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JP Morgan: “Gold is money, everything else is credit” or (no) credibility!

Gijsbert Groenewegen
Dec 14, 2011

The three point plan of the member states

The Euro zone crisis centers around two major problems one is of European governments’ solvency which is being addressed with tougher fiscal rules and then there is the liquidity issue needed to keep the bond and money markets from freezing up.

Thursday December 8 the European Central Bank announced an interest-rate cut from 1.25% to 1%. That returned the rate to the record low level that had prevailed from 2009 until April. Mr. Draghi did not rule out the possibility that the rate could go even lower. The following day the member states decided on a three-point plan.

The three points include:

  1. Tougher fiscal rules with more automatic sanctions;
  2. A permanent €500bn European Stability Mechanism (ESM), would be put into effect a year early, by July 2012, and for a year, which will run alongside the existing and temporary €440bn European Financial Stability Facility (EFSF) which has €250bn left in its coffers; The EFSF, which could barely raise money recently, is at great risk of a ratings downgrade, and is also ineligible for direct loans from the IMF. The ESM, on the other hand, with a granted banking license and therefore being able to borrow from the ECB, would also be eligible for IMF loans. In contrast to the EFSF, which is funded based on promises (callable capital), the ESM will require that Euro zone countries actually start ponying up real money.
  3. And a capital increase for the IMF general resources of €200bn (the total now stands at €290bn after commitments to Greece, Ireland and Portugal) , to help increase a “firewall” of money in European bailout funds to help cover Italy and Spain, to be confirmed within 10 days by the countries that agree to it. The €200bn, a €150bn contribution from the euro region’s national central banks and €50bn from the non-euro EU states. One potential concern for investors is funneling the cash through the Washington lender’s general account rather than a fund earmarked for Europe is that any loans it makes likely require repayment before privately held bonds as happened with Argentina.

ECB: Lender of last resort of the banks not governments!

According to Draghi it was "a very good outcome for the euro area member states," and according to him "It is going to be the basis for something that comes quite close to a good fiscal compact." Though Draghi made clear that the ECB is the lender of last resort for the European banks but not for the European governments. He stressed that European treaties prescribed the limited role of the ECB and the ban on central banking funding for Euro zone governments very much also the stance of the conservative Bundesbank.

The central bank also announced additional measures to aid euro zone banks suffering from a dearth of the short-term lending and to avert a credit squeeze. The European Central Bank said it would start offering unlimited three-year loans on favorable terms, at the benchmark interest rate, compared with a maximum of about one year previously. Banks will be able to borrow as much as they want. Lower interest rates will be particularly welcome in countries like Portugal and Italy, where the debt crisis has pushed up interest rates and made it harder for businesses to get loans. And the cuts will provide immediate relief to the many homeowners in Ireland and other euro countries who have variable-rate mortgages tied to the central bank’s rate.

Instead the ECB is rescuing the states through the banks!

It basically means that the Italian banks can borrow at 1% whilst the Italian state has to pay 6-7% as a result banks will be in a position to finance the state debt at lower levels than 6-7%!! In other words the ECB is “rescuing” the member states through their banks!!!! We want to emphasize again that the countries/governments and banks are inextricably connected. It is a vicious cycle in which the banks when they are downgraded this most likely will lead to a downgrade of the sovereign debt of the country because of the required rescue operation needed (Dexia, Belgium). Last Thursday the European Banking Authority (EBA) stress test revealed that the capital that the banks must raise by June 2012 increase from €106bn to €115bn.

The ECB has also relaxed rules on which collateral the banks can use in order to qualify for ECB liquidity. The support of Mr. Draghi and the ECB to continue to buy the bonds of troubled large countries like Italy and Spain is according to some crucial to buy time for their economic adjustment and restructuring, to reduce their debt and avoid a collapse of the euro.

The intergovernmental treaty which can be ratified much more quickly by parliaments than a full treaty amendment requires the European member states to enforce stricter fiscal and financial discipline in their future budgets. But efforts to get unanimity among the 27 members of the European Union failed as Britain refused to go along because they couldn’t get assurances to protect Britain’s financial services sector. The intergovernmental pact was welcomed by Mario Draghi.

The leaders also agreed that private-sector lenders to euro zone nations would not automatically face losses, as had been the plan previously demanded by Germany and was seen by many as having inflamed the crisis. Merkel had championed “private sector involvement” as a way of lessening the bailout burden on taxpayers, running into warnings from the ECB and investors that such a ploy fanned contagion. When Greece’s debt was finally restructured, the private sector suffered, making investors more anxious about other vulnerable economies.

Chancellor Angela Merkel of Germany, who pressed hard for a treaty that would codify and enforce debt limits and central oversight of national budgets, said the decisions made here would result in increased credibility for the euro zone. “I have always said the 17 states of the euro zone need to win back credibility,” she said.

Credit, credibility, gold, money

We hereby want to refer to the quote of JP Morgan “Gold is money, everything else is credit”. Credit and credibility are of course inextricably linked to each other, without credibility no credit. Credibility refers to the objective and subjective components of the believability of a source or message. And what we are witnessing is that the credibility or believability of the politicians and monetary authorities is diminishing quickly. Nobody of the politicians dares to take strong medicine needed to deal with the serious problems for fear of not being reelected. On the other hand we think the problems are too big to overcome. Only drastic measures would suffice. In Italy Prime Minister Monti is trying to save an additional €30bn over three years on a total debt of €1,900!!!!! That is 1.6% over the total debt. Next to that we have to see if the proposed savings will indeed be realized. Anyway the debt problems in the western world are so big that we can’t grow out of debt anymore by putting on more debt or through austerity problems. The time is up. In order to solve the sovereign debt problems we probably would have to see GDP growth of between 10-15% for the next 20-30 years which we all know is unrealistic.

The economy of the 17 countries in the euro currency union is almost stagnant, growing just 0.2 percent in the third quarter, with unemployment at 10.3 percent. Economists expect the euro zone economy to slip into recession early next year if it has not happened already. Declining output makes the debt crisis even worse by cutting tax receipts. For 2012 the estimates indicate a 0.7% contraction of the total Euro zone.

Euro governments and Euro banks 2012/13 financing needs €2trn+!!!!

In 2012/13 the government funding in Italy will be €592bn, Spain €334bn, Belgium €109bn, Greece €96bn, Portugal €49bn and Ireland €45bn totaling €1,225bn or €1.2trn!! The total debt outstanding of these countries in 2010 was €3.7trn. About €519bn of Italian, French and German debt are maturing in the first half of 2012 alone, data compiled by Bloomberg show. European banks have about $665bn of debt coming due in the first six months, according to Citigroup Inc., based on Dealogic data.

We believe that with slowing economies in Europe going into recession the €2trn+ funding requirements for the next 2 years sound a bridge too far. Holger Schmieding, chief European economist at Berenberg Bank in London, said the “avalanche” of refinancing needs in the next two months means the crisis could worsen and “the ECB would then finally be forced to step up its anti-crisis response to save the euro and itself.”

We don’t believe that the system will be able to supply the needed funds at current interest rates. It is our opinion that interest rates have to rise much higher to incorporate the increased credit risk which in turn would lower the ratings of the sovereign debt. This would lead to even higher interest rates and the vicious circle is complete.

Following the lack of leadership the European Union and 15 Euro countries were put on credit watch

Another test will be the response of credit-ratings agencies. The European Union had its AAA long-term rating put on “credit watch negative” by Standard & Poor’s, which is also reviewing ratings for BNP Paribas SA, Commerzbank AG and Deutsche Bank AG. The ratings company put 15 euro negative watch and review the triple-A ratings of Germany, France, the Netherlands, Austria, Finland, and Luxembourg, and lower them to a AA+ if reviewers are not convinced that European policymakers are making enough progress to justify the ratings, FT reported, saying it would conclude its review following the leaders’ summit outcome. While a “unified stance” could prompt delay, rating cuts remain possible within the next three months.

Double A will become the new triple A as commentators are saying because there are no triple A countries left. But in fact what it means is a continued competitive currency devaluation and debasement of all asset classes except for gold and silver or asset classes that have intrinsic value and are not dependent on political decisions. We again repeat JP Morgan “Gold is money, everything else is credit”.

Enforcement questions “does the emperor have clothes?”

The new fiscal accord goes beyond a toughening of rules already slated to take effect next week. It would curb “structural deficits” at 0.5 percent of gross domestic product and require each country to establish an “automatic correction mechanism” when budgets stray from the target. This “golden rule” will be anchored in national constitutions. These “structural deficits” can be manipulated very easily and therefore in our opinion don’t have any solid and realistic meaning and therefore also not the automatic correction mechanisms.

The blueprint also foresaw a near-automatic disciplinary procedure for wayward countries and “more intrusive control “of taxing and spending by governments that overstep the deficit limit of 3% of GDP. It caps a three-month drive by Merkel to lock tighter budget discipline into treaties as part of what she calls the “deeper integration” needed to support the euro.

Investors may still ask whether the penalties against deficit sinners will have any effect and what legal instruments exist to impose them, said Kraemer at Commerzbank.

If the new arrangement turns out to be too toothless to enforce the rules, which we think is a typical political characteristic; we’ll be back to square one. Will penalties against deficit sinners have any effect and what legal instruments exist to impose them? In 2003 France and Germany were breaking the deficit ceilings imposed and each voting against condemning the other killed enforcement efforts. It is kind of the same in the US. You can have all the regulation in the world but if the rules are not properly monitored and enforced with severe penalties the legislation is without teeth and thus validity. The emperor has no clothes!!


Markets continue to be unconvinced by the 'solutions' put forward by EU leaders at last week's summit and a move by Moody's Investor Service to place eight Spanish banks on review for possible downgrade late on Monday followed earlier warnings from Moody's and Fitch Ratings on the credit worthiness of European nations. Moody's said it intended to review the ratings of all 27 members of the European Union, including the ten EU member states not in the euro zone. Fitch added that no "comprehensive" solution had been reached at the summit and European credit ratings remained under pressure. Moody’s Investors Service and the Fitch Ratings warned that European efforts to protect the common currency had not resolved the immediate dangers of a significant economic downturn and troubles in the banking system. By taking a “gradualist” approach to forging a true fiscal union among the 17 euro zone members, politicians were imposing additional economic and financial costs on the region, Fitch warned. “It means the crisis will continue at varying levels of intensity throughout 2012 and probably beyond, until the region is able to sustain broad economic recovery,” the agency said.

On Friday the markets went up on the reaching of an agreement between the Euro member states. Again the markets were acting on headlines and not fundamentals. With about €2trn in refinancing needs for the sovereign Euro states and Euro banks in the next 2 years (also confirmed by the BIS) we believe all the jockeying about more fiscal integration etc etc is not going to pull off the required rescue. Even with the funds remaining in the EFSF, estimated to be €250bn, and the proposed €500m for the ESM and the €200bn from the IMF we don’t think, looking at the figures involved, that the solvability and credibility can be restored. European central banks have loaned €600bn to banks as inter-bank lending has dried up. “The cost and terms of credit deteriorate,” BIS researchers wrote.

And even if these rescue funds would be enough to restore tranquility and credibility in the markets the deficits would still overhang the markets. Just think what kind of growth and budget surpluses we would need to have to substantially reduce the total Italian outstanding sovereign debt of €1,900bn! The proposed fiscal integration and budget deficit ceiling and automatic cuts and sanctions haven’t worked in the past so why would they work now. Especially considering the fact that the countries that are proposing them now, Germany and France, helped each other out in 2003 circumventing the sanctions they would incur for breaching the rules they had agreed to!! We are quite cynical why the adhering to the proposed rules and sanctions would work this time. Don’t forget Sarkozy wants to be reelected! As we mentioned “the emperor has no clothes”.

What we have witnessed since 2008 is a major shift from intangible assets to tangible assets that have real, intrinsic value. Hence our favored JP Morgan’s quote “gold is money, everything else is credit” or credibility as we put it.


Dec 12, 2011
Gijsbert Groenewegen

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