The ESM (European Stability Mechanism) is a game of musical chairs

The ESM, or European Stability Mechanism, is a fund proposed by the ECB and member countries of the EU (some of which are coming along kicking and screaming, including Germany, the biggest contributor) to stabilize the financial system and economies of EU countries.  The fund has a proposed value of 700 billion euros, with each of the 17 full member countries providing their proportionate contributions, based on GDP.  For example, Germany has the largest GDP, so it is responsible for the largest percentage and dollar amount of the fund – about 27% of the total, or about 190 billion euros.

Here is the interesting part – the very countries that need to be bailed-out are also expected to contribute their proportionate amount to this fund!  For example, Italy is expected to be the third largest contributor with about 18% of the total, or about 125 billion euros.  Spain is expected to contribute almost 12%, or about 125 billion euros.  Even Greece, a country that has already received multiple bail-outs and has defaulted on sovereign debt is expected to contribute about 3% or 20 billion euros.  Portugal and Ireland are on the list as well – both countries that are in dire straights.  If you add-up the expected contributions from the PIIGS – Portugal, Ireland, Italy, Greece and Spain – the five major countries in the EU that definitely need to be bailed out (there are others), these five account for about 37% of the total fund, or about 257 billion out of the 700 billion euros.  Huh??

How can the very countries that need money be expected to provide the money to be used to bail them out?  The short answer is, they can’t.  The reality is, despite Draghi’s recent statement that the ECB will buy an “unlimited” amount of sovereign debt, there is simply very little actual money available to make these purchases.  The remaining amount of the fund, if you deduct the constributions from the PIIGS – 443 billion euros – may sound like a lot of money, but the reality is that it is very little when compared with the massive national debts of these troubled countries.  Keep in mind as well that the 443 billion euros assumes that all of the other countries contribute their proportionate share.  Many of the other countries in the EU are in worse shape than the PIIGS and will not only be unable to contribute to the ESM, but will need bail-outs themselves.

Draghi obviously knows this.  The only conclusion I can draw from this is that Draghi and the other ECB members are simply buying time, hoping that either the economies of the EU will improve, or we will bail them out if they can hold out long enough for our economy to get better.  Wishful thinking!

From an investment perspective, sooner or later, and probably sooner rather than later, the realities of this problem are going to sink in.  Stocks are at multi-year highs with corporate profits and GDP growth slowing across the globe.  Just today FedEx lowered their guidance for their fiscal 2013 outlook.  Frankly, I do not understand why investors keep buying, except that small investors are driving the markets and are always late to the party, and are always wrong.  They will be wrong this time as well.  Smart investors will not allow themselves to get caught-up in this frenzy, and will reduce exposure to equities and thus reduce risk.


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