The Economy Guy

European War Chest…….

The Europeans have the EFSF – the European Financial Stability Facility – and it is a promise of an amount of money from each of the EU nations.  The EFSF will morph into the500B Euro ESM – European Stability Mechanism – sometime in the future.  The EFSF has a definite ending date, so it can’t last forever, and the Europeans need something in the “forever” category – to give people confidence.

Christine Lagarde, the head of the IMF, just said that the EFSF needs a date for when it will move (an additional 500B Euro) into the ESM, and the sooner the better, and it needs MORE money.  The purpose of these funds is to provide a “firewall” between Greece and the other nations – specifically Italy.  However, it is obvious to the most casual observer that the EFSF doesn’t have enough to bail out Italy, let alone Portugal and Spain and whoever else.

The German Finance Minister said this weekend that increasing the ESM is not under discussion – in other words, it is not politically correct for Germany to agree to any increase.

The reason that the IMF, with the US being the biggest contributor of its funding, has its nose in this issue is that it provides about 1/3 of the money for all the past bailouts – like Ireland, Portugal, and now Greece.

Where does this money come from……

Now let’s use some pure logic and talk about these big numbers.  The money comes from the nations in the EU, and they are “promises” only.  That means they are not real until the need to use the money happens.  Then what?

Then, the nations have to put up the money – they actually have to lend the money to the EFSF or EMS – and put that money on its fiscal books as a loan.  My first point is that more lending is not the way to solve the problem of too much debt. (It’s like solving a alcoholic problem with more alcohol.)  My second point is that every European nation suddenly looks “weaker” in the eyes of the rating agencies, and on its fiscal balance sheet.  Where does this money come from?  Will the nations have to tax more, or spend less to create the money?  I doubt it.  I think they will just carry the money on their books, and sigh.  It will be explained away as an “extraordinary” expense that will somehow, someday come back to it.

But, what if it doesn’t?  What if it’s lent to Italy, and then Italy leaves the Euro and defaults on the debt?  That’s a good way to drag all of Europe down the sewer with the Greece’s of Europe.

No nation is immune.  While Germany was spared from the rating downgrades of S&P, it was not spared by another rating agency last week, when it was downgraded one notch because it was supporting so much of the European debt.  France is spending way too much money on its government employees, and is having a major unemployment problem at the same time.  All the nations are in contraction (recession.)

My very strong belief is that Greece will not default this time around, and will be bailed out by the EU/ECB/IMF.  But, later this year, Portugal will raise its hand, and say that it needs the same “voluntary” downgrade of its debt, and another bailout.  When that happens, Ireland should be the next to raise its hand.  Somewhere along this story, the idea of a country leaving the Euro will be “seriously” discussed by the European leaders – as they look over the cliff, and don’t want to fall down there themselves.

What does this mean to you…….

The US is bailing out Europe in so many ways.  We had the “swap agreements” where the FED “loaned” the ECB an unlimited amount of money – and the ECB gave the European banks 600B Euros worth of it.  That was ALL US money.

Any IMF loans include US money – and a lot of it.  Greece, Portugal, Ireland, and now Greece again – all have IMF money included in their bailouts.

If Greece or any other nation actually defaults, the banks of Europe who hold that debt will be bankrupt immediately as their nations allow European banks to leverage their reserves by 30 times to 40 times.  So, a small default on any debt held could easily wipe of the entire reserve amount – and cause bankruptcy.  Then, there will be a massive loss in the US banks – by payout of “debt insurance – credit default swaps” and loss on any European sovereign debt held.  The FED would come to the aid of these US banks – and guess what, YOU get to bail them out again.

There are an unlimited number of ways that the FED can spend your money – and you will pay in the future through increased inflation.  Even the Federal Government may feel sorrow for Europe and spend real taxpayer money out of our fiscal budget – thereby increasing our deficit.  Doesn’t that give you a warm and fuzzy feeling?

More on Greece…..

The European leadership made a very big mistake early during the Greek crisis – about 2 years ago – and thought that Greece was having a liquidity problem (not enough money) and by lending them money via a bailout, Greece could work their way out their problem.

Then, they got smarter, and understood that more money doesn’t solve the problem, and they thought (now think) that reducing the total Greek debt (through a voluntary default – bankruptcy) and providing more money through a new bailout and having Greece reduce spending through a severe austerity program, then Greece will be able to work their way out of the problem.

In the background, the European leaders understood that a Greek involuntary default would decimate the European banking system, so the leaders became committed to “helping” Greece – and they also had the ECB give that 600B Euro liquidity injection into the European banks to bolster them.

But, the European leaders have got it wrong again.  You see, the current Greek plan won’t work.  Greece will default in the future.  Why?  Because they are;

1. contracting in their economy;
2. spending less by the government
3. decreasing their exports as they are not competitive with other parts of Europe.
   

You cannot do all 3 of these at the same time, and survive.  It is mathematically impossible.  So, Greece will come to a bad end, and the current actions regarding Greece are only “kicking the can further down the road.”