More On Greece And More QE

One of the biggest issues in Europe at the moment is whether or not Greece will exit, or be allowed to exit, the EU.  My view is that the massive bailouts that have been going on globally since 2008, starting with the massive taxpayer bailout of the big U.S. banks, are about saving the banks and not about saving countries. Because of this, I would argue that Greece will be kept in the EU family and the financial systems in Spain/Italy/France/England/U.S. will be re-monetized, likely in that order.

But let's look just at Greece for a moment.  It has been estimated that the big banks have around $60-70 billion in derivatives exposure to Greece.  The "net" exposure is supposedly around $3 billion.  Of course, we are now seeing with the JP Morgan derivatives meltdown going on that the "net" number reported by banks and widely accepted by regulators and institutional investors is not to be trusted.

I think it's probably fair to estimate that, in a chaos, "2-sigma" scenario, that the likely "net" exposure to Greece via derivatives is at least 50% of the notional.   Mind you, this estimate rests on the viability of the counterparties who have issued payment guarantees in the event of default being able to stand up their side of contract.  This is not a given.  But let's go with 50% for the sake of running a "stress test" (note:  a realistic stress test as opposed to the Fed's fraudulent version of a stress test - see JP Morgan for more proof the Fed is full of shit).

Now let's run through the math if Greece leaves the euro.  If this happens, Greece would reinstate the drachma as its currency, which would then start trading against all other fiat currencies (plus gold) in the world forex market.  It has been estimated that a new drachma would likely trade at about 30-40 cents vs. euro, so roughly 38-50 cents vs the dollar.  Now,  what happens to the value of a credit default swap on Greek debt that was denominated in euros but is now denominated in drachmas, because Greece would now be paying those debt claims back in devalued drachmas? 

For the sake of argument, let's say banks which are the largest underwriters of credit default swaps have 90% of the exposure to Greek credit default swaps.  This is actually a quite realistic assumption per the quarterly BIS report on OTC derivatives, with JP Morgan by far the largest underwriter of these instruments.  This would mean that U.S. banks likely have gross derivatives exposure $45-63 billion in Greek credit default swaps.  If Greece were to revalue and repay its debt claims using drachmas, it would mean that the big banks like JP Morgan would potentially be on the hook for their ratable share of $22-32 billion in credit losses.

I personally do not believe that the big banks/central banks will allow this happen and will therefore engage in some kind of coordinated money printing, bailout operation.  It's already being done in the "disguised" form of the massive dollar/euro swap facility that has been put in place by Bernanke.  We would love to see the details of this swap facility - like how much is used, by whom is it being used and what's the current market value of the swap - but the Fed has spent a considerable amount of money to legally keep these details undisclosed (so much for the new Fed transparency policy).

Now take the Greece scenario and multiply it out by roughly 4-5 multiples for the potential Spain problem, and so on for Italy and France.  And make no mistake about it, Germany/Merkel understands this, as Deutsche Bank is probably the largest credit default swap underwriter after JP Morgan.  This is why Merkel and has been backing down from her "no more bailouts" stance is starting to issue statements of support for some kind of structured bailout for Spain.

The liquidity in the entire western financial system is starting to dry up and it will require a lot more printing in order to avoid a massive banking system collapse.  We are starting to see all of the Fed officials - even the liquidity hawks - make statements in recent speeches with allude to "all options are still on the table" with regard to more QE.  See speeches yesterday from Lockhart and Evans, for example.  And just yesterday one of the chief policymakers for the Bank of England made the statement that Bank of England should consider buying more than just Government debt to facilitate QE:  LINK

I would also argue that this is the reason we are seeing the eastern hemisphere Central Banks ramp up their purchases of physical gold:  LINK  Gold is starting to shift into view as a primary store of value.  In fact the Central Bank of Turkey - Turkey being one of the largest importers of gold in the world - is now allowing commercial banks to count gold as part of their capital reserve calculation:  LINK

Several people asked me why, in the absence of any specific news, gold and silver spiked up this morning about 30 minutes into Comex trading.  The only explanation I can think of - again, in the absence of any specific news - is that the smart, wealthy pools of capital around the world are finally starting to move a lot of capital into physical gold and silver in response to the "print or collapse" corner into which Europe and the U.S. have painted themselves.

The only way to protect your wealth against what is coming our way is to own a lot physical gold and silver.  This would unequivocally not include any ETFs like GLD (although it would for sure include PHYS and PSLV if you own enough shares to convert your shares into delivered bullion).