Credit Writedowns Weekly Report, Vol 1 Issue 1: European and US Sovereign Debt
With the fundraiser week winding down, I am going to start making a few changes now. One thing we probably need is a synopsis of the past week’s posts in order to tie the week’s events together thematically. I will make this synopsis using the most read and tweeted posts plus the ones I think are most relevant to what’s actually happening in global markets and the economy.
This week there is a ton of stuff here. So, here we go with the weekly report volume 1, issue 1.
My Favourite Post
In case you missed it last night here is one that is sure to get your feathers up. It’s about time they Occupy Congress
Charts of the Day
Yesterday, I showed you that contagion had spread and default probabilities were blowing out right across Europe. Every single name on the list for sovereign credit default wideners was European and names like Austria, Estonia, and Slovakia showed marked deterioration, with default probabilities over 10%. Today is no different. The Netherlands is the notable credit
The following numbers come from a recent article in Die Welt on the backlash in Europe against the ratings agencies
Central banks have done a great job at driving up the price of gold but a horrible job at creating wage inflation. If it now takes 88 hours to buy an ounce of gold versus 20 hours in 2000, hasn’t that grossly deflated real wages in a strict monetary sense?
The BBC has a terrific chart tool that gives you a good feel for exactly how much the sovereign debtors in each of the European countries owes and to which other countries.
This chart from the IMF illustrates how China was able to skirt — in relative terms — the deep economic contraction by generating a huge expansion in domestic credit and increase in its money supple.
Topic du Jour: Deflation
The events in Europe are definitely deflationary. We have had a few posts this past week highlighting the deflationary impact of pro-cyclical fiscal consolidation. From an investing standpoint, this should underpin bond markets of high grade corporate and sovereign currency issuers because it puts a cap on inflation and a floor on bond prices. I believe we are entering a permanent phase of risk off until the policy uncertainty in Europe and now the US is lifted. With the US set to join Europe in pro-cyclical fiscal consolidation, the economic outlook globally looks weak. Even the Chinese are talking about this. China’s Vice Premier warned of the certainty of a long term global recession, suggesting we actually could see more stimulus in China. Something to watch
If you are a debtor who wants to cut your debt load for fear of a liquidity-induced insolvency, there are two ways to make your debt metrics improve. One is to increase revenue and the other is to shrink the debt.
“Without consumption, markets are going to shrink. Companies won’t invest, stores will close, “for rent” signs will spread on the main streets and local tax revenues will fall. Companies will lay off their employees and the economy will shrink more.
Marshall Auerback was on Fox Business talking about the European sovereign debt crisis. He said he is very concerned not just about the national solvency problem in the euro zone but also about the debt deflationary policy remedies now being implemented across the whole of the euro zone.
For all practical purposes the Fed has done it all. And yet unemployment remains at depression levels of over 9% (and over 16% the way it used to be calculated not long ago) and the only thing keeping what’s called ‘inflation’ over 1% is a foreign monopolist supporting the price of crude oil.
The situation in the markets
The Wall Street Journal’s Matt Phillips describes the turmoil in European sovereign bond markets. He says some traders tell him that they now consider countries like France a part of the periphery and are pricing it as such. This risk-off sentiment has spread throughout the euro zone to countries like Finland.
The European sovereign debt crisis is rapidly approaching what could be a significant tipping point as it threatens to spread to the heart of Europe. In recent days Italian 10-year bond yields have soared to 7.22% and today Spain was forced to pay 6.975% at its auction. Even French 10-year yields have climbed to
I thought I should flag this since it a cornerstone of the present European sovereign debt crisis strategy
What will the European Central Bank do?
The next big topic is about what the European Central Bank does. The fiscal responses are already deflationary. If the ECB allows yields to continue rising in Spain and Italy, we will have a depression. I have said that I expect the ECB to cave and monetise and/ore set interest rate caps. They have bought up some bonds in the secondary market, but their actions have been both sterilised and ineffective. Kyle Bass thinks this is as far as the ECB will go and German policy makers have been out in force making this seem like the right bet. Below, you can see a variety of views from different authors.
This phrase ‘lender of last resort’ has been bandied around by people who, it seems to me, have no idea what lender of last resort actually means, to be perfectly honest. It is very clear from its origin that lender of last resort by a central bank is intended to be lending
Former bank of England central banker and present Citigroup Chief Economist Willem Buiter spoke to Tom Keene this morning on Bloomberg Radio. His view is similar to mine, that Europe must act now to avoid a default. He believes we could have a few months or a few weeks. But time is running out.
German central bankers (current and former) continue to voice their hostility to what the financial community now calls a Euro-style Quantitative Easing (aka big bazooka). This talk (by one of the boldest opponents of an ECB solution to the sovereign debt crisis) reveals how weak is the position of those who prefer to explore
BBC’s Hardtalk recently featured Kyle Bass, Founder of Hayman Capital, a hedge fund based in Texas to talk about global markets and the sovereign debt crisis. Video below
We are baffled by the analysis of the analyst community, some, of which, are not so analytical. They say that Europe’s fundamental problem is that it has a central bank which is unwilling to monetize sizeable debt maturities which bondholders are unwilling to refinance . They look to the Federal Reserve as a model
Alarm signals have been going off over the last week, not only due to the surge in the yields on Spanish and Italian debt but also due to evidence that the infection (contagion) is now spreading to what was previously considered to be the core (France, Austria).
I think Monti and Papademos are going to try to shoehorn the standard policy responses into the situation in order to reduce the range of outcomes they have to deal with. In a practical sense, that means going with the standard formula of cutting budgets, selling state assets and working within the Euro framework.
The EZ crisis is approaching a tipping point beyond which market panic and slow government reaction threaten to create a generation-defining loss of jobs, savings, and pensions. This open letter to the president of the German central bank presents arguments that counter German objections to using the Eurozone’s last remaining defence against economic calamity
The escalation of the European debt crisis and mounting evidence of new economic contraction has increased the scrutiny on the region. Yet it seems like many observers may be failing to grasp several important points, including the nature of the new governments, the Italian challenge, pressure on the ECB, risks of a euro zone break up and the coming election in Spain.
What will the EU do?
European economies are really breaking down and panic has set in. You see pointless proposals to lord over supposed fiscal free riders from Finland and unelected governments lacking in political legitimacy and taking unfavourable economic policies in both Greece and Italy. Europe is clearly on the edge
With sovereign interest rates in the euro zone rising, Finland is feeling the contagion effect despite being only country in the euro zone except tiny Luxembourg which is both AAA-rated and meets all of the Maastricht Treaty requirements.
Sources close to the German government have told Reuters that the German Chancellor Angela Merkel is seeking agreement to make changes to the Lisbon Treaty, considered the European Constitution. According to Reuters’ sources, Merkel wants all 27 EU member states to sign off by the end of 2012.
Spiegel is reporting that European Commission President Jose Manuel Barroso plans to talk up Eurobonds on Wednesday and to present three different options for issuing Eurobonds as a solution to the European sovereign debt crisis. This is an idea to which the Germans have been resistant.
Claus Vistesen says I am not, and have never been, advocating a break-up of the eurozone, but it seems to me that obvious decisions are being avoided because they are deemed to conflict with an underlying plan the meaning of which I find difficult to see. An adjustment is needed in Europe – and, like with Dan and Elise, any adjustment should be to the plan itself.
What should you do?
Given the policy uncertainty, the real question is where can you hide. This looks like risk off to me but there are not as many places to hide when it is sovereign debt in the developed economies that is in crisis. We haven’t seen this since the 1930s. Here are some thoughts on those issues.
The most important debate of our lifetimes is now ongoing. The question: Should the ECB “write the check’ for the euro area national governments? In thinking about the answer to this all-important question, I prefer to shift the focus by changing the verb “should” to “will”.
PIMCO’s Mohamed El-Erian and Bill Gross spoke exclusively with Bloomberg Television’s Tom Keene today from the company’s headquarters in Newport Beach, CA about Europe’s crisis, PIMCO’s investment strategy and Treasury yields.
Warren Buffett was on CNBC this morning for three hours talking about a whole range of issues from the European sovereign debt crisis to too big to fail to housing in the US to penalties for corporate crime. The video of Europe is below, with more to follow.
The yen and the Swiss franc were seen as safe haven currencies during the tumultuous crisis in Europe. The Swiss National Bank has effectively and apparently cheaply took the franc out of the game. This may have increased some speculative pressure toward the yen.
Will the euro zone break apart?
When I was running through Italian default scenarios earlier in the day, I asked “Could Italy unilaterally exit the euro zone and redominate euro debts at par into a new Lira currency to forestall the default? Perhaps. That is something to consider at a later date.” Well that later date is now.
The well known eurosceptic Nigel Farage is having a field day over the sovereign debt crisis in the euro zone. Farage says that the EU lacks democratic legitimacy, a complaint heard ever more often during this crisis. He goes further, saying political puppets are being put into place right across the euro zone.
Monetary union was not a good idea, even in the best of circumstances. Time to abandon the failed experiment
It is beginning to look like a Greek exit is ever more likely, which means that the end of the EMU could be near. Even if exits and a break-up are not inevitable, countries should have a plan on the shelf.
The following is the text of the recent ratings action taken by Moody’s on twelve German state-owned banks
The following is the text of today’s Moody’s press release on the Irish banking system.
Consequences: Government collapse and nationalism
With the euro zone about to implode, it makes sense for politicians outside of the main stream to rise up, grab the metaphorical mic and make a play for a nationalist response. That’s what Marine Le Pen hopes to do
New governments in Greece and Italy have brought no real relief to the financial markets. There are forces in motion that are not about which personality or interest group is implementing the various austerity programs
The left-wing nationalists will return with force to the House of Representatives after 15 years of years of absence through the Amaiur coalition according to data from the first ballot count
Having run through it that way, I feel now that I have a better perspective. Hopefully, it was useful for you as well.
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