Are the non-industrialized countries in the EU actually just another version of sub-prime (sovereign) debt on a global scale?
I wrote this article for TheStreet.com (OptionsProfits), so I have excluded some details which are noted by "-snip-".
Speaking to the casual market participant often times I hear only a superficial understanding (or willingness to understand) of the current global financial situation -- specific to Europe but also including Asia. Let’s talk about the Euro Zone, what it is, what it was supposed to be, why it exists, who garners power from it and what incentive there is to keep it or scrap it. Somewhere in all that, we’ll find the trouble and the potential impact it has on the global economy, or more relevant to us, our US economy.
Let’s start with, once upon a time… Oddly, a chunk of this article comes from a post I published in May of last year... Hmm...
Here’s a link to that post:
The European Crisis ExplainedFirst, a very quick background on the Euro:The Treaty of Maastricht (formally, the Treaty on European Union) was signed on 2-7-1992 by the members of the European Community in Maastricht, the Netherlands. Amongst other things, it created the rules (requirements) for joining the European Union (i.e. the Euro).
The idea behind the Euro: By amalgamating these currencies, countries like Spain, Portugal, Italy and Greece, which were traditionally agricultural economies, would now be able to borrow money with the same terms as the highly efficient and industrialized economies (i.e. Germany and France).
Greece: The requirements to enter the EU were focused around debt, inflation and trade. Greece did not meet the requirements, but never fear, Goldman Sachs to the rescue. I’ll spare you the details, but let’s just say there was some “finagling.”
Of course, no matter how you "arrange," reality strikes back.
-snip-
For all you who think Greece is going to get "kicked-out" of the EU...
-snip-
Germany’s motivation: Keep in mind that Germany's geo-political clout stems from the EU existing and growing, without it, they're just Germany, with it, they are Europe (is there any precedence to worry about that?... hmmm).
Back to the Present: I think we’ve read enough about Greece, but here’s a snippet from an article I posted 10-31-2011, entitled
“Risk in Not Out of the Picture.” I wrote this in a response to the market upturn after the European leaders got together and finally settled on what at times seemed a contentious negotiation. This is a hyper shortened version, you’re invited to read the original one on OP.
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1. -snip-
2. The Eurozone banking sector needs recapitalization to the tune of 106 billion euros.
3. The “bail-out” fund for emergencies has been increased from 440 billion euros to 1 trillion euros. This is the fund that has already been used to prop up Greece, Ireland and Portugal.
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And of course, the “potential” problems:
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1. -snip-
2. -snip-
3. The “bail-out” fund was increased to 1 trillion euros, but, where does that money come from? Yeah, there were no details, no sentence fragments, nothing that I have found that tells us where the magical 600 billion euros come from except for this: “Around 250 billion euros remaining in the fund will be leveraged 4-5 times, producing a headline figure of around 1.0 trillion euros, which will be deployed in a variety of ways.”
An FT article writes:
The €1,000bn that has been touted for the fund’s size is, as a result, a guesstimate based on the still-untested ability to multiply a still-unknown asset base by four to five times. “This is an approximate value,” acknowledged Angela Merkel, the German chancellor. “We don’t know yet how this works.”
Source: Financial Times; The devil in the details and the data, by Peter Spiegel in Brussels
4. Not that #3 isn’t bad enough, but there weren’t any details about how the money from the “bail-out” fund would be used. What if Spain, Portugal, Italy, Ireland and Greece all need it? What if Germany and France need it?
5. Just to be clear about Greece, AFTER the writedown of its debt, the country will face a debt load that is 120% of GDP by 2020. Whoa! It’ll be 120% in eight years and working down from ~160% until then. Problem solved... Really? Even further, the details of the writedown aren’t really even close to being done.
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Here’s where the bears come in:Italy is the third largest economy in the EU. This isn’t Greece, Ireland, Hungry or Portugal. Estimates hover around 2 trillion (with a “t”) Euros for a full Italian bailout – thus the phrase “too big to fail, too big to bail.”
But it get’s worse. And by worse I mean, on a global scale. Here are some snippets from an NYT article entitled,
France Keeps a Watchful Eye on Turmoil in Italy ---
While Italy has replaced Greece as the focus of anxiety amid Europe’s worsening debt crisis, investors are increasingly concerned about the outlook for France, whose banks are among the world’s biggest and are closely linked with their counterparts in the United States.
One crucial gauge of investor sentiment, the difference between what France pays to borrow versus what Germany pays, has doubled since the beginning of October, and last week reached its widest point since the formation of the euro currency zone in 1999.
“Once you are dealing with Italy, you are dealing with France as well,” said Hans Mikkelsen, senior credit strategist at Bank of America Merrill Lynch. “This is cutting into the core.”
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How big is France? Here are the top eight largest economies ranked by nominal GDP (
source: Wikipedia).:
1a. EU
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1. US
2. China
3. Japan
4. Germany
5. France
6. UK
7. Brazil
8. Italy
If Italy fails, it seems tautological that France’s rates jump to the now “unsustainable” levels of Italy (7% is the magic number here). Or, in English, that France’s need for short-term financing becomes impossible (too expensive) to fund. That could create a cataclysmic rise in Germany’s rate and the EU for all intents and purposes contaminates the only truly industrialized economies in Europe. So, rather than bringing everyone’s debt rates down to Germany/ France, Germany/France get brought up to the rate of everyone else. This, IMHO, is an obvious outcome – or at least, the obvious risk of forming the EU. When in finance has combining toxic with clean resulted in a clean combination? Did Countrywide get washed away when it combined with Bank of America?
On a side note, if you're wondering about the UK (ya know, #6 on the list)... They just hit a 15 year high in unemployment. For details on that, you can read this:
UK unemployment hits 15-year high The final straw in this potential global nuclear meltdown is China. Yeah, China… The country that is slowly revealing an accounting fraud the size of which the world has never seen, or even contemplated. Here’s a snippet from a France 24 article, today entitled
“IMF warns China's financial system vulnerable” ---
China's financial system is at risk from bad loans, booming private lending and sharp falls in property prices, the International Monetary Fund warned Tuesday, as it called for sweeping reforms.
In its first formal evaluation of China's financial system, the Washington-based lender blamed "heavy" government involvement in the country's banks and watchdogs for reducing market discipline and corporate governance.
[...]
Rampant lending since the 2008 financial crisis has left many companies and local governments in China with huge debts, while a recent slowdown in economic growth and falling property prices have fuelled fears of an explosion in defaults.
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For those keeping score, that would be the largest economy in the world (amalgamated it’s the EU) and then the third largest economy (China). Who’s in the middle? That would be the United States – saddled with persistently high unemployment, a crushed real-estate market and a massive debt load spiraling to record highs (remember that US debt rating downgrade?).
The world is collapsing! Wait... Is it?...Silver LiningThe silver lining is quite bright and brings us back the basic theorems of finance and financial markets. Remember something called the “Efficient Market Hypothesis?” Keep it simple, people know what’s out there – that’s all the news ‘n stuff.
None of the ideas I’ve presented above are unknowns. I am not conveying information that is a surprise. So what? The US market is up – that is, the bad news and potentially worse news has been digested, reacted to, adjusted for and… thank you very much, been priced. Dow 12,000 (or SPX 1,250) has been agreed upon as fair value for now. The world isn’t ending, in fact, the SPX has returned positive 4% this year.
But... If you wondered why VIX is persistently above 30... well, you tell me, is there more risk now than ever before on a global scale?
Yeah, I think there is.
UPDATE #1Because we needed more...
India can't avoid eurozone fallout11:34 AM Anand Sharma, India's minister for commerce and industry tells James Lamont, the FT's South Asia bureau chief, why India cannot insulate itself against the fallout of the eurozone crisis. The minister reiterates that both India and China are committed to do whatever they can to help the eurozone within constraints and warns against protectionism.
Source: Financial Times;
Credits (video): Produced by James Fontanella-Khan. Filmed and edited by Kanupriya Kapoor
UPDATE #2This article that came out one day after this blog is funny to me... Not because of the content, but because... duh...
Futures fall after new warnings on EuropeNEW YORK (Reuters) - U.S. stock index futures fell on Wednesday as policymakers warned Europe's debt crisis posed dangers to the global economy and on growing signs the contagion was starting to spread to larger European nations.
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