Rumors today that Greece would default on its sovereign debt were received with relative calm by the bond markets. Now that Greece’s public debt is approaching 150% of GDP and is forecast to increase by at least 10%, even the most optimistic analysts, namely S&P, are coming to one inescapable conclusion:
Greece is in technical default.
This is news to no one in the world of finance. The numbers in Greece haven’t penciled out for at least three years and have shown absolutely no sign of improvement. Anyone with significant exposure to Greece has either sold it or obtained some sort of guarantee from the ECB and/or IMF that they will be made whole on their exposure.
Hence, the lack of panic in the markets.
For financial market participants, the guarantee of the ECB works as a hallucinogen. Traditional analysis no longer applies once an infinitely solvent guarantor signs on to back the debt of a weak partner. The weak partner is no longer seen as insolvent, but rather, devoid of credit risk.
However, 2012 is shaping up to be a tough year for the ECB itself. With every cent of spare Euro liquidity fleeing to American shores, the ECB is now the lone ranger as its lending activity increasingly dominates the Euro money markets.
Assuming that it must fund a large majority of the Eurozone’s debt rollovers in in 2012, how many Euros will the ECB need to conjure up? The rough tally is 740 billion euros worth of European sovereign debt.
Additionally, it is almost a bygone conclusion that the ECB will need to step in and buy the debt of European banks whose country’s sovereigns are under pressure. This includes:
- 25% of Irish banks outstanding debt
- 20% of Spanish banks outstanding debt
- 15% of Italian banks outstanding debt; and
- 15% of Italian banks outstanding debt
To borrow an old but relevant metaphor, 2012 will be the year that the ECB’s wine, the Euro, turns to sewage. Thanks to their unlimited swap line at the Federal Reserve, the US currency is likely to begin to smell funny as well.
Could this be why the FED funds rate has creeped up from its flatline the past few days?
No matter how you look at it, the 2012 Euro funding picture does not pencil out. The sooner that Greece and the other insolvent sovereigns and banks declare the default that the markets have long since priced in, the sooner growth and hope will return to the Eurozone.
On the other hand, the longer the sewage is allowed to backup at the ECB, the greater the risk of a Euro currency collapse. Nobody wants to see that, especially the FED.