The World Is Too Intertwined


Europe cannot be rescued and thus the US and the Rest of the World. The world is too intertwined

The world is more intertwined than ever before and contagion and counter party risk will rule in the next breakdown hence why we favor US treasuries, a US$10trn (liquid) market, physical gold and silver, diamonds, agricultural land and water reserves.

CDS offers no insurance in case of voluntary haircut: more uncertainty

Greece with 2·y interest rates above 80% is technically in default. It is only for cosmetic and political reasons that it has not been officially declared a default, although every day we are getting closer to the unavoidable outcome. By the way how crazy is it that the ISDA has deemed that a "voluntary" haircut of 50% on Greek sovereign debt doesn’t trigger a payment from the CDS or Credit Default Swaps. In other words no insurance can be obtained against so called voluntary haircuts. What we are witnessing is increased intransparancy and instability. Politicians are losing popularity because of the austerity measures they have to take resulting in their resignations (Papandreou, Berlusconi) only to be replaced by the next batch of politicians. The strong medicine needed to cure the debt disease will not be any different. So unless the new people in charge have a lot of credibility and charisma the outcome for the new politicians, resignation will not be different. Monti (Goldman school as is Draghi) might be a technocrat and have sound ideas how to tackle the problems and gain the trust of the member states but he still will have to deal with the Roman civil servants. Ideas is one, execution is another. We believe more instability, uncertainty and unrest is in store.

Unrest will be common denominator going forward

We believe that unrest will be the common denominator going forward, all for different reasons. In the Western world insurmountable debt and pensions that can’t be paid, "freedom" of dictatorial and not democratically elected regimes in Northern Africa and the Middle East, and (food) inflation in the Emerging Countries, more specific also, the corruption and unaffordability of housing in China with more than (non·reported) 100,000 riots a year. We will see unrest worldwide before we will see better times.

No decisiveness in Europe

The entire process of the much needed unanimous agreement of the 17 member states of the EMU is too much of a hurdle to decisively solve the serious problems we are witnessing. The downgrade of Italy in October from A+ to A also confirms the inability of the politicians to swiftly and boldly put a believable and effective austerity plan in place, hence Berlusconi’s resignation. The countries can’t even agree on the functions and powers of the different bodies such as the ECB, EFSF, IMF and SPV. They are demanding asset sales of ¤5bn from Italy!! What is ¤5bn going to do on a total debt of €1,900bn? According to a Banca d ‘Italia report published December 2010, at the end of 2009 net wealth of Italian households was estimated to be some €8,600bn vs a public debt mountain currently of €1,900bn. The Italian problem is one of solvency and not liquidity. Around 50% of Italian Government bonds are in domestic hands according to Credit Suisse. According to international standards, Italian households have relatively little debt, only 78% of disposable income, versus 100% for France and Germany, and 130% for the US and Japan. In Italy the problem clearly lies with the State with a Debt/GDP ratio approaching 120% but also with the lax tax morale, as we have also witnessed in Greece. Although Italy has a high savings rate, which means that its domestic banks have customarily been able to pick up most of its government debt, their ability to do so is coming under pressure. There has been a constant erosion of the investor interest for Italian debt, both inside and outside the country.

The black economy in Italy and Greece are estimated to be between 25-27% in 2011. So why should the frugal countries such as Germany, the Netherlands and others have to bail out Italy and Greece, who have lived beyond their means and haven’t made enough effort to collect taxes to the favor of the net wealth of in particular the Italian and Greek households.

Countries contributing to the EFSF in need of rescue themselves!

Assuming a bail·out of Italy, next to the €250bn that is remaining of the original €440bn assigned to the EFSF €139bn must be put in by Italy. How crazy is that? Italy’s 10·y bonds were yielding an unsustainable 7.48% on November 9, 2011, and Italy would have to contribute €139bn whilst they most likely will have to be rescued. The EFSF, which could barely raise €3bn the other day, and the way the member states are (not) addressing the problem are a farce. It will not work. It is too little too late.

If anything, the strong countries in the Euro zone better look at injecting the proposed EFSF contributions into their own banking system instead of throwing good money after bad. The contributions are too small to rescue the PIIGS that, as illustrated by their rising interest rates, are already beyond the tipping point. In the end even a 50% haircut, "reducing" the Greek debt from €355bn to €175bn will not get Greece out of their troubles, with a contracting economy and a tax morale whereby everybody is looking out for themselves to survive. And last but not least surrounding economies, also in dire straits, won’t be able to pull the Greek economy out of its rut. Moreover if the results of the Greek rescue would be "contained", which money would be left to deal with the other countries in a similar situation, be it the size of the total debt (Italy €1,900), unemployment (Spain 21.5%) or Debt/GDP ratios (Italy 120%). In the end the banks holding sovereign debt still wouldn’t be rescued. In the Spanish region of La Mancha the Government owes the pharmacies some €150m for dispersed drugs and the Spanish Government is not paying its bills to help "reduce" its budget deficit. What does that tell you? In our point of view it shows that the problems in Spain are running very deep. Five banks in Spain are not complying with the required capital ratios. The Spanish population, unlike the households in Italy, is highly leveraged due to mortgage debt and still grossly overvalued housing. Banks have only assumed 15% write offs in residential housing prices, whilst 50% is probably a more accepted figure. Telefonica’s reported its first quarterly loss in 9 years reflecting the very weak Spanish marketplace. Spain, with unemployment of 21.5% (and 45·50% for the 25 year olds and younger) so far has been able to avoid an attack on its sovereign debt though is most likely next in line.

A sovereign debt crisis affects the banks and visa versa

As we know, the problem with the default of Greece and other European countries is that the banks have a lot of sovereign debt on their books which will incur significant losses following official defaults. As above mentioned the reason the other European countries are not declaring default on Greece is that the banks would have to take the losses on their Greek sovereign debt portfolio which will weaken their balance sheet and capital ratios.

According to the BIS, Bank of International Settlements, US banks alone have an exposure of €478bn or $665bn to Greece, Ireland, Italy, Portugal and Spain. Greece has €355bn in sovereign debt (160% Debt/GDP), Ireland has €148bn in sovereign debt (96%) , Portugal €161bn (93%), Spain €637bn (60%) and Italy €1,900bn in sovereign debt outstanding, representing 120% of GDP. That adds up to approximately €3,3trn or $4,5trn in questionable European debt.

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