ITS CURTAINS FOR THE EURO

UNDERSTANDING THE CRISIS AND WHAT IT MEANS TO YOU

Bryan Rich

ITS CURTAINS FOR THE EURO

UNDERSTANDING THE CRISIS AND WHAT IT MEANS TO YOU

By Bryan Rich
2012. All Rights Reserved. No part of this E-Book may be reproduced or distributed without the written consent of Logic Fund Management, Inc.

Logic Fund Management, Inc.

2012 Logic Fund Management, Inc. All Rights Reserved.

Table of Contents
About the Author.. 4 Welcome and Introduction.. 5 Sovereign Debt Crisis Just Getting Started 7 The Euro: Flawed for the Beginning .. 11 The REAL Risk in Europe. 16 The music stops ONLY when the people say no more . 20 The End Game for the Euro . 22 How to Protect and Profit .. 22 Learn more .. 23

2012 Logic Fund Management, Inc. All Rights Reserved.

Bryan Rich is an entrepreneur and an accomplished currency specialist with more than 14-years of experience in trading, research, and consulting in the global foreign exchange markets. He is President of Logic Fund Management, a currency and macro advisory and consulting firm. Bryan began his career as a trader for a $600 million family office hedge fund in London. The macro-oriented fund managed assets for a prominent European family. Later, he was a senior trader for a $750 million leading global macro hedge fund located in South Florida. There, he helped manage and trade a multibillion dollar foreign exchange options portfolio.

His consulting resume includes work for a boutique currency fund in New York, where he developed trading models and strategy for the core investment program of the company. He later joined the company as a partner, based in their Wall Street office.
He has a BA from the University of North Florida and an MBA from Rollins College.
---------------------------------------------------------------------------------------------Follow Bryan at www.globalinvestorweekly.com and www.fxtraderprofessional.com.

2012 Logic Fund Management, Inc. All Rights Reserved.

Welcome and Introduction

Why It Could Be Curtains for the Euro
by Bryan Rich | Saturday, March 7, 2009 at 7:30am

Over the past three and a half years, Ive written extensively about the global financial crisis, the global recession the ongoing sovereign debt crisis, currency wars and the impending fall of the euro. Back in January of 2009, I wrote a widely published piece titled, Why It Could Be Curtains for the Euro. In that piece, I pointed to the many flaws that had been exposed in Europes single currency concept, following the eruption of the global economic crisis. It was clear that when economies in Europe were put under stress, when the global economic crisis unfolded, and global investors started scrutinizing the balance sheets and fiscal position of countries, the weak countries in Europe were in trouble. And it was clear that it was going to be very bad news for the euro currency. Indeed, when the skirt was lifted in Europe, it was found that many countries within the euro zone had structurally unsustainable economies, designed to take advantage of a stable currency and stable, low interest rates that had been anchored by their strongest
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Will the Euro Become the Most Hated Currency for 2010?
by Bryan Rich | Saturday, January 2, 2010 at 7:30am

The Future of the Euro in Question

by Bryan Rich | Saturday, February 20, 2010 at 7:30am

Welcome and Introduction

partners in the euro zone, Germany and France.

The End Game for the Euro

by Bryan Rich | Saturday, December 11, 2010 at 7:30am

When the markets finally began demanding interest rates to compensate them for the risk of holding debt in a country with uber-high debt levels and massive budget deficits thats when the euros demise was set into motion. I warned of this very early on, and warned of the threats the euro represented to the global economy. As the worlds second most widely held currency, which is tied to the largest aggregate economy in the world -- the euro zone clearly, the reverberations of a euro demise would be very bad news for the global economy. But all along, the politicians, influential economists, Wall Street figure heads and government leaders, not only didnt see it coming, but actually touted the euro as the candidate to replace the dollar as the worlds reserve currency.

Portugal is big warning flag for ALL investors!

by Bryan Rich | Saturday, March 26, 2011 at 7:30am

Rolling Sovereign Debt Defaults and Euro Break-Up Ahead

by Bryan Rich | Monday, September 19, 2011 at 8:00am

With that in mind, given the poor advice thats been distributed to investors in such a critical time in history, its never been more Important to educate yourself on the challenges facing the world. And a big one is the euro.
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Sovereign Debt Crisis is Just Getting Started

Who says? History!

2012 Logic Fund Management, Inc. All Rights Reserved.

Sovereign Debt Crisis is

Just Getting Started

Its easy to lose perspective on where the global economy stands, to be confused by the daily deluge of information.

Europes Common A Study of Market Eight exemplifi Centuries of es a Financial situation Crises shows that is unfavora Financial ble to a Crises tend common to lead to currency.

So I want to give you some perspective on the big-picture, and where we are today. Because as an investor the bigpicture is critical for you. It can mean the difference between making and losing a lot of money.
First, during this economic crisis, we endured the sharpest fall in global economic activity since the Great Depression, and one of the most threatening financial crises. Yet all along the way, markets, politicians and policymakers were expecting, or rather hoping, for a quick return to normalcy. But its all been based false hope and naive expectations. Heres why The IMF has done what is perhaps one of the most thorough studies on recessions that share the combination of a global recession and financial crisis like the one weve experienced.

Sovereign Debt Crises -Milton

Friedman

And the IMFs study shows that the recoveries of past recessions with these dualities (global recession and financial crisis) tend to be longer and slower than normal recoveries.
Moreover, theres a very important study that has been done on historical financial crises. It was done by a Harvard economist, Kenneth Rogoff and a Maryland economist, Carmen Reinhart. These two compiled the most extensive database of this type of crisis and they found striking commonalities in the aftermath. First, they found in studying over eight centuries of financial crises, that they tend to be followed by 2012 Logic Fund Management, Inc. All Rights Reserved.

Sovereign Debt Crisis is Just Getting Started

Next Stage: Defaults

sovereign debt crises. And sovereign debt crises tend to be contagious. remain anywhere from 20 percent to 50 percent below peak levels, and 3) unemployment will hover around 5 percent higher than pre-crisis levels. While this might be news to you, its not news to policymakers. After fumbling through the first two years of the crisis, global central bankers took notice of this analysis back in 2010. Thats why Bernanke rolled out a second round of quantitative easing, despite the intense scrutiny and claims that a massive wave of inflation was coming. It didnt happen. In fact deflation remains the bigger threat for all the reasons Rogoff and Reinhart discovered in their research. Thats why we should all expect more economic shocks to come. And the sovereign debt crisis will end in defaults. And history shows it will be contagious. The Four Stages of Sovereign Debt Crises Stage #1: Burgeoning Deficits In a financial crisis government spending increases dramatically in attempts to stabilize the financial system and stimulate economic activity. Tax revenues fall. Fiscal surpluses turn into deficits and economies with existing deficits keep piling it on.

Given this analysis, we should expect a sovereign debt contagion. And we should expect defaults.
Rogoff and Reinhart presented this analysis as early as 2008. And its been nothing less than a playbook for the way this global crisis has played out. Reinhart went on to look at the 15 severe financial crises since World War II and found that they were typically driven by credit bubbles. And the credit buildup typically took as long to de-lever as it took to build. Credit Buildups and Deleveraging of Debt Are Long Cycles In the current case, the credit build was about a decade. If you mark the start of the crisis as 2007, that means were just half way through the deleveraging phase. And deleveraging tends to mean ultra-slow economic activity as consumers, businesses and governments are paying down debt, not spending. So those that have been looking for recovery at every corner, are not in touch with the magnitude of this global economic crisis.

Reinharts research also suggested that throughout this 10-year deleveraging period: 1) Economic growth will trend at lower levels than pre-crisis growth, 2) Housing prices will

How its playing out

All of the Emus members were (many still are) guilty of runaway spending.

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Sovereign Debt Crisis is Just Getting Started

Next Stage: Defaults

All sixteen members of the European monetary union have violated treaty limits on allowable budget deficits some to the tune of more than four times as much! Moreover, the leading economies of the world have all seen their deficits shoot higher, some to record levels. In fact, the deficit spending thats gone on in recent years can be summed up as follows: Over 40 percent of world GDP comes from countries that are running deficits in excess of 10 percent. Stage #2: Ballooning Debt When economies are contracting or even growing slowly, bringing these deficits back down to earth becomes an unenviable challenge. Governments have to make ends meet by turning to the markets. Then those burgeoned deficits turn into growing debt loads. How its playing out activity appears unlikely to curtail fiscal problems, the credit worthiness of the government falls under intense scrutiny. And thats when we see downgrades.

How its playing out

Both Greece and Portugals sovereign debt rating has been downgraded to junk status. The US has lost its AAA status. France has lost its AAA status. Spain has lost its AAA rating and Germanys top rating has been threatened. Stage #4: Defaults This is the final and most deadly stage. Thats because downgrades only make the vicious cycle of weak economic activity and growing dependence on debt worse. When investors see more risk, they require more return. Therefore, the borrowing costs for these troubled countries rise. Then it becomes harder to finance spending needs and harder to finance existing debt. And thats when we see defaults. How its playing out

When debt reaches 80 percent of GDP

When debt reaches 80 percent of GDP threshold, the borrowing costs for governments starts ticking higher and so does the market scrutiny. The IMF says five of the top seven developed countries in the world will have debt levels exceeding 100 percent of GDP in the next few years.

Greece is on its second round of life support for the EU/IMF. And its debt holders are getting less than 30 cents on the dollar back on their investments the same debt that was stamped as A-rated just three years ago! Stage #3: Downgrades And while many are waiting to wave the allclear signal for Europe, it doesnt stop with When deficits and debts rise and economic Greece. Expect Portugal and Ireland to come calling for debt relief next. 2012 Logic Fund Management, Inc. All Rights 10 Reserved.

The euro: Flawed from the Beginning

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The euro: Flawed from the Beginning

Predicting failure
Famed Economist Milton Friedman predicted, shortly before 2000, that the euro-member countries would succumb to systematic flaws and fail within ten years. He might not have been too far off. He said: A one size fits all monetary policy doesnt give the member countries the flexibility needed to stimulate their economies.

A fractured fiscal policy forced to adhere to rigid EU rules doesnt enable member governments to navigate their country-specific problems, such as deficit spending and public works projects.
Nationalism will emerge. Healthier countries will not see fit to spend their hard earned money to bail out their less responsible neighbors. A common currency can act as handcuffs in perilous times. Exchange rates can be used as a tool to revalue debt and improve competitiveness of ones economy. I want to focus on these four bullets. What did Friedman mean? Bullet #1 What did Friedman mean when he called the euro zone monetary policy one size fits all? Put simply, the member countries in the EMU cant cool down their economy, nor stimulate it as needed when they have no direct power over monetary policy.

Milton Friedman Famed Economist

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This is a key fundamental problem for European Monetary Union members. The fact is, their economies may be, and will likely be, operating at different speeds from one another. Therefore, whats good monetary policy for Germany, could be bad monetary policy for Spain. Yet, through the European Central Bank, there is one central power over interest rate setting policy. And they will tend to set that policy based on how the bigger, stronger economies are behaving. What tends to happen, in this case, is that countries that are performing poorly, without the luxury of cutting interest rates, will find other ways to stimulate their economies. And they do so through fiscal policies, like cutting taxes and increasing government spending. Typically, there is a natural economic mechanism that keeps these fiscal policies in check: Its called the financial markets. When countries cut too much and spend too much, threatening their solvency or financial position, global investors penalize them by selling their currency and selling their government bonds. After all, who wants to invest in a country that may not be able to generate enough revenue to pay their bills and pay you back. With that, when the currency falls and government interest rates rise, it makes it more expensive to trade and more expensive to borrow. In the case of the EMU members, they never had that penalty, until recently. They found that they could keep pushing their economies along through very liberal fiscal policies, and never suffer consequences. Because the markets continually valued the euro currency and euro zone interest rates based on the strongest euro zone countries: France and Germany.

Bullet #2
So given the discussion above on the incentive for countries to use (possibly abuse) fiscal policies to stimulate economic 2012 Logic Fund Management, Inc. All Rights Reserved. 13

activity, the European officials that conceived the monetary union built in limits on the extent to which countries could spend or carry debt. They limited budget deficits to 3% of GDP. And they set a ceiling on how much debt a member country could have at 60% of GDP. That may sound good policing procedures on paper, but in fact, it creates more problems. It further handcuffs these member countries. When a country is in recession, deficit spending and government spending can be an effective way to achieve economic recovery. And they may need to run a bigger deficit for a period of time to bridge the downturn in their economic cycle i.e. until the economy naturally returns to organic growth.

These limits set in the EMU rule book, the Maastricht Treaty, in theory, restricted a countries ability to work through these economic downturns using fiscal policy. That creates more problems, as Friedman forecasted. Bullet #3

Given bullets one and two countries within the monetary union are bound to run into economic problems. And Friedman argued that the citizens of stronger countries would have a hard time parting with spending their money to bailout weaker member countries.
Bullet #4 Finally, the easiest way to solve indebtedness and a weak economy is through currency devaluation. It inflates away the debt and makes exporting easier typically a key driver in emerging from recession. But members of the euro dont have that tool. The common currency is, like monetary policy, out of the control of country governments.

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The Culprit? The euro

The Problems in the Euro Zone Are All Rooted in the Single Currency: The Euro!

The euro-member countries are in trouble for all of the reasons Milton Friedman, one of the most influential economists of the 20th century, cited prior to that currencys inception over twelve years ago. The global recession and financial crisis has resulted in ballooning debt levels and growing budget deficits for nearly all major economies. And typically, when countries find they cant pay, they have two options: Either a currency devaluation to reduce the value of debt OR an outright default. Neither will work with weak EMU countries after all, they share a currency with 15 other countries (now 16). So currency devaluation is not a tool at their disposal. That makes an outright default by a troubled euromember the most practical option. But its NOT an option, at least not an option the euro zone members can consider for reasons Ill cover a bit later. For now, the euro zone officials have created option #3: pour money into these weak countries to keep them breathing and then attempt to force all member countries into a fiscal union where fiscal policy is managed at a central level. But fiscal union is an unimaginable step. It would entail all members to give up their sovereignty, their history, their rich cultures and heritage. The result would be a United States of Europe, where government, monetary and fiscal policy would all be made in Brussels and likely led by the strongest countries Germany and France.

And it would mean transferring wealth from the stronger euro zone countries to the weaker ones. 2012 Logic Fund Management, Inc. All 15 Rights Reserved.

The REAL Risk in Europe

Political Meddling has made a big problem MUCH, MUCH BIGGER

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Its Not About Greece; Its All About the Banks

Dont think for a minute that European officials have been going to such extreme measures as they have in the past two years because they care about Greece. They dont. They first responded because they cared deeply about defending the euro. They arrogantly thought they could convince the markets that they would plow some money into Greece and scare the bond market vigilantes away, those investors that were dumping bonds in the weak euro zone countries and driving up the yields on government bonds to dangerous levels. By promising to give Greece money they hoped the bond sellers would go away, and therefore the threat to the euros existence would go away. But it didnt work. And in May 2010, we got a clear message from Europe just how desperate the situation was there. Thats when the powers of Europe gathered to determine a game-plan for dealing with Greece. The European Union, the IMF and the ECB could have backed away and let the country pull-out of the monetary union and go on with its business of mending itself through currency and debt devaluation. But they didnt do that! Instead, in perhaps the most shocking development in the entire global financial crisis, they vowed to rip up the rulebook that the European monetary union was built upon. They vowed to use taxpayer money of the stronger countries to support the fiscally irresponsible weaker countries to the tune of 750 billion euros.

If you owe the bank $1,000, you have a problem. If you owe the bank $100 million, the bank has a problem.

That was a jaw-dropping move that completely contradicted the guiding principles of the European Monetary Union. When they made the decision to take tax payer money from the likes of Germany and give it to Greece, the politicians effectively tore up the Constitution right then, right there.
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The REAL Risk in Europe

Systemic Fallout
Moreover, the ECB got involved breaking the rules of the central bank by buying sovereign debt in these insolvent countries, in turn putting their own solvency at risk. They didnt go to such extreme measures because they really cared about saving the likes of Greece, Portugal and Ireland (and even Spain). They did so because they had to! You see, when the world was in the depths of the financial crisis, global central banks were doing anything and everything they could to stimulate. The ECB, for its part, was offering up unlimited funds to its European banks for a paltry 1 percent interest. The stated purpose was to keep credit flowing in its economy. However, the banks werent lending to consumers and businesses; they were lending to the PIIGS (Portugal, Ireland, Italy, Greece and Spain), to push down the borrowing rates in those insolvent countries. The struggling countries were happy. They were able to borrow at reasonable rates, even though they were maintaining massive budget deficits and burgeoning debt loads The banks were happy. They were borrowing at 1 percent and lending at juicy yields And the ECB was happy, because it was aiding the struggling countries through the back-door maintaining adherence to its guiding principles and keeping its appearance as staunchly independent. But finally, market participants took notice and went on attack, selling the government bonds of the weak euro members. Consequently sending borrowing rates for these countries soaring. 2012 Logic Fund Management, Inc. All Rights Reserved. That exposed their spiraling deficits, AND as it turns out, the flaws of the greater European monetary union. So when the decision had to be made by European officials and the IMF, back in May 2010, to let Greece go or go all-in the choice was obvious. They had to go all-in, because the European banks were loaded with Greek debt. If Greece had fallen, the other weak countries would have fallen, putting $2 trillion worth of European bank exposure to the PIGS countries on course for massive write downs and triggering another financial crisis. With that, the European sovereign debt crisis isnt a Europe problem, its a global problem. The failure of the PIIGS countries, indeed, would create another wave of global financial crisis.

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The REAL Risk in Europe

Systemic Fallout
Take a look at the map below from the BIS report. If youve forgotten how systemic the fallout surrounding the failure of Lehman Brothers in 2008 was, this will give you a quick reminder of just how interconnected the financial system is globally. The size of the circles represents each bank nationalitys share of the total global banking system, in terms of bank to bank claims. The thickness of the arrows represents the size of those claims with foreign banks. Ultimately the chart shows that all banks around the world are heavily exposed to failing foreign banking institutions. Its the ECB Too Its not just European banks, but the European Central Bank is also at risk of failing. A European think-tank, Open Europe, estimate the ECB is 23 to 24 times leveraged. When Lehman Brothers failed it was 30 times leveraged. If a contagion of defaults or restructurings does take place, and the ECB is forced to take losses on the sovereign debt of the weak euro zone countries, the ECB could become insolvent itself. If that happens expect another wave of global financial crisis, bigger than the first, where markets trade in two tiers: Risky and safe.

Source: BIS 2012 Logic Fund Management, Inc. All Rights Reserved. 19

Social Uprising:
The music stops ONLY when the people say no more

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Systemic:

Social and Political Unrest

Europe is Europe is composed of composed of separate nations, separate nations, whose residents whose residents speak different speak different languages, have languages, have different customs, different customs, and have far and have far greater loyalty to greater loyalty to their own country their own country than to the than to the common market common market or the idea of or the idea of Europe Europe -Milton Friedman -Milton Friedman
Every step of the way through this global economic crisis the shocks have been thought to be contained.

But theyve proven time after time to be just the opposite: Contagious!
Thats been the case with sovereign debt problems in Europe once said to be contained and now known to be systemic. And its proving to be the case with public uprisings, too. It started in the Middle East, and now its finally spreading through Europe.

Weve seen these uprisings across Europe to fight the tough austerity measures that have been imposed, in many cases, by politicians from other countries or global organizations, like the IMF.
The people are finally standing up against what promises to be a long road of economic depression especially those in Greece, Ireland and Portugal, all of which have taken direct bailout money and are now dealing with the massive job losses, government spending cuts and tax hikes associated with taking money from its EU neighbors and the IMF. To be sure, the politicians will keep this game going of floating these insolvent countries as long as possible. And they will continue to use their power over these countries to attempt to force them into a fiscal union unifying Europe into a United States.

But at some point, the people will say enough is enough keep your money and keep your euro.
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Defaults, Departures, Devaluations

The end game for the euro

Friedman said, Nationalism will emerge. Healthier countries will not see fit to spend their hard-earned money to bail out their less responsible neighbors. And weaker countries will not see fit to give up their sovereignty to help save vulnerable European banks and a single currency that has left them handcuffed. The Euro is at the core of all the sovereign debt problems in Europe. The easiest way to address a government debt problem is with the currency. Devalue the currency, inflate away the debt and get on the road to recovery. The most palatable option for the likes of Greece, Portugal and Ireland: outright default. Defaulting, leaving the euro and re-adopting their own currency would allow them to devalue their debt and start rebuilding. The alternative is giving up their sovereignty and fighting through years if not decades of economic depression. I think the people will vote for the former. And they will likely express their vote by overthrowing their governments and then kicking the IMF and EU officials out. Thats when the game of kick the can down the road in Europe will come to an end. And that will likely mean the end of the euro or at least in the form that we know it. And while its true that European banks are on the hook for the lions share of the risk from a default of a country in Europe, the Lehman crisis made it abundantly clear that a major bank failure has acute global consequences.

How can you be prepared to weather another global financial storm?

Raise cash: When global fear elevates global capital flees to the relative safety of US Treasuries and the dollar. In these types of crises CASH is king. Hedge: Buying puts on the S&P 500, the euro or global stock indicies can reduce your risk to global market turmoil OR an inverse ETF, like the ProShares Short S&P 500 ETF (SH) can serve a similar function. Exploit opportunities: Buying the ProShares UltraShort Euro (EUO) can give you two percent profit for every one percent fall in the value of the euro.

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Dear Investor, If there is one thing thats been clear throughout the duration of this global economic crisis, its that average investors have been given bad information and bad advice all along the way. In short, its exposed the Wall Street machine for what it is a mechanism to soak money from the masses, for the enrichment of few. Its exposed the financial media as tabloid-like operations, more concerned with creating great headlines than they are about communicating facts. And its exposed government leadership as ill-prepared, inexperienced and nave, in handling the worst economic period of our lifetimes. The net effect of those three sources of poor guidance and mis-information has been wealth destruction for average investors. For the many investors that lost in the stock market collapse, its meant insult to injury. Ive always thought to myself, there has to be a better way. Thats led me to create Global ETF Monthly an investment advisory program that is free of conflict, with focus on one thing: intelligent investing. With ETFs, its never been easier to diversify across geography and asset class in a cost efficient way. Thats a big advantage in preserving and growth capital in todays environment. So there are no excuses. Dont leave your net worth exposed to a broker or mutual fund manager or the swings of the broader stock market. Join me by becoming a member of Global ETF Monthly! If you do so today, for reading my E-Book, youll receive 25% off of the annual membership. To get your discount please see the next page. Sincerely, Bryan Rich

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