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Sunday, June 05, 2011

O2 LIFE MATTERS | > A Random Walk Through the Minefield



>By John Mauldin - RITHOLTZ.com

Would You Like to Read Over My Shoulder?
Dysfunctional, Thy Name Is Europe
What Happens if the Greeks Default?
Trigger Points and Evasive Action
A Random Walk Through the Minefield
Gaming the GDP Numbers
Tuscany (And I Get the Irony)

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All political thinking for years past has been vitiated in the same way. People can foresee the future only when it coincides with their own wishes, and the most grossly obvious facts can be ignored when they are unwelcome.”
George Orwell
“ Hindsight is not only clearer than perception-in-the-moment but also unfair to those who actually lived through the moment.”
Edwin S. Shneidman, Autopsy Of A Suicidal Mind
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Brinkmanship is defined as the practice of pushing dangerous events to the verge of disaster in order to achieve the most advantageous outcome. It occurs in international politics, foreign policy, labor relations, and (in contemporary settings) military strategy involving the threatened use of nuclear weapons.
This maneuver of pushing a situation with the opponent to the brink succeeds by forcing the opponent to back down and make concessions. This might be achieved through diplomatic maneuvers by creating the impression that one is willing to use extreme methods rather than concede. During the Cold War, the threat of nuclear force was often used as such an escalating measure. Adolf Hitler also utilized brinkmanship conspicuously during his rise to power. (More on ignoring events and Hitler later on.)
In the last 48 hours, so much news has come out of Europe that has me frankly shaking my head. It is a strange game of brinksmanship they are playing, and it is one we should be paying attention to (as if the brinkmanship played by US politicians over the debt ceiling is not enough). This week we look at what seems to be European leaders taking random walks through the minefield at the very heart of the European Experiment. As Paul Simon wrote, “A man sees what he wants to see and disregards the rest.” But first…

Would You Like to Read Over My Shoulder?

As you know, I read scores (if not hundreds) of reports and analyses each week to put together my letters. Wouldn’t you like it if I could filter for you what is important? The few things that you should read? What would it be worth to you to have someone with my years of experience and breadth of resources available to you as your own personal reader/filter?
I can be just that. I’ve now launched a new service called Over My Shoulder to bring you the very best 5-10 pieces I read each week.
I’ll call your attention to some of the most fascinating analysts out there, people with non-intuitive perspectives on some of the most pressing issues facing us as individual investors. Concerned about inflation/deflation? Wondering about the future for US markets and sovereign debt? Europe? It’s all here.
If you need cogent analysis and clear reasoning, this is the service for you. And if you want to see the data, charts, and graphics that back it all up, you’ll get them. Would that be worth just $39 every three months? What is just one piece worth to you that helps you make that critical decision?
My job is to find you the best of the best, making sure your radar is pointed at the critical issues and weeding out all the noise. If your time matters as much as your investments, click here to learn more: http://www.johnmauldin.com/overmyshoulder/recent/
And let me hasten to note, this weekly letter will not change. It will still be free, coming to you each weekend. And now on to this week’s letter.

Dysfunctional, Thy Name Is Europe

This week one member of the European Central Bank after another repeated the warning that if Greece defaults or restructures its debt, then Greek debt would not be eligible for use as collateral at the ECB, nor would Greek bank debt. They are continually warning of “contagion risks” and the end of the euro as we know it, and all in stentorian tones that would make any doomsday prophet of Armageddon jealous.
But this ignores reality. Greece simply cannot bear the burden of the debt. Some sort of restructuring or “reprofiling” is clearly going to be needed, if not outright default. There are those in the EU who are recognizing this.
Even a Greek EU commissioner (of fishing) noted the problem openly:
ATHENS, Greece – A Greek EU Commissioner warned that the country’s participation in the euro was under threat, though the prime minister insisted Wednesday his government would see through new austerity measures and keep Greece in the joint currency. The EU’s Fisheries Commissioner, Greece’s Maria Damanaki, warned that:
“ ‘The scenario of removing Greece from the euro is now on the table. I am obliged to speak openly. We have a historical responsibility to see the dilemma clearly: either we agree with our borrowers on a program of tough sacrifices with results … or we return to the drachma,’ she said in a statement on her personal website. Damanaki does not represent the Greek government, but she is part of the ruling Socialist party.” (Yahoo)
Of course, there were quick denials by the government and the prime minister that there were even any discussions of leaving the eurozone, which I find rather odd. I mean, if you are not having discussions about all the options (behind closed doors) then you are being derelict in your duties. We shall learn soon enough that there have in fact been such discussions. The Greels may in fact reject the idea of leaving the euro, but to think they did not have such a discussion rather strains credulity.
Here’s the reality in Europe. Greece and Portugal are effectively shut out of the debt market without EU and ECB loans. Ireland will not be able to (nor should it!) handle the debt it has taken from the ECB to bail out its banks. If they acknowledge that debt, lenders will recognize they cannot service any new debt, and they will be shut out of the debt markets without ECB and EU guarantees.
The IMF warned this week it may not continue funding Greek debt in the very near term. Greece might be denied the next tranche of financial aid if an audit of its budget accounting shows that the country cannot guarantee financing for the next 12 months, Eurogroup President Jean-Claude Juncker said Thursday. “I’m not the spokesman of the International Monetary Fund, but the rules say they can only disburse if there is a financing guarantee for the 12-month period,” Juncker told reporters at a conference in Luxembourg. Juncker is very discreet and savvy. Clearly he had discussions with IMF leaders before making such a statement.
“If that happens, he said, the IMF’s rules could stop the fund from contributing its share of the next slug of bailout money, due to be paid out to Greece on June 29. The review, from the so-called troika of officials from the European Commission, European Central Bank and IMF, is due to be presented next week. ‘I don’t think that the troika will come to the conclusion that this’—12 months of funding commitments for Greece—‘is certain,’ said Mr. Juncker, speaking at a conference in Luxembourg.
“In that case, the IMF would expect other euro-zone governments to step in and cover the funds. Drumming up that financing would be hard in countries such as Germany and Finland, he said. IMF spokeswoman Caroline Atkinson said Thursday in Washington that the fund generally doesn’t lend if there are gaps in financing, and that it was seeking reassurance from the euro-zone countries who are also lending to Greece. The IMF is providing €30 billion of the €110 billion facility, with the balance provided by euro-zone countries.” (Wall Street Journal)
This is all brinksmanship. The ECB says Greece will get nothing if they default. The EU says that to get money the Greeks must make even deeper cuts, while a soon-to-be-completed audit will show they are in worse shape rather than improving. The Greeks have an obscure minister who is not part of the government say they might leave the euro. The IMF says they may not fund without further commitments from the euro members, which are going to be tough to get from Germany and Finland, at the least.
The German government has been proposing to fill Greece’s finance gap without providing more loans, by asking holders of Greek bonds maturing in the next couple of years to agree to postpone their repayments. Yeah, like that’s going to happen. Let’s depend on the kindness of strangers.
Again, from the Journal:
“Analysts and officials say a political fudge will likely be worked out that won’t leave the euro zone hanging on a precipice on June 29. Since the IMF is providing only around a quarter of the funding, the euro zone’s existing commitments alone would tide Greece over for a few months as European leaders debate additional financing.
“However, short-term fixes won’t resolve the fundamental tensions around Greece’s debt that are putting the ECB, IMF and creditor governments at odds, analysts say. Many believe if something gives, it will be the ECB. ‘One of the sides will have to give way. I believe that the ECB’s threat of leaving Greek bonds out … is not something it will actually carry through. I don’t think it’s a credible threat because it’s a nuclear option,’ Mr. Kapoor said.”
Brinkmanship indeed. Let’s look at a few graphs from a scathingly critical post in Der Spiegel about the central banks of the various countries in Europe and the ECB itself, which show us why the ECB is so worried about a default. As it turns out, the ECB would be in worse shape than Lehman was in September 2008! You can read the article at http://www.spiegel.de/international/business/0,1518,764299,00.html. It is not pleasant reading if you pay taxes in Europe. Especially if you are German.
“While Europe is preoccupied with a possible restructuring of Greece’s debt, huge risks lurk elsewhere – in the balance sheet of the European Central Bank. The guardian of the single currency has taken on billions of euros worth of risky securities as collateral for loans to shore up the banks of struggling nations.
“… Since the beginning of the financial crisis, banks in countries like Ireland, Portugal, Spain and Greece have unloaded risks amounting to several hundred billion euros with central banks. The central banks have distributed large sums to their countries’ financial institutions to prevent them from collapsing. They have accepted securities as collateral, many of which are – to put it mildly – not particularly valuable.
“Risks Transferred to ECB
“These risks are now on the ECB’s books because the central banks of the euro countries are not autonomous but, rather, part of the ECB system. When banks in Ireland go bankrupt and their securities aren’t worth enough, the euro countries must collectively account for the loss. Germany’s central bank, the Bundesbank, provides 27 percent of the ECB’s capital, which means that it would have to pay for more than a quarter of all losses.
“For 2010 and the two ensuing years, the Bundesbank has already decided to establish reserves for a total of €4.9 billion ($7 billion) to cover possible risks. The failure of a country like Greece, which would almost inevitably lead to the bankruptcy of a few Greek banks, would increase the bill dramatically, because the ECB is believed to have purchased Greek government bonds for €47 billion. Besides, by the end of April, the ECB had spent about €90 billion on refinancing Greek banks.” (Der Spiegel)

Two graphs from the article say a lot:





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