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The Great Euro Unwind: How Will Germany Let It Go Down?


Germany could stagger the fall by allowing the ECB to monetize sovereign debt, but the question is -- why would it?

I'm sure that by now you've heard that German Chancellor Angela Merkel has tasked her government with drafting a blueprint for countries to abandon the euro without exiting the European union. It is difficult to assign causation between certain headlines and movements in the markets. However, I doubt it is a mere coincidence that French spreads to German bonds have completely blown out over the last seven hours, and rating agency Egan Jones, which downgraded the United States well ahead of the other agencies, is beginning to grumble over France creditworthiness.

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Some time back, I stuck my neck out suggesting that should Greece somehow default or leave the euro currency, there would be no way to backstop the ripple effects across Europe and indeed across the world. With the grand European Financial Stability Facility-1 trillion euro scheme left as a great sales pitch that attracted no takers, I might still end up being wrong (I hope I am), but every sign is now pointing toward the beginning of the end of the euro currency. While countries will go to the mat to effect this unwind in a gradual and orderly manner, if they were able to morph a Lehman Bros.-style collapse into a slow-motion train wreck, it would be truly a first in the history of financial crises.
With the two-year swap spread now at 45bps, Italian two-year rates at 6.4%, and a variety of other measures flashing full red, it may not be as useful anymore to watch the screens for further signs of danger.

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What we now need to start looking out for is people lining up to get their money out of those European banks, which everyone knows only still exist on a hope and a prayer. If we see that scene developing, it will likely be game-over in a matter of days. Will it happen? No one knows, but certainly it feels to me like what I have described for years as "not a story for today, tomorrow, or next week" might very well be "today, tomorrow, and next week's" story.
The only maneuver I can think of (and the only one anyone is discussing) to delay the inevitable and bring the unwind down the path of inflating the debt away rather than the optically more frightening default route would require Germany to close its eyes and tacitly consent to the monetization of sovereign debt by the European Central Bank. Good luck with that, but we shall see.
I agree 100% with Todd Harrison: We are living in a time that will be the history our grandchildren will read about in their classrooms. It is not going to be a pretty read, but since it is what it is, we've got to deal with it. On the bright side, for all the bazookas, bailouts, and financial alchemy brought to us by our utterly incompetent leaders, this unwind will indeed be a substantive solution to our problems, and it will lay the groundwork for future generations to prosper again.

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Positions in US Equities and Long-Dated Bonds
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