As the Euro Rolls Over, Why Hasn't Gold Rocketed?

In early May of this year, with the euro hovering in the $1.46-$1.48 range, I disagreed vehemently with euro bulls such as portfolio manager Axel Merk who argued that the common currency was no longer vulnerable to a sell-off (see Merk's May 11 FT article titled 'Dollar in graver danger than the euro' and my counter arguments here, here, and here). 

Merk's argument was basically that in 2010, when the euro sank to a low of $1.18, the currency served as a proxy for the sovereign debt crisis. Now, however, investors were shorting sovereign debt directly and, according to Merk, recognized that it is a lot harder for the ECB to print euros than it is for the Fed to print dollars.

For awhile, as you can see from the below chart, it appeared that Merk perhaps had made a good point. From May the euro has shown remarkable resilience; for the last six months one sovereign after another has white knuckled its way through uncertain debt auctions and ever higher interest expense. Meanwhile the ECB kept its 'bazooka' semi-holstered with purchases of sovereign debt apparently capped at €20 billion per week. While the euro did soften from mid-May onwards it was able to keep it's head above the $1.40 mark for the summer and a good chunk of autumn.

Click to enlarge

Continue reading the full article at Seeking Alpha here.

Video: SNL's A Closer Look at Europe

A Closer Look At Europe, SNL S37E05, Greece, Germance from Sandy Sandcake on Vimeo.

World's Most Dangerous Banks and Their Host Countries

Below is the Financial Stability Board's list (by host country) of systemically important financial institutions (SIFIs), alternatively known as the 29 banks which are simply Too Big to Fail.

Twelve different countries are home to these 29 banks. Half of those countries host just one Too Big to Fail institution, and the other half host anywhere from two (Germany and Switzerland) to the U.S.'s eight.

Continue reading the full article at SeekingAlpha here.

Recommended links

1. Rogoff: 80% chance that Greece will leave the euro (Bloomberg)

2. More Greece love from Sarkozy: Greece should have been denied euro (BBC)

3. Nominal GDP targeting is unlikely to work (INET)

4. World power swings back to America (Telegraph)

5. Hugh Hendry at LSE Alternative Investment Conference (Greshman's Law). My writeup on Hugh's Jan. 2011 interview at the AIC can be found here. Hugh has agreed to come back to the 2012 AIC conference, which I look forward to attending.

6. Portugal enters the 'Grecian vortex' (Telegraph). AEP has been on a roll lately.

7. Italian 10-Year Yield Tops 6% in Auction, Setting Record (CNBC)

Video: Niall Ferguson Says Financial Repression Preventing Full-Scale Italian Bank Run

Niall's latest comments on the Eurozone crisis after the jump:

Graphic: European Sovereign Debt Crisis - It's All Connected

This is a BIG graphic. The original NY Times version, which is easier to view, can be found here, with the interactive version here.

(click to enlarge)

Default Myth Busting: Sorry Simon and James, the U.S. is not a Default Virgin

Professor Simon Johnson and James Kwak of The Baseline Scenario have an article at Vanity Fair about the geopolitical importance of credit in late-18th century France, Great Britain, and (especially) the United States. Their article, however, fails to mention an important detail which also happens to contradict their claim that "the (U.S.) federal government would always honor its debt".

The consolidation/conversion of U.S. revolutionary state debt into federal debt, which took place in the early 1790s, and which the authors refer to in the paragraph prior to the above quote, represented a U.S. sovereign default. (For more on this event see Reinhart and Rogoff (click on the U.S. tab) or Sylla, et al, which describes the 'haircut' bondholders received (6% to 4%).)

The notion that the U.S. has never defaulted has unfortunately been repeated often enough that, like the incorrect claim that TARP was "profitable", otherwise well-informed people have come to believe it.

In terms of other U.S. defaults, Reinhart and Rogoff also count Franklin Roosevelt's 1933 prohibition on owning gold and the subsequent devaluation of the U.S. dollar vs. gold as a default.

It's not very surprising to see Vice President Biden promoting the myth that the U.S. has never defaulted (in his case following a visit to the U.S.'s largest creditor, China). Professor Johnson, however, should know better.

"Dexia Has a Problem of Liquidity, Not Solvency"

In a move eerily reminiscent of 2008 Belgium and France have agreed to bailout Dexia, with a French official apparently claiming that Dexia "has a problem of liquidity, not solvency".

Ok, so it looks like Bear Stearns would have made for a better metaphor than Lehman.

But now that it's been decided to backstop the Brussels-based megabank (again) Belgium's caretaker government might have to explain in the not too distant future whether the country itself is having a liquidity or solvency problem. Per the below chart Dexia's assets are almost 200% of Belgian GDP.

(click to enlarge)

(Note: the above chart from ZeroHedge does not appear to include France's GDP in the calculation of Dexia's ratio, just Belgium's. However, it does give a sense of just how big Dexia is relative to the size of Belgium's economy, along with other large banks in Europe.)

AEP on Euro Endgame: "Sorry Deutschland. History has conspired against you, again."

Evans-Pritchard on the Eurozone's Debt Endgame:

The Geithner Plan must be accompanied a monetary blitz, since the fiscal card is largely exhausted and Germany refuses to lower its savings rate to rebalance the EMU system. The only plausible option is for the ECB to let rip with unsterilized bond purchases on a mass scale, with a treaty change in the bank's mandate to target jobs and growth. 

This would weaken the euro, giving a lifeline to southern manufacturers competing with China. It would engineer an inflationary mini-boom in Germany, forcing up relative German costs within EMU. That would be the beginning of a solution, albeit a bad one. 

Sorry Deutschland. History has conspired against you, again. You must sign away €2 trillion, and debauch your central bank, and accept 5pc inflation, or be blamed for Götterdämmerung. It is not fair but that is what monetary union always meant. Didn't they tell you?

Full article here. 

Video: Meltdown - Documentary (all 4 parts) on the Financial Crisis

h/t Barry R.

Lehman Part Deux: The Dexia Domino and Belgium’s Caretaker Government

The fear that Dexia, a Brussels-based money center bank, may become the 'another Lehman' thought to be lurking somewhere in Europe was given further credence a few days ago when its CEO resigned suddenly. The surprise departure of a senior executive -- often a grave omen -- turned up the heat up on a stew which had already been simmering for months. 

While both the French and German governments should have enough reserves and borrowing capacity to backstop their banking systems following default by one or more European sovereigns, the Belgians recently broke Iraq's record for being the country unable to form a government for the longest period of time (500+ days and counting). While the political dysfunctionality appears to have been a boon for the local economy it raises questions about what will happen should Dexia need a bailout following what appears to be an imminent Greek default.

Reflecting its regional significance, the Belgian, French and Luxembourg governments injected over 6 billion euros into Dexia during the last financial crisis. But without a Belgian authority to negotiate with, and given that France's banks are coming under significant speculative attack (for good reason. More on 'slippery' accounting at French banks here), there is a very legitimate question of whether a similar regional bailout can be orchestrated again.

Continue reading the full article at SeekingAlpha here.

Michael Lewis on Germany & the Eurozone

The latest and final instalment in a series of what author Michael Lewis has described as 'Euopean financial disaster tourism' articles he's penning for Vanity Fair can be found here. This latest article focuses on Germany (the previous two covered Greece and Ireland - google them or click on 'Michael Lewis' tag below to get the link).

The Germany articles also features an accompanying interview with Lewis, where 'Europe's least welcome tourist' discusses the problems with the broader Eurozone:

VF Daily: Where did the euro go wrong? 

Lewis: At its conception. They glued together a bunch of countries and cultures that didn’t really belong together in the same currency. So if you put Germany together with Greece in a single currency, it’s a little like watching an Olympic sprinter and a fat old man running a three-legged race. The Greeks will never be as productive as the Germans, and the Germans will never be as unproductive as the Greeks. So if they’re in the same currency—unless the Greeks simply up and move to Germany to work for the Germans—it implies a lifetime of transfers from Germany to Greece. 

VF Daily: Greece was allowed a partial default this week, to the tune of $157 billion, despite the E.C.B.’s disapproval. This measure seems like a Band-Aid, though. Can we expect something much larger to happen, or do presidents and prime ministers just enjoy getting together to argue every six months? 

Lewis: The Germans are basically calling the shots here, because they’re the only ones who can afford to pay the bill. My impression is that the German people do not want to pay it, but the German leadership does not want to be labeled as the people who destroyed the euro. So the way Angela Merkel is playing it is to tell the German people what they want to hear until the moment another crisis occurs, and then she goes into parliament and says, “I need this little check to get us through this rough patch, or you will be responsible for the disintegration of Europe.” What she doesn’t ever come away with, however, is a commitment for fiscal union. She doesn’t get Germany agreeing to underwrite euro bonds—to take all the debt of the southern countries. 

VF Daily: Well, it would be political suicide, right? 

Lewis: She may have already committed political suicide. German people are increasingly unhappy with how she has handled the crisis. I don’t think that the German people are going to go all-in. The step that they would need to take is much more dramatic than this Band-Aid.

Top Holders of Greek Government Debt

Graphic: Countries Most (Directly) Exposed to Greek Debt

The below picture doesn't tell the whole story as it misses indirect exposure to Greece, which in the case of the U.S. is purportedly quite significant.

From the BBC.

Fareed Zakaria Needs to Study More History

Fareed Zakaria

A good geopolitical discussion with CNN host and Time magazine editor Fareed Zakaria on Charlie Rose, although I take issue with one of Zakaria's suggestions:

Charlie asked him for his prescription for preventing conflict between the U.S. and China, and his response smacked of the same arguments and thinking which were prevalent prior to World War I.

Fareed stated that if the U.S. and China can increase their "dependencies" then this would prevent war from occurring. I was surprised to hear Fareed say this as he generally gives off the impression as someone who is well versed in history.

Fareed's thinking about what will prevent conflict is identical to what was said prior to World War I, the original era of globalization when arguably the world was even more interconnected by trade than it is today. Because everything was so interconnected, because nations like Britain and Germany traded as much as they did, war was considered impossible.

Many people are not aware of the fact that today's interconnected world is not our first experience with globalization. One of the better quotes on just how bound up the world was prior to WWI comes from John Maynard Keynes. Below he describes just how eerily similar life in early 20th century London was to today:

The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages; or he could decide to couple the security of his fortunes with the good faith of the townspeople of any substantial municipality in any continent that fancy or information might recommend. He could secure forthwith, if he wished it, cheap and comfortable means of transit to any country or climate without passport or other formality, could despatch his servant to the neighboring office of a bank for such supply of the precious metals as might seem convenient, and could then proceed abroad to foreign quarters, without knowledge of their religion, language, or customs, bearing coined wealth upon his person, and would consider himself greatly aggrieved and much surprised at the least interference. But, most important of all, he regarded this state of affairs as normal, certain, and permanent, except in the direction of further improvement, and any deviation from it as aberrant, scandalous, and avoidable. The projects and politics of militarism and imperialism, of racial and cultural rivalries, of monopolies, restrictions, and exclusion, which were to play the serpent to this paradise, were little more than the amusements of his daily newspaper, and appeared to exercise almost no influence at all on the ordinary course of social and economic life, the internationalization of which was nearly complete in practice.

Speaking of history, if you have a little extra time there was another excellent interview on Charlie Rose with the historian David McCullough about his new book, The Greater Journey: An American in Paris.

Why Greece Will Default Soon, and What Happens Next

As the haze and rhetoric surrounding the Greek debt crisis begins to lift we can now paint a pretty good picture of what's in store over the next few weeks for Europe's seemingly never-ending debt saga.

The June 29 Deadline

The FT describes the latest details and deadline in the Greek debt endgame:

...pressure is building to have a deal done within three weeks because of an IMF threat to withhold its portion of June’s €12bn bail-out payment unless Athens can show it can meet all its financing requirements for the next 12 months. 

Officials think Greece will be unable to return to the financial markets to raise money on its own in March – as originally planned in the current €110bn package – meaning that the IMF is now forbidden from distributing any additional cash. Without the IMF funds, eurozone governments would either be forced to fill the gap or Athens could default. 

To bring the IMF back in, the new deal must be reached by a scheduled meeting of EU finance ministers on June 20.

The hard deadline may in fact be June 29, when a 12 billion euro ($17bn; £10bn) payment is due to be made to Greece, of which 3.3 billion euros would come from the IMF.

Driving the IMF's credible tough stance are hard lessons learned (and apparently not forgotten) in Latin America a decade ago.


Remembering Argentina

Paul Blustein has written two very insightful and accessible books on recent sovereign defaults and IMF bailouts. His first, titled The Chastening, details the 1997-1998 Asian financial crisis. His follow-up focussed on the financial crisis which struck Argentina's shortly thereafter, and is titled And the Money Kept Rolling In (and Out): Wall Street, the IMF, and the Bankrupting of Argentina. Both books are available in in the Good Books and Films section on the right side of this blog.

Continue reading the full article at SeekingAlpha here.

Video: Niall Ferguson Outlines Possible Collapse of Eurozone

Video here.

Video: Niall Ferguson on DSK, Europe's Debt Crisis

Video here.

Video: John Stewart on Dominique Strauss-Kahn (DSK) Imbroglio

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Video: Dominique Strauss-Kahn (DSK) Saturday Night Live (SNL) Skit

For more great edutainment check out this video, which is from a year ago and still spot on as nothing has really changed with Europe's debt crisis in the past twelve months.