Two weeks after Zero Hedge readers were informed about it, slowly the sell side is coming to the realization that not only will the EFSF have to be expanded (that much was known), but that Germany, and specifically the outright economy, will be on the hook by an unprecedented amount of money. And expanded it will have to be: not by two, not by three, but by a cool four times, to a unbelievable €3.5 trillion which according to Daiwa's Head of Economic Research, Grant Lewis, is an act which will be necessary to convince financial markets of euro area resolve to save Italy and Spain. Says Lewis: "France, Germany contribution to EFSF’s capital would increase to 80% if Spain, Italy had to drop out of guarantee structure. France, German contingent liabilities would be > 50% of GDP if EFSF expanded; added to France, Germany current debt may trigger downgrades to both countries." Yes... and no. As we explained when we referred to a far more accurate and complete report by Bernstein, merely a €1.5 trillion expansion in the EFSF, would mean that Germany is on the hook to the tune of €790 billion or 32% of German GDP. If France is downgraded, Germany essentially becomes the sole backstopper of the entire Eurozone, to the tune of €1.4 trillion or 56% of its GDP. Now let's assume Daiwa is correct, and the full amount under the EFSF has to increase to €3.5 trillion. That means that Germany "contin[g]ent liabilities", in the worst case scenario where France again gets downgraded, and it likely will eventually, would surge to about €3.3 trillion, or an insane 133% of German GDP!
Now let's put today's events in perspective.
Basically what just happened an hour ago, is that the ECB gave a green light to use the SMP program to buy Italian and Spanish bonds: the two countries which recently put themselves into a self-imposed capital markets exile as we reported earlier. The problem is that the SMP's unsterilized purchasing capacity is de-minimis and it is merely a stopgap until the sterilized EFSF is enacted in its final form. The question is precisely what this final form will be: will it be €1.5 or €3.5 trillion. Nobody knows yet which is why Rehn refused to answer the question twice already today.
Either way, let's assume EFSF gets clearance. At that point the SMP gets deactivated, and EFSF takes over.
And here is where Germans get angry, because explicitly they end up backstopping everyone in europe! And the cost to them becomes 133% of their entire economy in a worst case scenario, which of course in this centrally planned world, is now guaranteed.
So the ball is now basically in Germany's court: will the German export sector be ok with leaving the country on the hook to a complete implosion once the final European house of cards implodes, or, will German practically once again take over, and tell the ECB, the bureaucrats and every other insolvent European country to go shove it, in the process bringing back the D-Mark and returning to a life of quiet contentment without a customs, cultural or monetary union.
Oddly enough, our money is on the latter.
PS. In the meantime, short Bunds (or to borrow a Gartmanism, go long gold in Bund terms) ahead of the market's realization that peak risk transfer from the periphery to the core is now in process.
PPS. A fully funded EFSF will need to issue €3.5 trillion, or $5 trillion in debt. Repeat: $5 TRILLION.