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« Who gets the jobs story wrong? Everyone! | Main | Investment Themes: The first step in finding a great stock. »

November 06, 2011


Angel Martin

Mike C, thanks for the links, it took a while for me to get back to them...

In your links, one has euro depreciation spiking gold, and the other has forced financial asset seizures funding insolvent eurozone governments.

I expect to see both outcomes. On wed, gold fell along with the euro, so the correlation change from that post was short lived. But i think the end game for the euro is major devaluation along with significant eurozone inflation. The more inflation there is, the more it spooks the inflation fear demand for gold.

Residents of latin america would be familiar with financial repression such as exchange controls, forced conversion of bank accounts into gov't debt etc. But, residents of latin america also know that such measures never seem to change the outcome which is usually default, devaluation and hyperinflation.


Angel - First off, I have no special expertise about Europe, so my inferences come from the more generalized field of public policymaking in a democratic environment.

What I see happening is something I have observed many times, the negotiating among disparate interests and the process of compromise. It is accompanied by strident lectures from outsiders and everyone hates the process.

Meanwhile, I have been fairly accurate so far. It was not that long ago that the skeptics were saying that the various parliaments would not approve the changes in the EFSF and we were fixated on Malta and Slovakia.

The Chinese and other SWF entities will not be the "first in." They will play hardball. But I am just repeating what I have written several times...

You cannot just add up the liabilities, since there will definitely be participants other than Germany and there will be leverage.

Good discussion here. I am trying to keep up my end, but I'll be on the road for a couple of days. Feel free to carry on, and maybe someone will take up my (lonely) side!


Mike C


One more note I just came across with Russell Napier thoughts on one more way this plays out:

"However, Russell thinks that the electoral bias against endless printing might on this occasional actually prevent it happening in the kinds of volumes required. There'll be a bit of European Central Bank-led QE he reckons, but not as much as I think. Instead, governments will end up going for national theft solutions."

Mike C

Angel, I appreciate the detailed response. You might find this an interesting read

I guess my overall thoughts are that I am in total agreement with your first few bullet points. Ultimately, the aggregate debt is unsustainable. Really, it just takes elementary school arithmetic to come to that conclusion. The harder question is what happens with the debt.

Does the ECB ultimately cave and monetize it? What I wonder (the cynic in me) is if all the various machinations we are going through now are just to move the debt from parties A, B, C to the bagholders who eventually get defaulted on down the road?

Angel Martin

Mike, here's what I assume about the future of the euro:
-the PIIGS are all insolvent including Spain and Italy
-Germany and the other non_PIIGS countries don't have enough borrowing capacity to fund a debt reduction for the PIIGs that would make them solvent
-neither the IMF or the BRICs are ultimately going to ride to the rescue
-the euro-elite is extraordinarily committed to the euro to the point that they are willing to risk severe economic damage to keep it going

If you put that all together, I get see the end game is either all the PIIGS crash out of the euro in a forced exit and devaluation, OR the ECB monetizes the PIIGS debt and gets severe inflation.

Along the way, because of the commitment of the euro-elite to the maintenance of the euro, I think you will see proposals (if not actual implementation) of eurobonds, fiscal transfers, a common finance ministry and even political union.

What is not clear is how far Germany will go with debt monetization. I claim no expertise on german politics but my assumption is that as long as the ruling coalition is CDU/CSU/FDP then really big debt monetization is off the table. If the more pro euro SDP/Greens somehow take over before this is done, we could see massive debt monetization and even an Argentina style hyperinflation.

I think the trajectory of the euro is down no matter what happens. The eurozone appears to be slipping into recession. Even if the US goes into recession as well, the chaos of uncontrolled defaults etc is going to weaken the economies of the remaining eurozone members and drive the euro down against the US dollar.

If they start on a course of aggressive monetization, the euro could drop to levels that would truly represent a "black swan".

Some caveats on trading strategy: the eurozone elite still has many cards to play, every time they announce something like fiscal transfers or eurobonds the euro is going to spike up.

My trading strategy is to have a small short position using out of the money options, which I will add to as the euro-elite graudually exhaust all their optoins like eurobonds and fiscal transfers.

If the SPD and Greens somehow become part of the ruling coalition in Germany, I am really going to pile in.

Another caveat, Jeff has 25+ years experience doing this for a living, plus experience as an academic specializing in public policy decision making, as well as quantitative methods, and he thinks that the eurozone will somehow get thru this without the catastrophic collapse that I am forecasting. Jeff was completely correct about the outcome of the debt ceiling, while I thought that the tea party Republicans i the House would use their leverage to force massive, immediate spending cuts...

So, you need to do your own thinking here...

Mike C

Good stuff Angel. Your analysis reminds me of Soros versus the Bank of England. I think it was Carville who said he wanted to be reincarnated as the bond market. Ultimately, the markets are bigger then government policymakers.

All that said, what is the long-term trade here? I'm just not sure that short euro for the long-term is the trade. The stronger countries could just give the PIGS the boot.

Angel Martin

my take, totally bogus. This paper has a cross country comparison of the determinants of consumer debt. Declining incomes by the "working class" is not one of them. by

The lack of wage growth is not related to "corporate power" or the "class interests of the wealthy" but is a function of the global labour supply shock of China and India abandoning autarchic socialism and entering the global economy. Global labour supply has quadrupled in the last two decades, it's actually amazing that wages have not gone down more.


jd -- analyzing the strong financial interests of various parties is a good method.

You are on the right track with your conclusions, and you might also add China and various sovereign funds to the analysis.

All will discover, bargain, and eventually act in their own interest.

Good concept, and thanks,


Angel Martin

Jeff, my point about the bond offering pull was that Germany and France had no problems selling bonds last week, and the EFSF is also supposed to be AAA rated... it may be that there is very little demand for EFSF bonds at sustainable interest rates; as you noted we will see.

On the power of markets vs governments: I think the that is at the core of what is going on here. A few weeks ago, Merkel said that part of what they were doing was to re-establish the power of political decisions over markets. I think that is delusional thinking and if that is their strategy for saving the eurozone, they are going to fail for sure.

I'm not pushing my political views here (although i am generally a less government, more markets guy) i'm just talking historical fact. In my view, the power of markets is going to totally crush the eurozone leadership because they cannot force independent economic agents such as BRIC sovereign wealth funds, US money market funds, or even their own citizens to lend money at low interest rates to weak creditors like the PIIGs.

Governments are sovereign and they have a lot of power. But they do not have sufficient power to force economic agents to accept losses when they can be avoided. Even totalitarian states have limits on the control of economic behavior by their subjects, if they did not, the USSR would probably still be in business.

Joseph Stalin murdered millions, but even he could not eliminate the difference between the black market price of wheat and the official Gosplan price.

The EU wants to, in effect, use various incentives and partial guarantees to manipulate markets into lending to the PIIGs at below market rates. I don't think they are going to be successful.


When I think of Europe, I ask the question, "Who has a vested interest in Europe succeeding?" I think the answer is, "the rest of the world." The rest of the world in various buckets has a great deal of money available.

So, in the final analysis, at the right time, when the political process has finally run it's course, the money will be there.

I used to be concerned about Europe. Now, not so much.
Although, many years of discipline will be needed. But, that discipline will have to unfold slowly, year after year, according to what the system can handle.

Strangely, it's the magnititude of the danger, that gives me comfort. It's about countries, banks and interconnections (contagion). The world simply can't fail in this one. So, it won't.


I just saw an animation about how class works made by Richard Wolff. Now I know that this isn't really related to investing but I just wanted to ask your opinion on this, Jeff. First off, here's the animation (12 mins):

First question: Do you know anything about this Richard Wolff? What is his "track record"?

Second question: What is your take on the animation and the point Richard is making?

I personally have a bit mixed feelings. On the other hand I think he's on to something but on the other hand I think that it cannot be that simple.


Angel -- So if you were in charge of the bond offering, you would have recommended going ahead despite the Greek referendum turmoil? I thought that the delay was a rather routine decision. We'll see how it prices when they try again.

You are raising a great point about markets and political decisions. Democratic leaders do not like to be told that they MUST do something. They believe they are deciding. Sometimes the market "opinion" is not the best solution -- at least in a social or public policy sense. The participants and values are quite different.

It is a good question, and there is no easy answer. The political process in 2008 would have avoided some of the damage if it had been faster. Same for the Obama transition. Same thing now in Europe.

Thanks for your continuing valuable observations and links.


Angel Martin

Jeff, I know we disagree on the likely endgame in europe. For me, this week, the most important story out of europe was when the EFSF pulled the auction of 3 bil for Ireland, citing "market conditions".

The way things are going in Italy, the EFSF is soon going to have to do much larger fundings than 3 bil, in much worse market conditions than last week. If they can't, then the EFSF is going to go way of the last half dozen "solutions" to the eurozone crisis.

I would also question the idea that the political process in europe is slow, and that's just how it is but they will get there eventually...

Sometimes markets have their own time table, that politicians have to meet whether they want to or not. Markets open every monday and if you are not ready, you get eliminated (like Lehman did).

We can see from the EFSF Ireland auction pull that the balance of power over schedule is shifting from governments to markets.


Thanks for the post Jeff.

It is my understanding that the Prime Minister of Greece called off the referendum. Now he is trying to form a unity government to take Greece through the austerity program.

Here's some news on this subject:

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