The European bailout fund, ESFS, had a great deal of difficulty recently, in managing to sell a rather small 3 billion euro issuance of bonds. The bond issue was designed to support the economic recovery of Ireland. Past issuances had been purchased by the Chinese central bank, among others, but in spite of its underwriters traveling all over the world seeking buyers, few were still in a buying mood.
Last Friday, markets were cheered by the fact that the fund had finally managed to place all the bonds -- until Sunday. But a report in the Sunday edition of the British newspaper, the Telegraph, says that a reliable source told them that the fund itself bought more than 300 million euros worth. Allegedly, banks managing the sale could only find real buyers for about 2.7 billion euros. An ESFS spokesman, denied the newspaper story. The spokesman insisted that all 3 billion euro bonds were sold to third parties. Yet, when dealing with such statements that conflict with a fairly reliable newspaper, one must consider the idea that the spokesman is telling the "truth" while not telling the whole truth.
It is possible that one of the big "third-party" buyers is actually the ECB, making the newspaper story essentially true, while technically inaccurate. Technically, since the ESFS is not a eurozone national government, the ECB could reinterpret its governing rules to allow the purchase of ESFS bonds. Let's face it, almost every taboo that once existed, has already been broken by the Fed, BofE and ECB already. So why not one more?
If the ECB is the buyer, it is grave news for the eurozone. The level of desperation must be very high. The ECB would essentially be the enabler of a ESFS Ponzi scheme. But whether or not the newspaper is correct is not really the the key to this story. Maybe ESFS eventually managed to sell the bonds to true third parties. Or, maybe it is resorting to a quasi-ponzi scheme. More important is the fact that ESFS has had a devil of time selling the bonds. Many entities, like the Chinese sovereign wealth fund, which partook heavily of the first issuance of ESFS bonds, didn't want any part of this one.
So why don't buyers want ESFS bonds? According to treaty, bonds are backed by guarantees given by the euro area member states in proportion to their share in the paid-up capital of the ECB. In other words, the ESFS is backed by the full faith and credit of the big still-solvent sovereigns of Europe, at least in part. Apparently, because part of the guarantee is also the responsibility of over-indebted nations like Italy, the debt is undesirable. Bond buyers clearly believe the eurozone, as we know it today, is doomed.
There is no reason to eagerly buy national bonds from triple A sovereigns, like Germany and the Netherlands, while rejecting jointly issued bonds backed to a large extent by the same nations. I believe that those "in-the-know" are expecting the AAA European sovereigns to reinstitute national currencies not too far in the future. Issuing such currencies alongside the euro would cause the value of the euro itself to drop dramatically, even though both the national currencies and euro would circulate simultaneously. This scenario is discussed in detail in another article.
The reinstitution of national currencies is an attractive proposition for AAA sovereigns, compared to a number of other worse options. National currencies from economically strong nations would free their citizens from the spector of hyperinflation. It is this spector that gives German politicians the wisdom and wherewithal to resist calls for the ECB to print an unlimited number of euros in order to "save" the banks that invested in fiscally profligate European nations. But concurrent circulation of the euro (as opposed to an overt end to the currency) allows southern European nations to play the same game as the USA is playing.
Northern Europe can allow southern Europe to debase the euro and avoid overt legal default, so long as the north has its own national currencies. Northern Europe based banks will take some currency losses, but that politically powerful constituency would not necessary need to be overtly bailed out in a euro debasement scenario. The debasement itself would be their bailout. Bank balance sheets are oriented toward debits and credits, not the real value of money. Loans repaid in euros, with interest intact, means European bankers will show profits so long as the assets are moved into divisions whose accounting is done in euros.
The big losers, of course, will be innocent non-bank owners of southern European euro denominated bonds. Unlike the northern national bonds, the southern European bonds will remain denominated in euros. People who have accumulated euros (savers), buyers of southern Europe bonds, and holders of ESFS bonds will suffer the loss of purchasing power. That is because quantitative easing by the ECB (no matter how they rename the activity) will torpedo the real buying power of the euro. But, at least innocent northern European citizens, who never received the benefits of profligate spending in southern Europe, will suffer less.
Historically, bond buyers have a better record predicting future economic trends than often over-zealous stock buyers. This is probably no longer true in the USA, UK, and Japan, where central banks have engaged in heavy quantitative easing, creating a semi-artificial bond market. However, it is certainly still true in Europe, where ECB interventions are still being partly sterilized, and consist of supposedly temporary "repo" operations, rather than injections of arguably "counterfeit", new money that will never leave economies.
A deeply devalued euro provides what the banks want in southern Europe. After an initial time of disarray, there will be a complete economic "recovery" in spendthrift southern Europe. Of course, it will be at the expense of southern European savers and bond investors. But those folks are going to get burned anyway, no matter what choice is made. If the euro is dumped completely, they would hold bonds denominated in Lira, Drachma, Pesetas, etc. Better that a nominal "euro" therefore, be retained, though it would behave similarly to those extinct currencies.
Meanwhile, a reintroduction of national currencies in northern Europe, with concurrent retention of the devalued euro for southern Europe will spur demand in the south. New cars, oil, gas, TVs, radios, clothing, etc. will all be bought in the normal amounts by people newly free from debt due to monetary debasement. Aggregate demand in the euro nations in the south would be preserved, while demand in the hybrid 'hard currency/euro" nations of the north would stay about the same as it is now.
It is very likely that we will see a deep collapse of stock prices when national currencies are initially reintroduced in northern Europe. Stock prices will probably fall below the lows of March 2009, if investors are watching the eurozone unravel and feeling helpless to respond. Stock prices in the USA and UK will almost certainly tank along with those of Europe. While the printing-mad Fed and Bank of England will surely intervene with more heavy printing, it will take some time.
In other words, the collapse of the euro, as we now know it, into a southern Europe-centric currency, will provide excellent stock buying opportunities. Smart investors will take advantage of it. The window of stock price collapse will eventually close, however, as it becomes clear that southern European economies are recovering and money printing machines are turned on, at full throttle, in the USA, UK and Europe. The USA and UK will also be very eager to depreciate against the momentum of the renewed money printing in southern Europe. The buying power value of most currencies will be further reduced by a new aversion against paper money and the fiat money system.
The demise of the dollar and pound will probably happen with a distinct delay with respect to the collapse of the euro. Once things have stabilized, all the new money sloshing about in the system will spur demand for stocks and other asset classes. Bond investors, outside northern European national debt, will not be so lucky. As the value of the euro, dollar and pound jointly collapse, the value those currencies represent will be redistributed to stock and commodity market speculators and investors, spendthrift governments and debtors generally. The damage to bond holders will be done on an altar of so called "growth".
Life will go on. The creation of the euro was a dream of the European banking industry. It was aided by internationalists and political dreamers. It is not necessary to life in Europe. European prosperity needs only a tariff free zone, free movement of people from nation to nation, and uniform guidelines for common issues like airspace and consumer protection. A common currency appears to be hurting the European project, not helping it. Too many people irrationally fixate on preserving the status quo even at the expense of everything else.
With the introduction of northern European national currencies, the euro will essentially be transformed into a duplicate of the old Italian Lira. But it retains its current name. The US dollar, British Pound and Japanese Yen will also eventually crash and burn. But delays between the crashes of these various paper currencies are likely to create "windows of opportunity" for investors holding currencies that have not yet crashed.
For example, it should be possible to buy some excellent euro denominated assets very cheaply at the right time. People will need to consider serial buying and selling bouts. This is because the implosion of the USA, U.K. and Japan will still lie ahead. For long term stability, the world will need to move away from Keynesian economic theories, and the current paper based monetary system.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.