Most Popular
1. Banking Crisis is Stocks Bull Market Buying Opportunity - Nadeem_Walayat
2.The Crypto Signal for the Precious Metals Market - P_Radomski_CFA
3. One Possible Outcome to a New World Order - Raymond_Matison
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
5. Apple AAPL Stock Trend and Earnings Analysis - Nadeem_Walayat
6.AI, Stocks, and Gold Stocks – Connected After All - P_Radomski_CFA
7.Stock Market CHEAT SHEET - - Nadeem_Walayat
8.US Debt Ceiling Crisis Smoke and Mirrors Circus - Nadeem_Walayat
9.Silver Price May Explode - Avi_Gilburt
10.More US Banks Could Collapse -- A Lot More- EWI
Last 7 days
Stock Market Volatility (VIX) - 25th Mar 24
Stock Market Investor Sentiment - 25th Mar 24
The Federal Reserve Didn't Do Anything But It Had Plenty to Say - 25th Mar 24
Stock Market Breadth - 24th Mar 24
Stock Market Margin Debt Indicator - 24th Mar 24
It’s Easy to Scream Stocks Bubble! - 24th Mar 24
Stocks: What to Make of All This Insider Selling- 24th Mar 24
Money Supply Continues To Fall, Economy Worsens – Investors Don’t Care - 24th Mar 24
Get an Edge in the Crypto Market with Order Flow - 24th Mar 24
US Presidential Election Cycle and Recessions - 18th Mar 24
US Recession Already Happened in 2022! - 18th Mar 24
AI can now remember everything you say - 18th Mar 24
Bitcoin Crypto Mania 2024 - MicroStrategy MSTR Blow off Top! - 14th Mar 24
Bitcoin Gravy Train Trend Forecast 2024 - 11th Mar 24
Gold and the Long-Term Inflation Cycle - 11th Mar 24
Fed’s Next Intertest Rate Move might not align with popular consensus - 11th Mar 24
Two Reasons The Fed Manipulates Interest Rates - 11th Mar 24
US Dollar Trend 2024 - 9th Mar 2024
The Bond Trade and Interest Rates - 9th Mar 2024
Investors Don’t Believe the Gold Rally, Still Prefer General Stocks - 9th Mar 2024
Paper Gold Vs. Real Gold: It's Important to Know the Difference - 9th Mar 2024
Stocks: What This "Record Extreme" Indicator May Be Signaling - 9th Mar 2024
My 3 Favorite Trade Setups - Elliott Wave Course - 9th Mar 2024
Bitcoin Crypto Bubble Mania! - 4th Mar 2024
US Interest Rates - When WIll the Fed Pivot - 1st Mar 2024
S&P Stock Market Real Earnings Yield - 29th Feb 2024
US Unemployment is a Fake Statistic - 29th Feb 2024
U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - 29th Feb 2024
What a Breakdown in Silver Mining Stocks! What an Opportunity! - 29th Feb 2024
Why AI will Soon become SA - Synthetic Intelligence - The Machine Learning Megatrend - 29th Feb 2024
Keep Calm and Carry on Buying Quantum AI Tech Stocks - 19th Feb 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Europe Is Not a Matter of Opinion… It’s a Matter of Math

Interest-Rates / Eurozone Debt Crisis Aug 08, 2012 - 10:11 AM GMT

By: Graham_Summers

Interest-Rates

Best Financial Markets Analysis ArticleIt’s a simply question of math.

I realize my views on Europe are much in the minority. The entire world continues to believe that somehow Mario Draghi or Ben Bernanke have a magical button they can hit that will solve the EU Crisis.


Most people believe that magical button is the “print” button. But this completely overlooks the fact that Europe is facing a solvency crisis, not a liquidity crisis. It’s a key difference. In a liquidity crisis, financial firms needs easy money to meet short-term funding needs because interbank lending has dried up.

In a solvency crisis, a bank has far too many assets relative to its equity/ capital base. In this scenario the issue is NOT one of too little liquidity, but one of TOO MUCH Debt relative to actual capital/equity (neither of which can be increased by lending more money to the firm).

Put it this way… Europe’s banks in general are leveraged at 26 to 1. This means that for every €1 they have in equity/ capital, they have €26 in assets (which are in fact loans they’ve made to EU governments, EU businesses, etc.).

When you have this much leverage, if your asset base (all those loans) falls by even 4%, then you’ve erased ALL of your capital/equity. At that point there is NO MONEY to fall back on and you are forced to liquidate your loans at massive losses.

This in turn brings about a crisis of confidence, resulting in people pulling their money out of the bank… which renders the bank even more insolvent.

Thus, in this situation, for the ECB to come along and say, “here Bank XYZ, take €5 billion in debt from us at an interest rate of 3%” accomplishes nothing. It fact it actually increases the bank’s leverage, which was the basic problem to begin with.

There’s a second component here.

Everyone now knows that many EU banks are in serious trouble. So when the ECB came along with its LTRO 1 and LTRO 2 plans (basically providing cheap loans to EU banks to help them meet funding needs), the bond and credit markets took this as an admission of guilt on the part of the banks.

In plain terms, when Bank XYZ stepped up and said to the ECB “please give us some money via the LTRO 2” the markets realized “this bank is in serious trouble… why else would it be asking for help?”

As a result, the bank’s bonds dropped, pushing the cost of meeting its interest payments higher (draining even more of its much needed capital).

So in many ways, asking the ECB for help actually made things worse for the bank from a private sector funding perspective (investors were far less willing to lend money to the bank).

That is precisely what happened after LTRO 1 and LTRO 2. ECB President Mario Draghi knows this, which is why he’s not issued LTRO 3.

With all of this out of the way, let’s look at the actual math regarding Europe today.

The EFSF fund, after the Spanish bailout, has just €65 billion in firepower left. That won’t do anything to help Italy which is on the brink, let alone Slovenia and other smaller EU countries.

The other EU bailout fund, the ESM, has not even been ratified yet (Germany won’t vote on it until September 12).

Moreover, Spain and Italy are supposed to provide 30% of the ESM’s funding. Does anyone see a problem with the idea that nearly €1 out of every €3 meant to prop up the EU will be coming from two bankrupt countries?

In the end, it all boils down to Germany… whose finances are getting worse and worse by the day.

Axel Weber, the former head of Germany’s Central Bank has admitted publicly that Germany’s real debt to GDP ratio is over 200%. However, even if we ignore unfunded liabilities, Germany is just €300+ billion away from hitting an official Debt to GDP ratio of 90%.

We all know what happens to countries when they reach this point.

Moreover, Germany has already made nearly €1 trillion in backstops/ loans to the EU via its Central Bank.  Not only does this put Germany’s official Debt to GDP well over 100%, but it means that should these loans go bad (what are the odds given that they were made to the PIIGS?) then Germany will be on the hook for hundreds of billions of Euros’ worth of losses.

Do you really think Germany has the firepower to handle this? It doesn’t. It would most assuredly lose its AAA status and get dragged down with the rest of Europe.

This is simple math, not my opinion. You can argue about magic solutions and hitting “print” all you like, but in the end Europe doesn’t have the capital needed to solve this Crisis. There is truly only one solution: default.

Only a default cleans out the debts, lowers leverage ratios, and brings the EU’s financial house in order.

However, there’s a major problem with the “default” option. Indeed, this is THE “check mate” position for the ECB and Germany. It’s the reason why EVERYONE was so desperate to claim that the second Greek bailout wasn’t a default.

It’s also why the EU has been spending as much money as possible to avoid a default (seriously, they decided to give €300 billion to Spain in just one weekend).

Those investors looking for actionable investment ideas could also consider our Private Wealth Advisory newsletter: a bi-weekly detailed investment advisory service that distills the most important geopolitical, economic, and financial developments in the markets into concise investment strategies for individual investors.

To learn more about Private Wealth Advisory and how it can help you navigate the markets successfully…

Click Here Now!!!

Graham Summers

Chief Market Strategist

Good Investing!

http://gainspainscapital.com

PS. If you’re getting worried about the future of the stock market and have yet to take steps to prepare for the Second Round of the Financial Crisis… I highly suggest you download my FREE Special Report specifying exactly how to prepare for what’s to come.

I call it The Financial Crisis “Round Two” Survival Kit. And its 17 pages contain a wealth of information about portfolio protection, which investments to own and how to take out Catastrophe Insurance on the stock market (this “insurance” paid out triple digit gains in the Autumn of 2008).

Again, this is all 100% FREE. To pick up your copy today, got to http://www.gainspainscapital.com and click on FREE REPORTS.

Graham also writes Private Wealth Advisory, a monthly investment advisory focusing on the most lucrative investment opportunities the financial markets have to offer. Graham understands the big picture from both a macro-economic and capital in/outflow perspective. He translates his understanding into finding trends and undervalued investment opportunities months before the markets catch on: the Private Wealth Advisory portfolio has outperformed the S&P 500 three of the last five years, including a 7% return in 2008 vs. a 37% loss for the S&P 500.

Previously, Graham worked as a Senior Financial Analyst covering global markets for several investment firms in the Mid-Atlantic region. He’s lived and performed research in Europe, Asia, the Middle East, and the United States.

© 2012 Copyright Graham Summers - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Graham Summers Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in