What the hell took them so long?
After months humming and hawing, the credit rating agency Standard & Poor’s has finally come out and said what the markets have been saying for months: Europe is crocked.
This week S&P put practically the whole of Europe on “negative credit watch”. That means there’s a fifty-fifty chance that the sovereign bonds of 15 of the eurozone’s 17 countries will be downgraded over the next 90 days. S&P isn’t the only bond rating agency in town, but alongside Moody’s and Fitch it’s one of the big three – many institutions base their investments on what they say. That means we can’t ignore them.
Of course that’s exactly what European ministers want us all to do. They’re livid that S&P, a US business, is poking fun at them and their bonds. They’ve threatened to take action against these nasty messengers of doom before. But that’s the point, S&P is only the messenger – the markets are well ahead of the game.
I suspect that S&P finally woke up last week when Germany suffered a failed bond issue. If Germany is having trouble raising funds, it presents a clear and present danger to the whole European financial system.
It seems like only yesterday that the US Treasuries were downgraded by S&P. Yet even after the downgrade US bonds have held up remarkably well. So, does this mean we can ignore S&P’s Europe downgrade as irrelevant?
No chance. This is as serious as it gets.
As my colleague Tim Price says in his latest report: “Europe’s debt crisis has entered a dangerous new phase… one that I think edges the average investor’s money closer to disaster. “
And that could mean you. Today I’ll explain why you need to get ready for a complete re-boot of the financial system.
The bond markets are dictating things now
Rating agencies are paid to go out and assess the credit risk of bonds. They assess the corporate bonds I’ve been writing so much about recently too. They grade the bonds according to the risk that the investor won’t get his money back. How do they work out ‘credit risk’? Well, they’ll tell you that they look to company, or national accounts. They go out and gather as much market data as they possibly can, crunch the numbers and come out with a smart assessment based on all the knowable facts.
Poppycock!
It strikes me that what they actually do is watch the action in the bond markets, see which bonds the market thinks look dodgy and then they grade the bond accordingly. After all, the theory states that the market knows everything that is knowable about the stock and reflects it in the price. And because the agencies use this ‘smart’ tactic, it means they are never wrong. That’s why no investment grade bond has ever gone bust. As soon as the bond is marked-down in the market, the rating agencies notice and put in their downgrade.
The only way out is to print money!
They should have noticed before now that the bonds of most European nations are no longer ‘risk free’. In fact there should have been a downgrade. The risk now is that the ECB will continue to sit on its hands. Without a bit of money printing from Europe’s central bank I fully expect to see a continued sell-off for European bonds.
And that could be nasty – it leads into a devastating vicious circle.
The banks holding the rotting eurobonds will need to be propped up. And who does that? Government of course. The Irish are deeply in hock to the IMF as they were forced to recapitalise their banking industry. The French and Belgians are dealing with the recent collapse of Dexia – again the figures are mind-bogglingly large. And of course, here in the UK, we taxpayers are still counting the costs of bailing out our own miscreants.
James McKeigue explains .
In fact as Tim Price points out, practically all of Europe’s big banks hold largely worthless IOUs from these semi-insolvent countries.
More bank bail-outs would put serious pressure on government finances. That means government bonds look less appealing to investors. Even German bunds! Yes, though Germany is an economic stalwart it has a massive banking industry too. And so you have it, a deadly vicious circle.
The only way out is for the central bank to print money. But we’re not going to get that (not yet anyway).
News is already leaking out.
Get ready for a re-boot of the financial system
This week’s summit of European leaders will supposedly culminate with the issuance of a new and improved Eurobond. One that’s backed collectively by all the nation states. And what’s a bond ultimately backed by? Tax of course. So now they’ll need to bring together Europe’s tax-collectors too. I guess the Germans are going to show the Greeks how to improve their tax-take.
Oh dear, oh dear. Not only will this not solve the bank and government solvency problem, it’ll also upset voters up and down the so-called European Union.
Still, the good news is, the markets will probably enjoy whatever’s announced on Friday. Sarkozy’s got a presidential election looming in 2012… he needs to hold back the tide at least until then.
But over the long run the bond markets will see through the ruses. The truth will out in the end. And it’ll be ugly. It’s what I like to refer to as a financial system re-boot. I’ll talk some more about how that can happen shortly. But for the moment, get hold of some gold.
How much? Tim Price recently told me that he has 50% of his wealth in gold. That stopped me dead my tracks. But after reading his latest report, I can see where he is coming from.
As far as I’m concerned the safest bet is physical gold. Go for sovereigns, krugerrands, US eagles, or Canadian maples. My recommendation is between 5 and 10% of your investment portfolio in physical gold.
On top of that, I’ve also got shares in some of the world’s biggest gold miners through the Market Vectors Gold Miners ETF I mentioned before. I still say that gold miners are good value today. They aren’t reflecting gold’s strong run, as Dominic Frisby explained in today’s Money Morning. Another 5% in the miners could be a shrewd move – especially if Tim’s right.
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