{"id":4776,"date":"2011-11-01T07:08:00","date_gmt":"2011-11-01T13:08:00","guid":{"rendered":"http:\/\/www.jasonapollovoss.local\/?p=4776"},"modified":"2018-09-21T02:04:39","modified_gmt":"2018-09-21T06:04:39","slug":"european-sovereign-debt-crisis-opera-has-the-fat-lady-sung","status":"publish","type":"post","link":"https:\/\/jasonapollovoss.com\/web\/2011\/11\/01\/european-sovereign-debt-crisis-opera-has-the-fat-lady-sung\/","title":{"rendered":"European Sovereign Debt Crisis Opera: Has the Fat Lady Sung?"},"content":{"rendered":"<p>&nbsp;<\/p>\n<p><span style=\"font-size: 16px;\">Unquestionably, the economic and investing question of the last two years has been the European sovereign debt crisis opera.\u00a0 Financial markets rallied in expectation of a plan to resolve the crisis and then orgasmed upon the revealing of the plan.\u00a0 So the question now becomes: has the fat lady sung and is the opera over?\u00a0 That is, does this plan end the drama?\u00a0 In short, the answer is &#8220;no.&#8221;<\/span><\/p>\n<p><span style=\"font-size: 16px;\">Unfortunately the symptoms of this problem are what have been addressed by the plan, and not the disease.\u00a0 What is the disease?\u00a0 Fundamentally, the problem is the issuance of massive amounts of capital &#8211; in the form of debt &#8211; that far outstrips the underlying capital base&#8217;s ability to pay it back.<\/span><\/p>\n<p><span style=\"font-size: 16px;\">A well functioning financing mechanism\u00a0recognizes that debt is issued against the value of a profit generating asset.\u00a0 Instead, we have approximately 30-40 years\u00a0where globally\u00a0debt has been issued against the most corruptible of assets: a promise of repayment.<\/span><\/p>\n<p><span style=\"font-size: 16px;\">Normally this is not a problem so long as your credit can generate income high enough and consistently enough to meet the debt covenant&#8217;s repayment terms.\u00a0 That is, so long as there is\u00a0sustained economic growth that makes use of the capital purchased with the debt.\u00a0 \u00a0However, in Europe there is a lack of innovation, stifling bureaucracy, horrible financing decision-making and outright fraud.<\/span><\/p>\n<p><span style=\"font-size: 16px;\">Europe&#8217;s plan to escape this quagmire &#8211; too much debt issued against too few quality\u00a0assets &#8211; does not address this fundamental\u00a0problem.\u00a0 What I am saying is that the real way to escape the quagmire is to have a meaningful bout of introspection and address core economic questions.\u00a0 Questions such as:<\/span><\/p>\n<ul>\n<li><span style=\"font-size: 16px;\">For capitalism to work doesn&#8217;t there have to be a fear of loss?\u00a0 Therefore, shouldn&#8217;t investors of\u00a0poor debt be made to accept capital losses?<\/span><\/li>\n<li><span style=\"font-size: 16px;\">Shouldn&#8217;t debt issuers be held accountable to a modicum of ethical and prudent behavior?<\/span><\/li>\n<li><span style=\"font-size: 16px;\">Shouldn&#8217;t outright fraud (Greece lied its way into the EU and the eurozone) be punished somehow?<\/span><\/li>\n<li><span style=\"font-size: 16px;\">Shouldn&#8217;t the EU charter have addressed all of these potential problems in the first place?<\/span><\/li>\n<li><span style=\"font-size: 16px;\">If economic growth outstrips debt growth and is more sustainable than debt maturities then you can issued debt ad infinitum.\u00a0 Since that isn&#8217;t occurring shouldn&#8217;t we be talking about how to grow the economy and about how to shrink debt issuance?<\/span><\/li>\n<\/ul>\n<p><span style=\"font-size: 16px;\">I could go on.<\/span><\/p>\n<p><span style=\"font-size: 16px;\">So while the financial markets have rallied on the details of the most recent &#8220;plan&#8221; I don&#8217;t really see this as cause for celebration.\u00a0 Let&#8217;s look at where we are at:<\/span><\/p>\n<ul>\n<li><span style=\"font-size: 16px;\">Globally we have debt issuance that far outstripped economic growth on a percentage basis.\u00a0 That means that a greater proportion of each additional dollar of economic growth was effectively siphoned off to make an interest payment or to pay off a debt&#8217;s principal amount.\u00a0 Unfortunately, this happened for almost forty years.\u00a0 Effectively this was like printing money and it is no surprise that consumers the world around have bought all kinds of crazy stuff from flat panel TVs to multiple personal computers to multiple houses to diamond encrusted Rolexes.\u00a0 But these are not economic purchases &#8211; that is they do not generate much of a return.<\/span><\/li>\n<li><span style=\"font-size: 16px;\">It is also therefore not a surpise that all of this printed money ended up generating multiple asset bubbles.\u00a0 Bubbles eventually inflate to such a degree that collective delusion eventually gives way to reality.<\/span><\/li>\n<li><span style=\"font-size: 16px;\">The solutions to the economic stagnation brought on by too much\u00a0un-economic growth\u00a0sponsored by too much debt all are talking about using more debt.\u00a0\u00a0Put more simply: how can a debt problem be solved with more debt?\u00a0 That is literally like telling someone who is obese to keep eating.\u00a0 Yes, really.\u00a0 Unfortunately, some version of this story is being proposed in the United States, Europe, China and Japan.\u00a0 Here we are talking about the world&#8217;s very biggest economies all simultaneously facing a similar problem.<\/span><\/li>\n<li><span style=\"font-size: 16px;\">Structurally, the EU is not set up to solve its problems.\u00a0 There is a collision of economic, political and sovereign interests and no mechanism in place to resolve very real conflicting interests.<\/span><\/li>\n<li><span style=\"font-size: 16px;\">In Europe,\u00a0banks are\u00a0over indebted so cannot bailout the governments of Europe.\u00a0 In Europe, the public sector is over indebted so cannot bailout the banks.\u00a0 Oops!<\/span><\/li>\n<li><span style=\"font-size: 16px;\">In Europe, banks bought each other&#8217;s debts such that they are hopelessly interlinked with one another.\u00a0 In Europe, banks bought each other&#8217;s governments debts such that they are hopelessly interlinked with one another.\u00a0 Normally the backstop against a meltdown would be a powerful, well-funded entity outside of the system that could bailout the system.\u00a0 Unfortunately, the U.S., China and Japan are all in similar situations.\u00a0 Oops!\u00a0 What about private entities like the IMF?\u00a0 While they are well funded and have excellent financial discipline the capacity of their bailout mechanism is small compared to the size of the problem.\u00a0 Normally in this circumstance you would then look at the\u00a0amount of equity on a banks&#8217; balance sheets to see the amount of absorptive power.\u00a0 In Europe bank balance sheets are woefully small in comparison to the size of the problem.\u00a0 This means that if one nation, or one big bank in Europe capitulates then the first of many dominoes is likely to fall.\u00a0 To me this is actually the biggest problem with the plan: too much correlation between the entities that are supposed to protect one another.\u00a0 That means they are both susceptible to very similar economic shock waves.\u00a0 Ouch!<\/span><\/li>\n<li><span style=\"font-size: 16px;\">One of the proposals of Europe&#8217;s latest plan is to leverage the amount of money in the European Financial Stability Fund (EFSF) to turn it from a $200 billion fund into a $1 trillion fund.\u00a0 This has taken on two forms.\u00a0 One relies upon private investors to purchase sovereign\u00a0debts in Europe and the EFSF will guarantee performance on the first 20% of losses &#8211; this is where the 5x leverage comes from (100% \u00f7 20% = 5).\u00a0 Unfortunately, private investors around the world have already been stung, and repeatedly, by credits that don&#8217;t pay their bills.\u00a0 So who will buy these new debts to the tune of $800 billion?\u00a0 That remains unknown.\u00a0 Alternatively, the EFSF is also trying to drum up monies from other governments in the world, such as China and Russia to fund the other $800 billion.\u00a0 Unfortunately, China finds itself proportionately in a bigger property bubble than did the U.S. or Europe.\u00a0 Ouch!\u00a0 Meanwhile, Russia does not have nearly enough in its sovereign wealth fund to purchase the full $800 billion.\u00a0 What they do have they are willing to share with the Europeans.\u00a0 Why?\u00a0 Because Russia is looking to reassert itself in Europe and return to its Cold War status as superpower.\u00a0 So Europe is necessarily cautious.<\/span><\/li>\n<li><span style=\"font-size: 16px;\">Germany, the largest solvent nation in Europe has voted that they will not be contributing more monies to the EFSF.\u00a0 So that means that additional monies must come from some other source.\u00a0 The other big economies in Europe &#8211; France, UK, Spain and Italy &#8211; all are colossally indebted and are not going to be able to increase the size of the EFSF without tremendous strain on&#8230;guess what?&#8230;their ability to pay their own debts.<\/span><\/li>\n<\/ul>\n<p><span style=\"font-size: 16px;\">What we have here is an opera.\u00a0 Not only that, but when the fat lady does sing and die at the end of the opera, she may actually die, unlike in an actual opera.<\/span><\/p>\n<p><span style=\"font-size: 16px;\">What can you do?\u00a0 I refer to you my other piece where I recommended that you broaden your idea of what investment actually is: putting a surplus of capital into an idea that has a surfeit of capital.\u00a0 So your own personal education might be smart.\u00a0 Buying depressed property in a place like Detroit, Michigan or Dayton, Ohio might be smart.\u00a0 Paying down your own debts is smart.\u00a0 Etc.<\/span><\/p>\n<p><span style=\"font-size: 16px;\">What good news is out there?\u00a0 The good news is, as I have been saying for many months, that U.S. businesses are doing very well right now.\u00a0 That means that the U.S. economy just might start creating jobs.\u00a0 That means the U.S. just might escape the European crisis vortex.\u00a0 But folks, the odds look even to me.<\/span><\/p>\n<p><span style=\"font-size: 16px;\">Jason<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"<p>&nbsp; Unquestionably, the economic and investing question of the last two years has been the European sovereign debt crisis opera.\u00a0 Financial markets rallied in expectation of a plan to resolve the crisis and then orgasmed upon the revealing of the plan.\u00a0 So the question now becomes: has the fat lady sung and is the opera [&hellip;]<\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","footnotes":""},"categories":[3],"tags":[],"class_list":["post-4776","post","type-post","status-publish","format-standard","hentry","category-the-blog"],"_links":{"self":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts\/4776","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/comments?post=4776"}],"version-history":[{"count":0,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/posts\/4776\/revisions"}],"wp:attachment":[{"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/media?parent=4776"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/categories?post=4776"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/jasonapollovoss.com\/web\/wp-json\/wp\/v2\/tags?post=4776"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}