European Bailout: The facts Financial Markets are ignoring

Financial market professionals and the media are placing high bets that Germany will effectively assist financing the bond program in Europe. The program as most are aware of, is designed to assist nations in desperate need of assistance – Spain and Italy – to stay afloat for another couple of months.

One should look far deeper than the surface before starting to believe that Germany will be able to participate in the program without facing some serious criticism by its own citizens and opposition parties.

There are some facts being ignored; among the most important is the fact that in order to have a REAL PLAN implemented by the ECB; what the media doesn’t talk about or focus on is the very Harsh reality behind European Central Bank Rules.

In order to use the Financial Stability Facility there has to be a UNANIMOUS agreement between all participants.  There is one country opposing the plan without showing any signs or intentions to change its position: Finland!

As long as one participant disagrees, the ECB hasn’t got the ability to explore the facilities.

Another important aspect hardly mentioned is the fact that the ECB must respect a limit on amounts they can lend to Europeans Banks, therefore drawing a limit for funds available to European Central Banks.  If that is not an  important detail to be mentioned in terms of the entire bailout Feasibility, I don’t really know what is.

Mario Dragui – an Italian formal Italian Central Bank president - is doing his ultimate best to get funds to Italian Central Bank.  He states often that the ECB must take a Aggressive Action in terms of supporting the European Union and the Euro. Easy said, difficult done.

I have mentioned in a previous article that Germans – and the Dutch + Finnish Citizens – are very unhappy about seeing their money being use to pay somebody else’s debts.  Angela Merkel may be willing to change her views, but it doesn’t imply that it will get broad support. Elections will take place next year in Germany and she may be using an alternative strategy to gain votes but the response from the public has been far from positive.

A couple of weeks ago, The Germans & The Dutch voted against granting a Banking License to the ESM ( Bailout Bank). ECB president Mario Dragui was beyond upset and literally pointing fingers to Dutch and Germans alike stating that they were old fashioned and narrow minded.

 I guess it isn’t necessary to mention that Finland has opposed the License granting, but I am just making sure everyone knows.  To add more fire to this entire situation, Olli Rehn, EU Commission Vice President , has openly stated that as Finland will oppose any plans regarding Spain and Italy.  

Mr. Mario Monti, Italian prime minister was campaigning for support from Germany, The Netherlands and Finland early in August.  The results were far from expected. He was met with skepticism and criticism instead of support. There are sound reasons for the skepticism. Italian economic results are worsening by the day and show very little sign of improvement and efforts.

Mr. Monti’s reaction was one of retaliation: He stated that if the European Union and ECB don’t come to assist Italy, they can count on a NON-EU oriented, NON- EURO and NON Fiscal discipline oriented Italian Government.

Being very sincere, I don’t think that Germans, Dutch or Finns were surprised. Actually, for them, is just Business as Usual at this point. Put it very simply they don’t seem to be to concerned at this point. It is very bad as it is and even if they would do their best to Worsen the situation, the Italians would not do much worse.

Any changes in opinion from Germans, Dutch and Finns would come as huge surprise and complete unexpected. Fact of the matter is they are tired to pay for others mistakes. Wouldn’t anybody be quite frankly? They tighten belts, put pressure into businesses and citizens to try to get their home economies at better shapes and are dealt blows from neighbor’s sharing a complete different strategy. As I mentioned before, differences in mentality and behavior between European nations are huge. These are gaps difficult to fill and they tend to become more accentuated when things go wrong.

Financial markets are hoping that Germany Finland and the Netherlands will change their mind and will support the Bond Program and any additional Fiscal Bailouts. I doubt, but as I always say, nothing is impossible.

European Economic Figures:

The figures released earlier this month showed that Italian debt has expanded reaching almost 2 EUR Trillion. Italy's total government debt outstanding rose by + 6.637 billion EUR during the month of June and the debt outstanding increased by 21.7 Billion Euros. The situation has been accelerating since April.

To put things into perspective government Debt is 125% the size of GDP. If that doesn't come as Bad News, I don't really know what is...

Industrial Output does look any better:

and last but not least

The figures are dismal and provide little comfort for those willing to SUPPORT Italy’s spending.  If we translate that into layman terms, it is fair to say that Germans, the Dutch and Finn’s must work “Very Hard” to pay Italy’s bill? Is that fair? I don’t think that they agree and it is showing.

Germans are well aware that their support elsewhere is having a direct impact on their domestic economy. Below an extract of the latest press release from the Zew Report:

-          The erosion in business confidence comes on the heels of the

seventh consecutive fall in Germany's composite PMI to its lowest level

(47.0) in over three years.

     "August PMI data highlights the weakest German private sector

performance for over three years, with a return to falling services

activity offsetting an easing in the manufacturing downturn," said

Markit Economics senior economist Tim Moore.

     "Overall, the latest survey indicates that the German economy is

sailing into greater headwinds as the third quarter progresses, with PMI

readings slipping deeper into territory normally associated with GDP

contractions," he added.

     The Bundesbank warned last week that the risks to Germany's

economic outlook have "increased notably" for the second half of 2012,

given the recent escalation of the Eurozone sovereign debt crisis.

There is deterioration on the 5 and 10 year Bond Yield Spread express clearly what the expectations are for the near future. 

Here is the Graph from the 10 year Bund:

GERMAN INDUSTRIAL OUTPUT 2004 to 2012

GERMAN Debt to GDP

How Markets interpret data stays completely detached from the current situation. Markets are discounting mechanisms. While situation in Europe has not improved - actually it has worsened if one reads economic data across Europe, the Euro has reached 8 week highs yesterday. 

Certainly for the public, it is difficult to follow this mechanic. It leaves people rather confused and  asking themselves what defines the value of investment instruments. In short, what the latest appreciation of the Euro represents is nothing but the perception of market participants that the European Central Bank will intervene and find solutions for the current situation.

The speculation is based upon the promises made by the ECB president as well as the overall perception that the Europeans HAVE TO DO something about it. Now, the HAVE TO is just a perception; by law they are not obliged to intervene. In fact, they don't have to do a single thing. 

Market valuations today express the view that member countries will support the members with problems and the situation will improve in the future. That is far from clear, however being as it may, the market has a BID tone and the Euro is appreciating against other currencies. Helping the cause is the fact that the Federal Reserve should engage again on further monetary easing, therefore depreciating the dollar and automatically appreciating the euro.

Making it far more clear, the Euro is a single instrument created to facilitated trade and somehow set standards for those willing to participate. If the regulations would really apply, many countries would have already been  sanctioned or expelled from the Euro Economic zone due to their economic results. 

The Debt as ratio to GDP, Budget deficits, low inflation and interest rates have all been breached by several member countries. So far, there have been no sanctions. Exceptions are being made and most likely the ECB will continue to do so for the foreseeable future. 

The euro was established by the provisions in the 1992 Maastricht Treaty. To participate in the currency, member states are meant to meet strict criteria, such as a budget deficit of less than three per cent of their GDP, a debt ratio of less than sixty per cent of GDP (both of which were ultimately widely flouted after introduction), low inflation, and interest rates close to the EU average. In the Maastricht Treaty, the United Kingdom and Denmark were granted exemptions per their request from moving to the stage of monetary union which would result in the introduction of the euro.

The situation has not improved; The European economy is not expanding and the countries aren't facing brighter futures. All that is at this point are promises - in my opinion difficult to be fulfilled - and hopes that things will turn around elsewhere. If that Elsewhere would be China, I think everyone should reevaluate their priorities, simply because things are far from Rosy in China. 

But, living in a world of hopes and promises, principally when we approach elections, reality has been placed second for the time being and will remain so until further notice.