"It's a Ponzi scheme, it's a fraud, it's a sham," observed Jim Rogers this week when interviewed on the BBC World Service. One of the world's most successful investors was, however, not giving his verdict on the dastardly deeds which have confined Bernard Madoff to prison for 150 years, but rather the current strategy of the European Central Bank (ECB) and European leaders in trying to solve the euro zone sovereign debt crisis. For Rogers, their approach is based more on Peter Pan than sound monetary policy.
Ever since euro zone banks snapped up almost half a trillion euros in very low interest three-year loans offered by the ECB last week, the question was to what extent these banks would do the sovereigns a favour, as Nicholas Sarkozy hoped, by buying the bonds of euro zone governments. The answer, based on the results of Italy's latest bond auction on Thursday, is not encouraging. Investors are simply not prepared to lend money to Italy on a long-term basis without a cripplingly high premium, which at 6.98% is barely below the 7% level that forced Ireland, Greece and Portugal to request international bailouts.
If investors in government bonds seem a little nervous at the prospect of buying what until recently were seen as virtually risk-free financial assets, the reason for this reticence, as Jim Rogers observed, is not hard to discern. Money, as Harvard historian Niall Ferguson notes, is about trust and over the last two years the euro zone's political leaders have been extraordinarily successful at blowing every opportunity to solve the debt crisis and restore trust in the single currency project. When ordinary citizens can borrow money at less interest than the Italian state, then it's clear just how serious this crisis has become. For Anthony Crescenzi, executive vice president at Pimco, the largest bond fund in the world, European sovereign debt is "toxic" with about the same status that subprime mortgage assets have had ever since the financial crisis of 2008.
What got rather less attention than the ECB handing out money last week was the news that a large number of euro zone banks actually deposited €452 billion ($589 billion) with the Frankfurt-based central bank at a paltry rate of interest, and for far less than they could earn making loans to other financial institutions. The reason? These banks are simply too nervous to lend at more profitable rates because they fear not being repaid. Across the euro zone there are zombie banks that have effectively failed and are only being kept alive with funds from the ECB. In this environment even healthy banks would sooner make next to nothing depositing their cash at the ECB, rather than risk lending to a competitor that might run into trouble as the Franco-Belgian bank Dexia did recently. Things wouldn't be so bad if the banks and bond investors had confidence that euro zone governments would step in to support their banking systems the way the UK did in 2008. But given the parlous state of government finances in most euro zone countries, underlined by the recent credit downgrade
If the markets were convinced that a credible government treasury like that of Germany was standing full square behind Europe's monetary union project, confidence could be restored, but every botched EU summit and failed rescue plan shows just how rickety the euro edifice has become. Resolving a systemic banking crisis requires that the politicians involved in finding a solution recognise that the markets do not move at the glacial pace of government. Investors in sovereign bonds will render judgements swiftly and ruthlessly if the measures taken are not seen as credible. Even as the ECB continues to inject money into the crippled banking system, the hope of its policymakers is that some of this liquidity will either find its way into the real economy or at least bring down the borrowing costs for the euro zone's governments. To paraphrase Jim Rogers, 'Welcome to Never Never Land'! Far more likely is that this suffocating embrace between indebted euro zone governments and their living dead banks will simply ensure that when the day of reckoning comes, when the bond markets finally say "No more money," the pain will be that much greater.
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However, if European (and American) countries modify their economic cost structures, the standard of living for the citizens would also meet the international standard. The current standard is set by China and India. Almost half of world's workers live in these two countries. An average worker in China, in the rich regions, makes about $200 per month, or about 1/19 that of the U.S.
What investor would want to buy toxic bonds, even at 7%, when they can buy US bonds at half that rate and still come out better over time.
This taboo should be lifted, and a frank discussion held on the pros and cons of euro abandonment. As long as politicians cannot even admit the possibility of something that seems increasingly inevitable, there can be no trust.
The easiset way for Greece and the other PIIGs to skate free would be to default on bonds, re-establish their own currency & bite the bullet. Their credit worthyness would be viewed badly for years - but it is going to be viewed badly anyway.
Refinery Crunch In Europe
A few weeks ago we discussed the pressure the Greeks were under to source their energy needs from Iran since no one else would extend them credit.
The European credit strain contagion now appears to be spreading rapidly as Europe's largest independent refiner by capacity, Petroplus Holdings AG, is suspending operations at three plants as banks freeze a $1bn revolving loan facility.
S&P cut its rating from B to CCC+ citing a sharp deterioration in the firm's liquidity position. As a pure play refiner, meaning it needs to buy all of its crude supplies (on credit obviously) to feed its plants, it seems evident that both vendor- and bank-financing mechansims are starting to clog up very seriously if the largest independent refiner can't get credit. Bloomberg notes that refining margins are down considerably and we suspect that the closure of the Petroplus plants will help margins implicitly but as headlines show:
*PETROPLUS SAYS TEMPORARY ECONOMIC SHUTDOWNS IN JAN. '12
*PETROPLUS SAYS RESTART DEPENDS ON ECONOMIC CONDITIONS, CREDIT AVAILABLE
Of course no one trusts any of them...all of them have been trying to hide and minimize their own nation's problems and growing problems. Some have point blank lied about their Debt, their future obligations, tax revenues, growth forecasts and so forth.
No investor in his right mind wants these guy on the books, unless you're taking a purely speculative gambling play. Now with CHina's economy showing significant problems...whihc will get MUCH worse, the EU won;t have any solution or traction for year(s)..
I'd opt for the latter anyday.
The problem here is government overspending. The only answer is reducing that spending. The EU progressives and socialists have run out of other people's money.
However, considering that about 60% of all working people in Europe work for the government and large percentage of public spending goes toward their salaries, reducing spending will mean cutting wages and laying off millions of currently emplyed people. As Europe heavily relies on consumer spending, the above solution will mean years of recession. Civil service wages will simply become (somewhat lower) unemployment and welfare payments.
Not a pretty picture, even if (probably) the only one possible...
http://www.paecon.net/PAEReview/issue58/Koo58.pdf
for details and lots of actual data on how handled a bubble collapse.
It has to do with how the euro was set up. Badly. Very, very badly.