ZULAUF: THE KEY TO 2012 & THE COMING BANKING BUST
The 2012 Barrons Roundtable came out this morning and the discussion is always interesting. I have tended to veer towards the comments of Felix Zulauf since he’s the global macro master at the table. That said, here are some of his macro thoughts. I think he’s a bit dramatic, but given that he’s one of the few roundtable members who has been able to connect the dots (for the most part) his comments are always worth considering (see past performance from Roudtable members here):
Zulauf: Europe is going to be key this year for the markets and the economy. China is slowing; the emerging world is slowing, and the U.S. is barely above water, constrained by its structural problems. I have called the euro a misconstruction since its birth. The problem is a difference in competitiveness among European countries, and you can’t solve it by lending money to the less competitive countries. You have to deflate wages and prices in the south, and inflate the north. But given Germany’s history, it will never inflate.
The members of the euro zone agreed in December that each country could have a structural deficit of no more than half a percent of GDP. If a deficit goes above 3% of GDP, the country will be sanctioned. This agreement now has to be ratified in all countries. But when you agree to such a prescription and you are uncompetitive, your currency is overvalued by 30%, you can’t devalue, and your nominal interest rates are too high, that is a recipe for a depression. It is a death sentence. Several countries won’t ratify the contract, and the next day their markets will be repriced accordingly. They will exit the euro, and the turmoil will go to the next level. Greece is bust in either case. If you can devalue your currency by 40% or 50% in that situation, at least you will have the chance to see the sun again and recover.
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Zulauf: The banking system goes bust. Assume Greece won’t repay anything, or at most 10% of its total debt. It is not just the government but the private sector that is bust. That means banks in other countries will be in trouble, which means they will be nationalized. Governments won’t have the money to pay for this, so they will assume even more debt. That is the chain of events I expect in 2012, and if you believe it won’t affect the U.S. you are dreaming. The estimated notional value of the over-the-counter fixed-income-derivatives market in Europe is estimated to be about 60 trillion euros. There are many links to the U.S. banking system, although we don’t yet know who is positioned how. If one country exits the euro, all hell will break loose.
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Zulauf: Every European country will be in recession in 2012, and probably in 2013.
Source: Barrons
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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21 Comments
By thinking and pondering MMT, its been clear to me for months that Europe has no solution that doesn’t involve an “infinite checkbook” somewhere in the union. Be it via breakup of the union or via the creation of some central entity to create and distribute Euros.
And thats why a recession in the US remains overwhelmingly likely, IMO. While we are running a large deficit to support deleveraging and demand here, and would probably muddle through on our own, Europe seems completely bent on self destruction. Anybody who read up on MMT and its factual principles could be well aware of this.
Oh, but wait, I guess thats not MMT anymore, MMT is a political entity now. Also apparently willing to launch thinly veiling character attacks on its most successful proponents if they don’t jump on the liberal bandwagon. And unwilling to work rationally for the greater good that their thinking could bring, by at least trying to win the super-basic debates before launching a political-bomb on the world.
Its been bumming me out ever since I sat down last night to read up on the blogs I missed while traveling for work all week.
@ anonymous
Well said…. Who ever you are.
Thanks for pointing Zulauf’s latest analysis Cullen,
I don’t know what is scaring me most, the fact that I have reached a similar conclusion with Zulauf, or the scary prospect of the upcoming collapse of our European flutter similar to the Gold Standard collapse of 1931:
http://macronomy.blogspot.com/2011/12/markets-update-credit-european-flutter.html
“The problem is a difference in competitiveness among European countries, and you can’t solve it by lending money to the less competitive countries. You have to deflate wages and prices in the south, and inflate the north.” – Zulauf
This is exactly a path my friends at Rcube have highlighted:
“In a nutshell, labor forces in many Eurozone countries are now getting paid in a currency that is vastly overvalued compared to their productivity (this can also be seen in the degradation of the trade balance of many European countries including France).
To restore to competitiveness of PIIGS (and to a lesser extent France and Belgium), labor costs will therefore have to decrease significantly.”
“4) The ECB could crash the Euro. Monetizing huge amounts of sovereign debt would contribute to this (in addition to solving the liquidity situation of PIIGS). However, Germany and other countries that are already competitive will oppose this. Additionally, it would not solve the structural problem of unit labor cost divergence, which would inevitably lead to new crises further down the road.”
“But given Germany’s history, it will never inflate.” – Zulauf
Which is a point you and I Cullen discussed in your post:
http://pragcap.com/the-impossible-refinancing-burden
“Given the issue of circularity and the need for economic growth to break debt dynamics, I do not see the solvency issue resolved without the ECB stepping in. The big question is, would Germany allow the ECB to alter its DNA given it would contravene the Lisbon treaty, if it starts intervening massively? I have some doubt about it, and it is a scary prospect. So far the Bundestag and German Constitutional court have stepped in to rein in the expansion of the EFSF, because they do not want to betray German people. Either they know it is not the solution and are buying some time to allow for more integration within Europe and using it as a bargaining tool to force Greece and others to concede their independance somewhat in exchange of stronger support, or, the game is for Germany to buy some time and leave and join force with Austria, Finland, the Netherlands, and leave peripherals on their own.”
“The biggest game of chicken” – FT – Richard Milne – 22nd December 2010:
http://www.ft.com/cms/s/0/0ae7048e-0deb-11e0-86e9-00144feabdc0.html
“For Germans haunted by the spectre of the Reichsbank in the Weimar Republic, a central bank monetising the debt of weak eurozone states might not seem the ideal answer.
Instead, the favoured approach seems to be to muddle through and hope for the best.”
But it isn’t the spectre of Weimar the real cause. It is a wrong assumption.
Interesting comment from a reader following Dylan Grice piece on Weimar and Hyperinflation on FT Alphaville:
“The Weimar hyperinflation is often cited as the main reason for Germany’s ‘obsession’ with sound money. But visiting Germany frequently on business and speaking to Germans I doubt that.
Most people alive today did not live through that period. The real reason is that post WW II-Germans got used to their DM as a reliable store of value and kept on doing that with the Euro.
Only 40% of Germans are home-owners, as indeed, under a stable currency renting often makes more financial sense. Germans don’t invest in the stock market but prudently put their money in cash in a savings account. Hence, the typical German family is completely unhedged against inflation, and is therefore worried about it.
For the average German who has worked and saved 20 to 30 years, it is actually a better prospect to live through a deflationary depression and have a 30% chance of being out of work as opposed to seeing his life’s savings wiped out through currency debasement. That’s what’s driving German politics, not the Weimar memory. Most Germans I talk to aren’t too worried about loosing their jobs as they have plenty of savings to fall back on.”
So indeed we have a very big game of chicken still going between Germany and the ECB and a very scary one which could end up collapsing the European Union like the collapse of the Tacoma Narrow Bridge or the collapse of the 1931 Gold Standard.
Best,
Martin
nice thoughts. Thanks Martin.
The Germans also maintain a semblance of full employment by allowing wages and hours to be cut. It would be difficult for these labor contracts to endure if the currency was allowed to inflate.
@martin
““But given Germany’s history, it will never inflate.” – Zulauf”
if you listen to what stark etc say, then i would agree. but if you watch what they do (sit on their thumbs while the ecb expands its balance sheet even more than greenancke), then you have to wonder.
just a guess, but i see greece doing a coercive restructuring/default, and then there are political repurcussions. sarko is out-o, and maybe merkle too.
then things will get interesting!
I agree. FZ provides the best macro picture in this year’s BRT. Martin is right. Just because the news of the European crisis is old, it does not mean the all clear sign is out. The EC is no fast passing tornado. The ECB LTRO is just a bank liquidity tool not a panacea. Insolvency in peripheral governments and most large banks remains, as do all the problems related to the awkward design of the EMU.
If there is one thing I loose seep over is the European crisis.
http://www.zerohedge.com/news/jamie-dimon-says-jpm-could-lose-5-billion-piigs-exposure
A good reminder of what the EC is all about. A lot more than just talk about a “miserable”* 5 billion.
*Jamie’s take since none of it is his money:-)
Zulauf has the most interesting comments by far. Interesting how the bulls qualify their outlooks with “if Europe/China muddle through” and go no further on pertinent issues. Even if stocks are cheap on a historical basis (I don’t think they are), the current environment is a historical outlier. I feel some of them need to brush up on their statistics. Bayes’ theorem, people.
And Faber actually turning somewhat bullish here saying that troubles are starting to get priced in. I wonder if that is the case though. Hard to price in vicious cycles without knowing when the cycles end.
Also interesting how everyone is bullish on gold and expects countries to print money, despite recent policy that point in the other direction. I don’t doubt that governments will start printing when things get really bad, but where will gold be by then?
More on Europe. Mauldin’s latest.
http://advisorperspectives.com/commentaries/millenium_011412.php
So the Friday European downgrades which made the US market actually rally were all already reflected in market prices right? Think again….
http://advisorperspectives.com/commentaries/pimco_11312.php
Equity markets end of year/new year love affair may end before January is over.
On Gudlach’s recent public stint in a lot greater detail than you have read anywhere.
http://advisorperspectives.com/newsletters12/Gundlach_on_the_Key_Risk_for_Bond_Investors.php
The CNBC recent video is too high level to get anything useful out it. Thereis value added here.
Gundlach has been sucking “hind titty” vs. Gross since Thanksgiving. As I’ve said before, he is a one tick(mortgages) pony. I’m still waiting for the best performing asset class of 2011 – muni bonds, to collapse like he predicted.
Felix is a stud, but his 1000-1500 S&P range call is not nearly as bearish as his individual market comments.
I think Gross go the wakeup call and will do well in 2012. But he is too much like me, frequently w reckless in the management of risk, taking larger bets than he should in his market beating quest. Let’s see how Gudlach does once the mortgage cow runs out of milk. iMO, he is better at risk management than Gross and i think he will be fine. I i’vegot bets on both men but my DBLTX is larger.
BTW, I don’t think the US equity market can afford to ignore the events in Europe next week.
All da’ bears in a single post:
http://www.businessinsider.com/bearish-statements-2012-2011-12#the-most-accurate-forecaster-on-the-street-thinks-stocks-are-going-down-1
I think we’re in one of two environments at this point, the first one I find the most interesting because I’ve not heard anybody else talk about it anywhere…
1) Emerging markets are actually in a secular bull market that began in ~2000. If so, that makes the tightening cycle they just went through this past year along with the timing (~12 years into the cycle) the equivalent of 1995 in the US. We were 12 years into our secular market/economic bull cycle, the Fed had tightened aggressively into 1994, the market stalled and then the Fed signaled the tightening phase had peaked and actually began to ease. The rest is history (1995-2000). The tightening phase in EMs could be over now and the global cycle they’re in could be powerful enough to propel or at least prop up developed economies/markets for another 5 years or so. The SPX continues to rip higher and there is no hard landing in China (when has a thesis so universally well disseminated actually occurred?).
2) Greece defaults sometime in 1Q12 and the market bottoms concurrently at ~-20% YoY as it usually does in a bear market (~1000-1050 on the SPX) and we get a period of 12-18 months of sustainable upside in global equity markets with further downside thereafter.
Pretty interesting. All I know is that despite all the clear negatives out there in the world, global economies and markets seem to somehow display a crap ton of unexpected strength!
I agree there is in the markets a strength I can’t explain, me being more in the FZ camp. All this contrariness is wearing me out and probably others. Trying to stay on my toes, weariness in participants seems to energize the markets.
Just read the Barron’s roundtable. A couple of my favorite head-scratchers are below:
-Gross: Euroland is a dysfunctional family. It is the parental north versus the spoiled children of the south. The children have spent their inheritance, so to speak.
-Faber: It would be best for all governments to cut spending by 50%. Then the private sector would expand again.
It’s clear these guys still don’t get it…
@Ted, Yes, Gross makes it sound like all EU’s problems are due to the spoiled kids in the south. But those in the parental north want to keep exporting and running a big trade surplus. Then they wonder why the importers in the south can’t balance their budgets and increase private savings.
And Marc Faber is worse. He doesn’t realize that austerity on a massive scale with 50% gov’t spending cuts would cause a depression, hurting private business as well. Who are the vendors who sell goods and services to the gov’t?
By the way, in 2011, Marc Faber recommended at least 11 securities that lost in the double digits for the year, more than offsetting his gainers. His forecasts were way off last year. He is a super inflationista, over-simplified.
ECB either prints to kick the PIIGS can.
or PIIGS leave and the ECB prints to recapitalize the banks.
in the world’s fragile finasncial environment, its recession now or recession later.
more QE from ben in an election year.