Dead End Road
Research for Online Investors

12/15/11

The market is struggling with the aftermath of the European Summit.  What are the answers?  It seems we are all believers now.  We finally believe German Chancellor Angela Merkel when she says the European Central Bank should not print money.  This means the eurozone countries need to cut budgets and raise taxes, the bankers are not going to save them with inflation and cheap interest rates.

European economic news isn’t good.  Every report shows slower growth and contracting employment.  This means government revenues will be down, so there will need to be more cutting.

We Are All On the Same Dead End Road

The dismantling of the entitlement state is before us, and nobody likes it.  Who can imagine giving up all the benefits big government has bestowed over the past 50 years?

Kyle Bass, managing partner of Hayman Capital, told CNBC yesterday that last week’s European Summit produced “a blank piece of paper…there are no details…it won’t work.”  Bass believes the eurozone will eventually breakup.  He said “The adjustment mechanism that these countries need is a much weaker currency.  It’s very difficult to go through a hard restructuring and become competitive one again as a nation unless you have a currency adjustment mechanism that’s associated with your restructuring.”

Bass told CNBC the problem lies with the eurozone treaties.  One country can’t devalue, so Greece is trapped with high debts and no mechanism to devalue them.

The ECB has committed to rescuing banks, but not countries.  Last week Mario Draghi announced a new 36-month loan program for banks to borrow from the ECB.  Eurozone banks can borrow at a low interest rate, and they don’t have to mark sovereign debt to market.  They got trapped with the write down on Greek debt which damaged their balance sheets.  Now Merkel says that was a one-time occurrence and will never happen again.

If a country chose to leave the eurozone, what would happen to their sovereign debt?  They would pay it off in their new national currency, which would have been devalued.  With this possibility, why would any bank buy sovereign debt from a country other than the one they are domiciled in?

Michael Platt, founder of Blue Crest Capital Management LLP, told Bloomberg the eurozone is “completely unstable.” Many of the eurozone countries have negative economic growth, higher interest rates on debt and lowered government spending.  He believes the current round of austerity measures will grind the continent’s economies into a recession that “can turn all the countries of Europe, given enough time, into Greece.”

The eurozone has over $400 billion dollars in debt to issue or roll-over in 2012.  The ECB stands by not engaging in quantitative easing, but if investors don’t buy debt, local banks are the only reliable buyers.  Eurozone banks are all weak, so where do they get the money to buy the flood of debt issued by each of their countries?  The European Central Bank.  The Central Bank’s balance sheet has increased 20% in the last year to $3.36 trillion.

As each nation’s debt migrates to their banks as the “buyer of last resort” the possibility of breaking with the eurozone becomes easier.  This makes it more likely.

Citizens will become fed up with austerity and “vote the bums out.”  This sentiment is exactly what has led to the present situation.  Politicians vote for benefits today and put off paying for the same until tomorrow.  Eventually the bill comes due.  Now the voters must look for a new politician that will tell them he can put off the payment for a few more years!

The debt crisis in Europe is not an economic problem, it is a political problem.  The same problem the U.S. is going through.  We are on the same road, just trailing along behind the leaders, but we will end up at the same dead end.

Do you remember when Italian Prime Minister Silvia Berlusconi promised Merkel and Sarkozy to raise the retirement age for Italians to 67 from 60 as part of Italy’s austerity measures on Oct. 23?  Two days later he sent them a letter that the Italian Cabinet had agreed to raise retirement ages by 2026?  We reported it in All About Europe.

To prove we are on the same road, just back from the leaders, yesterday Democratic Senator Wyden agreed with Rep. Paul Ryan’s proposal to let seniors buy private Medicare insurance by 2022.  Do you think we have 11 years?  Did the Italian Cabinet?

Quote:
It is not considered sufficient that the law should be just; it must be philanthropic. Nor is it sufficient that the law should guarantee to every citizen the free and inoffensive use of his faculties for physical, intellectual, and moral self-improvement. Instead, it is demanded that the law should directly extend welfare, education, and morality through the nation.

This is the seductive lure of socialism. And I repeat it again: These two uses of the law are in direct contradiction to each other. We must choose between them. A citizen cannot at the same time be free and not free.—Frederic Bastiat

John

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions. It may contain errors and you should not make investment decisions based solely on what you believe you have read here. Do your own research, it is your money. If you lose it, it is your responsibility, not ours or your grandmothers! The editor may or may not have a position in any securities discussed. The editor may have held a position in a security earlier, or in the future.

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