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European Sovereign Defaults


_w_
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It looks like the chances of a bazooka solution with Europe being drowned in magic money is not on the table and never was. At least, the odds are decent that Germany is after a proper default rather than a bailout. We should find out by either the next EU (next weekend) or G20 (November) meeting. Not long to go now.

My interpretation / guess of what Germany is after is that it wants interest rates on sovereign bonds to be in line with each country's fiscal discipline, a form of market discipline restored.

The answer to this is to make lenders feel serious pain with a sizeable Greek default. The lesson would force investors to properly assess each country's creditworthiness rather than assume everyone's as good as Germany however irresponsible the country's government's behaviour.

I find a European default hard to visualise.

The immediate consequences I can think of are:

- The rates on the government bonds of Italy, Spain, Portugal, Ireland, Belgium and France immediately start rising towards pre-euro (normal) levels.

- These countries took on immense amounts of debt since euro introduction, debts that could only be serviced with a German (post euro alignment fantasy) level of interest rates. They will be quickly identified as being in the position Greece is in now: their income will not be sufficient to service their debts at current levels however much they cut expenditure.

- Default pricing is promptly discounted by markets leading to skyrocketing interest rates in these countries and a repeat X10 of the recent Greek experience.

- The kind of bank recapitalisation I hear about ($200bn or so for all European banks) would be purely symbolic IMO. Something to try and bamboozle the markets with while avoiding a wipe out of exec stock options and minimising the damage to state deficits. $20bn for BNP is something I've read, that would be 1% of a $2 trillion balance sheet filled with sub-prime garbage of all sorts (property, sovereign, 'industrial', etc.) from all continents. It looks like a fail from the start that would only be compounded by a sovereign contagion across all the Club Med states.

- A second recap would come when those countries that need to do the biggest recaps are least able to get finance. I could imagine bank nationalisations at this stage with some sort of triage to decide which banks are nationalised and which ones go bust. This would imply a 'Lehman moment' X 10.

- In the meantime, Greece having failed to scare Europe into giving it free money, is beginning to squirm now that Angela is calling their bluff. Should Greece default, the biggest victims would be the Greek banks as well as pension and insurance funds that have been forced to stuff themselves full of Greek bonds. It is worth noting that all Club Med countries have resorted to the same tricks to create artificial demand for their bonds. Upon default, Greek banks immediately go bust and have to be bailed out. By a government that has no money. What next?

Can anyone think of other/more likely consequences?

How could the ECB help out if Germany says no more debts?

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Can anyone think of other/more likely consequences?

Lets not forget the recapitalization needed for the Bundesbank. All the capital flows between euro countries haven't actually been paid for. The German central bank is sat on Target2 claims of $400 Billion euros. Either we get some payment with foreign currency / gold transfers from other euro central banks - or the Bundesbank goes kaput.

Edited by Police
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My interpretation / guess of what Germany is after is that it wants interest rates on sovereign bonds to be in line with each country's fiscal discipline, a form of market discipline restored.

The only way to actually achieve this, would be for the PIIGs (or Germany) to leave the Euro.

The immediate consequences I can think of are:

- The rates on the government bonds of Italy, Spain, Portugal, Ireland, Belgium and France immediately start rising towards pre-euro (normal) levels.

Exactly. Without the ability to devalue their currencies, the PIIGS would just implode.

EDIT: spelling

Edited by Deckard
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Lets not forget the recapitalization needed for the Bundesbank. All the capital flows between euro countries haven't actually been paid for. The German central bank is sat on Target2 claims of $400 Billion euros. Either we get some payment with foreign currency / gold transfers from other euro central banks - or the Bundesbank goes kaput.

Oh yes! And the ECB's balance sheet wouldn't look too good either.

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The only way to actually achieve this, would be for the PIIGs (or Germany) to leave the Euro.

In theory, why wouldn't it be possible for each euro country to have sovereign bond rates that reflect the country's creditworthiness? Isn't it what we have now, but with currently overoptimistic market rates?

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It looks like the chances of a bazooka solution with Europe being drowned in magic money is not on the table and never was. At least, the odds are decent that Germany is after a proper default rather than a bailout. We should find out by either the next EU (next weekend) or G20 (November) meeting. Not long to go now.

My interpretation / guess of what Germany is after is that it wants interest rates on sovereign bonds to be in line with each country's fiscal discipline, a form of market discipline restored.

The answer to this is to make lenders feel serious pain with a sizeable Greek default. The lesson would force investors to properly assess each country's creditworthiness rather than assume everyone's as good as Germany however irresponsible the country's government's behaviour.

I find a European default hard to visualise.

The immediate consequences I can think of are:

- The rates on the government bonds of Italy, Spain, Portugal, Ireland, Belgium and France immediately start rising towards pre-euro (normal) levels.

- These countries took on immense amounts of debt since euro introduction, debts that could only be serviced with a German (post euro alignment fantasy) level of interest rates. They will be quickly identified as being in the position Greece is in now: their income will not be sufficient to service their debts at current levels however much they cut expenditure.

- Default pricing is promptly discounted by markets leading to skyrocketing interest rates in these countries and a repeat X10 of the recent Greek experience.

- The kind of bank recapitalisation I hear about ($200bn or so for all European banks) would be purely symbolic IMO. Something to try and bamboozle the markets with while avoiding a wipe out of exec stock options and minimising the damage to state deficits. $20bn for BNP is something I've read, that would be 1% of a $2 trillion balance sheet filled with sub-prime garbage of all sorts (property, sovereign, 'industrial', etc.) from all continents. It looks like a fail from the start that would only be compounded by a sovereign contagion across all the Club Med states.

- A second recap would come when those countries that need to do the biggest recaps are least able to get finance. I could imagine bank nationalisations at this stage with some sort of triage to decide which banks are nationalised and which ones go bust. This would imply a 'Lehman moment' X 10.

- In the meantime, Greece having failed to scare Europe into giving it free money, is beginning to squirm now that Angela is calling their bluff. Should Greece default, the biggest victims would be the Greek banks as well as pension and insurance funds that have been forced to stuff themselves full of Greek bonds. It is worth noting that all Club Med countries have resorted to the same tricks to create artificial demand for their bonds. Upon default, Greek banks immediately go bust and have to be bailed out. By a government that has no money. What next?

Can anyone think of other/more likely consequences?

How could the ECB help out if Germany says no more debts?

I'm not quite sure what you mean by europe not being drowned in magic money. The money either goes to the banks via the greek "haircut" or directly into the banks to keep them liquid after a default. To me it's what consequences this has for the system in the long term that's the interesting issue.

Short term there could be some fun if the governments hesitate on recaping the banks after a default, but I doubt this will happen. IMO the default and the stuffing of the problem banks will be co-ordinated simultaneously with the default, otherwise the Lehman moment will occur.

The other issue is whether the Greeks leave the euro at the same time as default. I can't understand the mechanism here.

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In theory, why wouldn't it be possible for each euro country to have sovereign bond rates that reflect the country's creditworthiness? Isn't it what we have now, but with currently overoptimistic market rates?

The only reason why Spanish and Italian 10yr bond yields are not much higher at the moment, is because the market is betting on a deus-ex-machina type last minute solution to the Eurozone impasse.

The moment it becomes apparent such solution does not exist, Spanish and Italian yields will go through the roof, spelling the end of EMU.

North of 7% was flagged by many commentators as the point of no return.

Edited by Deckard
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I'm not quite sure what you mean by europe not being drowned in magic money. The money either goes to the banks via the greek "haircut" or directly into the banks to keep them liquid after a default. To me it's what consequences this has for the system in the long term that's the interesting issue.

I mean the leveraged EFSF proposals, promised money (itself to be borrowed but not yet given) being used as margin for leveraged loans up to x trillion euros.

Edited by _w_
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_W_,

What about the affect on those who think that they have assets now? If Greece and Portugal go down, some individual somewhere has to take a loss. I reckon that a lot of that will fall on people with deposits in banks, and people in pension funds who think that they have enough put away for their retirement.

The real nasty of course, is how this affects our supply chains. Those chains bring food into our supermarkets, fuel to our petrol pumps and cars to our showrooms, amongst other things. If they collapse because of lack of credit or lack of demand, we could have anarchy.

And what about deflation? If banks go under, the credit that they have managed to create gets destroyed, there could be a huge fall in the money supply. This isnt pretty because due to various laws, things like wages and pension payouts cannot go backwards. It wouldnt matter if we destroyed 90% of our money, and everyone was paid 10% of what we had previously. However, if a few dont get any reduction in what they are paid, then everyone else gets to shoulder their burden instead, at which point they riot and revolt until those with protected incomes lose them too. This is very pertinent to a country like the UK, where state and public sector pensions are protected against inflation, as are benefits, and I dont think that they can ever be cut. So if the money supply shrinks, private sector employers cannot cut wages in line with the reduction in revenues, and will have to cut jobs or close entirely. A larger and larger portion of the national wealth will go to those not producing as a result, until of course everyone stops working and then the system resets. Such a reset could be accompanied by a complete breakdown of law and order.

I dont think that many people will take the changes needed to avert this sort of societal breakdown gracefully. If I were in charge, I would have to think about plans to axe all benefits, all government pensions, end the minimum wage laws and huge cuts in public sector posts and salaries. This would be a bare minimum needed to cope with a financial meltdown, and ensures that resources are directed at those producing in the private sector, encouraging output of any sort.

Interesting times lie ahead.

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_W_,

What about the affect on those who think that they have assets now? If Greece and Portugal go down, some individual somewhere has to take a loss. I reckon that a lot of that will fall on people with deposits in banks, and people in pension funds who think that they have enough put away for their retirement.

The real nasty of course, is how this affects our supply chains. Those chains bring food into our supermarkets, fuel to our petrol pumps and cars to our showrooms, amongst other things. If they collapse because of lack of credit or lack of demand, we could have anarchy.

And what about deflation? If banks go under, the credit that they have managed to create gets destroyed, there could be a huge fall in the money supply. This isnt pretty because due to various laws, things like wages and pension payouts cannot go backwards. It wouldnt matter if we destroyed 90% of our money, and everyone was paid 10% of what we had previously. However, if a few dont get any reduction in what they are paid, then everyone else gets to shoulder their burden instead, at which point they riot and revolt until those with protected incomes lose them too. This is very pertinent to a country like the UK, where state and public sector pensions are protected against inflation, as are benefits, and I dont think that they can ever be cut. So if the money supply shrinks, private sector employers cannot cut wages in line with the reduction in revenues, and will have to cut jobs or close entirely. A larger and larger portion of the national wealth will go to those not producing as a result, until of course everyone stops working and then the system resets. Such a reset could be accompanied by a complete breakdown of law and order.

I dont think that many people will take the changes needed to avert this sort of societal breakdown gracefully. If I were in charge, I would have to think about plans to axe all benefits, all government pensions, end the minimum wage laws and huge cuts in public sector posts and salaries. This would be a bare minimum needed to cope with a financial meltdown, and ensures that resources are directed at those producing in the private sector, encouraging output of any sort.

Interesting times lie ahead.

Which is why they'll just print and print and print.

Theres been the vaguest whiff of austerity and there are thousands on the streets in towns and cities all over the world.

The CB can either print and give them what they demand or the CB can get replaced with someone who will. All fiat tales end this way.

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I dont think that many people will take the changes needed to avert this sort of societal breakdown gracefully. If I were in charge, I would have to think about plans to axe all benefits, all government pensions, end the minimum wage laws and huge cuts in public sector posts and salaries. This would be a bare minimum needed to cope with a financial meltdown, and ensures that resources are directed at those producing in the private sector, encouraging output of any sort.

Probably the easiest way to implement this would an "austerity cap" - just let everyone keep their pensions and index linkage, but apply a cap over the top, eg no pension to exceed £50K regardless of entitlements. So few people would be affected, and they would have little sympathy due to their relative richness, that rioting would not be a problem.

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Probably the easiest way to implement this would an "austerity cap" - just let everyone keep their pensions and index linkage, but apply a cap over the top, eg no pension to exceed £50K regardless of entitlements. So few people would be affected, and they would have little sympathy due to their relative richness, that rioting would not be a problem.

For a little while...

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The only reason why Spanish and Italian 10yr bond yields are not much higher at the moment, is because the market is betting on a deus-ex-machina type last minute solution to the Eurozone impasse.

The moment it becomes apparent such solution does not exist, Spanish and Italian yields will go through the roof, spelling the end of EMU.

North of 7% was flagged by many commentators as the point of no return.

Yep.

There would be instantaneous capital/currency controls, banks shut down etc whilst the Gipsis or Germany exit the euro (easier if it's Germany) and devalue/revalue.

If they don't do that there will in any event be instantaneous bank runs into German banks. Why would you keep your euros in a bank in a countty which is guaranteed to default when the same euro may as well be in a German bank?

Germany will lose this game unless they also exit at the same time imo.

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Probably the easiest way to implement this would an "austerity cap" - just let everyone keep their pensions and index linkage, but apply a cap over the top, eg no pension to exceed £50K regardless of entitlements. So few people would be affected, and they would have little sympathy due to their relative richness, that rioting would not be a problem.

The people with a lot of pension do tend to be the more dangerous and/or savvy members of society, however.

Just sayin'

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What if the political powers say Nein?

They get replaced.

Check them out, your actual historical examples. You wind up with cowering banksters and politicians in some government building with a street full of people outside it demanding more money to go buy stuff with - until the ironman figure arrives, he blows the ****** out of some poor crowd at random to prove he's serious, locks up some of the old guard/kills them as well and then it's off to the totalitarian races in earnest.

Comically he's also the guy who actually tries to keep the government books balanced. After that comes a tussle, then republic then the slow decline back to where we are now. Happened over and over again. Always the same.

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If they don't do that there will in any event be instantaneous bank runs into German banks. Why would you keep your euros in a bank in a country which is guaranteed to default when the same euro may as well be in a German bank?

I read somewhere that this is already happening . . . lots of money flowing from peripherals into Germany. German banks should now be better placed than they were, and perhaps explains why Merkel can now afford to be less sympathetic to the plight of Sarky's banks.

But who really knows. Deutsche Bank was put on negative review only the other day.

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I read somewhere that this is already happening . . . lots of money flowing from peripherals into Germany. German banks should now be better placed than they were, and perhaps explains why Merkel can now afford to be less sympathetic to the plight of Sarky's banks.

Not really. German banks have to find a use for the money and european central banks do not settle cross border flows - so the Bundesbank will have more claims on other central banks to lose out on.

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