Europe's New, New Math

From Mark Grant, author of Out Of The Box

A Novel Approach

The focus of the markets these days is driven by the headlines that are pumped out by the European Union. Hope is promised, the next big summit to fix all issues is touted, Germany is going to come around any day is offered up as Ms. Merkel denies any such thing and “muddling through” holds up prices as the by-word of belief  as the blinders of the great propaganda machine direct everyone’s attention away from what is most important. As one example of this is some firewall, no matter what size, that does not do one thing to address the core issues of Italy and Spain which both have too much debt and too many other liabilities in a time of recession where contingent liabilities become outright liabilities and hidden in a vast variety of ways. These firewalls accomplish nothing except to dissuade investors from being involved and their capitalization weakens the finances of the countries providing the capital, whether counted or not, and ends up weakening the balance sheets of the core countries of Europe as we roll from promises and guarantees to moments when real money must be put up. If you stand far enough back you can visualize what is going on; “look at our firewall and do not pay attention to the countries which are having severe economic declines” and so the head fake continues until it cannot any longer as the bills overcome the ability of a nation to pay them.

“Pay no attention to the man behind the curtain.”


                                     -The Wizard of Oz


The recent focus on Spain has been their banks. Europe is trying to come up with some approach which will not involve the sovereign credit. The talk is $125 billion for the troubled Spanish banks to come from some source that is either not yet in existence or that has no provisions to lend any money to anyone but sovereign credits. This, then, would all have to be changed of course and modified which would take weeks if not months but no one seems to mind this too much. This is Europe where reality gets slurred and, to be polite, no one is supposed to notice.  The amount of money being contemplated is nowhere near what is really needed but then the assumption for the capital required is based upon balance sheets that do not accurately reflect the real losses in Real Estate of both value and defaults as so much is securitized and resides at the ECB under the cover of darkness. So it is garbage in and garbage out and the audit results promised by the end of June were just postponed yesterday to September as I laughed out loud when I read this because I had just commented to one large institution that this would surely happen just moments before. There was no wizardry exercised here just some understanding of how Europe operates so that expectations can match reality and not rest upon European promises that most times have all of the solidity of some passing wisp of cloud.

Back at the ranch, however, are the regions of Spain and their debt. Spain is talking about guaranteeing their debt in some fashion which will not be counted as part of Spain’s debt to GDP ratio because guarantees are not counted. Fascinating; this manner of arithmetic. One plus one can mean anything Europe likes and then everyone is offended when it is challenged. I never did well with spoon feeding my mother has told me and I suppose it has not changed in all of these years.

Spain’s regional debt is now $183 billion which is up about 4% in the last three months or 12% on an annualized basis. This represents 13.5% of Spain’s GDP. This is not all of their debt of course as many of the regions do not pay their suppliers who then borrow from the banks against the regional liabilities and so the charade continues. Now the largest region in Spain is Catalonia who debt burden is up by 15% in the last year. While no one is paying attention the two year debt for Catalonia is now trading at thirteen percent (13.00%) which is higher even than bailed-out Portugal. Bank debt, regional debt and whatever fancy schemes are proposed; Spain is going to have to be bailed out because they can no longer afford to pay their bills.

I formally apologize to Spain and Europe this morning. I offer my sincere confession to the Inquisitors and in public. I am unable, both ethically and morally, from using your new, new math and I am afraid that I am only capable of the old “one plus one equals two” type of arithmetic. Therefore, using the banal and the ancient, Spain is going to have to welcome the Men in Black and pay due homage. The new European math is a odd thing, it tells you one thing but then when you walk into the counting house to see your wealth; it isn’t there. Funny how that works.