Thursday: Will A $3 Trillion 'Redemption Pact' Be Enough To Fix Europe?

Includes: FXE
by: Philip Davis


$3 TRILLION dollars!

That's the latest number being floated around again (it was being discussed in November) that has been drawn up by Germany's own Council of Economic Experts and is currently being viewed as the only viable route out of the current impasse. The Redemption Pact covers all public debts of EMU states above the Maastricht limit of 60% of GDP, roughly €2.3 trillion. It is modeled on Alexander Hamilton's Sinking Fund in 1790 to clear up legacy debts after the American revolutionary war.

The idea is to treat the first decade of monetary union as a learning experience -- with mistakes made all round - and allow a fresh start. The excess debt would be paid down over 20 years. The beauty of the proposal is that it would return Europe to the Maastricht discipline where each state is responsible for its own debts. It is the exact opposite of fiscal union. Officials at Germany's top court say it appears compatible with the country's constitution - unlike eurobonds. There would be a fixed limit to costs and the fund would not endanger the tax and spending sovereignty of the Bundestag.

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It is not yet clear whether Chancellor Merkel can persuade her own party to support the pact. Her own finance minister Wolfgang Schäuble poured cold water over the idea earlier this week. "This fund is not feasible because it breaches with the European treaties and the `no bail-out' clause, which says countries cannot be responsible for the liabilities of another country. Without a joint fiscal policy you can't have shared liabilities," he told Stern Magazine.

What is clear is that SOMETHING does need to be done and it needs to be done soon because we're not even sure $3Tn will be ENOUGH to set Europe back on a path to growth and stability. Just this morning, the ECB projected the the eurozone GDP will fall as much as 0.5% this year (recession) and possibly 0% in 2013 but that is (and get this): "Subject to increased downside risks relating, in particular, to a further increase in the tensions in several euro area financial markets and their potential spillover to the euro area real economy." So, IF all goes well, THEN we can look forward to recession and no growth for a couple of years.

Germany is coming back to the table on this plan, which rallied the markets last October and crashed it in November when it was scuttled, because their own economy is beginning to fall apart. April Industrial Production throughout the EU was down 0.8% in April but Germany fell a startling 2% as demand for goods is simply falling off a cliff. A look at euro area unemployment is even more startling because, unlike the U.S. (and we're not so good ourselves), EU unemployment is now 20% WORSE than it was in the crash of '08 and '09:

Despite (or because of?) the $125Bn bailout, Moodys finally cut its rating on Spanish debt by three notches to Baa3 (essentially junk) saying the newly approved eurozone plan to help the country's banks will increase its debt burden and citing the government's "very limited" access to international debt markets. Spanish banks borrowed a record €324.6B from the ECB in May, up from €319.9B in April, according to Bank of Spain figures. Total net borrowing was €287.8B in May vs. €263.5B in April. The data casts doubt over whether the proposed €100B banking bailout will be sufficient. And as this post is being written: Spain's 10-year bond yield continues to climb, just hit 6.97%.

It is amazing to me that I still have to have idiotic conversations with people who believe austerity is the answer to the world's problems. I know that Fox and Romney and company pound this nonsense into people 24/7 but it's such a glaringly obvious policy failure that you would think people would realize at this point how unworkable this "solution" is. Fortunately, there is now a cartoon that we can play for our Fox-viewing friends.

China's growth forecast has also been lowered by CS and DB to between 7.7% and 8% for 2012, the weakest growth since 1999 and Inida's ability to boost its own economy has been called into question as headline inflation over there rose to 7.55%. It is not good when 100% of your economic growth comes from inflation but, then again, that's been the U.S. system for two decades now as median family net worth in the U.S. dropped to $77,300 - the same as it was in 1990 and down 40% since 2007.

The top 1% of course, have coincidentally gained 40% since 2007 so it all works out nice and even and we'd like to thank the little people for their contributions and sacrifices in these difficult times. Median family income is down from $49,600 in 2007 to $45,800 and it's that extra $3,800 a year that corporations no longer have to pay (productivity is, in fact, up over 8% during that time) that is giving us those record profits.

That's why the top 10% had an average INCOME of $349,000 a year, which is five times the entire net worth of the median family while the average net worth of the top 10% is $2.9M. Moral of the story - DON'T BE IN THE BOTTOM 90%.

According to President Romney (it's in the bag, I've heard) - the only people who aren't in the top 10% are the ones who don't want to work for it so 90% of the people have only themselves to blame. Step one in the GOP plan to get America back to work is to stop coddling the unemployed with "benefits" (even though they kind of paid insurance so it's not really a hand-out when you think about it) and force them to get back in the workforce by accepting whatever work is out there, even if it doesn't pay enough to cover their bills. Once a former factory worker takes that job mopping floors at Burger King for $320 a week - he will finally be back on the path to economic prosperity - as long as we can repeal healthcare reform, of course because we certainly can't expect Burger King to take care of this bum if he gets sick, can we?

386,000 of our fellow Americans were handed pink slips last week but continuing claims fell by 33,000 as more and more people run out of benefits or simply give up on ever finding a job. Consumers are cutting way back on spending and the CPI fell 0.3%, putting the U.S. economy in some real deflationary danger (and PPI was also down sharply yesterday). Who could have imagined that 8% of our population completely out of work with another 16% in jobs that pay less than half of their prior jobs and a 10% decline in median income would cause consumers to cut back in spending? It's just going to be one of those things that will mystify Republican Economists for years to come.

$3 Trillion MIGHT be enough to get Europe back on track but we'd better get our own act in gear real soon.

Disclosure: I am short MA, V, AMZN, QQQ, DIA.

Additional disclosure: Positions as indicated but subject to change (we're bearish until we take back our levels).