By Graham Summers
While
various media outlets and “analysts” try to claim that the EU summit was
somehow a success and that Europe’s issues are solved, the fact remains that
Europe is out of money. And I mean TOTALLY out of money.
I realize this flies in the
face of what 99% of analysts are claiming. But this is a proven fact. Of the
various entities that could hold the EU together (the ECB, the IMF, Germany,
and the two bailout funds: the EFSF and the ESM) none and I mean NONE of them
actually have the capital to do it.
I am continually bombarded
with emails from people saying, "well, if things get bad the Fed or ECB
will just print and everything is solved."
This is beyond wrong. It is
just groupthink based on the idea that the Fed has intervened ever since the
Great Crisis began in 2008 (ZeroHedge recently ran an article showing that the
Fed has intervened in over two thirds of the months since the Crisis began).
To whit, the Fed has now
pulled back from any aggressive monetary policy for over a year. There has been
no money printing. Instead, the Fed has re-arranged its portfolio to attempt to
flatten the yield curve.
Why is the Fed doing this
instead of simply engaging in more QE? The answer is because QE removes Treasuries
from the banking system. We are facing a solvency Crisis and Treasuries are the
senior most asset on US bank balance sheets.
When the Fed buys a Treasury
from a US bank, it is providing liquidity (cash) to the bank to meet the bank's
short term funding needs.
However, by removing the
Treasury from the bank's balance sheet, the Fed is removing one of the banks
senior most assets: the very asset against which the bank has leant or traded
hundreds of billions and possibly even trillions of Dollars' worth of
loans and trades.
Put another way, the Fed, by buying Treasuries is making insolvent banks even more insolvent. It is a short-term gain (liquidity) for a long-term disaster: banks need as much collateral as they can get their hands on right now. And with Treasuries rallying (raising the value of the banks' assets) any aggressive Fed program to take Treasuries out of the system would be a MAJOR step towards another solvency Crisis a la 2008.
The same pattern is playing
out in Europe right now though on a much grander scale (its banking system is
nearly four times as large as that of the US). While everyone continues
to believe the ECB can save the day, the fact
remains that the ECB has NOT bought a single sovereign bond in 14 weeks.
Why is this? The same reason
that the Fed is not doing more QE: Europe is facing a solvency Crisis. Removing
sovereign bonds from the market may be helpful from a purely liquidity
standpoint (cash for trash) but the Crisis in Europe is not based on liquidity,
it’s based on solvency. And EU banks need as much senior assets as they can
get.
Everytime the ECB buys a
sovereign bond it's removing much needed collateral from the EU banking system
(a sovereign bond may be garbage, but it's usually less garbage than a EU
mortgage loan or an EU corporate loan).
This in turn only increases
the solvency issues in the EU banking system. And remember, bank runs are
already underway in Spain, Italy, France, and Greece. So banks are
desperate for capital and collateral.
THAT is why the ECB cannot and
will not simply print to "save the day": doing so would NOT save the
day but would in fact accelerate the EU banking Crisis.
So the Fed and the ECB WILL
NOT be stepping in unless the entire system starts to go. This leaves the IMF
which is a US-backed entity and thus cannot perform a large-scale EU bailout
(it's an election year in the US and voters will not tolerate a US-lead bailout
of Europe).
So all that is left to prop up
Europe are the two mega-bailout funds (the EFSF and ESM) and Germany.
The EFSF's capital is already
full committed and stretched to the limit in propping up Portugal and Ireland.
So it's not an option anymore.
As for the ESM... well, it
doesn't even exist yet: it has yet to be ratified by all the countries that
need to vote on it. Moreover, Spain and Italy together are to account for 30%
of the ESM's funding. So... these countries would be bailing
themselves out!?!
Finally, both Finland and
Netherlands are rejecting the idea that the ESM can be used to buy bank bonds.
So the ESM, assuming it can evenget ratified,
will face
major political pressure
regarding how it spends its capital.
This leaves Germany as the one
and only true EU prop. However, Germany is stretched to the limit.
First off, the country is only
€328 billion away from reaching an official Debt to GDP of 90%: the level at
which national solvency is called into question.
Moreover, that €328 billion has
already been spent via various EU props. Indeed, when we account for all the
backdoor schemes Germany has engaged in to prop up the EU, Germany's REAL Debt
to GDP is closer to 300%.
In Euro terms, Germany now has
€1 trillion in exposure to the EU via its various bailout mechanisms. That's
EQUAL TO roughly 30% of German GDP.
If even a significant portion
of that €1 trillion goes bad (which it will as this money has been spent
helping the PIIGS), Germany's financial system will take a MASSIVE hit.
This will guarantee Germany
losing its AAA status, which in turn makes its funding costs much higher (see
what happened to France in the last year: that country is now facing bank runs
and its own solvency Crisis which you'll be hearing about in the coming weeks).
Angela Merkel is up for
re-election next year. There is no way on earth she'll opt to let Germany get
dragged down by the EU. She's even said she will not allow Eurobonds for
"as long as [she] lives."
This is not empty rhetoric.
This is fact. Germany has expressed its intentions dozens of times in the last
month: NO Eurobonds and NO guarantee of EU banking deposits.
The reasons for this are
simple: EITHER option renders Germany insolvent. It's already teetering on
insolvency to begin with. But to allow Eurobonds or some kind of guarantee of
the EU banking system to occur on top of the money Germany has already spent
propping up the EU will take Germany down.
The German economy is already
slowing. Most Germans are fed up with the Euro. Merkel would rather die than
let her country become like Greece (which the creation of Eurobonds or EU
deposit guarantees would most assuredly result in).
So Germany is tapped out as
well. This leaves... NOBODY.
Again, Europe is out of money.
End of story. This is the truth and investing based on the idea of some magical
bailout occurring is like investing on Hank Paulson's Bazooka policy for Fannie
and Freddie (three months later the markets imploded).
Smart investors are using this
latest rally in the markets to prepare for what’s coming: an EU banking Crisis
that will make 2008 look like a joke. On that note, I recently published a
report showing investors how to prepare for this. It’s called How to Play
the Collapse of the European Banking System and it explains exactly
how the coming Crisis will unfold as well as which investments (both direct and
backdoor) you can make to profit from it.
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