Watching international financial policy persisting on a concept to fight debt with more debt in an environment where official GDP growth rates only remain positive because of ridiculously low deflators, while interest rates apart from those central bank help for banks via laughingly low interest rates begin to surge everywhere else, this observer begins to wonder if one can expect anything else than a fast-rolling, simultaneous European banking collapse.
Engulfed in more exponentially rising debt on public and private levels than ever before there simply cannot be another end of the longest growth cycle in history than a simultaneous collapse of international banking when lending freezes up due to fears about the real creditworthiness of the respective counter party.
Globalization will have made it possible.
Bank Reserve Requirements: EU 2% - China 21%
The rise of supra-regional financial institutions that have evolved from two decades of radical deregulation of financial markets and are now too big to fail overshadows all major industrial nations as it has given birth to unprecedented bulks risks never seen before. The situation gets aggravated by the fact that banks have never held more derivatives than nowadays.
At a notional volume of $580 trillion as of 2010 derivatives now exceed global GDP of roughly $50 trillion by a factor of 12. It strongly appears this world is overleveraged as derivatives volumes have remained at this level for the last 3 years.
Minimum reserve requirements of a paltry 2% in the Eurozone mean that European banks are geared 1:50 (and possibly higher through the use of off balance sheet vehicles). An adverse 2% move of markets can wipe out any bank overnight.
Compare this with China where minimum reserve requirements have been raised to a staggering 21% in order to curb speculative lending.
But while China takes aggressive steps in order to reduce private indebtment the Western world remains in wishful mode. A lot has been written about national debts, sitting at record levels and rising strongly due to investors suddenly asking higher risk premiums for government debt like Greece's, where 2-year issues now yield above 25%, confirming the foreseeable default of a country that was bankrupt one out of two years in the last two centuries.
The stream of news has not changed much since late last year when the EU inofficially split into the Euro hardcore area of AAA-rated Germany, Austria, Finland, Luxembourg and the Netherlands and the risky rest which is only half represented under the acronym PIIGS.
I do not include AAA-borrower France in the core group as it is heavily exposed to the coming Spanish and Italian crisis which will have the same roots as all banking crises around the world: reckless lending to irresponsible public and private borrowers that fuelled a property boom thanks to the lowest interest rates in history. Holding Greek bonds with a volume of €54 billion, French and German banks were the main benefactors of Greece's first €100 billion bailout in May 2010.
The hard landing is only a question of time. European politicians are stuck in a deadlock over the resolve of the crisis while tending to lend their ears to bankers who are trying to cover their ass as their low interest rate strategies will not work any longer in a world of surging commodity inflation that will take its toll on consumers and and industry alike.
With the creation of a monetary union without a fiscal union the Euro will become the death trap of the old continent as the inventors of the common currency raced down a one-way street, never thinking about the possibility of an exit of a Euro member.
Current negotiations on an inevitable restructuring of Greek debt have not moved since last winter. Recent discussions to extend Greek debt for 7 years beyond maturity will lead into the same dead end all previous meetings have ended before as governments shy away from calling to account private debt holders.
This preference of investors over taxpayers has led to the mess we are in. Regaled investors bulk at the idea of a haircut and force governments with the threat of withdrawal from their debt auctions to keep the status quo where they are essentially bailed out by taxpayers.
This does not go down well with 500 million European non-millionaires who have been squeezed between stagnating salaries and doubling of costs since the introduction of the Euro 10 years ago.
Massive protests against austerity programs have been spreading in Europe since a year. Beginning in Greece a wave of protests has mushroomed to London, Paris, Madrid, Barcelona, Lisbon, Berlin and Brussels.
These protests against an "everything for banks and austerity for the people" policy are justified by the global economic outlook best described as stagflation giving way to hyper inflationary depression.
Banks are playing a losing game as their recapitalization dreams rest on a foundation of a artificially low central bank interest rates coupled with high yielding government debt. It is certainly a winner's game to borrow money at 1.25%, only to turn around and buy German Bunds yielding 3%.
The ESM Is A Subprime Construct
As investors almost fist-fight for German government bonds, chancellor Angela Merkel's is certainly getting moneyed support from investors who realize that all their other holdings may turn into ashes if Germany does not keep firing the European debt engine at lower yields than any other Euro country.
Alas, the idea of finding cheaper money for the European deficit spenders will stall in its own tracks as the so called European Stability Mechanism (ESM) is inherently flawed. European politicians nurse the hope that the ESM will be able to borrow money at rates close to Germany's financing costs. The achilles heel of the ESM are its members. So far Greece, Ireland and Portugal will be on the receving end of the ESM, leaving only 14 countries - among them the insignificants like Cyprus etc. - to back the fresh debt.
As only 6 nations in the Eurozone are left with an AAA rating it is a miracle how rating agencies can rate this new debt again with AAA, repeating the CDO failures and aiding irresponsible European politicians in making subprime a business model for a whole continent!
Total issued government debt of the Eurozone stood at €8.5 Trillion in May 2011.
Current Greek bailout reports yo-yo between €70 billion and €100 billion for the second attempt to fix Greece.
Transpose this onto Ireland and Portugal and it looks likely that the €750 billion ESM will run dry even before it comes into reality in 2013.
The pressure to increase capital ratios under new international rules between 2013 and 2019 according to plans of the Bank for International Settlements (BIS) is designed to suffocate the economy meanwhile, intensifying the beginning of the Kondratieff winter.
As banks have to increase their capital set against private and business loans, a credit crunch is written on the wall, and it will be boosted by higher interest rates as lenders will compete for money.
At the same time banks will be able to continue to zero-weight government debt in their portfolios according to new proposals by the European Commission in 500-page legal paper "CRDIV".
This is clearly a head-in-the-sand strategy. All Euro members can be safely assigned a negative rating outlook at this point of time and such a weighting will again only delay, but never mitigate the banking sector's problems.
The Coming Giga-Credit Event
So far I have not met a critical member of the financial industry recently who disagreed about the high possibility that the failure of one of Europe's top 25 banks may start a simultaneous European banking collapse because markets are intertwined as never before.
When one of these banks cannot meet its obligations, leaving countless counter parties without expected funds, the dominoes will fall at unprecedented speed in a realtime financial world.
It all could happen within 24 hours from the breakdown of a major bank to a Europe-wide market holiday in an attempt to stop the unstoppable: The reduction of the banking sector to a size that meets the needs of the economy and not the needs of the bankers.
No industry has expanded more than the financial industry in the past four decades, turning not only Europe, but most parts of the world into overbanked territory.
Given the long delay in restructuring banking - the most important step will be to regulate financial derivatives - thanks to a clueless political elite in the EU probability, and the subsequent continued buildup of still more risks a meltdown initiated by early market rumors trickling down into media is the most likely end scenario.
In the past, financial crises were limited to the reach of the affected currency. As the Euro now unites 17 countries in a monetary union that was achieved by political will and not by reason, these 17 members now man a ship with a lot of deficit holes. Finding themselves in a financial tsunami, one or more countries will jump at some point.
It could be anybody. Either a weak Euro member seeking rescue by exiting the Euro and devaluing its own new currency while KOing investors with a bond haircut or a core Euro member pulling the emergency break and leaving the mess behind it.
Either way it goes it will lead to a discussion about the future integration of Europe as the concept of paying your neighbor's debts has never worked before
