Tail Risk in shipping recovery still very much present!

Lately there is a lot of capital chasing shipping assets, arbitraging on vessel prices.   Oaktree Capital is one of the high profile leaders.  Wilbur Ross was an early forerunner in the Diamond S. venture, doing the Cido deal in 2011.

It has nothing to do with business plans, building value with companies to gain competitive advantage and market share in transport and logistics services. This is pure and crude asset speculation, betting that we are at the bottom of the shipping cycle, vessel values will begin to move up and a quick profit will be made by unloading these assets on the next company, who in turn riding the cycle will hope to gain themselves on the next leg upwards until the last guy in – like a Villy Panayiotides at Excel with the Quintana merger – gets stuck carrying the candle and goes bankrupt with the losses as the market crashes.

My personal view is that Oaktree and others are desperately looking for yield without many options in the present world of ZIRP.  The FED policy under Ben Bernanke’s reflects today's conventional wisdom, trying to push asset inflation to reflate and get out of the current Great Recession aftermath of the 2008 Global financial Crisis.

Shipping assets have caught their radar.  Putting money in risky assets and companies for yield has not always gone very well in past shipping cases.  Berlian Laju, for example, just months after a massive debt restructuring with US$ 200 million in new funds and repeated earlier high cost lease deals ended in debt default just months later, illustrating the risks involved in this strategy.

Whether the present FED policies will ultimately reflate the world economy depends on future real demand for goods and services that generates cargoes for these vessels, pushes freight rates up and then vessel values increase geometrically on the future earning expectations. Until and when this happens, this speculative money is actually generating more over capacity and prolonging any market recovery in the shipping industry.

Meanwhile, we have increasing zombification of many shipping companies like General Maritime now reorganized along with TORM and Eitzen Chemical now renamed Jason, OSG/ BLT are in purgatory with their ultimate fate still in limbo.  Excel Maritime recently moved into a hopefully pre-packed Chapter 11 reorganization.  Genco and others like Eagle are tottering in the brink. The recent Baltic Trading follow on capital raise seems a back door doubling up for Genco - see my recent piece: "Peter Georgiopoulos tries to regain his lost credibility" http://amaliatank.blogspot.gr/2013/06/peter-georgiopoulos-tries-to-regain-his.html.

Their Bankers are desperately trying to keep the dead alive. In turn, speculative capital like Oaktree and others, are buying up distressed debt to keep the banks themselves alive with an increasing number of zombie banks around.  Warehousing of bad assets has become the fashion.  Commerzbank - basically a zombie institution - recently issued a statement that it does expect to sell any shipping assets because they expect the market will bring the prices up...  So why worry about any 'book' losses at current mark to market price levels, capital (in) adequacy, etc.?

Oaktree seems to have a rather chaotic investment approach with different parts putting shipping assets on their books in a rather haphazard way. After all, did it make sense or show good analysis to invest in General Maritime only months from declaring Chapter 11 and needing even more money in a second round?

Normally, investments are supposed to yield value and then second round financing is done to invest in another leg up in the private equity world.  Here Oaktree was doubling down on a bad position, which is not normally good trading practice.  The normal practice would be to lighten up and reduce exposure.  In the current 'pretend and extend' world that we live in, however, everyone is trying hard to avoid cutting losses and many actively practice 'doubling down'. 

Did Genmar ever really have much intrinsic enterprise value as a shipping company beyond its physical assets to warrant the Oaktree "investment" in recapitalization??? I would say no!

Peter Georgiopoulos  never really thought of Genmar as an enterprise - at least in the sense of a logistics transport business serving customers in carriage of cargo.  Peter G. was and is foremost an asset speculator.  He ignored strategic positioning for Genmar to gain market share, improve earnings margins and generate growth through retained earnings. Employment was just a means of holding his assets rather than serving and building a customer base. His biggest sin was ignoring trends in the tanker market and new growth areas. His mindset was on trading assets.  Others like TK Shipping and his nemesis 'Big John" Fredriksen handily outperformed him and provided superior performance to their investors.

In the case of Petros Pappas, the Oaktree approach is to fund Pappas like a bond trader. Pappas has a successful record in asset trading. Oaktree has Pappas like a stock picker in different vessel classes. Pappas trades largely on his own instincts with his own money on a 50-50% basis with Oaktree. His own skin in the game satisfies Oaktree for the moral hazard. Neither Pappas nor Oaktree are looking to build businesses or really have any business plans at all beyond the asset trading.

A recent Tradewinds interview with Lazard’s Head of Shipping, Peter Stokes, sheds a lot of light on this matter. In fact, I am amazed and somewhat gratified to see someone like Stokes, thinking and saying publicly, many of the same things that I have been saying privately and publically when I was recently a keynote speaker at the Hong Kong shipping forum.

Stokes sees two basic scenarios ahead (see "Bungled QE exit could 'burn out' ship values" http://www.tradewindsnews.com/weekly/w2013-06-21/article319083.ece5)):

• Scenario A: - conventional wisdom ‘muddle-through’ recovery in the next few years that is likely to be subpar in quality, partly because of so many trying to ride the coat tails of same scenario.  If everyone is arbitraging, then each is cancelling out the other in any meaningful price action.  Further this self-defeating over time in creating over supply with a new wave of speculative ordering that will grow with any upwards price movement.  There is too much speculative money and too much yard overcapacity.
• Scenario B - complete collapse with another leg down, where investment firms like Oaktree, shipping banks, etc. experience painful and unavoidable losses. The zombie shipping companies finally die. Assets are written down to true values and finally there is a proper shipping recovery based on an industry shake up where only the fit survive: much dreaded Joseph Schumpeter’s ‘creative destruction’. 

A  preview of scenario B is the recent reportage in Tradewinds about an apparently unsuccessful attempt by Wilbur Ross, First Reserve, etc. to float an IPO in the Oslo capital markets for their Diamond S venture that was built on a huge block purchase of product tankers from Cido a few years.  My previous two pieces on the Diamond S venture make interesting reading in retrospect: 

• "Does the CIDO deal mean tanker values are on the upside?" - http://amaliatank.blogspot.gr/2011/08/does-cido-deal-mean-tanker-values-are.html.

• "Diamond S. a new business model for shipping?" - http://amaliatank.blogspot.gr/2011/08/diamond-s-new-business-model-for.html.

Obviously, the latter Scenario B would be a devastating setback for governments (especially the European Union political elite) and many financial institutions.  Such an outcome might ruin their careers and threaten the integrity of their institutions. On the other hand, they are slowly running out of resources for the constant backstopping. “Pretend and extend” credit policies with the massive socialization of losses is far more costly than they are representing to their voters.  So far little of this has proved helpful to an economic recovery. Only the US has had some relative success, but their boost in energy resources may be a more substantive driver in this tepid recovery than FED financial engineering pulling on strings.

The two key elements ahead that may affect shipping asset prices are the US and its tapering to wind down the FED asset purchases and the Chinese restructuring, given that the Chinese marginal rate of investment is unsustainable and the losses are corrupting their banking system. The US and Chinese both realize that this needs to be done and it is unavoidable, unlike their EU counterparts with their “muddle through” theories, eternal dissention and dream-world mentality resembling Mann’s Magic Mountain novel.

Admittedly, I am strongly influenced by my friend Michael Pettis in China. I believe Chinese growth will ultimately disappoint.  The volatility concerned that Pettis expresses about the very large Chinese speculative position in commodities worries me given the potentially negative impact on shipping markets. So I would not be surprised about Stoke’s concern about further drop in shipping asset prices, driven by lower replacement cost in steel, etc. All this shipping investment is predicated on Chinese growth reflating the markets again – lots of very concentrated risk if this does not pan out.

See "Crunch Time: Why low growth is China's new normal" http://www.foreignpolicy.com/articles/2013/06/27/credit_crunch_time_china_low_growth_new_normal

On the other hand, the politicians, particularly the EU elite – our PM Samaras with his never ending Greek success story being the success story of the Eurozone – and Oaktree Capital are really betting the house that the worst is over and there will be happy days again with a robust recovery in just a few months.

Former colleagues of mine like the present Head of National Bank of Greece, Alex Tourkolias, saying that a shipping recovery will lead Greece out of its crisis and John Platsidakis of Intercargo, saying that two years from now the Greek debt crisis will seem like a bad dream gone away are lately exhibiting lots of boosterism.

In Hong Kong, by contrast, the shipping circles were subdued and cautious about a quick recovery in the markets.  Some companies like Pacific Basin have been aggressingly buying newer second-hand units, but these purchases are to renew their fleet and backed against a substantial cargo book, not the kind of overt and open speculation mentioned above by the likes of Oaktree.

So who knows? Stokes and I could be incorrigible pessimists and totally wrong. All I can say is that I still see a lot of tail risk around in shipping and elsewhere.

Photo Album of HK Shipping Forum



Speaking with Conference organizers.





Discussion with Martin Rowe and Bing Tang of Clarksons (Asia) Office



Chat with Paul Oliver of China LNG Shipping on Greece





Making my presentation on business models and strategies in shipping





Answering some questions from conference participants



Parting private discussions on shipping issues



Peter Georgiopoulos tries to regain his lost credibility with a US$ 23 million follow-on offering to expand Baltic Trading

Investors seem to have given a warm welcome to Peter Georgiopoulos’s (Peter G) latest gambit, raising US$ 23 million to scale up in the dry cargo market, looking towards a cyclical recovery.  Representative of this sentiment was Doug Mavrinac of Jefferies, who thought that this was “well-timed play” for Baltic to “realize its potential for shareholders as a consolidator in the dry bulk shipping sector” Does this argument make any sense for a company of nine vessels that has never turned a profit and is managed by another Peter G company - Genco  at high transaction costs that has 50% chances of bankruptcy, running out of liquidity later this year - if the dry bulk markets do not turn up? 

Peter Georgiopoulos reminds us of Nassim Taleb’s anti-hero John – a high yield trader – who was perceived as a financial genius and made a vast fortune - until he blew up as market conditions turned against him. Are we fooled by randomness? Is Peter G a skilled investor and ship owner/ manager in the shipping space or was he simply (to paraphrase Taleb) a lucky fool  successful in the pre-2008 shipping boom, now trying to repeat the same formulas again with investors riding his coat tails?

To be honest, what is any different in the approach of the Oaktree venture with Petros Pappas from the premises of the Baltic gambit, except for scale, money and wider shopping list of the Pappas venture? Both cases are asset plays based on arbitrage, rather than any effort towards a serious business plan to build a credible shipping business with competitive market position, servicing end user customers. Both Peter G and Petros Pappas tend to view shipping as trading in floating assets. In turn, their financial backers like Oaktree view them as high yield traders, who share in the risks by putting some personal skin in the game.

The investment thesis is a hefty return on asset appreciation, having bought in at low prices with the object to sell out as the market rises. The eventual sale could be in terms of shares as NAV rises or vessels in the fleet or an eventual merger with another shipping company. Transaction costs are relatively high in terms of management fees and hefty executive compensation. It is a vessel provider business model. Employment is largely by time charter to cargo operators, often at indexed rates. The enterprise really does not have much intrinsic value beyond the physical assets and the gut instincts of its management in timing decisions.

With a US$ 23 million war chest even with bank leverage, Baltic will likely never be much of an industry consolidator or a shipping enterprise of scale. At best, Baltic might expand by two or three units. Already speculative money pouring into shipping assets in pursuit of yield in a ZIRP world have pushed up dry bulk prices by 10%, without any appreciable increase in demand for these vessels. Further, as RS Platou Markets pointed out: “shares printed at below net asset value,” are “expensive growth”, albeit “historically low asset values mitigate a large portion of the dilution in a mid-cycle perspective”. In short, the acquisition prices will be at a premium with expensive funding and vessel operating expenses will have to cover high transaction costs – requiring a hefty future market upturn to make a profit. I wonder whether Doug Mavrinac pointed any of this out in his above-quoted analysis to would-be investors.

Nassim Taleb points out some of the negative traits of traders:

• Overestimation of the accuracy of their beliefs. This was what led Peter G to disaster in the 2010 Metrostar block tanker deal for Genmar. It was a carbon copy repeat of previous deals that went well. Investors bought the story and suffered major losses.

• Tendency to get married to positions. Peter G has always stuck to commodity shipping, ignoring other growth areas like LNG or offshore. The tanker deal was a repeat of two previous deals. This dry bulk deal is a repeat of his first attempts with Baltic that did not meet expected results.

• No precise idea what to do in case of losses. In fairness, Peter G handled the General Maritime debacle quite well putting Oaktree into the business at an early stage and then pre-packing the Chapter 11 reorganization with support of his senior creditors. The issue with Baltic and Genco is whether or not Peter G is running out of resources to afford another losing position. After all, Peter G is no John Fredriksen in terms of personal wealth or scope of shipping empire to back stop his losses.

• Absence of critical thinking expressed in their stance with “stop losses”. Peter G has never been involved in any pro-active business restructuring to consolidate; sell assets and redeploy capital more productively like a Fredriksen, Maersk or TeeKay Shipping. In the case of Baltic Trading – like the Genmar misstep – he is looking to double up his position for a cyclical market recovery, even to point of share dilution by raising expensive capital with Baltic shares trading below NAV to grow himself out of his present woes.

Peter G’s management of Aegean Petroleum Network demonstrates some of these same tendencies. For example, the marine bunkering has some of the poorest margins and lowest returns in the fuel business. Peer companies like Chemoil - backed by giant Gencore - want to expand in more profitable sectors like aviation fuel and reallocate assets by selling off storage facilities. By contrast, Aegean Petroleum insists on expanding in the bunker fuel sector and craves for investment in low yielding related physical assets like bunker vessels. Further Aegean Petroleum has no problem borrowing money with a new massive US$ 800 million loan (despite  debt covenant problems not long ago) to boost low margin incremental bunker business.  By contrast, better capitalized competitors like World Fuels are virtually debt free and heavily diversified in more profitable aviation fuel and land fuel business with a mean and lean balance sheet. The results are that Aegean’s share price consistently trails its peer competitors.

Like a trader and many peer Greek market vessel providers, Peter G really does not care about his operating margins or returns on asset because he expects to make up for this by taking a long position and make a killing in cyclical market upturn. The facts are that Baltic has been consistently making losses. Just compare Genco and Baltic stock performance since the 2008 meltdown with Pacific Basin, an integrated and well managed dry cargo company operating from Hong Kong that considers its business transport.

 

This does not present a flattering picture for Peter G management for the pockets of its shareholders. Likewise, Aegean Petroleum under Peter G management exhibits same poor share performance with peer competitors. 

None of the above is meant to condemn this strategy. If there is a recovery in the dry bulk markets, buying into Baltic Trading stock could prove to be an extremely profitable play. Peter G will certainly regain his aura of a shipping tycoon. That would be nice for everyone.

What concerns me personally is that current mass of speculative capital pouring into the shipping space - particularly Greek companies - chasing the same cyclical asset plays and even pushing up asset prices in current dismal market conditions. It would be a terrible mess if markets ultimately disappoint. This could lead to a substantial shake up in the Greek maritime industry, especially with major dry bulk players like Eagle Maritime and Excel Maritime Carriers on the verge of bankruptcy along with Genco, which is interconnected with Baltic Trading.

Greeks face loss of competitiveness with Asian Peers

Keynote Speaker at Hong Kong Shipping Forum on Business Models and Strategy in the Shipping Industry

Why not a derivatives market in vessel asset values?

Shipping investment projects have always been mostly asset plays rather than new business models to serve customers more efficiently in the transport of cargo. The Greek shipping industry craves for investment in physical assets as opposed to the Norwegian asset-light cargo operator model with chartered-in tonnage often on purchase options. Profits are generated from moving in and out of assets in the shipping cycle. Cargo transport operations remains secondary in the process mainly to keep holding costs down. Lately investment firms have also gotten into the game, teaming up with operating companies to acquire shipping assets.

Would not it be easier and more efficient to develop a derivatives market for this process rather than taking on all the headaches of physical asset ownership?

The latest version of this asset play concept is the Oceanbulk Carriers partnership between Petros Pappas and Oaktree Capital with the purpose of picking up distressed dry cargo shipping assets and eventually making profits on market recovery. Petros Pappas has an excellent record as one of the most successful asset players in the Greek shipping community, having sold off most of his dry cargo fleet in the heady boom years of the late 2000’s to the point of even moving out of basic ship management and operations.

There is no doubt that the dry cargo business is currently under severe stress. The sector has been plagued for years with a historically high vessel order book on expectations of infinite Chinese growth with their insatiable appetite for commodities imports and incessant speculation in commodities resources. The Chinese themselves have become major shipbuilders with huge expansion of yard capacity, mainly for dry cargo vessels. It did not take much of a drop in Chinese growth rates in 2012 and some inventory destocking to send dry cargo freight rates tumbling.

As this point, several high profile listed dry cargo companies like Genco (GNK) and Excel Maritime (EXM) are on the verge of bankruptcy, plagued by asset prices falling below loan outstandings and cash flow problems to service the debt payments. Unlike Asian competitors like Pacific Basin with large cargo books, these companies themselves started as asset speculations. They leveraged up with debt to expand their fleets in large block purchase deals, playing the market cycle.

Excel Maritime went to the extreme of merging very unwisely with another asset play, Quintana (QMAR) shortly before the 2008 global financial crisis and reportedly taking on US$ 1 billion additional debt to finance this transaction. The motive to merge for the Quintana stakeholders backed in part by First Reserve private equity was to realize their asset position for profit because their operating profits were restricted by long term time charters and this kept their stock price from appreciating as much as they would have liked to see. Just the announcement that they were planning this move caused a bounce in their share price.

Contrary to their mission statement to focus on distressed assets, the Oceanbulk-Oaktree venture recently decided to place new orders rather than to wait for opportunities in existing tonnage. At the same time, their new business development director and former investment banker, Hamish Norton, recently gave a dry bulk presentation at an industry forum in Athens where he sagely noted that the continued drybulk order book risks putting off any market recovery for another year yet in the sector. So ordering additional dry cargo vessels would at least appear to be contributing to more industry distress and counter-productive in hastening any market upturn in rates.

Perhaps a vessel asset futures market – if feasible – would be a more efficient tool for these cyclical asset plays. The ship derivatives could be based on standard type bulk commodities vessels, just as the Baltic Freight index is based on standard voyage routes. Banks could use the derivatives in order to hedge their loan exposure, reducing their credit risks to shipping companies. Shipping companies could hedge their asset purchases against fall in value and impairment charges. Hedge funds and institutional investors could take speculative positions on rising and even falling asset prices.

The beauty of a derivatives market for ship values is that it would not entail any ship ordering. Shipping companies could go back to the fundamental business of transporting cargoes for their customers. Because the derivatives market would allow for both long and short positions on vessel values, it might even assist in providing a reduction of vessel asset price volatility. Positions could be taken and unwound very quickly.

All this would relieve investors from the trouble for these cumbersome partnerships to buy physical assets, the need for bank finance, the travails of ship management and needs to charter the vessels with risks of charterer default, etc., only to lead to a game of musical chairs on market recovery to sell the assets or the shares in the company to the next guy with a mark-up.

Of course, the last guy in the chain like Excel Maritime in the Quintana merger or Berlian Laju (acquiring Chembulk from AMA at a sizeable mark-up), is invariably left holding the candle, facing bankruptcy as the market sours.

The shipping industry would become more of a logistics business, but is it not what it was supposed to be in the first place?

Eurozone politicians face growing credibility problems from angry European voters

The European Union project is one of the biggest attempts in history to change the geopolitical status quo in Europe and eventually abolish the nation-state with rule from a supranational entity in Brussels. A principle mechanism for this unification is the Eurozone currency union, where 17 European Union (EU) member states that have adopted the euro (€) as their common currency and sole legal tender. Monetary policy of the zone is the responsibility of the European Central Bank (ECB) which is governed by a president and a board of the heads of national central banks. There is no common representation, governance or fiscal policy for the currency union. When rarely taken to plebiscite as in Sweden or Denmark, rank and file voters have rejected the concept, preferring to remain with national currencies. None of this has much broad public support or popular legitimacy in Europe beyond the European political elite.

Since 2008 an increasingly larger number of Eurozone Periphery countries have been facing national bankruptcy with high levels of public debt, trade imbalances and loss of market access to issue debt. The bailout programs have put the EU Periphery in deep recession with loss of output at levels similar or in excess of the Great Depression with very high levels of unemployment in excess of 20%. Last year the World Bank cited the Eurozone debt crisis as a major threat to the world economy that could lead to a renewed global financial crisis. We have not seen such an attempt at internationalization since the Soviet Union in the 1920’s and 1930’s at such heavy human cost with presently millions of Europeans out of the work and economically marginalized. The rise of broad-based popular discontent with the economic hardship is now challenging this new status quo in Europe.

Recent Italian elections results have reopened the Eurozone debt crisis with a majority of Italians voting for anti-Eurozone Beppe Grillo five star movement and the increasingly Eurosceptic PdL/ Legha Nord coalition. The pro-Eurozone Socialist PD and Monti parties had disappointing results. There are three basic dimensions to the Eurozone debt crisis:

• The EU political elite are locked into the concept of the Eurozone monetary union in which they have staked their careers as a new economic Utopia.

• The Eurozone area is mired in a deepening recession with a growing divergence between the Core members setting the policies and Periphery countries suffering by these policies severe loss of GDP, massive unemployment and permanent damage to their economies.

• The currency union is a powerful tool for forced political integration, but it was not founded on sound economic fundamentals nor the broad consent of European voters.

The severe economic dislocation with resulting social turmoil is discrediting the EU political elite and unleashing new political forces of renewed nationalism that may in the end result in a breakup of the currency union if the growing divergences cannot be resolved.

The purpose of the Eurozone was to enhance the single market and move the member states to political union. European policy makers frequently cite the United States as a proto-type with optimism that they will achieve the same political union under a single supra government. Of course, they overlook the fact that even today there exists considerable political tension between the US federal government and the various states. There is a continuing debate about the size and role of the US federal government – issues taboo for open discussion in Brussels. Further, it took a long and bloody civil war for the union to prevail in the US.

The challenges in Europe for union are much larger. European countries are nation-states with different languages and political cultures. European societies like Greece and Italy have no wish to become multicultural melting pots. The Greeks, for example, revolted from the Ottoman Empire with the concept of a homeland for all Greeks - both living in Greece and abroad – to be free, not terribly different from the more recent case of Israel.

The currency union was sold to the smaller EU countries as a road to prosperity because they would not have to worry about future currency devaluation vis-à-vis the other members and they would benefit by credit enhancement with lower interest rates and more credit availability.

The EU political elite discarded from the outset any trade flow criteria that would justify rational participation in a common currency zone. Instead of starting with a small and sound base of core members, they tried to get the maximum number of EU members to sign up for the project at the outset with the aim of using this currency zone as a lever for greater political union. Frequently, Eurozone entry - as in the case of Greece - was finessed by use of credit derivatives and accounting tricks with the collusion of the Brussels policy makers.

The Eurozone set-up lacked a central bank lender of the last resort. The commercial banks were to supply credit to member state governments. The ECB, moreover, operates under rules that the Germans insisted for their participation to mimic the German Bundesbank. The rigid monetary policy favored Germany and its exports over the other member states. This led over time to asset bubbles in the Periphery and created chronic import dependency in the Periphery countries, devastating local production. The growing trade imbalances left the Periphery country members with the dilemma of increased public indebtedness or deep recession and unemployment

Perhaps the most poorly understood aspect of a currency union is that by giving up national currency, basic social contracts like social security systems as well as commercial banking system were put in jeopardy.

Member countries no longer had any control over monetary policy, money creation or interest rates. They faced severe spending restraints.

They could no longer fund via their central banks their social security systems nor could they bail out their banking system in their local currency when under stress. Their heavy reliance on local commercial banks to finance their deficits starved their private sector from credit and ultimately led to the insolvency of their banking systems.

In financial crisis, they were totally beholden to the ECB, Brussels policy makers and the mercy of other member states for any assistance in a cumbersome, interminable and dysfunctional resolution process. In effect, Core members – namely Germany –dictate their terms on the weaker members in the workout programs with entire brunt of the adjustment process and pain falling on them. They suffer unwittingly a severe loss of their national sovereignty.

The Bank of England foreseeing these factors in their risk assessment blocked the UK from entering the Eurozone. The UK has its problems but its fate is in its own hands.

Eurozone members lack defacto the right to request IMF assistance without the consent of the other Eurozone members and then with heavy EU involvement with EU officials often at loggerheads with the IMF staff.

Normally for a sovereign nation under a bilateral IMF workout, the IMF would propose structural reforms along with a currency devaluation. The devaluation is meant to produce a boost in exports making immediately all goods and services cheaper whilst leaving wages, salaries and pensions intact. This primes the period of structural reforms making up for the lost output and unemployment in the restructuring process. The adjustment is less economically painful and socially destabilizing.

The Germans view EU periphery countries in terms of their unification experience with East Germany, where they developed their theories of ‘internal devaluation’ now used in all EU workout programs for debt-ridden EU periphery countries. Contrary to current US thinking to avoid recession and deflation, the EU/ German process purposely provokes deep recession and high unemployment to drive prices levels down through deflation in place of currency devaluation.

In the case of German reunification, it took over ten years for these structural reforms to have a serious impact. The cost for this process was a permanent population loss of 12% with chronic unemployment and low wage levels that remain today. This has been the pattern in all EU workouts, with severe GDP loss and high unemployment.

The countries under these EU/ German-style workouts are left with permanent economic damage from the severe deflation. Aging, shrinking European societies like Greece and Italy, simply cannot afford permanent population loss much less a prolonged period of lost growth. The severe loss in GDP is almost impossible to recoup. Chronically high unemployment, low wages and living standards remain for years.

The countries under these EU/ German workouts are invariably left with very high levels of debt as the relative value of debt increases in the deflationary environment whilst the capacity to pay it down diminishes with the shrinking economic output and population loss leading to an outbreak of private and public sector bankruptcies together with ensuing debt restructuring.

If bilateral IMF workouts left scars from the experience of pain and humiliation in South Asia countries, which led to their adoption of export policies to run trade surpluses for more financial independence, the severely harsher EU/ German method of ‘internal devaluation’ constitutes a highly explosive political time bomb in Europe.

The present European climate where EU periphery countries are mired in deep economic depressions with GDP compression and unemployment in excess of 20% has become surreal. EU governments promise a future nirvana of European unification with prosperity just around the corner. The Greek government, for example, is currently betting the house for economic recovery latter this year to buy time with increasingly violent protest.

The European electorate is rapidly discovering that the utopia of the Eurocurrency zone is a nightmare of economic pain and social marginalization. There is a growing sentiment that the EZ workout programs with constant creditor pressure for harsh measures for the next bailout installment and heavy-handed interference in local elections for a government of EU approval are an exhibition of tyranny and coercion. Voters increasingly feel that their political elite have not been truthful with them. Political rage is leading to the collapse of the traditional party systems and to creation of new anti-EU/ Eurozone protest parties that are growing rapidly in ranks.

This was the message of the recent Italian elections. Now the EU elite is currently searching desperately for a solution that they managed last June to achieve in Greece with the present docile, compliant pro-Euro government to continue the same highly unpopular policies. Italy as opposed to Greece is a larger country with considerably more debtor leverage. Should the EU/ Germany ultimately be obliged to consent to the growing demands in Italy to jettison austerity and higher taxes reversing the Monti government; then they risk a rebellion of the smaller Eurozone members, who are increasingly desperate.

The issue remains whether the EU elite will be able to put the genie back into the bottle and regain control as happened in the 1848 European unrest or this protest momentum will ultimately lead to their overturn and disgrace of the existing European Union status quo with the emergence of new political and social order in Europe.

Greece in the position of Oliver Twist under supervision of the EU in the role of Mr. Bumble could potentially get swept up in the Italian protest if it grows and spreads to other Eurozone member states.