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The original
parameters used to construct the European Monetary Union were set up by the
Maastricht Treaty of 1992. The Treaty on European Union contained
strict limits on debt and deficits. In particular, deficits were not to
exceed 3% of GDP and gross public debt was to be south of 60% of total
output. Today, not even Germany can claim to have held true to those
strictures. In fact, all but a few countries in the EU have egregiously
violated the Treaty’s mandates.
However, we
are now being told that a new Maastricht Treaty—let’s call it
Maastricht Light—is to be adopted by those permanently-profligate
Western European Nations. The European Summit meeting held last week
proposed a blueprint for member nations to curb deficits and also to bolster
the bailout fund. In other words, this time is different and now they
really mean it!
But there are
some significant problems with this latest solution. For starters, how
will violators be sanctioned and what enforcement mechanisms can there be?
For example, if the new plan is to throw out transgressors of this new treaty
then what is the excuse for not starting now? More importantly, how can
a country already having a debt to GDP ratio north of 100% pare down their
debt to a viable level? In order to become a member in good standing in
this new frugal club of nations; Portugal, Italy, Ireland, Greece Spain and
perhaps even France and Germany, must first default on a significant portion
of their debt.
But the act
of defaulting in trillions of Euros worth of debt will lead to a depression
in the Eurozone, if not the entire globe. Therefore, I expect the new
name for this agreement coming from the European Summit meeting should be
called Maastricht Light. But this new treaty will be much shorter in
duration and profoundly less effective than the first…
In the
interim, global markets continue to be held hostage by the ECB and its
(UN)/willingness to massively monetize Eurozone debt. The covariance of
most assets is currently extremely high because of debt levels that are also
near their apogee. Last week we received further confirmation that the
economy just isn’t deleveraging.
The Flow of
Funds report, put out by the Federal Reserve, showed that Total Non-financial
debt is at 250% of GDP.
That’s
the same level it was in Q3 2010 and also in 2009. Due to the
precarious level of debt in the developed world, the direction of the dollar
continues to dictate the direction of markets. Whenever the ECB
communicates clues to the markets that it may buy-up insolvent EU (17) debt,
the dollar drops, as most asset prices rise. And whenever ECB President
Mario Draghi steps away from that eventuality, the
dollar rises and global asset prices fall.
It appears,
from his statement released last Thursday that Mr. Draghi
is currently a bit reticent to bring back the good old days of Weimar
Germany. But sadly, he is a politician like all central bankers and sooner or
later will succumb to the pressure engendered by a depression. Much
like our own Treasury Secretary Hank Paulson acquiesced to borrowing and
printing trillions of dollars after facing the collapse of the entire U.S.
banking system, which was brought about by the imminent insolvency of AIG.
Investors
should be aware that gold and other commodities will experience extreme
volatility in 2012--even more than what was witnessed in 2011. However,
the timing for the next move to new highs will hang on the ECB’s
deployment of its ultimate plan of massive monetization of unsterilized
European debt.
Michael Pento
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