The Euro Emperor Has No Clothes

This chart, courtesy of Moody's, shows the degree to which bank equity is exposed to the peripheral markets of the EU.

Anyone familiar with accounting, will recognize that banks are reluctant to mark their assets to market value as such actions would severely impact their balance sheets.

In the event of a Greek default, which may happen as soon as the middle of March, we can expect to see bank lending slow or even freeze as banks attempt to preserve capital.

Due to the potentially catastrophic impact of such an event, we can expect to see desperate Eurocrats racing around the clock to find some way to stop or slow the contagion.

Several ideas have been floating around including a massive liquidity (bailout) fund on the order of One Trillion up to Ten Trillion Euros.

Again these bumbling bureaucrats fail to understand (or perhaps acknowledge) that the issue is one of insolvency, not liquidity.

Three and a half year after the 2008 financial crisis, we still have the same unsuitable responses to the solvency problem.  The Central Bankers and Central Planners refuse to let spendthrift banks and nations go broke.

But as the problem is delayed by adding more debt funded liquidity, the magnitude of the problem grows much larger.  

If we see a massive liquidity injection, we could have not only a bond crisis, but a full fledged currency crisis as investors seek safe havens.

The key to understanding the problem is to grasp the concept of Credit Default Swaps (CDS).

The are, for all intents and purposes, insurance policies between financial institutions that promise to make the claimant whole if a default occurs.  The twist of CDS is that the insuring institution also provides collateral to the institution being insured.

When a claim is made, then we see whether the collateral has any value.

This is why the Eurocrats (and indeed American officials) want to continue to prop up the system with borrowed money from taxpayers.

Credit Default Swaps (CDS) are the glue that link one bank to another.

And this is why, when a significant default does occur, we will find that the Euro Emperor has no clothes.

This fiat currency is totally exposed.

So then, what is a Euro really worth?