01/20/2012
James A. Kostohryz
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In various articles I have said that the endgame in Europe will probably take the form of PIIGS economies shrinking more than expected, their revenues shrinking more than expected and fiscal deficits ballooning more than expected. All of this will cause fiscal targets and commitments to be violated on the part of PIIGS. This in turn will lead to a showdown with Germany centered on how such shortfalls will be handled.
Spain has now begun the process of acknowledging publicly that it will violate its commitments under recent accords …
Extraordinary political and economic Pan European efforts were made during the second half of 2011 to cobble together a series of gut-wrenching agreements and compromises that would enable the financing of targeted fiscal deficits for the PIIGS in 2012 – in the case of Spain a deficit of -4.4% of GDP.
Spain will not meet its target … . (It was based on a) forecast of 2.3% economic growth for Spain in 2012. …. In my view, the absolute best-case scenario for Spain’s GDP growth in 2012 will be a contraction of -2.0%. … Spain will be lucky if it can keep its deficit below its 2011 level of -8.0%+. …
If it has been impossible (which it has) to secure mechanisms that would ensure financing of a Spanish fiscal deficit of -4.4% of GDP, how is a fiscal deficit of -9.0% or more going to be financed? …
(And what about) Portugal, Greece, Ireland, Italy, and several other eurozone countries that will not meet their 2012 fiscal commitments. …
The market has not yet come to terms with the (fact that) the size of the fiscal shortfalls will be enormously greater than currently forecast. … I maintain my view that prior to late April of 2012, the S&P 500 will have initiated another leg down that will eventually take it to the 950-1,020 range.
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John Mauldin
01/21/2012
… When Europe approaches the edge of the Abyss and looks over, the rest of the world gets to take a look, too. We can all be taken to the edge and over. …
Europe has three main problems. …
1. A growing number of its countries are insolvent or close to it. …
2. … Because of growing fears of multiple defaults (just Greece would be bad enough!) most of the banks in Europe are seen to be insolvent and in need of hundreds of billions of euros of new capital. The interbank market in Europe is in a shambles, and banks park their cash with the ECB …
3. The real problem in Europe is the massive trade imbalances between the peripheral countries and the so-called core countries … without the ability to adjust currencies … .
One cannot solve one problem without solving all three (and) Europe is (only)trying to address problems 1 and 2. …
Now, the bankers and leaders of Europe are getting ready to walk to the edge of the Abyss. It will be a long way down, and look like the 7th level of Dante’s Inferno. Their first real look will come in the next few weeks, as Greece is negotiating aggressively with its lenders (and) Europe … . If they walk away and there is an uncoordinated default, it will guarantee chaos. Bank collateral will collapse and credit default swaps will be triggered, including many sold by European banks that are already essentially insolvent.
The legal euphemism here is that if debtors “voluntarily” accept a 50% haircut, then no credit default swap protections will be triggered … Greece can legislatively force them to take the haircut, but CDS contracts are written in such a way that that action would be seen as a loss, triggering the CDS insurance. The governments involved want everyone to accept, so there is no crisis. …
Europe … can lend Greece more money on promises to turn things around, which can’t happen because of … austerity being imposed and … GDP trade imbalance with the rest of Europe. But if they don’t lend the money … an uncontrolled default (is likely). It will mean hundreds of billions of euros in losses at their banks, which will have to be bailed out eventually by taxpayers. …
If Greece gets a 50% reduction on its debt, will not Portugal point out that they deserve it more? … Yields on Portugal’s 10-year bonds climbed to 14.39% on Thursday. Credit default swaps measuring bond risk have reached 1270 points … Citigroup, says, “Without a sizeable haircut to its debt stock, Portugal will not be able to move into a viable fiscal path. We expect a haircut of 35pc at the end of 2012 or in 2013.”
Ambrose Evans-Pritchard, (says,) “Portugal is a troubling case for EU officials, who insist that Greece is a ‘one-off’ case rather than the first of a string of countries trapped in a deeper North-South structural rift. … While all eyes are on Greece, it is the slower drama in Portugal that will ultimately determine the fate of the eurozone.” …
Let’s turn to some charts … (In terms of credit risk) Portugal is where Greece was last year. Then pay attention to the fact that Italy is likewise where Portugal was last year. …
(In terms of labor) Greece (would) have to endure a 30% pay cut relative to core Europe if they want to compete (resolve their trade imbalance). … Greece is not alone. Are you reading of any general pay cuts in the proposed solutions for Italy, where labor costs are now above those of Greece? Likewise, no move in Portugal (not shown in graph). The entire eurozone is out of balance, and no one is making any moves to deal with it or even acknowledge the basic problem. …
Greece has two choices. They can choose Disaster A, which is to stay in the euro, cutting spending (labor and benefits) and raising taxes so they can qualify for yet another bailout (while) getting further behind on their balance of payments; and suffering … a depression for a generation. … There is a run on their banks. Any Greek who can is getting his money out.
Greek voters will then blame whichever political group was responsible for choosing Disaster A and vote them out, as the opposition calls for Greece to exit the euro. Which is of course Disaster B.
Leaving the euro is a nightmare of biblical proportions, equivalent to about 7 of the 10 plagues that visited Egypt. First there is a banking holiday, then all accounts are converted to drachmas …
Whether they opt to go straight to the drachma (Disaster B) is only a matter of timing. They will get there soon enough. … (But) Europe fears a disorderly Disaster B. For the rest of Europe, it is the Abyss. The Greek hope is that Europe (read Germany) keeps funding them in order to keep back from the edge of the Abyss. …
Europe is getting closer to the point where it must make a decision about what to do with Greece. In theory, the deadline is March 29 for the next round of funding. … The markets are getting exhausted. There will be no private market for Greek debt at any number close to what is sustainable. Greece will be on European life support for a very long time if they stay in …
And Europe will all too soon face what to do with Portugal, (and) don’t forget Ireland … I think “polite” Ireland is just waiting until its $60-billion default is seen as small potatoes, which will not be too long, as Italy must raise almost €350 billion just to roll over current debt. … The bottom line is that Italy (and most likely Spain at some point) cannot raise the debt it needs at rates it can afford without massive European Central Bank involvement. … If they go for a haircut, it will be much larger. French banks holds 45% of Italian debt … They cannot even backstop their banks if Italy becomes a solvency risk. … The most recent downgrade of their debt was just the first of many. …
Europe will have to make its choice this year. Either a much tighter, more constrictive fiscal union with a central bank that can aggressively print euros in this crisis, or a break-up, either controlled or not. I don’t think they can kick the can until 2013, as the market will not allow it. … I think this is the year the crisis moment for the euro arrives. …
I know the markets are discounting a happy ending to the euro crisis. I just see the substantial “tail risk” and suggest you manage accordingly. …
(Read the whole article)
