“We have been through a big global financial crisis,the biggest downturn in world output since the 1930s,the biggest banking crisis in this country’s history,the biggest fiscal deficit in our peacetime history,and our biggest trading partner, the euro area, is tearing itself apart without any obvious solution.”
-Sir Mervyn King

The rebound didn’t last long in the Asian markets. All main stock indices were down again this morning, after US stocks closed mostly flat yesterday.

Risk-aversion was back in vogue as the euro lost more than 1 percent against the US dollar due to news reports quoting former Greece Prime Minister Lucas Papademos saying that preparations for the country’s exit from the euro zone are being considered and the risk is real.

Of course all eyes will be on an informal summit of European leaders today, who are expected to discuss the idea of regional bonds jointly underwritten by all euro zone member states.

But expectations are not very high and today’s meeting will probably not deliver any solutions or decisive actions. “The market is likely to be more prone to disappointment. There’s this delusion of a quick fix either via monetary policy with the European Central Bank or via some kind of fiscal decision, but unfortunately this won’t happen,” said Matteo Regesta, a strategist at BNP Paribas.

So is Germany going to push for a united euro zone? That is the one-million dollar question right now that is bothering people’s mind and keeps some of them up at night.

In an interview with The Sunday Times, the financial historian Niall Ferguson said the euro will survive and the crisis will leave Berlin heading a federal Europe.

Here are a few paragraphs from that article, which show why he thinks a breakup of the euro zone is possible but unlikely:

It is still possible that the game of chicken between Athens and Berlin ends with the two cars colliding. But my sense is that both will swerve at the last minute – the Greeks because they see the costs of exit would be catastrophic for them, and the Germans because – if they don’t realize it already, they pretty soon will – the banking crisis that this would unleash as deposits fled the periphery would be highly destabilizing for the whole euro zone, Germany included.

The Greeks say, ‘We’re not going to comply with our commitments’. The Germans say, ‘Then you’re out’. They’re both bluffing.

The Germans have the biggest interest in preserving the euro. It has been highly advantageous to German business not have a super strong Deutschmark, and I think that’s one of the reasons Germans will swerve in this game of chicken, because anything that threatens monetary union is pretty threatening to German business … Germans are going to have to make some kind of concession to the periphery. It’s not enough just to say ‘austerity, austerity’.”

He also added that he is just trying to be realistic, not overly optimistic (although some people may think so after reading these excerpts from the interview):

As a Scotsman, I’m not a congenitally optimistic person. I’m just telling you from a historian’s vantage point which seems the more likely of two difficult scenarios.

Even if just one country leaves the euro zone, that creates a massive contagion effect, and no one knows where the ripples would stop – it could even be a tsunami that hits New York.

Also, although the German political elite appears slowmoving and plodding, it wasn’t slowmoving and plodding in 1989/90 when the opportunity presented itself to reunite Germany: monetary union with East Germany was the product of political thinking, not economic logic. But the point is, I think you might be surprised by how quickly they move when the chips are down.

Are the Greeks going to choose to self-destruct? And are the Germans going to let Greece self-destruct? Then there would be an unstoppable effect as deposits exit Portugal, exit Spain, exit Italy.

It is easier by miles for the Germans to say, ‘Okay, austerity wasn’t quite enough; we’re also going to have structural funds deployed to Greece; we are also going to have recapitalization of the Spanish banks.’ And the money is there...

They should have done this two years ago, but they thought they could kick the can down the road. What they didn’t realize was that each time they did that, the can got more explosive. I’m not an optimist about Europe. That’s why I live in America. So don’t call me an optimist.”

In the end, is Germany going to keep on focusing on AUSTERITY as a key part of resolving the euro zone’s debt crisis, or will it give in and agree with a French-led call for euro zone governments to issue COMMON BONDS? Only time will tell...

To finish off this commentary I would like to present some snippets that I find worth mentioning:

Bumi, one of the most widely-held stocks in Indonesia, which is also listed on the London Stock Exchange, surged as much as 16% in London after Barclays initiated coverage with overweight recommendation and called the stock “a diamond in the rough”. This was its biggest intraday gain since the company sold shares in July 2010.

Although the stock is quite popular in Indonesia among retail investors, personally I do not recommend it as the company is still struggling with high debt levels (DER > 500% or 5x based on the latest financial statements) and corporate governance issues.

If Europe experiences a financial collapse, the losses experienced by US banks could be potentially devastating. The following is from a recent article by Graham Summers from Phoenix Capital Research:

According to Reuters once you include Spain and Italy as well as Credit Default Swaps and indirect exposure to Europe, US banks have roughly $4 TRILLION in potential exposure to the EU.

To put that number in perspective, the entire US banking system is $12 trillion in size.

Still need some more proof that things are going from bad to worse in Spain? Just have a look at the chart below from www.agorafinancial.com, and you may come to the conclusion that the situation in Spain could get very ugly indeed. As an example, Moody’s recently announced that it has downgraded the credit ratings of 16 Spanish banks, including Banco Santander, which is the largest bank in the euro zone. And the yield on 10-year Spanish bonds is back above 6.1%...

Finally there is more news about JP Morgan’s miserable trading loss. The JP Morgan loss that was $2 billion a few days ago is now $3 billion, report Nelson Schwartz and Jessica Silver-Greenberg in The New York Times. Why? Because every hedge fund in the world knows JP Morgan is stuck in a position so big that it can’t unwind it and they’re betting against it.

Rick Santelli told King World News that traders and hedge funds are making it costly for JP Morgan to exit their $2 billion+ losing position. He also said:

This is a position that they hold in CDS’s, at least part of their position that caused their $2 billion and potentially higher loss. Well, the hedge funds that dabble in this type of esoteric derivative, they know which way JP Morgan is (positioned).

So I guess my anecdotal story is it’s going to be much more painful for JP Morgan to flee or unwind this complicated position/hedge, with the competition just breathing down their neck.

I am of the opinion that $2 or $3 billion is just peanuts, and that we haven’t seen anything yet. You don’t believe me? Well, then read on what The Economic Collapse Blog had to say on May 14, 2012 and why the author thinks this is just a very small preview of what is going to happen:

When the “too big to fail” banks make good bets, they can make a lot of money. When they make bad bets, they can lose a lot of money, and that is exactly what just happened to JP Morgan. Their Chief Investment Office made a series of trades which turned out horribly, and it resulted in a loss of over 2 billion dollars over the past 40 days. But 2 billion dollars is small potatoes compared to the vast size of the global derivatives market. It has been estimated that the notional value of all the derivatives in the world is somewhere between 600 trillion dollars and 1.5 quadrillion dollars. Nobody really knows the real amount, but when this derivatives bubble finally bursts there is not going to be nearly enough money on the entire planet to fix things.

We never learned one of the basic lessons that we should have learned from the financial crisis of 2008. Wall Street bankers take huge risks because the risk/reward ratio is all messed up. If the bankers make huge bets and they win, then they win big. If the bankers make huge bets and they lose, then the federal government uses taxpayer money to clean up the mess. Under those kind of conditions, why not bet the farm?

Posted by Nico Omer Jonckheere | VP Research and Analysis, PT. Valbury Asia Futures