A Day Of Reckoning For The Euro Has Arrived – 26 TRILLION In Currency Derivatives At Risk

Yanis Varoufakis - posted to Twitter by Utopian FiremanThis is the month when the future of the eurozone will be decided.  This week, Greek leaders will meet with European officials to discuss what comes next for Greece.  The new prime minister of Greece, Alexis Tsipras, has already stated that he will not accept an extension of the current bailout.  Officials from other eurozone countries have already said that they expect Greece to fully honor the terms of the current agreement.  So basically we are watching a giant game of financial “chicken” play out over in Europe, and a showdown is looming.  Adding to the drama is the fact that the Greek government is rapidly running out of money.  According to the Wall Street Journal, Greece is “on course to run out of money within weeks if it doesn’t gain access to additional funds, effectively daring Germany and its other European creditors to let it fail and stumble out of the euro.”  We have witnessed other moments of crisis for Greece before, but things are very different this time because the new Greek government is being run by radical leftists that based their entire campaign on ending the austerity that has been imposed on Greece by the rest of Europe.  If they buckle under the demands of the European financial lords, their credibility will be gone and Syriza will essentially be finished in Greek politics.  But if they don’t compromise, Greece could be forced to leave the eurozone and we could potentially be facing the equivalent of “financial armageddon” in Europe.  If nobody flinches, the eurozone will fall to pieces, the euro will collapse and trillions upon trillions of dollars in derivatives will be in jeopardy.

According to the Bank for International Settlements, 26.45 trillion dollars in currency derivatives are directly tied to the value of the euro.

Let that number sink in for a moment.

To give you some perspective, keep in mind that the U.S. government spends a total of less than 4 trillion dollars a year.

The entire U.S. national debt is just a bit above 18 trillion dollars.

So 26 trillion dollars is an amount of money that is almost unimaginable.  And of course those are just the derivatives that are directly tied to the euro.  Overall, the total global derivatives bubble is more than 700 trillion dollars in size.

Over the past couple of decades, the global financial system has been transformed into the biggest casino in the history of the planet.  And when things are stable, the computer algorithms used by the big banks work quite well and they make enormous amounts of money.  But when unexpected things happen and markets go haywire, the financial institutions that gamble on derivatives can lose massive quantities of money very rapidly.  We saw this in 2008, and we could be on the verge of seeing this happen again.

If no agreement can be reached and Greece does leave the eurozone, the euro is going to fall off a cliff.

When that happens, someone out there is going to lose an extraordinary amount of money.

And just like in 2008, when the big financial institutions start to fail that will plunge the entire planet into another major financial crisis.

So at the moment, it is absolutely imperative that Greece and the rest of the eurozone find some common ground.

Unfortunately, that may not happen.  The new prime minister of Greece certainly does not sound like he is in a compromising mood

Greece’s new leftist prime minister, Alexis Tsipras, said on Sunday he would not accept an extension to Greece’s current bailout, setting up a clash with EU leaders – who want him to do just that – at a summit on Thursday.

Tsipras also pledged his government would heal the “wounds” of austerity, sticking to campaign pledges of giving free food and electricity to those who had suffered, and reinstating civil servants who had been fired as part of bailout austerity conditions.

Prior to the summit on Thursday, eurozone finance ministers are going to get together on Wednesday to discuss what they should do.  If these two meetings don’t go well this week, we could be looking at big trouble right around the corner.  In fact, Greece is being warned that they only have until February 16th to apply for an extension of the current bailout…

Euro zone finance ministers will discuss how to proceed with financial support for Athens at a special session next Wednesday ahead of the first summit of EU leaders with the new Greek prime minister, Alexis Tsipras, the following day.

However, the chairman of the finance ministers said the following meeting of the Eurogroup on Feb. 16 would be Greece’s last chance to apply for a bailout extension because some euro zone countries would need to consult their parliaments.

“Time will become very short if they (Greece) don’t ask for an extension (by then),” said Jeroen Dijsselbloem.

The current bailout for Greece expires on Feb 28. Without it the country will not get financing or debt relief from its lenders and has little hope of financing itself in the markets.

And as I mentioned above, the Greek government is quickly running out of money.

Most analysts believe that because of the enormous stakes that one side or the other will give in at some point.

But what if that does not happen?

Personally, I believe that the eurozone is doomed in the configuration that we see it today, and that it is just a matter of time before it breaks up.

And I am far from alone.  For example, just check out what former Fed chairman Alan Greenspan is saying

Mr Greenspan, chairman of the Federal Reserve from 1987 to 2006, said: “I believe [Greece] will eventually leave. I don’t think it helps them or the rest of the eurozone – it is just a matter of time before everyone recognizes that parting is the best strategy.

The problem is that there there is no way that I can conceive of the euro of continuing, unless and until all of the members of eurozone become politically integrated – actually even just fiscally integrated won’t do it.”

The Greeks are using all of this to their advantage.  They know that if they leave it could break apart the entire monetary union.  So this gives them a tremendous amount of leverage.  Greek Finance Minister Yanis Varoufakis has even gone so far as to compare the eurozone to a house of cards

The euro is fragile, it’s like building a castle of cards, if you take out the Greek card the others will collapse.” Varoufakis said according to an Italian transcript of the interview released by RAI ahead of broadcast.

The euro zone faces a risk of fragmentation and “de-construction” unless it faces up to the fact that Greece, and not only Greece, is unable to pay back its debt under the current terms, Varoufakis said.

“I would warn anyone who is considering strategically amputating Greece from Europe because this is very dangerous,” he said. “Who will be next after us? Portugal? What will happen when Italy discovers it is impossible to remain inside the straitjacket of austerity?”

After all this time and after so many bailouts, we have finally reached a day of reckoning.

There is a very real possibility that Greece could leave the eurozone in just a matter of months, and the elite know this.

That is why they are getting prepared for that eventuality.  The following is from a recent Wall Street Journal report

The U.K. government is stepping up contingency planning to prepare for a possible Greek exit from the eurozone and the market instability such a move would create, U.K. Treasury chief George Osborne said on Sunday.

A spokeswoman for the Treasury declined comment on the details of the contingency planning.

The U.K. government has said the standoff between Greece’s new anti-austerity government and the eurozone is increasing the risks to the global and U.K. economy.

“That’s why I’m going tomorrow to the G-20 [Group of 20] to encourage our partners to resolve this crisis. It’s why we’re stepping up the contingency planning here at home,” Mr. Osborne told the BBC in an interview. “We have got to make sure we don’t, at this critical time when Britain is also facing a critical choice, add to the instability abroad with instability at home.”

And if Greece does leave, it will cause panic throughout global financial markets as everyone wonders who is next.

Italy, Spain and Portugal are all in a similar position.  Every one of them could rapidly become “the next Greece”.

But of even greater concern is what a “Grexit” would do to the euro.  If the euro falls below parity with the U.S. dollar, the derivatives losses are going to be absolutely mind blowing.  And coupled with the collapse of the price of oil, we could be looking at some extreme financial instability in the not too distant future.

When big banks collapse, they don’t do it overnight.  But we often learn about it in a single moment.

Just remember Lehman Brothers.  Their problems developed over an extended period of time, but we only learned the full extent of their difficulties on one very disturbing day in 2008, and that day changed the world.

As you read this, big financial troubles are brewing in the background.  At some point, they are going to come to the surface.  When they do, the entire planet is going to be shocked.

 

Ack! They Are Actually Going To Let Greece Default!

I wish that I had an “aha moment” to share with you today, but instead all I have is an “ack moment” to share.  As I was analyzing all of the info coming out of Europe in recent days, I came to the following realization: “Ack! They are actually going to let Greece default!”  The only question is whether it is going to be an orderly default or a disorderly default.  Of course the EU (led by Germany) could save Greece financially if it wanted to.  But Germany has decided against that course of action.  Many in the German government are sick and tired of pouring bailouts into Greece and then watching Greek politicians fail to fully implement the austerity measures that were agreed upon.  At this point a lot of German politicians are talking as if a Greek default is a foregone conclusion.   For example, Michael Fuchs, the deputy leader of Angela Merkel’s political party, recently made the following statement: “I don’t think that Greece, in its current condition, can be saved.”  But that is not entirely accurate.  Greece could be saved, but the Germans don’t want to make the deep financial sacrifices necessary to save Greece.  So instead they are going to let Greece default.

Many prominent voices in the financial world that have been watching all of this play out are now openly declaring the Greece is about to default.  Moritz Kraemer, the head of S&P’s European sovereign ratings unit, made the following statement on Bloomberg Television on Monday: “Greece will default very shortly. Whether there will be a solution at the end of the current rocky negotiations I cannot say.”

You might want to go back and read that again.

One of the top officials at one of the top credit rating agencies in the world publicly declared on television that “Greece will default very shortly.”

That should chill you to your bones.

If the EU allows Greece to default, that would be a signal to investors that the EU would allow Italy, Spain and Portugal to all default someday too.

Confidence in the bonds of those countries would disintegrate and bond yields would go through the roof.

Right now, confidence in government debt is one of the things holding up the fragile global financial system.  Governments must be able to borrow gigantic piles of very cheap money for the system to keep going, and once confidence is gone it is going to be incredibly difficult to rebuild it.

That is why a Greek default (whether orderly or disorderly) is so dangerous.  Investors all over the world would be wondering who is next.

At the end of last week, negotiations between the Greek government and private holders of Greek debt broke down.  Negotiations are scheduled to resume Wednesday, and there is a lot riding on them.

The Greek government desperately needs private bondholders to agree to accept a “voluntary haircut” of 50% or more.  Not that such a “haircut” will enable the Greek government to avoid a default.  It would just enable them to kick the can down the road a little farther.

But if Greece is able to get a 50% haircut from private investors, then why shouldn’t Italy, Spain, Portugal and Ireland all get one?

Once you start playing the haircut game, it is hard to stop it and it rapidly erodes confidence in the financial system.

This point was beautifully made in a recent article by John Mauldin….

So our problem country goes to its lenders and says, “We think you should share our pain. We are only going to pay you back 50% of what we owe you, and you must let us pay a 4% interest rate and pay you over a longer period. We think we can do that. Oh, and give us some more money in the meantime. And if you refuse, we won’t pay you anything and you will all have a banking crisis. Thanks for everything.”

The difficult is that if our problem country A gets to cut its debt by 50%, what about problem countries B, C, and D? Do they get the same deal? Why would voters in one country expect any less, if you agree to such terms for the first country?

But if Greece is able to negotiate an “orderly default” with private bondholders, that would be a lot better than a “disorderly default”.  A disorderly default would cause mass panic throughout the entire global financial system.

One key moment is coming up in March.  In March, 14 billion euros of Greek debt is scheduled to come due.  If Greece does not receive the next scheduled bailout payment, Greece would default at that time.

But the EU, the ECB and the IMF are not sure they want to give Greece any more money.  There are a whole host of austerity measures that the Greek government agreed to that they have not implemented.

Since the Greeks have not fully honored their side of the deal, the “troika” is considering cutting off financial aid.  The following comes from the New York Times….

Officials from the so-called troika of foreign lenders to Greece — the European Central Bank, European Union and International Monetary Fund — have come to believe that the country has neither the ability nor the will to carry out the broad economic reforms it has promised in exchange for aid, people familiar with the talks say, and they say they are even prepared to withhold the next installment of aid in March.

But the austerity measures that Greece has implemented so far have pushed the Greek economy into a full-blown depression.  Greece is experiencing a complete and total economic collapse at this point.  The following comes from the New York Times….

Greece’s dire economic condition can hardly be overstated. After two years of tax increases and wage cuts, Greek civil servants have seen their income shrink by 40 percent since 2010, and private-sector workers have suffered as well. More than $75 billion has left the country as people move their savings abroad. Some 68,000 businesses closed in 2010, and another 53,000 — out of 300,000 still active — are said to be close to bankruptcy, according to a report issued in the fall by the Greek Co-Federation of Chambers of Commerce.

“It’s an implosion — it’s an endless sequence of implosions from bad to worse, to worse, to worse,” said Yanis Varoufakis, an economics professor at the University of Athens and commentator on the Greek economy. “There’s nothing to stop the Greek economy losing 60 percent of its G.D.P., given the path it is at.”

But Greece is not the only one in Europe with major economic problems.  The unemployment rate for those under the age of 25 in the EU is an astounding 22.7%.  And as I have written about previously, there are a whole host of signs that Europe is on the verge of a major recession.

Greece is just the canary in the coal mine.  The truth is that the entire European financial system is in danger of collapsing.

Today, it was announced that S&P has downgraded the European Financial Stability Facility.  It is pretty sad when even the European bailout fund is getting downgraded.

Of course most of you know what happened on Friday by now.  Very shortly after U.S. financial markets closed, S&P downgraded the credit ratings of nine different European nations.

Only four eurozone nations (Germany, Luxembourg, Finland, and the Netherlands) still have a AAA credit rating from S&P.

But even more importantly, the nightmarish decline of the euro is showing no signs of stopping.

Right now, the EUR/USD is down to 1.2650.  It is hard to believe how fast the EUR/USD has fallen, but if a major financial crisis erupts in Europe it is probably going to go down a whole lot more.

So what happens next?

Well, if there is a Greek default all hell will break loose in Europe.

But even if Greece does not default, the coming recession in Europe is going to put an incredible amount of strain on the eurozone.

Many have been speculating that Greece or Italy could be the first to leave the euro, but actually it may be the strongest members that exit first.

The number of prominent voices inside Germany that are calling for Germany to leave the euro continues to increase.

In addition, public opinion in Germany is rapidly turning against the euro.  One recent poll found that only 47 percent of Germans were glad that Germany joined the euro, and only 36 percent of Germans want “a more federal Europe”.

As this crisis continues to unfold, there will probably be even more “ack moments”.  European leaders have mismanaged this crisis very badly from the start, and there is no reason to believe that they are suddenly going to become much wiser.

Once again, it is important to emphasize the role that confidence plays in our financial system.  The entire global financial system runs on credit.  Banks and investors lend out money because they have confidence that they will be paid back.  When you take that confidence away, the system does not work.

Let us hope that the folks over in Europe understand this, because right now we are steamrolling toward a credit crunch that could potentially make 2008 look tame by comparison.

***Epilogue***

Now another of the three major credit rating agencies, Fitch, is publicly saying that Greece will default….

“It is going to happen. Greece is insolvent so it will default,” Edward Parker, Managing Director for Fitch’s Sovereign and Supranational Group in Europe, the Middle East and Africa told Reuters on the sidelines of a conference in the Swedish capital. “So in that sense it shouldn’t be a surprise to anyone.”

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