David R. Kotok
July 24, 2012


Europe appears to be dismembering. We see Spanish yields breaking well above 7%. The Spanish government bond market is essentially closed to private investors. The only funding for Spain, and many of its political subdivisions, is now institutional and governmental from elsewhere in the eurozone.

The sovereign default process in Europe resembles falling dominoes. It started with Greece and has moved on to Ireland (which appears to be attempting resuscitation on its own), Portugal, Cyprus, and now Spain. The danger is that this sequential toppling of countries may be accelerating.

Remember that the eurozone consists of 17 separate entities. Germany is by far the largest. France is number two, Italy number three. Spain is (or perhaps was) number four, at about 12% of the total weight.

Each time a domino falls, the member state requires assistance from the remaining member states. When Greece fell into financial disarray and then failure, the other 16 states had to provide the subsidy. When Ireland fell, there were 15. Portugal made it 14. Cyprus made it 13. Now Spain leaves 12 remaining.

As the dominoes continue to fall, the costs are reapportioned among the remainder, which is a shrinking cohort.

We are beyond worry about Spain. It is now a question of survival or failure for Spanish governmental finance.

The biggest country to worry about is Italy. Italian spreads are sending messages of danger and fear. Italy is the third largest debtor in the world. Its debt-to-GDP ratio is over 120%. Its economy is shrinking. The restructuring of Italian budgets has not included the necessary expenditure cuts for Italy to survive. Italy is now a troubled state.

France is the second largest country in the eurozone. It has imposed excessive wealth taxes. It has used the prospective collection of those taxes to balance, or improve, its budgetary mechanism. A year or two from now, those tax receipts will have disappeared. Why? French wealth is leaving France. It is going to London, Basel, and elsewhere. When you threaten to confiscate three-quarters or more of people’s wealth, you cannot expect them to hang around when they have options.

Wealthy French, Italian, Spanish, Greek, Portuguese, Cypriot, Irish, and other citizens are voting with their feet. The financial flows reflect it.

European political leaders have yet to realize that they have to change their ways quickly and profoundly.

Cumberland is still maintaining a cash reserve in international and domestic accounts and has underweighted Europe. We have written about this many times.


David R. Kotok, Chairman and Chief Investment Officer

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