FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
November 29, 2011
N THIS ISSUE:
1. The Economist – European Debt Crisis Deepens
2. The Eurozone: Is This Really The End?
3. Super Committee – The Dirty Little Secret
4. Metropolitan Capital Strategies Webinar This Thursday
The Economist: European Debt Crisis Deepens
The European debt crisis has dominated the pages of my weekly E-Letters since mid-summer. While Eurozone leaders have announced one rescue plan after another, the crisis has continued to worsen to the point that something disastrous could happen in the months just ahead. But rather than giving you my take on the latest developments in Europe, I have reprinted the latest warnings from The Economist.
I have been reading The Economist for almost 30 years and this London-based publication is widely respected around the world. But in all those years, I don’t remember reading an issue that is as alarming as the article below. That’s why I felt the need to bring this assessment to your attention. What follows appeared in The Economist last Saturday. QUOTE:
The euro zone: Is this really the end?
Unless Germany and the ECB move quickly, the
single currency’s collapse is looming.
Nov 26th 2011 - from the print edition
EVEN as the euro zone hurtles towards a crash, most people are assuming that, in the end, European leaders will do whatever it takes to save the single currency. That is because the consequences of the euro’s destruction are so catastrophic that no sensible policymaker could stand by and let it happen.
A euro break-up would cause a global bust worse even than the one in 2008-09. The world’s most financially integrated region would be ripped apart by defaults, bank failures and the imposition of capital controls (see article). The euro zone could shatter into different pieces, or a large block in the north and a fragmented south. Amid the recriminations and broken treaties after the failure of the European Union’s biggest economic project, wild currency swings between those in the core and those in the periphery would almost certainly bring the single market to a shuddering halt. The survival of the EU itself would be in doubt.
Yet the threat of a disaster does not always stop it from happening. The chances of the euro zone being smashed apart have risen alarmingly, thanks to financial panic, a rapidly weakening economic outlook and pigheaded brinkmanship. The odds of a safe landing are dwindling fast.
Markets, manias and panics
Investors’ growing fears of a euro break-up have fed a run from the assets of weaker economies, a stampede that even strong actions by their governments cannot seem to stop. The latest example is Spain. Despite a sweeping election victory on November 20th for the People’s Party, committed to reform and austerity, the country’s borrowing costs have surged again. The government has just had to pay a 5.1% yield on three-month paper, more than twice as much as a month ago. Yields on ten-year bonds are above 6.5%. Italy’s new technocratic government under Mario Monti has not seen any relief either: ten-year yields remain well above 6%. Belgian and French borrowing costs are rising. And this week, an auction of German government Bunds flopped.
The panic engulfing Europe’s banks is no less alarming. Their access to wholesale funding markets has dried up, and the interbank market is increasingly stressed, as banks refuse to lend to each other. Firms are pulling deposits from peripheral countries’ banks. This backdoor run is forcing banks to sell assets and squeeze lending; the credit crunch could be deeper than the one Europe suffered after Lehman Brothers collapsed.
Add the ever greater fiscal austerity being imposed across Europe and a collapse in business and consumer confidence, and there is little doubt that the euro zone will see a deep recession in 2012—with a fall in output of perhaps as much as 2%. That will lead to a vicious feedback loop in which recession widens budget deficits, swells government debts and feeds popular opposition to austerity and reform. Fear of the consequences will then drive investors even faster towards the exits.
Past financial crises show that this downward spiral can be arrested only by bold policies to regain market confidence. But Europe’s policymakers seem unable or unwilling to be bold enough. The much-ballyhooed leveraging of the euro-zone rescue fund agreed on in October is going nowhere. Euro-zone leaders have become adept at talking up grand long-term plans to safeguard their currency—more intrusive fiscal supervision, new treaties to advance political integration. But they offer almost no ideas for containing today’s conflagration.
Germany’s cautious chancellor, Angela Merkel, can be ruthlessly efficient in politics: witness the way she helped to pull the rug from under Silvio Berlusconi. A credit crunch is harder to manipulate. Along with leaders of other creditor countries, she refuses to acknowledge the extent of the markets’ panic (see article). The European Central Bank (ECB) rejects the idea of acting as a lender of last resort to embattled, but solvent, governments. The fear of creating moral hazard, under which the offer of help eases the pressure on debtor countries to embrace reform, is seemingly enough to stop all rescue plans in their tracks. Yet that only reinforces investors’ nervousness about all euro-zone bonds, even Germany’s, and makes an eventual collapse of the currency more likely.
This cannot go on for much longer. Without a dramatic change of heart by the ECB and by European leaders, the single currency could break up within weeks. Any number of events, from the failure of a big bank to the collapse of a government to more dud bond auctions, could cause its demise. In the last week of January, Italy must refinance more than €30 billion ($40 billion) of bonds. If the markets balk, and the ECB refuses to blink, the world’s third-biggest sovereign borrower could be pushed into default.
The perils of brinkmanship
Can anything be done to avert disaster? The answer is still yes, but the scale of action needed is growing even as the time to act is running out. The only institution that can provide immediate relief is the ECB. As the lender of last resort, it must do more to save the banks by offering unlimited liquidity for longer duration against a broader range of collateral. Even if the ECB rejects this logic for governments—wrongly, in our view—large-scale bond-buying is surely now justified by the ECB’s own narrow interpretation of prudent central banking. That is because much looser monetary policy is necessary to stave off recession and deflation in the euro zone. If the ECB is to fulfil its mandate of price stability, it must prevent prices falling. That means cutting short-term rates and embarking on “quantitative easing” (buying government bonds) on a large scale. And since conditions are tightest in the peripheral economies, the ECB will have to buy their bonds disproportionately.
Vast monetary loosening should cushion the recession and buy time. Yet reviving confidence and luring investors back into sovereign bonds now needs more than ECB support, restructuring Greece’s debt and reforming Italy and Spain—ambitious though all this is. It also means creating a debt instrument that investors can believe in. And that requires a political bargain: financial support that peripheral countries need in exchange for rule changes that Germany and others demand.
This instrument must involve some joint liability for government debts. Unlimited Eurobonds have been ruled out by Mrs Merkel; they would probably fall foul of Germany’s constitutional court. But compromises exist, as suggested this week by the European Commission (see Charlemagne). One promising idea, from Germany’s Council of Economic Experts, is to mutualise all euro-zone debt above 60% of each country’s GDP, and to set aside a tranche of tax revenue to pay it off over the next 25 years. Yet Germany, still fretful about turning a currency union into a transfer union in which it forever supports the weaker members, has dismissed the idea.
This attitude has to change, or the euro will break up. Fears of moral hazard mean less now that all peripheral-country governments are committed to austerity and reform. Debt mutualisation can be devised to stop short of a permanent transfer union. Mrs Merkel and the ECB cannot continue to threaten feckless economies with exclusion from the euro in one breath and reassure markets by promising the euro’s salvation with the next. Unless she chooses soon, Germany’s chancellor will find that the choice has been made for her. END QUOTE
Like many other observers, The Economist is calling for more bailouts, and even Quantitative Easing, by the ECB. These actions may be necessary given the current dire circumstances, but we all know that these are not long-term solutions.
Big Banks Prepare for Eurozone Breakup
Most European leaders, including Germany’s Angela Merkel, assure the world that a breakup of the Eurozone is simply not going to happen. But some banks are no longer so sure, especially as the sovereign debt crisis threatened to ensnare Germany itself this week, when investors began to question the nation’s stature as Europe’s main pillar of stability.
Last Friday, Standard & Poor’s downgraded Belgium’s credit standing from AA+ to AA, saying it might not be able to cut its towering debt load any time soon. Ratings agencies also cautioned that France could lose its AAA rating if the crisis continues to spread. On Thursday, agencies lowered the ratings of Portugal and Hungary to junk status.
Banks including Merrill Lynch, Barclays Capital and Nomura issued a cascade of reports last week examining the likelihood of a breakup of the Eurozone. “The euro zone financial crisis has entered a far more dangerous phase,” analysts at Nomura wrote on Friday. Unless the European Central Bank steps in to help where politicians have failed, “a euro breakup now appears probable rather than possible,” the bank said.
While European leaders still say there is no need to draw up a Plan B, some of the world’s biggest banks and their top officers are doing just that. I have included a link to an article with more information on this topic below in SPECIAL ARTICLES at the end of this E-Letter. I strongly suggest that you take the time to read this insightful article (see first link below).
Super Committee – The Dirty Little Secret
The Joint Select Committee on Deficit Reduction, better known as the “Super Committee” failed last week as you are no doubt aware. As usual, the mainstream media has distorted the reasons for the failure and would have us believe that the impasse was entirely due to the Republicans’ refusal to raise taxes. This is utterly false.
At one point in the heated deliberations, the Republicans caved and offered $300 billion in net tax hikes that would have limited deductions for home mortgage interest, charitable giving, etc. The Democrats on the Committee rejected the Republicans’ offer and continued to insist on tax hikes of $1.2 trillion. As a result, the Super Committee failed.
The result is that mandatory spending cuts of $1.2 trillion automatically begin in on January 2013 – if the law is not changed beforehand. The so-called “sequestration” would include spending cuts of $600 billion in defense and $600 billion in non-defense areas. The media now warns that $600 billion in defense cuts would threaten our national security.
Question: Since when did the mainstream media care about cutting defense spending? Answer: Never!
The dirty little secret about the failure of the Super Committee is that federal spending will continue to go up EVERY YEAR, even if the sequestration of $1.2 trillion goes into effect. You see, the $1.2 trillion in spending cuts is spread over 10 years, so it means only $120 billion in spending cuts per year.
The fact is, the federal budget is projected to go up by more than $120 billion each year, so the sequestration of $1.2 trillion over a decade will only serve to SLOW THE RATE OF GROWTH in federal spending. No department of government will actually see cuts in their budgets!
Assuming the sequestration is not repealed, the Defense Department would get around $600 billion less in budget increases over the next decade, yet its annual budget would still increase every year. I think it is fair to say that the DOD can live with that. National security should not be threatened, as the media would have us believe.
The bottom line is that the failure of the Super Committee is not the doomsday scenario that many on the left (and even some on the right) are claiming. To the contrary, we should be celebrating the failure of the Democrats’ plans to raise taxes by $1.2 trillion.
Despite what the mainstream media claims, federal spending will continue to go up every year, even if the sequestration survives until January 2012. That’s the dirty little secret!
Europe Will Continue to Dominate Markets
I have maintained since mid-summer that the European debt crisis was going to get much worse, and that this would ultimately be bearish for the US and global equity markets. Thus far, I have been correct. The US stock markets have surprised on the downside since mid-April.
The daily volatility in the markets has been record breaking in recent months, in both directions. Yesterday, for example, US equity markets exploded on the upside due to mere rumors that European bailout fund (EFSF) might be expanded, and that the IMF might offer a large new rescue package for Italy. The IMF denied this rumor, yet the markets boomed anyway. The point is, expect continued crazy volatility depending on the news from Europe.
Metropolitan Capital Strategies Webinar This Thursday
With the continued high volatility in the markets, more and more investors are moving to the sidelines. They realize that it is simply impossible to navigate these uncertain markets. Many investors are looking to the actively-managed strategies we recommend as a way to participate in today’s volatile markets.
One of my favorite professional money managers is Metropolitan Capital Strategies (MCS). MCS is unusual in that they will go 100% to cash (money market) and stay there until their system indicates a 90% confidence level as to the next trend.
MCS is also unusual in that they invest in ETFs (Exchange Traded Funds) rather than traditional mutual funds. The MCS Tactical Growth program can trade options on a limited basis while in cash, but the primary strategy is to wait patiently for the next opportunity and strike quickly when it comes.
We are hosting a WEBINAR with Metropolitan Capital Strategies
this Thursday, December 1 at 1:00 EST.
Click here to register for this free webinar.
I highly recommend it! You will see a presentation by the principals of MCS about their investment strategy and how it works, followed by an interactive Q&A period where you can submit your question(s). If you are frustrated by today’s highly volatile markets, MCS may just be the investment alternative you are looking for.
Wishing you profits in this crazy market,
Gary D. Halbert
Banks Build Contingency for Breakup of Euro