an intellectual argument against the cuts by claiming they are recessionary, and opposition to them is growing.

What has become lost in the political debate is that at no time is the Coalition government actually cutting public spending: it is set to rise in every year of this Parliament.[i] The pain expressed so loudly in all sections of the community is solely the result of a reduction of the increase in previously planned expenditure. It is evidence that bureaucracy triumphs over services provided, and it is an illustration of the extreme difficulties politicians face in merely reducing the rate of increase of public expenditure.

These difficulties have their roots in the current situation, but a glimpse at the future also confirms government spending has to rise exponentially, with welfare and other future liabilities compounding at an alarming rate.  We know that there are more pensions to provide and people are living longer, requiring increasingly expensive care services; and that all this is expected to be funded from the public purse. Less appreciated are the long-term destructive effects of inflation on private sector savings and nominal cost of providing state welfare. In other words, inflation itself has directly increased the burden on the state, and indirectly has ensured there is little private capital to fund any shortfall.  Consequently, future public spending is firmly tied to an exponentially accelerating path.

In most Western democracies it is already too difficult for politicians to face up to this reality.  Instead, they pursue policies conceived through hope rather than any realistic assessment of the prospects, dreaming of an economic recovery that will bring public sector borrowing back under control. This allows governments and their independent statisticians to concoct tables showing economic growth, an improvement in tax revenues, and a reduction in welfare costs as employment improves. There is no actual evidence to support this optimism.

A detailed critique showing why economic recovery is a forlorn hope is beyond the scope of this article; but if the private sector is expected to regenerate itself without savings, no sustainable recovery can possibly occur.  It will also require an historical precedent: an economy increasingly under government command to actually succeed. Furthermore, governments continue to believe that all that is required is the stimulation of further bank credit, when it was excessive levels of bank credit that created the economic crisis in the first place: this is the quackery of prescribing port to cure gout. And there is very little evidence that meaningful economic recovery is developing.

The supposed economic recovery of 2010 was merely statistical, with governments using monetary inflation to puff up the numbers,[ii] and not the start of an improving economic trend. Furthermore, targeting tax increases at high earners discourages the most successful elements in society from further productive effort, and encourages them to redirect their efforts at tax avoidance instead. The consequence of these simple policy errors is to make economic recovery even more remote and reduce actual tax collected, and so spread-sheet forecasts of lower government deficits are even less likely to be achieved.

For all these reasons, we can see that socialistic government policies rely on accelerating monetary inflation. As inflation accelerates, it becomes increasingly difficult to escape the compounding effect of this exponential arithmetic.

The only way the exponential loss of purchasing power that results from monetary inflation ends is through the complete collapse of fiat currencies.  Whether this is brought on by a financial crisis or through hyperinflation is irrelevant: the result is the same.  Furthermore, quantitative easing programmes have merely accelerated the trend. Particularly worrying is the dramatic expansion of the monetary base in the US, which has greatly exceeded our theoretical example of 25% by increasing 168% over the last two years.  While this is routinely explained as a policy response to the banking crisis, it has the likely effect of accelerating future government demand for printed money even more, speeding up its inevitable demise.

For those of us who will be victims of the collapse of paper money, there is little point in hoping that more port will somehow cure our gout: it will not. Nor can we turn to our leaders for salvation: they know not what they do. And to this rough law of the exponential trend of monetary growth we must add the abounding systemic risks present today, which we have ignored in order to simplify this analysis.