Cliff Wachtel's  Instablog

Do you feel confused about the EU Debt Crisis? Or have you just not kept up with it? Not sure what will happen or how to protect yourself and prosper from it? Here’s the past 4 months summarized. It’s a bit simplified, but not by much:

1. Greece needs to pay off about €20-30 Bln in maturing debt between April and May. They don’t have it. Spain needs a similar amount in July. Portugal and some others will also need to sell bonds over the coming months.
2. No one wants to pay for Greece and other PIIGS [Portugal, Ireland, Italy, Greece, Spain] mismanagement, corruption, tax dodging, lack of economic dynamism.
3. However, Everyone is rightly petrified of a Greek default,  which would probably scare bond markets so badly that none of the other PIIGS (nor about 10 other equally distressed economies in the eastern Europe, the ME, Latin America, etc) will be able to sell bonds at affordable rates.
4. THAT CAUSES: an historically unprecedented wave of sovereign defaults by most or all of these countries.
5.  THAT CAUSES higher borrowing costs even for the better economies.
6. THAT CAUSES ANOTHER CREDIT FREEZE UP AND MARKET CRASH, PROBABLY WORSE than in the Fall of 2008 following the mere collapse of Lehman Brothers (one measly big US investment bank), because NOW markets are even more nervous, governments even more debt burdened from the last round of stimulus and bailouts etc.
7. No EU leaders can volunteer taxpayer funds to bailout PIIGS without committing political suicide, because their own economies and taxpayers are struggling and the PIIGS do not evoke much sympathy anyway, having done so much to deserve their fate. Nor can PIIGS leader expect to impose or sustain the draconian spending cuts demanded by the EU over the coming years and expect to survive in power.
8. THEREFORE, the EU and PIIGS leaders best serve their own interests by pretending but failing to achieve a rescue package for Greece, (using the unstated but clear threat of a global economic crash to extract as much cash from the rest of the world as possible)
9. RESULT: Some kind of international coordinated plan that allows EU leaders a chance to save their careers, or at least, reputations:  
   1. the EU leaders can contribute taxpayer funds to a bailout but tell their electorates they got the best deal they could and made the best of bad situation, paid the least, and avoided a financial collapse (at least for now).
   2. The PIIGS leaders can impose painful austerity plans and possibly cede control of their economies to international overseers (demanded by the rescuers to ensure compliance and repayment of funds contributed), thus transferring blame for the local suffering to international forces beyond their control.

With the above facts in mind, the recent events become clear. They explain:

1. The comic repetitious cycle of EU support pledges for Greece, followed by refusals to offer any actual cash, or even loan guarantees. Illogical on the surface, but makes perfect sense if the goal is just to pretend to rescue Greece without actually doing so.
2. After months of prideful declarations that the EU could solve its own problems, the sudden admission this past week by Germany that the IMF should help save Greece (and by implication, the other PIIGS). The IMF is funded internationally, the US being the biggest contributor by far. While EU leaders may not be able to get away with short term painless money printing, the US sure can.

While the long term best solution might be to suffer the consequences of the defaults and begin anew, the near term economic pain would be bad for the careers of the current global political leaders, thus they want to avoid that. Politicians tend to choose short term benefits over longer term solutions in order to defer painful solutions until after their terms in office.

There will be intense pressure to get Greece resolved before July.

The pressure to devise some solution that calms markets is considerable. In July:

Spain needs to sell about €30 bln in bonds to avoid default. It is in better shape than Greece, but that won’t matter if a Greek default has sent borrowing rates soaring for its fellow PIIGS block members. That means a Greek default in April or May makes a Spanish one in July far more likely.

In the US, July 2010 begins a wave of residential mortgage rates resetting higher on scale not seen since…late 2008 (scene of our last market meltdown). As the below chart shows, 2009 was a lull in this storm during which rate resets fell to multi-year lows and took some pressure off of mortgage default rates (which have remained brisk nonetheless).

02 mar 19

Hat Tip to Graham Summers: U.S. Housing: The Big Picture

It’s no accident that the peak in mortgage resets in 2008 occurred around the same time as the last stock market collapse and extensive mortgage write downs in the banking sector.

Remember what happened to stocks in 2008?

S&P 500 Weekly AVAFX Chart April 2008 – March 2009       04 mar 19

The scale of mortgage resets to occur in 2010-2011 is identical to that of 2007-2008. Stocks are already at 52 week highs and thus have plenty to give back.

True, conditions aren’t exactly the same. They are much worse.

1. The US economy is weaker, having shed around 10 million jobs since then
2. Financial markets more nervous, as they have seen how quickly a contagion can spread
3. Bank loan portfolios are more damaged, and mask an already massive ‘shadow portfolio’ of loans still carried on the books but in fact needing to be written off (after the bonuses are paid, off course)
4. The Federal Reserve has already shot most of its bullets. In 2007, the Fed had yet to resort to its unprecedented stimulus package of special bank borrowing facilities, bailouts, takeover off bad assets, cut interest rates from 5.25% to 0.25% (from September ’07 until now), taken over AIG for $85 billion (September ’08, and later another $40 bln given), initiated TARP for $700 Billion, bought close to $2 trillion in assorted US Treasuries, agency mortgage backed securities and debt (March 2009-forward)

I’ve left out plenty, but the point is clear: the Fed’s arsenal is mostly empty, except for just expanding money printing.

One way or another, there will be more money printing, by most or all major central banks. That means:

1. Long Term:  further feeding long term inflationary pressures and the bull market in commodities, especially the preferred USD hedges, gold and oil, and other hard assets.
2. For the rest of 2010, the fear and uncertainty should continue to favor the US Dollar and other safe haven assets, as Greece, Spain, other PIIGS debt sales, and the US mortgage resets all pressure markets lower, especially as we get deeper into the second half of 2010 around July.

 We hope to do a more detailed analysis of the likely scenarios for the EU debt crisis soon. Stay tuned!

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