Outside the Box

Things That Make You Go Hmmm…

John Mauldin

November 15, 2011

What do the “Big Fitz,” the largest ship ever to sail the Great Lakes, and the Eurozone have in common? Hint: the former sank without a trace. Or, as Grant Williams so eloquently puts it, in his Things That Make You Go Hmmm… for Nov. 13 (this week’s Outside the Box), “One can’t help but think … that this week may well have brought us to the wall at the end of the road down which Europe has been kicking the can for quite some time now.”

Grant inspects the SS Europe from bow to stern and concludes: “The smoke has pretty much cleared now and those in charge of the SS Europe are left with a stark choice – print money or allow the break-up of the Eurozone and the end of the common currency known as the Euro. At this point it really IS that simple.”

So come on along as Grant takes us on an eye-opening and at times jaw-dropping ride – there are some real insights here. From his perch in Singapore he sees the same problems I do, just from the other side of the globe. And that perspective is worth your time.

As you read this, I am on my way to Capitol Hill to meet with a member of the Super-Committee. If there is anything I can report, you will get it this weekend. I hope I can bring good news at some point. Then it’s back to the UBS Wealth Management Conference in time to hear Ken Rogoff (and Alan Greenspan) on a panel. I am looking forward to that. Tomorrow night in my own bed again. And be looking for a special note from me on Thursday.

Your trying to figure out how we get out of this mess analyst,

John Mauldin, Editor
Outside the Box

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Things That Make You Go Hmmm...

Grant Williams | Nov. 13, 2011

“Common responsibility for the European currency will also engender a common decision-making instance for the European economy. It is unthinkable to have a European central bank but not a common leadership for the European economy. If there is no counterweight to the ECB in European economy policy, then we will be left with the incomplete construction which we have today… However even…

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Peter J Taylor

Nov. 20, 2011, 5:22 p.m.

Inflation changes buying habits in three stages:
Stage 1: “I’m going to need some of those next month. Better buy them now before the price rises.”
Stage 2: “I’ll probably need some of those some time. Better buy them now whilst I can afford them.”
Stage 3: “I may never need those, but I’ll use my depreciating cash to buy them now, to sell or barter later.”
In November 1923, one German lady, who had been rich, entered a shop to invest her rapidly depreciating savings in durable goods to sell on later.
“Sorry, said the shopkeeper, I’ve nothing left but BEDPANS”.
“How many have you got?”
“About 500.”
“I’ll buy them all.”
So she handed over her barrow-full of banknotes to the shopkeeper, and filled the barrow with bedpans. In fact she had to make several journeys.
Then the government introduced the Rentenmark, almost overnight. The new currency was backed by a mortgage on all industrial and agricultural resources, including the railroads. It was accepted and trusted because people wanted it to be accepted and trusted.
The market for bedpans disappeared overnight.

Hans Krauklis

Nov. 17, 2011, 6:20 a.m.

I agree with John Mauldin’s and Grant Williams’ conclusion that perhaps the only way to manage the Euro-crisis is by the ECB involving itself in a large-scale TARP-like exercise.  The price for Europeans and the rest of the world will still be high, but there do not seem to be viable alternatives left on the table.

Back in late September / early October I participated in a blog discussion sponsored by the German national TV network ZDF (http://blog.zdf.de/zdflogin/2011/09/29/es-kann-sein-dass-wir-haften-muessen/ ) with Dr Michael Meister, who is also a CDU deputy floor leader in Ms Merkelâ??s coalition government.  I have translated my comments from German to English, below:

- - -

Comment 7: In my opinion we need to restate the basics (about the Euro crisis) in this discussion (blog): Whoever buys foreign (eg Greek) government bonds normally has to weigh two risks: the currency risk and the creditworthiness of the borrower state (eg Greece). This was the case before the introduction of the Euro. Within the Euro-zone the currency risk is eliminated, however, there remains the credit risk. (Why has this risk been seemingly ignored?)

Logically, therefore, the investors (ie banks) need to accept potential losses. If this should lead to the bankruptcy of large banks (“too big to fail”), the home state would need to, if necessary, take over these banks temporarily and re-capitalize them, in order to restore confidence and protect the domestic economy.

It would be better to wipe the slate clean and to limit losses, rather than to drag out the Euro-crisis. It is also not acceptable that taxpayers should be on the hook for the entire bill, while shareholders of the banks get away relatively unscathed.

Hans Krauklis | 29. September 2011 | 06:44 |

- - -

Comment 11: I am pleased that Dr. Meister took up my theme—to consider the creditworthiness of debtor countries and the respective pricing of investor risk. It would be highly regrettable if by disregarding this fundamental factor the Euro and possibly the whole European project were to be irreparably damaged.

The currently almost adopted “rescue umbrella” [ETSF bail-out fund] of â?¬ 440 billion is, it seems, not enough to get the Euro-crisis under control, and targeted “leverage” will only increase the risk for donor and guarantor countries. The prestigious U.S. ‘think tank’ STRATFOR estimates that a truly effective “shield” would need to be raised to over two trillion (2000 billion) Euros, if Italy and Spain should look for protection under it as well. The risk of becoming infected is growing even for the major donor countries, since the PIGS countries cannot credibly guarantee their share of the â??rescue umbrellaâ?.

In its current economic crisis Greece cannot meet the conditions of the “Troika” anyway. Thus, will the next installments of the “bailout” be paid out under softened conditions? In this way the Euro crisis will only be dragged out; it probably will affect the other “PIGS” countries and become probably even more expensive. It would be better to get on top of the crisis now.

In my view, the European Central Bank (ECB) may have revealed a potentially viable alternative path; however, the ECB is taking it currently in the wrong direction, namely in that it buys new PIGS government bonds.

My suggestion would be that the ECB should offer to buy any PIGS existing bonds, but at a moderate discount (“processing fees”), which should hit the banks and other investors in the pocket book, but without making them illiquid. At the same time - sooner rather than later - the ECB should state that it would buy additional bonds only at realistic market prices, if at all. For existing bought-up PIGS bonds, the ECB could then negotiate at a later date with the debtor countries and, if necessary, unilaterally provide for write-downs in its portfolios (“haircuts”).

This change in the ECB’s mandate would of course need to be secured by renegotiated treaty. The central bank (Federal Reserve) of the U.S. has indeed shown us by example how to do “quantitative easing” on a large scale, without driving the U.S. dollar into the ground for the time being. The effect of such an ECB action would probably be a long-term devaluation and inflationary trend of the Euro, but that could be managed. On the other hand, Europe would remain capable of action and the Euro less exposed.

Although in this way countries like Greece would not be freed suddenly from their debts, but with the ECB as a negotiating partner and the declared will of the States of the Euro-zone not to let drop weaker partners, sustainable solutions might be easier to find “in-house”.

These countries would need to negotiate sales of new government bonds at commercial interest rates, and if these rates are too high, the partner countries and the IMF might be able to assist. Mandated structural change and savings requirements should, however, be subject to a certain amount of consideration of the social consequences and should encourage competitiveness and economic growth at least in the medium and long term.

In other words, under my approach, the ECB would sequester a large portion of the PIGS old debts, and the “Troika” (IMF, EU and the ECB) would provide to a limited extent any necessary assistance for unavoidable new debt.

Hans Krauklis | 4. Oktober 2011 | 15:00 |

Robin Day

Nov. 15, 2011, 7:33 p.m.

Further to my earlier comment, I see in today’s business news that Europe is proposing to ban naked CDS going forward. Many will argue that doing so reduces market efficiency and liquidity, however, when outstanding naked CDS exposure is estimated at least 20 times global GDP, I believe it is excessive and must be curtailed. With a ban on naked CDS, gov’ts must then continue to print sufficient money to make good on sovereign debt as it matures, ensuring no outstanding naked CDS claims are triggered as they could snow ball into a collapse of the system…..I believe gov’ts will see the resulting wage and price inflation as a lesser evil.

Bill Yoe

Nov. 15, 2011, 2:46 p.m.

Way too much information.  Keep it simple and direct or you will lose your audience.

Robin Day

Nov. 15, 2011, 11:10 a.m.

THE problem as I see it is that naked CDS exposure on sovereign debt is about two orders of magnitude higher than the actual debt. This problem threatens not only Europe and the Euro, but the financial system world wide. For example, it was only a few weeks ago that JP Morgan tried to move $75 trillion (yes, trillion with a “t”)  in CDS exposure to a US gov’t insured subsidiary.

I see only one solution as follows:
1)gov’ts must print sufficient money to make sure no insured sovereign debt triggers CDS claims, and do so on an ongoing basis until leveraged CDS exposure expires with maturity of debt.
2)new rules must limit CDS coverage to only the amount of new sovereign debt issued. 

As I see it, welcome to the new world of spiralling prices and wage demands.

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