Friday, November 4, 2011

Weekend links

1--Press conference--Mario Draghi, President of the ECB (text)

Excerpt: The economic outlook continues to be subject to particularly high uncertainty and intensified downside risks. Some of these risks have been materialising, which makes a significant downward revision to forecasts and projections for average real GDP growth in 2012 very likely....

Turning to fiscal policies, all euro area governments need to show their inflexible determination to fully honour their own individual sovereign signature as a key element in ensuring financial stability in the euro area as a whole. The Governing Council takes note of the fiscal commitments expressed in the Euro Summit statement of 26 October 2011 and urges all governments to implement fully and as quickly as possible the measures necessary to achieve fiscal consolidation and sustainable pension systems, as well as to improve governance. The governments of countries under joint EU-IMF adjustment programmes and those of countries that are particularly vulnerable should stand ready to take any additional measures that become necessary.

It is crucial that fiscal consolidation and structural reforms go hand in hand to strengthen confidence, growth prospects and job creation. The Governing Council therefore calls upon all euro area governments to accelerate, urgently, the implementation of substantial and comprehensive structural reforms. This will help the euro area countries to strengthen competitiveness, increase the flexibility of their economies and enhance their longer-term growth potential. In this respect, labour market reforms are essential and should focus on measures to remove rigidities and to enhance wage flexibility, so that wages and working conditions can be tailored to the specific needs of firms. More generally, in these demanding times, moderation is of the essence in terms of both profit margins and wages. These measures should be accompanied by structural reforms that increase competition in product markets, particularly in services – including the liberalisation of closed professions – and, where appropriate, the privatisation of services currently provided by the public sector. At the same time, the Governing Council stresses that it is absolutely imperative that euro area national authorities rapidly adopt and implement the measures announced and recommended in the Euro Summit statement of 26 October 2011.

2--Greek Tragedy: "there is hope, but not for us", The Nation

Excerpt: On the contrary: speaking in Greek after the Brussels meeting, Papandreou presented the agreement as a step away from dependence and pronounced the country “saved”; speaking in German to the Bundestag a few days earlier, Chancellor Angela Merkel said that Greece’s problems will require “permanent oversight.”

The fact that it’s Germany calling the shots and German tabloids slandering all Greeks as tax-evading scroungers stings especially. On October 28, the national day commemorating Greece’s entry into World War II, the army march-past in Thessaloniki [Salonika] was canceled because tens of thousands came out to demonstrate. Parading schoolchildren in many towns turned their faces away from government officials and raised fists wrapped in black; musicians hung black ribbons on their instruments; a banner in Syntagma Square proclaimed, Arbeit Macht Frei. The symbolism of these acts is doubly powerful: they not only brand the government as traitors and collaborators but recall the start of the civil war that tore the country apart after the occupation, killing many tens of thousands, depopulating the countryside and ushering in thirty years of repression.

Perhaps it was that insult that prompted Papandreou to stake all on a referendum, which comes too late to promise anything but danger. This is a man who saw himself as the white knight of politics, the one who would clean up the clientelism and corruption nurtured by his father and modernize the state. He may have thought, when he called in the EU and the IMF, that they would help him do it; having once summoned the gods he is now powerless to control them. Nor can he manage the mortals in his own government, determined to protect the system that has nourished them. Instead of the needed reforms he has presided over a brutal scorched-earth policy, crushing the country’s economy, immiserating its people, throwing open the gates to the most predatory forces of international finance. What meaningful choice can he put before the Greek people now? To stay in Europe and accept more years of dependent austerity, or to default and take their chances as a bankrupt Balkan state, shut out from financial markets? As Franz Kafka put it many years ago, there is hope, but not for us.

3--Bank exodus from euro zone sovereign debt quickens, Reuters

Excerpt: Banks including BNP Paribas (BNPP.PA) and ING (ING.AS) are ditching billions of euros of euro zone government bonds, cutting their exposure to the region's trouble spots.

More lenders are expected to retreat as the euro zone crisis deepens and leaders raise the possibility of the exit of Greece from the bloc, further damaging prices.

"The market value of the debt of the countries most under scrutiny is likely to decline further as banks unload sovereign bonds," Charles Dallara, managing director of the Institute of International Finance, warned on Wednesday.

BNP, the biggest overseas private holder of Greek government debt, took a 2.4 billion euro writedown on Thursday as the crisis in the currency bloc deepened, mostly as a result of its holding of Greek bonds.

4--Consumers Remain Pessimistic, WSJ

Excerpt: U.S. consumers remain pessimistic about the economy, according to a survey released Thursday. The sour mood is reining in holiday shopping plans.

The Royal Bank of Canada said its consumer outlook index increased to 39.6 this month from 39.2 in October.

The RBC current conditions index fell to 27.7 from 28.5. The expectations index rose to 51.7 from 50.8.

“With no positive economic news, stubbornly high unemployment and continued political dysfunction, American consumers can be forgiven for having a hard time finding a silver lining to current economic conditions,” the report said.

On a positive note, consumers were slightly less downbeat on the jobs situation. The RBC Jobs Index posted its first gain since June, improving 1.8 points to 49.0.

The Labor Department is scheduled to release its October employment report Friday. The median forecast among economists is that October payrolls grew by 100,000 and the unemployment rate stayed at 9.1%.

In a series of special questions, RBC asked about the euro-zone debt crisis and holiday shopping plans.

The results of the first question show 57% say they are following the debt issue, about unchanged from 59% last month.

On the second question, it is not surprising that worried consumers are being cautious about holiday spending plans. The RBC survey found 46% plan to spend less this year compared with 2010. Only 6% plan to spend more and a large 12% plan no spending at all.

5--Swimming naked in China, The Diplomat

Excerpt: With the Chinese government tightening credit, the massive leakage from the formal banking sector into the ‘shadow system’ ultimately risks sinking the country’s financial system.

For quite some time, analysts of China have been puzzled by a strange phenomenon: the country’s public and financial institutions are decidedly subpar by any international standard, but its economic growth rate is anything but. This puzzle can only be explained by two conclusions: either China has been fudging its growth data, or Chinese institutions aren’t as bad as outsiders commonly think.

There is, however, a third possibility. During the peak of the credit bubble in the United States, bankers on Wall Street had a popular saying: “When the tide is high, nobody knows you are swimming naked.” What this aphorism means is that apparent economic prosperity can cover up many dubious if not outright shady practices that eventually lead to financial calamities....

the task of stanching off this incipient financial panic is daunting. In the short-term, this involves the formulation and execution of policies that would effectively bail out those who have been swimming naked in China’s high but turbulent economic tide. For years, China’s state-owned banks systematically restricted credit to China’s dynamic private sector. While Chinese private firms are the fastest-growing economic entities and creating most of the new jobs, the Chinese government channels the bulk of bank loans to state-owned companies. The data on bank loans show that, as of 2009, explicitly identified non-state firms accounted for only 2 percent of all outstanding loans.

This discriminatory policy forces private firms to tap the “shadow banking system.” Such a system came into being because state-owned banks wanted to make more money with their low-cost (if not free) household deposits, because when state-owned banks lend to state-owned firms, they can charge only regulated (low) interest rates and repayment is not assured. Generally, such lending is politically safe (since no bank managers go to jail for making bad loans to state-owned enterprises) but economically unprofitable. On the other hand, lending money to private firms is politically unsafe (bank managers risk corruption charges should loans go sour) but economically lucrative (as they can charge high rates).

To manage the political risks of lending to private firms, Chinese state-owned banks created new investment options for their depositors, who are eager to invest their hard-earned savings at rates higher than government-controlled rates for deposits. Called “wealth management vehicles,” these new financial instruments effectively enabled state-owned banks to channel consumer deposits into loans targeting credit-starved private firms at rates that, when annualized, normally reach double digits. Effectively, the “shadow banking system” has been siphoning off credit from the state-owned banks. In the last few years, when Beijing opened the credit spigot to stimulate the economy following the global financial crisis, few noticed the effects of such leakage, which has grown enormously. Estimates by economists put the total amount of outstanding loans made by the “shadow banking system” at close to 20 percent of all outstanding bank loans.

6--Lurking in the Shadows—The Risks from Nonbank Intermediation in China, IMF Direct

Excerpt: Talking to people in China, and looking at what numbers are available, one cannot help but have an uneasy feeling that more credit is now finding its way into the economy outside of the banking system than is actually flowing through the banks.

The means by which such “lending” is being provided is wide-ranging and dynamically evolving.

Certainly many are aware of the high volumes of bankers’ acceptances—off-balance sheet short-term credit—being used of late. Over the past couple of years, trusts and entrusted lending vehicles (China’s own particular form of asset securitization) have also taken off. Then there is the world of informal lending: loan sharks charging high interest rates to those poor souls that are rationed out of regular channels of intermediation. The recent narrative from Wenzhou has certainly excited many.

But the shadows stretch even beyond these tales.

In the 12 months to June, over RMB 600 billion poured into China from short-term lending by nonresidents to Chinese corporations. Financial leasing companies have expanded, providing services that look a lot like credit by another name. The corporate bond market has blossomed, perhaps reaching RMB 1 trillion in new issuance for this year. There is an unknown volume of inter-corporate lending passing from one large company to another. And finally, some nonbank institutions have entrepreneurially moved into the lending space, providing loans to large corporations

as a way to profitability....

Despite these efforts, this risks the regulatory authorities perpetually being one step behind the financial innovators, always patching up the last hole in the system.

What is needed instead, as we have argued for some time now, is a careful reexamination of the whole monetary and financial framework. Policies that restrain credit through administrative means are becoming increasingly difficult to sustain. It is only going to get worse. This has been the experience of every other country that has tried to exercise macroeconomic control this way. China, admittedly, has held the system together exceptionally well for many years and it is never wise to bet against the government’s ability to diagnose and successfully resolve problems as the economy develops and becomes more sophisticated.

That does not alter the fact, though, that China is now facing a clear choice: pursue financial and monetary reform on a timetable that is driven by careful, pre-emptive, and concerted policy planning. Or, face the possibility that change will evolve in an uncoordinated and disorderly way, with innovation and disintermediation outpacing supervisory capabilities and revealing regulatory gaps along the way.

7--Quick bites, Tim Duy, Economists View

Excerpt: The Fed hold steady. Mark Thoma has the story here. Inexplicably, monetary policymakers slashed forecasts, claimed dissapointment at the state of the economy, and yet choose to take no policy action. The path to additional action is blocked by the lack of clear indications of deflation risks. The economy is bad, just not bad enough.

Another financial casaulty of the European crisis? First was Dexia, next was MF Global. Is Jefferies Group the third to fall? That was concern today as investors took the stock down 20% before it rebounded. More disconcerting is the message the price actions sends about the vulverability of US financial markets to European contagion:

“It is a testament to the fragile nature of the markets that the collapse of MF Global, following a monumental display of bad judgment by that company’s management, should generate contagion,” said Chris Kotowski, an Oppenheimer & Co. analyst in New York. Jefferies is “a very conservatively run firm where management has enormous ‘skin in the game.’”

Bottom Line: This is starting to feel like 2007 all over again. Then, like now, equity markets discounted the smoldering financial crisis, sending stocks higher through much of that year. I continue to think Europe is much further from a solution than American observers appear to believe, and that as the global situation deteriorates further, so too will the US economy. But we have yet to see that story fully emerge in the US data, and thus I understand the hope that the US is able to squeak through this episode with only limited bruising.

8--Vital Signs: Productivity Turns Up, WSJ

Excerpt: U.S. productivity grew at its fastest rate since the start of 2010 during the last quarter. Productivity, as measured by output per hour, rose at a 3.1% seasonally adjusted annual rate in the third quarter from the second. It had declined in the two previous quarters. The reason for the rebound: The economy picked up even as companies adopted a more cautious stance on hiring. (See chart)

9--MF Bankruptcy Causes Biggest Foreign Bank Liquidity Scramble To 'Fed Safety' Ever, Harbinger Of Major Eurobank Stress, zero hedge

Excerpt: Bond European Central Bank Lehman MF Global Reverse Repo

When Lehman filed for bankruptcy in that fateful week of September 2008, one thing caught everyone's attention: the epic surge in the Fed Reverse Repos originated by "foreign official and international accounts": essentially cash placed at the Fed by foreign institutions in exchange for collateral, primarily in the form of Treasurys, as well as other securities. This is nothing but an immediate cash parking in a 'safe place', which withdraws overall liquidity from the market, and as has been noted elsewhere, serves as an indirect gauge of banking system funding stress. In the week of September 24, this number soared from $46.6 to $93.7 billion, a $44 billion increase, or the single biggest jump in the history of the series. Well, as the chart below demonstrates, what happened with MF Global caught foreign banks, which as we have noted over the past several weeks have been dumping US Treasury and MBS paper, entirely by surprise as they scrambled to withdraw the last traces of available liquidity from the market, and to place as much of it as possible within the safety (and we use the term loosely) of the Fed. In the just released H.4.1 update, foreign Reverse Repos with the Fed soared from $81.3 billion to $124.5 billion, the most ever, and a weekly surge of $43.2 billion, the second largest ever, second only to the Lehman collapse. Furthermore, as noted daily, European banks have been doing precisely that with local cash from non-US subsidiaries, and parking near record amounts with the ECB (today the European central bank disclosed a whopping €253 billion had been deposited with it: just shy of the 2011 high), even as they have been dumping US Treasurys on one hand, and now are forced to repo what little paper they have left with the Fed due to systemic uncertainties in the MF aftermath, one can see why suddenly there was absolutely no liquidity left in the market, and why the meager €3 billion EFSF bond offering, so desperately needed to fund the ongoing Irish bailout and which incidentally is the story of the week, had to be pulled.

10--ECB President Mario Draghi cuts the euro's last lifeline, Telegraph

Excerpt: Anyone thinking that the arrival of Mario Draghi as president of the European Central Bank might herald a change in approach to the eurozone debt crisis would have been sadly disappointed by his first public appearance in the new role on Thursday.

No, and a thousand times no, he said to those calling on the ECB to stem the crisis with massive purchases of periphery-nation debt. The ECB's function, he reiterated, was to focus exclusively on price stability, not to act as lender of last resort to governments. Already, he seems like a clone of his predecessor, Jean-Claude Trichet, who famously had only "one needle in his compass" – inflation...

You'll be pleased to know, however, that widening spreads in European bond markets are nothing to worry about, as, according to Mr Draghi, they merely reflect differences in growth prospects and competitiveness which have always been there between eurozone nations. The solution to these differences is not central bank intervention, but economic reform in the afflicted countries, he said....

On one level, his analysis is spot on; no amount of central bank intervention is going to correct an underlying problem of lack of competitiveness. In fact, it might make it even worse. But nor can it be right for the ECB to be washing its hands of a dynamic that is fast pushing the entire eurozone into recession.

The ECB's position is also a mass of contradictions. The ECB has already intervened quite heavily in sovereign bond markets, to the disgust of German council members, two of whom have resigned over the issue. But on this too Mr Draghi is sticking to the sophistry of his predecessor's justification. The purchases are temporary, limited and justified by monetary policy considerations, he insisted. The disingenuity of this explanation is as astonishing today as it was when it was first made. For what other purpose is the ECB intervening other than to depress bond yields in the afflicted countries? The ECB's position seems to be that a little intervention is fine, but a lot is off-limits.

And while the ECB apparently sees it as not part of its job to act as lender of last resort to countries, it is perfectly happy with that position as far as the banking system is concerned. Banks were again promised unlimited liquidity by Mr Draghi on Thursday.

A substantial part of the collateral advanced for such liquidity is, in fact, sovereign debt. Forgive me, but I fail to see the distinction. The ECB is not prepared to act as lender of last resort to governments, but it is perfectly happy to accept their currency as collateral when acting as lender of last resort to banks. Explain that one....

In fairness to Mr Draghi, it has to be said nobody would have expected him to change the ECB's stance overnight. Even if he had felt inclined to, it would have looked too much like dumping on his predecessor, whose decisions, by the way, Mr Draghi was very much a part of as a member of the ECB council.

Yet he left himself no room whatsoever for changing his mind in his comments at Thursday's press conference. Having said it is no part of the ECB's function to act as lender of last resort to governments, it's hard to see how he can now reverse his stance. Instead, he's nailed his colours to the mast of the Bundesbank tradition. Not until the debt crisis spreads to the core, threatening the single currency as a whole, could he be persuaded.

This is a crisis that is set to run and run, locking in the now near certainty of another Continental recession which the UK will be lucky to escape.

11--Rogoff sees ECB monetisation followed by recapitalisation or seigniorage and currency depreciation, Credit Writedowns

Everyone is focused on the narrow issue of whether Greece can be cowed into austerity-induced depression and whether they will hold a referendum, default or leave the euro zone. There are bigger existential issues. Harvard Economist Kenneth Rogoff has a post up at Project Syndicate which does a good job in laying out the core conundrum that Europe faces in the sovereign debt crisis. He theme is exchange rates and currency revulsion. But the underlying framework Rogoff presents is anchored in a presentation of debt and monetary policy issues that is similar to what you read at Credit Writedowns.

His basic points are as follows:

1.The October 26th “comprehensive package” for Greece will not hold up because it is inadequate. It is a gimmicked hodge-podge of vague promises which do not cut the sovereign debt levels in Greece nearly enough to put the country on a sustainable fiscal path.

2.This so-called solution is all the more inadequate because Euroland would need a tighter fiscal union if it is to avoid the kind of liquidity crisis it is now experiencing. As this is something that requires constitutional changes which take time, “it seems clear that the European Central Bank will be forced to buy far greater quantities of eurozone sovereign (junk) bonds.”

3.“That may work in the short term” but eventually “the ECB will in turn have to be recapitalized. And, if the stronger northern eurozone countries are unwilling to digest this transfer – and political resistance runs high – the ECB may be forced to recapitalize itself through money creation.”...

If the ECB were like the Fed and it was backstopping a central European treasury that emitted Eurobonds, there would be no problem in Euroland. In fact, the Europeans could run government debts up to 200% of GDP like the Japanese without currency revulsion or spiking interest rates – not that they should want to, but they could. But, that’s not the institutional structure in Euroland, so they can’t do that and so they are exposed to currency revulsion and rates are spiking....

There’s a further problem....


The failure to sort out the ambiguities concerning the distribution of the fiscal burden that may arise through bail-outs of banks operating in multiple Euro Area nation states puts a large question mark behind the effectiveness of the Euro Area financial stability arrangements. The Euro Area has proven itself to be capable of handling a banking sector liquidity crisis. The institutional arrangements, including the fiscal burden sharing key, for handling a banking sector insolvency crisis are opaque at best, non-existent at worst.

We must know who would recapitalise the ECB should it suffer a material capital loss, and through what mechanism this would occur.

-Willem Buiter, May 2008...

Bottom Line: The ECB will monetise and the Europeans will top it up with capital. That is how this is going to play out.

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