The EU is drowning debt and heading into recession. What if Germany can’t save Europe, either by contributing more dough to a eurozone bailout fund or by pressuring the European Central Bank to buy the debt of troubled nations such as Greece, Italy, and Spain? A currency breakup would inflict huge financial and political costs that would surely damage the U.S. economy, as well. Would Federal Reserve Chairman Ben Bernanke and President Barack Obama really just stand by and watch Europe drag America down with it? And in an election year? Coming to profligate Europe’s aid would cause a political firestorm worse than TARP with both the Tea Party and Occupy movements hammering Washington. But yet it is not out the realm of possibility …
Scenario One: Obama goes for a SuperTarp (via John Ellis of Business Insider):
In the days leading up to the collapse of Lehman Brothers, then French Finance Minister (now IMF Managing Director) Chistine Lagarde told then-Treasury Secretary Hank Paulson that he could not allow Lehman to fail. The ramifications would be catastrophic, she said. She was mostly right. Three years later, it will be Angela Merkel talking to President Obama,Treasury Secretary Geithner and Federal Reserve Bank Chairman Ben Bernanke with exactly the same message. The United States government and the Federal Reserve must come to the rescue of the Eurozone or the ramifications will be catastrophic. And she will say that she needs roughly $1 trillion in financial guarantees and liquidity support. That’s the number that will calm the markets. … And there will follow perhaps the defining moment of the Obama Presidency. If Obama goes forward and provides all or part of the $1 trillion guarantee, he will likely cut his own political throat in so doing. If Obama declines to go forward and provide all or part of the $1 trillion guarantee, he will likely preside over the second massively destabilizing financial panic in four years, thus insuring a second Great Recession, thus cutting his own political throat.
2. Scenario Two: Bernanke creates a Coalition of the Willing Central Bankers (via economic analyst Ed Yardeni):
Given the ECB’s reluctance to act, I suspect that the Fed will spearhead the formation of a Global Liquidity Facility (GLF) to avert a global financial meltdown. Fed Chairman Ben Bernanke demonstrated that he is a master at putting together such emergency measures back in 2008. In effect, it would act as the world’s central bank. Mr. Bernanke is clearly very worried about the prospect that the European sovereign debt crisis is a contagion that could spread to the US, as evidenced by his bizarre town hall meeting with troops returning from Iraq on November 10. The GLF would receive deposits from the Fed and other participating central banks, including the ECB. The funds would be used to buy the bonds of debt-challenged governments that would be required to accept strict supervision of their fiscal and regulatory policies by the IMF.
You might be thinking that I’ve gone mad. Actually, I’m simply predicting the behavior of our wild and crazy Fed officials. Last Wednesday, Boston Fed President Eric Rosengren noted that the Fed and the ECB worked together during the 2008 global market meltdown, and “if there was a (new) crisis I would expect that there would be some coordinated activities (again). We would want to make sure … that people have access to short-term credit markets.” He added, “We’re not at that point right now, but there are clearly stresses in short-term credit markets.” He said, “We’re watching that very closely, and if it becomes appropriate for us to take more actions to try to relieve that, I fully assume that we would do something.” Mr. Rosengren isn’t on the FOMC, but he is one of Mr. Bernanke’s most supportive colleagues.
3. Scenario Three: Bernanke goes all unilateral (via David Zervos of Jefferies):
A mass exit from or a complete breakdown of EMU will be determined by the German stance on monetization. There have been hundreds of calls by non-German Euro area leaders, US politicians, academics and private sector business leaders to monetize. And if the Germans block it in Euros, the printing presses in Drachma, Punt, Escudo, Peseta, Lira and Francs will surely be fired up once again. In the end of course there will be more paper money in the world chasing the same amount of goods and services – that is the end game!! The path to the end game is of course messy! And let’s face it, we would all like to avoid “messy” if possible.
There is one easy way to do that – get the Americans involved. The US can force monetization at the ECB. If the Colonel deems sado-fiscalism as a global systemic threat (which it is), the Fed could act. The Fed has an account at the ECB in Euros. When the pesky Europeans borrow dollars from us on currency swaps to fund their insolvent banks we get this lovely account. And right now the Euros just sit there! If things get messy we just jack the “unlimited” lines up, back up the forklift, and buy Euro area bonds. Lots of them. Say a trillion or two across all non-German markets. The Fed already owns nearly 100b in German and French bonds. And if anyone tries to default down the road, well we have a few hundred billion in European gold to confiscate in the basement of the NY Fed. And if that’s not enough we just institute “annual fees” for NATO membership or start confiscating European assets in the US. If the shenanigans in Europe are going to mess up a US recovery, or even a presidential election, then there should be a serious US response. We did not spend all that money on the Marshall Plan just to have Europe blow up the world again! Good luck trading.
None of this sounds too appetizing. Then again, neither does another major U.S. recession. 2012 maybe like 2008 — in all the worst ways.