Target Luxembourg

It will first start as trickle, and then it will grow to the size of a brook, then as other brooks join it will grow to the size of a creek, and then as other creek join it then a small river, and as the small rivers join together a large continent draining river.

The trickles are just starting in Luxembourg, a country known for it’s banking, but not much else.  Luxembourg is a country with banks deposits in significant excess of its gross domestic product, just like Cyprus.  But just like Cyprus, Luxembourg cannot print enough physical currency to cover the entire electronic Euro currently held/deposited within the various disk drives of its banks.

Cyprus banks had deposits greater 10.8 times the GDP of the country.  Luxembourg banks according to IMF in 2011 held deposits greater than 20 times the countries GDP.  I suspect that deposit growth has been greater than Luxembourg GDP growth, meaning that deposit to GDP is even greater today.  If you think Cyprus is bad, just wait.  The “ChubbChubbs” are coming.  It will sweep over the continent, each of the weak sisters being picked off one by one, as they succumb to monetary forces at work.

It was a good wave to ride while it lasted by the shore is close at hand the wave is starting to break lose form, it is really had to keep on your board in the spray and foam of a crashing wave.  The smart surfers would have already pitched out, looking for the next wave.

So the really smart money is starting to slowly move those electronic Euro’s out of Luxembourg.  I suspect a significant percentage of those electronic Euros’ that are being moved are also being converted to electronic Dollars.  Given that of all the various world currencies that are convertible and not illiquid, and that have enough GDP to cover deposits being held within the confines of their banking system, the United States is it.  At this time the exchange rate is rather favorable for jumping out of the Euro, not as good as it was a few weeks ago, but it is only going to get worse in the coming months.

Some of electronic Euro’s are staying in Europe.  These electronic Euro’s are just going to other location in Europe, which for the moment appear to be safer.  The reason for this is that individuals and companies need to cover operating expenses within Europe.  But where to put those funds is the solvency question?  As I look upon the GDP landscape the only European country with enough GDP to cover this flood of electronic Euro’s is Germany.

Another possible location is Switzerland, but even the Swiss have limits how many Euro’s they are willing to accept at the current exchange rates.  A big large flow of Euro will destabilize their currency something the Swiss National Bank is battling everyday, but even their reserves are limited.

As stated in the CNBC article "The Insanity of the Cyprus Crisis".  The ECB is not the FED.  The ECB on its own has no ability to print money to rescue failing banks.  The ability to print money falls to the various member National Country Banks that are members of the ECB who issue money in the name of the ECB.  The ECB is responsible for just 8 percent of the notes issued the various National Country Banks.  The National Country Banks are responsible for the remaining 92 percent, and the bad news it that their responsibility is limited to only those notes that they physically issued.  The majority of the printing of Bank notes his handled by each member country.  There is a country code printed on each note.  For those who are interested “G” is the code for Cyprus.

The European Banking Authority, which has some limit responsibility in regulation bank the majority of the authority rest with the respective nations and their respective agencies, does not have the authority to borrow money (issue bonds) to rescue these failed banks, since it does not have any taxing capacity to back up any bonds.

What individual/corporation would put their electronic Euro’s in Italian Banks, Spanish Banks, Portuguese Bank, French Bank, Belgium Bank, or Dutch Bank?  If I were a citizen of any one of the afore mentioned countries, I would be giving serious consideration to a minimum the amount of funds held in a bank.

The next question is when is a Euro note not a Euro note.  Some would say that it is any such note with a Country Code of “G”, after all 92 percent of that note is backed by the full faith and credit of the Government of Cyprus.

We have gone from “one for all and all for one”, to “one for some of us and some for some of us”, the finally step will be “one for me and nothing for the rest”.  It will be a very interesting summer, as another one bites the dust.

Yet Another Rectal Bleed

The story in Europe just keep getting better, now there is a story about language being removed from the proposed/draft EFSF (European Financial Stability Facility) Bond Prospectus.   This particular language deals with an “explicit warning to investors that the euro could break apart or even cease to be a “lawful currency” entirely.”

This particular language had been inserted by the lawyers charged with drafting this document, what were they thinking?  They were probably confused since they were used to drafting prospectus for commercial entities, where the documents are legally required to convey germane, pertinent, and fiduciary facts to prospective purchasers.

The report goes on and states that management, who ever they are, had not approved the clause, no surprise there; the surprise appears to be for the purchaser.  Well what a welcome breath of fresh air on the part of the European Union in particular the people associated with this program.  Why would any one in their right mind purchase any of these instruments at any where close to par value?  These instruments are nothing more than unsecured junk.  I might be inclined to look at these investment if they were discounted such that their yield was somewhere north of 15 percent.

The EFSF is a “Special Purpose Vehicle”, word that should strike terror into the heart of every citizen.  The 27 member states of the European Union agreed in May 2010 to create this monster via incorporation, and it only exists as long as it has debt outstanding.   The European Investment Bank (EIB) was chosen as agency to provide treasury management services and administration support through a service level contract.

Theoretically the emission (bonds or some other type of instrument) would be backed by full faith and credit of the European Central Banks primary members, those that share in the profits that the bank generates.  The 17 National Central Banks (Germany (18.9%), France (14.2%), and Italy (12.5%) are on the hook for 45.6%) in proportion to their share of paid-up capital.  There are other members of the bank, they do not share in the profit of the bank, but do have funds deposited at the bank, primarily for international banking account transactions, clearances and guarantees.

Every day Europe is looking more and more like a house of cards.

What a novel thought

What a novel thought that George Papandreou, the Prime Minister of Greece would insist on a binding public referendum for the European Union Greek Bailout Proposal.

George Papandreou has a 2 Vote Majority at best in the Parliament, and many suspect that he does not have that, and he does not want to find out the hard way.  The easiest decision to make is to let someone else make that decision, the blame is theirs not yours.  Of course you can advise them on the decision that they are being asked to make, but the fallout is theirs alone to bear.

If the people of Greece pass the referendum Mr. Papandreou will be able to say “I did not force this upon you, a majority of your fellow citizens agreed to accept this burden”.  The main problem will be that however the outcome of the vote the effects will not only affect the current generation it will be on at least the next two generations.  If the citizens of Greece pass of the life line with anchor attached, and then decide that Greece needs to go in a different direction, well so be it, again the choice was theirs to make and theirs to bear.

Greece might have been the birthplace of democracy, but since the end of World War II it has not spent much of the time in a stable democracy.  Greece history since World War II has been anything but stable.  About the only thing stable was the name.

Since the end of World War II some 67 years there have been 48 different governments in Greece.  Just a crude back of the envelope calculation would indicate that the average Greek government has a half-life of 8.4 months.  Mr. Papandreou must be doing something right considering that he is currently at 2.85 half-lives.  It could also mean that the situation is so balled up that no one in his or her right mind would even consider taking the position. (My condolences, You have won the election and you are the new Prime Minister).

The European Proposal has nothing to do with Greece, but everything to do with its own major banks, and the really sloppy practices (Regulators and Banks) that they have been operating with for at least past 10 years.

The various powers that are in place with banking over sight functions failed, and they failed big.  The data was there, and it was available, either by sheer incompetent or criminal collusion it was not acted on.

It was not an either or situation I believe that it started out with incompetents, and then graduated to criminal collusion.  Some of this incompetent is a result of deliberate/legislative blurring of the lines between commercial and investment banking.  Some of this incompetent was due to lack of experience with investment banking, or the assumption that investment banking was just like commercial banking.

That said when the various individual operating the banks started to make large amounts of loans to the Greek Government, and the incompetent regulator did not call them on it, and for that fact neither did their Board of Directors nor the stockholders.  Who wants to stop the elevator on the way up (The ride is really great counting those unrealized gains)?  The management of the Banks recognized this fact and jumped in with both feet, and just compounded the problem. (our depositors are demanding their interest payments, and I need my bonus)

Greece was writing IOU (they were not the only ones), Backed by the Full Faith and Credit of the Greek Government in a currency that they did not control.  The Investment Bankers where getting fat commissions and fee helping them write and place the IOU.  The Basel Treaty inadvertently provided a ready market for all the paper that was being created (Tier I Assets Requirements, the mistaken assumption between Zero Risk and No Risk, and that Sovereign Debt is “Riskless”) Zero Risk is relative, and No Risk is Absolute, the former is real and it is continually changing to reflect the current conditions.  The later is a figment of the mind and a delusional mind at that.

The European Governments do not want the Greek government to default.  A Greek debt default would trigger the first way of various Credit Default Swap agreements.  Since the Credit Default Swaps are not regulated (they are not regulated anywhere) no one has any idea of the magnitude of the counterparty risk, but if the experience of the United States is an accurate example we will all find out in rather short order.

Europe stands at the edge of the abyss, and I am afraid that they will fail the test.  In 2008 when the United States stood at the edge of the abyss the decision was easier to make since the states are united by form and function (Constitution, laws, monetary, de facto common language, common national history), we fought a civil war to establish most of these facts.  Europe has not had this experience (most of their wars have been just the opposite).  Europe in practice is not united by form and in reality by function.  Europe carries a tremendous amount baggage from its past, that makes it easier to be separate rather than united.

The term “common good” does not ring true in Europe, for Europe.  Common good does have resonance for the people only as it applies to their nation.  The lack of trust between the various members of the European Union is palpable, and in many case lies just beneath surface.  Any significant economic distress will bring this to the surface with all of attendant ramifications.

Many of the older and middle-aged Germans are scarred by the experiences economic turmoil of the Weimar Republic, and the initial post war period, in particularly their treatment at the hands of inflation and hyperinflation.  Many Germans are myopic and rather emotional on this subject (So are the Italian, French, you name them).  In many cases these Germans will not admit, much less understand that they benefit from this expansion of debt in Europe.  Many will not recognize that the debt allowed German industries to sell goods and services abroad.

Many of these Germans enjoyed the trip going up, but they are not looking forward to the trip down.  Many of the German that I talk to express a strong belief that this situation is only isolation to Greece, or maybe to the Southern Europeans, and that the effects will somehow by magic be isolated to these areas.

The various European governments, and for that matter the United States, are not coming clean with the various electorates as to just how vulnerable their countries are visa vie the risk in their respective financial systems (The United States passed the Dodd-Frank Bill and now we can sleep safe at night (NOT)).

The world has had sixty some years of peace in Europe, but this could be coming to an end in the coming years.  I hope that I am really wrong on this point.

Germany is the only European country with the financial resources to address this debt issue, unfortunately it will not address it, the internal political costs are too great, and the political cost of not addressing it are a matter for another day, and possibly another German Chancellor to address.  Regardless of the decision the People of Greece make it, the out come will not be good for Greece and the European Union.