-- Posted Tuesday, 3 July 2012 | | Disqus
By Graham Summers
While various media outlets and “analysts” try to claim that the EU summit was somehow a success and that Europe’s issues are solved, the fact remains that Europe is out of money. And I mean TOTALLY out of money.
I realize this flies in the face of what 99% of analysts are claiming. But this is a proven fact. Of the various entities that could hold the EU together (the ECB, the IMF, Germany, and the two bailout funds: the EFSF and the ESM) none and I mean NONE of them actually have the capital to do it.
I am continually bombarded with emails from people saying, "well, if things get bad the Fed or ECB will just print and everything is solved."
This is beyond wrong. It is just groupthink based on the idea that the Fed has intervened ever since the Great Crisis began in 2008 (ZeroHedge recently ran an article showing that the Fed has intervened in over two thirds of the months since the Crisis began).
However, even Fed intervention has a limit.
To whit, the Fed has now pulled back from any aggressive monetary policy for over a year. There has been no money printing. Instead, the Fed has re-arranged its portfolio to attempt to flatten the yield curve.
Why is the Fed doing this instead of simply engaging in more QE? The answer is because QE removes Treasuries from the banking system. We are facing a solvency Crisis and Treasuries are the senior most asset on US bank balance sheets.
When the Fed buys a Treasury from a US bank, it is providing liquidity (cash) to the bank to meet the bank's short term funding needs.
However, by removing the Treasury from the bank's balance sheet, the Fed is removing one of the banks senior most assets: the very asset against which the bank has leant or traded hundreds of billions and possibly even trillions of Dollars' worth of loans and trades.
Put another way, the Fed, by buying Treasuries is making insolvent banks even more insolvent. It is a short-term gain (liquidity) for a long-term disaster: banks need as much collateral as they can get their hands on right now. And with Treasuries rallying (raising the value of the banks' assets) any aggressive Fed program to take Treasuries out of the system would be a MAJOR step towards another solvency Crisis a la 2008.
The same pattern is playing out in Europe right now though on a much grander scale (its banking system is nearly four times as large as that of the US). While everyone continues to believe the ECB can save the day, the fact remains that the ECB has NOT bought a single sovereign bond in 14 weeks.
Why is this? The same reason that the Fed is not doing more QE: Europe is facing a solvency Crisis. Removing sovereign bonds from the market may be helpful from a purely liquidity standpoint (cash for trash) but the Crisis in Europe is not based on liquidity, it’s based on solvency. And EU banks need as much senior assets as they can get.
Everytime the ECB buys a sovereign bond it's removing much needed collateral from the EU banking system (a sovereign bond may be garbage, but it's usually less garbage than a EU mortgage loan or an EU corporate loan).
This in turn only increases the solvency issues in the EU banking system. And remember, bank runs are already underway in Spain, Italy, France, and Greece. So banks are desperate for capital and collateral.
THAT is why the ECB cannot and will not simply print to "save the day": doing so would NOT save the day but would in fact accelerate the EU banking Crisis.
So the Fed and the ECB WILL NOT be stepping in unless the entire system starts to go. This leaves the IMF which is a US-backed entity and thus cannot perform a large-scale EU bailout (it's an election year in the US and voters will not tolerate a US-lead bailout of Europe).
So all that is left to prop up Europe are the two mega-bailout funds (the EFSF and ESM) and Germany.
The EFSF's capital is already full committed and stretched to the limit in propping up Portugal and Ireland. So it's not an option anymore.
As for the ESM... well, it doesn't even exist yet: it has yet to be ratified by all the countries that need to vote on it. Moreover, Spain and Italy together are to account for 30% of the ESM's funding. So... these countries would be bailing themselves out!?!
Finally, both Finland and Netherlands are rejecting the idea that the ESM can be used to buy bank bonds. So the ESM, assuming it can even get ratified, will face major political pressure regarding how it spends its capital.
This leaves Germany as the one and only true EU prop. However, Germany is stretched to the limit.
First off, the country is only €328 billion away from reaching an official Debt to GDP of 90%: the level at which national solvency is called into question.
Moreover, that €328 billion has already been spent via various EU props. Indeed, when we account for all the backdoor schemes Germany has engaged in to prop up the EU, Germany's REAL Debt to GDP is closer to 300%.
In Euro terms, Germany now has €1 trillion in exposure to the EU via its various bailout mechanisms. That's EQUAL TO roughly 30% of German GDP.
If even a significant portion of that €1 trillion goes bad (which it will as this money has been spent helping the PIIGS), Germany's financial system will take a MASSIVE hit.
This will guarantee Germany losing its AAA status, which in turn makes its funding costs much higher (see what happened to France in the last year: that country is now facing bank runs and its own solvency Crisis which you'll be hearing about in the coming weeks).
Angela Merkel is up for re-election next year. There is no way on earth she'll opt to let Germany get dragged down by the EU. She's even said she will not allow Eurobonds for "as long as [she] lives."
This is not empty rhetoric. This is fact. Germany has expressed its intentions dozens of times in the last month: NO Eurobonds and NO guarantee of EU banking deposits.
The reasons for this are simple: EITHER option renders Germany insolvent. It's already teetering on insolvency to begin with. But to allow Eurobonds or some kind of guarantee of the EU banking system to occur on top of the money Germany has already spent propping up the EU will take Germany down.
The German economy is already slowing. Most Germans are fed up with the Euro. Merkel would rather die than let her country become like Greece (which the creation of Eurobonds or EU deposit guarantees would most assuredly result in).
So Germany is tapped out as well. This leaves... NOBODY.
Again, Europe is out of money. End of story. This is the truth and investing based on the idea of some magical bailout occurring is like investing on Hank Paulson's Bazooka policy for Fannie and Freddie (three months later the markets imploded).
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-- Posted Tuesday, 3 July 2012 | Digg This Article | Source: GoldSeek.com