In a previous article we had noted that European officials would do everything in their power to prevent Greece from default, and the extravagant proportions of the latest plan do not fail our expectations. We have another bailout of a gigantic scale from the European Union, directed towards preventing any potential sovereign default among its members.
The strong point of the bailout is its size at about €750 billion (about 2/3 of which will be provided by the Union while the rest will be supplied by the IMF). There are still many unanswered questions, some may be cleared in the next few days, while others will take longer to clarify, to wit:
1. If the ECB sterilizes government bond purchases (i.e. sells its own securities to international entities to prevent the monetization of government debt), a large amount of liquidity will be sucked out from the markets. This has a potential deflationary impact, and may in the end dampen overall growth, and credit expansion. The few nations in Europe that have relatively greater growth potential, and sounder fiscal systems, like Germany, and France, will be made to suffer. Inflation is at dangerously low levels, and sucking out liquidity is by no means a good idea in this environment.
2. While the present governments in much of Europe are mainstream parties, or were brought to power in the days of the boom before 2008, the nature of the next vintage of Eurozone governments is a frightful prospect. The imperiled future of the Euro is by no means clarified by the cortisole treatment of massive cash splashing. When the backlash comes in elections, it has the potential to cause problems even greater than a Greek bailout. One can only begin to imagine the results of a protest vote bringing the far-right, or the far left to power in Germany, however hypothetical, in comparison to the scenes of the great, but largely inconsequential Greek wrath of last week.
3. Although markets, in their limited attention span, are focused on the fiscal problems of the Eurozone, there are big, and in cases bigger problems in the periphery of the Eurozone and some parts of the developing world. It is only a matter of time before nations in this group experience their own meltdowns. This outcome is delayed for now.
4. The ECB has set the completely unprecedented and unjustified precedent of bailing out nations, in a sense, by taking over the fiscal responsibilities of governments. Sterilized or not, this constitutes a change of policy, a capitulation in the face of difficulty, and is a major detriment to ECB credibility. While we do not see great chances of inflation in the Eurozone, this is a step in the wrong direction however one regards it. Central banks were not made independent for no reason.
5. The so-called moral hazard, about companies and individuals taking risks in expectation that they would be bailed out in case of failure, is now a problem for nations, too. Governments have little incentive to assume fiscal responsibility when there is already a fund, running up to $1 trillion, ready to bail them out of their excesses.
As per our previous posts, we never expected a Greek default, and events are hardly surprising from that perspective. The indicative value of this crisis is not its immediate consequence, but its nature as a wake-up call of the beginning of a new era for financial markets. The focus on Greece and a few European nations is completely misleading in the era of globally interconnected financial markets. With the exception of a few nations, the majority of the world`s governments are leveraged players, and many run deficits in sustainable levels. The issue for markets players and speculators is not about whether any of them will default, but only about who gives the best odds for default speculations. The question is not one of "if", but "who". Given enough speculative pressure, there are a number of nations that can be brought to their knees, making the present time similar to the 70s, when speculators wielded massive power against a fundamentally unsound system (at that time, of pegs).
The environment is suitable to the generation of major bubbles in certain asset classes, some of which may well reach proportions that are at the moment beyond the imagination of the common public. Gold appears to be on a mission to appreciate regardless of the nature of events. As we see, some commentators argue in justifying its trend on inflation, others on deflation. But a study of the charts shows that the rise has the closest correlation with the non-adjusted total U.S. public debt, something which will most likely keep rising in the background, regardless of short term events. We regard the European bailout in the same light. It is more of the same, and after some short term volatility to the upside, we should expect EURUSD to resume its downtrend.
Disclosure: No positions