FMX|Connect- WWW.FMXConnect.com (Reported on 11/18/2011)

While navigating the news and trying to find the debt-pea under the ECB, IMF, Euro, shell game; we were sent an excerpt from Wikipedia from our Banker friend who is on top of banking shenanigans in Europe and the real estate fluff in China. Before using our copy-paste skills, we’d like to share our own opinion on the situation.

Interest rates go up for one of two reasons, the first being that an investor needs more compensation for weaker purchasing power of the currency in which the bond is denominated. The second is sovereign risk: Interest rates will go up if a government is perceived to be unable to pay or will default. This type is particularly insidious, as we are seeing.

Interest rates have a snow ball effect. As fear grows, rates rise to compensate the risk hopefully. However this fear is based on the return OF capital, not the return ON capital. The result is a feedback loop wherein the liquidity providers cannot justify a bid/ask to compensate their risk, leading to one-sided markets, fewer participants and seized markets. The market is now pricing in a digital event: Default or no default.

One would suspect Germany would like a weaker Euro, as an exporter of goods, but not a euro that won’t be accepted for fear of default.

So this could encourage Germany to perhaps take it to the brink and to not print money to rescue weaker countries. Why should it care? The D-Mark can always make a return, and with the Russian bourgeois buying BMWs, they have their new captive clients.  “The periphery Euro countries? We’ve replaced them.” But this is a form of Brinkmanship and can blow up in their faces.

Reading the Wikipedia entry on brinskmanship can be illuminating in context of the European situation:

Brinkmanship (or brinksmanship) is the practice of pushing dangerous events to the verge of disaster in order to achieve the most advantageous outcome, the ostensible escalation of threats in order to achieve one's aims. The term brinkmanship was coined by Secretary of State John Foster Dulles under the Eisenhower administration, during the Cold War. Eventually, the threats involved might become so huge as to be unmanageable at which point both sides are likely to back down. This was the case during the Cold War; the escalation of threats of nuclear war, if carried out, are likely to lead to mutual assured destruction. The British intellectual Bertrand Russell compared nuclear brinkmanship to the game of chicken.The principle between the two is the same, to create immense pressure in a situation until one

person or party backs down. . . or both are annihilated. The dangers of brinkmanship as a political or diplomatic tool can be understood as a slippery slope: In order for brinkmanship to be effective, the threats used are continuously escalated. However, a threat is not worth anything unless it is credible; at some point, the aggressive party may have to back up its claim to prove its commitment to action. The chance of things sliding out of control is also often used as a tool of brinkmanship, because it can provide credibility to an otherwise incredible threat.

Pioneering game theorist Thomas Schelling called this "the threat that leaves something to chance."

Along comes Zerohedge, commenting on the fact that Germany would rather kick countries out of the Eurozone than print money. This we believe is where the brinksmanship is coming in.

from our friends at Zerohedge

It's official - Germany has become just like China (or, rather, has always been like it): the more it is pushed to do something (let ECB print), the more it will do the opposite. Half a year ago we discussed that the weakest point of the European bailout language was its reliance on Collective Action Clauses which imply that any resolution which does not have 100% backing of all bondholders would potentially push a country into default. In essence, this took control out of the hands of the Eurozone head, Germany, and put it to the bondholders. Well, according to a preliminary draft released by the Telegraph and FT, as part of the new bailout 'indenture' contained in the ESM, "under a section headed “The establishment of a procedure for an orderly default as part of the ESM”, Berlin makes clear that countries which are deemed to be insolvent – rather than just suffering a temporary loss of access to the financial markets – would be allowed, in effect, to declare bankruptcy and default on their bonds: If [a debt sustainability review] is negative, the affected member state would instead receive loans for a limited time only, during which the procedure for an orderly default would be prepared. In order to make sovereign defaults possible where they are unavoidable, the threat of instability in the financial system resulting from such a default must be able to be credibly excluded. A plan to maintain the stability of the financial system in the event of an orderly default needs to be developed in close co-operation with European banking regulators. This would determine which banks would be restructured and/or recapitalised, which will necessitate the drawing up of Europe-wide rules on bank restructuring." And as we discussed previously, the voluntary language will likely be taken out from the final draft, effectively giving Germany the unilateral ability to kick countries out. Which explains why the market is about to plunge: according to just released information from DPA, "the German Foreign Ministry on Friday confirmed that Germany was considering the possibility of more eurozone "orderly defaults" beyond that of Greece, as suggested by a paper leaked by the British press." In essence, what this means is that instead of relenting on the ECB issue, which as every investment bank has said would be the end of the world unless massive printing is permitted, Germany would rather kick countries out of the Eurozone instead of entering a hyperinflationary collapse. Perhaps it is now time for the banks to start toning down their language on the imminent destruction that would ensue if the ECB does not print, as this is apparently not happening...

From the FT:

Our friends and rivals over at The Daily Telegraph have gotten their hands on an interesting document from the German government detailing its proposals for EU treaty change, and have helpfully posted it online (with an English translation by the Open Europe think thank).

Although the Telegraph focuses on its implications for Britain, there is a significant amount of detail on how Berlin would like to change eurozone economic governance, including yet another stab at enshrining bondholder “haircuts” in the EU treaties.

For those who haven’t followed the debate closely, there is now a closed-door fight going on about whether Greece really will be the only country that sees its bondholders pushed into losses – as the eurozone’s leaders have repeatedly insisted in their summit conclusions – or whether the bloc’s new €500bn rescue fund, which could come into place as early as next year, should allow for organised defaults.

Why is this a market moving event?

When broader default powers were mooted for the ESM at this time last year in a much-discussed agreement between France’s Nicolas Sarkozy and Germany’s Angela Merkel in the French seaside town of Deauville, bond markets swooned, sending Ireland and then Portugal into bail-outs. Days later, during a G20 meeting in Seoul, Merkel was forced to back down. But the issue clearly hasn’t died.

In other words, while everyone believes Germany has been boxed into a corner and has no choice but to relent on global demands to let the ECB do whatever France demands, Germany was making other plans all along. Such as having the opion to kick France out of the Eurozone if and when it so chooses.

Because after all, money talks. And in Europe, only Germany has the money.

And there you have it.

1. The Problem: The Euro’s collapse

2. The Risk to Germany: print and inflate or do not print and destroy

3. The German Brinksmanship: we will not print, and if the Euro ends, we’ll be fine thank you.

While it is obvious Germany wishes to avoid another Weimer republic and has a fear of inflation. Perhaps their fear should be of war. A collapsing European economy is just as dangerous.

To paraphrase: Central Bankers are always fighting the last war

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