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Europe Shocks the Markets by Firing Bazooka at Sovereign Debt Crisis

Stock-Markets / Articles May 10, 2010 - 06:49 PM GMT

By: Axel_Merk


Best Financial Markets Analysis ArticleFrench President Sarkozy wasn’t kidding when he promised to shock the markets with a series of measures aimed at containing the sovereign debt crisis. Europe got the bazooka former U.S. Treasury Secretary Paulson always wanted. German chancellor Merkel and European Central Bank (ECB) President Trichet control the bazooka’s safety. What are the implications for liquidity and solvency issues? The euro and U.S. dollar?

The decisions were breathtaking – literally so, as wheelchair-bound German finance minister Schauble was rushed to hospital after almost suffocated due to an adverse reaction to new medication. Those thinking such an emergency would weaken Germany’s hand were quickly proven wrong: Germany’s interior minister de Maziere was an even more stubborn negotiator. As the package to support weaker eurozone countries grew, Germany dug in its heels, requesting that any country asking for support must meet International Monetary Fund (IMF) terms (read: severe austerity measures). Germany insisted that those contributing to the emergency facility must go beyond guaranteeing the debt of weaker countries and actually provide access to credit. It is our understanding that, as of Sunday night, no final agreement was reached on the mechanism. However, total fiscal commitments are approximately EUR 770 billion or US$ 1 trillion, in our assessment well above the funding requirements of all weaker eurozone countries for the coming years. Beyond existing commitments for Greece and (an older facility) for Eastern Europe, we are talking about a fresh commitment of EUR 500 billion by governments and over EUR 100 billion by the IMF.

For better or worse, those who said Europe couldn’t act have been proven wrong. Europe put in place a de facto central fiscal authority over the weekend. Germany is fighting to ensure that control of the facility will remain with the member countries, i.e. Germany has to agree to how its money is spent, but this may well morph into an independent body to spend money over time.

Very relevant is that part of the package are new austerity measures announced by weaker European countries (with the exception of Ireland) ranging from 0.5% to 1.0% of the respective GDPs for this year in addition to similar cuts next year. Portugal, for example, will tighten its belt by 1% of GDP this year, amongst others by cutting public infrastructure spending; Italy announced measures to cut expenses by 0.7% of GDP both this year and next; Spain will cut expenses by 0.5% this year and 1.0% next year.

Not to be trumped, the European Central Bank (ECB) joined the fray and announced:

•A re-opening of select emergency lending facilities.
•A re-opening of USD swap lines with the Federal Reserve (Fed) and major central banks around the world, ensuring European banks have sufficient access to U.S. dollar credit.
•A program for the ECB to have its Governing Council decide on the purchase of government and corporate debt to ensure “depth and liquidity” in the markets. Any ECB action is to be sterilized.

It looks like the ECB has “learned” from the Fed playbook: the ECB says it won’t buy government bonds to lower yields, but to ensure “depth and liquidity”. Important is the sterilization component: the ECB may issue its own debt in return for buying other debt in the market. If conducted properly, any money “printed” will immediately be absorbed again. This mechanism is a giant leap for the ECB. Notably, the ECB must have judged that this announcement was necessary because the markets know the ECB can act immediately, whereas the heads of government have yet to come to an agreement on the implementation of emergency credit lines (which may take some time); drawing the credit lines may have become a self-fulfilling prophecy without the ECB support.

What does this all mean? These facilities provide liquidity to a market that had frozen up. At the end of last week, banks in Europe were screaming for help, as no one wanted to deal with banks with exposure to any weaker European country.

This mechanism will buy Europe time, but it does not solve structural solvency issues. However, steps to address structural issues have been taken with the announcement of further fiscal consolidation. Our fear is that the relief provided by the announced programs may take the pressure away to actually follow-through with the cost cuts. It is in this context that Germany once again, with its insistence of IMF involvement, appears to be showing appropriate leadership.

Despite present measures, there is still a risk that Greece defaults. We believe Greece will implement many of the cuts the IMF demands. As a result, Greece will have a debt to GDP ratio of about 150% in a few years. At that point, Greece may still default to wipe out a good portion of its debt. Any country is free to default on its debt; the problem is that few, if any, will give you a loan the day after you default. From Greece’s point of view, the country has a choice of defaulting now, imposing an overnight 15% adjustment to GDP; or considering a default in about 3 years, imposing an adjustment of about 4% of GDP overnight then. The latter may be something the political leadership may be willing to contemplate.

Because of this risk, it is paramount that a) creditors use the time to bolster the balance sheet and b) countries use the time to engage in aggressive fiscal consolidation (cost cutting) to ensure they can stomach the shockwaves that are almost certain to flare up yet again.

What does this mean for currencies and the markets? First, it shows once again that when policy makers throw trillions of dollars at financial problems, markets act. Unfortunately, it also means that investors may be more concerned about the next trillion dollar move than fundamentals. The one positive about the sovereign debt crisis is that bond markets fulfilled their duty: by making the cost of borrowing exorbitant, governments have been forced to cut expenditures. If a central bank intervenes, the most powerful mechanism to impose fiscal discipline is in jeopardy. As a result, it is absolutely key to monitor how the ECB implements its new campaign to enhance “depth and liquidity” in the markets. Is it a question of when or a question of whether the ECB will yield to political pressure to finance government deficits?

While so much focus has been on the eurozone’s problems, we may lose sight of the fact that the eurozone may actually be in a better position than the U.K., the U.S. or Japan. We continue to believe that it is more difficult to spend and print money in the eurozone than in these other regions. There’s no threat of IMF involvement in California; there may be little reluctance in the U.K. to have the Bank of England finance government spending with a weak new government incapable of addressing reform; Japan’s debt situation – in the long-term – may be hopeless. Note that the U.K., a European Union member, but not eurozone member, refuses to participate in any aid plan for weaker European countries; it is quite understandable that the U.K. does not want to load up on euro denominated commitments, but it also means that help from the European Union may be more difficult to obtain if and when the U.K. is in need of help.

This crisis is a reminder that monetary policy may be more accommodating than is priced into the markets right now – not just in the eurozone. As we have said for some time, there may no longer be such a thing as a safe asset and investors may want to take a diversified approach to something as mundane as cash. Central banks globally have been diversifying

We manage the Merk Absolute Return Currency Fund, the Merk Asian Currency Fund, and the Merk Hard Currency Fund; transparent no-load currency mutual funds that do not typically employ leverage. This analysis is a preview of our annual letter to investors; to learn more about the Funds, please visit

By Axel Merk

Manager of the Merk Hard, Asian and Absolute Return Currency Funds,

Axel Merk, President & CIO of Merk Investments, LLC, is an expert on hard money, macro trends and international investing. He is considered an authority on currencies. Axel Merk wrote the book on Sustainable Wealth; order your copy today.

The Merk Absolute Return Currency Fund seeks to generate positive absolute returns by investing in currencies. The Fund is a pure-play on currencies, aiming to profit regardless of the direction of the U.S. dollar or traditional asset classes.

The Merk Asian Currency Fund seeks to profit from a rise in Asian currencies versus the U.S. dollar. The Fund typically invests in a basket of Asian currencies that may include, but are not limited to, the currencies of China, Hong Kong, Japan, India, Indonesia, Malaysia, the Philippines, Singapore, South Korea, Taiwan and Thailand.

The Merk Hard Currency Fund seeks to profit from a rise in hard currencies versus the U.S. dollar. Hard currencies are currencies backed by sound monetary policy; sound monetary policy focuses on price stability.

The Funds may be appropriate for you if you are pursuing a long-term goal with a currency component to your portfolio; are willing to tolerate the risks associated with investments in foreign currencies; or are looking for a way to potentially mitigate downside risk in or profit from a secular bear market. For more information on the Funds and to download a prospectus, please visit

Investors should consider the investment objectives, risks and charges and expenses of the Merk Funds carefully before investing. This and other information is in the prospectus, a copy of which may be obtained by visiting the Funds' website at or calling 866-MERK FUND. Please read the prospectus carefully before you invest.

The Funds primarily invest in foreign currencies and as such, changes in currency exchange rates will affect the value of what the Funds own and the price of the Funds' shares. Investing in foreign instruments bears a greater risk than investing in domestic instruments for reasons such as volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. The Funds are subject to interest rate risk which is the risk that debt securities in the Funds' portfolio will decline in value because of increases in market interest rates. The Funds may also invest in derivative securities which can be volatile and involve various types and degrees of risk. As a non-diversified fund, the Merk Hard Currency Fund will be subject to more investment risk and potential for volatility than a diversified fund because its portfolio may, at times, focus on a limited number of issuers. For a more complete discussion of these and other Fund risks please refer to the Funds' prospectuses.

This report was prepared by Merk Investments LLC, and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advice. Foreside Fund Services, LLC, distributor.

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11 May 10, 00:09
Birds of a Feather

This is a very nice article, and although I generally agree with it, I tend to look at this Greek debacle thing from a slightly different perspective. The points I would like to make are as follows:

1. The big near future event (probably this year) is the markets and currency crash of the USA. Compared to this crash, the Greek sovereignty crisis is a tempest in a teapot.

2. There has been considerable covert economic warfare between dollar-land and euro-land lately. Is the current Greek crisis a result of or related to this conflict? (i.e. Did the USA sucker the Greeks and euro-land into taking a Trojan horse? Two big US banks are much richer, world attention if focused away from the US economy, gold and the dollar are going higher together, and the IMF--a US front organization--is now involved in the crisis, etc. The US is either very clever or very lucky.)

(For much more necessary information in support of the above two points, please access Market Oracle TV and read "Gerald Celente: Crash of 2010 inevitable" (on page 1) and "William Engdahl: U.S. Economy Won't Recover For at Least 15 Years" on page 3. I think that the Celente TV is available via the sidebar, and you only have to change the page to access the Engdahl TV.)

3. There is much discussion on whether the euro countries will continue to be linked to the USA (a choice without a future), or will it move much closer to the Euro Asia group (a better economic move with access to resources and more trade possibilities). The point is usually made that the USA will severely retaliate, but I think its only a question of timing (when the US economy is going south, it won't be in a position to retaliate).

4. The Greek economic situation is a microcosm of the US economic situation. The Greek problem is to much debt, and greatly increasing its debt (at 5% interest) might help it out in the near term, but they will have a much more server problem in the long term. The big difference between the Greek and US situations is that the Greeks don't have their own currency and inflation is not an option. Anyway, all this bazaar economic nonsense will be much more obvious that is the case with the USA.

13 May 10, 09:32
Goldman Sachs Terrorizes the USA

In a market where 70 of all trades are executed by computer algorithms via High Frequency Trading, Goldman Sachs has the power to make the market crash or rise at will. In fact, Goldman has a major Weapon of Mass Destruction in its Program Trading monopoly of the New York Stock Exchange,...I can tell you that Goldman, JP Morgan and the gang simply pulled the buys from their computer trading programs and manufactured a crash. And when the coast was clear, and it was clear the politicians were not going to vote for anything that would break up the too big to fail banks; all the sells were pulled from the computers and the market roared back

On Friday, the next day, after the break up the too big to fail banks amendment was soundly defeated by a 61 to 33 margin in Senate and a deal was struck to eliminate key provisions from the audit of the Federal Reserve bill

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