May 5th, 2014 Alex Jurshevski
“By its very nature, a government decree that “it be” cannot create anything that has not been created before. Only the naive inflationists could believe that government can create anything; its orders cannot even evict anything from the world of reality, but they can evict from the world of the permissible. Government cannot make man richer, but it can make man poorer.”
Ludwig von Mises, A Critique of Interventionism (1929)
Long suffering fans of the Toronto Maple Leafs are used to disappointment. For the past 47 years, year in and year out, the fans’ early season cup hopes burn oh so brightly; only to give way to disappointment, despair and finally dejection as the NHL season finally draws to close and the Leafs find themselves yet again out of play-off contention entirely or dispatched to the golf course after an early round loss.
And so it seems is the case in the last half decade with the academics, media cheerleaders and other shills for the G7+ (G7 plus China) Finance Ministry and central bank intelligentsia who have to date been eagerly predicting that their funny money policies and market manipulations would combine to produce a robust recovery from the 2008 recession funk.
Early last week, the mainstream media blared variously “Better Times ahead for Canada, US”; and “Recovery Gathering Steam” and similar tripe only to be once again disappointed by week’s end with the release of the US Non-Farm Payroll report. It must be said that the media did try to put as good a spin on the numbers as possible. In fact, the report of a gain of 288K jobs for the month of April and a drop in the unemployment rate to 6.3% on the surface did seem indicative of a strongly recovering economy south of the border; coming on the heels as it did, of average monthly increases of around 195K in non-farm payrolls over the past year.
Unfortunately, “the large print giveth and the small print taketh away”.
What most of the pundits failed to recognize and report to the folks on Main Street is that the drops in the unemployment rate have been an artifact of a collapsing Labor Force. The US participation rate is now the lowest it has been since 1978. Other worrying signs provided by last week’s releases showed an anemic 0.1 real growth rate for the first quarter of 2014, implying a continuation of weak productivity trends south of the border. This problem is also well entrenched in the Canadian economy – to an even greater extent. Also weak growth in average US wages was reported which flew in the face of the strong average monthly employment trend. This indicates that most of the job gains are occurring in low wage sectors signalling that we should not be expecting too much of a bounce in US consumption trends particularly in the durables and higher-priced goods sectors. Again, bad news for Canada.
Some observers argue that the drop in participation rates is nothing more than “a mid-cycle correction” as the US gears up for what they are calling “the second leg of the post-Lehman expansion”. What these folks are ignoring is that, at over 60 months, the very weak “non-recovery” we have had is already long in the tooth as measured against the average 58 month duration of previous post-World War II recoveries.
This is the part where we talk about the Roach Motel once again…….
A big part of the announced aim of QE was to entice economic agents (i.e you, me and the local pension fund) away from holding cash and into risk assets. This grossly misguided policy has now produced misleading signals in key asset markets for over 5 years. An entire generation of traders and market participants has been reared on nothing but misinformation and centrally-planned manipulation of stock, bond and real estate markets. As a consequence of these deliberate policies, the major economies of the world are plodding along at stall speed, while stock and real estate valuations are more geared to rather more lofty valuation benchmarks than they are to the soggy reality.
In fact, the chart below courtesy of Advisor Perspectives shows that US markets are red-lining and are now more vulnerable to a big dump due to these mis-alignments than they were just prior to he 2000 Tech Wreck or the 2008 Crash.
In this context the question we have to ask ourselves is: ”just how resilient can these major economies be in the face of a fresh downturn?” This question comes into sharper focus when we consider the following: the fact that most rate structures are anchored at or near zero; the fact that major Central Bank Balance sheets have become grotesquely swollen with term assets; the fact that there are elevated levels of unemployment and under-employment plaguing Europe and other economies; the fact that there is a huge asset bubble in China; the fact that levels of public market debt in the major economies are now averaging over 100% of GDP; and finally, the fact that many countries, and most importantly the US, have not adequately addressed their structural deficit problems.
We think that everyone is going to find out…..
January 9th, 2014 Alex Jurshevski
“I can call spirits from the vasty deep.”
“Why, so can I, or so can any man; but will they come when you do call for them?”
King Henry the Fourth, Act 3 Scene 1; Shakespeare
Central Banking operations typically feature ongoing efforts to mask and obfuscate what the central bank may be up to (in reality) at any given point in time. In this respect they are not that different from your typical trader. With the assistance of various hangers-on and their friendly propagandists in the mainstream media, the Fed appears to have successfully implanted a number of memes into the psyche of the investing public and market participants. These truisms include the proposition that the taper can be pulled off with no ill effect (as evidenced by last month’s muted market reaction to the announcement of a reduction of $10 Billion per month of asset purchases).
In this context Fed officials must be feeling pretty smug so soon after the events last spring when Bernanke’s botched attempt to introduce markets to the idea that the QE Kool-Aid taps might be turned off, caused them to recoil and the Fed to hit the chicken switch in response to this initial frisson.
Since that time US Central bankers and their toadies in the media seem to have also successfully convinced markets that the massive money printing does not carry with it inflation risks, that interest rates can continue to remain artificially depressed without creating dangerous distortions affecting relative prices and market behavior, and that the Fed can steer the economy with precision and predictability.
The capper in this spectacle is the successful confirmation of Janet Yellen, until now the Chief Aider and Abetter of Bernanke – Money Printer Extraordinaire – as the next Chair of the Fed. She has never worked outside the Fed or Academia.
Our take on this is that the magical edifice upon which the current Ivory-Tower cabal in charge of policy at the Fed stands and is drawing its authority and power from, is in fact becoming unstable.
No better evidence of this observation is given by the confirmation vote for Yellen herself.
Yellen was confirmed by the smallest margin of any incoming Fed Chair in the 100 year history of the institution – 56 votes for, to 26 against.
To be sure, if the nomination rules had not been adulterated by Senate Democrats manoeuvering in collusion with the Obama Administration in advance of the confirmation proceedings, Yellen’s candidacy for Chair would have never even been put to a vote. In all previous confirmation hearings, a minimum of 60 supporters in the Senate was necessary for a formal vote of this kind to be held to its conclusion.
In addition, the reality is that Yellen (or anyone else) would never have gotten the job without a commitment on her part to continue to toe the party line and maintain the thrust of policy intact. Expect no material policy changes and therefore no end to QE as long as she is the incumbent Fed Chair. This was the price of her ascendance to the pulpit.
Therefore we reiterate what we have said in the past:
- QE operations are doing nothing nor can they do anything material to help the real economy. Since we made those claims, the Fed’s own economists have corroborated our contention. Many other prominent market commentators now also understand this and are beginning to speak up. The real reasons why QE is being implemented have never been disclosed by the Fed to the Market;
- QE operations and similarly aggressive policies in other countries have depleted the ability of policymakers to respond with similar force in the event of a new set of Black Swans, ie “they have shot their bolt”;
- Government finances are in much worse shape that at the time of the last crisis and it is hard to see how the same fiscal patches that were used between 2008 and 2010 could ever be applied again. See immediately above;
- Government and Corporate debt portfolios (particularly among the many zombies) are extremely vulnerable to an interest rate shock;
- Nothing has been done to remediate zombie bank and zombie corporate balance sheets and other structural economic problems. No durable solutions have been pursued or applied since the last crisis. In fact the SIFI** problem may now even more intractable as formerly large institutions have gotten even larger and more complex with the blessing of the US authorities. Beyond the US, these observations extend in various measures to Canada, Europe, the UK, Central Europe, Japan and China;
- The imposition of QE, ZIRP and the abandonment of tried-and-tested regulatory frameworks (the Prompt Corrective Action Law, Mark-to-Market Accounting, aggressive enforcement of fraud crimes and violations of SEC Rule 10B5-1 etc); in favor of new and untested regulatory regimes (e.g. Dodd Frank, the ESM, the new Banking regulatory framework in Europe) are heightening the probability of other Black Swan events befalling the markets
Of course, here we have not mentioned another by-product of ZIRP and QE: the existence and persistence of the chronically money-losing corporation and the ability of investment bankers to foist shares associated with such entities onto professional investors. For example, more than two thirds of US hi-tech IPOs in 2013 were companies that have never made a cent. The question is : how can irrational speculation not be a result of the funny money policy? We thought that we had left this behavior behind back in 2000.
As such, the lukewarm confirmation vote in favor of Yellen may be the proverbial canary in the coal mine as far as the remaining half-life of the current Fed policy stance is concerned. [Perhaps this voting result also indicates that there is a modicum of higher intelligence resident inside the Beltway after all.]
Unfortunately this fleeting flash of what alcoholics call “a moment of clarity”, may be a matter of “too little too late”
In the last several decades the Fed Chair has always been tested shortly after assuming the mantle of office.
Given the risks that have heretofore remained unmitigated, the failure to address the real issues, and the unwillingness to change course on policy; we may not have to wait too much longer long before we see Yellen no longer “Standing Tall” as the World’s Most Powerful Banker, as she is currently being portrayed. In this context, and assuming that the disintegration of support for the Fed’s unconventional and over-reaching policy formulation accelerates, we should expect her stature to revert to the mean and more closely resemble an Oompa-loompa scurrying about, vainly trying to fit a queen-size rubber sheet onto a king-size bed as one corner and then the next keeps popping off.
Watch this space.
* “Painting the screens” (or painting the tape) is an activity that professional traders engage in that features the provision of misleading or inaccurate information to the general market and to specific counterparties through sales chatter; published information, and the intentionally misleading and manipulative posting of market bids and or offers on trading monitors and systems with the intention of enticing gullible market participants to engage in a transaction or series of transactions that are guaranteed to have them lose money on the deal to the pro or allow the pro to get rid of unwanted exposures. P.S. It is illegal.
** SIFI: Stategically Important Financial Institution
August 29th, 2013 Alex Jurshevski
This just in from our Correspondent in the Nation’s Capital, David Hidson:
The current Democratic administration in Washington seems determined to embark on their next ill-advised intervention in a brutal civil war in the Middle East.
After two and a half years of fighting, over 100,000 deaths, a quarter of a million injured and nearly 2 million refugees, suddenly the tragic deaths of 300 people, apparently from sarin nerve agent, has produced a storm of “moral indignation” requiring that the Western nations launch a military attack on the Assad regime.
Whether or not the Assad regime carried out the attack, or al-Quaeda or some other group of rebels, is still in doubt. That said, the “moral indignation” is just a shimmering pile of moralistic humbug that lacks valid substance.
Back in the Cold War days, chemical weapons were classed as Weapons of Mass Destruction (WMDs) mainly because any country attacked with them could respond with another WMD, possibly nuclear. Chemical weapons were labelled the “poor man’s nuclear bomb” because they can be highly effective against unprotected populations, either military or civilian.
Chemical weapons were used extensively in the Iran-Iraq war in the 1980s by both sides and inflicted tens of thousands of casualties. The rest of the world did in fact “stand idly by” then because, quite simply, that was all that could be done.
Any military operation must have a clear objective in strategy and a detailed tactical plan for achieving that objective. The military requires solid decision making from the political leadership and an assurance of continued support during military action. Ask any military man or woman.
President Obama can supply none of these things. He is a feckless leader who has consistently shown his lack of understanding of the military and political situation. He has made threats that he has had no intention of following up on (“red lines”) and has supported, in Egypt most recently, the Muslim Brotherhood, which is devoted to establishing an Islamic tyranny. He has failed at each opportunity to even merely protest the persecution of Christians by Muslims in the Middle East and, if one recalls his now infamous Cairo University speech, he has demonstrated an appalling ignorance of history.
Leadership flows from force, power and strength, never from weakness. And “leading from behind” tells the rest of the world that weakness leads America.
Obama and his Administration have thus rendered American foreign policy in this part of the world nugatory.
Poking a stick in the eye of one contender in a fight between two warring thugs and then running away after a day or two, which is what this Administration appears to be gearing up for, will impress no-one, except of course, the President, who seems endlessly impressed with himself. Unfortunately we have no doubt that his sycophantic supporters in the liberal media will grovel in faux admiration.
To address just a few of the risks in this dangerous game: suppose that this attack does not deter the use of chemical weapons? What then? What if Hezbollah decides to attack Israel in revenge? What if some other baddies decide to give the Americans a bloody nose on home ground? What if Putin decides to test Obama’s mettle in some devious way using proxy assets – cyberattack on Corporate America anyone? The obvious conclusion is that these interventionist schemes proposed by Team Obama all carry with them the risk of extremely serious unintended consequences
Before appearing to backpedal yesterday, Prime Minister Cameron in Britain said recently that the response should be “legal and proportionate”, or words to that effect. Here again, we see a total lack of understanding of the mind-set of the people they are up against. They are fanatics who are willing to fight and die. Unless you are prepared to do all that is required and use overwhelming force to crush your opponent, your opponent will win.
Military force should never be used unless there is an absolute commitment to follow through to achieve a defined objective coupled with a credible exit strategy. This is not a board game of “Risk” or “Diplomacy”, the lives of our military are at stake; and it goes without saying that telling the enemy when you will go home before the shooting has even started is the height of foolishness.
America and the world deserve a better leadership than this.
June 21st, 2013 Alex Jurshevski
“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
Ludwig von Mises
As the G8 summit rapidly turned into a non-event in the early part of the week, market attention quickly shifted to Bernanke’s announcements on Wednesday, which as expected, signaled that the long-awaited tapering move for the QE3 program is to occur sometime later in the year. In the aftermath, stocks endured their worst two-day sell-off so far in 2013. After the big plunge on Thursday, Friday’s dead cat bounce left prices far below where they started the week.
To a few people, the sell-off and uptick in volatility seems odd. After all, market participants were told that the Fed is trying to be as transparent as possible and offer the best, unvarnished guidance possible to them. For his part, this includes, according to Mr. Bernanke, an easing of the ultra-loose policy settings because the US growth engine now is being touted by him as doing well enough that the stimulus may soon no longer be needed. (A rising tide will lift all boats and all that.) However, paradoxically, the prospect of an acceleration of economic growth was judged as a negative for stocks.
And then there are some who believe that far from being “Open Kimono” about the next change in policy, that the Fed may be continuing a longstanding policy of “painting the screens” and keeping the markets guessing about its intentions and the probable timing of its next policy moves. According to this view, this added uncertainty is what was depressing the indices .
As our readers know, our view for some time has been that the Fed and other Central Banks have undertaken extremely radical policy actions in response to the GFC that have effectively:
- reduced the degrees of freedom of future policy actions;
- set the stage for new, harmful and unanticipated shocks to beset markets and economies (Black Swans); and
- done little to alleviate the underlying conditions that led to the crisis in the first place.
In short, the authorities have led us into a Roach Motel.
Our opinion is that a new and serious crisis of confidence is on its way. This time the consequences will be far worse than than those confronting the West during any crisis since the late 1960’s because financial malfeasance, fiscal indiscipline, the dismantling of needed safeguards (The shelving of the Prompt Corrective Action Law, removing Mark-to-Market Accounting rules, failure to Prosecute Lawbreaking Bankers, etc) and massive increases in financial leverage since the last meltdown five years ago have made financial panics and contagion now all but impossible to contain.
For the past few years it seemed like we were a lone voice. Therefore late last week we were extremely gratified to open our latest edition of Institutional Investor and be treated to a very well thought out treatise of where were are and where we are likely to end up by Ian Bremmer and Nouriel Roubini, which we are linking to here.
The article covers much of the same ground that we have in our various public statements and blogs. In brief they are agreeing with us that:
The bottom line? Japan, Europe and the other major Western economies are actually in worse shape, more prone to unexpected shocks and have less financial resources to cope with these problems than they had five years ago BEFORE the onset of the Global Financial Crisis.
The fact that they and other leading economic thinkers are aligning themselves with our views is not a cause for celebration, but rather concern.
But then again, you can only avoid a trap if you know of its existence.
April 8th, 2013 Alex Jurshevski
In modern social psychology, cognitive dissonance is the feeling of discomfort when simultaneously holding two or more conflicting cognitions: ideas, beliefs, values or emotional reactions in your mind at the same time. The theory of cognitive dissonance proposes that people have a motivational drive to reduce dissonance by altering existing cognitions, adding new ones to create a consistent belief system, or alternatively by reducing the importance of any one of the dissonant elements.
Following last week’s announcement by Bank of Japan Governor Kuroda that it will “do anything it can” to get Japanese inflation up to 2%, JPMorgan said in a communication that the Japanese, European and U.S. central banks are now in the same camp when it comes to monetary stimulus. The JPM economist who provided that assessment is undoubtedly well-remunerated, being in the regular habit of taking obscurantist developments and putting them in language that his less erudite bosses find comforting, easy to understand and easy to pass on as Gospel to the bank’s clients and investors.
In fact, based on actual statements made recently by these various central banking institutions, it seems that nothing could be further from the truth.
In January, Bloomberg blared the headline “Bernanke Dissatisfied With Growth Will Press on With QE”. The Fed seems to be expecting growth and NOT inflation to be the result of its QE program.
Based in his recent comments ECB Governor Draghi is also focused on pushing a form of QE in the hopes that Euro-Zone Growth can recover to a more stable and higher growth path.
However, in contrast, the BOJ is hoping for inflation, and not growth. The specifics are simply that Governor Kuroda announced plans to double the BOJ’’s monthly bond purchases and achieve 2 per cent annual inflation within the next 2 years. This follows the smaller-sized, though entirely similar, expansionary policy that in the last two years has caused the Yen to fall almost 20 percent against the majors. Only the Venezuelan Bolivar and Malawian Kwacha have fallen by more over the same period.
The reality is that over the last 4 years one of the most enduring fictions promulgated by the authorities and their handmaidens on 19th Street, is that central bank money printing and central government pump priming will act together to generate self sustaining growth in the economies hit by the Global Financial Crisis. This is an elaborate fantasy on which we have commented before.
There is in fact no amount of funny money and deficit finance that can steer things back onto a sustainable path unless the obstacles to growth and recovery are removed. All of the serious economic research and actual economic history that we have reviewed supports this central truth.
And now we have evidence that the world’s central bankers do not even agree on what it is possible to achieve through QE.
Is it inflation or is it growth??
This is like asking you if the objective of your exercise regimen is to gain more muscle or more fat and you actually believe that you can achieve either by following the same plan.
The real reason for the QE being pursued in the various economies of the G7 and the Euro-Zone is that Government finances in certain key countries are hemorrhaging and that this is interfering with the ability of certain Governments Â to even keep up the pretence that financing requirements can be funded in the normal course.
As such the latest BOJ announcement is a sign of weakness and cause for concern rather than renewed hope. The markets which rallied on the news have got it wrong.
Source: The Japan Times
Beyond this, there are additional problems and concerns specific to the just announced Japanese policy update. For example
- Financial Policy. THis latest policy wheeze is nothing more than another salvo in an ongoing currency war. Therefore it is only likely that Japan’s trading partners will pressure the Government there to slacken their efforts to weaken the Yen in order to preserve their own growth prospects. This could lead to international tensions over economic policies;
- Monetary Policy Flexibility. The BOJ has been expanding its QE more aggressively than either the the FED and ECB, burdening its balance sheet with riskier assets and making even the possibility of an exit from this policy nothing more than a wistful fancy;
- Investor and Consumer Behavior. The QE policy distorts price signals; obscures the risk and risk/reward properties of investments; penalizes savers at the expense of borrowers (The Government being the biggest with the biggest interest tab. See above.) and encourages mal-investment;
- Starting Point Risk. This policy does not sufficiently take into account the very serious structural problems in the Japanese economy which have hampered growth and resulted in deflation. These include, most importantly the failure to properly remediate weakness in bank balance sheets, the effects of an aging population, including waning tax receipts; and the fact that Japan already has the largest (and effectively unsustainable) debt load on the face of the planet. Finally, what private sector agent is going to want to own term debt yielding less than 1% when the BOJ’s inflation target is now said to be 2%?;
- Re-entry Risk. Monetary Policy implementation is a very uncertain process and the transmission mechanisms and relationships are not stable or predictable in even the medium term. There is no plan, no way to reverse what is being proposed, not in Japan, not in Europe and not in the US. If these policies do act on inflation and money demand drops as the policymakers wish, then it may trigger a self reinforcing bout of price inflation that (a) will be hard to control; (b) will cause a variety of easily anticipated economic problems (eg: everyone sells their bonds – see above), and (c) very likely create new unanticipated problems, stresses and conflicts relating to the policies of competitive devaluation that are being pursued.
Of course we are sure that the policy wonks at the BOJ (and the FED and the ECB) are completely aware of the dangers and problems regarding their policies and of which we write. It is just that they cannot muster the intestinal fortitude, leadership and political will to opt for a solution that does not amount to a combination of bargain basement wallpaper, cheap glue and a snappy sales patter.
Therefore, at this juncture it is of only one thing we can be certain: if there is a limit to “safe money printing” (as if this term is not an oxymoron in and of itself), then the current set of central bank incumbents seem dead-set on finding it.
“…nobody is qualified to wield unlimited power.”
Friedrich von Hayek, The Constitution of Liberty, 1960
March 17th, 2013 Alex Jurshevski
“An emphasis by bankers on the collateral value and expected value of assets is conducive to the emergence of a fragile financial structure.” Hyman Minsky, Stabilizing an Unstable Economy (1986).
More than 25 years ago the famed American economist Hyman Minsky postulated that financial stability would be weakened when lending in the economy became excessively dependent on the value of the underlying collateral rather than the income-earning potential of those same assets. In recent years his theories, this one included, have been vindicated by real world examples time and time again â€“ the most obvious instance of a credit system run amok and dependant on rising asset prices was Japan in the Postwar period: everything was linked to real estate. They are still sweeping that one .and even after more than twenty years of failure, most people in that economy remain oblivious to the incompetence of their bankers, policymakers, and government officials that led the country into the abyss.
Today in Europe (and elsewhere) we are witnessing the compounding of policy mistakes made not so much strictly in advance of the recent GFC (Global Financial Crash) but in the months and years since its sudden onset in 2008. These mistakes centre on a belief by the authorities that everything would be all right if collateral values just picked up, and their unshakeable conceit that what they have done and what they are doing to remediate the damage done by the crisis in this way is safe, efficient and correct.
In the face of it all, job prospects, particularly for Europe’s youth have worsened; plant closures have run apace, workers benefits have suffered, pensions and social services have been cut; yet the European economy remains stuck in neutral.
Last week for example thousands of workers again took to the streets to demand an end to the austerity measures that have seen a number of European countries wracked by social, strife, high unemployment, and despair. Most of the Euro-zone economies have remained mired in slow or negative growth mode for almost three years. With 26 Million out of work across the EU and the Eurozone registering its sixth consecutive quarter of negative growth, ordinary people are coming to the obvious conclusion : “these policies do not work”.
In January, even the IMF got into the act by proclaiming that its austerity-based policy prescriptions may have been erroneous and could in fact be making things worse.
So its fairly easy to conclude that last week’s EU summit wasn’t exactly a warm and fuzzy family barbeque type of scenario. In fact the most recent set of meetings was probably the 250th get-together involving politicians and government officials since the crisis began. All of these jamborees have passed without a positive, workable solution to the crisis being tabled, much less implemented.
Last week was no different: Again, the usual platitudes were served up; accompanied by the usual hand-wringing from Europe’s brightest and best minds. No specific policies were discussed much less adopted that would have been aimed at steering away from austerity; and, importantly, there was no nod from Germany and its po-faced representatives that they would in fact countenance such proposals if they were in fact seriously put forward.
The Vatican that is not the only Global Institution that is stuck in a rut!!
Artist: Jeremy Nell, The New Age, South Africa 3/15/2013
Moreover, we have said from the beginning that pursuing austerity policies in an effort to right the ship was a VERY long shot at best. In fact this interview from 2010 sums up our views on this matter quite neatly. In the intervening period since that segment aired it has also become obvious that there are a number of headwinds that are blunting the impact of aggressive expansionary policies. These factors are additional important reasons why the economies of the European countries (as well as those of the US, Canada, Japan) cannot seem to find any traction in generating growth significantly above “stall speed” despite the policy impetus:
- Government Debt loads have increased a lot and this has reduced policy flexibility while eating up revenues of cash strapped Governments;
- Rapidly developing demographic factors promise to chew up Government finances at both ends: lower tax revenues as people retire accompanied by higher pension, social assistance and health-care payouts;
- Basel III capital rules and other regulatory requirements are contractionary;
- Austerity has prompted significant increases in rent-seeking behavior and tax evasion;
- Financial repression has cut savers’ incomes and contributed to yawning pension shortfalls.
There is more in fact the biggie is:
The Restructuring Deficit
For some time now it has been obvious that there have been no real attempts made to recognize, write down and remediate losses that occurred in the immediate wake of the GFC. In fact the entire focus of the policy response has been to avoid doing just that and to instead try and engineer a re-appreciation of collateral values in the economies so that investors, lenders and other creditors can see their asset exposures skate back onside.
“No Pain” is the Objective.
“Financial Repression” is the Name of the Game.
Unfortunately, these policies are not only delivering “Max Pain” for everyone but the creditors; they are risking the welfare and social peace of today’s generations of Europeans.
Under capitalistic forms of economic organization, Banks must ordinarily be held accountable to deal with their distressed credits promptly and the public balance sheet must not be used to subsidize bad risk decisions nor to prop up zombie companies at public expense and to the ultimate detriment of employees, taxpayers and other more efficient and productive entities.
However, this departure from the norm in order to favor creditor interests is exactly what has been happening.
These policies of Financial Repression have been followed before. The most obvious examples are failed communist states many of whom had to abandon the experiment over twenty years ago with the fall of the Berlin Wall and more recently, hyperinflationary Zimbabwe. Some examples in the developed economies include New Zealand in the late 1970’s / early 1980’s before the 1984 collapse and Germany in the immediate Post WWI “Weimar” period. In every instance, the outcome of these episodes was negative. Today, the Europeans (and North America and Japan) are conducting policies of Financial Repression in a variety of formats.
The negative effects of these policies include restrained GDP growth, distorted asset markets, a drag on productivity, hidden credit risks, moral hazard, risk of higher inflation, misallocation of resources, destruction of savings, financial contagion and a de facto “theft” of market share and profitability from successful, non-zombie businesses. This has been accompanied in the austerity countries and many others in Europe (e.g. the UK) by rapid increases in debt levels.
Rising levels of debt may not be the only cause for alarm; particularly when one considers that they are accompanied by a single-minded focus to raise asset and collateral values. In those situations, (such as now) financial structures can become extremely precarious. This is because leveraged asset positions may not always generate enough spread revenue to either service or repay the debt. As a result, and according to Minsky, the financial system can become increasingly vulnerable to what would otherwise be relatively innocuous events, such as a small rise in interest rates or a decline in asset prices.
Italy 10 Year Bond Yield
As just one example in this regard, please note that prior to EMU, Italian bond yields were in the range of 11% and the Italian Treasury quite happily financed their deficits without any concerns. To compare, in today’s market a sustained rise in Italian yields above 6% would spell “Game-Over” for their economy and for that of Europe.
Fascism on the Rise
A further non-trivial concern is that ominous storm clouds are forming over the European political landscape in reaction to the authorities’ tin-eared and single-minded focus on the solutions, inappropriate as they are, that they have been pursuing with vigor but with so far, none of the intended effect. Because of this, mainstream political parties are under pressure in many major Euro-zone countries. In Greece the far right parties’ membership comprise most of the police and security forces and have been rising in the polls. The Jobbik fanatics in Hungary are proposing a roll-back in social freedoms inconsistent with the EU Charter. Spaniards are trying to cope with secession risks and extremely high youth unemployment. The rise to prominence of Beppi Grillo’s Party in the recent Italian elections is being soft-pedaled by the mainstream media with the byline that “he is a comedian”. He is anything but. A cursory look at his website reveals hundreds of Anti-Semitic comments, diatribes and attacks while, at the same time, it shows him to be singing the praises of the fanatics that are running Iran, looting its Treasury, oppressing its people and exporting terrorism. Grillo’s party looks to be next in line to govern Italy.
It is worth remembering that Hitler and Mussolini were both elected by folks who didn’t want austerity
Unfortunately it seems that for now, the Brussels crowd is happy to be dancing on the edge of the volcano and, that nothing can convince them to take a less risky and saner path to recovery.
October 2nd, 2012 Alex Jurshevski
The Maginot Line, named after the French Minister of War Andre Maginot, was a military defensive construct consisting of a deep line of concrete fortifications, tank obstacles, artillery casements, machine gun posts, and other defenses, which France constructed along its borders with Germany and Italy, during the interwar period between WWI and WWII.
Military experts extolled the Maginot Line as a work of genius, believing at that time that it rendered France impregnable against invasion from Germany. In the event, while the fortifications successfully acted to dissuade direct attack, they were completely ineffective from a strategic military standpoint. This obvious defect was laid bare at the beginning of WWII when the German Blitzkrieg easily outflanked the Maginot Line by moving through the Ardennes forest and Holland, completely sweeping past the heavily defended fortifications and conquering France in less than six weeks. Although constructed at huge public expense and using the best minds and materials available at the time, the Maginot Line has heretofore become emblematic of any plan or announced remedial strategy that people hope will prove effective but instead fails miserably.
When Lehman Brothers was sent to the knacker’s yard by its street rivals at Goldman Sachs and Morgan Stanley following closed door sessions with Government officials during the summer of 2008, the Best Minds on Wall Street and Constitution Avenue thought that they were protected from the fallout of a mega credit event by their risk management models and counterparty legal arrangements that included margin requirements, collateral postings and mark-to-market protocols. In fact with all major counterparty banks in place and able to continue functioning as market participants, the effect of the mega crash could have been contained, minimized and worked out. Before Dick Fuld and his management team was sent to the proverbial gibbet, the preponderance of derivatives contracts and exotic securities positions could have been settled out in a reasonably orderly fashion over time. However, with Lehman out of the way, the “netting” of derivatives and other exposures between institutions could no longer take place and someone had to step in to buy up the toxic waste that resulted from the abrupt halt to the “pass the hot potato game”. With Lehman out of the loop, the toxic waste had to end up on “someone’s” book.
The consequential effects of the secondary detonations in the securities and derivatives markets in the US following the demise of Lehman unleashed a wave of re-rating of sovereign risk which fell primarily onto the Europeans, who more than a decade ago had abandoned their treaty-bound commitments to fiscal probity and restraint in order to consummate a flawed monetary union riddled with institutional shortcomings and massive governance problems. Someone had to prop up Government Finance in the Euro-zone in order to give the pretence that things were still manageable or all of the banks there would have gone down the gurgler.
The “someone with the hot potato” in the US is the Fed which since the event has been mainly concerned with somehow papering over the losses, minimizing them, and possibly inflating them away. In Europe, the “someone” is the ECB which has under the prodding of its client institutions been stretching out the remediation process in order to dragoon the taxpayers of the various Euro-zone countries to shoulder the load of bailing out greedy banks and their profligate government clients.
The story of the Global Financial Crash is far from over. Nothing has been solved; and as we have repeatedly stated in our interactions with the public through speaking engagements, or on TV, or in the press, the policies that have been implemented so far have simply narrowed the degrees of freedom for future policy steps while at the same time increasing the likelihood of negative unexpected consequences being visited on markets (potentially with a heretofore unseen ferocity).
There are therefore still a few more chapters to play out in this unfolding narrative.
The present chapter opened around three weeks ago when, after a sleepy summer where nothing much happened, ECB President Draghi announced that he was going to do whatever it takes to save the Euro-zone and support the bond markets of all the deadbeat Euro-countries through central bank purchases of bonds (something that only a year ago had been definitively ruled out). At the time, most pundits fell into line and proclaimed that this brilliant move had effectively ended the crisis and all risk assets rallied sharply.
Since then, reality has set in. In fact, Draghi can no more proclaim to have unlimited resources to solve Euro-Crisis that he can claim to be able to solve world hunger. As we have said repeatedly in the past the democratic fact is that voters in the affluent Euro-core are not going to go for what these solutions imply. Moreover as the ECB expands its balance sheet without limits, the credit quality declines and the risk profile of the ECB shareholders correspondingly increases. The expansion at Europe’s Central Bank is off-set with a deterioration of the national credit quality of the nations so that the entire construct sets itself up for the possibility of being further downgraded. We pointed this obvious flaw in this strategy out on the air around a year ago.
To complicate matters further, most securities analysts have been paring back earnings forecasts and published data has turned rather negative. In fact over 80% of the world’s manufacturing capacity is now in contraction.
On this side of the pond we were treated to Dr Bernanke going “All-in” with his open-ended commitment to print money through QE3 (an event that we have been predicting since QE1 was announced ). Without belaboring all of the issues, we have with Mr Bernanke’s implied claims that he knows better that the markets what interest rates should be and how capital and lending flows need to be directed at a particular point in time; let us just examine a small example of his fatal conceit that we have drawn from the speech he gave yesterday in Indianapolis.
The securities that the Fed purchases in the conduct of monetary policy are held in our portfolio and earn interest. Ultimately, the securities held by the Fed will mature or will be sold back into the market. So the odds are high that the purchase programs that the Fed has undertaken in support of the recovery will end up reducing, not increasing, the federal debt, both through the interest earnings we send the Treasury and because a stronger economy tends to lead to higher tax revenues and reduced government spending.(Page 7)
While Dr Bernanke so glibly proclaims that the securities held by the Fed will mature or will be sold back into the market as if this operation was some kind of benign voodoo magic with no real-world consequence, we would ask the good Doctor what will happen to the issuing institutions whose securities are maturing on the Fed’s books? Won’t these notes have to be re-financed to support asset positions or ongoing activities at the borrowing institution? Who will conveniently show up to buy this re-issued paper in the amounts that the Fed has so done in the past, and, more importantly, at what price?
This is debt management 101.
In deference to the esteemed Fed Chairman, we will only ask one more question that flows from this fantastical description of his policy: If this is the magic bullet, and printing money actually reduces debt painlessly as you so describe, then why have we ever bothered with trying to do things any other way?
Now, after having read his speech yesterday and having managed to regain cognitive equilibrium, we offer on sober reflection that the ECB and Fed policy announcements boil down to acts of desperation that are now, so shortly after being introduced, becoming obvious to the markets. Market participants know that all they have to do is wait for the cracks to appear before pouncing and bleeding the central bank players for significant trading profits.
The bottom line thus is that all Draghi and Bernanke did with their “Big Bazooka” announcements is buy some time, much in the same way that the French Military planners bought some time in constructing the Maginot Line before the German Military planners found a way to beat it. The only question is, “How much time have they bought?” Our expectation is that within a few short months, the ECB and Fed policies will again fail to prove equal to the task. Unfortunately the two biggest central bank players in the world have gone “All-in” on a policy which amounts to an ill-advised high stakes game of poker with the markets. There can be no retreat now.
This is the worst position a gambler can be in because it exposes their strategy to significant event risks and unanticipated outcomes.
The next card that is dealt could in fact blow the hand that they are jointly holding completely out of the water.
Postscript: A little known fact is that the Maginot Line and the Federal Reserve Building in Washington DC were both completed in the same year: 1937, during a period in history when failed financial policies and regional hostilities were driving the world towards catastrophe. In the just two short years following, there ensued an outbreak of general hostilities that led to WWII which brought with it global privation, outbreaks of disease, the directed mass extermination of ethnic groups, the mentally challenged and LGB populations; the first detonation of nuclear devices over heavily populated areas, the forced resettlement of hundreds of millions of people and the death of tens of millions.
July 24th, 2012 Alex Jurshevski
This month’s Recovery Partners Blog features a double-barreled treat: Direct access to the latest Ipsos Reid Global Advisor Analysis released just this morning, followed by commentary by Dr Lloyd Atkinson summarized from a speech he delivered in Toronto almost two months ago, and who, with his customary prescience, seems to have anticipated the very gloomy findings of the Ipsos Reid missive.
According to Canada’s leading pollster, “If economists and others expected a full recovery rebound based on this trajectory they would be sadly mistaken. The theory goes that a rebound looks like an alphabet letter: a “V” or a “U” or maybe a “W”. However, what is evident now is a new letter: “L”. This flat line has had a long run now so we can actually add it to the lexicon. Clearly the region that is the worst is Europe for obvious reasons and if not for Germany’s constant and robust confidence, it would be a forgone basket case.”
Further, according to Ipsos Reid, “By two months time we’ll probably know the measure of the malady. Let’s hope it’s a passing chill and nothing more.” The full release of the survey findings and analysis are provided here and the Ipsos press release is here.
Now let’s turn to the summary of the address given by Lloyd.
THE GLOBAL DEBT BOMB: CRISIS IN REALITY OR THINKING?
By Lloyd Atkinson
The global debt problem — especially the global sovereign debt problem is so pervasive and severe that we are virtually guaranteed several years of sub-par growth characterized by low employment growth, low inflation, low interest rates and low overall stock-market returns. About the only thing not likely to be low is financial market volatility. But it is not the only possible outcome. It could be so different, so much better, if our leaders were to adopt a very different approach, which I will discuss here. One warning however:, the policy prescriptions are so startlingly different from current policies virtually everywhere in the Western world that they are unlikely to be championed by most politicians or electoral majorities, at least for the next while.
Austere budget policies, in the form of expenditure cuts and/or tax increases, are the near-universal response to burgeoning government debt. Look at Greece, Portugal, Spain, Italy and virtually every other nation state in the European Union; look at the federal, provincial and municipal governments in Canada, and Federal and State & Local governments in the U.S. As many critics have pointed out, the implementation of such austere policies may actually make the debt/deficit problems worse. The proposed solution by those critics is clear: expand government spending and/or cut taxes to reinvigorate the economy. The problem with this view is that there are circumstances when expansionary fiscal policies will work, and other circumstances when they will not. Unfortunately, the debate over the matter almost never gets properly cast.
What was lost in all of this tumult and which is still not understood by a great many commentators is that each of the peripheral Euro-zone countries had violated the most fundamental law of macroeconomics: it is not possible for any economy to sustain a level of total economy-wide spending larger that its total economy-wide income. It can be done for a while by borrowing or by printing money but even those avenues have their limits: in the case of borrowing, the ultimate loss of confidence of lenders; and in the case of printing money, inflation, or in the extreme, hyperinflation.
We all need to be reminded of this basic fact: the total income available for distribution, or redistribution, is no more or less than the total value of its production of goods and services. If fiscal actions undertaken by government have the consequential effect of causing total national spending to exceed total national income, the outcome will not be sustainable. Borrowing, or, where available, printing money, are stopgap measures only. Either national spending has to be reined in, or total income increased in ways that are sustainable.
I am led to one ineluctable conclusion: Governments and their leaders can never see the writing on the wall until their backs are to it? Maybe that’s just human nature.
But is not the U.S. in more or less the same boat? What is taking place there is one of the messiest fights ever over the proper role and size of government, a debate that has never really taken place in Europe, and I dare say, in Canada. The U.S. tax code is a mess, and so are the Medicare and Medicaid programs. But don’t doubt that they can be fixed in ways that are much easier than in Europe. Second, the U.S. has the ability to print money, the most popular means these days being called quantitative easing (QE). Indeed, since quantitative easing is all about the purchase of assets “toxic and otherwise” by the U.S. Fed in exchange for money, the U.S. Central bank has accumulated a huge portfolio of securities in the past few years. And while the creation of money in that way was essential to the rescue effort following the 2008 crisis, there will come a day with the return of more normal financial market conditions when the Fed will have to unload its portfolio of securities which will present its own challenges.
Notwithstanding the extensive use of quantitative easing, and major fiscal stimulus, the U.S. economy has been performing sub-par. In part this has to with the fact that the 2008 crisis hit the economy so hard that all these measures provided only partial offsets. Monetary policy, in the form of near zero interest rates and quantitative easing, has been the only policy tool holding the whole thing together.
It would appear that Canada has fared quite well by comparison, the result in part of a more conservatively managed and regulated financial sector that has stood up well against the onslaught, and a good bit of luck, most notably the strengthening in commodity prices that provided much welcome offsets to the weaknesses taking place elsewhere in the economy. But to acknowledge this good fortune, it would be wrong to conclude that all is well. When one looks at the combined Federal, Provincial, Municipal debt/deficit totals, there is not a lot to brag about: as percentages of GDP, both are not much different from the U.S., and by further comparison with the U.S., we have a lot less tax wiggle room.
It should be apparent from this discussion that the task facing the world economy of righting the ship listing under the weight of global debt is indeed daunting. But in truth, that is only the half of it!! The globe not only must struggle with burdensome sovereign debt matters, it has to do it at the same time as it tries to meet the crushing new demands being imposed by the relentless aging of populations
The challenges posed to policymakers by aging populations are double barreled. To meet the needs of the elderly, whose average life expectancy keeps advancing, ever greater resources must be provided by those who are producing the country’s goods and services, in other words, from those who are working. However, over time, and at an increasingly rapid pace, the percentage of the population made up of workers will be shrinking. To illustrate, Canada this year, for the first time, is experiencing more exits from its workforce than entrants. And although today there are about 4 workers per 2 retirees, by 2030, the numbers will be 2 to 2.
Why are these ratios so important? Because meeting the resource demands of the elderly must come from each country’s national income; that is, from the employed population. The alternative? To pare back the support for the elderly: cut social security payouts; cut health care benefits; cut other elderly programs; impose or expand inheritance taxes. This would be construed as an assault on hard-earned entitlements. And as the elderly continue to make up an increasingly large percentage of the eligible voters, this concentration of political power is unlikely to change dramatically even if the young get out to vote.
Virtually every major country is drowning in debt. Debt service costs eat up huge amounts of the budget, a situation that can only get worse once interest rates move from their current emergency low levels to more normal levels as the economic picture stabilizes and then improves, as it most assuredly will, maybe four to five years down the road. Because of a double whammy effect, continued sluggish growth as the world economy struggles to bring debt down to more manageable levels resulting in only a slower pace of sovereign debt growth, not a decline; and the gradual increase in interest rates as world growth strengthens, carrying with it further increases in sovereign debt to meet higher debt service costs, the overall debt burden has little or no prospect of being much lighter four or five years from now, unless economic growth were to speed up significantly.
So what is the prospect of a sharp advance in global growth in the years and decades ahead?
As far as labour force growth is concerned, the numbers almost everywhere promise to be low. For decades the birth rates in most of the so-called developed world have been well below the 2.1 rate needed to replace the population. In any event, the point to be made is abundantly clear: if labour force growth is all we can rely on, then we are in for some very challenging times. Bluntly put, it will not be possible to both service significantly larger amounts of government debt and meet the needs of an aging population without very material increases in taxes and/or sharp cuts in program spending.
This of course leads naturally to the discussion of productivity. Improving productivity is, the only reliable and sustainable way of getting out of the mess we find ourselves in. To get to 4% real growth in the economy year after year, which is what I estimate is necessary to throw up the revenue needed by government to meet current program requirements and service the debt — means compound growth in labour productivity of almost 3% per year. To achieve anywhere near that rate will be judged by some as near impossible given that, notwithstanding a great many government initiatives in that direction, including material cuts in corporate taxes, we in Canada have been able to eke out productivity gains of barely 0.5% annually for a long time.
A great many things can be done to improve production efficiency. At the top of the list has to be business investment, the well-documented source of strong productivity growth over time and across countries. Why business investment in Canada has been so weak in the past few years is a mystery to me, even after taking account of the uncertainties created by the financial crisis in 2008. The strong Canadian dollar combined with the notable improvements in many business balance sheets should have been a much stronger spur to investment. But it did not happen.
There is also much more that Government can do. But in order to justify the more it could do, there first has to be a better acknowledgement of the magnitude of the daunting tasks we face to meet both the debt/deficit challenges and those of our aging population. Only then could we set about the task of rooting out inefficiencies wherever we find them
The point of the whole exercise to improve productivity is that there will result a higher level of national income, and we are all aware that higher incomes generate higher tax revenues.
Sticking with the revenue theme, there is much more that governments could do to generate savings that could be used to meet the needs of the elderly and debt service/retirement. Consider major reform of public sector pensions and benefits that have been talked about ad nauseum in the press; significantly raising the age of eligibility for CPP/QPP and OAS to possibly 75; rewriting the Canada Health Act to permit private enterprise. This suggests that no one should kid himself that anything less than draconian measures will bring about the conditions necessary to meet the needs of current and future generations. And as draconian as the measures must be here, rest assured they will be more gut-wrenching overseas in Europe.
Lloyd Atkinson is an economic superstar who offers authoritative perspectives on international economies, financial markets and global trends. A captivating speaker, he has the ability to explain complex issues in applicable, understandable terms.
For nine years, Dr. Atkinson served as Vice Chairman, Chief Investment Officer, and Chief Strategist at Perigee Investment Counsel Inc.
Prior to joining the investment management industry in 1994, Dr. Atkinson was Executive Vice-President and Chief Economist at the Bank of Montreal where he also served as the head of the bank’s Investment Committee of the Pension Fund Society. Previously, he spent four years working for the United States government in Washington, D.C., first as Senior Advisor at the Joint Economic Committee of the U.S. Congress, and then as Deputy Assistant Director of the U.S. Congressional Budget Office. He taught economics and finance at a number of American universities, including the University of Michigan and the University of Maryland, and has also served as a consultant to the U.S. delegations at the International Monetary Fund and the World Bank.
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 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 patched.
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)
Isn’t it time for the leadership of Europe to start talking about solutions that are actually possible instead of fantasizing about magic bullets?
Isn’t it 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 won’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 1930’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. Therefore, 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 handy credit line and that the crisis was now over 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 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 credit line 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 look-back 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 handy credit line (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, 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 handy credit line 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 “loss recognition, write-down and remediation” is taken soon.
The experience so far easily proves that anything short of swallowing that bitter pill simply won’t work.