STAFF NEWS & ANALYSIS
Does Announced EU Deal Leave Out Critical Elements?
By Staff News & Analysis - June 29, 2012

'Armageddon' to Happen Despite EU Deal … Jim Rogers, Chairman of Rogers Holdings says the latest euro zone deal does nothing to help solve the region's biggest problem, which is its high debt levels. Even as markets cheered the agreement by European leaders to allow the direct use of the bloc's bailout funds to recapitalize struggling banks, well-known investor Jim Rogers told CNBC the move does nothing to help solve the region's biggest problem, which is its high debt levels. – YahooFinance

Dominant Social Theme: Everything will be okay with this deal in place.

Free-Market Analysis: Jim Rogers's analysis of the "deal" that has been reached by top EU "policymakers" (excerpted above) is probably accurate. Apparently, EU leaders will now be able to lend to banks without further degrading their various countries' credit status.

But why filling up bank coffers with paper money is seen as a triumph of some sort is difficult to ascertain, as Rogers astutely notes. The real problem faced by the EU is that member states spend too much money and that they cannot devalue their currencies to pay off debts and "spread the pain."

Here's more from the article:

"Just because now you have a way to get them (the banks) to borrow even more money, this is not solving the problem, this is making the problem worse," Rogers said on Friday. "People need to stop spending money they don't have. The solution to too much debt is not more debt. All this little agreement does is give them (banks) a chance to have even more debt for a while longer," he added.

After negotiating late into the night, European policymakers agreed on Friday morning that the bloc's bailout fund, the European Stability Mechanism (ESM), would be able to lend directly to recapitalize banks without increasing a country's budget deficit, and without preferential seniority status.

Summit leaders also agreed that euro area rescue funds could also be used to stabilize bond markets without forcing countries that comply with EU budget rules to adopt extra austerity measures or economic reforms …

Rogers argues that the deal does not improve the solvency of indebted nations such as Spain. Spain's central government budget deficit has soared to 3.41 percent of GDP in the first five months of 2012, above the EU limit of 3 percent. He adds that the governments need to stop coming to the rescue of failing banks, even if it results in "financial Armageddon."

What Chancellor Angela Merkel is committing Germany to with this vague deal is perhaps unconstitutional and likely will need political support. Inevitably, it will be seen as a way to empty the pockets of the German taxpayer.

Merkel is already defending the deal, which she claims is a good compromise. According to a BBC report, the funds will not only be able to lend directly to banks, "they will also be used to buy bonds of countries like Italy and Spain whose borrowing costs have soared – with the intention that those countries will not have to apply for a formal Greek-style bailout."

She called the agreement "a good compromise" and indicated that Germans ought not to be worried that they will end up funding the profligacy of Europe's Southern PIGS.

But as Rogers points out, there have been numerous false starts within the EU. The chances of this latest summit offering a final resolution to the ongoing crisis is doubtful. In fact, the numbers are enormous. Here are some facts courtesy of ZeroHedge in an article posted in early June entitled "Systemic Risk: Why This Time IS Different and the Central Banks Won't Be Able to Stop the Crisis" by Graham Summers.

1. According to the IMF, European banks as a whole are leveraged at 26 to 1 (this data point is based on reported loans… the real leverage levels are likely much, much higher.) These are a Lehman Brothers leverage levels.

2. The European Banking system is over $46 trillion in size (nearly 3X total EU GDP).

3. The European Central Bank's (ECB) balance sheet is now nearly $4 trillion in size (larger than Germany's economy and roughly 1/3 the size of the ENTIRE EU's GDP). Aside from the inflationary and systemic risks this poses (the ECB is now leveraged at over 36 to 1).

4. Over a quarter of the ECB's balance sheet is PIIGS debt which the ECB will dump any and all losses from onto national Central Banks (read: Germany)

Summers concludes by noting the European banking system is nearly four times that of the US ($46 trillion vs. $12 trillion) with at least twice the amount of leverage (26 to 1 for the EU vs. 13 to 1 for the US). The EU Central Bank has purchased a good deal of sour sovereign debt as well.

We can see from the above how extensive the banking problem really is – and yet even were those in charge of euro solvency capable of solving it, the bigger issue of PIGS solvency remains. The idea of a gold-backed sinking fund, which we have reported on in the past, still makes sense as the Eurozone's one chance at solvency. Perhaps what has been announced – a vague announcement to be sure – will include this larger program.

As it stands now, providing additional funds to banks does nothing to affect Eurozone sovereign solvency, as Rogers points out. Nor does it solve the constitutional issues with which Merkel has to contend.

After Thoughts

Either EU leaders have simply decided to pretend they have solved the problem while merely figuring out a way to provide their largest banks with additional funds or there is something else involved in this scheme that has not yet been explained.

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