Friday 23 September 2011

Zero Hour Approaches

Things have gotten to the point where we may be reaching “zero hour”. My core risk assessment in place since March 1st and earlier is materialising fast.

On March 1st 2011 I wrote that we are seeing the first symptoms of a far more serious global situation, thanks to rising public debt, slowing economic growth, and a lack of political will.

On July 13th 2011, I did a quick analysis of the US debt situation, and why the Eurozone had to find a quick resolution to the Greek crisis to prevent international contagion.

On August 22nd 2011 I wrote that the Greek situation was trending worse, and that core indicators were indicating a rapidly slowing economy, particularly in China, and that domestic political issues jeopardised the ratification of the EFSF. My forecast on premature elections materialised this week in Slovenia, of all places. I expect more to follow.

September has proven to be the worse month yet. On September 6th 2011 I wrote that we were entering Black September. On September 18th 2011 I reported on the disappointing failure of the Eurozone finance ministers’ summit and listed nine reasons why the situation was extremely alarming. Italy was downgraded on Tuesday, September 20th 2011. Thursday, internal PASOK opposition to the new austerity measures was vitriolic. It is not certain that these measures will pass, or that the government will survive. (I do believe there is a 60% chance they will rally and pass the measures, but it's impossible to be certain). 

There is now essentially one chance to get by this right: strong, coordinated action needs to be agreed upon and delivered by the G20 by Monday at the IMF/World Bank meeting in Washington. This mst include a public commitment to recapitalise European banks and defend the sovereigns with at least EUR 2 trillion in commitments, probably EUR 800 bln from the EFSF, EUR 1 trillion from the ECB, and hopefully EUR 200 bln from the US, Canada and BRICS. Absent this, the widely-expected sell-off may begin.

Yet even these actions do not offset the economic fundamentals: they merely buy time.

I would also like to warn once again on unseen risks: Toxic debt and derivatives contracts in the European banking system are ever-present. Austria and Denmark face major banking sector risks at present, the former from derivatives exposure, the latter from rising interest costs and refinancing needs. Spanish and Italian banking problems remain well-known; French banks have major exposure, which has been well-documented in the past 2 weeks. Switzerland, Luxembourg and Belgium are black holes. Several US banks, in turn, are exposed to European banks, particularly French ones. Commercial property requires re-financing and restructuring. The IMF has warned that European banks need about EUR 300 billion in capital support; I believe this may be higher. I still have not understood how some banks can have a loan and derivative book which can be, for one institution alone, more than 100% or even 300% the GDP of their home country.

Given these weaknesses, and given rising rates for Italian, Spanish and other bond spreads, as well as the opacity on Chinese and US public debt, it’s clear that the problem in public finance is accelerating.

It should be clear that the Greek tail that has been wagging the dog since the end of October is so preposterous a thesis as to be rejected. Eurozone leaders have been perfectly content to demonise Greece, but the problems in their respective countries are far, far higher, and far more substantial.

The “disappearance” of private sector involvement (PSI) in the second Greek bail-out, and the evaporating European support for EFSF recapitalisation, most likely means that European governments and banks are no longer willing to spend their firepower on Greece. They are probably reserving it for their own emergencies.

Apart from passing the new austerity law, which will intensify the recession/depression, the other hope is for a government of national unity. Elections in Greece would have nearly the same effect as not passing the new austerity law. It’s a massive Catch 22. The total failure of Greek politics, and the wider socio-economic system which supports them.

Some relevant reading from developments this week:

On Monday, Standard & Poor’s downgraded Italy. IMF chief economist Olivier Blanchard stated that "There is a wide perception that policy-makers are one step behind markets.” This came a lot sooner than I expected, but it will soon be followed by Moody’s.

On Wednesday, Fed Chairman Ben Bernanke announced a $ 400 bln debt “twist”, but announced that the US faced “significant downside risks”. The DJIA fell by 3%.

On Thursday, the Dow fell by another 400 points; Reuters attributes this to recession fears and European sovereign debt.

On Thursday, seven world leaders also demanded that Europe’s leaders get a handle on their sovereign debt crisis in a letter to France, which chairs the G20: "Euro zone governments and institutions must act swiftly to resolve the euro crisis and all European economies must confront the debt overhang to prevent contagion to the wider global economy

Mohammed El Erian, PIMCO MD, comments on the emerging crisis on Bloomberg: World on the Eve of the Next Financial Crisis.

El Erian also published a must-read in the Financial Times: French Banks could tip Europe into a Full-Blown Crisis.

© Philip Ammerman

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