All you need to know about the €100bn Spanish bail-out

It’s rarely worth your while salivating too long over financial news. It goes stale very quickly.

What really counts is trying to understand the knock-on effects of today’s news. Think about it in terms of snooker. It’s not potting the red that counts, it’s where the white ball ends up that’s most important.

Today I want to show you where the €100bn Spanish bank bail-out leaves the cue-ball. Many of us consider ourselves lucky to be out of the euro debacle and spectating from the sidelines. But underneath it all, I suspect you feel inextricably linked to this mess.

And from what I can see, the knock-on effect of the Spanish bank bail-out is heading our way.

A fascinating Ponzi scheme

The euro saga is fascinating to watch. I honestly believe that we’ll look back at these financial crisis years and wonder how things were ever allowed to escalate so badly.

Today we laugh at the incessant euro-fudging and can-kicking. No sooner is a solution proposed (and the can kicked), than another problem rears its head.

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I mean, the long-term refinancing operation (LTRO) idea was supposed to kick the can into the long-grass for at least a few years. Yet it barely lasted a few months. LTRO was the package where the ECB gave banks practically free money for three years or so. But I guess the markets saw through that one!

Then this weekend the latest can-kick was aimed at the Spanish banks. How long did that last? Not months, not weeks, not even days…

Prime Minister Mariano Rajoy was so elated with his fantastic bank bail-out that he flew off to watch his team play Italy in the European Championships on Sunday. It’s always the same. The euro-guys make some big song and dance and appear totally cock-a-hoop with their ‘fantastic’ solutions. Then the whole enterprise collapses.

Spain’s IBEX stormed upwards by some 5% as markets opened on Monday. Yet, by the end of the trading day, the index actually finished in negative territory. It didn’t take long for the markets to work out what was wrong…

Suddenly reality dawned on investors…

The problem in Europe is the same as for the rest of the West. Debt. I’ll try to put things simply…

Like us, they have too many long-term commitments. The assets of one (ostensibly pensions and savings) are the liabilities of another. And in reality, there’s nothing tangible there to back up these future claims/commitments.

Financial savings come down to promises. That is a promise that tomorrow’s taxpayers and borrowers will make good on their commitments to fellow savers and pensioners.

Never before have we seen such a massive experiment in financial claims. I guess, never before have we seen such a massive contingent of retirees in society.

But the problem is – and it’s what I always like to emphasise –  financial promises are only ever as good as the faith in them.
What we have seen in Europe is the dissolution of faith in financial promises, or if you like, ‘the financial system’.

It makes no difference what kind of can-kicking is undertaken. It only ever amounts to the same thing. And that is, pushing financial claims from one guy to another. And the more the problem gets passed around, the more faith in the financial system is damaged..

So far we’ve seen the problem pass between private banks, individual governments, EU institutions and then back to the banks as they buy up ever dodgier government bonds.

But if Spanish banks can’t make good on their promises, why should Spanish taxpayers? And if Spanish taxpayers won’t make good on their promises, then why should EU institutions? And if EU institutions won’t make good on their promises, then why should taxpayers in other EU countries?

You see how this can-kicking can’t ever work?

Come Monday morning, the €100bn loan to Spain had added a further 10% to its national debt. It’s obvious that isn’t good news for Spain. And so all the bluster of the political elite was blown away within hours of the markets opening on Monday morning.

And the burden moves ever closer to the UK

You may remember a few weeks ago when I said I could see exactly why France is fanatical about keeping Spain in the euro. French banks have loaned Spain around €41bn. And the French don’t want to see their investments go pear-shaped.

Well, now let me show you the UK’s big concern…

The UK banks’ massive exposure to Ireland

Exposure of world banks to Irish debt

Source: BBC

Now, if France was concerned about the €41bn it’s lent Spain, then where does that leave us with over €104bn of loans to Ireland?

And here’s the thing. Following revelations that Spain is getting what looks like a free-ride on a €100bn loan direct from the eurozone, many Irish are up in arms.

Post 2008, the Irish bailed out their banks. And it was ostensibly to save all the other nations that had lent to them. They were forced into seeking loans from the IMF – and those loans came with one big proviso – AUSTERITY.

And of course now the Irish are upset. Why should there be one rule for Spain, and another for Ireland?

Many want to renegotiate the whole thing. Others just want to renege on the whole IMF deal. They want to dump their commitments to bail out their banks. Why bother? Just so that the likes of the UK banks are made whole?

My advice – stay defensive

With every contortion of the eurozone it gets weaker. And at some point I see it dragging the UK into its vortex.

As I say, it’s fascinating to watch this debacle unfold right in front of our eyes. BUT we mustn’t get complacent. This is likely to affect us more than many realise.

My investments remain defensive. Recently I said that I’m 25% invested in high yield bonds – that’s because this debacle could play out for years – and I still want some income in the meantime.

I’m 25% commodities, which includes precious metals… the ultimate hedge against financial catastrophe.

And because of my defensive stance, I’m staying 25% cash.

I’m not saying eurogeddon will necessarily happen. But I do think it’s prudent to prepare for the worst. To my mind a nasty endgame is playing out right under our noses. The knock-on effects of what’s happening in the eurozone could be very dangerous for UK investors.

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  • Boris MacDonut

    Bang on the truth as usual Bengt. Ireland is an awful mess and we are badly exposed. You avoided mentioning Italy, well done. The point is sinking in that Italy is like Japan with only 20% mortgage debt, and nothing like broken Sapin.

  • Vaz

    dear Bengt
    Thank you for your great article. Please watch FOUR CORNERS on Australian ABC tv this week — all about the Euro and what you have said all along. Great historical report upto the present.
    You described your allocations as 25% bonds, 25% cash, 25% precious metals. What was the last 25%? Also, with precious metals which metals would you include?

  • Dinsdale Broderick

    As with all MoneyWeek & other financial writers, they portray this crisis as if it started in Europe & is specific to this region. The USA is almost in as much trouble. It has been running huge budget deficits for so long, most financial commentators have got bored with it & assume it will “do nothing” for years to come & are largely ignoring it. Yet there is one of the main roots of the problem. Once reality sets in, the “US Debt Crisis” will rear its ugly head, paling the European issues by its size. It is then that a 1930’s – style stock market crash will unfold, knocking unsuspecting (over-confident) investors for six!

    We are not too far away from that Day of Reckoning.

  • Steve

    The chart is very informative. Why not complete the picture by showing how much the other countries in the EU owe each other.

  • Boomer

    Hi Bengt
    Several months back you tipped LTSB senior bonds (5.375% 2015 and 5.5% 2016). This I found comforting because I had both. LTSB has a lot of Irish debt. Is it time to sell? HMG is backing LTSB but it is also best able to change the rules!

  • Steve2

    Click on the ‘Source: BBC’ link in the article to find the debt diagrams for other countries. Bengt, thanks for the update on asset allocation percentges.

  • bengt

    Boomer

    I can’t ever remember tipping a lloyds bond… do you have a better memory than me – perhaps!!

    Dinsdale. You are quite right about the rest of the West being largely in the same hole as Europe (and I alluded to it in the article). But this article wasn’t about that…

    This article was about how when you shift financial ‘claims’ from one group to another, then gradually the faith in the claims is eroded. And this is what’s happening in europe today.

    And Vaz, the last 25% of my asset allocation rests with equities. I like EM and I like certain defensive western stocks.

    Thanks for all your thoughts. It’s great to get the feedback.

    bengt

  • RP

    No issue with the content, but the analogy doesn’t not fit the bill. If you kick a can down the road, when you finally get to it – it is still a can and you can kick it again. However if you stand at the top of a mountain and roll a snowball down the hill, it gets bigger and bigger – you chase it but can’t catch it, it keeps growing moving faster, eventually it’s out of control, you are helpless and until it triggers an avalanche and destroys everything in it’s path.
    This I’m afraid is a more appropriate analogy to describe this ridiculous FED,ECB, IMF, LTRO, Flip & Twist, Roll-the-dice money printing debt enhancing fiasco – SNOWBALL not a CAN!

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