On the Ratio of Rich to Poor Uncles

Once again the fragility of the European PIIGS sovereign risk is findings its way back into the news which is another problem the global economic and financial community would like to be without. The pricing of Greece’s sovereign debt has slipped again to yields of 13% so that it hardly qualifies as investment grade either by the market or by the rating agencies. This slippage in pricing although not back to the panicky levels of last April and May strongly suggests the market is once again giving up on Greek debt despite the bailout underway. On top of that Ireland this past week has decided to bite the bullet and complete a banking sector bailout that runs its current year fiscal deficit to 32% of GDP further straining the credibility of Euro sovereign debt.

So we now need a bailout fund to fund the individual country bailouts. The bailout vehicle put together to purchase the weak Euro sovereign debt is a Special Investment Vehicle (SIV) as explained last May in The Smoke and Mirrors of the Greek Bailout Package has consisted of rounding up other willing and perhaps some unwilling Euro sovereigns and their institutions to fund the SIV to allow it to purchase shaky sovereign debt. How the bailout entity is being funded is by soliciting Rich Uncles to fund the purchase of irresponsible Poor Uncle’s debt within the Euro family of governments. The Rich Uncles thought it only fair that the Poor Uncles also partake in the bailout so the bailout entity is funded by all including the Poor Uncles. But it is the ratio of Rich to Poor uncles that provides the financial insurance to the Poor Uncles. Since there are few genuine Rich Uncles in the Euro zone, the EU with limited taxing capability, the IMF and the European Central Bank despite a charter commitment to not engage in country bailouts have been recruited to be Rich Uncles.

As one would expect given the general shakiness of the income behind the Poor Uncles and the Rich Uncles for that matter, portfolio managers have used the opportunity since the bailout fund was established to unload their sovereign debt position with most being purchased by the ECB. Additionally, the body politic of at least one Rich Uncle, Germany, as one would imagine is now questioning its participation when the agreement expires in two short years.

One hailing from the US might find this arrangement of “support” difficult to understand but it is analogous to the FDIC which guarantees losses from broke bank’s deposits being funded through deposit insurance premiums paid by the same broke banks and a handful of banks that would become broke if they tried to support the deposit obligations of the entire system. That is, the Euro bailout is not without precedent and to some extent is modeled after US deposit insurance guarantees. The chilling fact is there are too few Rich Uncle banks to support all the Poor Uncle banks so the FDIC fund is also transparently broke but the FDIC sticker displayed by all banks still gives US depositors a sense of comfort and they line up to deposit at exceedingly low compensation perhaps because the US taxpayers will be the Rich Uncle. More smoke and mirrors as the US government with its sizable deficit and explosive entitlements and a weak growth economy hardly qualifies as a genuine Rich Uncle any longer.

The Euro bailout package is explained in the smoke and mirrors referenced above and the absurdity of the package is perhaps best explained by the penetrating dry British wit contained in the following video clip. Yes, it’s almost that bad except perhaps it s worse in that the Rich Uncle of last resort has been the European Central Bank which has given up on its charter of being the stalwart Rock of Gibraltar of monetary conservatism of not being forced to print and purchase the sovereign debt the market will not. The larger stakes in the game are not saving PIIGS debt and their ability to continue to fund debt that cannot be serviced, but whether the monetary union will not in turn crumble if investors abandon the currency and hence eliminate the primary benefit of the monetary union’s reserve currency status that provided its businesses greater access to private global capital on favorable terms.

Once again, the short run beneficiary of PIIGS distress are Dollar fixed income holders as the 2009 US capital outflows has turned back into a US capital inflows that has put the US fixed income market in somewhat of a bubble since by comparison only, US sovereign debt is relatively safer….at least for now. Enjoy the video clip if you can laugh through the tears.

This all leads to the notion that it is time to give up on the “responsible” developed world financial claims including US fix income claims that are in a bubble and find an investment manager skilled in the art of finding and dealing with islands in the sun, perhaps called, Australia, New Zealand, Norway, Denmark, Canada, Brazil, etc. where the Rich Uncles are truly rich.

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