Is That A Bailout Or A Lit Fuse?


Is That A Bailout Or A Lit Fuse?

Posted by Karl Denninger

The rumors came fast and furious – first Greece was going to get “help” from Germany, then it was denied, and then maybe it was again.  The latest?

Germany is considering assistance for Greece after the country’s deficit threatened the stability of financial markets, two lawmakers from Chancellor Angela Merkel’s governing coalition said. Olli Rehn, who takes over as European Union economic affairs commissioner tomorrow, said EU support for Greece will be discussed in coming days.

Let’s not forget what we’re dealing with here.

The EU is a loose confederation with a common currency.  They lack common laws, they lack the ability to bind each other’s economic policies, and they lack the ability to play “print money.”  To mount any sort of concerted rescue based on the ECB all nations must agree – that you can forget about.

Bilateral – that is, single-nation – support is another matter.  Of course any nation can choose to support any other in any way it chooses.

But let’s look at the underlying realities that are in play here.

The EU in totality must roll over or issue somewhat more than EUR 1.5 trillion in debt this year.  The German Bund got pounded when the rumors started circulating that they were planning on bailing out Greece, and that of course will impact borrowing costs, which simply fuels a spiral (the wrong way) when it comes to interest expense and thus budget deficits.

The truly bad news, however, is that Greece (even with our banks more than $100 billion of exposure to them) isn’t the worst of it.  Their economy is tiny compared to those of Spain and Portugal, both of which are much larger – and bigger problems.

One would hope that Merkel and friends in Germany aren’t really stupid enough to implement such a transfer of a peripheral nation’s problem to the EU’s core, but then again we have seen time and time again that “can-kicking” is the mantra of the world since this crisis began.  Rather than deal with the underlying problems – excessive leverage, naked swaps that the seller can’t possibly pay, various forms of fraud and gamesmanship in securities issue and similar – governments have instead decided to lift up the corner of the carpet and sweep, time and time again.

Should the EU implement this with Greece they may indeed set a precedent that could easily destroy the European Union over the next couple of years.  Faced with Spain, Portugal, Italy and Ireland, all of which are huge problems compared to Greece both in terms of the debt outstanding and the size of their economies Germany will find itself unable to backstop all four nations – yet it will have to, once the die is cast with Greece.

Yet unlike Greece, which has a GDP of EUR $261 billion, Spain’s is EUR 1.134 trillion and Italy’s EUR 1.406 trillion.  Portugal and Ireland’s economies are smaller, but they belie big problems, with the “best” indication being the external debt to GDP ratio.

Italy’s is 127% (the US is running close to 100% at present), while Greece’s is 161%.  Spain’s, on the other hand, is 171%.  Germany, for all of its vaunted “strength”, runs 178% of GDP, Portugal is at 214% and Ireland is running an unbelievable 1267%.

That’s right – tiny Ireland with EUR 144 billion in GDP has well north of a trillion Euros outstanding in external debt.  This, by the way, makes clear that debt service is likely compounding upon itself even now, which is a death spiral from which one cannot escape – whether it is being recognized or not.

Oh, and don’t look at Great Britain as a bastion of “fiscal responsibility” – they’re over 400% – nor the Swiss, at 423%.

The lesson here?  We have not only fixed nothing the so-called “coordinated actions” of so-called “world leaders” have set up a potential catastrophe originating in Europe. 

More than two years ago I predicted that Europe was the most likely place where the second leg – the real “Oh…. My…… God” moment – would originate in this economic mess.  These ratios were the reason for my prediction, and all that has happened over the last two years is that they’ve gotten worse.

Neither Germany or the rest of the EU can fix this without massive reform – read that as restructuring and/or default – of the external debt in these nations, including Germany itself.

Go ahead and believe this won’t blow up if you want to.  I look at today’s action, and indeed that of the last couple of weeks, as a clarion call and a warning that when we had the opportunity in the depths of 2008 and early 2009 to take the CDS monster out and shoot him – to lock up the fraudsters – to change the way banking works worldwide – we instead refused and let the “wise guys” off the hook.

As a consequence we have fixed nothing and the fuse has not only been lit, it is now much shorter than it was two years ago and may have gone inside beyond the reach of a pair of scissors.

The United States, ironically, is one of the better-positioned nations to survive what is coming.  No, it won’t be easy for us, but of the developed world there are few who have the internal capacity to pull in the horns and make it – not comfortably, but to survive.

“Here it comes”