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European Financial Crisis 2009

2 Comments March 20, 2009 – 9:50 pm |   | Permalink |  Print This Post |

The impending European Crisis will make the Asian Crisis child’s play by comparison. Asian account deficits and debt levels were much smaller than Eastern European deficits now. The Asian currencies spiralled south in 1997, mitigating the impact of the financial crisis by boosting their exports to the West. Now with the Euro all time high, a global economic meltdown and debts still waiting to be written off, Europe is a ticking time bomb waiting to go.

European Financial Crisis 2009 versus Asian Crisis 1997

European Union leaders have expressed “broad support” to double the bailout aid to Eastern Europe to 50 billion dollars. Only last week the ECB were against money-printing; hoping to let the Americans do their dirty work and for the trillions of USD to spill over, oil their banking system and get things flowing.

That combination of news sent the Euro dollar up against all currencies in particular the USD (By the way, we anchored another short Euro/GBP at 0.95 mini). US Treasury Bonds skyrocketed after staying dormant for a few months along with Silver and Gold, catching all shorters convinced that they were on a downtrend.

European Commission President Jose Manuel Barroso said the initial bailout fund has already been used by Hungary and Latvia and the Commission are ready to double the ceiling. 50 billion Euro will only be a drop in the ocean; and apart from Latvia and Hungary, there are many more Eastern European countries in silent distress. There is more leverage in European banks than their American counterparts - and they have not been writing off these debts backed by high (aka AAA) rated assets. The rating of assets these days mean little - AAA may not always stay AAA. Investment banks specializing in asset securitisation that went on a shopping binge last year leading up to this collapse will attest to this. Most of these assets are still marked close to par on many balance sheets of many European banks - so if what we saw was indeed the bottom then perhaps they may get away with it.

Our main concern is with the (poorly regulated) Eastern European countries. The credit boom in Eastern Europe funded by Western European banks will no doubt feel more pain as credit dries up. The cracks are there and the writing is on the wall. It is a matter of time before ECB will have to provide more bailouts. Credit Suisse have ranked countries around the world on a financial vulnerability scorecard, top on the list expectedly is Iceland. Of the next 14 countries on the list, 8 are Eastern European: Bulgaria, Lithuania, Estonia, Latvia, Romania, Hungary, Poland, Ukraine. These countries would have been in Iceland’s position if not for the Euro. Now if you were Big Brother Germany or France (highest GDP in Euro) expected to bail these countries out, what would be the best solution? The obvious way out is to hit the money-printing press, which will no doubt help the weaker nations - but Germany have ruled out any chance of that. The Germans have learnt their lesson back in 1923 where hyperinflation rendered their currency worthless (famous picture attached showing a German young lady burning worthless paper money to heat her home in 1923).

german-hyperinflation

vulnerability-score

Austrian banks having been most acquisitive of any European banks are postulated to be in the worst shape. Even the ultra conservative Swiss banks are implicated - but have been writing off billions of impaired assets. With private funding drying up, government bailouts (ie tax payers money) are the only way to recapitalize. 90% of all cross border loans to Eastern Europe originate from Western European banks. Whilst the Americans and the Swiss have been diligently writing off their losses, the Europeans have been keeping their cards closer to their chest - hoping to escape by waiting for everyone else to fold (and print more money).

The media have been too busy focusing on the problems in the US and UK, creating a false sense of security in Europe. On paper, Europe (and its currency) may seem defensive - the economies of multiple countries tied together akin to a defensive diversified portfolio. The recent Iceland crisis would no doubt trigger a wave of Euro Buying as non-Eurozone countries in the region cash out of their currency and into the Euro for fear of a similar crisis.

The question is this: Is the unprecedented all time high of the Euro justified and sustainable? And back to the more important question: How do we profit from this?

Conspiracy theorists have talked about a secret document stating an impaired asset worth 18 trillion EUD. Whilst we doubt the validity of such estimates, the current bailouts measured in billions are far from todays debt measure unit of trillions.

The commission warning came in a confidential 17-page guidance paper given to governments – and seen by the Guardian – on how to treat toxic and other impaired assets, which are estimated as being worth much as €18.2tn (£16.1tn), or about 44% of EU bank balance sheets.

Conclusion: To Short or Not to Short the Euro?

• Shorting at all time high is reassuring and usually profitable (Jim Rogers Rule: ” I have never lost money buying at the bottom and selling at the top”)
• Question is what do you short the Euro against? Our plan is to short the Euro against the AUD (which we have), and also to short against the GBP. Both EUR/AUD and EUR/GBP are at unprecedented highs (tick point 1). Fundamentally, we are convinced the Australian economy is in much better shape compared to Europe (other eligible countries include commodity (agriculture included) rich countries: New Zealand, Canada, Brazil). Although we are not bullish on the UK per se, we feel that the combined weakness of the Sterling and simultaneous strength of the Euro presents a one in a lifetime opportunity. Forex is a game of relativity.
• We also love the EUR/AUD pair as the cost of holding is zero (or even positive) because of positive interest rate swaps.

EUR/AUD relative to EUR/GBP chart