Even in August, while nearly all of Europe is on vacation, we find that economies don't get to take vacation. Europe will come back from its holiday and find that nothing has improved and some things have gotten worse. Specifically, Germany looks to be rolling over into recession. In this week's Outside the Box, Charles Gave of GaveKal looks at Deutschland and notes that while it might be able to handle a mild recession, problems will be that much worse in the rest of Europe, which needs a robust German consumer. This letter will print long due to a number of charts.
"While Europe's biggest economy should be able to endure this loss of altitude, the reverberation across Europe will be significant. The absence of exchange rate volatility over the last 15 years has allowed economies such as Italy and France to escape depression-type conditions, which might otherwise have occurred given their economic underpinnings.
"Now, however, there can be no escaping the fact that reduced German imports must cause a decline in French and Italian exports. This will likely be a shock for those who expect the German juggernaut to drag the southern economies back to growth. To put it bluntly, Germany will very shortly be subtracting from growth in the rest of Europe."
Charles is one of the founders of GaveKal (along with his son Louis and Anatole Kaletsky). GaveKal is one of the world's leading independent providers of global investment research. It also advises several funds, with combined assets of more than US$1.2 bn. With eight partners and 45 employees, GaveKal has its headquarters in Hong Kong and offices in the US, Europe, and China.
I am back from a needed time off and feel ready to get back into the harness. So, without further ado, let's look at what Charles has to say.
Your wondering how David Copperfield does it analyst,
It is a lazy summer day here in Texas, and the market and investment news front is rather quiet as well. But that will change before too long. We should enjoy the relative calm while we can, because Europe will soon be back in full crisis mode, coming off the summer. In today's Outside the Box we'll look at three brief pieces that may give us a preview of the near future, as well as an incisive retrospective on the recent past.
The first is from Roubini Global Economics. It's part of a longer piece by Megan Greene, looking at what lies ahead in Europe. The fun & games there promise to ramp back up all too quickly. Then we have another extract from a longer piece by Kiron Sarkar, looking at Germany, that echoes some of the themes from last week's Thoughts from the Frontline. The German leadership has not really been transparent with their people, but then you can't hide trillion-dollar commitments very easily.
Finally, we wrap with Ambrose Evans-Pritchard's latest column, which I think is one of the better ones he has done in years. I would call it a must-read. Under the title "Five years on, the Great Recession is turning into a life sentence," he concludes with:
"As for our [the developed world's] debt mountain, we have barely begun the great purge. Michala Marcussen from Societe Generale says the healthy level is around 200pc of GDP for advanced economies. If so, we have 100 points to cut.
"This cannot be achieved by austerity alone because economic contraction would tip us all into a Grecian vortex. Such a cure is self-defeating.
"Much of the debt will have to be written off. Whether this done by inflation (1945-1952) or default (1930-1934) will be the great political battle of this decade. Pick your side. Pick your history."
When you come to the Endgame of the Debt Supercycle, something must indeed be done with all the excess debt that has been accumulated. Different countries will choose different options, but no matter the choice there will be pain. It remains to be seen how that pain is spread around.
In the US, Romney has evidently decided to stop playing small-ball politics and turn the discussion into a referendum on the direction of the country. Both sides think this discussion will be to their advantage, which, if it were not my home country with consequences for my kids, I would find somewhat entertaining. But, as I wrote almost two years ago, this is a national discussion we absolutely must have. The issues are complicated, and there are no easy answers when you have to move out of the realm of theory and into the messy real world. Workable solutions to our big fiscal problems will be a much harder "sell" to the American public than either side currently thinks, as the majority of Americans, according to the polls, would like to eat their cake without paying for it. It is not clear what our choices will be when the true consequences are understood. I will comment further on this topic on Friday.
In the meantime, have a great week. My congratulations to my British friends on a marvelous Olympics.
Your getting ready to kick back a little analyst,
It seems like the whole world is expecting Ben and Mario to ride in and save the day with yet more stimulus. But to what effect, I wonder. Is a short-term rise in the market a cure for the basic disease of too much debt? And, as today’s Outside the Box hilariously points out, it can even make things worse.
Joan McCullough is perhaps my favorite curmudgeon. She writes so freely and with such style and feeling, but she also gives us such exquisite bits of information that no one else seems to find. Today, as I sat in a Denver hotel, I read her and just had to laugh a few times (mostly to keep from crying). She can be a tad hard on sensitive nerves, but we are all adults here, right? Be forewarned, though, that while she may pokes at someone you don’t like today, tomorrow she may be pointing out the issues with your guy. She is an equal-opportunity skewer.
Today she has Ben and Mario in her sights, and toward the end the poor Department of Labor incurs her wrath, too. On this both Joan and I agree: Europe is going to end in tears. The longer they keep piling up debt, the worse it will be. Their choices are Disaster A and Disaster B. Try to avoid both and you get Super Disaster C.
Joan has been trading and pontificating for longer than most of us have toiled and has forgotten more than I have ever known, assuming she ever forgot anything. She works with East Shore Partners, and God Bless them for giving her free rein to write as she sees fit. The wire-house boys would just die.
But before we hand it over to Joan, here is a quick paragraph from Yanis Varoufakis, writing about Greece at http://yanisvaroufakis.eu/2012/07/28/23-crucial-days-for-greece/. This shows just how absurd things are, and also how pernicious. The Greeks are paying back the ECB on the backs of Greek and other European taxpayers. Just to keep the game going. This is wrong on so many levels.
On 20th August, the Greek government will have to borrow 3.2 billion from one arm of the Eurozone (from the EFSF) in order to repay another (the ECB). Yet Greece is insolvent. The very idea of an insolvent entity borrowing more from a community, like the Eurozone, in order to repay that same community is obscene. All it does is to shift the burden from the Central Bank to the taxpayers of Germany, Holland, Austria and Finland. This is not an act of solidarity with Greece. It is an act of irresponsible kicking-the-can-up-a-steep-hill. The simple point I have been trying to drive home for a long while now is that the Eurozone must make a simple decision: Either to give Greece a proper chance of exiting its current death spiral. Or to dump Greece now, before the Greek state loses all its remaining assets and before it gets deeper into debt. And if our Eurozone partners are not prepared to make up their minds (caught up in their own short term concerns and shenanigans), then Athens must force their hand to decide within the next 23 days. How? By announcing that Greece will NOT be borrowing on 20th August monies it cannot repay under the present scheme of things.
I am speaking tomorrow at the Financial Advisor magazine conference for my partners Altegris Investments. But first I get to be a groupie and meet George Will, who is one of the truest wordsmiths of my generation. Tonight there will be a dinner and then some fun with Altegris partner and old friend Dick Pfister and his team.
I fly home and then on to Maine to be with many more friends for the annual Shadow Fed fishing-camp meeting. I think I will be on Bloomberg at 6:30 AM with Tom Keene (he may be the only one awake!) and then on with Mike McKee at some point. They will be cutting away to Maine throughout the morning, so you might want to tune in. Some good commentary on the employment number should make for some fun TV and radio. They do tend to change the schedule at the last minute, but it will be good whatever it is.
Time to hit the send button. Good friends (including Vitaly Katsenelson) are waiting. Have a great week, and the letter will be heading your way Friday from Maine.
Your shaking my head at Europe analyst,
In today's Outside the Box, the ever-philosophical Grant Williams introduces us to the ancient and profound art and science of alchemy – "the original 12-step program," as he calls it, the avid pursuit of übernerds from Hermes Trismegistus to Isaac Newton to (believe it or not) John Maynard Keynes, who referred to certain early works of econometrics as statistical alchemy (and some still are!). And we should not forget Carl Jung, who wrote the seminal work Psychology and Alchemy (for those who do not sleep or are looking for something to put you to sleep: http://en.wikipedia.org/wiki/Psychology_and_Alchemy).
Grant notes that, in contrast to the mechanically and spiritually laborious (not to mention ultimately futile) process of transmuting lead into gold, the steps to convert paper into money are only two: (1) Plugging and (2) Pushing. Nevertheless, he says, the fervid attempts by latter-day magi to concoct a successful outcome to our present economic crisis are proving no more successful than the Alchemical Work. Where alchemists got hung up, says Grant, was in the final, climactic step of the process, Projection.
Projection "was the moment when, despite all the work that went into getting to that last point in the program, hope and faith took over as the alchemist found himself having to rely on just a little bit of magic in order to get the outcome he so desperately wished for."
And Projection has much in common with Pushing. Whether it is Ben Bernanke pushing the outlandish assertion that "subprime is contained" or Spanish Prime Minister Mariano Rajoy hopefully projecting that Spain would "... stop being a problem and instead form part of the solution [to the debt crisis]," the economic alchemists have struggled. (I have a mental image of Ben Bernanke as the Sorcerer's Apprentice, with about the same results – forced to try and clean up the mess he made and ultimately being swept away in it!)
Grant wishes to speed the economic magicians in their arduous task by offering a new, slimmed-down transformational schema – it only has seven steps: Greecification, Backtrackification, Transmission, Restatigence, Bullyfication, Renegotiation, Realization. The outcome might not be any more satisfactory than it was for the conjurers of old, but at least they may learn something as they kick the Holy Economic Vessel down the road.
(See, I don't call this letter Outside the Box for nothing.)
Grant, by the way, is the best "new" wordsmith/storyteller I have seen in a dozen years. I am a huge fan. (If you want to be a Hmmm…’er too, you can subscribe for free at http://ethreemail.com/subscribe?g=bdc736be.) And I get to see him tomorrow in Singapore, where he works at Vulpes with master hedge fund manager Steven Diggle, who was with us in Tuscany for a few nights. (I am not supposed to mention how much he lost on Italian soccer, betting against Newt Gingrich, so I won't. But then, Newt has to fund his campaigns somehow. Might as well take it from a hedge fund guy who thinks he understands soccer.)
I have been in New York today (I'm writing this note from the Virgin Lounge at JFK) and did media hits all morning. Two hours of air time and never had to repeat myself. A great deal of fun. We started off at 7 a.m. with two segments with the super-serious and wicked-smart Tom Keene and crew at Bloomberg, then three segments with Matt Nesto at Yahoo Breakout (where I surprised him by agreeing with President Obama, kind of), and then finished off the trifecta with old fishing buddy and always-fun (where does he get all those obscure facts?) Mike McKee for an hour on Bloomberg Radio. You can listen on or watch at:
(Bloomberg Radio has not posted yet, but I assume it will be there when you get this. Look for the Bloomberg Radio 10 a.m. show with Mike McKee.)
They will call the first leg of my 24 hours to Singapore in a minute, so time to sign off. The next letter will come from Singapore. Have a great week.
Your still seeing Mickey Mouse and Ben Bernanke in my head analyst,
I was on the ground in Spain a few weeks back, and then I ran into this piece in Spiegel Online about a small, struggling town on the Spanish border with (British) Gibraltar. This essay resonates in some of the same ways as the Michael Lewis piece on Greece. This is just one town, and Spain has many regions, some more prosperous than others; but in a country where there is 23% unemployment and 50% among youth, there is plenty of suffering everywhere. The general story is one of deep problems, especially with regard to inefficient labor laws.
The author asks a big question: "Can the demise of a single city serve as an example that reflects the crisis in the entire country, isolated like a bacterium under the microscope? A crisis that is so severe that it threatens the continued existence of the euro, if not the European Union as a whole?" The answer: probably not, but the plight of La Línea illustrates the problems and the difficult choices faced by the periphery.
Meanwhile, at the other end of the European economic teeter-totter (but just as peripheral, in its own way), we find the City, London's version of Wall St.; and while the residents of La Línea seem to be rather adept at smuggling, they can't hold a candle to the traders of Barclays (and, it would appear, other eminent financial institutions) when it comes to criminality. (There is never just one cockroach.) We have seen some egregious antics by the too-big-to-fail boys the past several years, but Liborgate really takes the cake and eats it too.
It will be hard to contain the outrage when hundreds of trillions of dollars of financial instruments are priced on this figure. A few basis points means tens of millions to the average guys. Heads should roll. And don't think for a minute that the damage – and the blame – are going to be confined to that side of the pond, either. In a deeply probing commentary yesterday on the Libor fiasco, David Kotok takes the Federal Reserve to task over the abandonment of its formal surveillance and oversight role with respect to its primary dealers (which include Barclays Capital, Inc.).
And so the global economic teeter-tottering grows more extreme and destabilizing. What will it take to restore the dynamic balance we need for continued growth? It's a big old system we're all part of, and it's not going to fly right as long as we're more interested in gaming it than growing it.
It was interesting to be at the table tonight with David Zervos of Jefferies, who invited a few local fund managers and your humble analyst to meet with a former voting member of the ECB and Greek citizen (a US-trained economist, too). I want to think more about what I learned, but I imagine my thinking will spill over into future letters. Dear God, we have dug a deep hole for ourselves. I hope at some point we can stop digging.
And finally, as an antidote to the rather somber take on Spain in today's OTB, take a few minutes and watch and listen to this flash mob in Barcelona. How can you be pessimistic for very long about a country that can do this?
Your wanting to stand on solid ground again analyst,
Even while here in Tuscany I go on reading my email, albeit at a pace that is somewhat less maniacal than usual. I can't help myself; I find it fascinating to "surf" my emails and other sources. I get several hundred emails a day and about 40-50 that get more than a cursory notice. (I always try to read emails sent to me personally!) Today, for your Outside the Box, I am going to do something rather different. Rather than posting one or two essays, I am going to cut and paste snippets that I have found interesting in the past 24 hours.
There's no theme at all, but this will give you a sense of what I am giving at least passing thought to. While we may have been focused on Europe in my recent writings, I do try to remain aware of the broader world and markets. I still actually read research on the equity markets, and read analysis of various alternative investments and their markets. I have a number of friends who gather information, and when they send me something, even if it's somewhat lengthy, I really do try to read it. And there are so many links to follow and searches to perform. This retreat to Tuscany has made me realize that I need to focus a little less on the immediate and urgent, as fascinating as it is in today's world, and more on the deeper, importantideas.
I am going to force myself to stop at five pages, so I don't know yet how many sources there will be. My Chinese translators are anxiously awaiting this note, even though I am somewhat ahead of my US editor's day here.
I will also go deeper into what I learned this week from the lengthy and stimulating conversations here in Trequanda, and share a few impressions of Italy. The villa is getting somewhat quieter and more relaxed, as there are only a few couples (Rob Arnott and his family, among others) for the next few days; and I have promised Tiffani I will actually leave the villa this week and explore during the day, rather than just making the evening forays to dinner; so there will be even more downtime, which I am finding I need more than I thought I did. And while my partners have all told me to actually take some time off, I am sure they will be glad to see me back in the saddle, which will happen on Monday. Speaking of which, I did go to Siena yesterday to watch that horse race (Il Palio) around the town square. It has been run for over 600 years, and there is an enormous amount of ceremony and pageantry associated with it. Google it.
This morning we saw Newt Gingrich and his wife Callista off. He has been here the last week, along with Neil Howe and David Tice, who brought their daughters (daughters seem to be the general theme this season). Steven Diggle dropped by on a few occasions. Steven ran what ended up being the largest hedge fund in Asia, turning what started out as a few hundred million into more than a few billion, although he modestly says that he simply had a few very good years during the recent crisis, while everyone else lost half (or more). He closed his fund at 'the top' and now runs his own family office. But his range of knowledge and insight is quite broad. He was of particular use in explaining the nuances of Italian football during the Eurocup games.
The conversations ran far into the wee hours most nights and were picked up the following mornings. I actually find such times more relaxing and invigorating than simply 'checking out.' And having a variety of views on numerous topics and subjects from people with widely varying backgrounds has been a real delight. The only downside from the past ten days is that my must-read book list was expanded by about 30 volumes. Listening to Newt and Neil expound on Roman history, a topic about which I realized I have no more than cursory knowledge, has inspired me to try to delve from time to time into the history classics.
So with that, let's jump into my inbox and explore some more or less random notes from today's reading. Again, the only criterion is that it arrived within the last 24 hours – and I promise to stop at around five pages. My comments are italicized or [in brackets].
Your living on Italian country time analyst,
After I sent out this week's OTB on Germany, I remembered this very intriguingly titled piece by my friend George Friedman, founder of a geopolitical analysis company called Stratfor.
The piece was written a few days ago, but when it comes to someone as ahead of the pack as George, who managed to write a book called The Next 100 Years, well, let's just say what he writes is pretty timeless.
The content of this report is as bold and thought-provoking as the title. Some nuggets:
• Greece disappointed Europe not because of the choice it made but because it was crippled with indecision.
• Germany has become the problem in the eurozone where once it was the solution.
• France is not yet leading a coalition against Germany, but it is difficult to imagine a different scenario.
If you like the piece below, consider subscribing to Stratfor. <<OTB readers can click here to access a pretty significant discount on a Stratfor subscription>>. Their coverage of Europe (and the rest of the world) provides a unique geopolitical perspective. I also know that a very in-depth report on the geopolitics of Germany is coming up in the next couple of weeks, so you may want to subscribe to access it.
Your wishing this Italy trip was also timeless analyst,
This week all eyes are on Germany, and the question is "What will Germany do?" We are going to look at four quite-short essays. Two are from GaveKal, one is from Dennis Gartman, and the last is from Kiron Sarkar – all on this very topic.
One of the reasons I really like to read the research from GaveKal is that they are very public when their analysts disagree, and you get to listen to the back and forth. Some of the best analysis I see is when Charles and Louis Gave (father and son) and Anatole Kaletsky do email battle with each other while they are on three different continents. This time it is Anatole and one of their analysts, Francois Chauchat (whom I have not had the pleasure of meeting), differing on whether Germany should (or even can!) leave the eurozone.
I should note that it is not unusual for there to be intense debates in serious research houses. Happens every day, and perhaps often during the day. When you are playing an "A"-level game at one of the best research houses, you are typically not a shy, retiring type. What is less than usual is for that debate to be played out in public for clients to see. While a strong, useful consensus may be reached, I find the sturm and drang of the debate to ofttimes be just as instructive.
Anatole thinks Germany should leave, and you find yourself nodding your head, and then you read Francois and you sit back. This is a very complicated issue.
I continue to believe that Europe in general and Germany in particular have no good choices. They can only choose between Disaster A, which is keeping the eurozone together, and Disaster B, which is breaking the eurozone apart. Either will cost trillions of euros and mean much pain. It is not a choice of pain or no pain. It is simply a decision as to what type of pain you want and in what doses you want to take it. Choose wisely.
Then Dennis Gartman weighs in this morning. For those who know Dennis, he is never shy about voicing his opinions when he writes every market day at 3 AM Eastern Time, from wherever in the world he is. But he is not married to any positions. His favorite quote seems to be from Keynes, which is (loosely), "When the facts change then so do my opinions." And then he tells everyone about the change and why. You have to love that.
But this morning he was exceptionally strong in his opening piece about Europe and Germany. After reading the notes from GaveKal, absorb Dennis's pithy analysis.
And finally there is a one-page summary note from Kiron Sarkar, which he sent me while we were exchanging emails today. (With m on my iPad 3 in Tuscany. There is an Italian company that sells a SIM card for the iPad that gives unlimited monthly data for €20. Awesome! Pay attention, AT&T).
This is a real feast for those who love to think about what's behind the headlines. I love it.
As noted above, I am back in the village of Trequanda in Tuscany. I do so love this place. Such peace and such views. Real, meaty food for the soul, while your body gets amazing Italian cuisine! The first of our guests arrived today, and the conversation while dining al fresco, gazing over the Tuscan hills soaking up the sunset, was so fascinating. My version of relaxing and recharging, even if it was with a nonalcoholic beer (sigh!).
Have a great week; I know I will. I see lots of fresh tomatoes and mozzarella in my immediate future. And lots of great conversations and time to read and think.
Your wondering why I only booked two weeks analyst,
This week I offer a main course, a veritable piece de resistance, for Outside the Box readers, from my friend Rich Yamarone. Rich is Chief Economist for Bloomberg and one really sharp talent. He helps write Bloomberg Brief: Economics, a daily notebook that comes out every business morning with an all-encompassing view of what's happening and will happen.
I have been on stage with him several times recently and have spent even more time with him over dinners. He keeps reminding me to pay attention to the slow-motion slowdown and eventual (he says) recession that is coming right here to the US. He thinks ten-year bond rates could scare 0.5% (not a typo!) if/when both Europe and China have a simultaneous crisis and the US is seen as a real – and perhaps the last – safe haven (to which I would add: besides gold). Certainly 1% on the ten-year and 2% on the 30-year will be on offer in such a scenario.
I asked him to give us a brief tour, based on some of the graphs in his latest presentation, and it arrived today. If you like, you can subscribe to their regular research by going to bloombergbriefs.com/economics.
But we can't ignore Europe entirely, so for an appetizer I offer this small note from Rob Arnott, founder of Research Affiliates (you may know them as the Fundamental Index guys) and manager of the extremely popular (for good reason) All-Asset Fund at PIMCO. Rob will be with me in about a week in Italy, and I look forward to great evenings over Italian food with friends and family.
Here, Rob looks into the future (something he does with great success in his funds) and walks us backward in time. But I will let him tell his story and then we'll get on to the main course. Quoting:
"On another topic, one of my favorite games as an asset manager is to look past current travails and ask what *must* happen in the years ahead. Then we can turn attention to working backwards, identifying the intervening "path of least resistance." Sometimes, this is *way* more powerful than looking at the near-term decision tree and working forwards.
"The EZ travails lend themselves elegantly to this treatment. What will happen in the months ahead? No one really knows. What will happen in the years ahead? Nations addicted to debt-financed consumption will have to balance their books. All of Europe (and the US and Japan) will be spending no more (or very little more) than their tax receipts, a few years hence. Why? Because – as with any family – debt-financed consumption is ultimately unsustainable.
"Likewise, some years hence, entitlements will need to be on a pay-as-we-go basis, give or take a little wiggle room, in order to not crowd out all other forms of spending. Debt service will need to be part of the nations' spending, crowding out other forms of spending; a 'primary surplus' will be irrelevant.
"When will this transition take place? It's impossible for the status quo to continue more than a few years, though Japan shows that debt-financed government spending can persist far longer than most observers might suppose. And it's impossible for status quo to persist after the capital markets begin looking these few years ahead, which telescopes this transition into the coming handful of years. The more a nation relies on foreign investors to fund its spending, the faster this cliff arrives.
"So, working backwards from these inevitabilities ...
· "Since government spending roughly equals tax receipts, less interest payments, collecting more in taxes is a very dubious path by which to arrive at balance.
· "This leaves us with spending cuts. Entitlement spending roughly equals tax receipts attached to the entitlements. So the same logic applies: entitlement spending will be cut. Age of eligibility, means testing, and rationing are the paths of least resistance; but this will require an evisceration of the public sector and empowering of the private sector, which will in turn require a stark liberalization of regulatory and employment law.
· "*Or* there will be a collapse of GDP, as public spending drops without allowing the private sector to pick up the slack. Increasing global pressure for financial transparency, to facilitate tax collection, will become the norm.
"As we move back closer to the present, the near-term implications are less clear.
· "Nothing in this end-point *requires* that countries leave the EZ. Greece can simply slash public-worker salaries or head count to be fully covered by tax receipts. Likewise, Spain, Italy, Portugal, France (!).
· "If any country does exit, its banking sector must rebuild from scratch. The domino effect here is obvious: countries exiting en masse becomes a possibility. Italy and France are not assured to remain in the EZ in this circumstance. So, it's implausible that one, and only one, country exits.
· "All of this means that EZ exits may prove to be too messy to be allowed to happen, in which case defaulting countries will simply default, then cut spending to balance their budgets ... and then move on, with sharply diminished public sectors and GDP."
And back with John. It all sounds so simple when he explains it. But we will lurch from crisis to crisis in Europe, and then Japan will enter the picture in a big way. Hopefully we in the US can learn a lesson and deal proactively with our very similar problems, about which I will write this week.
And now I have to go to my next meeting, although it will be a pleasant one over a low-cholesterol dinner. Have a great week. The next time you hear from me I will be in Madrid on my way to Italy. So adios and ciao for now.
Your ready for a little downtime and conversation analyst,
We woke up this weekend to a €100 billion "rescue" of Spanish banks, and the initial reaction of the market was relief. But did we not just see this movie, but with Greek subtitles rather than Spanish? Was this another of those "necessary but not sufficient" plot lines that Europe is so good at? Kick the can down the road and hope for a happy ending?
Pardon my skepticism, but I see numerous problems. In the first place, €100 billion will not be enough. While the current estimates are closer to €40 billion (if you ask the Spaniards), JP Morgan estimates it will be more like €350 billion. Others estimate more or less, but €100 billion is decidedly optimistic. Even the Spanish authorities are acknowledging that there is another 35% downside for the housing market, which is the main source of the losses. It appears that has NOT been included in the guesstimates.
Secondly, this saddles Spain with yet more debt, which will force the rest of already-sold Spanish debt into a subordinated position (more on that from Louis Gave, below). It does not address the problem that Spain is running an almost 10% of GDP deficit and will need to access the markets for very large sums in the near future. For all intents and purposes, they have been shut out of the bond market, which is why they needed a "rescue."
Third, it does not address one of the fundamental problems, which is the subject of this week's Outside the Box from Charles Gave: it does not help solve the trade imbalance between Germany and the periphery nations.
Germany has two very bad choices. It can finance the multiple trillions of euros of debt of Spain and Italy (and France), converting it into eurozone debt, while giving up its own fiscal sovereignty and allowing a eurozone-wide fiscal union and taxing authority; or the Germans can spend trillions of euros allowing the eurozone to break up, either by exiting themselves or allowing the southern countries to exit.
The market is not going to finance Spain, Italy, et al. in the short term (i.e., this year). That means the ECB will have to print money or some European entity will need to have a basically unlimited blank check at the ECB, if those countries are not allowed to default on their debt. Someone, or some group of someones, is going to have to write a rather large check. The question is whether it costs more to stay or to go. Germany leaving the euro would not be good for German exports, which are 40% of their economy.
Finally, it is not clear exactly how this bailout (let's call a spade a spade) is going to come about. There will have to be, I assume, agreement from the eurozone countries if the EFSF or ESM funds are to be used. Further, if you make this deal for Spain, then Greece, Portugal, and ESPECIALLY Ireland are going to demand a reset. I am sure there is a coherent plan here somewhere, but I can't find it as of Monday night. What I did find is this quote in the Financial Times (jumping to the end of the story):
" 'Many Irish people looking at the deal this morning will be asking themselves why is there one set of conditions for us and another for Spain,' said Mr Doherty. Ireland's economic crisis closely resembles the situation in Spain, where a property crash has morphed into a banking crisis, leading to calls that Dublin should renegotiate its existing EU-IMF bail out deal. Aware that it is unlikely to persuade the troika to reopen its own bailout program, however, Dublin moved quickly on Sunday to deny that Spain's program would be less onerous than its own.
"The Spanish program could also produce political problems outside current bailout countries, particularly over the issue of which of the eurozone's two bailout funds is used for the rescue.
"Dutch and Finnish officials have warned they do not want the new bailout funded through the existing rescue system, the €440bn European Financial Stability Facility, because its lending is treated like any other private lender, meaning it has no seniority in the repayment queue." (emphasis mine)
The Spanish prime minister played the Germans very well. He got what appears to be a much better deal than the Irish. But then, he was playing hardball. This note from Joe Weisenthal at Business Insider:
"According to El Mundo, Spanish PM Mariano Rajoy sent a stunning text message to FinMin Guindos prior to the bailout negotiations. He said, according to El Muno editor Pablo Rodriguez: "Resist, we are the 4th power of the EZ. Spain is not Uganda." Translation: We're a major power, not some random IMF-case banana Republic.
"The followup message (according to Google translate) "If you want to force the redemption of Spain will prepare 500,000 billion euros and another 700,000 for Italy, which will have to be rescued after us."
"Bottom line: hold out for something good. We are powerful, and if they don't give in, the whole thing will go down. It will cost Europe 500 billion if Spain goes bust, and then another 700 billion if Italy goes bust. No wonder Der Spiegel, which represents the German point of view, has an article blasting Spanish blackmail."
And before we get to Charles's piece, let's look at this quick analysis by his son Louis Gave, the CEO of GaveKal, writing from Hong Kong (www.gavekal.com):
"As we go through the few scant details of the bank bailout offered to Spain, we cannot help but shake an uneasy feeling of deja-vu all over again:
- Banks confronting a deposit flight – check.
- Sovereign shut out from debt market – check.
- Loans provided to help sovereign deal with the situation – check.
- Potentially pushing current sovereign debt investors into a subordinated position – check.
"It is on this last point that the Spanish 'bailout' could prove to do more harm than good. Indeed, as we highlighted with Greece, when policymakers transform government debt into subordinated debt, they may as well shut down that market for good. This for a very simple reason: most investors who buy government debt do so on the premise that the paper is the most 'risk-free'. These are not equity investors, carefully weighing the risk-reward of a current asset.
"Investors into sovereign debt are all about minimizing risk. The reason one buys government bonds is first and foremost for capital preservation and portfolio diversification. Subordinated debt does not meet those requirements. Thus, Europe's policymakers, from one day to the next, could potentially not only increase the Spanish debt load by 9% of GPD but simultaneously make Spanish debt considerably more risky, and thus more unattractive. Beyond an immediate knee-jerk reaction, it seems unlikely that the Spanish contraction in spreads will be meaningful or lasting."
What Europe did over the weekend was put a band-aid on a very deep gash. To actually fix the problem, Europe must remove bank liability from the various nations and make them joint and several. But that is going to be something that Germany and other nations will fiercely resist. When the dust settles, the markets will realize, I think, that this latest move did not solve the real problems. It was just a way to stop the immediate pain. There is more to come, and it will require a lot more money and the loss of a great deal of national sovereignty if the eurozone is to hold together. It took the US decades, if not a century, to get to that place. Europe has a few years under its belt at most, and the crisis is right on top of them.
I am in New York tonight, just back from dinner with some of "the guys." (Jonathan Carmel of his eponymous hedge fund, Dan Greenhaus of BTIG, Barry Ritholtz of the Big Picture, and Rich Yamarone of Bloomberg). The topics were all over the board. I am not certain we solved any big problems ourselves; but the Chinese food at Shun Lee was sure good, and the conversation was sparkling.
It is time to hit the send button. Note: There will be no new postings on the Over My Shoulder website for the next 24 hours, as we do a major web-hosting switchover.
And now, let's turn it over to the always-incisive Charles Gave.
Your sorry to rain on Spain analyst,
Nobody, in my book, slices and dices data more thoroughly or convincingly than Greg Weldon. In this week's Outside the Box, he first dispels the illusion that either of the two most-expected outcomes of the growing eurozone crisis is really any kind of a solution – neither expelling Greece nor keeping Greece in the club is going to work, he argues – and then, in a feat of legerdemain, he conjures up an alternative that just might work – and backs up his idea as only Greg can. But is this a rabbit he's pulled out of his hat, or is it ... a Black Eagle?
This letter will print a little longer but, as is usual with Greg, it's chock full of great charts. You can learn more about his work at www.weldononline.com. For institutions and hedge funds, it should be required reading. (It is a little more than your average service, but as you can see, he really gets into the data very deeply!)
I am in Philadelphia tonight to speak for Steve Blumenthal's Advisor Forum. We did an evening at the National Constitution Center museum, where they had a Bruce Springsteen exhibit on the first floor and rather fascinating historical display of the history of the US and the Constitution. At the end is a room where there are 39 bronze life-sized statues of the men who were at the Constitutional Convention, displayed as they might have been arrayed at the signing. It got me to thinking about the times. Indeed, there was a quote from Washington about how bad things had become in 1789, sounding much like so many who now see the US as a hopeless culture, careening down a path of socialism and entropy. And certainly, the US and much of the world face some very hard choices in the next year or so; but somehow I think we will do just fine, even if we make a few bad choices and have to correct our course more than we would like.
Of course, it helps to have a Washington, Hamilton, Franklin, Adams, Madison, and Jefferson to help guide the ship on its course, but we will have to make do with what we have. Every country needs leaders with a clear vision and a love of posterity. Maybe later generations will recognize leadership where we do not. Here's hoping.
On Wednesday I get to spend much of the day with David Rosenberg, and I am sure we will go over our own poor vision of what will happen. And Thursday I get to have lunch with George and Meredith Friedman of Stratfor, in Austin, where I will listen as he gives me his latest take on the world. I always come away from my time with them with a whole lot more insight. Then it's a few afternoon meetings and on to the University of Texas for a seminar with Rosie and Rich Yamarone (with whom I had lunch yesterday in New York). It will be fun.
Your trying to get a whole lot done in a short amount of time analyst,
For this week's Outside the Box I want to share with you a singularly interesting conversation between Niall Ferguson and Ben Laurance, in the Sunday Times of London. What really grabbed me about it was the way Niall goes right out on a limb and yet makes such a convincing case that, when push really comes to shove, Germany will bite the federalist bullet, because it's overwhelmingly in their interest to maintain a united eurozone.
"I am not a federalist," says Ferguson. "But the costs of the single currency disintegrating are really so high and would impact so many people, that the only responsible thing for me to do is to argue urgently for the next step to a federal Europe. I see no alternative at the moment that isn't a great deal worse."
And the other option? "On the other hand — and this is the message to Angela Merkel — to use George Bush's phrase: this sucker's going down. We've reached that point."
Niall has never shied away from addressing the big questions. His latest tour de force, Civilization: The West and the Rest (just released in paperback in the UK, as Civilization: The Six Killer Apps of Western Power), demonstrates how Europe went from being a fractious, disease-ridden fourteenth-century backwater to global dominance, through the development of six "killer applications": competition, science, democracy, medicine, consumerism and the work ethic — and is now experiencing a precipitious decline (along with the rest of the West).
Are the stakes really that high? You bet. Everywhere I go, people are talking about and working hard on solutions to the issues that will make or break us in the coming decade.
I was part of a great conversation like that just a couple weeks ago, at the Casey Research conference I mentioned, down in Florida. When I'm at one of these things, I keep thinking, "I just wish a couple million of my best friends could be here, too." Well, the Casey people just told me that the CDs of the conference are shipping out this week, and so if you want the next best thing to being there, you can pick up a copy here.
There was a real whirlwind of press and media interviews last week while I was in New York. You can go to www.johnmauldin.com and look on the left side for the interviews I did with the Wall Street Journal, Bloomberg, and Yahoo Finance. I am off to Atlanta tomorrow for two nights and a few speeches and meetings, plus a lot of time to read and think (I hope!) about some of the speeches I have heard the past few weeks. It really has been a lot to try and absorb.
Your looking for answers to the big questions analyst,