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What Blows Up First? Part 1: Europe

2013 was a year in which lots of imbalances built up but none blew up. The US and Japan continued to monetize their debt, in the process cheapening the dollar and sending the yen to five-year lows versus the euro. China allowed its debt to soar with only the hint of a (quickly-addressed) credit crunch at year-end. The big banks got even bigger, while reporting record profits and paying record fines for the crimes that produced those profits. And asset markets ranging from equities to high-end real estate to rare art took off into the stratosphere.

Virtually all of this felt great for the participants and led many to conclude that the world’s problems were being solved. Instead, 2014 is likely to be a year in which at least some – and maybe all – of the above trends hit a wall. It’s hard to know which will hit first, but a pretty good bet is that the strong euro (the flip side of a weakening dollar and yen) sends mismanaged countries like France and Italy back into crisis. So let’s start there.

The basic premise of the currency war theme is that when a country takes on too much debt it eventually realizes that the only way out of its dilemma is to cheapen its currency to gain a trade advantage and make its debts less burdensome. This works for a while but since the cheap-currency benefits come at the expense of trading partners, the latter eventually retaliate with inflation of their own, putting the first country back in its original box.

In 2013 the US and especially Japan cheapened their currencies versus the euro, which was supported by the European Central Bank’s relative reluctance to monetize the eurozone’s debt. The following chart shows the euro over the past six months:

Euro dec 2013

For more details:

Euro rises to more than 2-year high vs. dollar; yen falls
The euro jumped to its strongest level against the dollar in more than two years on Friday as banks adjusted positions for the year end, while the yen hit five-year lows for a second straight session.

The dollar was broadly weaker against European currencies, including sterling and the Swiss franc. Thin liquidity likely helped exaggerate market moves.

The European Central Bank will take a snapshot of the capital positions of the region’s banks at the end of 2013 for an asset-quality review (AQR) next year to work out which of them will need fresh funds. The upcoming review has created some demand for euros to help shore up banks’ balance sheets, traders said.

“There’s a lot of attention on the AQR, and there’s some positioning ahead of the end of the calendar year,” said John Hardy, FX strategist at Danske Bank in Copenhagen.

Comments from Jens Weidmann, the Bundesbank chief and a member of the European Central Bank Governing Council, also helped the euro. He warned that although the euro zone’s current low interest rate is justified, weak inflation does not give a license for “arbitrary monetary easing.

The euro rose as high as $1.3892, according to Reuters data, the highest since October 2011. It was last up 0.3 percent at $1.3738.

The currency has risen more than 10 cents from a low hit in July below $1.28, as the euro zone economy came out of a recession triggered by its debt crisis.

Unlike the U.S. and Japanese central banks, the European Central Bank has not been actively expanding its balance sheet, giving an additional boost to the euro.

Here’s what a stronger euro means for France, the second-largest and arguably worst-managed eurozone country:

French Economy Contracts 0.1% In Third Quarter
The final estimate of France’s gross domestic product, or GDP, in the third quarter remained unchanged at the previous estimation of a contraction of 0.1 percent, indicating that the euro zone’s second-largest economy is struggling to sustain the rebound it witnessed in the second quarter with a growth of 0.6 percent.

The third-quarter GDP growth was in line with analysts’ estimates. According to data released on Tuesday by the National Institute of Statistics and Economic Studies, the deficit in foreign-trade balance contributed (-0.6 points) to the contraction in the third quarter, compared to the positive (0.1 percent) contribution made in the preceding quarter.

Some thoughts
At the beginning of 2013, most of the eurozone was either still in recession or just barely climbing out. Then the euro started rising, making European products more expensive and therefore harder to sell, which depressed those countries’ export sectors and made debts more burdensome. So now, under the forced austerity of an appreciating currency, countries like France that were barely growing are back in contraction. And countries like Greece that were flat on their back are now flirting with dissolution.

Recessions – especially never-ending recessions – are fatal for incumbent politicians, so pressure is building for a European version of Japan’s “Abenomics,” in which the European Central Bank is bullied into setting explicit inflation targets and monetizing as much debt as necessary to get there. The question is, will it happen before the downward momentum spawns political chaos that spreads to the rest of the world. See Italian President Warns of Violent Unrest in 2014.

58 thoughts on "What Blows Up First? Part 1: Europe"

  1. I also think Australia is a likely candidate. It has a (private) debt to GDP ratio higher than the US has and a massive (in %) Current Account Deficit.

    1. Hi Willy

      As an Australian I can offer that we will be OK while China needs our minerals. China slows, all bets are off. We currently have low unemployment
      While I don’t have stats my impression through the media and conversations is that the average Aussie is delevering consumer and home debt. However, contrary to this property prices are booming (In Sydney) and I reckon they are forming an unsustainable bubble that won’t pop for a couple of years. There is huge investor interest in housing at record low interest rates that make the investment numbers look good, Auction clearance rates of 87% show that the property market is overheating and greater fools may be entering the market.

      Another interesting thing is how fast government debt is rising. Its around 30% to GDP having been at 0 within the last 5-10 years. Our federal deficits could become a real problem in a few years if this continues. Making this worse would be a fall in mining and corporate tax revenues if China slows.

      Overall, Australia is a relatively stable economy but because it is so small it can be massively affected by world events. Things can change for the worst for us very quickly as we are small and dependent on the rest of the world.
      The thing is, the average Aussie is quite complacent that the past will equal the future, which probably won’t be the case.

      1. China supposedly grows at ~ 6 to 8% but according to trade statistics the chinese economy is actually contracting.

        Did you follow the works of australian professor Steve Keen ? He’s the one that says that australian debt to GDP is higher than the one in the US.



        1. Steve Keen works at a uni 5 minutes from my place. Seems like an intelligent guy with some original ideas but has been calling a property price crash in Australia for nearly a decade which has compromised his forecasting ability in my view. He will eventually be right, much like a broken clock.
          He’s right about private debt in Oz being a risk but the economy will require a shock for that debt to be an issue.
          I’ll definitely have a look at those links, thanks !

  2. They’ve reflated (partly) the bubble that popped in 2008. It took trillions of dollars to do it and delayed the inevitable. Check out a graph of the stock market today compared to 1929:

    …“chart overlaying” is lazy and this is no less so. But it does remind us that as much as everyone thinks everyone else is “all bulled up,” these views still persist and have shown no indication they are going away any time soon.

    This is the crucial thing, which Dan nails. It’s not that the chart has any predictive value. It’s just interesting that everyone’s passing it around.”


  3. We’re all waiting for the great unwinding; that is when the Fed goes to sell all those toxic assets it bought at the going rate, and now aren’t worth anything. When the Fed starts to slow money growth that means the next great bank depression will be at your doorsteps, and it won’t matter if you live in Texas or Canada Mr Beyer.

    Moreover, the too big to fail are sitting on so much debt that when one goes down they all go down and the DoddFrankVloker act wiil be useless, and I can imagine the governments next step will be to collect all the gold, as FDR did, and we start over just like we did 80 years ago.

    It comes about every 80 years because people forget what and how it happened last time, and the bankers get greedy along with the monopoly corporations. People will be so down and out they’ll listen to the progressives again and then we’l get back on our feet and do it again in 80 years.

    The warrior class will rebel against the corrupted bankers and business people who have only one interest, and that is to make you destitute so that you’ll be glad to to take any job. Boy, have we come a long way.

    I can remember when Republicans use to claim that the American workers were the best in the world.

      1. The Fed is a private banking cartel held by private banks that have to stay in business. They’ve spent the last several years buying up Treasurys and mortgage-backed securities that are worth a lot less than the Fed paid for them. Those assets are on the Fed’s balance sheet, which is to say they are on the balance sheets of the Fed’s owners. Now if I were holding onto an asset whose value could only decline as the world’s investors gradually wake up to their real value, I’d be in a hurry to sell them even if I had created the money to pay for them out of thin air.

        1. Why though? Holding so much US debt maintains control of the US in several ways regardless of their true value, which is the real goal. People talk about China “owning” the US but the Fed owns about 30% (compared to 8% for China). The Fed can raise interest rates (or threaten to) by dumping them, or refuse to monetize the Federal deficit any further, or raise both the Federal deficit and debt level simultaneously by refusing to refund the interest “earned” on the Fed’s bonds, or – worst of all for the US – refusing to rollover their bonds as they mature which would effectively force a default by creating multi-trillion dollar balloon payments, etc.

          Hey, as long as people want to pretend that fiat currency is real then they have to pay for that privilege.

        2. My whole point is: If you can create money out of thin air to purchase anything why sell it? Wouldn’t it be easier to create more money out of thin air?

          Balance sheets are for legitimate businesses not an organization that can create revenue out of thin air.

      2. The FED did NOT print money, the FED CREATED money. The velocity of money has tanked over the last few years.

        1. The fed creates money with keystrokes; that’s why there isn’t any inflation, but the money is being transferred to the banks and corporations for almost nothing. Look up fractional banking. Buy buying assets from the banks, mortgage backed securities, they send money to the banks, and that bank then loans out another portion of their money, so on so forth. It’s turned into a ponzi scheme and we have a history of shutting down the private bankers in this country because they become criminals and send the county into recessions and depressions. Jefferson, Madison, A Jackson, and Wilson was sorry after he signed the Federal Reserve Act, as he thought that the country would get screwed by the money changers, and look what’s happened.

    1. Define ” Collects all the gold like it did 80 years ago ” for us. Your first mistake is you know nothing about history as the FDR gold grab was NOT a confiscation you WE’RE still allowed to own up to a $100 worth of gold. Two, funny I know of no one who actually posses gold bullion or would speak of it if they did! unless in your blithering you mean the government will go around collecting wedding rings. Born and Bred American Dopes are handing their gold over without a shot or executive order IE ” Cash for Gold ”

      Why do paranoid fools post on message forums. Dope is an understatement.

      1. I’ll define it for you. In April 1933 FDR issued excursive order 6102. All persons are hereby required to deliver, on or before May 1, 1933, to a Fderal reserve bank…or to any member of the Federal Reserve System all gold coin, gold bullion and gold certificates now owned by them…Whoever willfully violates any provisions of this Executive Order…may be fined not more than $10,000…may be imprisoned for not more than ten years.
        By the way tom, with your thumb up your you know what, I’m not a gold bug, but there are out there and it would be singing our death certificate again to go back to the gold standard because it would give more power to central bankers. You should get a book on the history of money in the world and who controls it. At the time gold was at $20.67 an ounce, and you were allowed to keep &100. Fort Knox was built to keep the gold and later it was raised to around $35 a ounce, and then promply depleted after WWII, and now the Fed has our gold. The money changers win again. The money changer in Europe wanted their gold back and our bankers made billions on the deal.

        1. I think I already made it clear…Dope. Been reading you doom and gloom bitches for 7 years strait now you bore the fu#k out of me to no end.

          I know I know any day now we’ll all be eating out of trash cans, and hanging bankers on the nearest lamp post…any day now.

          1. Ya, you made your self clear you are a condescending ignorant idiot, locked into your little world of intolerance for another person’s point of view that may be different then yours. But I really don’t care because I’m on a mission to find the truth and it doesn’t lie with your kind. Two men in different centuries on the topic of banks, money changers.

            “The Fed was largely responsible for converting what might have
            been a garden-variety recession, although perhaps a fairly severe one, into a
            major catastrophe. Instead of using its powers to offset the depression, it
            presided over a decline in the quantity of money by one-third from 1929 to 1933
            … Far from the depression being a failure of the free-enterprise system, it was
            a tragic failure of government.”. —Milton Friedman ,

            Jefferson:”If the American people ever allow private banks to control the issue of
            their money, first by inflation and then by deflation, the banks and corporations
            that will grow up around them, will deprive the people of their property until
            their children will wake up homeless on the continent their fathers

            If you don’t like what I write don’t reply………please. Thank you, and have a happy new year, it that’s possible.

        2. Dan, how would being on the gold standard give MORE power to central bankers? They couldn’t have even started QE1 if that was the case because gold is a finite and limited resource.

          Secondly, I don’t believe there is any gold left in Ft. Knox. Nobody knows because it hasn’t been audited since 1953.

  4. Only (my native) Germany, Austria, Denmark and the Netherlands are winners in the Eurozone as they export like crazy due to a weak Euro, compared to their previous currencies of DM, Schilling, Krona and Guilder. All other nations suffer as they are now unable to control their own currency.

    Example 1: instead of building Fiats in Italy with every cheaper labour denoted in Lira, instead they build more VWs in Germany, benefiting the Germans at the expense of the Italians.

    Example 2: instead of buying vacation real estate, holidays, red wine or Seats in Spain, on the cheap, denominated in Pesetas, people buy vacation properties in Dubai or Austria, holidays in the Alps or Dubai, vino from Australia or cars from Germany.

    In addition, there are massive population shifts, due to very high youth unemployment, as whole generations flock to economically strong regions, like UK, Germany, Austria, Denmark or Holland.

    Add the Euro and Eurozone regulations & administration at a huge cost and you see socialism in its finest, with GST exceeding 20% in most nations and income taxes well over 50% for even modest high income earners (say over Can$100,000).

    Europe: a great open air museum to visit, but not a great place to invest. I invest my own money and tat of our co-investors here in W-Canada or in Texas !

  5. I’ll have a little wager with you John that 2014 is NOT the year of collapse. My reasons, for what they are worth:

    – The ability of the TPTB to control the rules of the game and the game action. China’s response to a credit situation late this year is an example of what they can do. Sure many fingers will be inserted into dikes to prevent crises, but crisis on a large, global scale will be prevented. The manipulation of precious metals also shows how powerful and desperate these people are to maintain the status quo.
    – Global populations have been pacified and so there will be no uprising that causes a crisis, rather there will be violence and mayhem only after populations realise what the effects of a collapse that has already occurred. The web is full of blogs where “The people” will rise up against evil. If that was going to happen it would have already occurred in a PIGS country.

    – We’re not far enough down the rabbit hole yet. As this article points out, Europe is still showing restraint, so there is still plenty of “room” to move further. The US hasn’t yet fully experienced the effects of tapering which will cause it to later increase QE. While there is a sense of unease, there is no panic on the horizon. The lunacy in Japan has come this far, beyond belief, without huge market reaction and while it is unsustainable in the long run it is stable in the short run,

    – The current “crazy” monetary policies have been normalised by a subservient media. There are no alarm bells ringing that can cause a slide into crisis as people realise the danger that currently exists. The Titanic is probably an apt metaphor for how suddenly a crisis will strike. While the media tells people everything is OK it will be, until a financial component or element breaks down (Think bank failure, corporate collapse, a Euro country leaving or government default (not likely). It won’t be a Black Swan that triggers a global crisis, rather it will be an issue that has been on the horizon that suddenly comes into view, much like an iceberg !
    – There have been no retaliatory trade or currency actions by governments that have openly been stated as such. Currency and trade wars have not yet broken out as things are not yet desperate enough from a political perspective (excluding Japan). While there is jockeying for advantage, open trade and currency wars are yet to commence and are likely to be a precursor to crisis. How many politicians around the world are yet desperate enough to openly take on other countries in a trade/currency war ? Political desperation will be one possible indicator of imminent collapse. While politicians may be privately concerned the desperation will be become public through their actions.

    I remember at the end of 2010 thinking “we won’t get through 2011”. I remember at the end of 2011 thinking “we won’t get through 2012”. I remember at the end of 2012 thinking “we won’t get through 2013”. The TPTB have shown how willing they are to kick the can down the road. Don’t underestimate their ability to do so.

    Simply put, things aren’t absurd enough yet for the crisis to be forced on politicians.

    chthompson – Gold and Silver in physical form, held outside the banking system, but expect a rough ride before your insurance is paid out,

    1. The last crisis (2008) didn’t happen because all that could be done was done. Interest rates could have been lower, housing prices could have been higher, mortgage-backed securities could have been rated even higher, dead people could have been sold mortgages, etc. Besides, I personally sold my mother’s house in 2006 for what my sisters’ insisted was a steal. (True story: In 2004 we consulted with a number of realtors about what my mother’s house could be sold for. They all said “about 450”. My sisters were dumbfounded but ecstatic because we all would get a cut of that. Two years later I sold it for $575 cash and they both thought I was a fool. “You should have turned it down and immediately listed that house for 650, at least. It’s worth it!,” one sister exclaimed. House prices peaked in that area right about then. Considering that the house was bought for $22,000, how was I to know?)

    2. Tony D,
      I am a great believer in historical patterns dictating behavior. The difficulty is determining what incident/event starts the ball rolling. The TPTB have many weapons at their disposal, although I believe that even they have a finite number of tricks.

    3. Well said, Tony, but eventually some year will be the year, and we just don’t know which year it will be. I wouldn’t get too complacent about 2014. Coming into 2008 there were not a lot of worrisome signs either, unless you bothered to look. My prediction is that a series of bank failures in Europe or possibly China will trigger the next financial-sector tsunami, but predicting the precise sequence of events is probably harder than predicting the weather,especially since we don’t have nearly as much data about what’s out there.

      1. Agreed Dave, it’s coming for sure and I agree about complacency. I’m vigilantly watching but I’m a little tired of looking at “indicators” so repeatedly put out on the net like the “Baltic dry index” and “death crosses” on charts. It’s too easy to jump at shadows and it’s quite likely that when SHTF if you don’t have things in place financially it will already be too late. I can see an “after hours” or weekend announcement that shifts things beyond recognition. So while I don’t think 2014 will be the year I’m still ready in case.

    4. Great post and I do agree with you but I think there is one main point that will begin the process. We are rapidly approaching the day when paper gold and physical gold decouple. The COMEX inventories are so thin that one single country could sink the whole thing. Once they cannot control gold by naked shorting the paper market- look out.

      1. Please explain the process where an exploding gold price causes an economic collapse. Not sure rising gold price signals loss of dollars value to the average person Also why did Abn amro’s default not cause a ripple in gold prices ?
        Sorry – typed on phone

  6. The blow-up chair regularly rotates. Japan had it for a while when it launched Abenomics. The ECB isn’t structured to monetize so it will have to rely on its dollar swap lines with the Fed to launch any currency blow-up.

  7. – The USD weakened because foreigners were reducing their T-bond purchases.
    – France is suffering as a result of german financial policies.

      1. Home prices are not being driven by consumer demand but by cheap money that hedge funds and people with money have to throw around. If the average consumer were driving demand than we could say it was the market, but since it being driven by cheap money and low interest rates for people who have assets then it’s called a bubble, and we all know what happens to bubbles. It’s happening in the UK right now too.

        1. Like US or Canada the UK is not one market. Prices in London are actually rising, and they are rising too in many US states or many Canadian cities. With continued in-migration and robust job and GDP growth house prices rise as demand rises, as people have to live somewhere.

          With continued Maoist tendencies in China more folks will park their money elsewhere, such as UK, Paris, Germany, Singapore, US, Canada .. all safe havens for Chinese.

          Of course cheaper money helps too, but mortgages are already 3-4%, only 20% lower than a few years ago as the banks gorge themselves on cheap credit and consumers get the leftovers.

          Even with mortgage interest rates at 4-5% – a loooong way off btw – house prices will not fall. They might just not rise as fast ! There is no bubble in job creating regions. Yes, some markets will fall, namely those in socialist provinces like Ontario’s or Quebec’s rural towns where employers crater due to uncompetitive wages or high electricity rates or high taxes due to excessive political spending.

          1. And as I stated the bubble is growing with cheap money and when the Fed decides to unwind and sell those toxic assets they have on the books the end will come because the economy will tighten up for all.

            The Fed controls the inflation and deflation but has lost control of it by helping the too big to fail banks and corporations out of their debt instead of letting them fail. The Congress is still not helping matters much because the wealthy, bankers, and corporations, the economic royalists are still in control of the economy and recessions are a benefit to them, as they buy up assets, like rentals, stocks, paintings, etc.. And if you’ll notice those prices are inflating as the working man’s wages are not, as what happens in an economy that benefits the wealthy, not the middle class.

            Moreover, the middle class grew the most in this country from 1700 to 1800 when land was cheap, stealing if from the Indians, and when the north had indentured slavery, and the south had slavery. The second time it grew was from 1940’s to 1980, until the Reagan, Milton Freedman economic disaster started, based on Hayek economic theory, which was laughed at, until Friedman and the Chicago school economics started preaching it, and the wealthy created think tanks to promote it as well as media owned by them.

            We are now the beneficiaries of it after its failures in Latin America, Chile, Russian, and Poland. It’s what Naomi Klein calls shock economics, and the big shock is still to come.

          2. The small guy is priced out of it in my market……………because the people who benefited the most from the economic downturn are playing their hand now, and the down turn wasn’t caused by the government, but by government not regulating and putting people in jail for committing fraud in the banking sector. It Takes A Pillage, by Prins, writes on this. The Fed creates depressions as well as growth, and in this case asset bubbles. It’s is operating like a communist command and control system; the free market is just words now with out meaning. I might add, lowering taxes on the wealthy by Harding resulted in the same, a depression in 1929. He was the bankers dream come true.

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