The Unfolding EU Crisis

via TVR:

Coming into Focus

Earlier in the year I warned of a pending EU crisis that has now arrived in full force. I have been writing about the EU problems over the past month to bring them back into focus, because I believe this is the next, biggest, event on the timeline. While everyone was watching Washington Theater, the EU crisis was raging. This is a real risk to banking, currencies, and sovereign debt that is not easily fixed. Sadly, the public has very little understanding of what shapes their world, content to live ignorant until directly impacted. The majority of my writing has been about the US Money Market Mutual Fund exposure to the EU banks (in the area of 50% for some of the largest). I write about these problems not to scare, but to warn.

Funding Issues within the EU

Over the past few years, the banking industry has funded the majority of sovereign debt buying to keep the EU going. Now that this unsustainable process is coming to an end, interest rates are rising in Spain and Italy – big decisions need to be made soon. Remember the EU banks didn’t get their TARP, yet. Spain’s bond market is bigger than that of Greece, Portugal and Ireland’s combined, at about $900B. Italy’s debt market is roughly 3x the debt market of Greece, Ireland, and Portugal combined, at about $2T. The ECB will need to backstop these debt markets or else face a breakup of the EU. Ultimately the EU will cease to exist, but not yet.

Early Monday morning, August 8th, the ECB promised to “actively implement its Securities Markets Programme.” This decision was made at a time when the banking system was closer to failure than most recognize. One source involved in the talks stated, “I don’t see how we can survive another week like this one.” SocGen, France’s second largest bank, and UniCredit Banca, Italy’s largest bank were both on the brink. While the ECB’s intervention helped stabilize European markets and banking system for now, they will need to significantly expand their efforts in the near future.

Short Selling Ban

Similar to the ECB intervention on Monday, the recent ban on short selling financial stocks is a temporary stop-gap measure (15-days). The ban, introduced by Belgium, France, Italy and Spain on Friday, was in response to extreme pressure being applied to EU banks. They are in the midst of a bank run. People are sensing the risk in banks that have approximately 20-1 leverage on assets that are egregiously overvalued. Big money is taking deposits out of EU banks and running scared.

While the Spanish ban included derivatives, the French and Belgium bank did not apply the ban to derivatives. One side note, Germany implemented a ban of naked short selling last year, which did include credit default swaps. Nobody should expect this short-term policy to

have any lasting impact or resolve the current issues. In simple terms, the damage within the banking system is too severe and there is no way to contain the derivatives. I agree naked short-selling and CDS are destructive to markets, along with government sponsored manipulation (policies), but the partial ban on short selling will not save the Eurozone markets or banks.

Crossing the Rubicon

I will offer my view on how this will play-out, but I ask that you take prudent actions to prepare for alternative outcomes. My expectation is that markets will soon pressure the EU to commit to additional and significant steps to keep the EU intact. As I’ve mentioned in the past, these steps are part of the global QE agenda. Before any decision is made, markets (or maybe more appropriately men who walk with canes) will make their case to the ECB loud and clear. The EU sovereign debt market and the banking system will be taken down unless more credit/debt is created. In comes the EFSF. This outcome was decided long ago, the politicians just haven’t informed the underclass/uninformed yet.

This is where my concern regarding the mmkt funds comes into play. If the ECB doesn’t jump quickly enough to their demands, you could have a situation where some banks are sacrificed. Since US mmkt Funds are so heavily weighted in EU banks, it is quite conceivable that some will “break the buck”. Just as we hit the lowest point, the US investor could encounter a “freeze” in mmkt redemptions, unable to move out of the fire storm surely to hit western currencies. This is not high on the list of concerns of our “masters”.

Defined Contribution Retirement Accounts
Don’t blame retirement plans, blame the corruption and greed. Unfortunately retirement accounts are at the mercy of a broken system. Paper markets are a collapsing inverted pyramid. As the Ponzi system implodes, it will be difficult to hide within plans that limit investment options to mmkts, bonds, and general stock funds. Money will be running to safe havens, such as PMs.

Global stock markets will continue their downward move until more credit/debt is pumped in. As this unfolds (it is now), you can try to hide retirement assets (that have limited investment choices) in short-term treasuries or mmkt funds. If you are vigilant, nimble, and have a little luck, you’ll be able to exit these positions before they collapse. If you can navigate this mine field, you’ll then take refuge in a stock fund that will not keep pace with real inflation rates and will see many bankruptcies. The other option within these limited investment accounts is to sit in general equity funds and ride out all storms. Your choice should be based on your individual circumstances, and in either case, keep your fingers crossed that you’ll be able to salvage something in the end. Within an IRA, where you have alternative investment options, my preference is to have positions in funds that hold a physical asset, such as Sprott’s physical gold & silver along with resource and mining stocks.

Protective Measures

Additional credit/debts will fix nothing. The ECB and US Fed will continue to place a bid under the massive new debt issuance, leading to rampant price inflation for items of necessity. We will see lower growth, employment, wages, and cuts in entitlements, while cost of living will increase. The ugliness and ungodliness in our society will be on full display. At risk of sounding like a broken record, I am suggesting 30% of your assets be stored in physical gold & silver and holding a portion of your assets in physical cash. The main thing I want to reinforce is the purpose of holding cash. Although the outcome may be abundantly clear, current laws enforce currency which should be held for expenses, emergencies, purchases and so forth. By exiting cash completely, you forfeit your ability to protect other holdings or take advantage of future opportunities. Don’t give up your financial freedom or your ability to protect yourself – in my opinion it’s worth the potential cost of devaluation.

 ~David Freedom

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