by Dan Amoss
June 4, 2012
Dan Amoss, CFA, is a student of the
Austrian school of economics, a discipline that he uses to identify
imbalances in specific sectors of the market. He tracks aggressive
accounting and other red flags that the market typically misses.
Amoss is a
Maryland native, a graduate of Loyola University Maryland, and earned his
CFA charter in 2005. In spring 2008, he recommended Lehman Brothers puts,
advising readers to hold the position as the stock fell from $45 to $12.
Amoss is managing editor of the Strategic Short Report.
We’re on our way to a new global monetary system.
The current one isn’t
working, and each year, fewer parties have the incentive to keep it.
This summer will mark an acceleration of the move toward a new monetary
system. If European leaders want to hold the euro together (they do), Europe
has no alternative but the printing press. The cries for more printing will
drown out the German elders’ warnings against using the printing press to
finance government spending.
Reuters recently quoted a Spanish diplomat who likened the German cultural
aversion to currency debasement to the Taliban:
“It may go down to the wire;
it may get very bad,” he said.
“But Germany has to choose. With Greece, it
did not have to choose. It could allow Greece to fail. But if Spain fails,
Europe fails. So in the end, we have to believe that Merkel and the Taliban
of the Bundesbank (German central bank) will change their minds and do what
they need to do to save Europe.”
Which party is acting like a Taliban fanatic here?
The parties arguing that
central banks financing governments can set society on an inescapable road
to hyperinflation, or the parties blackmailing the rest of Europe into
unconditional bailouts (“if Spain fails, Europe fails”)?
This ultimately comes down to an ugly argument over which countries and
institutions will suffer losses and lower standards of living.
borrowers should suffer the losses, but thanks to the printing press and
bailout policies, losses are spread around to everyone holding currency -
even if they were prudent and responsible during the bubble years.
Two Choices For The Eurozone…
Looking at the big picture, the Eurozone crisis will keep pressure on
politicians until it forces an important choice:
Unite into a mediocre, fading welfare state. In this potential United States
of Europe, Brussels plays the role of
Washington, D.C., holding the power to
tax and issue debt. No country fails or succeeds, and everyone waits as
demographics and euro debasement slowly push the welfare state into
Break up, force losses on banks and bondholders and start over in the
aftermath with a series of currencies. In other words, restore a system in
which the currency has meaning and living standards rise and fall based on
Below is how I expect this crisis to proceed, based on political incentives.
But first, here is the backdrop to the choice Europe faces…
As expected, nothing concrete came out of the recent summit held by Eurozone
political leaders - the latest in a long line of summits dating back to
All of them deal with one key issue:
Who will shoulder the
losses from the past decade’s government debt bubble?
And is the European
Union destined for a full-blown “fiscal transfer” union, with richer
countries spreading the wealth around to the periphery?
Many respected investors see a movement toward fiscal transfer union, with
Brussels having the power to tax and issue debt guaranteed by every EU
Bridgewater CEO Ray Dalio, the world’s best macro hedge fund
manager, recently told Barron’s that he sees a fiscal transfer union as
inevitable. In Dalio’s view, it’s only a matter of how much pain European
financial markets and economies must endure before forcing the wealthier EU
countries into such an arrangement.
But at this point in the crisis, a transfer union looks like a long shot;
it’s not politically acceptable to core countries like Germany.
Germans ask, “should we subsidize the budgets of profligate governments that
have shown no ability to restrain their spending? These countries can’t even
foster conditions that allow for a competitive economy!”
That’s a valid question.
You can sympathize with the seemingly cruel,
miserly sentiment if you ask yourself the following: Imagine co-signing a
luxury car loan for a free-spending, un-creditworthy neighbor, just so you
can maintain a friendly relationship. You know you’ll be on the hook for the
debt, yet the benefits of co-signing are tiny.
Aside from understandable objections to a fiscal transfer union, Germany and
other core Eurozone countries also want to prevent the European Central Bank
(ECB) from behaving like it’s financing a banana republic.
On the issue of ECB policy, however, Germany is not likely to get what it wants.
will likely launch another round of printing and buying of
simply because the Greek and Spanish banking crises continue festering and
there is little hope of any quick political resolution to these problems in
the coming weeks and months.
More ECB printing would not solve the problems clearly on the horizon;
printing simply buys more time ahead of a needed restructuring of government
debts and banks.
Spain’s hidden and contingent liabilities are becoming all too real. For
instance, the regional government of Catalonia, Spain’s wealthiest region,
just asked the central government for help refinancing its debt: It must
roll over €13 billion in debt through year-end, and has been shut out of
international bonds markets for years.
As liabilities pile up at the central government, depositors continue
running from Spanish banks.
As we suspected, the recapitalization needs of
Bankia keep growing. The Spanish press recently reported on Bankia’s request
of €15 billion in cash from the government - money that the Spanish
government doesn’t have, and which would, if granted, push its own bonds
further into distress.
Prime Minister Mariano Rajoy’s response to the banking crisis has been
erratic and incoherent. The Spanish public is losing confidence in their
political leaders. It probably will fall to EU and ECB bureaucrats to decide
how to restructure the Spanish banking system, especially since they have
access to borrowing and printing options far beyond those of Spain.
I doubt many of the large banks can absorb the losses on Spanish loans and
mortgages, because the interconnectedness of the system means the weak banks
will drag down the stronger banks, both through the tightening of credit to
the rest of the economy and through the liquidation of overmarked
collateral, which pushes down collateral values backing loans at all the
For all the duplicity of his actions in 2008, Hank Paulson knew a successful
bailout required all too-big-to-fail banks to take
TARP money in 2008, even
if they didn’t want it; he understood that the most-bankrupt banks would act
in a manner that dragged down the supposed “fortress” balance sheets.
Remember, Spain doesn’t have the capacity to implement a TARP-like
recapitalization of its banks.
Spanish Prime Minister Mariano Rajoy at a
recent summit resorted to begging the ECB to buy more Spanish bonds. More
ECB buying would do nothing to solve the problem, and would only exacerbate
the flight of private-sector bond investors from Spain.
At the end of this process, the losses will likely exceed the value of the
Spanish banking system’s equity. Claims of subordinated, unsecured
bondholders will likely get haircuts, too.
The ECB and EU need to act fast. Private deposits in Spain’s banks fell 2%
in April, to €1.62 trillion, according to ECB data. The month of May must
have been even worse. Continued runs at this pace would hollow out the
banking system in a matter of months, leaving the ECB as the only entity
supporting the towering edifice of bank liabilities.
The central bank reaction to debt crises is prompting large bond fund
managers to ponder the future of the monetary system.
Bill Gross, manager of
the world’s largest bond fund, in his latest missive describes,
breaking point in our now 40-year-old global monetary system.”
He sees that
there is no way out of our current global debt problem other than continued
printing and repression of returns for savers.
Spanish bank insolvency lies at the heart of the country’s crisis. Until
it’s adequately restructured and recapitalized, Spain’s crisis won’t end.
This recapitalization process is why I’ve instructed my readers to short two
large Spanish banks - one of which we’re already up well over 10%.
In Greece, it’s more of the same.
The chances of political and economic
chaos are high. The Greek government is suffering from plummeting tax
receipts, and is likely to run out of cash to fund its budget right around
its June 17 elections. It faces the unpleasant choice of sticking with EU
bailout terms and receiving the next bailout cash payment or defaulting and
jumping into an uncertain economic abyss.
Putting myself in the shoes of Greek political leaders (even if the Syriza
party wins the next round of elections), I expect they’ll decide to “accept”
bailout terms for now, get the cash and then not adhere to the terms.
Depositors and bond investors would see this scenario as more of the same,
and the crisis would continue to boil.
Pressure on the ECB to ease will grow. It will cut interest rates. It will
expand loan programs and printing operations. The ECB will feel compelled to
announce a huge quantitative easing program - one much more similar to those
of the Federal Reserve. Such printing could buy time for the European
banking system as its political leaders decide how to allocate losses on
items like bad Spanish loans and Greek government bonds.
At the end of this process, the euro will be even more debased, and many
PIIGS countries and banks will still be insolvent. At that point, perhaps
the core EU countries will decide to push toward a fiscal union.
then, it will be more of the same.
Meanwhile, the ECB will ease further and likely gain support from the Fed
and other central banks in a “coordinated” intervention. So the weakness in
gold and gold stocks in early May was merely temporary. And the global
middle class will continue to be squeezed by the inflationary policies of
central banks that are increasingly becoming pawns of politicians.
More wealthy investors in the core of the Eurozone will come to view the
euro as trash and gold as money.
Hold your gold-related investments as we await the next deluge of money
printing, likely to arrive soon…