The financial world seems to have adopted the idea that things will somehow work themselves out in Europe. I don’t know if it’s because people don’t like to think about negative things or if someone sent out a memo to everyone that math doesn’t exist or count in Europe, but somehow investors seem to have decided that as long as we think positive thoughts everything will be fine.
The reality is that every day, Europe is approaching a debt implosion.
First off, European sovereigns need to roll over 740 billion Euros’ worth of debt this year. The brunt of this is going to fall on the ECB which has become the de facto bond market for Europe: the ECB was intervening on an almost daily basis during the second half of 2011… and things still nearly cratered.
Indeed, with the prospect of default and 50%+ haircuts now on the table, private bondholders (hedge funds in particular) are going to be much less willing to pony up the cash for EU sovereign debt. So this means the ECB will be stepping up to the table a lot more.
The problem with this is that Germany, (the de facto sovereign backstop for the EU) is not going to tolerate rampant monetization. Thus far, Germany has been willing to permit the ECB to implicitly monetize various EU sovereigns’ bonds rather than face the damage that a series of sovereign defaults would cause to German banks.
However, at some point, the market will force the issue of whether or not the ECB is going to be monetizing everything or not. Germany, having already seen the ultimate outcome of monetization (Weimar) has already made it clear that it will not tolerate this.
Which means that at some point, push will come to shove and either the defaults come fast and furious as the ECB steps back, or the ECB monetizes everything and Germany walks.
Whichever option occurs, the European financial system as we know it will collapse.
Mind you, we’re only considering the sovereign debt issue here. Outside of this, European banks are facing their own Crisis.
To whit, within the next 11 months…
- Irish banks need to roll over 25% of their outstanding debt.
- Spanish banks need to roll over 20%+ of their outstanding debt.
- Italian banks need to roll over 15%+ of their outstanding debt.
- French banks need to roll over 15% of their outstanding debt.
Rolling over debt isn’t a problem under healthy market circumstances… but when you’re posting Lehman-like leverage levels (EU banks in general are leveraged at 26 to 1)… and sitting atop hundreds of billions of Euros’ worth of EU sovereign debt (much of which has declined dramatically in value), convincing investors to lend you money isn’t easy.
Indeed, European banks don’t even trust each other at this point: interbank liquidity has all but dried up. What are the odds they’ll convince outside investors to load up on their debt? Will the ECB be monetizing bank debt too?
In simple terms, the metaphoric “bill” is coming due for European sovereigns and banks this year. The world continues to believe that somehow money will magically fall from the sky and solve this situation, but the reality is that the ECB is the only thing standing between Europe and complete collapse. And every day that the ECB expands its balance sheet buying worthless sovereign bonds, it comes that much closer to blowing itself up.
Do not believe the consensus or the hype: Europe is not fine, not even close. And those investors who are investing based on the idea that it is are just like those who bought in late 2007/ early 2008.
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Graham Summers
Chief Market Strategist
Phoenix Capital Research
