Thursday, November 24, 2011

Today's links

1--"We are in very big trouble", Fed Watch, economist's view

Excerpt: There has been no forward progress in the past week. To be sure, ECB bond buying has helped keep a lid on Italian bond yields. Yet, while ECB monetary policymakers focus on Italy, Spain and Belgium are slipping away. And France is clearly the next domino to fall. The "accidental" downgrade last week simply reveals that S&P has already prepared the report, clearly anticipating a deterioration in France's budget position as the Eurozone recession deepens. And to make matters worse, Zero Hedge points us to signs the Dexia bank rescue is faltering, and the Belgians realize they need to shift more of that burden of that rescue onto France. Meanwhile, the situation in Eastern Europe is rapidly deteriorating - Yves Smith directs us to the Telegraph for that story. And in Greece, the opposition party still insists they will not sign any pledge to commit to the October deal. Was any deal really reached last month?

Conventional wisdom is that the European Central Bank eventually acts as a lender of last resort to alleviate the sovereign debt crisis. This was clearly not on the mind of ECB President Mario Draghi in his recent speech. I certainly hope something was lost in translation, as the speech has some memorable moments. Notably:

Activity is expected to weaken in most of the advanced economies. This is the result of a weakening of various components of aggregate demand, both domestic and foreign.

Economic activity is weakening because the underlying components of economic demand are weakening. I am not sure this is particularly insightful. Is this the best analysis he can muster from the intellectual firepower of ECB economists? If so, we are in very big trouble.

2--What the German bond auction disaster means, credit writedowns

Excerpt: This morning the German government held an auction for 10-year money at just under 2 percent. The auction failed disastrously with a bid-to-cover ratio of just 1.1. The Germans wanted to issue 6 billion euros of 10-year bunds but managed to sell only 3.64 billion, with the central bank picking up 39 percent of the issue.

Many media outlets are reporting the disastrous bond auction results in Germany as an ominous sign. I am of two minds on this. Yes, this was a terrible auction but it is just one auction. So let’s not blow it out of proportion. There is still some time left.

On the other hand, the economic data this morning made clear that Europe is in a recession and that Germany and France are being dragged in tow. The euro zone PMI Composite came in at 47.2 (higher than expected) but below the 50 boom/bust divide. Germany’s Manufacturing PMI too was lower than 50 at 47.9. And it was lower than expected. I told you 1 1/2 years ago that Spain’s debt woes and Germany’s intransigence lead to double dip and now we are seeing this. Even India and China are slowing, with Chinese manufacturing data at 32-month lows

Chinese manufacturing output dips China's manufacturing activity fell to its lowest level in 32 months in November, according to the HSBC bank purchasing managers' index. The news renewed fears that the economic powerhouse is losing steam, and contributed to 2% falls on the Hong Kong and Sydney stock markets.

via Bbc .

. So we have a synchronised global slowdown.

Finally, I have to beat this into everyone’s heads because I have said it over and over again. It’s the currency sovereignty, folks! No lender of last resort means:

This is a rolling crisis wave through the eurozone infecting more countries, closer and closer to the core. As Marshall wrote recently, this is a structural problem. All of the euro zone countries face liquidity constraints and all of them will eventually succumb to the rolling wave of yield spikes one by one until we get a systemic solution: full monetisation and union or break up.

Germany is no different than the rest.

3--Euro Weakens as Reports Signal Region’s Debt Crisis Is Weighing on Growth, Bloomberg

Excerpt: The euro fell to a six-week low against the dollar as reports added to signs that Europe’s failure to resolve its debt crisis is weighing on economic growth and Germany received insufficient bids at a debt auction.

The 17-nation euro slid versus 13 of its 16 major peers as London-based Markit Economics said a gauge of European services and manufacturing output shrank for a third month. The pound fell for a third day against the dollar after the Bank of England’s minutes showed some policy makers said more stimulus “might well become warranted.” Sweden’s krona declined as central bank Deputy Governor Barbro Wickman-Parak said policy makers may cut interest rates if Europe’s debt crisis persists.

“There are a lot of reasons to be negative about the euro,” said Ankita Dudani, a currency strategist at Royal Bank of Scotland Group Plc in London. “The whole of the euro zone is getting entrapped in the lack of growth, and the cost of financing is so high. They are being hit from both sides.”

4--"Phase Shift" - JP Morgan Downgrades All Commodities To "Sell", zero hedge

Excerpt: If the ECB will not take the hint, JPM will bring the mountain to Mohammed. Or something. In a note just released by JPM's Colun Fenton, the firm has downgraded the entire commodity complex to "underweight" (yes, that includes gold). The reasoning? It is all the Supercommittee's fault. It also likely has nothing to do with the fact that JPM was selling commodities to clients all through this run up, and is now in finally buying, in anticipation of ECB printing and Fed's LSAP. Full report attached....

Change in view: Policy failures in the US and Europe have darkened the 6M outlook, forcing us to downgrade commodities to underweight. We expect outright TR losses near-term and see greater value in bonds.

5--The Fed Stress Tests While Europe Starts to Burn, naked capitalism

Excerpt...the biggest difference between 2008 and now is the lack of a common vision among the central actors in the epicenter of the pending crisis. In the US, the three key players, Paulson, Geithner, and Bernanke, had shared goals: do whatever it takes to keep the system from collapsing and to the extent possible and preserve the status quo. The first goal was arguably necessary, while the second one was the polar opposite of what needed to happen once some measure of stability was restored.

By contrast, in Europe, you have banks in Greece, Spain, Italy, Portugal, Belgium, much of Eastern Europe, France and Germany at risk. Any serious problems, ex an ECB deus ex machina, must be dealt with at a national level. How is that going to happen when the Eurozone banking system is 325% of GDP, far bigger relative to the size of the economy than in the US?

The risk here is not a Lehman like disaster. It’s a modern version of Credit Anstalt: a major bank failure precipitating cascading collapses. And this is entirely plausible. There are a ton more moving parts than in the US in 2008: more institutions at risk, multiple domestic banking regulators and national legislatures, Maastrict treaty rules. Anyone who has worked with networks knows that more nodes and more communication lines between those nodes means more points of failure. The odds of things ending up badly if the markets go critical are far greater than the last time around, and that’s before we factor in the caliber of Eurozone emergency responses thus far.

I cannot fathom how people in senior regulatory positions who lived through the crisis cannot see the trajectory. It’s obvious to anyone who reads the financial press. This willful blindness, born out of a reluctance to firmly enough with a reckless, predatory industry will cost the citizens of the world dearly. I can only hope history deals with these corrupt officials as harshly as they deserve.

6--European Bond Risk Climbs to Record, Bloomberg

Excerpt: French and Belgian bonds slumped as the cost of insuring European government debt against default rose to a record on concern the region’s credit crisis is crimping global growth. U.S. index futures declined, while European stocks were little changed.

The yield on France’s 10-year bond climbed 11 basis points to 3.64 percent at 7:25 a.m. in New York. The Markit iTraxx SovX Western Europe Index of credit-default swaps on 15 governments rose eight basis points to an all-time high of 373, and the euro weakened 1 percent after Germany failed to find buyers for 35 percent of the bonds it offered at an auction. Standard & Poor’s 500 futures slipped 0.9 percent, while the Stoxx 600 Europe Index lost 0.3 percent. Oil retreated 1.9 percent.

European services and manufacturing output contracted for a third month in November, while a preliminary gauge indicated China’s manufacturing shrank by the most since March 2009, reports by Markit Economics and HSBC Holdings Plc showed. Luxembourg Finance Minister Luc Frieden said talks on the rescue plan for Dexia SA are “continuing intensively.”

“The costs of Dexia’s guarantee are putting Belgium’s finances under such pressure that France may have to take a larger slice of the losses, which some analysts feel could be the straw that may break the back of France’s credit rating,” Bill Blain, a strategist at Newedge Group in London, wrote in a research note. “Concerns on U.S. debt, economic performance and rising China fears contribute to the miserable background.”

Bond Risk

The yield gap between Belgian 10-year notes and benchmark German bunds widened to a euro-era record. The yield on Spain’s 10-year bonds increased five basis points to 6.65 percent. Credit-default swaps insuring French government bonds rose seven basis points to 247, Belgium was 11 basis points higher at 362 and contracts tied to Spanish debt climbed four basis points to 489, all records, CMA prices show.

“The credit picture in Europe will continue to be negative for quite some time since policy makers at the core are trying to reconcile conflicting objectives,” Bart Oosterveld, a managing director at Moody’s Investors Service, said at a conference in Paris today.

7--EU Banks Struggle to Lure Deposits, WSJ

Excerpt: An intensifying battle for deposits among European banks is putting pressure on the Continent's banking system, threatening to deprive lenders of a key source of funding as the cost of attracting customers rises.

Individuals and businesses have pulled billions of euros of deposits out of banks in financially shaky countries such as Spain and Italy in recent months, according to bank disclosures and analyst research.

Several large Italian and Spanish banks recently reported double-digit percentage declines in deposits from corporate and other institutional clients, although their overall deposit levels fell more modestly, as lenders hold a greater share of retail ...

8--Europe’s Banks Relying on Money From E.C.B., NY Times

Excerpt: Banks clamored for emergency funds from the European Central Bank on Tuesday, borrowing the most since early 2009 in a clear sign that the euro region’s financial institutions are having trouble obtaining credit at reasonable rates on the open market.

Indebted governments among the 17 members of the European Union that use the euro are also finding it harder to borrow at affordable rates as investors lose confidence in their creditworthiness.

In a Tuesday auction, the Spanish treasury, for example, was forced to sell three-month bills at a price to yield 5.11 percent, more than double the 2.29 percent interest rate investors demanded at a sale of similar Spanish securities on Oct. 25. Spain also sold six-month debt at 5.23 percent Tuesday, up from 3.30 percent in October.

Italy’s 10-year bond yield, meanwhile, edged up once again — to nearly 6.8 percent Tuesday — as foreign investors withdrew their money from that debt-staggered country.

Together, the commercial banks’ heavy reliance on the central bank to finance their everyday business needs, along with the growing borrowing burden for Spain and Italy, raise the risk of failure for some banks within the countries that use the euro and the danger that nations much larger than Greece could eventually seek a bailout or be forced to leave the euro currency union....

The central bank said Tuesday that commercial banks had taken out 247 billion euros, ($333 billion), in one-week loans, the largest amount since April 2009. And the 178 banks borrowing from the central bank on Tuesday compared with the 161 banks that borrowed 230 billion euros ($310 billion) last week.

9--Tightening money and widening Eurozone spreads, Worthwhile Canadian Initiative

Excerpt: If you accept the Monetarist premise that tighter money means a fall in expected NGDP, then it is very easy to understand a widening of yield spreads as yet one more symptom of tight money.

Tight money may reduce interest rates on safe assets. At least, it reduces interest rates on safe assets that remain safe assets when monetary policy is tightened. But many previously safe assets will become risky assets when monetary policy is tightened, precisely because tight money means a fall in expected NGDP, and a fall in expected NGDP means less nominal income to pay fixed nominal liabilities.

For a given total quantity of assets, a tightening of monetary policy reduces the supply of safe assets, and increases the supply of risky assets. Because some previously safe assets now become risky. Since safe and risky assets are imperfect substitutes on the demand-side, this change in relative supply of safe and risky assets changes their relative price. The price of safe assets rises relative to the price of risky assets. So the yield on safe assets falls relative to the yield on risky assets. Tight money causes an increase in the yield spread.

Looked at in this way, the widening yield spreads between Eurozone government bonds is simply one more symptom of a tightening monetary policy.

Yes, this is an oversimplified picture. The rollover risk from short term bonds means there can be a run on government bonds not dissimilar to a run on a bank without an effective lender of last resort. And there can be multiple equilibria, because a high/low interest rate makes it harder/easier for a government to finance its debt, which increases/reduces the riskiness of that debt, and so increases/reduces the rate of interest at which people are willing to hold that debt.

But let's start with the simple stuff first. Widening yield spreads are a symptom of tightening monetary policy. Depressingly simple, really.

I'm not sure how much longer this particular yield spread will remain a useful indicator. So far, people seem to be assuming that German government bonds will remain safe. I wouldn't count on them remaining safe, if monetary policy continues to tighten.

10--Sliding into Depression--Why Credit Anstalt matters, Bradford Delong, UC Berkeley

Excerpt: Austria's major bank, the Credit Anstalt, was revealed to be bankrupt in May 1931. Its deposits were so large that freezing them while bankruptcy was carried through would have destroyed the Austrian economy, hence the governmetn stepped in to guarantee deposits. The resulting expansion of the currency was inconsistent with gold-standard discipline. Savers liquidated their deposits and began to transfer funds out of the country in order to avoid the capital losses that would have been associated with a devaluation.

In order to keep its banking system from collapsing and in order to defend the gold standard, the Austrian central bank needed more gold to serve as an internal reserve to keep payments flowing and an external reserve to meet the demand triggered by incipient capital flight. The Bank for International Settlements began to host negotiations to coordinate international financial cooperation.

It is possible that rapid and successful conclusion of these negotiations might have stopped the spread of the Great Depression in mid-1931. Austria was a small country with a population well under ten million. There was not that much capital to flee. A sizable international loan to Austria's central bank would have allowed it to prop up its internal banking system and maintain convertibility. A month later those whose capital had fled would realize that the crisis was over, and that they had lost a percent of two of their wealth in fees and exchange costs in the capital flight. Other speculators would observe that the world's governments were serious in their commitment to the gold standard, that the potential foreign exchange reserves of any one country were the world's, and thus that the likelihood of a speculative attack succeeding in inducing a devaluation was small.

Perhaps investors would then have begun returning gold to central banks in exchange for interest-bearing assets, would have begun to shrink down their demand for liquidity, and would have begun to boost worldwide investment. The Economist's Berlin correspondent thought that it might well have done the job:

It was clear from the beginning... that such an institution [as the Credit-Anstalt] could not collapse without the most serious consequences, but the fire might have been localized if the fire brigade had arrived quickly enough on the scene. It was hte delay of several weeks in rendering effective international assistance to the Credit Anstalt which allowed the fire to spread so widely.

We don't know because it was not tried. The substantial loan to Austria was not made. Speculators continued to bet on devaluation, investors continued to hoard gold, the preference for liqidity continued to rise, and investment continued to fall.

The substantial loan to Austria was not made because French internal politics entered the picture.

No comments:

Post a Comment