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Tuesday November 30, 2010 - 16:14:07 GMT
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The tail risk of two eurozones that wags the dog ...

We have been saying for years now that Germany is sucking the wind out of Europe.  But, then again that should be a surprise to exactly no one who ever bothered to consider the initial structure of the so-called common monetary union.  It wasn’t so common and it sure wasn’t structured for a lasting union. 

Germany is absorbing most of the growth opportunities—they always have since this so-called union was formed.  It was to be this way.  Otherwise why would anyone actually think the powers that be inside the German industrial machine would ever give up their Deutsche mark? 

But it is only recently the tale of two eurozones and the tail risk it has created has found its way onto the radar screens of high-IQ bank analysts far and wide.  “Oh gee, the spreads are blowing out. How can it be?”  The wine-sipping and croissant-eating big government socialists in Brussels have labored so diligently to foist this perfect union onto the people so their lives could be controlled improved. 

Remember people: the EU is a kind and gentle place where a no vote only means you will vote again until you get it “right.”  In fact, once you do get it “right” we will then decide when you shall be voting again.  After all, that sovereignty thing can be so messy when one is doing God’s socialists’ work in building a more perfect union.  Dare we say it—a worker’s paradise.   

[If you haven’t seen this video of the proverbial terd-in-the-punchbowl of the socialist love-fest called the EU, you will enjoy this… Nigel Farage harangues EU… ]

Worker’s paradise indeed, if you live in Germany…


Let’s see.  Which one of these countries is doing its own thing ... which one of these countries is only kind of the same?  Did you say Germany, boys and girls?  If so, you are right.

Is it Germany’s fault that their labor efficiency has improved while those of its eurozone competitors have deteriorated?  Is it Germany’s fault that all that virtual “free” credit created by years of below market interest rates for “member” countries that never should have been able to borrow at German interest rates was used to buy German goods and boost property markets instead of increasing efficiencies of local labor markets? 

No.  None of this was Germany’s fault.  But if I were a betting man, I would bet the Germans knew precisely what would happen when southern Europe was presented with massive amounts of credit.  It would create that captive market and allow Germany to expand its economic dominance over the zone in many ways.  But so what?  Aren’t countries supposed to exert their own interests?  Of course they are. 

And when you look at German performance, at a time when the rest of the eurozone is sucking wind, you have to wonder about what we have been harping on for at least a year now: Germany’s incentives for remaining in this union are fading fast. 

Just “good economics” was it when Germany announced it’s about time bond-holders take a haircut, instead of all the taxpayers, in the midst of the crisis?  Or is there more Machiavelli there than meets the eye?        

The Cold War was the last clear-cut confrontation, pitting Russia against a Western Europe backed — and to a great extent dominated — by the United States. This belt of countries was firmly if informally within the Soviet empire. Now they are sovereign again. My interest in the region is to understand more clearly how the next iteration of regional geopolitics will play out. Russia is far more powerful than it was 10 years ago. The European Union is undergoing internal stress and Germany is recalculating its position. The United States is playing an uncertain and complex game. I want to understand how the semicircle of powers, from Turkey to Poland, are thinking about and positioning themselves for the next iteration of the regional game.      

…In many ways, Germany is the mystery. The 2008 and Greek crises shocked the Germans. They had seen the European Union as the solution to European nationalism and an instrument of prosperity. When the crisis struck, the Germans found that nationalism had reared its head in Germany as much as it had in other countries. The Germans didn’t want to bail out the Greeks, and the entire question of the price and value of the European Union became a central issue in Germany. Germany has not thought of itself as a freestanding power since 1945. It is beginning to think that way again, and that could change everything, depending on where it goes.

One of the things it could change is German-Russian relations. At various times since 1871 and German re-unification, the Germans and Russians have been allies as well as mortal enemies. Right now, there is logic in closer German-Russian ties. Economically they complement and need each other. Russia exports raw materials; Germany exports technology. Neither cares to be pressured by the United States. Together they might be able to resist that pressure. There is a quiet romance under way between them.


                                                            George Friedman,, “Borderlands”


It’s a cold power calculation—something Germany is quite good at.  Does Germany enhance its global influence by being tied to the eurozone countries ... or by leaving and moving on to more dangerous, but powerful, alliances?  Leaving the eurozone doesn’t mean Germany has to say it’s sorry.  It means its taxpayers will be happy and they will still be the dominant export to the European continent. 

Spain-German 10-yr bond spreads:  Wholly rocket-launch Batman!!  Zoom!!


I remember a very smart man.  An economist, in fact, he was.  But he seemed very different than most economists in that he could actually communicate very complicated ideas in language even the serfs could understand.  This is likely why socialist governments near and far found him a bit dangerous.  He once uttered this famous phrase:  There is no such thing as a free lunch.”  Of course I am speaking of the late Great Milton Friedman.  We miss him so!

Can there be any more drastic attempt at a free lunch than suppressing the market interest rate for 10-years in order to build a more “perfect union”? *

Spain 10-year bond yield (black) versus Germany 10-yr bond yield (red):  Notice how the market priced in the risk, i.e. Spanish above German spreads, before the common currency was launched?  Do you think these risks just magically disappeared?  Of course not!  But all the free credit (free lunch) has disappeared and now Mr. Market is simply pricing the proper risks back into the equation.



[*When it comes to suppression of market interest rates, the US Fed is guilty as charged.  But the best example today of total disregard for the market rate and pricing system is China.  They take the prize.  And if you don’t think all those years of capital misallocation in China will not end badly, I have an Irish bridge or two to sell you.  That is a story for another day, but a day that we think comes sooner rather than later.]

So boys and girls, I have another question:  how will the other countries ever pay back rising debt levels while the cost of that debt rises while Germany sucks up most wealth creation across the zone?  Short answer: They won’t! 

Thus, despite all the continued band aids and patches and brave speeches by EU “leaders” and  local politicos about their strict adherence to new austerity plans, blah, blah, blah ... this game is about over! 

It’s like a US country song (yes, philistines like me enjoy country music).  But in this case, instead of a redneck like me getting my dog, truck and gun rack back, the European people are going to get their D-marks, lira, francs, guilders, pesetas, escudos, and punts back.  And maybe along with that, they will get their sovereignty back.  In the end, it’s all good.  That dog will hunt!


Jack Crooks

Black Swan Capital LLC


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