John Maudlin writes on the BusinessInsider of his prediction finally coming true. Germany notoriously deadpan against printing money due to its experience of Weimar hyperinflation had no solutions left to turn to, other than turning on the printing press. After all the LTROs worked for a short period but weren’t enough.
The simple fact is that Mario Draghi, the Italian president of the ECB, created €1 trillion euros to help fund European banks, which promptly turned around and bought their respective countrys’ sovereign debt. Germany’s Angela Merkel forced the Bundesbank to “play nice” and go along with what was seen as the only way to solve a growing banking crisis in Europe. Everyone breathed a sigh of relief, thinking that this at least bought a year during which things could be sorted out. But it turns out that a trillion euros just doesn’t go as far as it used to. The “relief” lasted about a month. The last few weeks have presented yet another budding crisis, as least as large as the last one. Where to get the next trillion?
This week the German Bundesbank waved the white flag. The die is cast. For good or ill, Europe has embarked on a program that will require multiple trillions of euros of freshly minted money in order to maintain the eurozone. But the alternative, European leaders agree, is even worse. Today we will look at the recent German shift in policy, why it was so predictable, and what it means. This is a Ponzi scheme that makes Madoff look like a small-time street hustler. There is a lot to cover.
The plain truth.
It is the world’s worst-kept secret: Germany does not want inflation but wants to abandon the European Union even less. And as we will see, the eurozone simply does not have enough money to keep itself together without massive ECB intervention.
Bild and Spiegel Online ran with stories of inflation stoking up deep-seated fears and memories from days gone by. The Bundesbank came out with a statement to try to prepare the German people.
“The panic-mongering was prompted by a statement by a senior official from the Bundesbank, Germany’s central bank, to the finance committee of the German parliament earlier this week. Jens Ulbrich, head of the Bundesbank’s economics department, said that Germany is likely to have inflation rates ‘somewhat above the average within the European monetary union’ in the future and that the country might have to tolerate higher inflation for the sake of rebalancing national economies within the euro zone.
I have been writing for almost two years about the fact that the cajas, or Spanish regional banks, are worse than bankrupt. US banks are shut down when their nonperforming loans are at 5% of their capital. Spanish banks are at 20% and rising rapidly. My coauthor Jonathan Tepper and I spent a whole chapter in Endgame on Spain, at the end of 2010. This week the Spanish government basically nationalized Bankia, the nation’s 4th largest bank, which had been cobbled together from seven failed cajas and given a large government guarantee and a €3 billion public-offering equity infusion. Only roughly half of its real estate loans are generating returns, and that is the number for public consumption.
The write downs are not enough and the eventual recapitalization will need to be extremely large.
“Aside from creating a financially unsound bank, the government also demanded an additional 30 billion euros worth of write-downs on loans – valuing 84 billion euros in total, when combined with the original requirement of 54 billion euros in write-downs. The combined write-down program is, however, unlikely to be sufficient to address the close to 180 billion euros in toxic assets held by Spanish banks. Furthermore, many of Spain’s struggling banks will be unable to maintain the core tier-one capital ratio required by EU regulations without the government’s assistance. Spanish banks will require an estimated 100 billion-250 billion euros in recapitalization later this year to reach this capital ratio target – a significant percentage of which will have to be shouldered by Madrid.
Maudlin breaks down the debt and commitments that the Spanish government has, which breaks down similar to what ZeroHedge reported.
We are talking the need for new Spanish-government debt amounting to roughly 25% of GDP that will be needed just this year, and that’s if things don’t deteriorate beyond present assumptions in their real estate sector. Care to make a wager on how sound those assumptions are? About as sound as Rajoy’s assessment, only a few months ago, that no public money would be needed, perhaps?
Let’s do some basic math. Spanish banks took down some €352 billion in the LTRO (created by the ECB), or over 1/3 of the total amount. They have about €80 billion left after deposit outflows and buying sovereign debt. Which will be needed to buy yet more Spanish government debt, so they can be bailed out.
As near as I can tell, Spain is guaranteeing about $20 billion of the new IMF funds that will be used for a European bailout. Spain already has $332 billion of liabilities to the ECB, $125 billion to the stabilization fund, another $99 billion for something called the Macro Financial Asset Fund, and various guarantees for other bank and European funds, all of which totals over $600 billion, give or take. Their public debt-to-GDP ratio is only 69%, but add in these other guarantees and commitments and you get over 130% debt-to-GDP. And that is before they start bailing out their banks, and before any additional debt from their fiscal deficit, which is running at 8%. (Yes, I know they say it will be around 5%; but they are in a deepening recession; unemployment is rising at an alarmingly high rate, which lowers revenues and increases government spending; and their bond costs are rising).
So what state is France in?
“However, the fundamentals are much grimmer. France has not balanced its books since 1974. Public debt stands at 90% of GDP and rising. Public spending, at 56% of GDP, gobbles up a bigger chunk of output than in any other euro-zone country – more even than in Sweden. The banks are under-capitalized. Unemployment is higher than at any time since the late 1990s and has not fallen below 7% in nearly 30 years, creating chronic joblessness in the crime-ridden banlieues that ring France’s big cities. Exports are stagnating while they roar ahead in Germany. France now has the euro zone’s largest current-account deficit in nominal terms. Perhaps France could live on credit before the financial crisis, when borrowing was easy. Not anymore. Indeed, a sluggish and unreformed France might even find itself at the center of the next euro crisis.”
The banks of France are over 4 times the size of French GDP. The markets have been punishing the larger banks, with some of them down almost 90%.
While French banks are not the problem that Spanish banks are, they are far larger relative to the size of their home country. Even a small problem can be large for the country. And French banks have very large exposure to European peripheral debt. A default by Spain would push them (and a lot of other European banks) over the edge. Which is one reason that Sarkozy was so loudly insistent that any bank problems should be treated as a European problem and not the problem of the host country. (Interesting idea if you are Irish!) France simply cannot afford to deal with any problems in its banks while it is running such large deficits. And not while it is guaranteeing all sorts of European debt, which is at the heart of the problem. Germany needs France to help shoulder the financial burdens of Europe. And as long as France can keep its AAA rating, Germany has a partner. But if France loses that rating, then any European debt it guarantees clearly loses that rating as well.
S&P has already taken France down one notch to AA+ and still has a negative outlook. Moody’s has warned of a possible downgrade to France. Italy now has a BBB+ rating, just below that of Spain. When you look at the actual balance sheet and total debt, France is not all that far from further downgrades, unless it embraces a new budget ethic, which is precisely what Hollande has said he will not do.
That would be a real crisis for the eurozone. German voters might not be willing to shoulder the European burden without a full partner in France.
Is there any wonder about the timing of the Bundesbank retreat? They looked at Greek and French elections and then at the ongoing Spanish crisis, which is trending from very bad to awful with a risk of horrific. They glanced at the balance sheets of their own banks and those of French banks vis-à-vis sovereign debt from peripheral Europe, then took a peek at German-voter polls and flipped through their own balance sheet, and decided that the only entity with enough money to stem the crisis was the ECB. And that means a “little” inflation.
I think the vast majority of Germans (and to be fair, the entire world) have no idea how many trillions of euros are going to be needed to keep patching the leaky ship that is the eurozone. It is even possible that most German politicians actually think it might only be 3% inflation.
Spain is too big to save and too big to fail. The only way for Spanish debt to remain at 6% is for the ECB to basically buy it (or lend to Spanish banks so they can buy it, or whatever creative new program Draghi and team can think up). When Spain goes, it is just a matter of time before we lose Italy and then, yes, even France. The line must be drawn with Spain. And the only outfit with a balance sheet big enough that can also do it in a politically acceptable manner is the ECB, and the only way they can do it is with a printing press.
Thanks for the hangover 😉
They will do whatever it takes to keep the European Union and eurozone together. And whatever it takes is a very open-ended plan. But it is going to cost them trillions of euros.
Someone is going to have to pay that bar bill. And there’s going to be one helluva hangover.