A More Perfectly Bankrupt Union

–The sober, level-headed, prudent financial minds are starting to leave the Euro project. Juergen Stark, the European Central Bank’s chief economist, tendered his resignation on Friday. He said it was for “personal reasons”. That’s superficially true, if by personal he meant, “I’m personally opposed to the ECB buying heaps of Spanish and Italian government debt”.

–You wouldn’t exactly call the current state of affairs in Europe a financial civil war. But it sure does feel like the old, anti-inflationary, mostly German guard of European monetary policy is losing a turf war with the new guard. The new guard is probably people like Italy’s Mario Draghi, who will become the new ECB president at the end of October.

–The new guard is in favour of expanding the European Financial Stability Facility. The new guard is in favour of expanding Europe’s political and financial union. The new guard is in favour of using the ECB to buy government bonds at lower interest rates (two-year Greek government debt yields nearly 60% at the moment). The new guard is responsible for what you see on the chart below.

Euro showing the effects of mismanagement

Euro showing the effects of mismanagement

–The Australian market was down as much as three per cent this morning. Is this an over-reaction to far away events that don’t have any obvious impact on the Australian economy? After all, if Greece defaults on its debt, it’s a Greek problem and a German problem and a European problem. Why should Australian stocks get clobbered because Greece can’t pay its bills?

–We chatted with Slipstream Trader Murray Dawes about it. Murray reckons the market is failing to hold the price distribution above 4100. The price action this morning has put a lot of recent buying out of the money. That could lead to even more selling. That’s what the price action is telling you.

–But again, why should Greece matter? Well, a Greek default is going to cause losses for European banks (and for the ECB). Banks will have to be recapitalised. And beyond Greece, there is the issue of losses faced by banks on Italian and Spanish debt too.

–In other words, we are right back to where we were in 2007-2008, with basic doubts about the solvency of the banking system. That is what investors have to worry about. In 2008, the freezing up of the credit markets left Australia high and dry. Risk capital hunkered down in US Treasury bonds and notes.

–Australia is a nice place for capital to visit when the sun is shining and banks are solvent. But in a synchronised global solvency crisis, the money runs home to momma. The Aussie dollar is trading down at $1.04 to the US dollar.

–Is this just another peak of anxiety? We asked our resident German expert, Nick Hubble, to enlighten us on events. His take is below.

The Germans bunker down … or leave
By Nick Hubble

The German Federal-Constitutional Court ruling on Wednesday may have gone off without a hitch for the International Bailout Party politicians of Europe. But other unknown unknowns came out to bite.

The financial media blamed Friday’s European and Wall Street sell-off on the resignation of a senior German central banker. At first it may seem like the media has once again plucked a random event out of the news and attributed the stock markets move to it. But they may be on to something…

You see, Juergen Stark is the second senior Bundesbanker to resign in months. Axel Weber, heir to the ECB’s top post, left only a few months ago. And here is the key: both resigned, according to German newspaper insiders, because of ECB and Bundesbank internal bickering. Put simply, they both opposed the ECB’s policy of buying government bonds. That put them in a minority, making their expected ascendance to ECB leadership problematic.

From a German’s perspective, those charged with keeping hyperinflation a historical concept are now gone. Germans gave up monetary independence by joining the Euro and they are rapidly losing monetary influence at the ECB. This is dangerous, as it only leaves the Germans with their federal government to hit out at if they want to express displeasure at Europe’s policies.

Remembering that your editor’s German grandmother described these policies as ‘blowing German money up other countries backsides’, the outlook of German voters does not bode well for pro-bailout governments.

And so Chancellor Merkel has responded. Her coalition is drawing up plans to save German banks from Greece’s inevitable default. (Inevitable based on the market’s current valuation of Greek bonds, which implies a default is more than 90% likely). John Mauldin points out in his free newsletter that the Germans are basing their really bad-case scenario on a 50% default by Greece.

That means Greek bondholders would get half their money back. The problem is that a 90% default is more likely, leaving the German plan 40% short. And the Greek default will only be the first round. Imagine the contagion effects.

At least the German government is being partially realistic, although there is speculation that won’t last either. Outspoken German finance minister, Wolfgang Schaeuble can expect the sack sometime soon in the same way Axel Weber and Juergen Stark did. His views are similar to the central bankers and that puts him in the minority too.

Being right comes second to being flexible in politics … and economics apparently.

If Schaeuble leaves, that will leave the rout of anti-bailout Germans complete. The International Bailout Party will be in government in Europe and the US. The euro will be free to fall…or in free fall.

Dan Denning,
for Markets and Money

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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Despite selling down the portfolio earlier, among the few last chairs standing is this one. The Canadian board traded daily price moves the right way in aggregate AUD outcome in a liquidity crisis and otherwise stands up tall when there is an inflationary melt up (futures liabilities however being the threat withstanding).


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