Notes From Underground: To Sarkozy, A Child is Born (While Berlusconi Cuts Off His Balls)

My 10-day hiatus is over and, lo and behold, Europe is still center stage. The drop-dead date of October 23 has been pushed back to October 26, with Merkel promising that there will be a comprehensive resolution, which will mean more Europe. The problems have not been resolved as to how big the BANK RECAPITALIZATION will be, for that will be dependent on the size of the haircuts on Greek debt that the banks will have to absorb.

The effects of the NEGATIVE FEEDBACK LOOP on the Greek budget are driving the costs of the Greek bailout higher as NOTES forewarned 18 months ago. Economies cannot correct past profligacies by solely instilling austerity measures without some DEBT reprieve and, most usually, a CURRENCY DEVALUATION. A domestic devaluation of squeezing wages and downsizing government budgets will only result in a DEPRESSION, which is why the Greek citizenry is taking to the streets. (The Greeks see it only as PAIN without GAIN.) The issue on Greek haircuts is still about the impact of large European banks who have loaded up on sovereign debt as the backbone of their holdings.

French banks stand to lose large amounts of capital on an increase in the HAIRCUTS but the negotiating position of the French diminishes everyday. President Sarkozy was laughing over the past year as he was able to defeat Germany’s desire to instill Axel Weber as the ECB President. Sarkozy also found great delight in pushing Chancellor Merkel to accept an enhanced EFSF backstop plan in the July 21 agreement over haircuts on Greek debt.

The more skirmishes that Sarkozy seemed to win, the greater his bravado. At the same time, the resolve of the GERMAN PARLIAMENT and CONSTITUTIONAL COURT HAS HARDENED. Chancellor Merkel was being beaten in every local election as the BAVARIA BURGHERS were taking out their anger on the EUROPEAN BAILOUTS by defeating CDU candidates on the local level. It now seems that Merkel understands that the French government is in a very tenuous position as Sarkozy loses popular support heading into 2012’s presidential election.

The French banks are a severe problem as any massive writedown of SOVEREIGN PERIPHERY DEBT will cause the FRENCH GOVERNMENT to provide capital to shore up the balance sheets or else outright NATIONALIZE the insolvent institutions. Either way FRANCE will lose its highly valued AAA credit rating. In a year that was supposed to be Sarkozy’s victory dance as the President of the G-20 and G-8, it has been a year of disaster and defeat for the “SMALL MAN IN SEARCH OF A BALCONY.”

The final blow to Sarkozy’s stature came on Thursday when Silvio Berlusconi stabbed President Sarkozy in the back. The Italians and French had agreed that Lorenzo Bini-Smaghi an Italian EXECUTIVE BOARD MEMBER OF THE ECB, would relinquish that role and assume the head of the Bank of Italy as Mario Draghi becomes the President of the ECB. Bini-Smaghi’s ECB seat would be given to a Frenchman as TRICHET departs the scene. Silvio Berlusconi, sensing Sarkozy’s weakness, pulled the plug on the deal and named a Bank of Italy insider, Ignazio Visco, to the BOI’s Presidency and thus leaving Bini-Smaghi in his seat on the ECB EXECUTIVE BOARD.

To say that Machiavelli is alive and well in Brussels is an understatement. It is not only the French and Italians struggling with each other but also the French amongst themselves. Rumors abound that in Saturday’s Finance Ministers meeting, IMF DIRECTOR Christine Lagarde was arguing about Greek debt haircuts with French Finance Minister Francois Baroin. Remember, it was Baroin who succeeded Lagarde, so the open conflict between the two is somewhat disconcerting.

Lagarde was demanding that the Greek debt haircuts be at least 50%, thus creating a difficult position for French finances. Mr. Baroin must not have understood that with Lagarde in charge of the IMF Treasury that the international community would ultimately be a main source for any massive European bailout.

The game of intrigue being palyed out in Brussels and Frankfurt did not result in the usual result of RISK OFF force at play in the financial markets. The DOLLAR actually weakened on Thursday and Friday and the S&Ps rallied strongly even in the face of growing European uncertainty. HOW COULD THE DOLLAR SELL OFF IN THE MIDST OF GERMAN INTRANSIGENCE AND ITALIAN POLITICAL INTRIGUE? It seems that the moving force behind the EQUITY RALLY and DOLLAR SELLING were comments made by FOMC GOVERNOR TARULLO AND FED VICE-CHAIRMAN JANET YELLEN.

It seems that Yellen is more worried about the threats to the global economy, especially as the EMERGING NATIONS are beginning to slow and have a negative impact on U.S. EXPORTS. Throw in the effects of EUROPEAN AUSTERITY and the possibility of a recesssion in the core of Europe and Yellen believes that the reemergence of deflation is a reason for the FED to pursue further monetary stimulus. The FED VICE-CHAIRMAN also fears a negative economic impact from the desire of Congress to move too fast to implement an austerity budget.

Daniel Tarullo is more concerned about the negative impact of the HOUSING SECTOR on economic growth. It may be time to rethink what further stimulus is needed as FED actions have had a minimum effect on relieving the drag from a moribund real estate market. NOTES FROM UNDERGROUND has argued for two years that Geithner and Obama have failed to aid housing because TIM GEITHNER was more concerned about protecting the banks. A major forced REFI program would have relieved the stress on many homeowners suffering under the the double burden of underwater mortgages and EXPLODING ARMS that have saddled them with ultra high monthly payments.


This is Schumpeter’s classic case of PUSHING ON A STRING. As the European situation remains fragile and the U.S. economy fails to generate JOB GROWTH,economic policy makers in Washington appear to be getting ready to generate a massive REFI program and most probably a new round of some type of FED stimulus. As Yellen emphasized, exports may also be a drag as the global economy slows, suggesting a weak DOLLAR is a desired element for export growth. When in Rome, do as Silvio does and generate your desired policies while others are weak and in turmoil.

2 Responses to “Notes From Underground: To Sarkozy, A Child is Born (While Berlusconi Cuts Off His Balls)”

  1. charles reeder Says:

    where were you- little nutsy?

  2. Peter Says:

    Excellent missive Yra.


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