Free Markets, Free People
The credit rating companies have had a number of European countries on a credit watch for a while. And they made it pretty clear that what the leaders of the EU had cobbled together late last year didn’t answer the mail. So really, this should come as no surprise:
Standard & Poor’s has downgraded France’s credit rating, French TV reported Friday, while several other euro zone countries face the same fate later in the day, according to reports.
"The consequence (if France is downgraded) is that the EFSF cannot keep its triple-A rating," said Commerzbank chief economist Joerg Kraemer.
"That may irritate markets in the short term but wouldn’t be a big problem in a world where the U.S. and Japan also don’t have a triple-A rating anymore. Triple-A is a dying species," he said.
Wow, that’s wonderful, no? “Triple-A is a dying species?” Oh well, moving on…
Triple-A is a dying species because of the obscene spending of welfare-state politicians. We’re supposed to shrug and accept it per the Kraemer’s of the world. This is just an “irritation”, you see.
In reality it is much more than that:
John Wraith, Fixed Income Strategist at Bank of America Merrill Lynch told CNBC the confirmation of a mass downgrade would be another serious step in the crisis and would lead to a serious worsening of sentiment.
"To a large degree it’s widely anticipated," Wraith said. "However, we think the reality of it is going to have a knock-on, ongoing impact on these markets."
“It clearly deteriorates still further the credit worthiness of a lot of the European banks and just keeps that negative feedback loop between struggling banks and the sovereigns that may have to support them if things go from bad to worse in full force,” Wraith added.
A downgrade could automatically require some investment funds to sell bonds of affected states, making those countries’ borrowing costs rise still further.
"It’s been priced in for several weeks, but the market had been lulled into complacency over the holidays, and the new year began with a bounce in risk appetite, thanks partly to a good Spanish auction," said Samarjit Shankar, Director Of Global Fx Strategy at BNY Mellon in Boston.
"But the Italian auction brought us back to earth and now we face the spectre of further downgrades."
Italy’s three-year debt costs fell below 5 percent on Friday but its first bond sale of the year failed to match the success of a Spanish auction the previous day, reflecting the heavy refinancing load Rome faces over the next three months.
As we’ve said for some time, the key to whether this works out or not lies in the bond markets. And this will make the bond markets very uneasy.
Oh, and just to add fuel to the fire. From Zero Hedge:
Last week, when we pointed out what was then a record $77 billion in Treasury sales from the Fed’s custody account, in addition to noting the patently obvious, namely that contrary to what one hears in the media, foreigners are offloading US paper hand over first, there was this little tidbit: "The question is what they are converting the USD into, and how much longer will the go on for: the last thing the US can afford is a wholesale dumping of its Treasurys. Because as the chart below vividly demonstrates, the traditional diagonal rise in foreign holdings of US paper has not only pleateaued, but it is in fact declining: a first in the history of the post-globalization world." Well as of today’s H.4.1 update, the outflow has increased by yet another $8 billion to a new all time record of $85 billion, in 6 consecutive weeks, which is also tied for the longest consecutive period of outflows from the Fed’s Custody account ever. This week’s sale brings the total notional of Treasurys in the Custody account to just $2.66 trillion (down from a record $2.75 trillion) and the same as April of last year. And since the sellers are countries who have traditionally constantly recycled their trade surplus into US paper, this is quite a distrubing development. So while the elephant in the room could have been ignored 4, 3 and 2 weeks ago, it is getting increasingly more difficult to do so at this point, especially with US bond auctions mysteriously pricing at record low yields month after month. But at least the mass dump in Treasurys explains the $100 swing higher in gold in the past month.
Click on over and check out the chart. Lots of questions to be answered for which, apparently, only a few are chasing answers.
While the media is dominated by political races and urinating Marines, this little drama is passing by almost unnoticed. But trust me, it’s effect, should everything collapse as it may, will be profoundly noticed.
One of the irritating things about being deeply in debt is dealing with your creditors. Happily, if your creditor is, say Wells Fargo, they tend to stay within strict legal bounds when dealing with you. If you’ve been unfortunate enough to seek credit from fellows whose last names end in vowels, they tend to be more…forceful in delivering their messages to you. As it happens one of the United States’ creditors also has a name that ends with a vowel: China.
And they have a message. The more or less official organ of the Chinese Communist Party—which is to say the Chinese Government—is the newspaper People’s Daily. So, it is with much interest that I read an op/ed piece in that fine journal with the title, "China must punish US for Taiwan arm sales with ‘financial weapon’". As messages go, this one’s pretty simple.
Now is the time for China to use its "financial weapon" to teach the United States a lesson if it moves forward with a plan to sale arms to Taiwan. In fact, China has never wanted to use its holdings of U.S. debt as a weapon. It is the United States that is forcing it to do so.
The U.S. House of Representatives just passed a debt ceiling bill on Aug. 1. On the next day, a total of 181 members of the House of Representatives signed a letter sent to U.S. President Barack Obama stating that the federal government should approve the sale of F-16 C/D fighter jets to Taiwan as soon as possible to help ensure peace and stability across the Taiwan Strait…
Despite knowing that major creditor countries, especially China, would be the main buyers of its new debt, certain arrogant and disrespectful U.S. Congress members have totally ignored China’s core interests by pressuring the president to sell advanced jets and even an arms upgrade package to Taiwan.
U.S. treasuries will lose value if China stops or reduces its purchases of them on a large scale, which will also affect the value of China’s U.S. treasury holdings. However,as the situation has gotten out of hand, allowing Washington politicians to continue their game might lead to more losses.
U.S. arms sales to Taiwan can only create more jobs for the United States but cannot improve the ability of Taiwan’s military force to compete with the Chinese mainland. The essence of the problem is that some U.S. Congress members hold a contemptuous attitude toward the core interests of China, which shows that they will never respect China. China-U.S. relations will always be constrained by these people and will continue along a roller coaster pattern if China does not beat them until they feel the pain.
I am mildly amused by the claim that such sales both threaten "China’s core interests", but "cannot improve the ability of Taiwan’s military force to compete with the Chinese mainland." Both of these arguments cannot simultaneously be true.
Less amusing is the common attitude of loan sharks to their creditors displayed here using much the same language that Tony "The Shark" would use: Namely, if creditors don’t do what they’re told, you have to "beat them until they feel the pain."
With the recent rise in bond prices and drop in yields, the Chinese have a number of options. The least damaging to the US would be to sit out a few bond auctions, which would force interest rates up. But they’ve also got the nuclear option of selling off as much paper as the market could bear. Yes, they’d forego some yield payments, but they’d probably make a nice tidy premium over the original purchase price to make up for it. Rising interest rates now, at a time when the economy is weak, and short-term rates are already effectively zero, would slow the US economy. At the same time, a massive repatriation of renminbi to China would cause a steep drop in the value of the dollar in foreign exchange markets. This would raise the price of imports equally steeply. This would cause something very similar to the oil price shocks of the 1970s, that plunged the US into stagflation.
Naturally, the Chinese would be hurt by the reduction in their export capability. The question then becomes, "Which of the two political systems, China or the US, is more concerned about democratic pressure to change policy in order to improve the economy?" Who is more responsive to public pressure: our government, or the government that initiated the Tiananmen Square massacre?
I don’t know about you, but I wouldn’t expect Hu "The Kommissar" Jintao to be the one that blinks first.
Of course, if we weren’t $14 trillion in debt, we wouldn’t be very vulnerable to this sort of thing.
I’m not sure how many times we or our politicians have to hear this, but to this point, it hasn’t made the impression it should:
Much of the public focus is on the nation’s public debt, which is $14.3 trillion. But that doesn’t include money guaranteed for Medicare, Medicaid and Social Security, which comes to close to $50 trillion, according to government figures.
The government also is on the hook for other debts such as the programs related to the bailout of the financial system following the crisis of 2008 and 2009, government figures show.
Taken together, Gross puts the total at "nearly $100 trillion," that while perhaps a bit on the high side, places the country in a highly unenviable fiscal position that he said won’t find a solution overnight.
Bill Gross runs Pimco, a based in Newport Beach, Calif., manages more than $1.2 trillion in assets and runs the largest bond fund in the world. Gross went on to say:
"To think that we can reduce that within the space of a year or two is not a realistic assumption," Gross said in a live interview. "That’s much more than Greece, that’s much more than almost any other developed country. We’ve got a problem and we have to get after it quickly."
"We’ve always wondered who will buy Treasuries" after the Federal Reserve purchases the last of its $600 billion to end the second leg of its quantitative easing program later this month, Gross said. "It’s certainly not Pimco and it’s probably not the bond funds of the world."
Now whether you realize it or not, that’s a good share of the bond market saying, "yeah, you know, not interested". That’s scary. And with China recently unloading some of its US debt notes, it’s not a happy picture for the US, fiscally. As Gross points out, in overall financial condition, we’re worse off than the basket case of Europe – Greece.
We have been getting these warning for literally decades. We’ve done absolutely nothing substantial to mitigate them. In fact, we added more to the pile (Medicare D and ObamaCare). We’re going to crash. It is time for a huge reality check, gut check or whatever you want to call it. But like the shopping addicted, we have got to cut up the credit cards, cut spending to the bone, get government out of areas it has no business and take as much power of the purse away from the Fed as we can.
This is beyond absurd. And the time to address it is now (if it’s not already too late).
In this podcast, Bruce, Michael, and Dale discuss the demonstrations by public employee unions in Wisconsin, and the state of the economy.
The direct link to the podcast can be found here.
As a reminder, if you are an iTunes user, don’t forget to subscribe to the QandO podcast, Observations, through iTunes. For those of you who don’t have iTunes, you can subscribe at Podcast Alley. And, of course, for you newsreader subscriber types, our podcast RSS Feed is here. For podcasts from 2005 to 2010, they can be accessed through the RSS Archive Feed.
Bruce mentioned yesterday that the 5-year note auction drew thin demand, with a low bid-to-cover ratio, and a steep drop in indirect buyers. This led to a jump in interest rates for both the Fives and the Tens also went up by 13 basis points. meanwhile, investors began moving into corporate paper, instead of treasuries.
I also note that this week saw weaker than expected durable goods orders, atrocious new home sales, and initial unemployment claims still at 442k–which is better than it was last week, but not great.
The “recovery”, apparently is still on pretty shaky ground.
Meanwhile, the new health care reform law attempts to shift a bunch of spending via Medicaid to the states, who are not really in a position to cover those costs, as state tax revenues have sharply declined from 2007.
In short, with a weak economy, we are planning on adding what may be as much as $2 trillion to the deficit over the next 10 years–deficits that are already at $1 trillion per year as far as the eye can see. How neatly that coincides with the announcement that Social Security will run into the red this fiscal year, paying more in benefits than it receives in payroll taxes, six years earlier than previously expected.
So, we got that going for us.
The United States is supposed to be the richest country in the world. But, on our present fiscal course, that cognomen will not attain in a very few years. We simply will not have enough money to service the debt load we will be carrying. In a very real sense, it doesn’t matter whether the Republicans can win in November and repeal the HCR law just passed. Or Cap & Trade. Or Medicare Part D. Or whatever.
We are directly on course to having to run massive inflation by monetizing the debt, or to simply defaulting on it, both of which will result in massively high interest rates, and economic stagnation. With the added bonus of runaway inflation, for good measure.
That this will happen cannot be in serious doubt if we continue our present course. Our fiscal and monetary policies are self-evidently unsustainable.
I can only presume that the Democrats believe that, at the appropriate time, fairies will appear out of thin air to sprinkle magical pixie dust on the economy, and all will be well. The current raft of policies they are proposing to enact will crush the economy. We’ve seen it happen time and again in South America, and now even in the EU, in which the Greeks are headed for a default in the very near future.
What is coming out of Washington is not policy. it is full-scale flight from reality.
In this podcast, Bruce, Michael, Billy, and Dale discuss the economy and the Sotomayor nomination.
The direct link to the podcast can be found here.
The intro and outro music is Vena Cava by 50 Foot Wave, and is available for free download here.
As a reminder, if you are an iTunes user, don’t forget to subscribe to the QandO podcast, Observations, through iTunes. For those of you who don’t have iTunes, you can subscribe at Podcast Alley. And, of course, for you newsreader subscriber types, our podcast RSS Feed is here. For podcasts from 2005 to 2007, they can be accessed through the RSS Archive Feed.
Amidst all the “happy talk” about signs that the economy is “turning around” we see more troubling signs that it is, in fact, being badly mishandled:
The US Treasury is facing an ordeal by fire this week as it tries to sell $100bn (£62bn) of bonds to a deeply sceptical market amid growing fears of a sovereign bond crisis in the Anglo-Saxon world.
The interest yield on 10-year US Treasuries – the benchmark price of long-term credit for the global system – jumped 33 basis points last week to 3.45pc week on contagion effects after Standard & Poor’s issued a warning on Britain’s “AAA” credit rating.
The yield has risen over 90 basis points since March when the US Federal Reserve first announced its controversial plan to buy Treasury bonds directly, a move designed to force down the borrowing costs and help stabilise the housing market.
The yield-spike may be nearing the point where it threatens to short-circuit economic recovery. While lower spreads on mortgage rates have kept a lid on home loan costs so far, mortgage rates have nevertheless crept back up to 5pc.
The housing market hasn’t yet bottomed out and Britain isn’t the only country whose credit rating Standard & Poors is reviewing. If we can’t sell debt instruments there are only a couple avenues left to us aren’t there? And, as noted, both would certainly “short-circuit” any economic recovery.
Is it too big to fail? Megan McArdle believes the possibility certainly exists (I mean was Arnie really in DC yesterday just to see the sights). Says McArdle:
If the government does bail out the muni bond market, how should it go about things? The initial assumption is that they’ll only guarantee existing debt. Otherwise, it would be like handing the keys to the treasury to every mayor, county board, and state legislature, and telling them to go to town.
But once the treasury has bailed out a single state, there will be a strongly implied guarantee on all such debt. So you don’t give them the keys to the vaults, but you do leave a window open, point out where the money’s kept, and casually mention that you’ve given the armed guards the week off.
Of course the right answer is not to bail out either. Failure is a great teacher. And then there’s the moral hazzard angle.
But in this day and age, that’s approach is almost unthinkable apparently. Government, as we’re being told, is the answer to everything.
My fear, based on what the federal government has done to this point, is they’ll “hand the keys to the treasury” on both the muni bond market and the states (with bailouts). They have no business doing anything in either place, but we’ve already seen that the arbitrary assessment that some entity is too big to fail apparently takes priority over economic law.
Once a single state is bailed out, there is nothing to stop other states from making a similar claim on the treasury.
Should such a thing happen in either case (or both), Federalism, which is on its last legs anyway, will be officially dead.
Sometimes, a message has to get out there, so that the people who need to hear it can hear it. Often, however, the message can’t be gotten out by presidents, finance ministers, or Fed officials. But, someone has to make the arguments. Samizdata’s Brian Micklethwait takes up the task today.
It needs to be said that under certain circumstances easily now imaginable, many Western citizens would argue, strongly and vocally, that those idiot foreigners who are now lending money to Western governments should in due course be told: sorry sunshine, you ain’t ever going to get it back. Our governments are bankrupt. Why the hell should we and our descendants in perpetuity be paying tribute to you? You knew that the money to pay you back would have to be stolen from us. You assumed we’d just cough up indefinitely. Well, we damn well won’t. You are now a definite part of our problem, and telling you to take a hike is going to be part of our solution. Our thieving class is now “borrowing” money from your thieving class like there is no tomorrow, and we are not responsible for the actions of either gang. A plague on both your houses.
We want you foreign thieves to stop lending to our thieves, now. And the best way for us to convince you that you should indeed stop lending, is to tell you that you are extremely liable never to see most of your money back.
Which has the added virtue of probably, approximately, being true, already.
The last sentence is the real kicker, because it’s beginning to look more like a question of when, rather than if. And, who of course. Of the Western nations, my favored picks, in no particular order, for winning 1st place in the 21st Century Debt repudiation race are, in no particular order: Hungary, Italy, Ireland, Spain, and Portugal.
Second place will be too close to call.
And you don’t have to couch it in Mr. Micklethwait’s incendiary libertarian rhetoric about their thieves and our thieves. I mean, I agree with it, but the plain fact is that even if you grant that everyone has the best intentions in the world, it still seems that we are very close to a tipping point where it could begin to happen. Bruce wrote about it earlier today.
If one of the Euro Zone nations decide to revert to Lira or Escudos, or whatever, the news that such a deal is in the offing will not only hammer the nation that tries, but anyone else who looks iffy, and, untimately, the Euro itself.
Investors are not going to sit around and wait to have their Euro-denominated paper revalued in Drachma. They’ll immediately start dumping that paper, and moving all the assets they can out of not only the offending nation, but any other country that looks like a weak sister. As the article Bruce quoted notes, “Such a wholesale shift would lead to a collapse in the money supply…” Gee, you think?
Germany, of course, would probably get the lion’s share of that new money, and to avoid a general economic collapse, they’d probably have to dump the Euro, too, and redenominate all that nice cash in Deutschemarks to avoid getting hammered as the rest of the Euro Zone economies collapse. Or, Germany might be the Euro Zone. Maybe France, too. France is more of a hindrance than a help, really, but palling around with the French is the price Germans paid for re-admittance to the human race, after the recent…unpleasantness.
No finance minister can yet say such unpleasant things publicly. But someone needs to to say them, especially since they are starting to sound less and less extreme.