Are You Ready For Eurogeddon?

May 28th, 2012

Dear subscriber

Are we facing a new “financial mega-shock” that could strike at almost any time which has the potential to be larger than the Lehman Brothers shock of 2008?

With the crisis developing in Europe, a financial mega-shock would not come as a great surprise to me.

And, even though major bankers and policy makers see it coming, it has not prompted them to change their ways. Nor has it motivated the majority of investors to run for cover — yet. Instead, they have done precisely the opposite, doubling down on their risky investments.

As I see it, the dangers we face today are actually GREATER than those of 2008 in SIX key ways:

ONE Before the Lehman collapse in 2008, it was strictly individual financial institutions that were on the edge of collapse. Today, entire nations are on the brink … think Greece … Spain …

TWO. In 2007, the last full fiscal year before the Lehman collapse of 2008, the U.S. federal deficit was $161 billion. That was already excessive by most historic comparisons. But it was small enough to allow room for more deficit spending to stimulate the economy — without causing wild inflation or panic in government bond markets. Today, the deficit is $1.327 trillion, or 8.2 times larger...

THREE. In 2008, most of the megabanks at the epicentre of the crisis were in the United States, where even the largest among them are smaller than their European counterparts. Today it is primarily the largest European banks that are in the most trouble…

FOUR. In 2008, governments had not yet deployed their “big gun” cures for the debt crisis. So they still had the fire power to ‘handle’ the crisis with a series of unprecedented rescues. Today, we have seen nearly every possible stimulus plan, bailout deal or austerity measures known to man fail or languish at best.

FIVE. In 2008, governments encountered little public resistance to major new policy initiatives. Today, millions of citizens are rebelling at the polls — or on the streets — in France, Greece, Portugal, Spain, Italy, and even Germany. Look out for the outcome of Greece’s second elections, as well as Ireland ‘referendum’ vote.

SIX. Most important, before 2008, central banks were largely restricted to their role of manipulating interest rates. Since then, four of the most powerful central banks in the world (the Fed, ECB, BOE and BOJ) have embarked on the greatest wave of money printing in the history of mankind.

Let’s have a look at the weakest link: Greece . . .

Any government that has to pay more than 7% to borrow long-term money nowadays is widely believed to be in the “red” danger zone. The central government in Athens now has to pay FOUR times that much.

Any government that’s rated double-B or lower by the major rating agencies is considered very risky. Greece has just been downgraded to triple-C, meaning that default isn’t just a possibility — it’s very likely.

Any banking system that ‘suffers’ more in withdrawals than it gets in new deposits is in grave danger… remember Northern Rock? Greece’s banks are undergoing withdrawals that are similar.

Still wondering why London’s housing markets is holding up that well? Many Greek citizens are trying to get their money out of danger before Greece is forced to leave the Euro zone, with some investing in prime London property while applying for UK citizenship.

Any federal government suffering political gridlock during a financial crisis is unable to take the needed steps to end it. Greece doesn’t even have a government. It’s under the auspices of a caretaker president who is, by definition, not empowered to make any policy changes.

What about Spain’s economy . . . which is five times larger than Greece’s …

Any government that has to pay more than 7% to borrow long-term money nowadays is widely believed to be in the “red” danger zone. Spain has been closing in to this ‘red line’ several times recently.

Spain’s latest tally of official unemployment figures (for the fourth quarter of last year) was a massive 22.9%. And, based on a record new surge in registered job seekers reported on recently, it’s now probably much higher.

Any bank that suffers big withdrawals and has to be taken over by the federal government is obviously in serious trouble… heard of Bankia? Spain’s Northern Rock.

It is in fact far more serious when, despite a government takeover, depositors pull even more money out of the bank. It sends the message that they trust the government’s management even less than the bank’s.

Yet, that’s precisely what is happening at Bankia, as you can see from a recent AP report:

Confidence in Spain’s banks and its teetering economy was shaken after a newspaper reported that depositors were rushing to withdraw their money from Bankia, a troubled bank that was effectively nationalised just one week ago".

Adding to the anxiety, rating agency Moody’s downgraded its credit ratings on Spanish banks. The banking sector has been hit hard by a collapse in Spain’s property market and is facing tough funding rules that many analysts fear it can’t afford.”

Or, these ones . . .

Bankia, the country’s fourth-largest lender, saw its shares fall as much as 27% during trading in Madrid after the El Mundo newspaper reported the bank was hit with more than €1 billion of withdrawals since the government announced the takeover."

The amount taken out by bank customers is equivalent to all withdrawals made from Bankia in the first three months of the year.”

Withdrawals from Spanish banks could quickly turn into a flood, as individuals and businesses — with $1.25 trillion in total bank deposits — wonder if their country will be the next to leave the European Union.

Is Europe Really “Too Big To Fall”?

In Portugal, Ireland, Italy and even France, banks are vulnerable to withdrawals. And once the stampede strikes more than two or three major countries, you could see bank runs all across Europe.

With the recent political change in France, the alliance between the leaders of EU’s two largest countries is history, and Europeans who favour a Greek exit from the Euro zone — no matter how dangerous — are clearly gaining the upper hand

Until recently, global investors apparently believed Euro-zone leaders when they agreed to a great “fiscal pact” — when they vowed austerity and promised tough cuts to their giant deficits.

That is why these global investors declared a “cease fire” in their attacks on the sovereign bond markets of Greece, Spain, Italy and France, meaning they stopped dumping their bonds...

But now, in the wake of new elections in Greece, France and Germany, and with political support for any form of austerity in Europe slowly collapsing, global investors are beginning to think again, threatening to crash most European bond markets and cut off the vital flow of cash that governments need for their day-to-day survival!

We have been here before!

Last year, we witnessed a very similar contagion when investors exited from the bonds of the weakest European countries.

Much like today, the first to be attacked was Greece, the weakest link in the chain. Then, Spain, Portugal, Italy and even France got hit hard.

Soon, nearly all of Europe was infected, prompting its central bankers to suddenly break their solemn vows of monetary piety and print more than $1 trillion worth of new Euros.

Now, despite all those efforts, they are facing a new contagion of a second kind — by bank depositors.

But bank runs are far more infectious — and dangerous — than investor stampedes.

They invoke frightening flashbacks to the Great Depression. And they immediately threaten the entire banking system.

According to a recent article in the New York Times, "the havoc that a stampede might cause to the Continent's financial system would greatly complicate efforts by European Union officials to fashion a longer-term plan to ease the debt crisis and revive Europe's economy, because authorities would have to cope with the staggering added costs of shoring up banks”... yet again!

As we have seen in recent months, these governments have only one last ‘way out’ left: a tidal wave of money printing… with hyperinflation certainly to follow swiftly.

When the next crisis strikes, who will bail out the governments?

No one has an answer . . . No government anywhere can create wealth and prosperity with worthless paper:

  • when investors sell bad government bonds, the value of those bonds must plunge, making it next to impossible for those governments to borrow.

  • when savers run to safety, money must flood from the weakest banks to the strongest, making it impossible for the weak banks to survive.

That is what is happening right now and what is likely to continue to happen in the weeks ahead — until and unless the authorities unleash a new wave of money printing that makes previous waves look small fry by comparison.

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Till next time

Steven Dotsch
Managing editor
EMAR Publishers
Dividend Income @Investoretire

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