Via email, Saxo Bank chief economist Steen Jakobsen outlines several scenarios in a series of three emails that I spliced together.
There are three major ways of dealing with this crisis:Geithner's TALF Play Rejected by Germany
- Japanization – A Slow Death - Like Japan. Accept deflation, along with slow gradual restructuring, massive fiscal deficits, negative real-rates, housing prices lower than 30 years ago and a stock market valuation at less than 50 per cent of its peak
- Crisis 2.0 – A Forest Fire of deleveraging, political and economic changes created by necessity and need for moving forward. This scenario features a deep one-to-three year recession followed by better debt to equity, more realistic future expectations, and a public sector under control.
- Monetization – The extend-and-pretend forever solution, buying time – more of the same, patch work solutions, slowly forcing Europe towards fiscal consolidation not changing the Maastricht but the ECB charter to allow it to be lender-of-last-resort. This is the final phase of ‘Maximum Intervention’ – bigger and bigger direct support on liquidity(as seen today) and no impact on the solvency.
In the ‘Maximum Intervention’ macro theme the next policy response will be something new, yet more of the same – this has been the historic reaction function of the EU. The consensus right now is that the ECB wants EFSF enlarged from 440 billion EUR to 2.000 billion EUR size in order to get ahead of the EU debt crisis. This is opposed by the Germany.
Another solution is to start Quantative Easing, using the ECB to print money, similar to the US, Japan, UK and Switzerland – this is opposed, for now, by the ECB.
The European "TALF" scheme proposed by Geithner is a full blown move to QUANTATIVE EASING in Europe, the legal standing vis-à-vis Maastricht and the Constitutional Court in Karlsruhe is shaky at best.
I doubt the Germans will accept this – and even that the ECB will want their mandate changed directly. The Germans wants Crisis 2.0 – the ECB wants EFSF enlarged to + 2.000 billion EU.
Any solution ‘permanent’ in nature is in violation of German Constitutional Court – meaning pretty much Euro-bonds is out. (As Germany would have to be lender-of-last-resort when everyone else goes bankrupt)……Any solution temporary could fly vis-à-vis the Constitutional Court but ONLY if approved by full parliament.
Everything else coming to the table is talk, talk and more talk. American “experts” fail to understand the above and …. Most importantly as you have heard me say 1000x of times: ‘Never underestimate the political will of politicians to make this work/survive’ – Never!
The point of no return is here – Between now and the installment paid out in October we have major risk.
This week will tell if FOMC comes to rescue or we start the hard part of Crisis 2.0 – the deconstruction of capital needed to create the political will to do proper economic and political changes.
Portions of Steen's comments were written last Friday. On Saturday, as Steen expected, Germany threw a money wrench into Geithner's leveraged TALF play as noted by Bloomberg in Germany Rejects Using ECB to Lift EFSF Rescue-Fund Firepower
Germany’s top two finance officials rejected using the European Central Bank to boost the euro-area rescue fund’s firepower, rebuffing a suggestion by U.S. Treasury Secretary Timothy Geithner.Fed Uncertainty Principle in Play
The German stance risks leaving the euro area without sufficient means to prevent the crisis from engulfing Spain and Italy.
“The EFSF’s sole purpose is the financing of states and that’s in order as long as it’s done via the capital market,” Bundesbank President Jens Weidmann told reporters today. “If it’s done via the central bank it constitutes monetary state financing,” which is forbidden under European Union rules.
Please note that corollaries 2, 3, and 4 of the Fed Uncertainty Principle are in play. Simply substitute ECB wherever you see Fed.
Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.Note that ECB president Jean-Claude Trichet purchased sovereign bonds of Greece, Italy, Portugal, Spain, and Ireland (over the heated objections of the German Central Bank) in what many think was a violation of the Maastricht Treaty.
Corollary Number Three: Don't expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem.
Corollary Number Four:
The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it's easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.
Thus, while it may seem Maximum Intervention is out, "Never underestimate the political will of politicians to make this work/survive – Never!"
Ultimately Crisis 2.0 It Is
Neither Maximum Intervention nor Japanization are sustainable. There simply is no political will by anyone for prolonged Japanese-style debt-deflation, and maximum intervention will blow up eventually. Eventually Crisis 2.0 will take hold, and the sooner the better.
Crisis 2.0 (at least as I see things) can itself resolve in one of three ways, as noted in Eurozone Breakup Logistics (Never Believe Anything Until It's Officially Denied)
I am not sure if Steen will agree with this, but I see Crisis 2.0 terminating in Plan B or Plan C.
- Plan B: Greece, Spain, Portugal, Italy and the "Club-Med" states break away from the Euro.
- Plan C: Germany, Austria, the Netherlands and Northern Europe break off the Euro. Alternatively Greece leaves via plan B, then Plan C takes over for everyone else.
- Plan A: Defend the Euro at all Costs - is similar to Steen's Maximum Intervention play and is therefore unworkable long-term.
Plan C is the least destructive for everyone, but politics may prevent it.
Mike "Mish" Shedlock
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