Thoughts from the Frontline

Changing the Rules in the Middle of the Game

By John Mauldin

November 26, 2011

Choose your language

Changing the Rules
When Even Germany Fails
European Inverted Yield Curves
Time to Review the Bang!Moment
The Risk of Contagion in the US
Time to Start Watching China
New York, China, and Some Links

Angela Merkel is leading the call for a rule change, a rewiring of the basic treaty that binds the EU. But is it both too much and too late? The market action suggests that time is indeed running out, and so we’ll look at the likely consequences. Then I glance over the other way and take notice of news out of China that may be of import. Plus a few links for your weekend listening “pleasure.” There is lots to cover, so let’s get started.

Changing the Rules

I have been writing for a very long time about the changes needed to the EU treaty if Europe is to survive. Specifically, last week I noted that Angela Merkel has made it clear that the independence of the ECB must not be compromised. This week Sarkozy and the new prime minister of Italy, Mario Monti, agreed to stop their public calls for such changes (at least until their own…

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Walter Bruno

Nov. 28, 2011, 8:25 a.m.

Just two quotes from the articles: “The only semi-realistic one is IMF participation. If that is seriously considered, then the US Congress should step in and protest. US funds should not be used for governments of the size of Italy and Spain. These are not third-world countries. This is a European issue of their own making and not the responsibility of US taxpayers, or for that matter taxpayers anywhere else. We should just say no.”
A little later: “The world is so connected”.
Jingoistic impulses vs. factual analyses do not seem to be prerogatives of Europeans. They seem to hamper American analysts, too.
P.S. By the way, the IMF is not the IBRD and is not confined to “third-world countries”. International monetary and exchange stability tasks primarily, concern developed countries which a priori will qualify Italy and Spain prime candidates according to IMF bylaws.

Alan Harris

Nov. 27, 2011, 5:12 p.m.

This is an essay about the present situation and question marks. I understand that John isnt in a position to create answers but Im getting bored. Ive still got a buck so Ive decided my time would be better spent going to the theatre rather than reading reading READING these tales of woe. Zod Merkle, I’ll settle for a Shakespearean tragedy: now thats a class act

Gerald Carr

Nov. 27, 2011, 4:37 p.m.

I understand your disappointment in not having CDS’s on an exchange but, an exchange is only as solvent as its clearing members.

Marco Fontana

Nov. 26, 2011, 5:48 p.m.

How can a Bear market start now if everybody has already positioned themselves for that event?  I am long equities and will continue to acquire more as nervous traders continue to use any excuse to sell.  It is very hard emotionally to be long risky assets at the moment, and that is why I think it is the best strategy in the intermediate term.  Markets always behave in a manner that allows the least amount of people to make money and punishes the most.  If everybody made money in the stock markets, then who would work?

Fred Pollack

Nov. 26, 2011, 5:36 p.m.

On the other hand, from T.S. Eliot’s “The Hollow Men”, “...This is the world ends / not with a bang, but with a wimper.”

But more to the point, I can’t resolve this dilemma:

- Merkel is very smart.  She also has access to the best economic minds.
- Current direction that Merkel is advocating will lead to an EZ disaster.  But Merkel doesn’t want this.

So what is going on in her mind?

Perhaps, since “you can’t tell anybody anything until they are willing to listen”, Merkel has a plan, but it makes no sense to share it, until we get to the situation in which people are ready to listen to her plan.

However, events take on a momentum of their own.  There are points of no return.  Once we get to the “bang” stage (per Mauldin), it will be too late.

Craig Cheatum

Nov. 26, 2011, 2:44 p.m.

I wonder to what extent we need to change the rules here in the US back to mark-to-market accounting.  A lot of business leaders are complaining that taxes and regulations are holding them back from contributing to economic growth, but they reportedly have some $2 trillion on the books and possibly another $2 trillion offshore.  I wonder if something else is going on here and they are holding back on concerns of another shoe to drop in the financial sector for lack of proper accounting.

Craig Cheatum

Jeff Martin

Nov. 26, 2011, 11:57 a.m.

John,
There is little we can do to change the arc of the Eurpean crisis but I stronly disagree with your domestic solution.  The fact that Dodd-Frank has no power to regulate the shadow banking system was born in the Gramm-Leach Bliley Act.  It was also this piece of legislation that repealed Glass-Steagall and essentially created this mess we have right now. It completely deregulated derivatives and created the shadow banking system. Repealing Gramm and reinstating Glass Steagall will be a good start but since our politicians are essentially branch offices of the banks and financial corporations, little will be done.
I think we need to begin to look for political changes instead of economic ones.  I am not referring to political parties or administrations but a significant change in how our government works.  The OWS movement is born of emotions that should not be ignored. At the core are legitimate grievences that have great historical significance.  You are fond of the phrase “This time it’s different” and how that really never works out.  History has shown what happens when financially desperate masses have nothing to lose. Now, with the ability of that outrage to be instantaneously shared by millions, those emotions can become an action plan with the result like an explosion. 
The problem is the lack of necessary regulation of financial instruments. That alone has created every financial crisis in American history. We have a dysfunctional government that at the beck and call of those opposed to any regulation.  Is it any different this time?

Jeff Martin

Claude Bovet 23553

Nov. 26, 2011, 10:53 a.m.

John, it seems all the talk is only about ECB printing, or EFSF or all of the other funding solutions including the IMF.  Why is this so?  Isn’t another solution simple default (of course, with it’s attendant financial pain and contagion)?  I fail to understand why most people only focus on borrowing more to solve a debt crisis as the above “solutions” suggest.  This is akin to postponing the problem, not solving it.  Why not let those bondholders and shareholders suffer their losses rather than socializing them?  They certainly benefitted from the gains when times were “good” (in quotes as clearly they were artificial given the problems now).  Deflate the debt, get rid of the elite politicians that let (helped?) this happen, wipe out those weak hands and let’s get on with rebuilding. After the Reset, global economies will rebuild stronger than before and opportunities will once again abound.  ECB printing is only the postponement of a certain collapse of the German state as there is no way that they can support the debt of the rest of the Eurozone (as effectively the only funding source of the ECB), not to mention the attendant hyperinflation from the creation of a permanent stock of new euros.  John, is there something I am not getting here?

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