Over the past few weeks, much has been written about Italy’s referendum and a potential “Basta e no!” vote. The Spiegel, on November 30th, wrote the following: “Italian Prime Minister Matteo Renzi may be facing defeat in a game of high-stakes poker with the electorate. If the Dec. 4 constitutional referendum fails, there are dark clouds on the horizon for Europe’s future. The country is in poor economic shape and financial markets are alarmed.”
They were right. And now, a loud and clear “BASTA E NO” has arrived. This is yet another blow to the Euro, the bureaucrats in Brussels, another powerful message to all those “globalization experts” and leftist media: The tide has changed. The people – in America and in Europe – want their countries and sovereignty back.
The implications of this lost “Renzi-rendum” are far-reaching. They are not merely social and political. They have a very direct and potentially detrimental impact on financial markets and the current global house-of-cards financial system.
Financial Meltdown on the Way?
Over the past few weeks, Italians have been bringing their gold into Switzerland for safekeeping in droves. Gold is the ultimate crisis currency. This hording of gold in Switzerland has been an early indicator of the next crisis unfolding in Europe, potentially setting off a domino effect in the global financial system.
Sovereign debt – the debt of national governments – has ballooned from $80 trillion to $100 trillion just since 2008. Squeezed governments have been driven to radical austerity measures, privatizing public assets, slashing public services, and downsizing work forces in a futile attempt to balance national budgets. But the debt overhang just continues to grow.
Could the “Renzi-rendum” trigger a $500 trillion derivatives meltdown by forcing the EU to allow insolvent member governments and banks to write down debt? Italy is in financial crisis and is already petitioning for that concession.
At this point, the fall of the global financial house of cards seems unavoidable. The big questions are timing and the exact nature of the meltdown. Italy’s no vote brings us one step closer to the edge.
The EU was constructed at high speed and made up of economies that are very different: different in culture, language and economic strength. Italy has one of the most indebted governments world-wide. It’s debt-to-GDP ratio is over 130 percent! And Italy’s government spending accounts for more than HALF(!!) of the country’s GDP. There are simply not enough Italians to pay the taxes and finance the growing deficits and debt much longer. Thanks only to the outrageous manipulations of central bankers, Italian government bonds are still trading at record-low yields.
The Italian banks are close to folding, and yet more than Euro 1 Trillion worth of Italian bonds are in negative yield territory. Based on the high-risk profile of lending to a bankrupt Italian government, under normal times and circumstances, the yields on Italy’s government bonds should be at record highs, not record lows. That is the smoke-and-mirror substance the current banking system is made of in Europe – and around the globe.
Fragmenting forces are growing across Europe. More and more Europeans are joining a separatist mindset and movement; they want out of the Euro straight-jacket. Unfortunately, it has become very clear that the establishment will defend the Euro and the current EU structure tooth-and-nail. What can be expected is more government intervention and large-scale central bank manipulations. You can be assured that governments will, as always, try to prop up and rescue the banks. The ECB has already announced, once again, that it “will do whatever it takes”.
Only now, “whatever it takes” is becoming more and more difficult and costly. Italy is close to bankruptcy. Many of its banks are broke. Shares of Italian banks have lost more than 50% of their share values year to date!
Socialists continue to love the illusion of cradle-to-grave support systems, financed by SOMEONE ELSE. They want more and more big government. And, they’ve been successfully pushing ahead in that direction for a long time now. We are coming to a secular crossroads. The imbalances are gargantuan. Even the starkest leftist should know from fact that big government spending stifles an economy’s productivity and efficiency. Merkel is right: we live in a post-factual world. Only, it is her and her globalist-big-government buddies who are neglecting the facts altogether.
So, here we are: The Italian government is close to insolvency, save the interventions from the ECB and other European countries. The question is whether the rest of Europe will bail Italy out? The backing of the Europhiles is melting away. The longer it takes, the uglier the mess it will leave behind.
A few commentators and experts have been warning us for some time now. Our friend, Felix Zulauf, has been emphasizing the need for the Euro to be replaced by national currencies as soon as possible, before a rough and rapid EU crisis sets off another meltdown in financial markets. The Euro is the brainchild of European politicians who thought they could force Europeans to become EU-ers by thumping the Euro onto them. The problem is that a joint currency should come at the end of an integration process, not at the beginning.
Derivatives – the one topic everybody is silent about
The unprecedented global expansion of credit over the past few years seems to be the last-ditch effort to keep a flawed and corrupt system going.
What seems likely is a massive global financial crisis caused by cascading failures of financial fantasies – derivatives, interest-only mortgages, inflated real estate prices – and exacerbated by banks calling in loans and restricting credit to legitimate businesses as they continue to fund government deficits to finance waste, war, and “welfare” transfers of wealth.
Yet, there is very little written about derivatives. The statistics of derivatives are readily available, for example, via the regular surveys of the Bank of International Settlements (BIS). Here are the highlights from their combined semi-annual and triennial surveys at end-of-June, 2016:
“New data show that central clearing has made very significant inroads into OTC interest rate derivatives markets but is less prevalent in other OTC derivatives segments. As of end-June 2016, 75% of dealers’ outstanding OTC interest rate derivatives contracts were against central counterparties, compared with 37% for credit derivatives and less than 2% for foreign exchange and equity derivatives. Overall, 62% of the $544 trillion in notional amounts outstanding reported by dealers was centrally cleared.
“The gross market value of OTC derivatives – that is, the cost of replacing all outstanding contracts at current market prices – rose to $20.7 trillion at end-June 2016 from $14.5 trillion at end-2015. The market value of foreign exchange derivatives involving the yen and pound sterling more than doubled in the first half of 2016 on the back of sharp moves in the respective currencies.
“Outstanding positions in OTC derivatives markets are concentrated among major dealers. Of the $544 trillion in notional amounts outstanding at end-June 2016, $512 trillion (94%) was reported by dealers from the 13 countries that participate in the BIS’s semiannual survey, and $32 trillion by dealers that participate only in the Triennial Central Bank Survey.”
No worries: if this doesn’t really tell you much, you are not alone. Quite possibly the reason so little is written about the global derivatives exposure is that it is so hard to understand.
In essence, the BIS states that the global exposure to derivatives has improved. The outstanding notional amounts are lower than they were in 2015, and 75% of “dealers’ outstanding OTC interest rate derivatives contracts were against central counterparties”. In other words, not to worry, the biggest part of the contracts are covered by the big players: governments and big banks.
Well, that should really comfort all of us. Is Italy one of those safe counterparties? Yes, of course, just as Spain, and Portugal, and Japan, and the USA…. You get the picture.
The Exposure to the Derivative Markets: An Understandable Explanation
Instead of giving you more academic gibberish on the topic, we’ve decided to simply share a story: a 101 primer on derivatives for the layperson, so to speak. We had come across this gem (author unknown) in 2009 after the last financial crisis, when people were earnestly trying to figure out what the MBS, CDO and CDS abbreviations really all meant.
So here it is – a lay-person’s explanation of the global financial meltdown that us ordinary people will be able to relate to. This will be helpful. Be sure to grab a good hot cup of coffee and learn a lesson that might help you in the mess we expect ahead:
Heidi is the proprietor of a bar in Detroit. In order to increase sales, she decides to allow her loyal customers – most of whom are unemployed alcoholics – to drink now but pay later.
She keeps track of the drinks consumed on a ledger (thereby granting the customers loans). Word gets around about Heidi’s ‘drink now, pay later’ marketing strategy and as a result, increasing numbers of customers flood into Heidi’s bar and soon she has the largest sale volume for any bar in Detroit. By providing her customers’ freedom from immediate payment demands, Heidi gets no resistance when she substantially increases her prices for wine and beer, the most consumed beverages. Her sales volume increases massively.
A young and dynamic vice-president at the local bank recognizes these customer debts as valuable future assets and increases Heidi’s borrowing limit. He sees no reason for undue concern since he has the debts of the alcoholics as collateral.
At the bank’s corporate headquarters, expert traders transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS. These securities are then traded on security markets worldwide. Naive investors don’t really understand that the securities being sold to them as AAA secured bonds are really just the debts of unemployed alcoholics.
Nevertheless, their prices continuously climb, and the securities become the top-selling items for some of the nation’s leading brokerage houses. Then one day, although the bond prices are still climbing, a risk manager at the bank (subsequently fired due to his negativity), decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi’s bar!
Heidi demands payment from her alcoholic patrons, but being unemployed, they cannot pay back their drinking debts. Therefore, Heidi cannot fulfill her loan obligations and claims bankruptcy. Both DRINKBOND and ALKIBOND drop in price by 90%. PUKEBOND performs better, stabilizing in price after dropping by 80%. The decreased bond asset value destroys the banks liquidity and prevents it from issuing any new loans.
The suppliers of Heidi’s bar, having granted her generous payment extensions and having invested in the securities, are faced with writing off her debt and losing over 80% on her bonds. Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off fifty workers. The bank and brokerage houses are saved by the government following the dramatic, round-the-clock negotiations by leaders from both political parties. The funds required for this bailout are obtained by a tax that is levied on employed, middle-class non-drinkers.
Finally, an explanation we can all understand…and one that unfortunately shows the real severity of the problem at hand.