The End Game

[Magox]

Another newsletter...

 

 

The European End Game

 

 

We all know that the U.S has a serious $14 Trillion debt problem that appears to have no end in sight, especially now with this rigged Deficit Commission panel that is comprised of ideologues from both ends of the political spectrum with no true intention of coming to some sort of bipartisan agreement in dealing with our countries perilous debt situation. One party wants to raise taxes on the “evil” rich simply for political class warfare reasons and the other just simply wants to cut spending, so most likely nothing substantive will come about until the Bond markets forces us to take action. But this isn’t the point of this newsletter, what we are seeing now is that it’s not just the U.S that has a bad debt problem, but pretty much the rest of the developed world such as Japan and Europe (particularly Southern Europe) find themselves in a similar, if not in some cases, a much worse situation.

 

Remember all the street protests and images coming from Greece, when it appeared that the Euro was in danger of breaking up? Greece was on the verge of defaulting and panic hit all the markets, chaos once again was creeping into the minds of investors who’ve been shell shocked over the past couple years. It wasn’t just isolated to Greece, but contagion had hit and all the peripheral nations were getting infected as well. Basically any European economy that had a high debt load was being targeted by the Bond vigilantes. What this means is that bond investors that owned these southern European bonds deemed these investments as crap, and essentially were panic selling these bonds, forcing yields to go sharply higher. When yields go higher, that means that the interest paid on their debt goes higher, which indicates that it makes it very difficult for these countries to repay their debt.

 

So the European Union along with the ECB came out with their $1 Trillion bazooka bailout and backstopped these economies. As I wrote a few months ago about this, I stated that this would only buy a certain period of time and that it wouldn’t actually solve the problem. Analysts for the most part agreed, but most believed that it would buy a couple years of time. Hmmm, let’s see here, it has been how long? Yeaah, it’s only been about four to five months. Not good!

 

So now we are beginning to see the same thing happen again; Irish bond yields are rising sharply, and even worse yet, Spanish bonds are doing the same. So what was the immediate solution? You got it, another Irish bailout fund that totaled $125 Billion. How long do you think this assuaged the fears of the market? Ready for this? A whopping 24 hours as the markets gave a vote of no confidence.

 

Right now, there are no real solutions that are being offered. Yes, they are imposing austerity measures which are intended to reduce their spending and their debt, and yes that is part of the solution. But this will take more than just austerity to solve these problems. When an austerity measures (which means government cutting of spending) takes place, there is a negative effect on growth. Think about it, you cut off the spending, and then this takes away money from the economy which means that growth gets affected, and tax revenues go down even further.

 

What they really want to avoid is having to bailout Spain. It is estimated that if Spain ends up in the same position, which I believe it eventually will, their total bailout cost will be over $350 Billion. You think the Germans want to continue bailing out these countries? It is a political nightmare for Merkel, the PM of Germany. Now some U.S official is talking about allowing U.S funds from the IMF to help with this possible future bailout. Yeah right! We barely can stand U.S bank bailouts; can you imagine the outrage here in the U.S if we are bailing out the Greeks, Spaniards and Portuguese? Yeah, I’m gonna say that isn’t going to happen.

 

The problem for everyone is that we are all interconnected. If you allow these economies to default on their debt payments, then we all take a tumble. What makes it tougher for the Germans for this not to happen is that their German private banks are huge investors of these heavily indebted countries through their purchase of bonds. So they can’t have them default because if they do, they will take tremendous losses in the hundreds of billions of dollars and that would create chaos in their economy.

 

So what is the End Game folks? Do they continue to keep backstopping them with these bailouts with no real solutions or do they attack the problem?

 

The real solution in my view is a three step process.

 

1) They have to impose tougher austerity measures.

 

2) They do have to provide more funding to weather this storm.

 

3) Last but not least, which they aren’t addressing as of yet, is that they have to restructure the debt of these bonds with these private banks. Meaning that these banks that have been investing in these bonds need to take a haircut on the value of those bonds. In other words take a certain percentage loss and lower the interest rates that these countries have to pay.

 

The reason why they aren’t doing this last part is because this would mean that the banks would have to take very large write-down’s (losses) which of course would affect banking behavior. Lending would go down, and the cost of credit would go higher, which means growth would be affected.

 

So what do we believe is going to happen? Will they kick the proverbial can down the road or will they actually make the tough decisions and address the problems? My guess is that they will meander around for a while and eventually when all else fails, they will begin to address the End Game by restructuring these debt obligations. Until then, you can expect to see the ECB continue with their version of QE (money printing) through massive purchases of European bonds. Of course they would refute my characterization of QE, as they adamantly oppose the notion of this idea, and there is a difference between our motives of QE and the Europeans QE. The U.S Federal Reserve is buying U.S bonds with the intent of stimulating the economy and boosting inflation, where the ECB is buying bonds to support these failing economies and prevent them from defaulting on their bond obligations. But it’s all the same, money printing is money printing, you say TomAto, I say Tomato.

 

Either way the value of paper currencies is getting debased, no matter what the motives are.

[Gene Frenkle]

1) They have to impose tougher austerity measures.

Which hurts growth...

2) They do have to provide more funding to weather this storm.

Which increases debt...

3) Last but not least, which they aren’t addressing as of yet, is that they have to restructure the debt of these bonds with these private banks. Meaning that these banks that have been investing in these bonds need to take a haircut on the value of those bonds. In other words take a certain percentage loss and lower the interest rates that these countries have to pay.

Which hurts growth...

 

Quite the complicated mess!

[Magox]

[/color]Which hurts growth...

[/color]

Which increases debt...

Which hurts growth...

 

Quite the complicated mess!

Yes it is...

 

There is no easy way out. That is why it is imperative that we address this problem here in the U.S before the bond markets force us to. The longer the delay, the more the pain. If we can address it now, it will just shave off growth over the next 5 years or so, if we wait until the bond vigilantes to correct us, then we will fall into another recession immediately, with unemployment reaching over 12%.

 

The strategy has to be short-term pain for long-term gain.

[....lybob]

Yes it is...

 

There is no easy way out. That is why it is imperative that we address this problem here in the U.S before the bond markets force us to. The longer the delay, the more the pain. If we can address it now, it will just shave off growth over the next 5 years or so, if we wait until the bond vigilantes to correct us, then we will fall into another recession immediately, with unemployment reaching over 12%.

 

The strategy has to be short-term pain for long-term gain.

Wildly optimistic

[RkFast]

Not to be a dumb populist (which I am, I know) but I love how the gubmit is looking to take MY tax breaks away and make it harder to realize the American Dream, yet are also prepared to give a bunch of !@#$ing border jumpers a free education and citizenry, just for registering at (not even attending!) a !@#$ing Community College.

Edited December 3, 2010 by RkFast

[Gene Frenkle]

Not to be a dumb populist (which I am, I know) but I love how the gubmit is looking to take MY tax breaks away and make it harder to realize the American Dream, yet are also prepared to give a bunch of !@#$ing border jumpers a free education and citizenry, just for registering at (not even attending!) a !@#$ing Community College.

Are you making more than 250K? Congrats if so.

[TPS]

Another newsletter...

The class warfare is coming from the top trying to force most of the pain on the rest of us--across the entire globe. I say raise taxes on the top, especially for those who caused the crisis and benefit from the bailout the most--Wall Street. Create a financial transactions tax on short-term holdings. Create a worldwide FX tax on non-goods/services related trades. Tax the speculators. Growth has been lower and there have been more financial crises since deregulation of finance began in 1980. AS Kevin Phillips writes in "Bad Money," the end of modern empires (since the birth of capitalism) is marked by the growing influence of finance.

 

Before I get painted by some generalization, I'm all for eliminating corporate income taxes (including the corporate payroll tax) because they are treated as a cost. If we must tax corps, mabye a small VAT. By the way, it's not that the top wouldn't get a tax cut, they would on the first $250,000...

Time for a beer mates!

[GG]

The class warfare is coming from the top trying to force most of the pain on the rest of us--across the entire globe. I say raise taxes on the top, especially for those who caused the crisis and benefit from the bailout the most--Wall Street. Create a financial transactions tax on short-term holdings. Create a worldwide FX tax on non-goods/services related trades. Tax the speculators. Growth has been lower and there have been more financial crises since deregulation of finance began in 1980. AS Kevin Phillips writes in "Bad Money," the end of modern empires (since the birth of capitalism) is marked by the growing influence of finance.

 

That's quite the sample size. Growth has been lower since 1980? Compared to what? Growth coming back after massive recession in 1970s, or a post-war torn Europe & Asia? End of modern empires since capitalism would include Great Britain and .... ..... ....? One can make a case that US is just a better sequel to the British Emprire, which keeps going.

 

One can also make a case that for all the faults & excesses, financial engineering and the speed at which capital is deployed has also paved the way for the fastest technological advancements in human kind. Compare the world now and 1980, and the world in 1980 and 1950 and how much changed between those three decades.

 

The only thing that the recent financial debacle showed is that as you open up financial speculation to a wider audience, a big bubble & big bust will ensue. Taxing transactions won't prevent the next bubble, as that cost will simply be priced in the transaction, hurting the end user, not the market maker. If you really want to be altruistic, you don't let anyone near a financial instrument who hasn't demonstrated a competency test.

 

Said another way, a Series 7 exam shouldn't be given to brokers, but to investors.

 

Time for a beer mates!

 

Can't disagree, but let's kick up the alcohol quotient.

[/dev/null]

Can't disagree, but let's kick up the alcohol quotient.

 

Four Loko?

[Magox]

The class warfare is coming from the top trying to force most of the pain on the rest of us

[ieatcrayonz]

Yes it is...

 

There is no easy way out. That is why it is imperative that we address this problem here in the U.S before the bond markets force us to. The longer the delay, the more the pain. If we can address it now, it will just shave off growth over the next 5 years or so, if we wait until the bond vigilantes to correct us, then we will fall into another recession immediately, with unemployment reaching over 12%.

 

The strategy has to be short-term pain for long-term gain.

I would like to become of of these bond vigilantes. I mean I alreadfy have enough money and all but it is getting more difficult to have fun making it. Being a bond vigilante sounds fun. Is there a training program you can point me toward?

[TPS]

That's quite the sample size. Growth has been lower since 1980? Compared to what? Growth coming back after massive recession in 1970s, or a post-war torn Europe & Asia? End of modern empires since capitalism would include Great Britain and .... ..... ....? One can make a case that US is just a better sequel to the British Emprire, which keeps going.

 

One can also make a case that for all the faults & excesses, financial engineering and the speed at which capital is deployed has also paved the way for the fastest technological advancements in human kind. Compare the world now and 1980, and the world in 1980 and 1950 and how much changed between those three decades.

 

The only thing that the recent financial debacle showed is that as you open up financial speculation to a wider audience, a big bubble & big bust will ensue. Taxing transactions won't prevent the next bubble, as that cost will simply be priced in the transaction, hurting the end user, not the market maker. If you really want to be altruistic, you don't let anyone near a financial instrument who hasn't demonstrated a competency test.

 

Said another way, a Series 7 exam shouldn't be given to brokers, but to investors.

 

 

 

Can't disagree, but let's kick up the alcohol quotient.

As I recall, he includes the Dutch, Spain and UK. Hmm..your conclusion is that technological change occurs faster because of finance? I always thought it was related to R&D spending, or research at University centers?

Or that it was the competitive push to maintain one's market lead? Most financial innovations have no relation to promoting technological advancement. This is really a stretch.

I don't disagree about taxing and preventing crises, I was talking about how to pay for the deficits mainly caused by finance. Regulations/taxation can restrain bubbles, but they will never prevent them.

 

I suppose in your mind using the term class warfare is a one-way street.

Edited December 4, 2010 by TPS

[Magox]

I would like to become of of these bond vigilantes. I mean I alreadfy have enough money and all but it is getting more difficult to have fun making it. Being a bond vigilante sounds fun. Is there a training program you can point me toward?

You're not the only one...

 

James Carville once said:

 

“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody."

[Clip Smith]

I would like to become of of these bond vigilantes. I mean I alreadfy have enough money and all but it is getting more difficult to have fun making it. Being a bond vigilante sounds fun. Is there a training program you can point me toward?

 

There is, but it's in Los Gatos.

 

The funniest part about this is that the same institutions that the government bailed out are only going to take the government down in the end. When you can write unlimited paper 3 levels out to put a cap on something, you can't lose. The only people that lose are the 95% of us other schmucks who get caught in the middle of 2 sides starting a paper avalanche.

[GG]

As I recall, he includes the Dutch, Spain and UK. Hmm..your conclusion is that technological change occurs faster because of finance? I always thought it was related to R&D spending, or research at University centers?

Or that it was the competitive push to maintain one's market lead? Most financial innovations have no relation to promoting technological advancement. This is really a stretch.

 

That's a bit of a stretch to include Netherlands & Spain in that category, but I'm guesisng that Phillips cherry picks data to back into his theory. There have been bubbles & manias throughout human history, some have coincided with empires falling, some have not. The rise of the Dutch empire is also due to financial innovations that allowed them to be the world's biggest traders. So which is it - finance is responsible for the fall, but not the rise?

 

That's also what I mean about finance speeding up technical innovation. Of course Wall Street types don't invent or build things. But they also built a very efficient money machine that was very effective in funding a lot of the technology advancements, that would not happen at the same speed if not for the financial innovation of getting a lot of capital all the way down from the angel levels up to the eventual IPO & buyouts that keep the machine churning.

 

 

I don't disagree about taxing and preventing crises, I was talking about how to pay for the deficits mainly caused by finance. Regulations/taxation can restrain bubbles, but they will never prevent them.

 

It's always good to separate that process from the manias that create bubble environments, because you will never prevent those.

[Magox]

That's also what I mean about finance speeding up technical innovation. Of course Wall Street types don't invent or build things. But they also built a very efficient money machine that was very effective in funding a lot of the technology advancements, that would not happen at the same speed if not for the financial innovation of getting a lot of capital all the way down from the angel levels up to the eventual IPO & buyouts that keep the machine churning.

Joseph Schumpeter would approve of this statement, I think he would of called this Unternehmergeist.

[....lybob]

 

 

That's also what I mean about finance speeding up technical innovation. Of course Wall Street types don't invent or build things. But they also built a very efficient money machine that was very effective in funding a lot of the technology advancements, that would not happen at the same speed if not for the financial innovation of getting a lot of capital all the way down from the angel levels up to the eventual IPO & buyouts that keep the machine churning.

 

 

How does the Wall Street of today compare to the Wall Street of 30-40 years ago in this function.

[GG]

How does the Wall Street of today compare to the Wall Street of 30-40 years ago in this function.

 

Not even close, as far as making capital available to start up ventures and then funding their growth. The downside is that as capital is more readily available, it feeds speculative manias.

[....lybob]

Not even close, as far as making capital available to start up ventures and then funding their growth. The downside is that as capital is more readily available, it feeds speculative manias.

How well do they do their due diligence and vet the start ups now as compared to then.

[TPS]

That's also what I mean about finance speeding up technical innovation. Of course Wall Street types don't invent or build things. But they also built a very efficient money machine that was very effective in funding a lot of the technology advancements, that would not happen at the same speed if not for the financial innovation of getting a lot of capital all the way down from the angel levels up to the eventual IPO & buyouts that keep the machine churning

I'd say that part is debatable.