Europe: An Intermediate Forecast Analysis

Reggie Middleton's picture

The following is a guest post by a very bright individual whom I've had the pleasure of building with on several occasions, Mr. Mordechai Grun. This is what he's had to say on the topic of Europe, with ample commentary from me along the way.


Human behavior predications usually follow the ‘least resistance, least painful, and self serving’ path in spite of its being harmful in the long run. This disposition is even more truly said of politicians and bureaucrats. "Will is the origin of all thought." Flowing from such will we have the intellectual analysis and arguments to justify those behaviors. We will therefore look at Europe through this lens and see where it takes us.

The next major crisis in Europe is lurking just beyond the bend.

Reggie’s note: the last crisis has actually never left, so this is not the next one, just a continuation of the same. I called this exactly three years ago, in explicit detail (The Coming Pan-European Sovereign Debt Crisis – introduces the crisis and identified it as a pan-European problem, not a localized one)

It will take form as either the comeback of Bond vigilantes or as a political calamity, where some peripheral country finally votes for a party that is seriously proposing to forsake the Euro.

Reggie’s Note: The EU Has Rescued Greece From the Bond Vigilantes,,, April Fools!!!

Or… As I Warned Earlier, Latvian Government Collapses Exacerbating Financial Crisis

Some smart politician will certainly test the ECB’s resolve and do away with austerity and call their bluff. The consensus of the population can only be subjected to so much strain before it turns on itself and they vote for radical (read: costly) change. While the case can be made that the government bond-funding crisis has subdued, the economic pain of the general public has not.

Reggie’s note: Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter?

The likeliest scenario is that both of these crises will play out at the same time, thus creating a Lehman-type crisis.

Faced with this crisis, only two options will present themselves:

  1. Massive sovereign debt defaults, bank runs and bankruptcies as many banks’ liabilities are larger than the GDP of the countries that are guaranteeing them – and a potentially resulting currency crisis

Reggie’s note: Ovebanked, Underfunded, and Overly Optimistic: The New Face of Sovereign Europe

Sovereign Risk Alpha: The Banks Are Bigger Than Many of the Sovereigns


image015.png image015.png


  1. A truly massive QE Program that not only bails out the banks and the existing governments debt and deficit, but also sponsors an enormous stimulus program for anything that can be thought of, e.g. infrastructure, education, green energy, etc.

Following scenario B, the challenge will be this: Why would the Germans and Fins want to debase their currency to send their monies elsewhere? The answer will be a mix of ‘candy and stick’, so to speak. The QE stimulus program will be structured upon some European formula – per capita or otherwise – that sends significant amounts of newly printed money to them too, while, in the alternative, if the Euro disintegrates, Germany will have to recapitalize the Bundasbank and resort to either massive stimuli or quantitative easing so to cheapen their currency and rescue their own economy. Those countries that leave the Euro will, nevertheless, default on any external bondholders, as they are restructured and recapitalized in the new currency, their banks will default as well. Why wouldn’t Germany be gracious and monetarily benevolent with funds they would lose either way? This would blend in with the fact that even the new Mark will be too expensive for their export-driven economy, and they would be pressed to cheapen it. They also won’t have destination countries to export to in Europe, as each country will turn to hyper-protectionism, safeguarding the jobs they have from disappearing in an effort to stabilize their home currency in order to avoid hyper inflation (Argentina, anyone?).

Reggie's Note: A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina - Now, referencing the bond price charts below as well as the spreadsheet data containing sovereign debt restructuring in Argentina, we get... Price of the bond that went under restructuring and was exchanged for the Par bond in 2005

image001 image001image001image001

Price of the bond that went under restructuring and was exchanged for the Discount bond

image003 image003

This turmoil will, obviously, generate widespread economic malaise as well. As a politician faced with this decision the answer is obvious. I can already picture the smiling politicians announcing their courageous decisions and courses of action, claiming that they have saved the Euro from certain demise while helping the people and creating new projects and job opportunities that will launch Europe into the future. It is possible that they will punish the instigator (Greece, presumably) and cut them out of the money party aka Lehman.

Is this feasible for Europe? I believe the answer is yes, as one significant minutia is overlooked. The Euro is way too high, even for Germany. This will become ever clearer as time clambers on. Europe can survive – even thrive – at 0.65 Euro to the dollar. I recall this precise scenario in Canada during the early 90s. The resulting inflation at the consumer level was much milder than expected, as taxes, services, rents, salaries and many consumer goods and products (including cars) are priced in the local currency. Of course, energy costs would rise. In Europe, though, lowering the high taxes on fuel can mitigate this. On the positive side, manufacturing and tourism in Canada flourished, generating a strong trade surplus (this was prior to the commodity boom). Europe can probably afford 6-8 trillion in QE over a 3-year period without hyperinflation, especially as this will be taking place while many other major currencies are orchestrating their own QE. If, as they do this, the peripherals restructure their own economies and bring down or solve their structural or primary deficits, the Euro may actually increase eventually, as they will have significantly lowered their debt to GDP ratios and positioned themselves on a financially sustainable path.

Reggie's note: This is code language for DEFAULT! The defaults will codify, quantify and solidify the capital destruction that we all know is there in the first place. I don't think the ride will be quite that easy. Greece has defaulted (exactly as I anticipated and clearly called) and is about to default again, and it's still f#@ked. For more on this, reference This Time Is Different As Icarus Blows Up & Burns The Birds Along The Way - Greece Is About To Default AGAIN! ... and then there's the contagion effect! Subscribers, see

All others, reference: 

    1. Financial Contagion vs. Economic Contagion: Does the Market Underestimate the Effects of the Latter?
    2. The Depression is Already Here for Some Members of Europe, and It Just Might Be Contagious!
    3. Introducing The BoomBustBlog Sovereign Contagion Model: Thus far, it has been right on the money for 5 months straight!
    4. With Europe’s First Real Test of Contagion Quarrantine Failing, BoomBustBloggers Should Doubt the Existence of a Vaccination

The sad reality, though, is that they will promise such changes and not deliver on their word.

Reggie's Note: WHAAAT???!!! You mean you can't trust the European oligarchs??? 

This will turn the crisis into only a short- to medium-term solution while eventually creating a fundamental currency crisis that will give way to no solutions.

Can the Euro handle that much QE? I believe the answer is yes. The ECB can forgive all the bonds they either own or collected as collateral for loans. Does anyone believe the principal on these loans will ever be paid down? The only stimulus from such a move will be the miniscule interest being saved.

Reggie's note: Moral hazard be damned, eh? What's to prevent other market participants from pushing to get a similar deal of borrowing money and not paying it back, expecting not to get punished. Massive forgiveness on this scale will fracture the market mechanism and destroy market pricing (as if it's not already wrecked as it is, does anybody really think core European bonds should yield what they do now?)

However, from a public confidence perspective, it would be huge, as it would drastically lower debt to GDP ratios.

Reggie's note: It will also bring about massively more stringent underwriting the next time around, effectively driving up rates anyway - you know, just as rates would have been driven up had the borrowers defaulted. Who in they're right mind would voluntarily make the same mistake twice in so short a period of time. As a reminder from my seminal link Greece Sneezes, The Euro Dies of Pneumonia! Yeah, Sounds Bombastic, Yet True!

Wait until a 2nd Greek default (virtually guaranteed as we supplied user downloadable models to see for yourself, the same model used to forecast the 1st default) mirrors history. Of the 181 yrs as a sovereign nation after gaining independence, Greece been in default 58 of them. Don't believe me! Check your history, or just read more BoomBustBlog - Sophisticated Ignorance Or Just A Very, Very Short Term Memory? Foolish Talk of German Bailouts Once Again...

image022 image022

It is important to note that Europe will be faced with a stark choice: either deflate assets and wages or deflate the currency. And, since as discussed, the Euro needs a significant reduction anyway, why not milk it and bring it down through QE?  The crisis created by a country like Spain leaving the Euro will harm the Euro by much more than a giant QE would. There exists capacity for Europe to kick this one down a really long road and, with some discipline, actually solve it along the way.

Reggie's note: Possible, yes! Probable, Nah!!!

The challenge will be that, unlike the US, Europe has multiple players and can't turn on a dime. The crisis, when it comes, will be overwhelming, and will require solutions over a weekend or short bank holiday. Can so many politicians and central bankers on opposing sides of the language barrier figure out that their collective interests are far more in harmony than their differences? Prejudice, ego and vindictiveness – combined with an overly sensationalist media and so many involved players – stage the scene for things to easily get out of hand. If history is any guide, the answer is not very encouraging. However, Europe now shares a bureaucracy and central bank as well as a mostly shared corporate interest. So let's hope this time around is a bit different.

Reggie's note: I really liked this piece, and Mordechai is bright fellow. Of course I like it better with my commentary, which sort of... well.. Keeps it real!

In closing...






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orangegeek's picture

Socialism and entitlements have run their course.  Bon voyage Europe.

medium giraffe's picture

Europe's disatster is not 'right around the bend' so much as 'hiding beneath the mainstream media'.  It's always good to see well reasoned arguments in print for why this catastrophe will happen, but I think here on ZH this is preaching to the choir.

I'm not so sure, however, that we will see a European politician challenge the ECB in any meaningful way.  The central banks control policy through their economic might, the solution does not lie in challenging them to help or to modify their behaviour, their agenda is unlikely to change and they will not relinquish power.

Bungasconi's coalition partner was strongly considering state backed currency as a proposal.  We don't really have to go into all of the reasons why one might not want to vote for the perverted old crook and his team, but I was surprised to see a central bank tell a voting public not to vote for him.  I do wonder if the state backed currency idea was the real reason for the cartel rubbishing the bungaparty in such a surprising (and pretty undemocratic) way.

Switching to state issued currencies backed with state assets seems to be the only alternative if we need something to quickly switch to that will still fit in with our current models of commerce, and I think we could all do with a 'German Miracle' about now.

As ever though, the bank cartels remain the real issue and trying to 'win them over' is not feasable.  Until we can wriggle out of the cold embrace of the vampire squid, we might as well be pissing into the wind.


TPTB_r_TBTF's picture

The German Miracle will be when they agree to print, which they will....


The Europeans disagree on how to kick the can.  But they will kick the can; iow, no breakup.

medium giraffe's picture

Yup, don't disagree.  ECB balance sheet has already grown by about 1/3 since beginning 2012.

Arthur's picture

"Europe can survive – even thrive – at 0.65 Euro to the dollar. I recall this precise scenario in Canada during the early 90s."

Would be nice.  I would buy a nice Benz at 1/2 the current price.  Time for a nice vacation too.

But it could work.  Brazil allowed the Real to be devalued in the mid to late 90's and has not looked back.

barkster's picture

am i missing something? .65 Euro to the dollar is significantly stronger than it's current .77 to the dollar.



TPTB_r_TBTF's picture

You got it backwards.  My screen says 1.3089


So .65 is about half as strong [sic]; rather, twice as weak as now.

barkster's picture

Europe can survive – even thrive – at 0.65 Euro to the dollar


.65 Euro to the dollar means 1 Euro = 1.54 USD. That is stronger than the Euro is now.



willien1derland's picture

If they devalue the Euro they undermine the portfolios that hold EU Sovereign debt...if interest rates are near zero the ability to appreciate is nominal...however, the currency which the debt is denominated in were to devalue it would REDUCE the overall yield on the investment thereby creating a negative feedback loop which would compel banks, hedge funds, sovereign wealth funds et all to liquidate positions - so the ONLY alternative would be for Draghi to take a page from the Bernacke playbook & for the ECB to buy & hold the debt - considering the Federal Reserve holds 29% of all outstanding UST 10 year bonds & a +$3Trillion balance sheet should not surprise anyone of the political expediency of such a strategy - as the Fed is to the US Treasury Market the ECB would be to the EU...and the current EU "laws" do not allow the ECB to act in that capacity, however, this time IS different - great analysis Reggie - God save us from ourselves

carbonmutant's picture

"Anything too big too fail is a Sovereign Power."


Haus-Targaryen's picture

If the Germans allow QE then the Euro could stay together for quite a while.  I'm just not sure the rest of Europe would be okay with Germany getting a cool Tril. 2.88€ for free (36% of total Euro GDP assuming 8T in QE).

bank guy in Brussels's picture

Curious theory here by Reggie's friend Mordechai Grun ...

He thinks that Hollande and Berlusconi can win their 'push' on Germany, to print like crazy ...

€ 6 to 8 trillion of QE ! ...

Euro losing half its current value re the dollar, down to 65 euro-cents per Bernanke Buck ! ...

Well. there are others also saying that Germany sees the writing on the wall, and has secretly agreed to Mega Printing Madness after the German elections in September ...

It is true this is the only way to keep the euro together ...

But doubtful the Germans, Dutch, Finns agree to this 180-degree turn

Doubtful things will hold together till after September's German election

Doubtful that there is much left of pro-united-Europe sentiment, with nationalist impulses surging ... that sentiment seems to mostly exist now in European Commission offices

More likely instead the euro-zone will split as events get out of hand

But it is the way a 'Fiskalunion' would work ... good to have the ideas out there ... Reggie is right here when he says « Possible, yes! Probable, Nah!!! »

Ghordius's picture

well done, Reggie! I don't agree on everything but you sure have the main points correct

- DEL -

the whole currency war thing lacks a proper picture - perhaps best as a race between sailing ships

the eurozone is "losing", but it is way upwind - it has more room to manouver

yes, it has a lot of captains, and each is busy in it's own hold - bailing out, mostly

but all this breakup talk always forget one thing: european nations partecipating to the eurozone have a quite good idea of the consequences of such a move. at best, it means a palliative - but it does sure not remove the root causes of the mess

btw, at one point my expectation is that all central banks have to reverse course

then, being last means being first, and being upwind is still the better way to be