Via Mark Grant, author of Out of the Box,
“What’s on your mind; big boy?”
-Otto Waalkes, famous German comedian
It was inevitable and despite all of the usual huffing and puffing on the Continent; the moves are correct. First Egan-Jones and then Moodys and Germany is downgraded or threatened with a downgrade and for sound reasons. The German economy is $3.2 trillion and they are trying to support the Eurozone with an economy of $15.3 trillion that is in recession and rapidly falling off the cliff. There is just not enough German capital to support the entire enterprise and the ratings agencies are finally taking note of the situation. Moodys also tapped the Netherlands and Luxembourg leaving only Finland with a stable outlook to maintain its “AAA” rating. By comparison the United States has an economy that is $14.3 trillion, that is 125% the size of all of our domestic banks while Germany is overshadowed by her banks, by the recession in Greece, Portugal, Spain and Italy and there is just not enough firepower to withstand the onslaught without consequences. It may be unpleasant but some parts of the equation were bound to give as a matter of economic necessity and it will be the ratings, Germany finding herself in a recession by the fourth quarter and an actual debt to GDP ratio that is getting stretched to well beyond 100% of the country’s resources. If the downgrades continue and are actualized then it will not just be the separate countries that are affected but the whole European construct that will lose its “AAA” status.
“In the end, you are exactly--what you are.
Put on a wig with a million curls,
Put the highest heeled boots on your feet,
Yet you remain in the end just what you are.”
-Mephistopheles
Germany is supporting at Target2 financing operation of over $800 billion, funding 27% of the operations at the EU including the EIB, the EFSF, the possible ESM and 22% of the $4 trillion balance sheet at the European Central Bank. Contingent liabilities which are not counted in the EU’s financial calculations are turning into real liabilities as money pledged to the EFSF has become actualized and as the demands of Spain with a first tranche of $125 billion for her banks, which must flow through the sovereign, enlarging soon as the Spanish banks and the Spanish regions are in quite serious trouble. Italy is also on the waiting list and with a real debt to GDP ratio of 202%, which includes their $211 billion in derivatives and their other contingent liabilities; the funding gap in Europe has gone from probable to actual as the demands of the periphery has shifted pledges of money to the necessity of handing over the money and real Euros, not just promises of them, are now being demanded.
“Even Hell hath its peculiar laws.”
-Faust
The Issue of Moments
We have had several Greek moments, an Irish Moment, a Portuguese Moment and now a Spanish Moment. I am constantly asked if there will be a Lehman Moment and this depends upon your definition of a Moment and the fear factor that accompanies it. Historically, if we note the demise of the Soviet Union, all of the countries that were included in this Bloc were part of the Soviet Union until the Moment when they were not but this occurrence had very little economic effect upon the United States and so was discounted as historical but not financially relevant. This will not be the case with the European Union and we are facing two specific Moments that may change the course of events. The first is Greece #3 where the Troika report will be made public and funding will either be continued or not. Greece is demanding another $50 billion in capital or threatening to default on its obligations which total some $1.3 trillion. Greece could not pay back its debt if it stood on its head and spit olive oil and so it must either be debt forgiveness or the end of funding and the consequences that accompany it. Germany is being forced to choose and it looks like the IMF and the EU are just about to say, “Nein.” Debt forgiveness, in my view, is a non-starter in German politics and it appears as if the long and winding road is about to end.
The second Moment in our gun sights is Spain and with the largest region, Catalonia, who has an economy roughly equivalent to Portugal, supporting an eight year maturity that is now yielding 14.4% the situation for the Regions in Spain is no longer tenable and the prospect of a full blown Spanish bailout is all but assured in my opinion. On two fronts Europe is hitting the wall and the prospects are dismal so that two real and quite serious crunch times are close at hand. The firewall concept has failed, the ring fences have collapsed and the contagion is spreading like wildfire all across the Continent. There is a scant $65 billion left in the EFSF fund and the ESM is hung up in the German courts until September 12 so that the European flanks are fully exposed and I do not even think some sort of ECB intervention will stem the flow of blood that is spreading like a dark stain from capitol to capitol in Europe.
Each new European enterprise gives the markets a shorter and shorter bounce as we all watch the yields in Europe rise, the stock market’s fall and the Euro in serious decline against both the Dollar and the Yen. There has been no Lehman Moment to date but moment-by-moment the decline in the fortunes of Europe diminishes. There is almost no historical precedent where debt paid by the addition of more and more debt has been a successful operation. There is always the inevitable wall or walls and the concrete slabs of Greece and Spain fast approach.
“Misunderstandings and neglect occasion more mischief in the world than even malice and wickedness.”
-Goethe