The Chart Spain's Mariano Rajoy Wishes Could Be Swept Under The Rug
A week ago, after peripheral European bonds soared and yields plunged on more hype and more promises that the ECB may monetize debt on the one condition that insolvent countries hand over sovereignty to the Troika ala Greece, we were not all surprised to learn that "suddenly, nobody in Europe wants the ECB bailout." And why should they? After all, The whole point of the gambit was to lower bond rates, which happened, which would allow insolvent government to stack even more debt courtesy of lower rates on top of record debt, taking the insanity of the old saying "fixing an insolvency problem with liquidity" one step further, and revising it to "fixing an insolvency problem with more insolvency." Furthermore, if the mere threat of the ECB stepping in and crushing any shorts or supporting longs was enough, why even bother with actual intervention. Simple: even infinite monetary dilution has its limits. That limit is and always has been cash flow, because a central bank can only dilute wealth, never create it. And for Spain said limit is approaching fast.
Recall that as we calculated on September 3, Spain is rapidly running out of cash: its consolidated cash balance has plunged from over €50 billion in March to just over €20 billion in July and dropping at an alarming rate. The cause for this drop: a budget deficit that refuses to go away, and with ~25% unemployment, what the government does to the tax rate is irrelevant as the Laffer curve crosses into the twilight zone of the Laughter Curve.
Recall also that Goldman made it very clear that Rajoy has to request an ECB bailout last week, because while he may posture for political reasons knowing once he invites the Troika his political career is done, and such posturing will cause even greater conditionality to be ultimately imposed on Spain, the real gating issue is cash.
Enter the chart that Rajoy wishes did not exist: the net cash in/outflow into the Spanish treasury due to bond/interest activity.
As is quite obvious on the chart above, and explains Goldman's urgency with a formal Spanish ECB activation request, the closer we get to October, the closer Spain gets to running out of cash. And in that particular case none of the currently implemented reality countermeasures will do anything to hide the fact that Europe's emperor was naked from the very beginning.
The flowchart then becomes as follows:
1. Find out what the Spanish cash balance was as of August. If the economy indeed contracted far more than expected, which it likely did, this number should dip below €20 billion for the first time since August 2011.
2. The September number will not be known until a month later. However, it is safe to assume that it will not be a blockbuster cash surge.
3. If the total cash balance extrapolated going into October is close to the ~€15 billion needed to satisfy the Net Cash Requirement, watch out below, as "Plan Silvio" comes into play.
3.5. What is "Plan Silvio" you may ask? Simple - in November 2011, the ECB made it very clear it would no longer purchase Italian bonds as long as Berlusconi was in charge. In essence, this was the first act of the now totally political ECB, courtesy of its then-brand new president Mario Draghi, who had replaced JC Trichet days earlier. End result: Italian bonds soared to their post-Eurozone highs, and Silvio was promptly replaced with a Goldman technocrat. Just as was planned from the beginning.
4. Of course, Plan Silvio will be called Plan Mariano in its 2012 version. It will, however, manifest itself in identical terms to its prior iteration: a bond curve inversion which forces the current administration to do the biddings of the market. Should the Spanish bond curve, however, invert, it would mean that the 2 years will literally implode, as the matched yield will soar by 300-400 bps.
5. Next steps: in 2011, one firm that literally bet the farm that the ECB would not allow a curve inversion in Italy (it did), as a catalyst to replacing the current government, was everyone's favorite client money vaporized: MF Global. Should Plan Mariano be a "go", we can only wonder how many other hedge funds and prime brokers will suffer the MF Global fate, now that buying the Spanish short end is the "no brainer" trade of 2012.
Naturally, all of the above assumes that the Spanish economic contraction has continued, and its funding needs are over and above those budgeted at the beginning of the year when the Treasury bond issuance schedule was announced.
One thing we do know: the wall of worry is now officially gone courtesy of coordinated intervention between the ECB and the Fed, both of which have gone all in on the reflation trade. And with no wall of worry to be surmounted, everyone will now be on the same side of the trade. Hopefully, for "everyone's" sake, the central planners are better equipped to dominate reality this time around, than they were back in 2006 when "subprime was contained." Sadly, they never are. Which means that the current attempt at reflation will fail, only to be followed by yet another sharp deflationary crunch, which in turn will be followed by even more CTRL-P based reflation attempts, and so on, until finally one day, disgusted by the central-planners intention to defer the advent of reality at all costs, leading to record amplitudes in prices at ever increasing frequency, money itself, in its current form, will be overthrown by the same people who use it. Because every ponzi scheme lasts only as long as there is at least one more sucker.
It is at that point that the lunacy of the status quo will finally end. Seen in this light, we actually wish to thank the central planners for taking the steps they did in the past two weeks: they simply made the arrival of the final monetary phase transfer that much quicker.