europe

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Britain Isn’t Working

George Osborne claims that spending cuts will produce a recovery.

From the Guardian:

The main test of a budget at this time is what it does for the recovery and growth of the British economy. George Osborne has repeatedly made clear that he wants to be judged by this test. He believes that deficit reduction is a growth policy which will be vindicated by its results. Growth has been postponed but, he insists, it is about to happen. So is he right?

It doesn’t look like it:

UK GDP has ground to a halt, while the United States has ticked slightly upward.

Now here’s unemployment:


Looks painful.

But at least we’re paying off the debt right? Nope:


Readers are of course advised to ignore the nonsensical future projections — particularly those for the United States — and focus instead on the fact that the UK is still amassing debt in spite of austerity.

So what the hell are we doing? Unemployment is ticking up, GDP is stagnant, and debt is still rising? Is this policy supposed to be working? Does the Cameron government not understand that cutting government outlays during a recession to pay down debt leads to falling tax receipts, which leads to bigger deficits (exactly what has happened!)?

The truth is — as Keynes noted — that the time for austerity at the treasury is the boom, not the bust. The only exception to this is if you can give back enough money to the taxpayer in tax breaks to offset the deleterious effects of spending cuts (as Ron Paul recommends), which itself is a form of spending. That way, government outlays remain roughly the same.

Cutting government waste is always a good idea; but using the savings to pay down debt (which very often in the modern world means sending the money overseas) during a recession seems like a very bad one. And it should be noted that the Cameron government isn’t even really cutting back much on what I consider to be waste. Britain spent billions effecting regime change in Libya.

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Euro Psychoanalysis

Joe Wiesenthal does some interesting analysis on Greece:

In a post last night, economist Tyler Cowen asked: “Is the goal simply to irritate the Greeks so much that they leave the Eurozone on their own?”

Here’s what might be going on.

Sometimes in life you give someone a “shot” at something that maybe they don’t deserve. You hire them, despite the fact that their qualifications were marginal. Or something like that. Bottom line is, you think you’re doing them a favor, and you’re also putting your reputation on the line a little bit. But you expect that they’ll step up and really appreciate the opportunity they have. And you expect they’ll kill it.

And when they fail — which is likely, because they might not have deserved the opportunity — you’re furious at them, because you gave them this great opportunity and they totally blew it, and they made you look like an idiot at the same time. And you just hate them for it.

And that’s what’s going on now. Europe feels like it gave Greece a “shot” with Euro membership, and multiple bailouts. And now it looks to Greece, and sees people rioting, and the reforms not happening, and they’re furious like never before. Merkel, Schaeuble, and the rest just can’t fathom that Greece was given this great shot to be a rich, wealthy European nation and it’s totally blowing it.

Well, if that’s so, Europe never really understood the creature it was creating. For all the talk of the supposed various benefits of the Euro — lower inflation, integrated markets, and so forth— its one huge dilemma — that nations were now budgeting in a currency they didn’t control, and so could not just monetise debt — was always brushed aside. Of course, policymakers were aware of some of the problems, at least in an abstract sense.

As Romano Prodi put it in 2001:

I am sure the Euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose that now. But some day there will be a crisis and new instruments will be created.

I suppose what was never understood was that the problems might grow and multiply to the extent that they would pose a threat to global economic stability before such “policy instruments” were created.

I suppose the moral of the story is that it is dangerous to create systems with inherent problems, and assume that the solutions to these problems will naturally emerge later at a time of “crisis”.

And certainly, there does seem to be a sense of punishing Greece for their fiscal misdeeds (even though Germany themselves were the first nation to violate the Eurozone’s deficit rules).

From the BBC:

Some eurozone countries no longer want Greece in the bloc, Finance Minister Evangelos Venizelos has said.

He accused the states of “playing with fire”, as Greece scrambled to finalise an austerity plan demanded by the EU and IMF in return for a huge bailout.

Simply, if Europe wants to maintain the global status quo, the ECB needs to crank up the printing press, and fast, to pump huge liquidity into the system. Of course, this creates huge problems down the road, as exemplified by Japan.

If not, they had better be ready for huge changes to the global financial order. Personally, I believe that the global financial system is fundamentally broken, and that printing more money, kicking the can down the road and hoping for the best will just lead to a worse and bigger breakdown down the line. I favour liquidation. But policymakers can be very reactionary.

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Indecent Exposure

Paul Krugman believes that American exposures to Europe is not bad enough to make a ballyhoo:

With American exports to Europe forming a small component of GDP, a European collapse would not necessarily mean a collapse in American demand:

The map above — taken from here — tells us that overall, exports to Europe are just 2 percent of GDP. Some states, notably South Carolina, are more exposed (presumably because of those European-owned auto plants). But Obama isn’t going to win South Carolina in any case. And more broadly, even a sharp fall in exports to Europe would be only a small direct hit to demand.

OK, caveats: this only measures goods exports, and we should mark the numbers up maybe 25 percent to take account of services. Also, exports aren’t the only channel: if European events cause a Lehman-type event, disrupting financial markets world-wide, all bets are off.

Um, that’s a pretty ginormous caveat. As far as I am aware, the case regarding America’s exposure to Europe has never been an issue of a collapse of demand in exports and has always been an issue of precipitating financial collapse.

As I wrote in September:

The global financial system is an absurd interconnected house of cards. One falling card (like a Greek default) or ten falling cards (like the European banks who were foolish enough to purchase Greek debt) might just bring down the entire banking system, and its multi-quadrillion-dollar evil twin, the derivatives system.

And that’s not fear mongering. American banks have huge exposure to the European financial system.

From Zero Hedge:

Morgan Stanley’s exposure to French banks is 60% greater than its market cap and more than half its book value

The one thing we will highlight is that $39 billion is about 60% more than the bank’s market cap and a whopping 65% (as in more than half) of its entire book (less non-controlling interests) equity value.

I feel rather sorry for Krugman. He’s analysing a factor that traditionally is very significant in international macro. And in this case it’s almost totally negligible: the real problem isn’t the economy; it’s the monstrous beast of a financial system we find ourselves encumbered with.

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The Great Treasury Dumping Game Continues

A few months ago I wrote:

A couple months ago, I hypothesises about the possibility foreign treasury dumping:

It is becoming clearer and clearer that America cannot and will not produce a coherent economic strategy. China seems to be beginning to offload not only its Treasury balance, but also its dollar pile.

Then I noted some of the prospective dangers:

Now we get the news that creditors are currently engaged in a huge Treasury liquidation.

A new post from Zero Hedge establishes that Russia is joining the Treasury-dumping party:

  • IMF’S LAGARDE SAYS EUROPE DEBT CRISIS `ESCALATING’
  • IMF’S LAGARDE: CRISIS REQUIRES ACTION BY COUNTRIES OUTSIDE EU

Well, we know the UK is now out, courtesy of idiotic statements such as this one by Christina Noyer. So who will step up? Why Russia it seems.

  • RUSSIA CONSIDERS PROVIDING UP TO $20B TO IMF, DVORKOVICH SAYS

Why’s that? Because like China (more on that in an upcoming post), Russia just dumped US bonds for the 12th straight month and instead both Russia and China are now focusing on making Europe their vassal state. So now we know where the money is coming from – sales of US debt of course!

Source: TIC

Is the US quietly becoming increasingly isolated in global affairs?

The question as to whether the US is becoming increasingly isolated is completely spurious; the United States isolated herself politically way back when in 1971 she took itself off the gold standard, and decided that she could get a free lunch at others’ expense from printing money.

The key thesis I have advanced seems to be hotting up:

What would a treasury crash look like? Most likely, it would be dictated by supply — the greater the supply of treasuries coming onto the market, the more there are for buyers to buy, the lower prices will be forced before new buyers come onto the market. Specifically, a treasury crash would most likely begin with a big seller dumping significant quantities of treasuries bonds onto the open market. I would expect such an event to be triggered bylower yields— most significant would be the 30-year, because it still has a high enough yield to retain purchasing power (i.e. a positive real rate). Operation Twist, of course, was designed to flatten the yield curve, which will probably push the 30-year closer to a negative real return.

A large sovereign treasury dumper (i.e. China with its $1+ trillion of treasury holdings) throwing a significant portion of these onto the open market would very quickly outpace the dogmatic institutional buyers, and force a small spike in rates (i.e. a drop in price). The small recent spike actually corresponds to this kind of activity. The difference between a small spike in yields and one large enough to make the (hugely dogmatic) market panic enough to cause a treasury crash is the pace and scope of liquidation.

Now, no sovereign seller in their right mind would fail to pace their liquidation just slowly enough to keep the market warm. After all, they want to get the most for their assets as they can, and panicking the market would mean a lower price.

But there are two (or three) foreseeable scenarios that would raise the pace to a level sufficient to panic the markets:

  1. China desperately needs to raise dollars to bail out its real estate market and paper over the cracks of its credit bubbles, and so goes into full-on liquidation mode.
  2. China retaliates to an increasingly-hostile American trade policy and — alongside other hostile foreign creditors (Russia in particular) — organise a mass bond liquidation to “teach America a lesson”
  3. Both of the above.
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Old Hatreds Flare Up…

It looks like I’m not the only political commentator to evoke the spirits of the past on Europe’s current breakdown (or breakdowns).

From the Daily Mail:

Greeks angry at the fate of the euro are comparing the German government with the Nazis who occupied the country in the Second World War.

Newspaper cartoons have presented modern-day German officials dressed in Nazi uniform, and a street poster depicts Chancellor Angela Merkel dressed as an officer in Hitler’s regime accompanied with the words: ‘Public nuisance.’

She wears a swastika armband bearing the EU stars logo on the outside.

Attack: A street poster in Greece has depicted Angela Merkel in a Nazi uniform with a swastika surrounded by the EU stars. The accompanying words describe her as a 'public nuisance'
The backlash has been provoked by Germany’s role in driving through painful measures to stop Greece’s debt crisis from spiralling out of control.

From a Greek perspective, it seems shatteringly obvious. For them, the Euro has become a battering ram for a kind of fiscal austerity that is set to benefit Germans (price stability) and penalise Greeks (austerity).

As advantageous as the Euro once seemed, it is becoming ever clearer that the union is suffering from deep political fracture. It is a union built without a common language (other than perhaps the belief in bureaucracy — and an unwillingness to give bankers haircuts), without a political head (or even a coherent political structure) without a common culture of work, and without an integrated economy.

That’s why decisive action is proving impossible, in spite of all the rhetoric.

Worse (because it shows contagion at work), it looks like Portugal is about to sink into the mud.

From Ambrose Evans-Pritchard at the Telegraph:

Cashflow problems (making it much, much harder to pay down debt) — that’s what you get when spend-as-much-as-we-want-and-then-print-money mediterranean nations entrust their nation’s monetary to stern-looking austerity-minded German central bankers.

Most startlingly, it looks like Paul Krugman finally got something right:

European leaders reach an agreement; markets are enthusiastic. Then reality sets in. The agreement is at best inadequate, and possibly makes no sense at all. Spreads stay high, and maybe even start widening again.

Another day in the life.

Of course, his solution — much, much deeper integration, with a good dose of money printing — is politically impossible, so whether or not it would work (clue: it won’t) is irrelevant.

Meanwhile Americans smoke their hopium (“GDP is up! Stocks are up! The recovery is here!“) hoping that the whirling Euro conflagration will just go away.

It won’t just go away. The global financial systems is an interconnected house of cards — a full Euro breakdown will bring down American banks with European exposure, like Morgan Stanley. Hank Paulson was telling the truth — either the thing is bailed out (again and again and again) or it will collapse under its own weight.

Creditors — starting with China (who are acquiring gold and Western industrials at a rapid rate) — will be hoping that the system can hold on for a few more years while they try to cash out with their pound of flesh.

Debt-ridden Americans and European would be forgiven for accelerating its collapse…

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European Leaders Scrabble For Agreement

From the BBC:

The outline of a large and ambitious eurozone rescue plan is taking shape, reports from the International Monetary Fund (IMF) in Washington suggest.

It is expected to involve a 50% write-down of Greece’s massive government debt, the BBC’s business editor Robert Peston says.

The plan also envisages an increase in the size of the eurozone bailout fund to 2 trillion euros (£1.7tn; $2.7tn).

European governments hope to have measures agreed in five to six weeks.

The bizarre thing is that the real issue is not whether or not some agreement can be reached, but whether or not any agreement will really have any real effect on the state of the European financial system. I am extremely dubious that the thrifty Scandinavian and Germanic nations will commit huge swathes of their wealth to save the Mediterranean ones. But even if an expanded EFSF can be brought together to successfully bail out Greece and recapitalise European banks who have to write down significant chunks of Greek debt, there is no guarantee whatever that any of these measures will address the underlying fracture in European budgeting. Namely, that European governments are spending like they are monetarily sovereign — in other words, behaving as if they can print as much money as they want to cover debts — when they are not.

Of course, there is no real guarantee that Europe will even effectively stabilise its banking system.

Continue reading →

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Junkiefication

What does the market slump of the past couple of days show?

When the market prices in favourable government intervention (endless free cash), and the government doesn’t meet expectations the easy-credit junkies slouch into a stupor, suffering harsh withdrawal symptoms.

From BusinessWeek:

Goldman Sachs Asset Management Chairman Jim O’Neill said the global financial system risks repeating the crisis of 2008 if Europe’s debt crisis escalates and spreads to the U.S. banking industry.

“This is where the parallels with 2008 are relevant, even though I think they are being over exaggerated,” O’Neill said in an interview on CNBC today. “It was when the financial system really imploded that financial firms stopped extending credit to anybody that the corporate world had to destock and we know what happened after that. We are not far off the same sort of thing.”

More than $3.4 trillion has been erased from equity values this week, driving global stocks into a bear market, as the Federal Reserve’s new stimulus and a pledge by Group of 20 nations fails to ease concern the global economy is on the brink of another recession. O’Neill said the Fed’s plan to shift $400 billion of short-term debt into longer term Treasuries hasn’t convinced investors it will strengthen growth.

“The fear that it’s all dependent on the Fed, together with this mess in Europe, is really getting people more and more worried as this week comes to an end,” O’Neill said. “The markets have taken the latest FOMC move rather badly, which adds a whole new angle to it. It’s the first time since the global rally started in early 2009 that the markets have rejected a Fed easing.”

“As the problem in Europe spreads from Greece to more and more other countries and in particular Italy, the exposure that so many people bank-wise have to Italian debt means the systems can’t cope easily with that and it would spread way beyond Europe’s borders,” O’Neill said. “This is why the policy makers need to stop being so sleepy and get on and lead.”

Yes — of course — what the market junkies need is another hit, another tsunami of easy liquidity, money printing and endless “bold action”. Otherwise, the junkies would be left shivering in a corner, cold turkey.

Continue reading →

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Economy Tanking, Precious Metals in Liquidation

Silver is getting pummelled:


So is gold:

What does this mean?

Hedge funds and speculators who were long gold are trying to get a buffer of cash to soak up hits from the coming default cascade.

What does that mean for gold’s long term fundamentals?

Continue reading →

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No QE3 (Yet)

So Bernanke announced a twist operation, shifting the weight of bonds toward the long-end of the maturity spectrum, and a program to roll maturing mortgage backed securities. This means that the Fed’s balance sheet will remain largely unchanged — in other words, very bloated.

But in the immediate term there will be no QE3, no drop on interest in excess reserves, no purchases of equities, commercial paper, foreign debt or any of the wackier theories about Bernanke surprising the economy into recovery. What does this mean for projections on the US economy? Very little — without an artificial updraft of stimulus, and with the ongoing global pressures, it seems inevitable that equities — Bernanke’s metric of choice — will sooner or later end up in the ditch by the wayside.

From the Guardian:

The Fed said the economy faced “significant downside risks”; one of those risks being the volatility in financial markets around the world. US stock markets reacted badly to the move. The Dow Jones Industrial Average closed down 283.82 points, or 2.49%, at 1124.84. The Dow has fallen two of the last three trading days following fears that Europe’s financial woes will spread to the US.

As I wrote last month:

Bernanke’s policy since 2007 as Governor of the Federal Reserve has been to pump money to reflate the rest of the economy to catch up with swollen debts acquired during the bubble — debts, especially in real estate, that would otherwise be defaulted upon as post-crash deflation took hold, leading to bank failures, credit retraction and a huge deflationary spiral to the bottom. That was his thesis in 1983 in regard to the 1930s, and he has been particularly lucky (or unlucky) to be able to test his thesis through policy. The real question is — what is supporting asset prices now? Is it real, new organic growth in America? No — growth is low, stagnant, and led by corporate profits, not small business or industrial output. Is it a booming real estate sector? No — confidence and prices are as low as 2009. Is it lower dependence on foreign oil, and a booming energy sector? No — America is more dependent on Arab oil than at any time in history, and the Arabs are wealthier than ever. Is it deeper, wider and burgeoning consumer demand? No — consumer demand for all but the rich is stagnant, burnt out by crippling food and fuel inflation, and rampant unemployment especially among the young.

He will print eventually — perhaps not this week or month, but he will — no matter how clear Wen Jiabao has been that QE3 should not happen.

Some interesting commentary comes from Peter Tchir of TF Market Advisors

Disappointment With The Fed

There are lots of things out there that once they have been done, can never be undone. Ben just disappointed the market for the first time. Whether he knew it or not he failed to beat expectations. He has been so good at managing expectations and using that as a policy tool he lost sight of how far ahead of itself the market had gotten. Everyone expected twist and seriously, what’s a 100 billion in size between friends in this crazy market.

He downgraded the economy but didn’t use that as an excuse to do more. There was no new, ingenious idea. If anything they tried to clarify the commitment to hold rates low til 2013 is dependent on economic conditions remaining weak.  Yet there were still 3 dissenters.

Ben has been a fan of making markets dance to his tune based on expectations. By disappointing some people I expect his ability to keep the market up by talking will be reduced as investors will need to see action rather than being told vaguely that there could be action. That will take time to play out and even I have to admit he gave us something today, just not enough.

The conclusion is very simple: intervention breeds expectation of more intervention, which breeds dependency.

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Another Sign of Coming Blowup?

Last week I asked:

Look at the following graph from the St. Louis Fed. It is the amount of deposits at the US Fed from foreign official and international accounts, at rates that are next to nothing. It is higher now than in 2008. What do they know that you don’t?

Here’s another sign that powerful insiders are increasingly running scared.

From Zero Hedge:

Back in the summer of 2007 two important things happened: the market hit an all time high, and the smart money realized what was about to happen (following the subprime and the Bear hedge fund blow up, it was pretty clear to all but Jim Cramer) and bailed out of stocks and into bonds, with Treasury holdings of Primary Dealers soaring at the fastest pace in history.

Finally, disgraced ex-President of the IMF Dominique Strauss-Kahn has weighed in, to confirm what everyone already knew.

From the Wall Street Journal:

The former International Monetary Fund’s Managing Director, Dominique Strauss Kahn, Sunday said Greece is unable to pay its debt and its creditors will have to take losses on the debt they hold.

“Greece got poorer, we can say Greeks will pay on their own, but they can’t,” Strauss Kahn said in an interview on French TV channel TF1. “There is a loss and it must be taken by governments and banks,” he said.

Yes — and so the real question, which nobody in a position of global or national authority has addressed — is just how will the global financial system be made to cope with the another Lehman-style cascade of defaults?