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ECONOMICS AND ESOTERICA FOR A NEW PARADIGM

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It’s your choice, Europe: rebel against the banks or accept debt-serfdom

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by Charles Hugh Smith
from Of Two Minds
Posted December 4, 2011

THE EUROPEAN DEBT BUBBLE HAS BURST, AND THE REPRICING OF RISK AND DEBT CANNOT BE PUT BACK INTO THE BOTTLE. It’s really this simple, Europe: either rebel against the banks or accept decades of debt-serfdom. All the millions of words published about the European debt crisis can be distilled down a handful of simple dynamics. Once we understand those, then the choice between resistance and debt-serfdom is revealed as the only choice: the rest of the “options” are illusory.

The euro enabled a short-lived but extremely attractive fantasy: the more productive northern EU economies could mint profits in two ways: A) sell their goods and services to their less productive southern neighbors in quantity because these neighbors were now able to borrow vast sums of money at low (i.e. near-“German”) rates of interest, and B) loan these consumer nations these vast sums of money with stupendous leverage, i.e. 1 euro in capital supports 26 euros of lending/debt.

The less productive nations also had a very attractive fantasy: that their present level of productivity (that is, the output of goods and services created by their economies) could be leveraged up via low-interest debt to support a much higher level of consumption and malinvestment in things like villas and luxury autos.

According to Europe’s Currency Road to Nowhere (WSJ.com):

Northern Europe has fueled its growth through exports. It has run huge trade imbalances, the most extreme of which with these same Southern European countries now in peril. Productivity rose dramatically compared to the South, but the currency did not.

This explains at least part of the German export and manufacturing miracle of the last 12 years. In 1999, exports were 29% of German gross domestic product. By 2008, they were 47%—an increase vastly larger than in Italy, Spain and Greece, where the ratios increased modestly or even fell. Germany’s net export contribution to GDP (exports minus imports as a share of the economy) rose by nearly a factor of eight. Unlike almost every other high-income country, where manufacturing’s share of the economy fell significantly, in Germany it actually rose as the price of German goods grew more and more attractive compared to those of other countries. In a key sense, Germany’s currency has been to Southern Europe what China’s has been to the U.S.

Flush with profits from exports and loans, Germany and its mercantilist (exporting nations) also ramped up their own borrowing – why not, when growth was so strong?

But the whole set-up was a doomed financial fantasy. The euro seemed to be magic: it enabled importing nations to buy more and borrow more, while also enabling exporting nations to reap immense profits from rising exports and lending.

Put another way: risk and debt were both massively mispriced by the illusion that the endless growth of debt-based consumption could continue forever. The euro was in a sense a scam that served the interests of everyone involved: with risk considered near-zero, interest rates were near-zero, too, and more debt could be leveraged from a small base of productivity and capital.

But now reality has repriced risk and debt, and the clueless leadership of the EU is attempting to put the genie back in the bottle. Alas, the debt loads are too crushing, and the productivity too weak, to support the fantasy of zero risk and low rates of return.

The Credit Bubble Bulletin’s Doug Nolan summarized the reality succinctly: “The European debt Bubble has burst.” Nolan explains the basic mechanisms thusly: The Mythical “Great Moderation”:

For years, European debt was being mispriced in the (over-liquefied, over-leveraged and over-speculated global) marketplace. Countries such as Greece, Portugal, Ireland, Spain and Italy benefitted immeasurably from the market perception that European monetary integration ensured debt, economic and policymaking stability.

Similar to the U.S. mortgage/Wall Street finance Bubble, the marketplace was for years content to ignore Credit excesses and festering system fragilities, choosing instead to price debt obligations based on the expectation for zero defaults, abundant liquidity, readily available hedging instruments, and a policymaking regime that would ensure market stability.

Importantly, this backdrop created the perfect market environment for financial leveraging and rampant speculation in a global financial backdrop unsurpassed for its capacity for excess. The arbitrage of European bond yields was likely one of history’s most lucrative speculative endeavors. (link via U. Doran)

In simple terms, this is the stark reality: now that debt and risk have been repriced, Europe’s debts are completely, totally unpayable. There is no way to keep adding to the Matterhorn of debt at the old cheap rate of interest, and there is no way to roll over the trillions of euros in debt that are coming due at the old near-zero rates.

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The Endgame: Europe is finished

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by Tyler Durden
Posted Zero Hedge on September 14, 2011

THE MOST SCATHING REPORT DESCRIBING IN EXQUISITE DETAIL the coming financial apocalypse in Europe comes not from some fringe blogger or soundbite striving politician, but from perpetual bulge bracket wannabe, Jefferies, and specifically its chief market strategist David Zervos. “The bottom line is that it looks like a Lehman like event is about to be unleashed on Europe WITHOUT an effective TARP like structure fully in place.

Now maybe, just maybe, they can do what the US did and build one on the fly – wiping out a few institutions and then using an expanded EFSF/Eurobond structure to prevent systemic collapse. But politically that is increasingly feeling like a long shot. Rather it looks like we will get 17 TARPs – one for each country. That is going to require a US style socialization of each banking system – with many WAMUs, Wachovias, AIGs and IndyMacs along the way.

The road map for Europe is still 2008 in the US, with the end game a country by country socialization of their commercial banks. The fact is that the Germans are NOT going to pay for pan European structure to recap French and Italian banks – even though it is probably a more cost effective solution for both the German banks and taxpayers….Expect a massive policy response in Europe and a move towards financial market nationlaization that will make the US experience look like a walk in the park. ” Must read for anyone who wants a glimpse of the endgame. Oh, good luck China. You’ll need it.

Full Report:

In most ways the excess borrowing by, and lending to, European sovereign nations was no different than it was to US subprime households. In both cases loans were made to folks that never had the means to pay them back. And these loans were made in the first place because regulatory arbitrage allowed stealth leverage of the lending on the balance sheets of financial institutions for many years. This levered lending generated short term spikes in both bank profits and most importantly executive compensation – however, the days of excess spread collection and big commercial bank bonuses are now long gone.

We are only left with the long term social costs associated with this malevolent behavior. While there are obvious similarities in the two debtors, there is one VERY important difference – that is concentration. What do I mean by that? Well specifically, there are only a handful of insolvent sovereign European borrowers, while there are millions of bankrupt subprime households. This has been THE key factor in understanding how the differing policy responses to the two debt crisis have evolved.

In the case of US mortgage borrowers, there was no easy way to construct a government bailout for millions of individual households – there was too much dispersion and heterogeneity. Instead the defaults ran quickly through the system in 2008 – forcing insolvency, deleveraging and eventually a systemic shutdown of the financial system. As the regulators FINALLY woke up to the gravity of the situation in October, they reacted with a wholesale socialization of the commercial banking system – TLGP wrapped bank debt and TARP injected equity capital. From then on it has been a long hard road to recovery, and the scars from this excessive lending are still firmly entrenched in both household and banking sector balance sheets.

Even three years later, we are trying to construct some form of household debt service burden relief (ie refi.gov) in order to find a way to put the economy on a sustainable track to recovery. And of course Dodd-Frank and the FHFA are trying to make sure the money center commercial banks both pay for their past sins and are never allowed to sin this way again! More on that below, but first let’s contrast this with the European debt crisis evolution.

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Saving the Euro Zone

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by Gordon Brown
Posted August 15, 2011

[I never imagined in my wildest dreams that I’d be posting a piece by Gordon, an elitist insider by some accounts, and who famously sold the UK’s gold at the lowest possible price back when he was Chancellor, but this is not bad at all, and is linked to the previous post by Jeremy Warner here on QP: Collapse in German growth will lead to Euro rebellion. – Aurick]

LONDON — How could a group of nations that came together with such promise and commitment more than half a century ago, prepared to surrender their currencies and much of their political sovereignty to strengthen integration, now find that their union has been brought to the brink by the small state of Greece, economically and geographically one-fiftieth of Europe? And how can we now prevent a European crisis from writing a new chapter in what will be called “the decline of the West”?

For months we have been told that Europe’s salvation lies in austerity, in the whole Continent applying Germany’s prescription of fiscal discipline to its deficits. We have been told that if austerity does not work it is just because there is not enough of it.

But when Chancellor Angela Merkel of Germany and President Nicholas Sarkozy of France meet in Paris on Tuesday they will find all around them evidence of what they did not expect — failing banks, waning growth and capital flight.

This confirms what many of us have argued from the outset: that Europe’s difficulties have arisen not merely from the one-dimensional issue of deficits, but from a disastrous, three-dimensional configuration that is financial and economic as well as fiscal.

These past few weeks have demonstrated that Europe has a deeply flawed banking system, a widening competitiveness gap, and a debt crisis that cannot get much better if the economy gets worse. It is an already lethal cocktail that becomes more deadly when mixed inside the euro, a currency created without the resilience to withstand difficult times and which has no structure for effective decision-making.

In the normally quiet month of August we have seen these difficulties escalate so rapidly that little now stands between Europe and a decade of low growth, high unemployment, industrial decline and popular discontent, the nearest modern economic parallel for which is the 1930s.

Some time ago I reached the conclusion that there was no solution possible within the existing euro structure. Either the euro has to be fundamentally reformed by Europe’s political leaders and the European Central Bank or it will collapse. After the events of the last few days I know for sure there is not even a chance of a middle way.

I was present at the first meeting ever held of the euro zone heads of government in October 2008, in the immediate wake of the Lehman Brothers crash. Although not a member of the euro, Britain had been invited to explain its decision to restructure and take ownership of some of Britain’s banks. I explained that Europe’s banks were under-capitalized by billions and that the prospect of them collapsing jeopardized the safety of the entire European economy — we could not run capitalism without capital.

I remember the skeptical looks when I explained that European banks were in fact more vulnerable than American banks, that they were far more highly leveraged and far more dependent on short-term wholesale funding. In fact, half of America’s toxic sub-prime assets had been bought by reckless institutions in Europe. Worse still — as we have subsequently discovered — the greater the European banks’ problems, the poorer their insurance coverage, the worse their leverage and thus the more dangerous the risk to us all.

Yet even as the crisis grew, it was difficult to get Europe’s leaders to accept that it was anything other than an Anglo-Saxon one. By convincing themselves that the problem was simply fiscal, they have drawn back from taking proper action.

Europe’s leaders are also handcuffed by an inadequate treaty of Union, by the problem of getting a coherent response from 27 different nations, and by a rise in anti-European sentiment in their home countries (particularly in Germany), which has deterred them from sanctioning collective action beyond that which protects short-term national self-interest.

The exigencies of domestic politics have locked the euro zone into an impossible set of economic constraints — no defaults, no deficits, no stimulus and, of course, no devaluations — which mean that there can also be no banking stability, no lasting growth, no sustained job creation and no boost to competitiveness from their currency.

There is no escaping the basic fact that Europe’s difficulties are indicative of deep structural defects — its declining competitiveness, aging population and persistently high unemployment. Its share of world output, which has already halved, is set to halve from 20 percent today to around 10 percent over the next two decades.

Yet as the world’s financial crash has evolved — expanding through Europe into an economic downturn, and then a debt crisis, the Continent has, at each stage of the process, remained doggedly behind the curve. Even as recently as a month ago it could have avoided the events now driving it to breaking point. A European stabilization fund of some €2 trillion could have convinced the markets that Europe meant business wherever it was confronted with problems. A Brady bond solution for Greece, Ireland and Portugal — in which private creditors restructure their holdings — might have cauterized the issue of insolvency in Europe’s periphery. (Forcing Spain and Italy to join the new precautionary facility might have worked as late as two weeks ago as a solution to the cost of financing their loans). A root and branch recapitalization of the banks would have sent out the desperately needed signal that the Continent was serious about the underlying weaknesses in its financial sector. Demanding private sector involvement not just in Greece but across Europe would have produced a lasting framework for sharing the Continent’s burdens.

But Europe has flinched at every turn from showing the decisiveness that its problems require — and in the market panic of the last few days its leaders have been caught out once again trying to stem the fallout from yesterday’s disasters instead of planning the pre-emptive action that will avert the problems of tomorrow.

The time for extemporized solutions is gone. The Continent has to commit to a plan that accepts difficult realities and underpins the several trillions in funding needed to ensure that governments from Greece, Ireland and Portugal to Spain, Italy and Belgium are adequately funded from now to 2014.

So there is no way out except through the biggest recapitalization of the banks in European history and a wholesale reformation of the euro, which will require the coordination of its monetary and fiscal policy, fiscal transfers from rich to poor nations and a commitment to a common European debt facility.

Of course no single country, not even Germany, can afford to bail out all the banks and underwrite all their neighbors. It will require an undertaking that is pan-European, involve commitment from the private sector, and will have to draw on support from the I.M.F., and possibly China and America.

These massive guarantees will necessitate a big shift in Europe’s thinking; that if the world used to need Europe, Europe now needs the world. And this global insight is also essential to equip us for global competition ahead. We will need a repositioning of Europe from consumption-led growth to export-led growth. It will require right across Europe the kind of radical capital product and labor market reforms only a few countries have tried.

The restoration of European growth will also depend on better global coordination, in particular a G-20 agreement with America and Asia to ensure financial stability and to coordinate a higher path for global growth. But for all this to happen Germany will have to take the lead.

Gordon Brown, a Labour member of the British Parliament, was Britain’s prime minister from 2007 to 2010 and chancellor of the Exchequer from 1997 to 2007.

America “makes the cut” – So what happens next?

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by Brandon Smith
Posted on Alt-Market, August 7, 2011

AROUND THE WORLD, STARTING MONDAY, ALL EYES ARE ON THE MARKETS. The tension is palpable. The uncertainty is ample. And anger is heavy in the air. As predicted, the debt ceiling deal was not only NOT enough to assuage economic fears, it actually exacerbated them, triggering a flight from the Dow, and creating a decisive opportunity for ratings agency S&P to cut the once perfect U.S. credit rating from AAA to AA+.

At Alt-Market, we often talk about points of balance, and how certain moments in history become highly visible indicators of balance lost. If we pay close attention, and know what we are looking for, these moments can be recognized, allowing us time to shield ourselves from the explosion and the resulting financial shrapnel. The past two weeks have culminated into one of these defining events that tell us the tide has fully turned, and something new and dangerous is just over the horizon. The question now is; what should we expect?

The nature of the credit downgrade situation is not necessarily “unprecedented” in history, but it is surely unprecedented on the scale we see currently in the U.S. It is difficult to predict how exactly the investment world will react. Some consequences, though, are probable, if not inevitable. Let’s examine the events we are likely to see in the coming weeks as well as the coming months, as nations attempt to adjust to America’s final plunge…

1) Ratings Agencies under attack

This has already begun. Italian authorities have raided the offices of S&P and Moody’s, apparently perturbed that their credit rating is not under their control. The U.S. is accusing S&P of making “accounting mistakes” and jumping the gun on the American downgrade. The battle between insolvent governments and the ratings agencies from here on will escalate quickly. More offices will be investigated and raided. The mainstream media will try to assert that the downgrades are “not that important”, and that the U.S. will recover quite nicely without a perfect score. Eventually, as the collapse becomes more evident, ratings agencies will fill the role as the go to scapegoat / economic hitman at which all governments will point accusing fingers.

“S&P is gonna’ cut you man! S&P’s a blade-man, man!”

In my view, it’s all theater. First, let’s set aside the recent ratings cuts altogether and look at the facts. The U.S. should have been downgraded years ago, especially after the Federal Reserve decided to begin purchasing U.S. Treasury Bonds in place of dwindling foreign interest and turned to monetizing our debt to the point of rampant inflation. Italy and numerous other EU members should have been downgraded to junk status a long time ago as well. If anything, the ratings agencies over the past few years have been PROTECTING the credit reputations of many countries which in no way deserve it. The recent downgrades are long overdue…

Second, suddenly governments and MSM pundits feel it necessary to point out the large part ratings agencies played in the derivatives bubble and subsequent credit crisis? Please! They were perfectly content with S&P or Moody’s giving fraudulent top ratings for toxic garbage securities, and even defended agency actions after the bubble burst! Now, after they finally start doing their jobs by downgrading bad debt, governments want an investigation?

Third, ratings agencies were not alone in the creation of the derivatives bubble. The private Federal Reserve artificially lowered interest rates and flooded the markets with cheap fiat. International banks used this fast money to create the easy mortgage groundswell and the derivatives poison that was fed it into the system. Ratings agencies went along with the scam and graded the worthless securities as AAA. The federal government and the SEC allowed all of this to take place by purposely ignoring the crime and refusing to apply existing regulations in investigating the fraud.

The Bottom line? You CANNOT create an economic crisis like the one we face today without collusion between big business, government, regulatory bodies, and ratings agencies. The Obama Administration is well aware of this, and the attacks on S&P are nothing more than a show. S&P is not to blame for the downgrade this past weekend. They are ALL to blame.

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In this grave crisis, the world’s leaders are terrifyingly out of their depth

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by Peter Oborne
Posted August 6th, 2011

Ineffectual: an emergency telephone conference among the G7 finance ministers feels as relevant as a Bourbon family get-together in the summer of 1789

CERTAIN YEARS HAVE GONE DOWN IN HISTORY AS GREAT GLOBAL TURNING POINTS, after which nothing was remotely the same: 1914, 1929, 1939, 1989. Now it looks horribly plausible that 2011 will join their number. The very grave financial crisis that has hung over Europe ever since the banking collapse of three years ago has taken a sinister turn, with the most dreadful and sobering consequences for those of us who live in European democracies.

The events of the past few days have been momentous: the eurozone sovereign debt crisis has escaped from the peripheries and spread to Italy and Spain; parts of the European banking system have frozen up; US Treasuries have been stripped of their AAA rating, which may be the beginning of a process that leads to the loss of the dollar’s vital status as the world’s reserve currency.

There have been warnings that we may be in for a repeat of the calamitous events of 2008. The truth, however, is that the situation is potentially much bleaker even than in those desperate days after the closure of Lehman Brothers. Back then, policy-makers had at their disposal a whole range of powerful tools to remedy the situation which are simply not available today.

First of all, the 2008 crisis struck at the ideal stage of an economic cycle. Interest rates were comparatively high, both in Europe and the United States. This meant that central banks were in a position to avert disaster by slashing the cost of borrowing. Today, rates are still at rock bottom, so that option is no longer available.

Second, the global situation was far more advantageous three years ago. One key reason why Western economies appeared to recover so fast was that China responded with a substantial economic boost. Today, China, plagued by high inflation as a result of this timely intervention, is in no position to stretch out a helping hand.

But it is the final difference that is the most alarming. Back in 2008, national balance sheets were in reasonable shape. In Britain, for example, state debt (according to the official figures, which were, admittedly, highly suspect) stood at around 40 per cent of GDP. This meant that we had the balance sheet strength to step into the markets and bail out failed banks. Partly as a result, national debt has now surged past the 60 per cent mark, meaning that it is impossible for the British government to perform the same rescue operation without risking bankruptcy. Many other Western democracies face the same problem.

The consequence is terrifying. Policy-makers find themselves in the position of a driver heading down the outside lane of a motorway who suddenly finds that none of his controls are working: no accelerator, no brakes and a faulty steering wheel. Experience, skill and a prodigious amount of luck are required if a grave accident is to be averted. Unfortunately, it is painfully apparent that none of these qualities are available: Western leaders are out of their depth.

Barack Obama feels more and more like a president from the Jimmy Carter tradition: well meaning but ineffectual. And contemplate the sheer fatuity of the statement issued by Angela Merkel’s office on Friday night: “Markets caused the drama. Now they have to make sure to get things straight again.” This remark reveals in the German Chancellor a basic inability even to grasp the nature, let alone understand the scale, of the disaster facing Europe this weekend. Such a failure of comprehension is entirely typical of a certain type of leader throughout history, at times of grave international urgency.

An emergency telephone conference among the finance ministers of the G7 (membership: United States, Japan, Britain, Germany, France, Italy and Canada) has been convened. There was a time when this organisation – with its sublime pretence that financial powerhouses such as India, China and Brazil do not exist – counted for a great deal. This latest discussion feels as relevant as a Bourbon family get-together in the summer of 1789.

Another symptom of the frivolity of the European political class is that the European Central Bank is being urged to intervene in the Italian bond market to restore stability. Standard & Poor’s and Moody’s do not produce ratings for the ECB, but if they did, it would be given junk bond status, or worse. The ECB is bankrupt, and this would be evident for all to see but for the fact that it has grossly overvalued the practically worthless Greek, Irish and Portuguese bonds in its portfolio. At some point, eurozone states will be asked to fill the massive holes in the ECB’s balance sheet, and matters will then get messy. Some may plead poverty; others will point out that the constitution of the ECB specifically prevents it from purchasing national bonds, and that its market operations must have been ultra vires.

Furthermore, it is unclear to whom the ECB – whose dodgy accounting, reckless investments and contemptuous disregard of banking standards make even the most irresponsible Mayfair hedge fund look like a model of propriety – is ultimately accountable. The idea that it can step effectively into the Italian bond market, whose total value of around 1.8 trillion euros makes it larger by far than Greece, Portugal and Ireland combined, is a joke.

Wake up: the eurozone is very close to collapse. It will come as no surprise if some Italian and Spanish banks are forced to close their doors in the course of the next few weeks. Indeed, British holidaymakers on the Continent should be advised to take care: hold only the minimum of the local currency, and treat with especial suspicion euro notes coded Y, S and M (signifying they were printed in Greece, Italy and Portugal respectively). Take plenty of dollars with you, which shopkeepers will certainly accept if there is a run on the banks, or if euros suddenly cease to be legal currency. The precautions may not prove necessary, but there is no point in taking risks.

Where does this leave Britain? First of all, there is no point intruding on private grief. Nothing we can do or say will solve the problems of the eurozone. George Osborne does, however, face one overriding imperative: he must maintain the British national credit. Fortunately, the Chancellor grasps this essential point very clearly. After last year’s general election, he took exactly the right steps to cut the deficit. He must not be driven off course, or the markets will refuse credit to Britain as well (a point that Ed Balls, Labour’s economic spokesman, appears not to understand). An economic firestorm is heading our way, and Britain will be doing very well just to survive.

Merkel faces a Hobson’s choice on eurozone

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by Philip Aldrick
Telegraph Economics Editor
Posted 06 August 2011

Muggings have been on the rise on the streets of east London, Scotland Yard said this week. And blood-stained necklaces have been turning up in pawnbrokers with alarming frequency. It’s no coincidence, police claimed. The surge in snatch-and-grab is all to do with the soaring price of gold.

GOLD HAS BEEN HITTING RECORD HIGH AFTER RECORD HIGH because the precious metal is considered the ultimate safe-haven by nervous investors. And there are a lot of nervous investors in the markets. This week gold struck another record, at $1,681.67 an ounce. Nick Bullman, managing director of ratings agency CheckRisk, reckons it will not stop until breaking its inflation-adjusted peak of $2,300.

It’s not just the shoppers of Canning Town who are getting a mugging. Fear is stalking the markets. Fear of a US downturn, fear of a sovereign debt crisis in Italy or Spain – countries considered “too big to bail”, fear of another global recession. As those fears gathered into panic this week, the world witnessed an extraordinary series of events.

Stock markets did not just crash, they crumpled. Some £149bn was wiped off the value of Britain’s blue-chip stocks as the FTSE 100 suffered the fifth largest fall in its history. Trading in the shares of the country’s biggest banks were suspended after dropping more than 10pc. In just seven trading days from July 26, $4.5 trillion was wiped off the value of equities worldwide.

As investors fled to traditional safe-havens of the Swiss franc and the Japanese yen authorities were forced to act. So strong had panic buying made their currencies that it threatened growth. Both nations intervened. Japan sold about ¥4 trillion (£30bn) of its yen reserves and did ¥10 trillion of quantitative easing (QE). Switzerland cut rates to zero and launched Sfr50bn (£40bn) of QE. The moves bought temporary relief.

The hunt for safety created other bizarre distortions. Yields on US treasury bills – short-term government debt – turned negative. Similarly, Bank of New York Mellon, America’s biggest custodial bank, started levying a fee on deposits of over $50m as it was flooded with cash. Market norms were turned on their head. Investors were paying to lend money. “When you do that, you are saying everything else is just too scary,” said Mr Bullman.

What had the markets spooked was the dawning realisation that Spain and, in particular, Italy may not repay their debts. If that happened, the world would suffer another seizure. “It would be Lehman Brothers on steroids,” as some traders have put it. Italy has been worrying markets since mid-June, a month after Standard & Poor’s put its credit rating on watch. Its benchmark 10-year bonds have been creeping higher ever since – the clearest sign of a looming crisis.

This week’s panic, though, was the culmination of weeks of frayed nerves and political paralysis. “Politicians keep scaring the hell out of people as they seem to be burying their heads in the sand,” Mr Bullman said. Which is why, if there was an original tipping point, it can be traced to July 21. That was the day the second Greek rescue was agreed and further measures unveiled to prevent another eurozone country being sucked into the crisis – following Ireland and Portugal as well as Greece. The backstop was dangerously weak, though. The size of the eurozone bail-out fund, the European Financial Stability Facility (EFSF), was increased from €250bn to €440bn and the terms of its operations broadened to make it more nimble. But the agreement needed a vote, due in September, and seemingly ignored the risk of a Spanish or Italian crisis.

To provide a real firebreak, the EFSF needs about €2 trillion, analysts reckon. Italy’s national debts are €1.8bn, the third largest debt market in the world behind the US and Japan. Spain’s are €640bn. An EFSF with €440bn was woefully inadequate. Europe’s leaders, though, simply closed their ears to the siren voices and turned to planning their summer holidays.

Alarm bells should have already been ringing. At 4.8pc on June 21, Italian bonds had surged to 5.68pc shortly before the Greek bail-out. The lesson from Greece, Ireland and Portugal was that once bonds top 5pc, they soar to 7pc within 30 to 60 days without intervention. At 7pc, the debt problem becomes a full-blown crisis – as markets decide the country can no longer pay its bills. With no credible backstop, market fears were allowed to burn out of control.

Already wearied by the drawn-out deal to raise the US debt ceiling, which only entrenched political cynicism, and unnerved by evidence that the global recovery is stalling, the second tipping point came this week. First the President of the European Commission, José Manuel Barroso admitted in a letter to European heads of state that the size of the EFSF needed to be increased. Hours later, the European Central Bank intervened in the markets – but instead of buying distressed Spanish and Italian debt it targeted Portuguese and Irish bonds. Seemingly, political divisions within the ECB were neutering its powers.

Holger Schmieding, economist at Berenberg Bank, said the ECB’s move “may go down in history as its worst blunder yet”. “What would we make of a fire brigade that responds to a major emergency but then drives to the wrong place and refuses to turn around and douse the real fire?” Traders scented weak political will and rounded in fear on Italy. Its bonds rocketed to 6.189pc – a fresh euro record.

If it can’t raise funds, Italy has until the end of September before it runs out of cash or Europe comes to its aid. Spain has until February. The problem is now purely political. Italy needs more austerity to reduce its debt burden, and to push through structural reforms to make its labour market more competitive. Spain must recapitalise its banks, and accelerate its own austerity plans. In return, Europe has to make the EFSF a viable safety net.

As usual in Europe, it all comes back to truculent Germany. Only Berlin can provide the guarantees needed to restore confidence. But it is too late to buy confidence cheaply. Angela Merkel, the German Chancellor, faces a classic Hobson’s choice. Put taxpayer money on the line and lose her job, or risk a catastrophe. That’s a mugging in all but name. Unsettling parallels are being drawn between the current panic and the market meltdown in 2008.

Then, as now, oil had blown sky high. It hit $145 a barrel in July 2008 before coming back down. This time it struck $125. Inflation, too, was out of control – at around 5pc – in line with most economists’ forecasts for the next few months. Stock markets had moved sharply lower and growth had started to slow.

More pertinently, the country had been wrestling with a looming crisis for months – that time with the banks. Seized by similar indecision, policymakers took five months to nationalise Northern Rock and failed to recapitalise other lenders until too late. Then, a political decision not to bail out Lehman Brothers triggered panic that paralysed markets. This time, it is again in politicians hands. The parallels are not surprising. Ultimately, the current crisis is the latest manifestation of the last one.

S&P downgrades U.S. debt rating‏

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from National Inflation Association
Posted August 6, 2011

S&P just announced late this evening that they have downgraded the U.S. debt rating from AAA to AA+ with a negative outlook.

NIA is absolutely shocked by this. What shocks us is just how long it took them to make this downgrade. Just like how S&P and Moody’s didn’t downgrade subprime CDOs until the mortgage-backed bonds they held were practically worthless, S&P waited for U.S. debt obligations to reach five times GDP and for the U.S. dollar to lose 84% of its purchasing power over the course of a single decade. The U.S. was a hair away from defaulting on its debt this week if the debt ceiling wasn’t raised, yet it still had a AAA rating.

NIA believes that a AAA rating should be reserved for countries that have budget surpluses, low levels of debt that could easily be paid off without printing money, and low levels of inflation. The U.S. had a cash budget deficit last year of $1.3 trillion, but once you include increases to unfunded liabilities, our real budget deficit was approximately $5 trillion. Even if Americans were taxed 100% of their income it wouldn’t be enough to balance the budget.

It is hard to imagine a fiscal situation worse than this, but the credit ratings agencies have justified giving the U.S. a AAA rating based on the dollar’s status as the world’s reserve currency and the Federal Reserve’s ability to monetize our deficits and debts by printing money. If it wasn’t for our printing press and the world’s willingness to accept and hoard the dollars we print in return for the real products and commodities they produce, the U.S. credit rating would be junk.

S&P claims that their reason for downgrading the U.S. debt rating at this time is because, “the differences between political parties have proven to be extraordinarily difficult to bridge”. According to S&P, it is because our two political parties are so far apart that we weren’t able to pass a bill with anything but modest spending cuts. The reality is, the Republicans and Democrats aren’t far apart at all. Neither parties are serious about cutting spending and the underlying fundamentals of both their proposed bills were exactly the same. The Republicans that American tea party supporters elected to office have broken their promises to make major spending cuts and have accomplished absolutely nothing positive since entering office.

Our country just had an unbelievable opportunity to dramatically cut government spending in a last ditch effort to prevent hyperinflation. Instead, our government passed a bill to raise the debt ceiling that had no real spending cuts at all. The mainstream media tried to spin the bill into being a victory for U.S. tea party supporters due to the purported “spending cuts” that it contained.

The truth is, government spending is set to rise every single year until the dollar is worthless. The $2.1 trillion in phony spending cuts are only tiny reductions to large spending increases and none of them will begin until early 2013 when we will need to once again raise the debt ceiling. Even if the government in early 2013 decides to follow through with them, rising interest payments on our national debt will mean substantially larger budget deficits than what are projected today.

With the stock market down big in recent weeks, NIA believes that this evening’s news is already mostly factored into stock prices. With the Fed Funds Rate having been left near zero for over two years, the world is flooded with excess liquidity of U.S. dollars and there is no chance of the stock market crashing like in late-2008/early-2009. In fact, the recent downward move in the stock market means the Federal Reserve is likely to soon implement additional monetary inflation measures and will leave the Fed Funds Rate near zero permanently.

The GDP was already on its way to becoming negative in the second half of 2011 and if the U.S. wants to avoid a debt default later this decade, it needs the Federal Reserve to print enough money to see at least 5% annual nominal GDP growth. It’s not just the Federal Government that needs GDP to grow, but most cities and states will default on their debts if GDP doesn’t grow rapidly. Cities and states don’t have printing presses so unless the U.S. government wants to bail them all out like the European Union is bailing out Greece, Portugal, and Ireland, it needs to create GDP growth even if that means the Federal Reserve eliminating interest payments on the $1.6 trillion in excess reserves held by banks and taxing banks who don’t lend the money.

NIA prays that Americans don’t make the mistake of buying U.S. Treasuries as a safe haven, as they are now the riskiest asset of all. If U.S. Treasuries rally next week, it will only be temporary and will be followed by the largest and sharpest reversal in history with a crash in Treasury prices and an explosion in yields like never seen before. Most Keynesian economists will likely forecast rising Treasury prices despite the U.S. debt crisis, because they claim the bond markets in other countries are tiny compared to ours and there simply is no other place to park safe haven money.

In our opinion, there is no reason to own the fiat currency denominated bonds of any country or company. Gold and silver are the only true safe havens and it is our belief that by the end of this year, the U.S. public will begin investing into gold and silver in droves as they realize that although we avoided a debt default for now, a debt default by inflation is still on its way. The largest ever short-term rally in precious metals and mining stocks is ahead.

It is important to spread the word about NIA to as many people as possible, as quickly as possible, if you want America to survive hyperinflation. Please tell everybody you know to become members of NIA for free immediately at: http://inflation.us