Europe Under Attack

By Kevin Freeman
August 04, 2011Aug 04, 2011

You probably won't hear this reported anywhere else. However, the problems today (including the stock market mini-crash with the Dow falling more than 500 points) were precipitated by direct assaults on the Italian, Spanish, French and Belgian economies by market participants. Credit Default Swaps jumped markedly despite European efforts to calm the situation. Market participants are going after the weak players in Europe in much the same way they went after Lehman Brothers in 2008:

"THE European Union voiced support for Italy and Spain under attack on financial markets but acknowledged that investors now doubt whether the eurozone can overcome its sovereign debt woes."

At present, the blame is being laid at the feet of Wall Street Hedge Funds according to Euro Intelligence reports:

Italy is now under a speculative attack from a number of US-based hedge funds. 10-year Italian bond spreads have reached 2.446% this morning, and Spanish spreads 2.865%, levels that are not sustainable. The euro dropped by 2 cents to $1.4186.

Consob (the Italian market regulator) imposes short-selling restrictions on Italian equities and bonds. When this happens, you know it is serious. The Italian stock market regulator Consob yesterday imposed short-selling restrictions on Italian equities and treasury securities, requiring investors give notice of any short position they hold in Italian treasury securities. This is not a ban on short sales, only a transparency directive, which, according to La Repubblica, is in line with EU rules. The measure takes effect today, and will last until September 9. . .The purpose of the measure is to reduce the extreme volatility in recent share price movements.

It is a simple thing to blame Wall Street Hedge Funds. As in 2008, however, there is the possibility that whoever is moving the markets has more than profits in mind. Without transparency, we cannot rule out the possibility of financial terrorism or economic warfare with the intention of destroying the Euro and European Union. In fact, there are some quiet suggestions that this is in fact what is happening.

In our 2009 report and subsequent media coverage, we described Phase Three as an attack on Sovereign Credit and currencies. Our primary emphasis was a concern for the U.S. dollar but the same logic applies. In fact, we described the trigger mechanism as an unsustainable debt posture, something we face in the U.S. but an even bigger problem for the European Union at this juncture. At the moment, problems in Europe have made the dollar and U.S. Treasuries look temporarily attractive. However, a collapse of a major European economy will set us up as a future target. Dominoes can and do fall as we saw with the failure of Bear Stearns then Lehman leading to a near collapse of Goldman Sachs (even though Goldman was considered substantially stronger at the time).

The reason that the United States has held up better so far is the single fact that our dollar is considered the reserve currency of the world. If it weren't for that, our government debt would be prompting market attacks. As things stand today, however, investors who panic are selling everything else and moving to cash which means holding dollars and U.S. Treasuries. If the dollar's reserve status is removed, we will be hostage to economic warfare and financial terrorism.

The troubling thing is that we are already hearing that several major players are planning to attack the dollar's unique status. At present, this would appear unlikely as there are few places that seemingly could absorb sufficient capital to replace the dollar. Nevertheless, history has numerous examples of failed currencies and shifting monetary systems.

We have already demonstrated that the Chinese consider their dollar and Treasury holdings as potential economic weapons. Most economists appear unconcerned, certain that the Chinese have little choice but to hold their dollar reserves. Rest assured, the Chinese are searching for alternatives as they have publicly expressed serious concerns with the dollar. One former Chinese central banker has even suggested that the reserves could be redeployed into global stocks. Imagine a half-trillion dollars moving from the Treasury market into public companies. While direct investment might be difficult, the assets could be deployed through non-transparent mechanism according to quotes in the August 1, 2011 edition of The Wall Street Journal:

China has nearly $3.2 trillion in foreign exchange reserves and some estimates put as much as 70% of that in dollar assets. But Chen said China needs to look elsewhere over the longer term and the protracted battle over the deficit may force Beijing to speed up the process. Chen said that some of its money could be put into direct investments in emerging markets. China has competitive advantages in Asia's emerging markets as it is a much sought-after investment partner, he said. Chen, who previously worked as a senior manager at sovereign wealth fund China Investment Corp. as well as at the central bank, said China is in urgent need of diversifying the management of its foreign exchange reserves.

He said China should divide its foreign exchange reserves into multiple management vehicles–each with a different purposes. China needs about US$1 trillion for its liquidity needs, and low-yielding Treasury bonds are the investment vehicle of choice for that purpose. The other segments of the reserves should be invested in higher yield areas such as publicly traded equities, private equity and hedge funds, he said. China should also consider setting up special funds to purchase strategic assets, such as key resources, or supporting Chinese companies moving into offshore markets or acquiring high technology products overseas, he said.

The point is this:  Today's market sell-off further underscores the risks of global economic warfare and financial terrorism. Our policymakers and national security community needs to wake up to these risks, study them carefully, and begin preparing response doctrines.

All posts Copyright (c) 2011 Kevin Freeman, All Rights Reserved