The European Crises will come to a head in 2012. On Monday, we laid out the European Crises that will resolve itself one way or another this year. Today, we’ll look at some possibilities of what that resolution could look like and what the ramifications would be for each.
1) Complete Fiscal Union
This would kick the can many years down the road, but will never happen. This would mean that Europe would basically become the United States of Europe. The federal government would have the power to tax all Euro area citizens. This would all the northern countries which tend to have better fiscal discipline control the inner workings of the southern countries which don’t.
It would work for some time because the countries which aren’t in as much debt would average out the indebtedness of the other countries and overall they could probably raise bond money in the markets. However, the basic differences between these countries would not go away and it would eventually lead to a bloody mess (between the riots and pacifying police action it would be ugly). And we’d end up at the same place down the road, but this would certainly buy a lot of time.
However, this is not really possible in a grand scale. In small scale, Europe has already done this by installing unelected dictators to run Greece and Italy. It’s actually quite interesting to watch. These people would all say that they believe in Democracy (I presume), but in actuality, they won’t allow Democracy to get in the way of them saving their sacred cow (the visions of a unified Europe with these same honorable souls leading us lucky masses). Course the same happens constantly in the US, so maybe it’s not all that interesting.
So unless the completely scrap all the legal agreements that the EU is based on, Europe is not going to unify anytime soon because the people don’t want it. For some reason the people of Germany can’t understand why they have to work till their 65 to provide an easy retirement on the beach to their cousins in Greece. And strangely enough, the people of Slovakia don’t seem to understand that it’s their duty to bail out Greece to pay for pensions that are five times as large as the pensions of the Slovak’s themselves!
2) ECB print its way out
This is probably the most likely scenario. As we said in Mondays post, the ECB has already increased their balance sheet by about a trillion Euros over the last year. So they’re already doing this. However, the money needed to quell this storm would be quite extraordinary and would be extremely inflationary. We still don’t think there will be direct obvious printing until a serious depression is obvious to all (or at least felt fairly significantly in Germany itself).
3) The Federal Reserve prints Europe out of its jam
This is a very intriguing possibility (although I’m sure it makes the blood boil of most of our readers). It was only a year or two ago that the Fed promised Congress that it would not be bailing out Europe again. This was after it massively bailed out European banks in the 2008 crash.
The Fed then promptly forgot its promise and bailed them out again last fall. Of course, they gave it a new name which makes it alright. They simply initiated Swap Agreements. This basically gave the ECB (and a few other national central banks) the right to print USD on demand as long as they credited Euro into a side account for the US that the US would never actually use.) So through this sleight of hand, it’s now the ECB printing USD!
It hasn’t gotten to crazy amounts yet, but perhaps as Europe is falling apart, they would use a technique such as this to print enough money to bail out the European banks and sovereigns. Again, this would take a massive amount of USD and would be extremely scary to anyone that holds a lot of USD denominated assets as the value of each USD would surely be soon to evaporate.
We are watching a possible scenario that the major governments of the world might be putting together in back rooms to use similar arrangements to shuffle newly printed fiat currency from one country to another. We’re hopeful this is a plan in the works as it could be extremely profitable. If it does, and details are vague if true, it would probably once again fall on the backs of the US Dollar holders in the form of inflation.
4) A Contagion of Sovereign Defaults.
This is the ugly scenario. As this piece is written on Friday the 10th, it seems more and more likely. The European power brokers might think it would be fine if Greece defaults. The US power brokers thought the same when they let Lehman Brother’s fail. They were wrong. This time it would be much much worse.
Fear of default would spread like wild fire. It would quickly become impossible for many countries to raise money in bond auctions. Since most western countries rely on deficit spending to get by, defaults would quickly multiply. Fear would reign supreme.
There would also be a Credit Default Swap (CDS) implosion! There are many trillions of dollars worth of CDS on Sovereign Debt. This system is ok as long as no one actually defaults. You see, a CDS is insurance against a default.
The big banks all write this insurance for other banks and hedge funds because they get free premiums for writing it and thus it’s very profitable so long as no one actually defaults. If a country did actually default, the bank(s) writing that insurance would have to actually pay up huge sums.
Of course, as we discussed in the last post, the banks are all broke. So if they have to come up with trillions of CDS redemption funds, they would go belly up. And that chain reaction would take out every major bank out there.
So the governments would have to step in to save the banks. But these are the same governments that are already broke and defaulting. Do you see the problem here?
It’s big and it’s ugly and it will be absolutely crazy if we go down this road.
This is the eighth post in a series. You should read the initial thoughts on these forecasts here. and the Overall Prediction Page here. Here are the rest of the posts: 3) Ben Bernanke’s Dollar Devaluation Plan, 4) The Coming US Dollar Devaluation, 5) Stock Market Volatility, & 6) Stocks to Fall in 2012, 7) The European Crises, & 8) European Options. You can also watch the most recent series of Economic Update videos at: 1) European Debt Crises, 2) European Debt Crises 2, 3) MF Global, 4) Gold & Silver Pt 1, 5) Gold & Silver Pt 2, 6) Gold & Silver Pt 3, 7) World Economic Update., World Economic Update 2, 9) The Chinese Economy, 10) Inflation or Deflation Concerns?, 11) Inflation Concerns Pt 2, 12) US Economic Update, & 13) US Economic Update 2.