From Mark Grant, author of Out of the Box
Les Folies du Frankfurt
Logical Consequences and Hard Numbers
In all of the Euphoria, capital “E” intended, of Friday when everyone got on the bandwagon that the ECB, in conjunction with the EFSF and perhaps with the ESM, if it comes into existence, will save the European Union and solve all of the known and unknown problems; I found myself smiling. I have seen this rush to utopia several times before during the last two years and not once has it proved to be the correct response. We play the Great Game to win and not to be right and so I take these rushes into market madness seriously but I also know that the players in the Great Game are not an uneducated crowd and will realize grand folly eventually for what it is and it is just that; grand folly.
What everyone seems to forget during these market speculative induced highs is that someone has to pay for them. Neither the ECB nor the Fed operates on a different existential plane that is not appended to the real world of finance or either or both could balloon their balance sheet to 100 trillion dollars or Euros and so bolster the nations that they represent. I was asked Friday about Inflation and its apparent lack and the lack is decidedly true at present but Inflation is not the bogeyman at the end of the tunnel; it is Valuation that includes the currency but also extends to the debts of the EU countries and their abilities to pay their debts, the EU lenders and their ability to fund and finally to the marketplace and anyone’s desire to contribute capital and at what levels. These are the real arbiters at the end of the pipeline!
In the case of Europe we have two marked distinctions with the first being the ECB and their balance sheet which is currently at about four trillion dollars and already 45% higher than the Fed’s at $2.2 trillion. The second is the European Union’s Stabilizations Funds with the EFSF in existence and down to $65 billion in available capital, after the $125 billion for Spain, while the second fund, the ESM, is only proposed at the moment and hung up in the German courts. Both entities are mired in present and future difficulties as having bailed out Greece, Ireland, Portugal, Cyprus, Spain and possibly Slovenia and Italy in the not too distant future. All of the talk of firewalls and those moments of Euphoria have quite obviously achieved nothing as Spain has fallen and Italy is about to fall (my opinion) and so the mis-direction is apparent from what was really important, the financial capabilities of Italy and Spain, and the firewall distractions accomplished nothing but a few moments of respite. Whether it is the Stabilization Funds of the European Union or the placing of debt and securitizations at the ECB in the end, and it will be recognized I assure you; someone has to pay for all of this and there is the rub so often overlooked or perhaps pushed to be ignored by the nations in Europe. I submit that the final act of this great drama will occur when the world (ratings agencies and investors) looks around and notices this reality.
If we were to suppose that Italy, Spain, Greece, Portugal, Ireland, Slovenia and Cyprus need some sort of help then this equates to a European Union whose capacity is diminished by 27.01% in their ability to fund as these countries cannot help (source: Eurostat). If we utilize these same countries at the ECB then then capacity of the European Central Bank is reduced by 26.092% (source: ECB). Then if we look at just one specific country, Greece, and they defaulted on their $447 billion in public debt it would wipe out the capital at the ECB which now holds the vast majority of Greek debt outstanding (estimated at $283 billion) and which, as of December 28, 2011 (source: ECB) had $13.236 billion in paid-in capital from Europe’s central banks. A Greek default would also cause a massive Target2 default where approximately $123 billion is pledged in collateral from the Greek banks and guaranteed by Greece. Then there is the $144.53 billion in Greek loans in the EFSF fund that would be decapitated by a Greek default. The total public debt then for Greece which is defined as either their direct sovereign debt or debt that is guaranteed by the government of Greece is $714.53 billion which does not count their $90 billion in derivatives or their private corporate debt or government guaranteed non-bank corporate debt or the non-guaranteed bank debt of the country.
Greek GDP as of December 31, 2011 $298.1 billion
Greek Debt to GDP ratio 239.69%
(EU Acknowledged Sovereign Debt Obligations)
Total (All In) Greek Debt $1.3 trillion
Total Greek Debt to GDP ratio 436.09%
Never forget; there are two sides to the European fiscal proposition. There are the funding nations and the borrowing nations and I suggest that the focus of the markets will soon turn to the funding countries and their capacity to provide capital without endangering themselves. I think the attention of the markets is about to turn to Germany and France, the largest components of the European Union, and with GDP’s of $3.2 trillion and $2.77 trillion respectively the question is going to come around to just how much these two countries can support without sending themselves into a serious economic quagmire. The EU officially recognized sovereign debt of Greece is now 22.33% of the GDP of Germany and 25.80% of the GDP of France. The banks in Europe dwarf the sovereigns with balance sheets three times larger than of all of the EU nations and with Spain having now fallen and Italy about to go; just how much that can be afforded is quickly coming into the focus of many money managers.
The question of today may well be, “If they will fund and how?”
The question of tomorrow is going to be, “Can they afford it?”