Jefferies: The Fed Should Print... In Europe

One could be forgiven for suspecting a hint of self-preservation in a research note by the firm that faces the most intense pressure given its apparent European sovereign exposure but David Zervos' note today seems extreme in many ways. With the sanctity of the known world at risk, Zervos describes the group-think of sado-fiscalism that has invaded German minds and how the Fed is the only one left with the 'bazookas' big enough to get the job done.

David Zervos: The Fed Should Just Do QE for Europe

If you want to read one of the most misguided pieces of research on the euro crisis look no further than here. After reading this you will understand the dark and disturbed German disease that my good friend, and esteemed global strategist, James Aitken has diagnosed as "sado-fiscalism". It has contaminated the minds of Merkel, Schauble and Weidmann who continuously vilify ECB monetization and envision a peripheral Europe of indentured servants working to pay for their government and banking sector's past borrowing sins.


Leaders infected with this disease induce so called "market forces" of higher funding costs, sadistically and strategically, on peripheral (and now core) overextended levered balance sheets. This ensures, ex post, that bad borrowing decisions are penalized – in size. Of course, this should have been done ex-ante so that no excess borrowing was done in the first place, but those same sado-fiscalists were happy to let their home town bankers expand balance sheets with zero risk weight sub-prime sovereign lending at low rates during the good times. Sound familiar?


In the article referenced above, the author goes on to at least acknowledge the obvious - forcing a sado-fiscal depression in the non-German parts of Europe might create systemic problems. Duh? Ya think? His solution – jam the banks, pension funds and insurance companies. His words - "If I am wrong and acute risk aversion in euro area sovereign debt markets remains and fear continues to trump greed in the face of reform implementation and progress, euro area regulators and policy makers must be ready to adopt new tactics. One of them would be a kind of soft "financial repression," in which reforming European governments would effectively direct nominally private euro area investors towards greater investments in peripheral government debt. Put another way, euro area governments overseeing a currency union in rough external balance—and one in which reform and progress are achieved—should not allow their pampered and politically protected domestic financial services industry to reduce its holdings of euro area sovereign debt."


So in the middle of a systemic crisis,  where the banking system is choking on excess exposure to debts that are about to become credit impaired and EMU is breaking down, the solution is to force the banks to buy more toxic assets. Seriously, can there be a dumber idea? We in the US need to snuff out these sado-fiscalists and fast, they are danger to the world! More on that below.


But first, the foundation of "sado-fiscalist" solutions is built on cognitive dissonance - it cannot work. Using "market forces" to generate austerity and reform will backfire. Nearly all European countries do not have the ability nor the desire to pay back - in real terms - the debts racked up by their over indulgent governments and banks. And the good news is, if they don't have to pay them back. They can just leave EMU, default or monetize, and go on their merry way.


The reason the Germans are trying so hard to implement a "sado-fiscalist" solution is that without it, they lose - and lose big. If the debts are defaulted or monetized away, the savers of Europe - the Germans in large part - get crushed. This idea that the vendors to Europe are paid back by indentured servants perpetually sending 50 percent of their wages up north to pay for previous sins is folly. The Germans cannot win this game. The question how much systemic pain is created as they waltz down the path to losses?


A mass exit from or a complete breakdown of EMU will be determined by the German stance on monetization. There have been hundreds of calls by non-German Euro area leaders, US politicians, academics and private sector business leaders to monetize. And if the Germans block it in Euros, the printing presses in Drachma, Punt, Escudo, Peseta, Lira and Francs will surely be fired up once again. In the end of course there will be more paper money in the world chasing the same amount of goods and services - that is the end game!! The path to the end game is of course messy! And let's face it, we would all like to avoid "messy" if possible.


There is one easy way to do that - get the Americans involved. The US can force monetization at the ECB. If the Colonel deems sado-fiscalism as a global systemic threat (which it is), the Fed could act. The Fed has an account at the ECB in Euros. When the pesky Europeans borrow dollars from us on currency swaps to fund their insolvent banks we get this lovely account. And right now the Euros just sit there! If things get messy we just jack the "unlimited" lines up, back up the forklift, and buy Euro area bonds. Lots of them. Say a trillion or two across all non-German markets. The Fed already owns nearly 100b in German and French bonds. And if anyone tries to default down the road, well we have a few hundred billion in European gold to confiscate in the basement of the NY Fed. And if that's not enough we just institute "annual fees" for NATO membership or start confiscating European assets in the US.


If the shenanigans in Europe are going to mess up a US recovery, or even a presidential election, then there should be a serious US response. We did not spend all that money on the Marshall plan just to have Europe blow up the world again!


(h/t Shawn)