June 26th, 2012 Alex Jurshevski
Somebody should have referred to the title quote before the EMU was launched on a hope and a prayer only 13 short years ago. Yesterday we were again interviewed on the Euro-crisis as that event took another turn for the worse and continued its torturous progress towards what now seems increasingly likely â€“ an uncontrolled dissolution of parts of the Grand Experiment.
Today we heard that Euro politicians are drafting federal plan to save the Euro-zone, that Moody’s has downgraded 28 Spanish banks, that a fellow named Yannis Stournaras has been named as Greece’s new finance minister, but also that the Greek Deputy Shipping Minster has resigned. And…wait, let’s not forget that Silvio Berlusconi has just thrown his hat into the ring to be Italy’s next Minister of Finance…You win some, you lose some.
Hope now fixes on the upcoming Euro-zone meetings this week. Euro-zone finance ministers are expected to hold a conference call tomorrow to discuss Spain and Cyprus’s requests for financial help, and there will inevitably be a lot more posturing ahead of the EU Summit scheduled for this Thursday and Friday
Again there are calls for Germany to take on the mantle of leadership and somehow bail everyone out. So far the Germans have been balking at calls for an end to the austerity push, to support the unification of fiscal policies and the issuance of jointly guaranteed Eurobonds and for the creation of an EU-wide deposit insurance mechanism. The problem with this view, that if only Germany were to change its stance, and then everything could be easily solved, is that it is naive in the extreme.
As I mentioned during the interview, even if Germany were to agree to all of these Grand Plans, the structural imbalances that gave rise to the crisis in the first place will not be resolved, economies will not resume growing, and a new crisis will rear its head in short order. Quite simply the periphery countries have a productivity disadvantage relative to Germany and also have uncompetitive wage structures relative to the Northern Europeans. This cannot be easily â€œpatchedâ€.
Moreover, we also know that in order for Germany to agree to such modifications to its membership in the EMU, it requires the Government to hold a public referendum on all of these changes. We also know that an overwhelming majority of Germans are not in favor of these new policies which see them subsidizing the zombies. (In fact, a recent poll showed that 69% of Germans want the Greeks out of the Euro)
Isnâ€™t it time for the leadership of Europe to start talking about solutions that are actually possible instead of fantasizing about magic bullets?
Isnâ€™t is time for the Europeans to stop the madness of throwing vast sums of money at what is in effect a bad trade?
"Quick operator, gimme the number for 911!!"
What Europe has needed from the very beginning is a reckoning and write down of the bad debts. They are on the books and wonâ€™t go away no matter how many policies are changed and how many bailouts are doled out. This “avoidance of loss recognition” has been the central aim of the bailout policies from the beginning. As we can now easily see, clinging to this strategy is causing a worsening of the loss position, causing a loss of confidence and contagion and promises to only increase the eventual size of the financial hole. This is being pursued nonetheless in the faint hope that the losses can avoided or pushed onto third parties that had no hand in manufacturing the crisis in the first place.(The taxpayers of other countries and future generations)
The only certainty that we now see regarding this miserable state of affairs is that there will be massive losses and that the eventual bill when it comes due will be much, much larger than it would have been two years ago when there was still a chance to nip this thing in the bud. Let us hope that that is where the similarities of our present condition with the 1930â€™s will end.
June 13th, 2012 Alex Jurshevski
(This title is attributable to Miguel de Cervantes Saavedra – “Don Quixote”)
Recovery Partners was interviewed last Friday and again this past Monday regarding developments in the European debt crisis. Unfortunately these interviews only allow a little time to get some sound bites in and not a whole lot of time for reasoned analysis. ThereforeÂ this blog is aimed at adding some needed color and insight to the SUN TV and BNN interviews that underline the seriousness of the situation.
The simple reality is that not much has been done to solve any of Europe’s financial problems since they started over three years ago and, as a consequence, the available runway that European policymakers have left with which to craft workable solutions to the debt mess is getting very short. What is extremely concerning therefore, is that the latest events indicate that the Euro-strategy of incrementalism and trying to stretch out the process before hard decisions have to be made is being pursued by the Eurocrats and politicians there with even more vigor now.
After dithering for years about the rot in the Spanish banking sector and botching the recapitalization of several failed banks a few short weeks ago, the political authorities there finally and reluctantly agreed to accepting aid from the Eurozone this past weekend. In flippant style, Spanish Prime Minister Rajoy triumphantly declared that he had arranged a â€œhandy credit lineâ€ and that the crisis was â€œnow overâ€ before jetting off to Poland to see the Spanish footballers tie the Azzurri 1-1 in Gdansk.
When have we heard this type of denial before?
There is in fact much to worry about in the wake of the news regarding the Spanish bank bailout not in the least because there are more questions than answers coming out of this series of announcements
As we mentioned Â in the TV interviews, these issues include:
- The fact that the EUR 100 MM amount mentioned, while much larger than the authorities may have admitted they were short in the past, is still likely far below the amounts that are really required. Certain estimates place the size of the hole at around EUR 400 Billion.
- The housing and real estate markets have been artificially propped up in Spain for years. Not only does this mean that it is now almost impossible to understand values without significant due diligence, this strongly suggests that there may be another downleg to the real estate bust there that would see even those lofty bailout requirements climb.
- This â€œcredit lineâ€ as Rajoy so euphemistically termed the panic decision involving EUR 100 Billion (or more) piles more debt onto the very large debt load that Spain already has. Spanish central government funding requirements approach EUR 220 Billion for 2012 and almost EUR 170 Billion for 2013. Unfortunately, Spain is all but foreclosed from the traditional bond markets. Where will that funding and the not insubstantial funding for local governments not included in those requirements come from?
- But even before we consider the source of general Government funding requirements it is not even clear where this bank bailout money is going to come from or the specific terms of the deal. This table, drawn from a speech we recently delivered at an RBC Dexia client seminar, shows that for all intents and purposes that the EFSF mechanism is already tapped out. After accounting for dud guarantees and monies already earmarked, there is almost nothing left over. Note that the “Bank Recap” line in the table refers to the EUR 110 Billion that was only a few short months ago estimated by the ECB and IMF that the entire European Banking system needed. Now we find that Spain itself has gobbled up EUR 100 Billion. Also please note that the EFSF/ESM mechanism has been unable to fund itself and has been dowdgraded.
- What will the Greeks, Portuguese and Irish now think about the deals that they agreed to and will they now demand a â€œlook-backâ€ adjustment to the terms of those deals? Almost equally as important: What will now happen to the Italians who have mountains of debt to refinance and a government that, as admitted by Prime Minister Monti last week, is in its death throes and will likely have to call a snap election before its term expires next Spring? Italy is next in line to be punished by the markets and everyone knows it, yet there is no lifeline in place and moreover, none of the myriad zombie problems festering away elsewhere in Europe have been durably fixed.
- Similar to the Greek re-boot, this transaction calls into question the seniority of existing Spanish government debt obligations, potentially subordinating those to the creditor group that will make the â€œhandy credit lineâ€ (ie BAILOUT) money available. This action has increased the risk of these obligations and has thus cast significant doubt over the ability of the Spaniards to raise any money at all from domestic and international bond markets.
Boiling all of this down, we come to the conclusion that we are seeing a tragedy play out in Spain that is very similar to the one still underway in Greece: The central Government has been foreclosed from raising money in the open market; there is an accelerating bank run in progress; to cope, Â a hastily conceived bailout patch is applied by the ECB, IMF and EU which results in the very significant probability that Spain will continue to be unable to meet its financing requirements in the normal course. This Financial Frankenstein thus threatens to run smack into the refinancing obligations that loom just ahead.
Given the magnitude of Spain’s funding requirements and the cross border exposures it has to the rest of Europe, this policy is thus far from being a â€œhandy credit lineâ€ as described by Prime Minister Rajoy. It rather more completely resembles a financial time bomb with the detonator already having been set in motion.
Nothing in this is therefore any cause for renewed confidence.
We reiterate the point that we have been making for several years now: Nothing has been solved by the various policy patches that have been applied by the Fed and other Central Banks together with the politicians in Europe and North America. Since the onset of the Global Financial Crisis all that has been achieved are temporary delays and the imposition of growing and severe constraints on future policy flexibility, while at the same time the risk of unanticipated open-ended outcomes, second order effects and other nasty surprises (Black Swans) has been vastly increased because of the approach followed. There is now a non-trivial risk that this Black Swan phenomenon could overwhelm the ability of existing institutions to successfully and properly cope with the various problems unless decisive action â€“ loss recognition, write-down and remediation â€“ is taken soon.
The experience so far easily proves that anything short of swallowing that bitter pill simply wonâ€™t work.
December 12th, 2011 Alex Jurshevski
â€œItâ€™s interesting to note that 20 years later we have realized â€” we have succeeded â€” in creating a more stable foundation for that economic and monetary union, and in so doing weâ€™ve advanced political union and have attended to weaknesses that were included in the system.â€ Angela MerkelÂ 9th December 2011
The weekend headlines blared a mixture of adulation and success: â€œResurgent Germanyâ€, â€œShrewd Sarkozyâ€, â€œBritain Isolatedâ€. In fact Germany is far from resurgent, Sarkozy is more reacting to events rather than leading solutions, and Great Britainâ€™s refusal to submit to fiscal control from Brussels is hardly a surprise given that she is not a member of the Monetary Union.
Had the agreement for fiscal union been reached prior to the launch of the Euro that would have been extremely favorable news; and the fiscal controls, had they been made to work would likely have muted the breadth and depth of the current Eurozone crisis. But alas, we are not living in 1991. It is 2011 and the promised reforms are just that: â€œpromisedâ€, they still are subject to debate and ratification by each member nation. And then there is the question of sanctions against members who violate the proposed fiscal rules. If the enforcement mechanisms are too stringent, no national government will ratify the fiscal proposals. If they are too lax, the agreement will be toothless and incapable of serving as a bulwark against some future crisis.
But the real story is that the proposed agreement does not address any of the urgent and important issues that the Eurozone is facing right now. These stresses threaten the continued existence of the common currency. Last weekâ€™s entire exercise, and the posturing before, during, and after therefore must be judged as a lost opportunity of significant dimensions
None of the structural problems relating to pensions and entitlements spending in a large number of countries has been adequately dealt with;
At last count, large European banks are undercapitalized to the tune of over EUR 120 Bn. Moody’s Investors Service downgraded the three largest banks in France on Friday and said there was a “very high” probability that the French government would be forced to step in to support them if conditions worsened.
Fifteen out of Seventeen EU countries were placed on negative Creditwatch last week by Standard and Poors.
Greece, Ireland, Italy, and Portugal and Ireland cannot fund themselves at economical levels. Spain is arguably close to the borderline as is Belgium. Over the next 12 months the aggregate funding requirements for these countries amount to EUR 1000 Bn.
The Â EFSF is broken and no credible mechanism yet exists to replace it. Announcement of the formation date of the ESM as being in 2012 in place of 2013 does not make money available sooner until the ESM is actually funded. No updated funding plans were announced in the wake of the recent â€œdudâ€ China funding effort launched in spectacularly disastrous fashion by Klaus Regler, the EFSF honcho.
There is no relief for countries suffering with austerity. The solution, according to Merkel and Sarkozy appears to be â€œMore Austerity!!â€. As we have said in the past, the track record of these programs is not good, and that reflects cases where countries were able to devalue their currencies. In the present scenario no â€œSoft Exitâ€ from the Euro for the PIIGS and other sufferers is being countenanced by the Euro Leaders. It is only a matter of time before large scale social unrest erupts in one of these places and/or the austerity programs are abandoned.
- The IMF is washing its hands of this mess. In fact, there may no longer be any legal or politically palatable way to re-engage the IMF after this episode. Similarly, the US is adopting a hands-off approach.
- One recurring theme of this crisis in Europe (and North America) was also played out yet again in that it was obvious that there is no political will to force banks that made all of the bad bets to pay for their oversights.
- The other recurring theme is that markets have again been asked to wait “another three months” for the next installment of this sorry saga.
Looking at the list above it becomes apparent that there are actually more and deeper problems on the boil now than in the late Fall when the crisis seemed to be close to a blow-off phase.
The Euro Leaders are likely taking comfort from the fact that there has been a muted to slightly positive market reaction to the announcements of last week. The reality is that what they are really admiringÂ is the market reaction to the efforts of the Euro spin doctors hired to generate false headlines, and not developments that are substantive and likely to contribute to renewed and durable confidence in Eurozone economic management or the Euro itself.
Being suspicious of free markets, what the current Euro Leadership does not recognize is that markets do not necessarily follow a rational path in reacting to information and do not process it in a temporally consistent and predictable manner. Recovery Partners believes that although a measure of calm has returned, it will prove temporary. This is because the ongoing failure of the Euro politicians to implement apprpriate measures with enough speed and force to counter market pressures that are threatening the Euroâ€™s survival is risking evaporation of what remains of the opportunity to turn things around. This is the fourth kick at the can this year. Each time anyone has looked for substantive progress, they have been left wanting.
For now, the relative calm in the markets is therefore more a reflection of year end book flattening andÂ position squaring behavior rather than a true reaction to last weekâ€™s efforts of the Euro people to fix the problems. In a sense, it appears that a â€œProzac Bubbleâ€ has formed to shield the markets from bad news in what is supposed to be a happy time of year.
Unless something intervenes to prick this â€œProzac Bubbleâ€, we will have to wait until the New Year to fund out what Mr. Market really thinks about the latest Euro-wheeze. Whatever the timing, in our opinionÂ the reaction won’t be pretty.
Happy and I’m smiling,
walk a mile to drink your water.
You know I’d love to love you,
and above you there’s no other.
We’ll go walking out
while others shout of war’s disaster.
Oh, we won’t give in,
let’s go living in the past.
Once I used to join in
every boy and girl was my friend.
Now there’s revolution, but they don’t know
what they’re fighting.
Let us close our eyes;
outside their lives go on much faster.
Oh, we won’t give in,
we’ll keep living in the past
Ian Anderson, Jethro Tull
November 23rd, 2011 Alex Jurshevski
“Now if I tell you that you suffer from delusions; You pay your analyst to reach the same conclusions; You live your life like a canary in a coalmine; You get so dizzy even walking in a straight line”
Sting and The Police
Monday’s news of the failure of the debt ceiling negotiations in the US ahould not have come as a surprise to anyone who has followed this issue. Disheartening, sad, and ultimately dangerous to our economic well-being and Global Stability, yes, but unexpected, no. Recovery Partners was interviewed on that very topic yesterday and the full interview is avialable here in part 1 and part 2 or you can watch an abridged version on our site.
On MondayÂ Zerohedge posted a note on Austria, entitled “35 Seconds Of TV Air Time Explaining Why Austria’s AAA Rating Is Doomed“. Most of the discussion focused on the massive Central and Eastern European credit exposure. According to them, massive bank credit losses and a sovereign downgrade is a sure bet as well as the fact that contagion has spread to several Central and Eastern European economies.
Elsewhere on the Continent, the Sovereign obligations of Eurozone countries were getting smoked as spreads against German bonds blew out across the board.Â Looking ahead at the heavy borrowing calendars for many of these countries the picture does not look good.
In related news, European stock markets dropped Tuesday after an expensive bond auction for Spain and as data showed that the U.S. economy grew at a slower pace in the third quarter than initially estimated.
Also today, IMF Managing Director Christine Lagarde said in an e-mailed statement to accompany a press release annoucing the creation of a new IMF fast-track liquidity facility. â€œThis is another step toward creating an effective global financial safety net to deal with increased global interconnectedness.â€Â It is no surprise as these announcements came as Europeâ€™s crisis threatens to spread to Spain and France. The real “non-announcement” here is that this is happening because the Euro-people have yet to implement the Bailout plans agreed to weeks ago in part because the EFSF has become non-functional and incapable of producing needed funding for cash-starved Euro-governments. This despite the recent publicly announced intentions to ramp up the EFSF to between EUR 1 and 2 Trn. How ironic it is that just over a year ago on the establishment of the EFSF, that Olli Rehn, EU commissioner, boasted that the EFSF would “never need to be used”. Now it is obvious that, apart from some half-completed bailouts, it has proven to be of extremely limited effectiveness and can no longer function.
And earlier this morning it was reported by the FT that the Chinese Banking Regulator (the CBRC) announced that the Chinese Property slump exceeded the test limits of the Chinese bank stress tests. In April, the CBRC told banks to test their loan books against a 50 per cent fall in prices, and also a 30 per cent fall in transaction volumes. In October, however, property transactions fell 39 per cent year on year in China’s 15 biggest cities, according to government data. The weaknesses in the Chinese scenarios echo earlier problems with stress testing in the EU, where regulators underestimated the potential impact of a sovereign debt crisis.
Joining the party, the Fed announced new stress tests for the top 19 US banks to take place between now and January and having the results announced by March 2012. There are six large banks that are going to attract particular focus according to the Fed press release and accompanying statements.
Watch this space.
Early Warning Systems and all That
During my time in New Zealand I remember seeing lorry loads and trainloads of sheep, cattle and pigs being packed offÂ to the slaughter houses and knackerâ€™s yards. Over the time I was in that beautiful country, I observed the behaviours of these animals as the transport vehicles rumbled past and this left me with the indelible impression that these creatures somehow knew that something ominous was afoot….even though they could not read, write or understand a sentence of English, much less the road map.
Â This brings to mind the OWS movement which appears to have swept the globe as a phenomemenon that defies definition. The OWS movement seems a jumble of contradictions: it professes respect for the enviroment but its activities have destroyed parkland and befouled inner cities with garbage and human waste; it professes respect and fellowship for citizens of the countries in which it staging its protests, yet itâ€™s activities have significantly interfered with the commercial interests of small businesses and their employees, threatened passersby with violence and has otherwise commanded the attention of our law enforcement authorities to the deriment of others who might actually have benefited more from their attention at a particular time; and yet all along it professes to be able to â€œsee the futureâ€ and is therfore justified in attempting to change that â€œfateâ€ for everyoneâ€™s benefit. Moreover, in conversation, not one of the OWS protesters has been able to articulate a coherent vision, objective or group mission that all OWS protesters can agree with.
Â The ultimate irony of the OWS â€œmovementâ€ however lies not in the paucity of substance, it lies in the fact that what little substance its demands and prescriptions contain, all seem to feature demands for exactly the wrong thing. This is quite simply thatÂ the common thread among OWS protesters is that they are screaming for : more Government, more state control, more handouts, and generally speaking, for the Government or some other central authority to â€œsolveâ€ their problems. This is precisely the wrong prescription delivered at a time when the reality is that the cause of many of our challenges today is that the modern Welfare State has run out of rope, our political structures have not responded well to recent challenges and, combined with the demographic picture, that there is simply is no more â€œwealthâ€ to be â€œspread aroundâ€. The choices Western society confronts today all revolve having to make do with less. That is the Bottom Line that the OWS is ignorant of at a fundamental level.
This â€œmovementâ€ in its present state will therefore likely fade away shortly and none too soon. Although the OWS folks sense that â€œsomething is wrongâ€ in the world, they, like the animals on the way to the slaughterhouse, cannot articulate what it is they sense and fear, and, because of that and other inherent limitations, they are in no way equipped to devise strategies or action plans to avoid whatever fate awaits them, nor by the same token, to be able profess that they can render such advice to anyone else.
Given the present unsettled state of the world the real issue for clear-thinking people is: “What comes next after these â€œoccupiersâ€ fade into the sunset?”
For more on that, please dial in to Part II of our Canaries Blog seriesÂ in 24 hours.
August 24th, 2011 Alex Jurshevski
Â ”The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design”
Â F A von Hayek, â€œThe Fatal Conceitâ€
Â If Ronald Reagan, Milton Friedman, or even Boris Yeltsin were alive today they would be shell-shocked to witness the transformation of Western countriesâ€™ public debate and public policy in the last twenty odd years from a celebration of victory by Free Markets over Communism into an embrace of the Power of the State.
In Europe and the US, governments now own or control banks, car companies, mortgage lenders, property companies and other former private sector enterprises. On both sides of the Atlantic public policy is increasingly reflecting an interventionist, heavy handed meddling by Governments who appear mistrustful of free markets. The folks currently at the center of policy-making in Brussels and Washington also seem to believe that it is possible to legislate results, pass laws to coerce behavior and generally thwart market outcomes as it suits them.
You might think that we are living in the old Soviet Union.
Donâ€™t like the fact that the markets are starting to question the stability of European banks? Contrive a â€œStress Test to allay market fears. When that doesnâ€™t work and bank shares continue to get hammered, outlaw short selling and talk tough like you mean it. Simple. Listen to Jean Pierre Jouvet, the head of AMF, the French Financial Markets Regulator,â€œThey wanted to test French resistance. This is our response, as always very determined, and it will be so for all those who want to put us to the test.â€ Weâ€™ll see.
Donâ€™t like the fact that a variety of Euro area bonds are selling off in response to justifiable market fears regarding the deterioration in sovereign creditworthiness and hence increased likelihood of sovereign default? Well, then instruct the ECB and EFSF to start buying up these credits with money that is magicked up on a keyboard. Never mind that in doing this, you (the ECB and EFSF), are asking government ciphers to match wits with the likes of Michael Sherwood and his crew at Goldmanâ€™s, Bill Gross at PIMCO and Louis Bacon at Moore Capital; and that therefore this doesnâ€™t really stack up as a fight that the apparatchiks can ever hope to win. Never mind that in all of recorded history government schemes to manipulate traded markets have always failed. And that in their wake massive credit and trading losses have accrued to the public purse accompanid by economic upheaval.
In the United States certain politicians (Nancy Pelosi among them), Â are telling voters that Unemployment Insurance actually stimulates the economy because people spend their dole checks on goods and services; and that the Food Stamp programs (Over 45,000,000 recipients being served and counting) Â are similarly stimulative. In the US it is now impossible for businesses to offer free coffee and donuts to clients; Grandmas canâ€™t make home-baked pies for church socials, and kids canâ€™t operate a lemonade stand without risking a $500 fine, all because of new US Federal regulations and armies of regulatory brownshirts freshly hired to enforce them (employed at salaries that are roughly double what they might earn in the private sector we might add). The new rules, regulations and directives burdening US business number in the thousands.Â
The budget management and deficit reduction talks among the twelve member Super Committee will be getting underway shortly South of the Border. The fireworks that we saw connected to the debt ceiling negotiations are just a foretaste of what is to come in this set of â€œtalksâ€. The real negotiation is over control of the 2012 Presidential and Congressional Elections. Democrats will be looking to recover ground lost by Obama in his botched handling of the debt ceiling debate while Republicans will be looking to drive the knife home and kill off Obamaâ€™s re-election chances for good. The stage is thus set for even more of the â€œpolitical dysfunctionâ€ that S&P alluded to in its recent decision to downgrade the US. And the drama will play out agonizingly slowly, but loudly, over the next several months. Not a pretty backdrop either for financial markets or for Main Street.
Through all of this the markets are starting to crumble. Most commentators have raised their forecasts of the probability of a renewed slowdownÂ to 1 in 3 or 1 in 2. Some, like David Rosenberg of Gluskin Sheff, are saying that slipping into negative growth is a certainty. It is undeniable that economic growth in both Europe and North America is slowing. European economies are all growing at 1% annualized or less. Japan just printed a negative quarterly growth number. The US is limping along with a raft of indicators pointing to a sharp slowdown. In only one dimension this puts at risk the entire EU/ECB strategy of kicking the can down the road and hoping that the PIIGS and other debt-laden Euro-zone countries can grow out of their problems.
It is in this environment that this weekendâ€™s annual meetings of Central Bankers at Jackson Hole Wyoming is taking place. Last year in a decidedly more upbeat environment (recall that the mantra then was that the recovery had arrived) Bernanke hinted at the unveiling of QEII and the markets promptly took off.
With the ECB and Brussels going â€œAll-Inâ€ to stem contagion in the Euro-zone, what can Bernanke pull out of his bag of tricks to help boost confidence and get the US economy growing again? The answer is: â€œNot Muchâ€. There is no more stomach for debt-financed stimulus in the US given the need to at least pay lip service to the objectives of the Super Committee. At the same time the Administration and Congress will continue to clamor for â€œactionâ€ to create jobs and re-start the economy.Â This means that there is huge pressure on the Fed to â€œdo somethingâ€. And, whatever the Fed â€œdoesâ€, the central banks of the world must fall in line or get steamrollered.
Our view is that the Fed has already recently tipped its hand by announcing the continuation of ZIRP for the next two years. Should the data continue soft as we expect it will, we foresee that Bernanke will at some point in the next few months, also implement another round of QE. Bernanke will likely strongly hint at this in any speeches and announcements coming out of Jackson Hole. No matter that the inflation indicators already exceed policy rates in both the Euro-zone and the US, Bernanke and the Fed are pre-disposed to action, can only take action in one direction, and will do so with a determination that reflects an unshakeable belief in their ability to control the economy. In our opinion they are sadly misguided in this and further, that any possible benefit can come out of the course they have already set.
So, for the period following the meeting of super-bankers,Â Â our Â short term prognosis is as follows: Government and Central Bank balance sheets will bloat further, unemployment will stay stubbornly high, economic growth will continue to crawl along at or below stall speed, the EU will continue to try and bail out failing Euro-sovereigns, the ECB and EFSF will continue to gorge on Euro-area debt that nobody wants to own; the Super Committee will serve up a dogâ€™s breakfast; and the Fed will goose things further.
Similar to the fading days of the old Soviet Empire, the pressures for a financial collapse are building. Expect the outcome of the Jackson Hole meetings this weekend to add to, and not to subtract from, those pressures.
July 22nd, 2011 Alex Jurshevski
Â â€œThe astonishment which I had first experienced on this discovery soon gave place to delight and rapture. After so much time spent in painful labor, to arrive at once at the summit of my desires, was the most gratifying consummation of my toils. But that this discovery was so great and overwhelming, that all the steps by which I had been progressively led to it were obliterated, and I beheld only the result. What had been the study and desire of the wisest men since the creation of the world was now within my grasp. Not that, like a magic scene, it all opened upon me at once: the information I had obtained was of a nature rather to direct my endeavors so soon as I should point them towards the object of my search, than to exhibit that object already accomplished. I was like the Arabian who had been buried with the dead, and found a passage to life, aided only by one glimmering, and seemingly ineffectual, light.â€
Mary Shelleyâ€™s Â Frankenstein 1818
The passage above could easily have substituted for the press communiquÃ© issued by the EU yesterday which laid down the agreement reached in Brussels regarding the European debt crisis and the measures adopted by lead Ministers to forestall contagion spreading from the PIIGS to other countries.
Â Illustration from the â€œFrankensteinâ€ edition published by Colburn and Bentley, London 1831.Â Public Domain.
The nuts and bolts of the bailout package according the that document are as follows:
Â Â Â Â Â Â Â – There will be new financing in the amount of EUR109 Billion for Greece;
Â Â Â Â Â Â – Loan rates on existing debt will be cut to 3.5% from as much 5.5% for Greece, Ireland and Portugal, and maturities will be extended to 15 and as much as 30 years;
Â Â Â Â Â Â – “Voluntary” private sector contribution to the Greek package would see creditors taking a haircut of 21 per cent. There would be no relief of this kind for Portugal or Ireland;
Â Â Â Â Â Â – The EFSF and its successor the ESM (The EU bailout funds) will obtain new powers to intervene in national bond markets in Europe and to recapitalize banks, but only with the go-ahead of the ECB;
Â Â Â Â Â Â – Greece will be given a â€œMarshall Planâ€ by the EU to help refloat its economy. Brussels is forming a team to help Greece administer the aid.
Â Â Â Â Â Â – No mention was made of any need to address issues in any other EU countries or of any plans to increase the size of the bailout mechanism from the present EUR 440 Bn.
The voluntary private sector participation which will result in haircuts amounting to around EUR 37 Billion is expected to result in only a short technical default that therefore will not trigger default clauses in existing CDS contracts, thus averting the nightmare scenario.
Similar to Dr Frankensteinâ€™s violation of every principle of medical ethics and morals involved in his grave-robbing and gruesome experimentation,Â by reaching this agreement the EU leadership has breached every principle on which the European Union was founded. On the kindest interpretation, this must be regarded as a measure of the desperation the EU leadership must have been feeling in the wake of recent market events and the growing levels of social unrest in a number of southern European countries.
While the intention is to provide this support only until Greece, Ireland and Portugal can re-finance themselves in private markets, the reality is that this new deal effectively gives those countries a commitment of indefinite support. What if other countries fall further into crisis and need to be bailed out? Will they end up with a Carte Blanche as well?
Â The deal as announced does little to address the key issues and much of the detail appears not to have been fleshed out. The haircuts apply only to Greece, and even at that, are miles short of what the market has been signaling is really required (we estimate around 70%) and the interest rate subsidies do nothing to address the fact that they apply to mountains of accumulated debt that under the terms of the deal will not go away. How the rate fakery will play in Spain and Italy who are having to pay what the market demands is also not clear. There are now evermore committees involved in trying to operate on the patient. The extension of new powers to the managers of the bailout funds, who on their creation in early 2010 assured the markets that they would “never be used”, make them an easy mark for hedge funds who do not have to trade by committee……Watch this space.
Â After the initial euphoria expressed by Dr Frankenstein, we all know how the story ends: the Monster kills a number of people in most horrible ways â€“ including a child and Dr Frankensteinâ€™s bride â€“ causes the death of others, and then ends up committing suicide and dying a most horrible death in the frigid waters of the Arctic Ocean. The immoral abomination is fated to die a grisly deathÂ from the moment of its creation.
This monstrous deal will suffer a similar fate, and not too far down the road.
July 17th, 2011 Alex Jurshevski
Q:Do you know what a banker is?
A: â€œA banker is someone who happily rents you an umbrella when the sky is clear but quickly demands it back again at the earliest threat of rainâ€.
Laugh if you will at this cynically humorous description, but having been a Corporate Lender at BMO for over 5 years earlier in my career I know there is more than a nugget of truth in this.
So, in this vein, let me offer a reminder. One which soon may prove timely given the recent build-up of toxic debt on central and commercial bank balance sheets and the growing scarcity of investment-grade opportunities for all the risk capital thatâ€™s out looking around for safe-harbours to park boatloads of â€˜manufacturedâ€™ cash in:
The best time to:
(a) shop for umbrellas is before it rains,
(b) strengthen your dyke is before the spring run-off begins, and
(c) build your ark is before the flood waters come.
Why do I say this now? Well, given the â€˜big storm cloudsâ€™ that appear to be forming over the global economy, I think there a real risk weâ€™re all going to get â€˜really soaked.â€™ So, if youâ€™re smart youâ€™ll get yourself prepared before â€˜all hellâ€™ breaks loose and time runs out for those excessively optimistic (particularly on the business front), for when the market changes, it will do so in a big rush!
Now, beyond the threat of government debt contagion building everywhere these days, many of the informed observers we and Recovery Partners have recently talked to have developed a realtively jaundiced view of the “economic recovery” story. The sense of deepening pessimism relates to a variety of factors: including recent anti-inflation-driven moves in Europe and China to higher interest rates, the realization tha there are many weak economies, demonstrably out of control borrowing by both governments and consumers and the seemingly conspicuous-consumption-led high level of demand for basic economic inputs that clearly is outpacing the global supply of easily-accessible (cheap) resources.
And, with private equity investors and investment and commercial bankers complaining about the lack of good investment opportunities, the globalization and computerization fed growth in corruption and fraud that has occurred in governmental and capital markets over the past 20 years, the high levels of un- and under-employment around the world and the growing realization that our earth better go â€˜greenâ€™ quick before we all end up killing ourselves, it all makes one wonder just how far beyond sustainability have we been living in recent years.
So, for those with open ears and minds to listen, (and brains that recall the talk two years ago about what type of Great Recession recovery we should expect – â€˜Vâ€™, â€˜Wâ€™ or â€˜VWâ€™?), I suggest itâ€™s time to pay attention to these ominous â€˜rumblings of thunderâ€™ for they portend the high risk that the global economic recovery will get washed out sometime all too soon.
Worse still (and God forbid) is that we might be facing a â€˜monsoon beginningâ€™ to a â€˜flood of biblical proportionsâ€™ if the current â€˜US federal debt / borrowing limit crisisâ€™ mushrooms into an actual crisis of confidence in the US economy and downgrades the safe haven status of the US Dollar and US markets in times of global financial and geopolitical stress.
Notwithstanding all of the above, I believe itâ€™s best not to despair (particularly those of you who are mindful and prepared to act). There are constructive things that can yet be done if you act prudently and soon. There are ways still available to cut your risk of getting swept away by the looming economic catastrophe that seems to be almost here.
For those with investable funds, two choices to consider are: (1) parking your money in high quality money equivalents (gold anyone?); and (2) buying Hi-Grade corporate bonds while you wait for (another?) once-in-a-life-time buying opportunity to develop.
And if you or your business are user of third-party capital, Iâ€™d say nowâ€™s the time to strengthen your balance sheet. And for those corporates with business performance or balance sheet issues, best you opt for as much permanent capital as possible because, should the economic storm Iâ€™m concerned about break, accessible capital definitely will be in very short supply, if itâ€™s available at all.
To reitreate the main message, (because itâ€™s always too late to figure out how to keep a leaky boat afloat when the downpour comes) the best time to:
(a) shop for (more third-party capital or) umbrellas is before it rains,
(b) (buttress your defences or) strengthen your dyke is before the spring run-off begins, and
(c) (look for more equity capital or) build your ark is before the flood waters come.
Compass North Inc.
Compass North Inc. provides CEO / CRO / CFO transition management, consulting and investment banking transaction advisory services that maximize Client Company:
- revenues, profit & cashflow growth,
- debt & equity capital raised, and
- enterprise market value realized.
April 19th, 2011 Alex Jurshevski
â€œAAA/A-1+â€™ Rating On United States of America Affirmed; Outlook Revised To Negative
We have affirmed our â€˜AAA/A-1+â€™ sovereign credit ratings on the United States of America.
The economy of the U.S. is flexible and highly diversified, the countryâ€™s effective monetary policies have supported output growth while containing inflationary pressures, and a consistent global preference for the U.S. dollar over all other currencies gives the country unique external liquidity.
Because the U.S. has, relative to its â€˜AAAâ€™ peers, what we consider to be very large budget deficits and rising government indebtedness and the path to addressing these is not clear to us, we have revised our outlook on the long-term rating to negative from stable.
We believe there is a material risk that U.S. policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation is not begun by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer â€˜AAAâ€™ sovereigns.â€
Nikola G Swann, Standard and Poorâ€™s 18th April 2011
The â€œbombshell releaseâ€ yesterday by Credit Ratings Agency Standard and Poorâ€™s was greeted by most media as a â€œWake Up Callâ€, that a â€œGovernment Bubble was targetedâ€ and that the Ratings Agencies â€œnow mean business when dealing with the US Government and its spendthrift waysâ€.
In reality the announcement yesterday seems to us more of a giant PR wheeze that doesnâ€™t necessarily mean that anything much will change at all. In fact, in our opinion, the intent of the entire exercise is to allow the can to be kicked a little further down the road rather than to initiate substantive action.
For starters, there was nothing in the report that is new information as far as the US fiscal situation is concerned. Nor does the report set out what would constitute grounds for a return to stable ratings status other than some vague language about â€œdeficit cuts greater than $4 Trillionâ€. This is an obvious soft target for politicians on both sides of the House and Senate to aim for and hit at some pint in the next three years.
Secondly a variety of academic studies have shown that credit ratings have and announcements of ratings changes tend to have almost zero predictive power. Typically these announcements are made after the event and tend to confirm what the market is already reflecting in terms of relative risk. What is surprising here is that the markets have held up as well as they have to this point.
Thirdly, the US Government has been on negative ratings watch before. Fitch put U.S. debt on a â€œnegative ratings watchâ€ in November 1995 until spring 1996, and Moodyâ€™s put some U.S. government bonds on review for a possible downgrade in January 1996.
Fourthly, The Chinese for their part laid down the gauntlet in November 2010 when Dagong Credit Rating Agency downgraded the US to A+ with a negative outlook. â€œWho listens to Dagong?â€ one might ask. The answer is that they only need one client â€“ the Chinese Government â€“ and if the ratings threaten to fall below single â€œAâ€ (the typical investment cut-off for central banks and Governments); what that client does or what it tells the market in intends to do with its holdings of US dollars and US Treasury debt is of vast significance. We already know that the Chiness haveÂ cut back on their Treasury holdings. What this tells us is tha the largest offshore holder of Treasuries thinks that they have already turned into a bad deal, not that they someday might.
Fifthly, having been myself involved in Sovereign Ratings negotiations as a Sovereign Debt Manager I can assure our readers that much of what was announced yesterday and the reaction to it by Treasury and Fed officials was long planned and stage-managed in advance through a cooperative effort between the US Government and the Ratings Agency in question. Typically nothing is left to chance – in this case including the opportunity forÂ Treasury and Fed spokespeople to flood the airwaves AHEAD of the S&P annoncement with theirÂ views on US creditworthiness.Â
What we also find hugely risible (if were not so deadly serious) is the references the S&P makes to â€œeffective monetary policyâ€ and â€œunique external liquidityâ€ in the US. The reality is that QE is an untested experiment that has been shown to feature a variety of unanticipated second order effects, some of which are contributing to various asset bubbles and civilian unrest; and that by itself, QE poses a huge re-entry problem for the Fed and US Financial markets (if not a treadmill to financial oblivion). Moreover, US â€œliquidityâ€ is simply the ability of the Fed to print money at will. What S&P is really doing here is lending its credibility (or what is left of it) to supporting the massive money printing that the Fed has engineered. This policy is attracting huge and unprecedented criticism, even from within the Fed, but we are supposed to beleive that this is “AAA” finacial leadership for the world?
The practical effect of the announcement was thus designed in many ways is to provide positive support (through the imprimatur of the S&P analystsÂ for a continuing AAA rating) for the current financial posture of the US rather than to apply a rational, transparent analytical framework toÂ US finances and come up with a coldly objective assessment of creditworthiness. If the S&P had done the latter, they would undoubtedly have come to the same conclusion as the IMF did almost one year ago when the economists on 19th Street concluded that the US needed a fiscal adjustment on the scale of Ireland or Greece to stabilize matters, rather than some nebulous level ofÂ deficit cuts “above $4 Trillion”. Ireland is rated BBB+ (also a wheeze â€“ they are bankrupt) and Greece is rated BB- The latter just auctioned 2 year bonds at yields in excess of 20%.Â Note that the US fiscal position has measurably eroded from one year ago as has the economic outlook.
In view of the foregoing one must ask whetherÂ the country still rates an “AAA” rating by any conceivable rational and objectiveÂ yardstick.
Some two weeks ago at a Euromoney Conference here in Toronto, our friend Barry Allan, Founder and President of Marrett Asset Management, summed up his views of Credit Ratings Agencies thusly:
â€œI donâ€™t understand the reason for the existence of these organisations. In the first place they operate from a privileged position because any borrower who wants a rating needs to pay them to obtain one. This opens up the whole process to significant risk of professional conflict. And then, if the ratings providedÂ are shown to be too sanguine by subsequent developments (and they frequently have been), there is no financial or other sanction assessed against the Ratings Agencies for the misdiagnosis and consequent losses to investors. This does not conform to any other rationalÂ business model that I know of.â€
December 9th, 2010 Alex Jurshevski
Yesterday, following an interview on BNN we received quite a bit of email in response to the remarks I made on-screen regarding Mr Bernankeâ€™s policy of Quantitative Easing (QE). There seems to be a great difference of opinion, and we might add, confusion, as to what this program actually entails and why it is being pursued.
The announced aim of QE is to raise asset prices above their market clearing levels in order to add a fillip to growth prospects in the US.Â Ben Bernanke, speaking recently contends: Â â€œI think we are underestimating and continue to underestimate how important asset prices, very specifically equity values are, not only for shareholders and the like, but for the economy as a whole.â€Â
The proposition that Monetary Policy can exert a growth impact on the real economy through an asset channel, AND that it will be significant, Â AND that the Fed can predictably control this effect within reasonable tolerances and timeframes as contemplated by Bernanke, is highly speculative at best. One needs only to review the available literature in this area or to do the math on the potential impact of the announced QE program to arrive at this conclusion. Once past the hurdle of needing to treat the Fed Chairmanâ€™s pronouncements with a dose of healthy scepticism, and given theÂ size of the intervention, the obvious conclusion one must draw is that the intended effect of QE is perhaps directed at certain other policy objectives that the Fed deems to be at least as important as raising employment and economic growth prospects. Bernankeâ€™s recent admission that unemployment would remain high until at least 2014/15 – essentially saying to the unemployed “There is nothing we can do for you folks beyond issuing dole checks” – Â underscores this interpretation.
There are in fact three interlinked goals of QE in combination with ZIRP (Zero Interest Rate Policy). The first has to do with the condition of bank balance sheets; the second with the condition of the Fedâ€™s balance sheet and the last with the funding requirements of the US Government.
Â Bank Balance Sheets
The FDIC Claims that it has 860 banks on its watch list, the most since the S&L debacle which occurred almost 30 years ago. As a regulator/policymaker there are three things that you can do in a situation where you have failing banks on your hands:
Â (1)Â Â Â Â Liquidate the banks â€“ Fire everyone; sell of the good bits and manage down the junk. Prosecute the criminals and fraudsters
(2)Â Â Â Â Put into receivership or conservatorship – Â Fire management. Restructure Business and off to the races again. Prosecute the criminals and fraudsters
(3)Â Â Â Â Subsidize â€“ Give money to fix TEMPORARY Problems. Everything else stays the same. This assumes that the business is basically healthy and there has been no accounting control fraud.
Â â€¦..and to execute any one of these strategies you need to ensure the following Best Practice Guidelines are met:
(1)Â Â Â Â Transparency. Ensure that the markets understand what is going on i.e. how bad the issues are and what the intended results are
(2)Â Â Â Â Assertiveness. Need to act aggressively and with purpose to stem the problems in the early stages
(3)Â Â Â Â Accountability. Hold executives etc responsible and measure performance during the restructuring , liquidation or subsidy period.
(4)Â Â Â Â Clarity. Explain the markets EXACTLY what forms of assistance that the banks are getting and why
We have written in that past about the fact that the zombie bank problem is much, much larger than what the authorities have been telling the markets. In fact we estimate that the scale of the problem in the US is on the order of USD 500 to 700 billion dollars. Therefore what is being attempted in the US (and in Europe) to cure the zombie bank problem is a stealth subsidization approach complemented by liquidation of only the most rotten of the zombie banks (e.g. in the US those banks, for example, that have a gross asset impairment ratio of over 20%). In pursuing this policy the Fed, the OCC and FDIC have implicitly adopted an approach that assumes that the institutions are basically sound and all they need is a bit of money and some time and the problems will take care of themselves.Â In fact the chart below shows that the Fedâ€™s usual trick of lowering the Fed Funds rate opening a wide spread against term rates and thereby allowing the zombie banks to re-capitalize themselves by riding the curve is not working at all as well in the present situation as it has in past years. This is why QE, which gives the banks more cash to play with, is being aggressively pursued.
The effort to keep the true condition of banks cloaked also explains why the US authorities suspended (without formal announcement) the application of the â€œPrompt Corrective Action Law“ and strong armed the FASB into striking down the mark to market rules allowing insolvent institutions to continue to â€œmark-to-fantasyâ€ and avoid liquidation. These policy actions are all related to maintaining the impression that almost all banks in the US are still healthy. Recall that our view of the Bank Stress Tests in the US (and Europe) is that they were designed to make the banks appear to be sounder than they really are. In the case of US banks, the stress tests did not properly stress real estate risks; and in the case of the European test, it was Sovereign Debt exposures that got the once over lightly treatment. Look at where we are today. How credible do the test procedures seem now in the wake of renewed concerns regarding the European Sovereign Debt situation and persistent weakness in US housing markets and the looming rollovers of commercial real estate loans there?
Hence we can infer that similar objectives have lain behind the refusal of banks and policymakers in Europe to consider debt write downs. This is why the bailout packages being forced onto the peripheral European countries are considered to be very rickety solutions in our opinion. They do not accommodate the needed reckoning and write down of the bad loans made by banks to those economies, pile more debt onto them that is then expected to be funded by taxpayers who, as a consequence of the situation, effectively become tax slaves.Â This situation is not socially nor politically stable in the medium term, and certainly will not last long enough for these economies to dig themselves out of the mess by using these means. Refer to our previous comments on the history of fiscal remediation efforts.
(Compare the actual actions of the authorities as described to the Best Practices Guidelines shown above)
As long as the banks remain weak, look for the US authorities to maintain their â€œextend and pretendâ€ policies; and look for QE to make another encore appearance. (Similar motivations, namely the need for a blanket solution to the Sovereign Debt Crisis in Europe is why the European Central Bank has just re-started its QE program.)
What would we have done? See here.
The Fed and the Treasury
There are two other reasons for running the QE, namely to help the Fed and the Treasury to dig themselves out of the holes that they are in:
The Fed needs to find a way out of the â€œroach motelâ€ it created for itself when it re-discounted toxic waste from the market at par (instead of market value) Â to keep the worst of the insolvent banks afloat, and when it bought back huge MBS inventories from Fannie Mae and Freddie Mac. The â€œelevator bootsâ€ afforded by its ability to massively leverage its footings without regard to capital considerations or credit risk are certainly helping it achieve this objective. Recent disclosures by the Fed regarding its lending operations and counterparties do not tell the entire story. Moreover, the fact that the Fed is not, and never has been, subject to mark-to-market rules or disclosure requirements as to its activities, in theory allows it to play this game until the combination of money printing and yield curve trading covers its internal asset valuation deficit. The fact that the QE undertaken so far is insufficient to cover this shortfall is one more reason why we will likely continue to see additional QE after this round is completed.
At 14.5 % of GDP, US Federal Tax revenues are off sharply from the usual 18-19% run rate. In combination with the various stimulus measures and entitlements ramp up, this has opened up a huge funding requirement. The Treasury needs a helping hand to fund its deficit as it is becoming clear that there is significant congestion in US bond markets as evidenced by recent price action and the withdrawal of foreign players from the buy side. There is in fact more than some reason to believe that the Treasury does not want to expose itself to funding risks because they want to maintain the fiction that they have no problem closing the deficit. Recent results of the coupon passes show that on-the-run bonds are being submitted back to the Fed, and thus even the pretence that these operations are not designed to monetise the deficit has evaporated. The Chinese for their part laid down the gauntlet a month ago when Dagong Credit Rating Agency downgraded the US to A+ with a negative outlook. â€œWho listens to Dagong?â€ one might ask. The answer is that they only need one client â€“ the Chinese Government â€“ and if the ratings threaten to fall below single â€œAâ€ (the typical investment cut-off for central banks and Governments); what that client does or what it tells the market in intends to do with its holdings of US dollars and US Treasury debt is of vast significance. By way of this indirect method, the Chinese are showing the US that they are in possession of some pretty big political and economic levers.Â We know the Chinese are upset with the QE and the “meddling” by the US as regards the yuan/US exchange rate. How this policy tussle shakes out is something that we will be watching with interest. Finally, the fact that there is at present almost no recognition among the US leadership that the US needs to get its fiscal house in order is a third reason that adds to the probability that the continuation of QE beyond the current program is very likely.
Â Risky Business
Note that the dangers of the QE and ZIRP stance are substantial and numerous. These include growing geopolitical tensions, social unrest, the intensification of imbalances and fiscal stressesÂ in emerging and other economies, rising inflation and a loss of credibility for the Fed. Moreover, far from being a set of policies solely designed to re-start the economy, the discussion above suggests that the financial underpinnings of the US are on a very precarious footing, that the Fed knows this, and that this is why it has chosen this untested and risky policy path involving QE and ZIRP.
As measured against Bernankeâ€™s announced intentions of lowering the dollar, lowering bond yields, raising stock and property prices, and boosting the economy the QE program must be judged a failure. However, the jury is still out as to whether the Fed will be successful in achieving its unannounced goals as described above, and if in fact QE and ZIRP are the appropriate tools for all of these jobs or just a perilous policy patchwork assembled and implemented in haste.
November 17th, 2010 Alex Jurshevski
Â “With all due respect, U.S. policy is cluelessâ€¦.(the problem) is not a shortage of liquidity. It’s not that the Americans haven’t pumped enough liquidity into the market.”
Â Â Wolfgang Schauble, German Finance Minister reacting to QE2
As we saw in the lead up to the G20 meetings in Seoul this past weekend and at the meetings themselves, there is a growing chorus of discontent regarding US economic policies. Direct attacks on the Fed and its Chairman would have been unthinkable at any time in the past 30 years. Thus, whileÂ his predecessors receivedÂ the utmost in the way of deferential treatment at all times, Ben Bernanke is rapidly becoming the sad-faced â€œno respectâ€ poster child for economic policies that have so far failed to live up to their advance billing and for the associated growing global economic tensions.
Just ahead of the G20 meetings, Chairman Bernanke penned an article in which he attempted to deliver an overview of the situation and the Fedâ€™s plans for reinvigorating economic activity.Â The letter is astonishing in a number of dimensions:
According to Chairman Bernanke, it seems that in spelling out Fed policy and the need for additional stimulus that the Fed intends to get the economy growing by creating false markets (ie higher prices) in the stock bond, and real estate sectors. This is short-sighted, arrogant and ill-considered even before one takes into account the fact that the man was announcing his intentions to the markets with the apparent conviction that the investment professionals who operate within them would heed his financial advice, rather than consider the logical implications of it.
Chairman Bernankeâ€™s piece waxes eloquent, saying that the risk of deflation warrants further strong doses of liquidity: â€â€¦â€¦â€¦ the need to achieve certain outcomes, low and falling inflation indicate that the economy has considerable spare capacity, implying that there is scope for monetary policy to support further gains in employment without risking economic overheating. The FOMC decided this week that, with unemployment high and inflation very low, further support to the economy is needed.â€ These are all laudable policy objectives, but the point is that nowhere in thisÂ article is there any mention of what the risks are of these proposals. For example, some of the second order effects of QE Â and ZIRP that we know about today include:
Liquidity leakage and consequent pressures on markets inÂ other countries, particularly emerging economies;
Contribution to economic imbalances and unwelcome swings in FX parities;
Disruption of trading relationships;
Rapid inflation of input prices and foodstuffs which falls disproportionately on low income population groups and countriesÂ and those on fixed incomes;
Intensification of the Sovereign debt crises in other economies;
A reverse wealth effect on consumption from the Zero Interest Rate Policy stance that hits retirees and savers.
Chairman Bernanke`s letter fails to mention other key risks of his policies including the possibility of significantly elevated inflation numbers down the road,Â dangers for the financability of the yawning US fiscal deficit, andÂ a potentially unmanageable downgrading of the United States as guardian of the global reserve currency. Predictably, his explanations also fail to acknowledge the vast solvency problem in the US financial sector that needs to be urgently addressed (in ways that are markedly different from the Fed’s and the FDIC’s Â â€œextend and pretendâ€ approach). Not surprisingly many commentators and observers are starting to mock Bernanke and his policies.
Given the fact that there is general agreement that QE1 has been a failure; these are issues that should make the Fed and Mr Bernanke sit up and take note. As for QE2 it is hard not to observe that since the launch of this policy the stock market has lost 4% of value; bond rates in the Fedâ€™s announced â€œbuying zoneâ€ have backed up 40-50 basis points and the economic numbers are still expected to remain soft by the mainstream economists.
On this latter point it also helps to do the math. Even if this round of QE works and raises prices in various asset markets, then the addition to GDP through the wealth effects that Bernanke is staking everyoneâ€™s future on, will, under the best of circumstances, only translate into about an extra 0.3 to Â 0.7 percent of growth. This is peanuts, and certainly not an objective worthy of risking significant disruptions to achieve.
For this and other reasons best dealt with under separate cover, there is now significant opposition being mounted against the BernankeÂ policies. Not only did Obama and the US delegation get a bollocking from their G20 colleagues over US economic policy last weekend, several prominent FOMC members, including Plosser, Â Hoenig and Warsh have spoken out against additional QE, others in the US have cautioned on Fed policy, and this week an number of prominent economists, investorsÂ and commentators issued a public letter to the Fed asking it to cease and desistÂ on QE.
The open dissent on the FOMC and the fact that this has been taken into the public domain is extremely noteworthy. TensionsÂ has beenÂ building between those in theÂ Fed that regard these policies as the only way out of the Roach MotelÂ and those who want to chart a different course and restore some measure of transparency and sanity to US monetary policy. One immediate outcome of the second alternative, provided that the policies are well thought out and capably executed is that it would defuse the systemic risks and spill-over effects that have been accumulating in the global economy and in international relations as a consequence of ZIRP and QE.
In the present scenario Chairman Bernanke is therefore in an unenviable and weak position: There is growing conflict regarding the path he has charted and what remains of the Fed’s credibility is at seriousÂ risk. There are obvious questions to be asked regarding his competencies. His communications style shows that he has little appreciation or understanding of risk and market behaviour. He failed to spot the crisis in its early stages, saying on numerous occasions that it was limited in scope and containable. His policies have not worked andÂ considerable international tension and opposition toÂ his policies and their intent has been building.Â Not to be overlooked, prior to QE1 he also mislead lawmakers and the markets repeatedly as regards the likelihood of debt monetization by the Fed – ie the willingness of the Fed to run aÂ QE.
In the meantime, there is scant hope of a major near term bounce in the US economy. Five million jobless on the US unemployment rolls will see their benefits run out in the next couple of months. Commodity markets continue red hot. Debt crises in a number of economies are worsening. If the Fed continues to plough on as per its policy announcement we can only expect the geopolitical picture to become even more fraught
Â â€œHonourable Committee Members…….the dog ate my homeworkâ€
With this and other depressing information painting the backdrop for his testimony, there is very little good news that Chairman Bernanke will be able toÂ serve upÂ to US lawmakers in February when he is obliged to deliver his semi-annual Humphrey Hawkins testimony regarding Fed Policy. He is presiding over a giant mess that he himself helped create and now cannot get out of.
The Bottom LIne: Barring a major failure of courage and leadershipÂ within the FOMC and US Government, and from the Obama AdministrationÂ (not exactly a zero probability outcome given the personalities involved)Â Â it is likely, but far from certain, that we could see Ben Bernanke sacrificed on the altar of political expediency or resign. In the meantime the political and economic ructions resulting from QE will continue.