Friday, February 10, 2012

Mafiosi Magician Mario Dragui's ECB, Debt, cash and bonfires....

Mafiosi Magician Mario Dragui's ECB, Debt, cash and bonfires....
By Chan Akya

So we have a deal. Do we have a deal? We have a deal. Well, kind of, but the finance ministers haven't signed off on it as yet. It may therefore change before you read this. It most certainly will change after you read this, irrespective of whether you read this on the intended publication date (February 10) or many months later. Welcome to the evergreen world of European sovereign debt restructuring.

This week's deal may or may not have been agreed? You see, here's how it is supposed to work. We give the Greeks 130 billion or so - no need to put a currency sign in front of the 130bn because it doesn't really matter. In return, the Greeks agree to 3.3bn of austerity - that is, budget cuts to that extent. No need to put a currency sign in front of this 3.3bn either, because it could be in baklava for all the good it will do for you anyway.

In any case, the 130 billion will be given to people to whom the Greeks owe money, not to the Greeks themselves. So it will be transferred from the European Central Bank (ECB) offices in Frankfurt through the clearing system in Frankfurt to banks in Frankfurt, and perhaps to the odd bank or two that dare to have branches in Paris or London instead. So to be clear, nothing will go to Athens anyway.

The Greeks also get some book entry adjustments. Instead of owing debt that looks like Mount Everest (this being an Asian publication), they will instead owe debt that looks like Mont Blanc. Even that mountain of debt will be worth, in terms of intrinsic purchasing power thanks to the below-market coupons they have to pay on it now and the next round of defaults, about the same as a pile that is as high as the average speed bump in Singapore but that is the denouement in the next act and one shouldn't rush to it quite yet.

Still with me? Marvelous. So these book entry adjustments are meant to lop 70% (50% from the principal balance and the rest from the losses suffered by the comically low coupon on the now-restructured debt) off the money owed by the Greeks to the private sector creditors, but they will be done voluntarily so that a miniscule amount of credit default swaps (CDS) outstanding on the debt is not "triggered". So an official sitting in Brussels (or is it Strasbourg?) gets to tick a box that says "Destroyed a useful little market that dared to speak the truth about European sovereigns".

Meanwhile, official creditors will get seniority so that they won't have to take any pain from this write-off. So that leaves the International Monetary Fund (IMF) and bilateral government aid donors (step forward, China) without the need to write off their debt. For IMF functionaries, this is useful because you don't have to write 100-page memos to the bosses explaining what happened (even if the situation was caused by those same bosses in the first place). Its even better for the central bankers from Asia or the Middle East because they, quite literally, dodge a bullet for buying Greek debt in the first place. So far, so good.

Except for the ECB, which purchased a bunch of the now-worthless debt of the same stock that was bought by the pirates; oops sorry I mean privates. It isn't allowed to take direct losses because that is the same as providing a financial benefit (this is the world of debt, stop trying to make logical sense of anything) to sovereigns, which the rules don't allow. Instead, the ECB would enter a complicated mechanism wherein it would take its Greek exposure and effectively exchange for paper to be issued by the European Financial Stability Facility (EFSF), which will then package them into an ABCD to sell to WXYZ. Okay, I may have made up the last two acronyms but you cannot be sure of that.

Yes, yes, but what about the contagion risks you ask, especially now that it looks like Portugal will be this year's big casualty. Oh that. Let's not get too wrapped up in it. You see the ECB has now made it easier for national central banks in Europe to accept pretty much any collateral in return for providing money to their banks.

You remember the three-year money supplied by the ECB at 1% in December? Well, there's hundred of billions, if not trillions, more where that came from. So when Portugal hits the reef later this year, its banks will be able to buy government paper, discount back with the national central bank for freshly printed money; and pocket the interest rate differential. Nice living, if you can get the job.

With all that monetary easing on the sly, we are talking hundreds of billions if not trillions. Once we talk numbers that big, the concept of value loses all meaning and you can see why I have insisted on not using currency signs in this article.

The Germans are apparently not too happy because they can't count very well with big numbers and all this talk of billions and trillions is proving quite vexing for them especially as the word "trillion" in German is spelled as "W-e-i-m-a-r". It also gives them a nasty nightmare about the chap who came after the Weimar Republic: a charming gentleman by the name of Adolf Hitler, to save you the trouble of looking up the Zioconned Wikipedia....

In any event, debt frenzy has now caught on in Europe, and there's a billion in bail-out money available for every outstretched hand. Amidst the frenzy, no one wants to listen to the Germans speaking sense. Indeed, the Greeks celebrated the bailout deal by having their national newspapers print images of Nazi flags being raised in Athens; about as clear as they can get about who they consider to be the villains of the piece.

Sheesh! You go and take money out of your pocket to help a fellow man in need and he calls you Nazi for doing that. The Germans are a hardy lot, who have impeccable manners and excellent financial sense. Where do they see this European experiment going now?

Suddenly, and as if the heavens themselves sent a message, we have news from Eastern Europe that provides an answer. With a worsening cold snap through Europe, the authorities in Hungary have taken to sending their cash notes to make fuel billets, that can then be used by the country's poor to burn and keep themselves warm. Cheaper than firewood, coal or natural gas, apparently.

Hungary, you will recall, is the Eastern European miracle economy that suddenly found out that printing loads of debt doesn't add up to an economic miracle. Its old forint aren't worth a lot these days, hence the move by the central bank to do something useful with them. At this rate, there will be surging demand for Zimbabwe dollars all over Europe, as they seek things to burn - such as the paper that Greek government debt is written on, rather than being collectors' items to be hung in people's toilets (I have a nice one from their past round of defaults in mine).
Imagine what the ECB can do with its trillions in euro currency notes in three years time when the next cold snap hits the continent. People from the Middle East and Russia, hoping to sell fuel at outrageous prices to the Europeans, will be sorely disappointed to learn about this new energy source....

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