Observations: The QandO Podcast for 24 Mar 13
This week, Bruce, Michael and Dale discuss the events of the week.
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.
Finland prepares for Euro-zone breakup
This is not good news by any stretch. But it is a prudent step. My guess, however, is it isn’t being well received in Brussels.
The Nordic state is battening down the hatches for a full-blown currency crisis as tensions in the eurozone mount and has said it will not tolerate further bail-out creep or fiscal union by stealth.
“We have to face openly the possibility of a euro-break up,” said Erkki Tuomioja, the country’s veteran foreign minister and a member of the Social Democratic Party, one of six that make up the country’s coalition government.
“It is not something that anybody — even the True Finns [eurosceptic party] — are advocating in Finland, let alone the government. But we have to be prepared,” he told The Daily Telegraph.
“Our officials, like everybody else and like every general staff, have some sort of operational plan for any eventuality.”
We’ve talked about the cascade effect many times before. What normally causes that effect is some sort of tipping point. So far, it seems, Europe has avoided that tipping point. One has to wonder if it might be Finland that tips the scales. To this point, the subject of the Euro-zone breakup has been pretty much tip-toed around.
Now you have a country that is actively preparing for it and making those preparations public. Note too what they’re saying – Finland has said it “will not tolerate further bail-out creep or fiscal union by stealth.”
That’s pretty final.
Additionally, if such a plan should be put forward:
Like other member states, Finland has a veto that could be used to block any new bail-out measures. However, unlike some states, its parliament would have to approve each future measure of the eurozone rescue, including a full bail-out of Spain.
And, as you read the article, you’ll see that’s not very likely to happen.
So … hold on. My guess is the ride in Europe is about to encounter severe turbulence.
~McQ
Twitter: @McQandO
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Observations: The QandO Podcast for 17 Jun 12
This week, Bruce, Michael and Dale talk about Niel Munro interrupting the president, and the Greek elections.
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.
Around the economic world in a few minutes
A post to update you on what is happening, economically around the world.
In Asia, some not so good signs. In China, housing prices fell in 100 Chinese cities for the 5th straight month. Chinese manufacturing has also cooled significantly:
Manufacturing activity in China and across a wide swath of Asia slowed in May, heightening fears that the turmoil in Western economies is dragging down one of the few remaining engines of global growth.
Two purchasing managers indexes for China fell in May, briefly rattling investors Friday and stoking speculation Beijing may have to respond aggressively to support growth. Indonesia posted its first trade deficit in nearly two years, and South Korea’s exports, considered a bellwether for Asia, unexpectedly fell for a third straight month.
"The green shoots of recovery that we were seeing a month or so back are wilting away," said Rob Subbaraman, chief Asia economist at Nomura Securities. "The crisis in Europe is one reason; the other one is the China slowdown. But I think less appreciated is that the height of uncertainty about the outlook has caused Asian firms and multinationals in Asia to pause in their investments, and I think that’s the bigger factor right now."
China’s official PMI, based on government data, showed manufacturing continuing to grow but by the barest of margins, falling to 50.4 in May from 53.3 in April. A figure above 50 indicates expansion. An index produced by HSBC and Markit showed Chinese manufacturing was worse, falling to 48.4 in May from 49.3 a month earlier.
"We feel that in China a very powerful stimulus"—combining fiscal outlays and cuts to banks’ reserve requirement ratio—"is required to arrest the slowdown in growth," said Frederic Neumann, co-head of Asian economic research for HSBC. "These numbers today suggest this is coming sooner rather than later. If that stimulus is not delivered, then China is indeed looking at a hard landing."
Both the US’s non-recovery recovery and the Eurozone crisis are being blamed for this slowdown.
The economies of Asia, both the emerging markets and the more developed countries, are being hit by a double whammy of slowing domestic growth and the impact of the European debt crisis on Asian exports and finance.
Signs of distress are proliferating.
In India, the government reported Thursday growth in the first three months of the year at the slowest pace in the past nine years—up 5.3% from the year-earlier quarter, well below the 8% pace of recent years. "A gasping elephant," said Leif Lybecker Eskesen, HSBC’s chief India economist, in a note to investors.
In China Friday, an official gauge of manufacturing activity fell to a lower than expected level, which is likely to add to market concerns about China’s slowdown. China’s official Purchasing Managers Index fell to 50.4 in May, compared with 53.3 in April and lower than the median forecast of 51.5. A reading below 50 indicates contraction. The Ministry of Commerce, meanwhile, is blaming "worse-than-expected" economic performance in Europe for disappointing export data.
Early Friday, South Korea said its exports unexpectedly contracted for a third consecutive month in May compared with a year earlier. South Korea is the first country in Asia to release trade data for the month and is often a harbinger of regional trends.
Meanwhile in Europe, the UK’s manufacturing is reported as slumping with activity dropping to its lowest level in three years. The Eurozone jobless rate stands at 11%. Additionally the Eurozone crisis is now beginning to effect countries with close proximity and ties which are not a part of the Euro:
The euro zone’s deepening fiscal crisis continued to take its toll on some of the neighboring economies of central and eastern Europe in May, as surveys released Friday indicated manufacturing activity contracted again in May.
The countries in Europe’s center and east have close trade and financial ties with the euro zone, and some have seen demand for their exports weaken as the currency area’s economy has stalled, while western Europe banks have cut their lending to the region.
A double whammy. And, finally, within the Eurozone itself, companies are trying to prepare for the Greek withdrawal from the zone (and possibly Spain’s as well):
As European officials race to quell fears that Greece may exit the euro, many companies doing business in the troubled country are preparing for the worst.
Most executives, analysts and others agree on one thing: the impact of a Greek withdrawal from the euro zone is impossible to predict. That’s why multinational companies are rehearsing for any number of contingencies. They range from a paralysis in cross-border payments to a civil breakdown in Greece to a broader breakup of Europe’s common currency.
Retrieving their cash is among the companies’ gravest concerns. If Greece were to revert to its former currency, many companies fear that any euros left there would be converted into less-valuable drachmas. Should that happen, Greece is widely expected to impose capital controls to keep the remaining cash in the country.
Can you say “completely mess?”
Meanwhile, here, the business climate remains unsettled, hiring still isn’t showing any real turnaround and the economy continues to bang along the bottom (one assumes, it could drop again if the Euro crisis explodes) with no real trend upward.
~McQ
Twitter: @McQandO
Denial is not just a river in Egypt
Dale’s post, “Fantasy v. Reality” is spot on. And there are plenty of examples of his point to be found. One of the characteristics of those who live in the fantasy side of things is their continued denial of the real cause of Greece’s problems specifically and Europe’s problem generally.
They, like certain politicians on this side of the pond, want to lay it off on others – the implication being that if that situation is changed, the problems that Greece and other countries are encountering will resolve themselves.
And then what? And then the strategy would appear to be to cauterise the amputation; to circle the wagons; to issue the most ringing and convincing proclamation to the markets that no more depredations will be tolerated; and to get the Germans to stump up, big time, to protect Spain and Portugal. We are told that the only solution now is a Fiscal Union (or FU). We must have “more Europe”, say our leaders, not less Europe – even though more Europe means more suffering, and a refusal to recognise what has gone wrong in Greece.
The euro has turned out to be a doomsday machine, a destroyer of jobs, a killer of growth, because it entrenches and exacerbates the fundamental and historic inability of some countries to compete with Germany in making high-quality goods with low-unit labour costs. Unable to devalue their way back into the game, these countries are forced to watch industry wilt under German imports, as the euro serves as a giant trebuchet to fire swish German saloon cars and machine tools across the rest of Europe.
Germany is almost alone in recording economic growth in the first part of 2012; Germany is doing well from the euro; and so the theory is that Germany should pay to keep the whole racket going by bailing out the improvident and the uncompetitive, just as London and the South East subsidise the rest of the UK.
Alas, it is not a strategy that is likely to work. As Angela Merkel has made clear, there is little political support – let alone popular support – in Germany. EU leaders may want a fiscal union, but it is deeply anti-democratic. We accept large fiscal transfers in this country because Britain has a single language and a single political consciousness in a way that Europe never will. Rather than creating an “economic government of Europe”, the project will lead to endless bitterness between the resentful donors and the humiliated recipients, as these diminished satrapies will be instructed to accept cuts and “reforms” – designed in Berlin and announced in Brussels – as the price of their dosh.
Or, “it’s all Germany’s fault”.
Germany implemented Greece’s labor laws, work week, retirement age, public pensions and government subsidies. You didn’t know that? It’s Germany’s fault that it has all caught up with Greece in a down global market. If Germany wasn’t so damn good, Greece would be in such damn bad shape.
Really. That’s what this guy is pushing. I mean, my goodness, imagine – “high-quality goods with low-unit labor costs”. How dare they? How can one pump up a welfare state and keep it going with competition like that? It is Germany’s job to enable Greece’s work 38 hour week. Germany’s job to ensure their generous pension plans, early retirement, subsidies and welfare payments.
How dare they do otherwise. They owe Europe. They owe the rest of Europe the lifestyle they desire but can’t afford.
What is wrong with that country?
~McQ
Twitter: @McQandO
Observations: The QandO Podcast for 20 May 12
This week, Bruce, Michael and Dale talk about Greece, and the folly of governments.
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.
Oh. This can’t be good…
Via Zero Hedge, I’ve acquired this very interesting little chart, that shows the number of margin calls on its credit-extensions to counterparties. Huh. Now, see, I just wrote that, and I have no idea what it means. It’s just lots of economic gobbledy-gook when you write it out in a single sentence like that. But, here, let’s take a gander at the chart, then I’ll explain, in human terms, what it tells us.
So, the European Central Bank (ECB) had this great idea, which was to implement a European version of Quantitative Easing. They called it the Long-Term Refinancing Operation, or LTRO.
It was actually pretty simple. The banks would go to the ECB and get an LTRO loan by providing collateral of some sort—generally A-rated securities. By which, I mean a security that at least one rating agency has rated as "A". Like, you know, Italian bonds. They don’t actually have to give the collateral to the ECB or anything, just let them know that, "Hey, we’ll just keep it safe, and can hand it over if we really have to." On the strength of those assurances, and the sterling quality of the collateral in question, like Spanish bonds, the ECB then gives the banks a huge hunk of cash. The banks then get to keep the money for up to three years, but are only charged the average overnight rate of interest.
Now, as long as the securities you put up for collateral are good, like Irish bonds, it’s a pretty sweet deal. Alas, if the securities turn out not to be so reliable, the ECB will make a "margin call", that is to say, they will demand the banks come up with additional cash or other assets to cover the collateral.
As you can see from the charts, that is exactly what the ECB is is starting to do. That’s troublesome. You see, the ECB has a €3 trillion balance sheet. But it only has a bit under €11 billion in actual assets. So the ECB has a leverage ratio of a little under 300:1. So, it really does have to go after better assets from the banks if the initial collateral turns, you know, sucky.
The problem then is, as Tyler at Zero Hedge puts it:
The rapid deterioration in collateral asset quality is extremely worrisome(GGBs? European financial sub debt? Papandreou’s Kebab Shop unsecured 2nd lien notes?) as it forces the banks who took the collateralized loans to come up with more ‘precious’ cash or assets (unwind existing profitable trades such as sovereign carry, delever further by selling assets, or subordinate more of the capital structure via pledging more assets – to cover these collateral shortfalls) or pay-down the loan in part. This could very quickly become a self-fulfilling vicious circle – especially given the leverage in both the ECB and the already-insolvent banks that took LTRO loans that now back the main Italian, Spanish, and Portuguese sovereign bond markets.
Essentially, the LTRO program is beginning to suck higher quality assets out of the banks to meet the margin calls that are issued when the initial collateral’s value starts to go belly up. Sucking those higher-quality assets into the ECB’s LTRO collateral program, mean that they can no longer be used to finance business and consumer credit, and, thus, spending. The banks essentially become bond storage warehouses, that don’t actually do any business.
That slows the economy, of course. Which means that those original A-Rated securities stand e much better chance of defaulting, in which case, they’re worth nothing. As Seeking Alpha explains:
The real menace comes in the event of a further weakening of the Eurozone economy. If the economy were to contract, the collateral that the banks have pledged to the ECB may cease to be "performing" (seemingly the only hard criterion for collateral for the second round of LTRO). The ECB would be at risk–and ultimately so would the banks that pledged the defaulting securities.
Any defaults, be they of collateral or the banks themselves, would be a serious issue for the ECB. The ECB is supporting its EUR 3 trillion balance sheet with EUR 10.76 billion in capital–leverage of nearly 300 to one. With the fiscal situation of European sovereigns already strained to the breaking point, it’s hard to see where the money to cover the defaults could come from. This issue of a ballooning balance sheet, coupled with shaky collateral and the 3-year tenor of the ECB loans, is precisely why Trichet and Weber would not go the Draghi route. They bristled at the risk.
The odds of a calamity of the sort that would endanger the ECB are not great, but nor are they impossibly long.
Well, that huge jump in margin calls may be an indicator that those not "impossibly long" odds are getting shorter and shorter. And I wonder how much exposure US banks have to an LTRO default through credit/FX swaps. Probably…really a lot.
So, we got that goin’ for us.
~
Dale Franks
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Observations: The QandO Podcast for 27 Nov 11
This week, Bruce Michael, and Dale record talk about the implications of Germany’s failed bond auction.
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.
The North South Divide
Fundamentally currency unions without fiscal union are flawed. Shoehorning the northern and southern countries of Europe into one (with our without fiscal union) made no sense at all (The Economist)
The economies of southern and northern Europe make strange bedfellows
SINCE bond investors began to discriminate between the euro-zone economies, pushing yields on Spanish, Irish, Greek, Italian and Portuguese government debt soaring, much of the talk in northern Europe has been of profligate governments in the south. As these indicators show, the euro zone’s problems go rather deeper than that. A large chunk of the single-currency area has a chronic competitiveness problem, with a horrible mixture of high unemployment, low productivity and low investment. One unsolved mystery is why all this ought to have some correlation with latitude. Answers to the Bundesbank, please.
Will Eurobonds Work?
(Originally posted at Risk and Return)
I have been skeptical and so is James Bianco:
The problem in Europe is simple – they created a common currency – the euro. For years, the market erred. It thought that meant that every sovereign debt had the same rating as Germany. I was buying Greek bonds. I was buying Irish bonds. I was buying Italian bonds. But I thought I was buying German bonds. Then, a couple of years ago, I had an epiphany – no, I was not buying German bonds; I was buying Greece, Italy, and Ireland, or whatever, not Germany.
Those countries, recognizing that they could borrow into infinity because everybody thought they were lending to Germany, pretty much did that and expanded their welfare states to the point where they cannot pay their debts.
Germany has disappointed everybody with its intransigence, its unwillingness to “get with the program,” and endorse massive ECB bond buying and Eurobonds. Their reason? They believe they will be stuck with the bill. Of course, they are right, they will be:
If a Eurobond market comes with with strict discipline/rules on borrowing and paying debt back, it might work. Unfortunately no one will agree to a Eurobond market with strict discipline/rules.
If a Eurobond market comes with no discipline/rules, then it is just another way to trick the market into thinking they are buying German Bunds. It will “work” for a while as the crisis will ease until everyone borrows too much money and then comes back much worse.
I am not even sure it will work more than a few days at this point, but maybe. Either way it is not a solution, but a stop gap at best. It is also a stop gap that should not be attempted unless an actual endgame is in sight:
So how do you fix the Euro crisis? Unfortunately there are only three solutions and all are distasteful:
- Call off the union and go back to legacy currencies. This destroys the banking system who will be paid back with devalued/nearly worthless currencies.
- Massive austerity. This option is very unpopular among the electorates and will cause a bad recession/depression.
- Fiscal union. This is a nice way of saying Germany finally wins WW2. Is the rest of Europe now ready to take orders from Berlin? Didn’t they fight two wars to prevent this?
The only reason ECB printing keeps being mentioned is because the three options above are untenable and money printing is the only other thing they can think of. Money printing does NOT fix anything, it just makes the problem better for a while until it comes back worse than before.
This dovetails with my analysis in The German Dilemma that their are no good options from the German perspective, and in fact fiscal union is far more problematic than commonly realized:
Full Fiscal Integration: Since all other solutions put in place circumstances that are unstable and merely kick the can down the road, the fundamental flaw in the Euro needs to be addressed. That is the lack of a unified fiscal policy. The answer then is the end of sovereignty, the creation of a US of Europe. An obvious objection is that Germany wants to be a sovereign nation. We’ll skip this niggling little detail, but even if they didn’t want to remain sovereign do they want to harmonize laws and economic policy with Greece and some of the other PIIGS? West Germany just integrated with East Germany and the experience was traumatic featuring massive transfers to East Germans. The PIIGS will still not be competitive with Germany. That means internal adjustments (internal devaluation or austerity) to allow them to become more competitive for the PIIGS’ or massive transfers. Thus unifying the Eurozone under a single fiscal policy means massive transfers from Germany to the PIIGS to harmonize the welfare states and unify the debt and avoid austerity throwing the entire Eurozone into depression. Germans will pay for the debt in one fashion or another.
Cullen Roche points out that in the US we don’t worry much about the need for internal transfers between states to keep the system sound. Today that is true, though it has led to large conflicts in our past, playing a role in civil unrest, uprisings, the conquest of a continent and near destruction of its former inhabitants and the Civil War. Our unity was easier to envision and still born of blood and tragedy.
I am not saying unification of Europe would lead to such tragedies and conflicts. However, we need to ask if Germany (or really all the countries) want to make the internal transfers that make such a system work? Germans would pay a great deal, Greece and the other PIIGS would suffer internal austerity to the extent that they contribute to the economic re-balancing. Do Europeans, or most importantly the Germans, view themselves as a people who will be responsible for paying all the bills to integrate the Greeks and others?
Are Europeans ready to think about their home countries in the same way Texans think of Texas? Their state, but completely subordinate to the US? Will they be able to secede? We answered that question in the US with a war of incredible savagery and destruction. My guess is a unified Europe would be far less stable. They will not choose a civil war comparable to the US, but instead countries leaving over time as well as never entering the union. That leaves us with all the problems we have now still being there. Without a European populace overwhelmingly in favor of a true union this will not work. We would be faced with a PIIGS like crisis with every election and the possibility of secession in each of the former countries.
The necessity of creating a union where there is no possibility of secession, where citizens are more loyal to the European sovereign entity than their own countries is incredibly unappreciated. Half measures will not work. If Texas were to get upset about staying in our own Union it would not matter how overwhelmingly popular the idea of leaving was in the Texas legislature, the US military will ensure that Texas stays a subordinate state. We decided that issue in 1865 at the cost of well over 600k casualties.
If a similarly firm enforcement of Eurozone union is not agreed to (and setting aside a war to force union) then why should the market assume the system will remain intact? Why consider the bonds issued by the various states, or the Eurozone as a whole, deserve a AAA rating? My belief is that eventually the Eurozone will suffer other crises as states face local elections that wish to leave for one reason or another. Critically Eurobonds and fiscal Union make it easier for countries to leave, since the debt will be the Eurozone’s, not theirs. They can leave and stick the remaining members with the bill. That is an incentive which virtually ensures instability.
Treaties don’t matter if there is no enforcement mechanism, and all enforcement mechanisms at the end of the day have to have a credible belief in military force behind them to matter. Otherwise those who wish to exit can just thumb their noses at whoever stays behind. Has there ever been a successful union where the underlying members could leave? Not that I am aware of.
There are no good options, only more or less realistic ones.