What is Europe going to do?

May 24, 2011

The below commentary was posted Monday on the Mercenary Live Feed:

05/23 Final Stretch
3:32 pm – May 23, 2011

We’ve got a bounce heading into the close, but not enough of one to change the tone or provide real daylight for bulls.

The remarkable thing about the Europe situation is this: There is simply no workable solution to the problems mounting now. The “get out of jail free” cards are all gone. The “kick the can down the road” option is expiring. Allowing a debt restructuring for Greece invites a catastrophic domino-like effect as other periphery countries get sucked into the vortex. Avoiding all talk of restructuring (the plan so far) is a recipe for voter upheaval, taxpayer revolt, and possible voluntary withdrawal by Greece or Ireland as the local economics grow unbearable.

And German and French taxpayers, via German and French banks, are on the hook for hundreds of billions in accumulated sovereign debt liabilities, regardless of whether the euro holds together as a currency or not.

The most realistic solution we see is some kind of back room euro zone deal that amounts to “print like hell,” i.e. aggressively monetize Europe’s debt (pay it off with monopoly money). This realization, on the part of other traders, may be part of what is contributing to gold’s strong performance on an otherwise dark red day. The yellow metal is still the one currency not subject to a printing press.

Long gold may be a new position soon, given the yellow metal’s relative strength and ability to win in both inflation and deflation scenarios. Otherwise, we continue to observe the carnage — having deliberately positioned for it — and let our short positions work as the speculative structure unwinds…


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13 Responses to What is Europe going to do?

  1. GoodBread on May 24, 2011 at 12:41 pm

    I’m surprised the idea of a “Brady Plan” for the eurozone periphery hasn’t gained more traction. An orderly restructuring is probably the only way to avoid an eventual collapse of the currency union and the only way banks will recover some assets without them being severely depreciated. Eichengreen has shown support for the following plan: http://www.ritholtz.com/blog/2011/04/a-credible-s

    • Jack Sparrow on May 24, 2011 at 2:16 pm

      In rough assessment, it seems the issues here are not so much technical but political.

      Divide eurozone politicians into two camps: Creditors and Debtors. In the event of a workout, creditor politicians are vulnerable to the charge of bailing out foreign deadbeats. Debtor politicians, meanwhile, would stand accused of kowtowing to shadowy foreign banking interests.

      e.g., the German public would be furious about paying off the Greeks etc; the Greek public would be furious about accepting a painful austerity compromise for the sake of faceless banks.

      Because of this calculus, the pols appear afraid to hammer out a true solution. Compromise has become a sort of electoral third rail threatening electrocution for those who touch it. This in turn is probably a consequence of experimenting with monetary union with no true cultural or political union. House rules and unity of purpose have to be cemented before the crisis, not during.

  2. GoodBread on May 24, 2011 at 2:30 pm

    It’s unfortunate that the politicization of economic arguments usually comes with so much hyperbole. Just like Geithner losing his mind about a technical default, the politicians calling a restructuring “a nightmare” are completely out to lunch.

    An orderly restructuring would probably ease the pressure on PIGS to follow austerity programs (only to a degree of course, but enough that GDP growth would be possible) which would benefit debtor politicians. Slightly tougher pill to swallow on the creditor side but the long-term benefits for both the banks and European borrowing costs are evident.

    Unfortunately the long-term isn’t a concept in most politicians’ lexicons.

  3. brett on May 24, 2011 at 11:05 pm

    So few politicians understand finance, markets and values. Thus, you have ignorant people weilding power disproportionate to their knowledge or skill set. Does not bode well for good outcomes.

    Can someone please explain to me why the Germans feel compelled to carry the Greeks? I have been watching this now for two years and am awed that the Germans didn't long ago say "kiss off" to the Greeks.

    • Jack Sparrow on May 25, 2011 at 3:07 am

      Short answer — because German and French banks are leveraged long on peripheral sovereign debt. If the PIIGS blow up, so does the Franco-German financial axis. German politicians cannot state this reality plainly, however, because it would only piss off the electorate even more to realize their wallets are being held hostage to foolish bank decisions.

  4. Mike C on May 31, 2011 at 10:35 am

    Thoughts on a short euro/FXE position here? Trying to make sense of the rally the last 3 trading days in FXE? Any opinion?

    • Jack Sparrow on May 31, 2011 at 1:06 pm

      Rally action in the euro feels mondo bizarro. The notion that another bailout check to Greece will solve anything is stubbornly delusional. We like a potential EURUSD short, but only if the price action confirms a clear bearish reversal.

      • texasradio on June 2, 2011 at 2:07 pm

        Debt denominated in EUR + defaults = Shortage of EUR relative to USD?

        • Jack Sparrow on June 2, 2011 at 11:07 pm

          Not exactly… a daisy chain of peripheral defaults would devastate the balance sheets of the euro area banks holding sovereign debt with leverage, resulting in a "Lehman 2.0" type credit event and a tidal wave of emergency liquidity from the ECB.

          • texasradio on June 3, 2011 at 12:34 pm

            “A tidal wave of liquidity”? Could be wrong, but I am not getting the sense that these guys have much in common with Bernanke. Wasn’t there something about a bank run in Greece recently? If all the EUR countries faced with a possible EUR exit withdraw their savings, I would expect the EUR to rise, fueling further withdrawals. The Neu Drachma had only one way to go: down.

            • Jack Sparrow on June 4, 2011 at 1:57 am

              In the midst of true crisis, central bankers essentially have one playbook. There is a point at which the equation boils down to 'monetize or die.' The ability of the EURUSD to keep rising, in the short run, is in large part predicated on the assumption that a Lehman 2.0 type event will be averted, thus averting forced emergency response to it. With that said, we don't have any strong near-term convictions on which way the EURUSD will go. There are too many intertwining factors involved now (like the presence of the high correlation "risk on / risk off" paradigm that has swept up all liquid asset classes) to place much weight on individual scenario pieces in a vacuum.

  5. Mike C on June 18, 2011 at 6:47 pm

    "With that said, we don't have any strong near-term convictions on which way the EURUSD will go."

    Any strong long-term convictions? I guess I'm wondering if the Euro now presents the same opportunity as housing circa 2004-2006 in terms of when not if the implosion is coming. FXE has 2013 options with 2014 to be added soon, and I'm wondering if there is a "Big Short" opportunity here ala what Paulson, Burry, etc did with downside bets on housing debt?

    • Jack Sparrow on June 18, 2011 at 11:58 pm

      We're short the EURUSD and various commodity currencies now in anticipation of a $USD short squeeze. Ultimately we see a significant correction in the euro, in the neighborhood of 10% or more, though as always time will tell…

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