EU in Crisis and More on Class Warfare

* PIIGS exposure: A reader sent me this handy list of EU bank exposure (in billions) to the debt of the PIIGS:


France: €76 to Greece, €36 Port, €196 Spain and, €494 Italy

Germany:€43 to Greece, €47 Port, €240 Spain and, €209 Italy

Netherlands: €12 to Greece, €12 Port, €127 Spain and, €78 Italy  

Belgium:€8 to Greece, €9 Port, €46 Spain and, €50 Italy


Here is the cross exposure among PIIGS banks:

Portugal: €10 to Greece, €29 Spain and, €6 Italy

Spain:    €1 to Greece, €89 Port and, €48 Italy

Italy:    €9 to Greece, €7 Port and, €31 Spain


Europe bank exposure to PIIGS > €2 trillion or > 150% bank common equity

PIIGS bank exposure in each other > €230 billion 


(all number ex-derivatives)


In sum, here is a total by of bank exposure by country:


Greece    159 billion

Portugal  200 billion

Spain     623 billion

Italy     885 billion


The sum total of this list is quite impressive, and even a 30% loss on these investments would be a disaster. And this just represents bank exposure. There is also the matter of investments which EU insurance companies and Pension Plans have in these countries as well. My guess is that there is a lot of cross lending/investing, which adds up to some multiple of bank exposures. As I suggested yesterday, banks and other investment players have a bias to ignore potential write-offs until the borrowers stop paying, or until the collateral is woefully below the value of the loan. In other words, inter-country debt problems will linger far longer than it will take any sovereign to default.


The Euro continues to sink to new one year lows, dropping below 1.28 this morning. See the attached chart. Based on a purely chartists perspective, the next stop is the low 120s which represents a 61.8% retracement of the entire move, and then, around 1.18, which is where there is good chart support. The impact in the US has less to do with our own economic growth, as Europe is a very small part of our export economy. But rather, it does have a rather large impact on the fortunes and earnings of US companies, which derive a significant share of their earnings from European operations. The falling dollar in 2006 through 2008 was cited as a positive influence on the earnings of US companies. Earnings will go in reverse as the Euro weakens. Surprisingly this morning, as the ECB announced no change in their policies, the Euro weakened further. There was some speculation that the ECB would announce plans to embark on quantitative easing, or printing money. And it is surprising that holding the line, and not easing further would hurt the euro. To my way of looking at things, this reflects underlying weakness in the Euro, despite how far it has fallen recently.


* Gold/S&P ratio: Also symptomatic of the weakening Euro, and related currencies, Gold hit another high at 1320 Swiss Francs per ounce today. Buying of gold in Europe will continue to give gold a bid in US dollar terms. After a few months during which Gold traded below the S&P, gold has risen above the S&P over the last day or two. I have attached a graph of the Gold/S&P ratio, which shows that there is a nice uptrend in this ratio, and that this ratio is bouncing along the support line which now crosses around a 1:1 ratio. Perhaps this is the beginning of a new relative value surge in gold. As deeply as I am into this trade, you know you will be hearing more about this from me going forward.


* Class Warfare – I want to include a reader’s comment which dove-tails with the point I was making about how the political machine is going to redefine economic outcomes, and to some extent, various markets:


I really don’t think “Class Warfare” is any different now than it was 30 years ago other than the animosity toward Wall Street.  Do you hear complaints towards people getting wealthy in non-Wall Street fields? I certainly don’t.  No one begrudges an entrepreneur because he/she has risked his/her money to make his/her dream come true. Additionally, they are adding to the betterment of everyone by creating something of value. Your comment, “The US needs to encourage risk taking and rally around its successes, otherwise that which made this country great will find a home somewhere else. Knocking down those who have succeeded in the existing system is not the way to go,” is still in vogue with the great majority of people. But what you are misreading is the “risk” that people on Wall Street take is not the same as people on Main Street. The majority of main streeters feel that Wall Street made lots of money without taking risk and the American public was left holding the bag. I have to agree with that assessment. You’d be hard pressed to show that Wall Street has added any value to society over the past decade. But they have certainly added plenty of value to their own personal balance sheet.” (End of readers comment)


This comment is a much simpler description of why Main Street, and the politicians are taking shots at Wall Street. I also like the Stratfor piece because it is clinical and defines economic outcomes as being the result of a political process, with the empowerment of our form of capitalism, and the modern corporate, limited liability (risk) based system, as being an invention of the political system. In other words, the political class created the rules of the economic environment, and it appears to me that they are going to re-define the rules again, since the system failed many people. From a philosophical perspective, one could argue that Wall Streeters did nothing more than what their individual mandates suggested they should do. But for so much pain to be spread so far and wide indicates that the system was flawed. I agree with that!


Another reader sends in the following interpretation of the Stratfor article:


“I don’t agree that the Stratfor analysis is brilliant! _most of this strikes me as inside the beltway B.S.  Any analysis of our recent financial problems with no mention of Fannie and Freddie and their political enablers (e.g., Chris Dodd) has a serious credibility problem.  There is no question that the roots of this crisis were in the intense political pressure on financial institutions to loan money to unqualified borrowers so as to further the political objective of home ownership for all.  The subsequent convoluted financial manipulations were largely attempts to manage the resulting risks (and, of course, to profit thereby).  Now, I’m not attempting to argue that the resulting financial instruments were effective, or that unscrupulous individuals in the financial institutions did not exploit the situation for great personal benefit, but rather, that the primary problem was political, not financial.  Not to explicate this is fundamentally misleading.


A lot of this strikes me as a smokescreen to divert attention away from the political roots of this problem.  For example (excerpted from the Stratfor piece):


“Put another way, the crisis occurs when it appears that the financial elite used the politico-legal structure to enrich themselves through systematically imprudent behavior while those engaged in prudent behavior were harmed, with the political elite apparently taking no action to protect the victims.”


Gee, so the problem was only that the political elite took no action to protect the innocent victims of greedy capitalists.  This is pure mumbo-jumbo to obscure the primary role of politicians (here described as the “political elite”) in precipitating the crisis by buying votes by shoveling favors to privileged constituents.  The irony is that these favored constituents included greedy capitalists.  It’s no accident that 3/4 of the political donations from Goldman Sachs went to the Democrats.


Some is just comical:


“[P]art of this analysis is designed to explain why the Obama administration must go after Goldman Sachs, Lehman Brothers and others.”


Gee, why would the Obama go after Wall Street?  Why “must” the Obami go after Goldman Sachs?  Oh, “to demonstrate that the political system is prepared to control the entities it created.”  Sure.  How about this?


There is precedent for this, and it will likely achieve its desired end: greater control over the financial system by the state and an acceptable moral tale for the public.


I readily admit to not being “sophisticated” or “nuanced” but it looks pretty simple to me: politicians not letting a crisis (that they precipitated) go to waste by using it to increase their power and control over the financial system.  This sure seems consistent with the Obama’s drive to control our medical system, big chunks of the industrial system (e.g., General Motors, Chrysler), and, yet to come, the energy sector.  Notice a pattern here?” (end of readers comments)


Sadly, I agree with all of this. I do not think the reader’s comments are in conflict with the Stratfor piece. Rather, I think that the political elite have used the system for their own purposes for a long time. FNMA and Freddie, a political creation, gave hundreds of millions of dollars to politicians over the last 30 years. Collectively, the politicians might be the real winners in this evolving situation.


Freddie Mac just reported a 10 billion quarterly loss, which it is asking the treasury to replace on their balance sheet, so it does not maintain a negative net worth. Over the last 11 of 12 quarters, Freddie has lost $82 billion, which is more than twice what it made over the previous 30 years.


And lastly, let me say that this all fits in with the analysis of William Strauss and Neil Howe, the authors of the 4th Turning, and Generations. As this crisis phase evolves, they predict that the wealthy class will lose their place on the economic totem pole. I have the books, but I cannot cite historical examples of how the wealthy was brought into the middle in the past. It is rather eery, that this is exactly what they are predicting. And of course, this brings me back to non-conventional views on wealth preservation.