Project Babylon anno 2011

Canadian ballistic expert Gerald Bull was a genius. At the end of his career, he developed a super piece of artillery with a barrel of 150 meters long, capable of shooting satellites from mother earth directly into orbit. He however sold the knowledge to the wrong people - Saddam - and was shot dead in in front of his Brussels apartment in 1990 (rumor goes it was Mossad but that's just a "wild" guess). The idea of building a super gun to launch satellites already in itself is pretty mind blowing ; the fact that it is even practically feasible, takes this experiment even one stage further.

Turning back now to the current financial crisis . Also here the numbers are mind blowing and impressive indeed. Let's first have a look at recent stress test results for banks and the amount required in case of a Greek structured default (ie, the barber effectively cuts the hair by 30% or more). Depending on how Basel would like to impose minimum requirements on Tier I, it would simply imply that European banks are in search of at least EUR 250 bio new capital with a Tier I of 9%. And with bigger haircuts you can do the calculus yourself. And then comes a first choice : the current EFSF rescue fund - also known as super government CDO and supported by the IMF and Euro zone members - only disposes of EUR 440 bio firepower. A "mere" EUR 440 bio ? Yes, because apparently in order to back-stop the sovereign debt crisis in Europe, the bail-out fund would need something in the range of EUR 2000 - even EUR 3000 bio EUR. Just when you thought you had seen it all, here comes Joooohhhnnnyyy !! Why : because the last line of defense (Italy, no3) needs to be backstopped and that would involve an astronomical number as mentioned.

And then of course comes the second question : if even slightly possible, where will the money come from and who will guarantee ? The Euro-zone taking up the whole is out of the question unless some revolution in Germany takes place. In comes the supra-national level. Apparently a possible scenario would be for euro-zone members coming up with a credible plan to solve the banking problem, Greece and a credible budgetary medium term roadmap (new institutional reforms, stronger supra-national level authority etc). In exchange, the war chest of the IMF - currently USD 390 bio - would be fuelled by wealthy IMF members. Of the total roughly USD 10000 bio of global currency reserves, 40% is held by BRIC (Brazil - Russia - India - China, with the latter holding USD 3200 bio and the remainder for RIB). Looking at various studies, the worst-case scenario would involve the IMF raising as much as an extra USD 1000 bio. Apparently India, Russia and China would not oppose - in exchange for more power within the IMF - but Russia is not convinced. Furthermore, how to achieve this practically, since BRIC countries have used strategic currency reserves as a tool of exchange rate targeting. Bilateral lines of credit ?

But there is finally another "minor" detail involving the European side of the bargain. With the CDO construction and AAA guarantees, we could face a major problem if one of these AAA countries is downgraded. And then suddenly France (EMU no2) comes to our mind and the rating agencies are apparently already trigger happy to cast a negative outlook in the short term. Now when looking towards France, this shouldn't come as surprise. Since the first oil-shock in '73, France has never once managed to have a budget surplus or balanced budget. As a result - and also making a correction for business cycle developments - the French budget is one of the worst in Europe in structural terms. And finally, France is one of the last EMU members to give some sort of intention on how to achieve medium term debt convergence. And with election fever brewing as well, it doesn't seem to be a short term priority either. And France has come under a lot of market strain lately with its CDS pricing clearly no longer being AAA, barely AA. So we are running out of time and the same applies for Belgium as well : we are talking days here, not weeks to come up with something credible.

Now when after the following decisive weekend the solutions are presented next Monday, will it imply that we are finally of the hook ? My experience in the field is that the German interpretation is usually a good proxy :

"Dreams are taking hold again that with a future package, everything will be solved and fulfilled. I am afraid to say that the search for an end to this crisis will surely extend well into next year"

Steffen Seibert, Angela Merkel's spokesman, 17/10/11

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