June 1, 2012

EUROPEAN UPDATE
The recent stress in Europe has largely arisen from two sources: 1) 2) Greece As long-term clients know, since 2009 we have wholeheartedly believed that Greece would ultimately exit the euro. economics of the situation now appears to be overwhelming the politics, we believe Greeces departure could be imminent. As the the potential of a Greece exit from the euro; and the deterioration of Spain

Greeces economy has now contracted by over 20%, and is currently contracting at an annualized rate of 7%. As a point of reference, the shrinking of Greeces economy equates to the depths of the Great Depression in the United States. However, rather than recovery being around the corner, Greece, at the behest of Germany, is being forced to implement vicious austerity, which is only exacerbating the situation. Austerity in a closed currency system, such as the euro, reduces incomes and increases unemployment and therefore bad debts. Because one persons debt represents anothers asset, a vicious cycle of deleveraging ensues. Individuals and institutions realize they are not as wealthy as they previously believed, and therefore either reduce consumption or sell other assets. Overall economic growth falls while a countrys sovereign debt remains, pushing up its debt-to-GDP ratioprecisely the opposite of what austerity is intended to accomplish. Because Greece is a current account deficit country, a role that someone must play in order to partly off-set Germanys chronic current account surpluses, they are required to import capital in order to function. No longer creditworthy today, Greece lacks the necessary capital flows. It is suspected the country may be out of money sometime around their June 17 elections. One of our independent macro consultants believes that because European banks have reduced their exposures to Greece, the Guardians of the EMU, as he refers to them, remain surprisingly sanguine about the prospect of a Greece exit from euro. We believe this nonchalance is misplaced, underestimating two critical issues: 1. The potential of bank runs in other European countries. If you are a depositor in Portugal, a country that has also been bailed out, yet continues to suffer within the euro, and you witness Greek bank deposits being redenominated into a new currency at a materially lower value, why not move your euro-denominated deposits to Germany where they will remain in euros, preserving your wealth? As deposits flee, banks, which are levered entities, are required to sell assets. Capital flight reinforces the deleveraging cycle. We suspect capital controls will soon be implemented Collateral issues. European sovereign bonds are used as collateral throughout the European financial system. As one of our consultants often says, In a credit-financed system, collateral is money. Fears of further defaults and restructurings of other peripheral sovereign debts increase the haircuts for which these bonds may be used as collateral. This reduces the overall liquidity in the financial system, creating funding stress and reducing credit available to the private sector, which hampers growth. This potential contagion effect on the plumbing of the system remains underappreciated in our opinion. We suspect collateral requirements will be loosened again soon

2.

Spain The escalating issues in Spain have not been as obvious as Greeces or even Italys because most of Spains debts reside in the private sector (i.e. banks, corporations and individuals). Similar to Ireland, which was ultimately forced to bail out its banking system, Spains private sector debts have represented a contingent liability of the sovereign. However, because governments always protect their banking systems in times of crisis, we view them more as direct liabilities. High employment and collapsing real estate prices in Spain have resulted in unserviceable debts, which have now created observable problems in the Spanish banking system. However, despite an unemployment rate of 25% (and a youth unemployment of 50%), Spains troubles are only now beginning.

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FISCAL DEFICITS: A SYMPTOM OR THE PROBLEM?

Nearly four years into the European crisis, the pervasive view remains that its cause was fiscal deficitsthat governments in the periphery over-borrowed, spent foolishly, and now they must pay the price (in the form of austerity) for their profligacy. We believe this conclusion is fundamentally false, and importantly, that it misses the bigger issue critical for devising a solution. Its important to recall that both Ireland and Spain entered the global financial crisis in 2008 with budget surpluses. The crisis in Europe is the result of imbalances within the European Monetary Unionthe persistent current account surpluses and deficits among certain countriesresulting in a balance of payments crisis, which, ironically, is precisely what the euro was intended to prevent. One underappreciated contributor to the crisis was the effect of the European Central Banks single policy interest rate. Because of structural differences, including varying inflation rates in member countries, over the years the ECBs nominal policy interest rate resulted in differing real interest rates across constituent countries. Our advisors at Lombard Street Research refer to this policy as one size fits none. For example, because inflation in Germany has been low, real interest rates were high, thus monetary policy was comparatively tight, which kept a lid on consumption. By contrast, low-to-negative real interest rates in more inflation-prone economies, such as Ireland and Spain, encouraged borrowing for consumption and speculation, especially in real estate. As asset prices increased, incomes and creditworthiness also accelerated, providing additional fuel to the cycle. The credit boom provided the illusion of a harmonious European relationship: northern export-led economies produced goods for the consumption-oriented south. Because a current account deficit reflects consuming more than a country produces, requiring borrowing from abroad, Germanys surpluses were effectively lent back, or recycled, to the periphery in return for more consumption. The imbalances in the form of growing current account surpluses (in Germany) and deficits in the periphery (Greece, Spain, Portugal) were largely ignored. Hardly anyone seemed to realize that Germanys growth was as dependent on continued borrowing in the periphery as the periphery itself.

POLICY OPTIONS
As weve discussed before, in dealing with situations of insolvency, policymakers have essentially three options: (1) Default and/or restructurings; (2) Transfer payments; (3) Inflation To understand what has been attempted, consider the following: Default and/or restructurings As recently as March, European officials orchestrated the largest sovereign debt restructuring in history, significantly reducing Greeces outstanding debt. Nonetheless, Greek bonds today trade at interest rates of 30%, proving that anything less than a 100% write-off was insufficient. Because nothing was done to address Greeces lack of competiveness, its ability to service any debt as its economy rapidly contracted was always going to be nil. Any further restructurings that fail to address the internal imbalances in the EMU will also prove insufficient in actually solving the crisis. Transfer payments Because countries such as Greece and Portugal, who along with Ireland have already received transfer payments (bailouts), remain globally uncompetitive, there is little hope of growing out of their problems (absent a deflation of wages so severe that a political uprising would be inevitable). Austerity, which Germany is demanding, crushes domestic demand in the countries where it is implemented. Because these uncompetitive countries cannot grow exports (i.e. external demand), economic depression is virtually assured. Therefore, continuing along the current path would require perpetual transfer payments in order to plug the funding gaps the peripheral economies are experiencing. These transfer payments represent gifts of money beyond what the EFSF and ESM have been structured to provide. Not only are these amounts incalculable, but despite widespread belief, no European country has the fiscal wherewithal to fund
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them. Germanys debt-to-GDP is 83%, a reality often overlooked. Significant additional liabilities would jeopardize its solvency and ability to borrow. Eurobonds, where the actual costs are certain to be less obvious to European voters, have been periodically suggested as an alternative solution. To date Germany has vehemently resisted. Even if Germany softens its stance, implementation would require time, which neither Greece nor Spain has. Additionally, Eurobonds would require all 17 EMU countries to go joint and severally liable, an aggressive leap towards fiscal unity that we dont envision. On CNBC a few months back, our friend Kyle Bass of Hayman Capital answered a question about Eurobonds by colorfully turning it back to the interviewer, asking with respect to your own assets and financial situation, how many aunts, uncles and a cousins would you go joint and severally liable with? Most recently news has surfaced of a potential FDIC-like deposit insurance scheme to prevent capital flight from the peripheral economies. Again, due to complexity and the potential liabilities to the corebank deposits in Europe are over 10.5 trillion with over 3 trillion in the peripherywe dont believe such a scheme can be implemented quickly enough. Inflation and/or Monetization (i.e. money printing to pay for debts) Many commentators have suggested that higher inflation in Europe would serve as a panacea. Again, this fails to recognize the imbalances within the EMU. For the present imbalances to adjust, higher wages (and consumption) in Germany, vis--vis the rest of Europe, would be needed. Said differently, Germanys propensity to suppress wages over the past decade has resulted in an artificial competitive advantage in trade, which has manifest as persistent trade surpluses (the effect of which has been to suck demand out of other European countries). Although higher wages in Germany would help to close the enormous gap in relative unit labor costs across Europe, there are no assurances that Germans would consume more. Over the past year, the ECB has engaged in a number of programs in order to reduce stress in Europe, including the outright purchases of sovereign debt (monetization), and most recently, its Long Term Refinancing Operations (i.e. LTROs, essentially 3year loans to banks). Although the LTROs were characterized as a liquidity measure, in effect it served as back-door monetization. Most European banks, especially those in Spain and Italy, borrowed the funds from the ECB in order to buy their respective countrys sovereign debt. Spreads initially fell, but as we can now see, the effect was temporary. Banks no longer have the ability to offset the selling of sovereign bonds by foreigners. As interest rates have once again risen, bond prices have fallen. So ironically, the banks are now underwater on their recent purchases, increasing their insolvency risk. In recent weeks, there has been a cacophony of calls for the ECB to once again step up their bond buying. We believe two issues with these programs receive too little attention: 1. The ECBs (outright or back-door) purchases of sovereign debt have not been successful in pushing nominal GDP growth in the periphery economies above the level of their interest rates. As long as interest rates remain above nominal GDP, debt-toGDP ratios will continue to rise, increasing insolvency Because central banks and other entities such as the IMF dont take losses, they are senior to other private sector holders of sovereign bonds. Therefore, with each purchase by the ECB, private sector holders are subordinated further, meaning they stand last in line in a restructuring. It doesnt require sophisticated math skills to recognize that in a restructuring, nothing will be left over to private holders. So paradoxically, by purchasing sovereign bonds, the ECB is discouraging private holders from also doing so. Yet functioning capital markets require participation from private investors. Therefore, they are essentially biting the hands that are ultimately needed to feed them

2.

THE ENDGAME
Unfortunately, it remains impossible to predict the ultimate outcome of the EMU, or the euro. However, we do know that since the outbreak of the crisis, policymakers have remained consistently behind the curve. Today is no exception. Contrary to common belief, the euro has not been good for Europe. By analyzing the 10-year period before the euro compared to the 10-year period since the introduction of the common currency, it is patently clear that growth slowed considerably. All members of the EMU underperformed other members of the European Union that maintained their independent currencies and monetary policy, such as Sweden and Switzerland. From a pure economic perspective, perhaps the best path would be to disband the euro and reintroduce 17 national currencies (facilitated by the ECB and each nations existing central bank). This course would no doubt come
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with significant costs, as well as global financial and economic volatility. However, maintaining the euro is certain to also come with enormous costs, including years of recession and economic depression in parts of Europe, not to mention the potential for political and societal upheaval. Of course, ending the euro is a politically unpalatable decision at this point. Therefore, we expect more patchwork policies and promises that do nothing to resolve the fundamental imbalances at the core of the problemthe imbalances between members, and particularly, the lack of competitiveness of the peripheral countries.

PORTFOLIO CONSTRUCTION
Our portfolios maintain little-to-no direct allocations to Europe, nor to international or emerging market equities in general (on the belief that the European crisis was far from resolved and that China was set to slow more significantly than what was discounted in financial markets). As US equity markets have outperformed, our portfolios have benefitted. We have also maintained a long position in the U.S. dollar index, of which the euro represents a majority (hence, we are short the euro). Not only does our long dollar position tend to exhibit negative correlation to the S&P 500, it also effectively denominates part of our gold position in euros, yen and pounds. In short, we have believed the dollar would appreciate against all three of these currencies, yet gold would ultimately appreciate against all of them. As todays global monetary regime comes unhinged, we continue to believe gold will benefit, albeit with considerable volatility. In May our long US dollar position rose 5% as the euro has fallen 7%. If you have any additional questions, please dont hesitate to call. --Bienville Capital Management
***For anyone who would like to discuss it, we have some additional analysis that we believe clearly highlights why Germanys prescription for austerity is deeply flawed. As long as Germany intends to run trade surpluses while fiscally balanced, mathematically, someone else must run a deficit. Not every country in the EMU can be a net saver. We also have a number of charts to support the analysis above. Please contact me if youd like to view them.

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ABOUT BIENVILLE Bienville Capital Management, LLC is an SEC-registered investment advisory firm offering sophisticated and customized investment solutions to a select number of high-net-worth and family office investors. The members of the Bienville team have broad and complimentary expertise in the investment business, including over 100 years of collective experience in private wealth management, institutional investment management, trading, investment banking and private equity. Bienville has established a performance-driven culture focused on delivering exceptional advice and service. We communicate candidly and frequently with our clients in order to articulate our views. Our clients include institutional investors, high-net worth individuals and family offices with complex needs, entrepreneurs and professionals. Bienville Capital Management, LLC has offices in New York, NY and Mobile, AL. DISCLAIMERS Bienville Capital Management, LLC. (Bienville) is an SEC registered investment adviser with its principal place of business in the State of New York. Bienville and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisers by those states in which Bienville maintains clients. Bienville may only transact business in those states in which it is notice filed, or qualifies for an exemption or exclusion from notice filing requirements. This document is limited to the dissemination of general information pertaining to its investment advisory services. Any subsequent, direct communication by Bienville with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Bienville, please contact Bienville or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). This document is confidential, intended only for the person to whom it has been provided, and under no circumstance may be shown, transmitted or otherwise provided to any person other than the authorized recipient. While all information in this document is believed to be accurate, the General Partner makes no express warranty as to its completeness or accuracy and is not responsible for errors in the document. This document contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. The views expressed here are the current opinions of the author and not necessarily those of Bienville Capital Management. The authors opinions are subject to change without notice. There is no guarantee that the views and opinions expressed in this document will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Past performance may not be indicative of future results and the performance of a specific individual client account may vary substantially from the foregoing general performance results. Therefore, no current or prospective client should assume that future performance will be profitable or equal the foregoing results. Furthermore, different types of investments and management styles involve varying degrees of risk and there can be no assurance that any investment or investment style will be profitable. This document is not intended to be, nor should it be construed or used as, an offer to sell or a solicitation of any offer to buy securities of Bienville Capital Partners, LP. No offer or solicitation may be made prior to the delivery of the Confidential Private Offering Memorandum of the Fund. Securities of the Fund shall not be offered or sold in any jurisdiction in which such offer, solicitation or sale would be unlawful until the requirements of the laws of such jurisdiction have been satisfied. For additional information about Bienville, including fees and services, please see our disclosure statement as set forth on Form ADV.

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