March 30

QOTD:

Won't it be cool if subsequent versions of QE are referenced with Roman numerals like the Super Bowl?
John Roque, WSJ.

The unbelievable truth about Ireland and its banks. BBC.

To prevent Irish banks toppling over one after another, the European Central Bank has lent 117bn euros to them and the Central Bank of Ireland has lent them a further 71bn euros. So that's 188bn euros of loans from the eurozone's taxpayers to Ireland's banks - which makes the 67.5bn euros lent directly by the eurozone and IMF to the Irish government look like peanuts. And a further 20bn euros of bank bonds - another form of bank debt - is still guaranteed by the Irish state through the Eligible Guarantee Scheme. So that is 208bn euros of taxpayer loans to Ireland's banks - equivalent to a remarkable 154% of GDP.

[Irish] Bank bailout cost (so far). Corner Turned.

The 'grand bargain' is just a start. Martin Wolf, FT.

It would be helpful – and honest – for the German government and the governments of other creditor countries to tell their people that they are rescuing their own savings in the guise of rescuing peripheral countries. The alternative is to write off loans and recapitalise their banks directly. To admit this would be to admit their policies have been at fault. That would surely be helpful.

Europe needs debt relief, not decades of austerity. The Guardian.

From Donegal to the Algarve, to the streets of Athens, voters on Europe's "periphery", as economists dismissively call it, are slowly waking up to a sobering truth – they face years of austerity, yet wage cuts, job losses and crumbling public services will not extricate them from financial crisis. In fact, by driving their economies into an ever deeper slump, it may even make things worse. The pain could just bring more pain....

Markets and voters across the eurozone have grown wearily accustomed to watching the cycle of a looming fiscal crisis as bond yields rocket, followed by just enough action from Brussels to jolt investors out of panic mode, followed by another bout of the jitters as they realise the rhetoric from euro leaders isn't matched by reality.

As Steen Jakobsen, chief economist at Saxo Bank, put it in a note on Friday: "It's clear that the electorates are beginning to realise that all solutions offered by the policymakers are based on the promise to do something in the future, and never right here, right now."

But time is running out, and Europe has two choices. It can continue hammering the economies of Greece, Ireland and soon Portugal deeper into crisis, while their already furious voters become increasingly resentful about the pain being imposed by their European "partners"; or it can accept that the scale of debts has simply become unsustainable, and open negotiations now about an orderly default.

As Obama and Congress fiddle, America liquidates housing sector. Chris Whalen.

the current national policy mix of more regulation, decreased government subsidies and, to add further urgency, a shrinking banking system, is the perfect storm for the housing, which is now down six months in a row. Despite my long-held desire to see market-based reform in the US housing sector, I think all parties need to be aware of the precarious situation facing the American economy and banks as home prices collapse for lack of credit....

The net, net here is that the available pool of credit available for the housing sector is shrinking and thus prices must also decline to adjust for that supply of credit. This fact of continued decline in home prices is going to have a chilling effect...

I estimate that Fannie and Freddie alone are hiding $200 billion worth of bad loans on their books simply because there is no market for these foreclosed homes. Ditto for the largest servicer banks such as Wells Fargo, Bank of America, JPMorgan Chase and Citigroup. To clean up this mess with finality is going to cost $1 trillion or so in round numbers. But nobody in Washington wants to go there.

Where the bailout went wrong. Neil Barofsky, NY Times Op-Ed.
As per James Kwak:

Back in late 2008 and early 2009, there was a lot of talk about how a true solution for the problems of the banking system would require a solution for the problems of homeowners, since the banks’ losses were largely the result of mortgage defaults. One of the major technical achievements of the administration was showing that it was possible to stabilize the financial system and restore the banks to short-term profitability without doing much for homeowners.

The Federal Open Mouth Committee is back in action. Pater Tenebrarum.

Hawks (relatively speaking) and doves within the Fed are busy trading slightly contradictory statements in public again, in a performance that is eerily reminiscent of the 'exit talk' (exit from unusual monetary accommodation measures that is) that proliferated about one year ago.....

led to this campaign of advance burying of 'QE3' by means of 'QE2' funeral eulogies. Surely 'QE3' won't be talked about so much anymore if even 'QE2' comes under official scrutiny. Since the current QE program is slated to end in June, market participants are given fair warning not to expect more 'coups de whiskey' for the stock and commodity markets immediately thereafter. This in turn means that the times are set to become slightly more interesting. Given that there is not the slightest evidence yet that private sector deleveraging has run its course, a cessation of excessive monetary pumping may end up stopping various bubble activities in their track in very short order. This is to say, both financial markets as well as the economy may slump again fairly quickly....

Helicopter pilot Ben Bernanke has been rather quiet, letting the rest of the board spread the message. Alas, we suspect he's personally still firmly in the pro easy money camp. At least this is what we would have to conclude considering his well known views on the Great Depression as well as Japan's post bubble era. His usual refrain was that policy makers were 'too timid' in these instances, but as it were, the BoJ is a veteran of two (now 2.5) QE programs as well, so if one wants to be 'less timid', then 'QE1' and 'QE2' alone obviously won't cut it. In that sense we would be inclined to discount the advance funeral rites for 'QE3' as just more hot air. Nevertheless, there will be a pause, and should the economy's momentum not falter again immediately, then we'd expect the 'exit' palaver to increase in both volume and frequency.

Surpluses, debt and depressions.... Randall Wray via Pragmatic Capitalism.

China's 5-year plan and global interest rates. Martin Feldstein.

Visualizing the food and energy crunch. Pragmatic Capitalism.

Debt: The first five thousand years. David Graeber.

The biggest urban legend in finance. Rob Arnott.

Fannie and Freddie hiding over $100 billion of losses? naked capitalism.


other fare:
Exceptional And Unexceptional America. Andrew Sullivan, The Atlantic.

January 24

Do we really have a balance sheet recession? David Beckworth.

The age of de-leveraging. Jason Leach.

How I learnt to stop worrying and love The Bank. Steve Keen.

How will they prop up stocks after QE? An answer? Bruce Krasting.

The Fed can’t go bankrupt. Anymore. FT Alphaville.

More evidence of undercapitalization/insolvency of major banks. Yves Smith.

National debt = great recession 2.0. Dian Chu.

Spain's bank nationalization and the euro zone crisis. Ed Harrison.

The real cost of Chinese NPLs. Michael Pettis.

China vs. inflation: a love-30 match so far. Dian Chu.

Beijing most likely will come to grip very soon that eventually somebody got to pay somewhere, and there’s just no way around it, and that the time has come for some decisive actions with a combination of more aggressive monetary, fiscal and regulatory measures to show it really means business.

For example, instead of the symbolic two 25-bps interest rate hikes in Oct. and Dec., Beijing probably will do an immediate 50-bps rate hike by early February and another 50 bps in early March to blunt the start of the typical yearly run-up of crude oil, and other commodities. Then, depending on the market reaction and new economic data, more hikes could be implemented later on in the year. Fiscal policies such as taxes, and financial regulations and restrictions on speculative activities could be necessary.

Meanwhile, the expectation of a Yuan appreciation is keeping liquidity swimming. So, perhaps China would do just the opposite, as suggested by Andy Xie, a currency depreciation, which would lead to a capital outflow forcing interest rates up. There [are]many more things that China has to do to get the inflation situation under control, which most likely will send shock waves throughout global markets.

Social Unrest Could Make or Break A Party: Nmbers may be rigged or "smoothed out", but can't fool the regular Chinese Joe's and the smart money.

China's runaway chariot. Charles Smith.

SocGen crafts strategy for China hard-landing. Ambrose Evans-Pritchard.

Record Food Prices Causing Africa Riots Stoking U.S. Farm Economy. Bloomberg.

Inflation: not here, not now. John Taylor.


other fare:
of amusement: Gartman investment SAT score 410.

January 20

Consumers and the Economy, Part II: Household Debt and the Weak U.S. Recovery. FRBSF.

The U.S. economic recovery has been weak, especially in employment growth. A microeconomic analysis of U.S. counties shows that this weakness is closely related to elevated levels of household debt accumulated during the housing boom. Counties where household debt grew moderately from 2002 to 2006 have seen a moderation of employment losses and a robust recovery in durable consumption and residential investment. By contrast, counties that experienced large increases in household debt during the boom have been mired in a severe recessionary environment even after the official end of the recession.

Quarterly Review and Outlook. Van Hoisington and Lacy Hunt.

We see seven main impediments to economic progress in 2011 that will slow real GDP expansion to the 1.5%-2.5% range. First, fiscal policy actions are neutral for 2011. Second, state and local sectors will continue to be a drag on the economy and labor markets in 2011. Third, Quantitative Easing round 2 (QE2) will likely produce only a slight economic benefit as the Fed continues to encourage additional leverage in an already over-indebted economy. Fourth, while consumers boosted economic growth in the second half of 2010 by sharply reducing their personal saving rate, such actions are not sustainable. Fifth, expanding inventory investment, the main driver of economic growth since the end of the recession in mid-2009, will be absent in 2011. Sixth, housing will continue to be a persistent drag on growth. Seventh, external economic conditions are likely to retard U.S. exports....

In spite of the adverse psychological reaction to the QE2, long Treasury bond yields dropped to 4.3% at the end of 2010, down 30 basis points from the close of 2009, producing a total return of slightly more than 10% for a portfolio of long Treasury and zero coupon bonds. The problematic economic environment and its depressive effect on inflation suggests long Treasury bond yields could easily decrease another 30 basis points in 2011, which would produce another double-digit rate of return for a similar portfolio. The probabilities of even lower yields are significant.

One step forward in the Euro zone? Claus Vistesen.

The system has reached the stage that a bankrupt sovereign state is issuing debt to buy bonds in a vehicle that is tasked with buying debt from a bankrupt Sovereign state that is no longer able to go to market. Folks this is reaching the level of a Monty Python skit.

This brings up a serious question not seen answered in the public yet.Who is ultimately responsible for the bonds that the rescue fund is going to be selling as AAA investments? Whose AAA balance sheet is guarantying these bonds that will be sold to investors like Japan?

EMU policies are pushing Southern Europe into systemic political crisis. Ambrose Evans-Pritchard.

Let us assume for the sake of argument that Europe succeeds in containing the immediate EMU debt crisis, with help from Asia, and that Germany’s fractious coalition actually agrees to a bail-out fund big enough to make any difference. What does this achieve, other than allowing banks to buy time by offloading liabilities onto European and Chinese taxpayers?

Is core Europe heading for a hard landing? Michael Darda.


Europe's Gordian Knot. Scott Minerd, Guggenheim Investment.


America has ‘reached the point of no return,’ Reagan budget director warns. Raw Story.

Stockman, who described himself as a libertarian during a recent interview with Reason.tv, told Raw Story that the economy got into this mess because of the public and private sectors' addiction to "guns and butter Keynesianism," an economic policy that amounts to a Ponzi scheme that has ballooned since 1990.

"If we see what's going on carefully, we've reached the final unmasking of the Keynesian illusion, that Keynesianism is really nothing but borrowing, stealing from the future to induce consumption today," he said. "There are no multipliers. Every one of these programs we've had from 'cash for clunkers' to housing purchase credits have disappeared as soon as they expired and simple shifted activities in time by a few months."

Stockman explained that before 1980, it took about $1.50 of new borrowing -- public or private -- to generate $1 of GDP growth. By the mid-1990s, it was $2.50 or $3 of borrowing for a $1 of GDP growth. By 2007, before the big collapse and meltdown finally came, $7 of public and private debt was added to the national balance sheet in order to get $1 of GDP growth.

"When you get to the point of $7 of borrowing to get $1 of income, you're obviously on an unsustainable path and pretty close to hitting the wall, which more or less we have," he said.

"So the addicts in Washington are now unfortunately terrified to stop all this borrowing whether it's for guns or butter for fear of the economy will collapse.... That's why we're just at the beginning of solving this massive financial collapse we had in 2008 and not in the process of healthy recovery as some of the pals in the White House or on Capitol Hill or on Wall Street would have you believe."

We cannot support ever-rising debt. Andrew Smithers.


Hedge funds bet China is a bubble close to bursting. Telegraph.


I like Ike: A powerful warning ignored. Jeremy Grantham.


I have been wrong -- I've been too bullish: Albert Edwards.

Sovereign debt crisis -- can it happen here? Soc Gen, via zero hedge.


Sustainable Credit Report 2011. World Economic Forum, via zerohedge.
finds that while global credit stock doubled from $57 trillion to $109 trillion in just 10 years (from 2000 to 2010), it will need to double again to $210 trillion by 2020 in order to provide the necessary credit-driven growth for world GDP to retain its current growth rate


The Financial Crisis: Will It Lead to America's Decline? FORA.TV.
Niall Ferguson, David Gergen, Mort Zuckerman.

December 25

as opposed to the new normal:
In defense of the "Old Always". James Montier, GMO.

Outlook 2011 and the next decade: is the smart money right on China? Dian Chu.

The opening act to the broader crisis. Scott Minerd, Guggenheim Partners.

The Fallacy of a Pain-Free Path to a Healthy Housing Market. FRB Dallas.

other fare:

Searching for Jesus in the Gospels. New Yorker.

December 13

Living with low for long. Mark Carney, BoC.

Current turbulence in Europe is a reminder that the crisis is not over, but has merely entered a new phase. In a world awash with debt, repairing the balance sheets of banks, households and countries will take years.

For the crisis economies, the easy bit of the recovery is now finished. Temporary factors supporting growth in 2010–such as the turn in the inventory cycle and the release of pent-up demand–have largely run their course. Fiscal stimulus is turning to fiscal drag and, for some countries, rapid consolidation has become urgent. Household expenditure can be expected to recover only slowly. This all implies a gradual absorption of the large excess capacity in many advanced economies.

This is not surprising. History suggests that recessions involving financial crises tend to be deeper and have recoveries that take twice as long. In the decade following severe financial crises, growth rates tend to be one percentage point lower and unemployment rates five percentage points higher.1 The current U.S. recovery is proving no exception.

In such an environment, very low policy rates in the major advanced economies could be in place for a prolonged period–a possibility underscored by the recent extensions of unconventional monetary policies in the United States, Japan and Europe.

Big numbers from the BIS. FT Alphaville.

The eurozone is in bad need of an undertaker. Ambrose Evans-Pritchard.

What the German people are being asked to do is to surrender fiscal sovereignty and pay open-ended transfers to Southern Europe, taking on a burden up to six times reunification with East Germany. "If we pool the debts of the countries in the south-west periphery of Europe, we are blighting our children’s future: the debt levels are astronomic," said Hans-Werner Sinn, head of Germany IFO institute. Any attempt to prop up the status quo will cement the current account imbalances of EMU’s North and South, to the detriment of both sides. "I doubt that the current leaders of Europe fully understand the economic implications of their decisions. They are repeating the mistakes that Germany made over reunification," he told the Handelsblatt.

Transfers to the East are still running at €60bn a year two decades after the fall of the Berlin Wall. There has been no meaningful East-West convergence for the last 15 years. To those who blithely argue that EMU is a good racket for German exporters because it locks in Germany’s competitive advantage, he retorts that a trade surplus is the flip side of a capital deficit. Germany has seen €1 trillion – or two thirds of its entire savings since 2002 – leak out to fund the EMU party, gutting investment at home. This is toxic for Germany too....

So as EU leaders flounder, the task of saving monetary union falls to the ECB. Yet it too has declined the burden, refusing to go nuclear with bond purchases. "Each country needs to be held responsible for its own debt," said Germany’s monetary avenger at the ECB, Jurgen Stark. He was joined last week by Mario Draghi, Italy’s governor and candidate for ECB chief, who said it was not the job of a central bank to carry out fiscal rescues. "We could easily cross the line and lose everything we have, lose independence, and basically violate the Treaty," he said.

Indeed. Maastricht forbids the ECB from buying the debt of eurozone states except for specific purposes of liquidity management. But this saga no longer has anything to do with liquidity. Southern Europe faces a solvency crisis.

Block those metaphors. Paul Krugman.

What we’ve been dealing with ... is a painful process of “deleveraging”: highly indebted Americans not only can’t spend the way they used to, they’re having to pay down the debts they ran up in the bubble years....

What the government should be doing in this situation is spending more while the private sector is spending less, supporting employment while those debts are paid down. And this government spending needs to be sustained:... spending that lasts long enough for households to get their debts back under control. The original Obama stimulus wasn’t just too small; it was also much too short-lived...

But wouldn’t it be expensive to have the government support the economy for years to come? Yes, it would — which is why the stimulus should be done well, getting as much bang for the buck as possible.... [but] the tax-cut deal is likely to deliver relatively small benefits in return for very large costs. ... Tax cuts for the wealthy will barely be spent at all; even middle-class tax cuts won’t add much to spending. And the business tax break will, I believe, do hardly anything to spur investment given the excess capacity businesses already have.

The actual stimulus in the plan comes from the other measures, mainly unemployment benefits and the payroll tax break. And these measures (a) won’t make more than a modest dent in unemployment and (b) will fade out quickly, with the good stuff going away at the end of 2011.

The question, then, is whether a year of modestly better performance is worth $850 billion in additional debt, plus a significantly raised probability that those tax cuts for the rich will become permanent. And I say no. The Obama team obviously disagrees. As I understand it, the administration believes that all it needs is a little more time and money, that any day now the economic engine will catch and we’ll be on the road back to prosperity.... What I expect, instead, is that we’ll be having this same conversation all over again in 2012, with unemployment still high and the economy suffering as the good parts of the current deal go away.

Reconsidering Japan and Reconsidering Paul Krugman. Truthout.

there is a commonsense aspect to this story that gets lost amid the rhetoric and the headlines. Two lessons of our times are that economic bubbles eventually burst, and that the environmental consequences of unbridled growth in this age of global warming are severe. The world needs to figure out how advanced economies can provide for their people without relying on roaring growth rates driven by asset bubbles. If consumer-driven growth was the order of the day in the post-World War II era, going forward it is going to be steady-state economic growth - growing not too fast, but not too slowly - and learning to do more with less.

Like bulls in a China shop. Bob Janjuah.

A terrible way to fix the economy: households deleveraging through defaulting on debt. rortybomb.

What to make of this? First off, I’m terrified at the idea that national wealth is roughly at the level to pay for the servicing of debt but not necessarily pay off any actual debt. Our household sector is at the point where we can make the minimum payment on our metaphoric credit card without paying any of it down, and the only other choice is to not pay it at all.

other fare:
Human extinction: not the worst case scenario. 3QD.

Civilization has bestowed our species with a distorted self-image. Many people seem to have the impression that we operate independently of nature. We are fortunate that we’ve been able to act as though we are independent for as long as we have. If we don’t adjust our way of living so that it becomes sustainable, however, nature will eventually do this for us.

December 10

Europe's inevitable haircut. Barry Eichengreen.

What once could be dismissed as simply a Greek crisis, or simply a Greek and Irish crisis, is now clearly a eurozone crisis. Resolving that crisis is both easier and more difficult than is commonly supposed.

The economics is really quite simple. Greece has a budget problem. Ireland has a banking problem. Portugal has a private-debt problem. Spain has a combination of all three. But, while the specifics differ, the implications are the same: all must now endure excruciatingly painful spending cuts.

The standard way to buffer the effects of austerity is to marry domestic cuts to devaluation of the currency. Devaluation renders exports more competitive, thus substituting external demand for the domestic demand that is being compressed.

But, since none of these countries has a national currency to devalue, they must substitute internal devaluation for external devaluation. They have to cut wages, pensions, and other costs in order to achieve the same gain in competitiveness needed to substitute external demand for internal demand.

The crisis countries have, in fact, shown remarkable resolve in implementing painful cuts. But one economic variable has not adjusted with the others: public and private debt. The value of inherited government debts remains intact, and, aside from a handful of obligations to so-called junior creditors, bank debts also remain untouched.

This simple fact creates a fundamental contradiction for the internal devaluation strategy: the more that countries reduce wages and costs, the heavier their inherited debt loads become. And, as debt burdens become heavier, public spending must be cut further and taxes increased to service the government’s debt and that of its wards, like the banks. This, in turn, creates the need for more internal devaluation, further heightening the debt burden, and so on, in a vicious spiral downward into depression.

So, if internal devaluation is to work, the value of debts, where they already represent a heavy burden, must be reduced. Government debt must be restructured. Bank debts have to be converted into equity and, where banks are insolvent, written off. Mortgage debts, too, must be written down.

Default, delusion and deceit (and other ways to spring the debt trap). Roger Bootle of Capital Economics, in the Telegraph.

There are five ways of escape [from the debt trap].

First, try to muddle through and hope that years of sustained economic growth will cause the weight of these debts to fall and for the burden to go unnoticed amidst increasing prosperity, so that it is unclear who has picked up the tab. This is far and away the best solution – if you can manage it. But in the vulnerable countries GDP is struggling – or even contracting.

Second, engineer a bout of inflation to reduce the real value of the liabilities. In this way just about everyone in society will pay – but hopefully no one will notice. (Being able to devalue your currency potentially helps you achieve both the first and the second routes.) The trouble is that even if this solution were available for the eurozone as a whole, for each embattled member country it is not, as they do not have their own money.

Third, force those who caused the problems and gained from the years of extravagance to cough up. That would mean the bankers, property developers and politicians. This seems the fairest solution, but it is also the least likely. And, believe it or not, even they do not have enough dosh.

Fourth, slash government spending and make current and future taxpayers pick up the tab. This is the way that Ireland and Greece are trying to go. The trouble is that the situation may be so far gone that attempting a solution this way is impossible. It may even be so deflationary that it proves to be counter-productive.

The fifth way is to default. Perhaps you can make someone not involved in the process by which the government gets elected take a good part of the hit. This is where Johnny Foreigner comes in. You say: "Sorry old chaps, but that money that you thought we owed you is now 'restructured'. In the words of Monty Python, it is an ex-loan."

This is what is going to happen. Huge amounts of money are going to be lost. At the moment, the prospective losers can afford it. But coming up in the lift are Portugal, Belgium and Spain. And then Italy. This looks eerily like the build-up to the financial crisis of two years ago. Perhaps the bail-out of Ireland is the Bear Stearns moment. Spain, or Italy, could be the Lehman moment.

Eclectica Fund: Manager Commentary, December 2010. Hugh Hendry.
subtitled "There are no policy remedies for debt deflation"



other fare:
The decline and fall of the American Empire. Alfred McCoy
also on Salon, provocatively but dumbly entitled How America will collapse (by 2025), and which led a colleague of mine to say, when grabbing the article off the printer, "Oh, this has you written all over it!" Well, maybe so, but I don't believe in collapse, per se; however, its hard to argue with the notion that the debt situation is onerous, or that unfunded liabilities will be a serious challenge, or that climate change and peak oil present potentially problematic possibilities, and that geopolitics and terrorism are serious risks, and even the internal socio-political-economic atmosphere, with high unemployment and the Tea-Partiers, etc., is difficult; so there are some very ominous impediments to the continuation of American "exceptionalism", and each of those issues are ones I find of significant (not just academic?) interest, even if only to acknowledge as risks to our outlook

December 9

The European Council is once again at each others' throats. Eurointelligence.

The three stages of delusion by Dylan Grice and the London Brief by Omar Sayed, both on Europe. via Outside the Box.

Grice: Simply expanding it in its current form so that the ‘solvent core’ commits to raise yet more funds for the ‘insolvent periphery’ fails to address the risk that as more dominos fall the bailers shrink relative to the bailees (Italy and Spain combined – who’s spreads have been blowing out this week – are combined bigger than Germany). At what point does the insolvent periphery include so many countries that markets lose confidence in the solvency of the shrinking core to bail them out. Leaving aside for now the unpleasant reality that the solvent core might not actually be so solvent, perhaps the spread between ‘insolvent’ Greece and solvent France should be narrower? I wish I knew. In the absence of ECB printing, I suspect we’re going to find out.

Sayed: So in order to preserve this unholy union, what options does the EU have?   I see four: (1) the Marshall Plan II; (2) the Treaty of Versailles II; (3) the printing press option and (4) the Icelandic option.  Each has its challenges and problems.

as for me, I think that Texans and Nebraskans have no choice but to support Californians and Illini, as they're already part of a fully-integrated fiscal-monetary-social-policitical union; Germans and Dutch have a choice regarding supporting Greeks and Portugese. Without a true fiscal and political union, how can a monetary union with such disparate member states actually operate effectively over the long-term?

December 2

Default, departures or denial? Buttonwood.

The euro at mid-crisis. Kenneth Rogoff.

probably only at the mid-point of the crisis. To be sure, a huge, sustained burst of growth could still cure all of Europe’s debt problems – as it would anyone’s. But that halcyon scenario looks increasingly improbable. The endgame is far more likely to entail a wave of debt write-downs, similar to the one that finally wound up the Latin American debt crisis of the 1980’s. For starters, there are more bailouts to come, with Portugal at the top of the list. With an average growth rate of less than 1% over the past decade, and arguably the most sclerotic labor market in Europe, it is hard to see how Portugal can grow out of its massive debt burden....

But bailouts for Portugal and Spain are only the next – and not necessarily final – phase of the crisis. Ultimately, a significant restructuring of private and/or public debt is likely to be needed in all of the debt-distressed eurozone countries. After all, bailouts from the EU and the IMF are only a temporizing measure: even sweetheart loans, after all, eventually must be repaid. Already facing sluggish growth before fiscal austerity set in, the so-called “PIGS” (Portugal, Ireland, Greece, and Spain) face the prospect of a “lost decade” much as Latin America experienced in the 1980’s. Latin America’s rebirth and modern growth dynamic really only began to unfold after the 1987 “Brady plan” orchestrated massive debt write-downs across the region. Surely, a similar restructuring is the most plausible scenario in Europe as well....

Here is where the latest Irish bailout is particularly disconcerting. What Europe and the IMF have essentially done is to convert a private-debt problem into a sovereign-debt problem. Private bondholders, people and entities who lent money to banks, are being allowed to pull out their money en masse and have it replaced by public debt. Have the Europeans decided that sovereign default is easier, or are they just dreaming that it won’t happen? By nationalizing private debts, Europe is following the path of the 1980’s debt crisis in Latin America. There, too, governments widely “guaranteed” private-sector debt, and then proceeded to default on it. Finally, under the 1987 Brady plan, debts were written down by roughly 30%, four years after the crisis hit full throttle.

Imminent Eurozone default: how likely? Simon Johnson.

The prevailing consensus – and definite official spin – is that over the weekend European leaders backed away from the German proposal to impose losses on creditors as a condition of future bailouts, i.e., from 2013. The markets, in this view, should and likely will calm now; there is no immediate prospect of any kind of sovereign default... But a close reading of the Eurogroup ministers’ statement from Sunday suggests quite a different interpretation... [I]t has potentially momentous consequences – as it envisages dividing future eurozone crises into two kinds. “For countries considered solvent, on the basis of the debt sustainability analysis conducted by the [European] Commission and the IMF, in liaison with the ECB, the private sector creditors would be encouraged to maintain their exposure according to international rules and fully in line with the IMF practices. In the unexpected event that a country would appear to be insolvent, the Member State has to negotiate a comprehensive restructuring plan with its private sector creditors, in line with IMF practices with a view to restoring debt sustainability. If debt sustainability can be reached through these measures, the ESM [European Stability Mechanism] may provide liquidity assistance.”

Translation: if it is decided your country is “insolvent”, rather than illiquid, then you have to restructure your debts. But who exactly will decide?... the bombshell: “On this basis, the Eurogroup Ministers will take a unanimous decision on providing assistance.”

In other words, any one member of the eurozone can veto a country being determined merely illiquid – thus cutting them off from cheap and endless credit (from the ECB or ESM or any window to be named later). So now Germany effectively has a veto – as do other fiscally austere countries. Most likely we will witness the creation of an Austere Coalition (actually a modified Hanseatic League) of Germany, Austria, Finland, Estonia, and a few of the smaller countries.

The man with the magic words. Richard Smith.
Monday/Tuesday, panic re: Euro; Wednesday, all calm. why? Trichet soothed markets, suggesting ECB will buy PIGS debt, but also that a monetary federation, which they have, is not enough, that they "need a quasi-budget federation as well"; but is that do-able? is there political wherewithal? or, more likely, will Merkel and Weber rile markets up again? either way:

ECB funding programmes won’t fix any of that. Handouts or haircuts: the next stage of the political debate in Euroland will have to deliver a choice, and a plan

More thoughts on the ECB decision. Marc Chandler.

European officials must have known they were going to disappoint the market with the decision to simply postpone draining liquidity. The firewall around Greece failed. The firewall around Ireland has failed. The politicians have dropped the ball and the left Trichet holding the bag. Many from the periphery appeared to lobby the ECB to help out. Trichet in essence says there is little it can do and that it is really up to the governments. What Trichet announced today seems like the bare minimum of what it could do without immediately intensifying the crisis

Are the banks insolvent? Fair question, given this... Karl Denninger.

The big economic story, and why Obama isn't telling it. Robert Reich.

Albert Edwards: China's leading indicators are flashing warning light. zero hedge.

Viral! Rick Bookstaber.
discusses the age of private information, the age of too much information, and the age of viral information:

The new, viral world means more surprises and more volatility; and not because of market shocks precipitated by content, but because of the randomness in what might happen to catch on and reverberate through the internet.

other fare:
Sarah Palin wasn't the only one: Tom Flanagan, an advisor to PM Harper, in a live TV intereview, also called for the assassination of Wikileaks founder, Julian Assange. Telegraph.

December 1

QOTD:

Politics is the art of looking for trouble, finding it everywhere, diagnosing it incorrectly and applying the wrong remedies. Groucho Marx.

Edward Harrison summarizes Bill Gross' latest, and offers some of his own views, including:

There are four ways to reduce real debt burdens:

• by paying down debts via accumulated savings.
• by inflating away the value of money.
• by reneging in part or full on the promise to repay by defaulting
• by reneging in part on the promise to repay through debt forgiveness

Right now, everyone is fixated on the first path to reducing (both public and private sector) debt. I do not believe this private sector balance sheet recession can be successfully tackled via collective public sector deficit spending balanced by a private sector deleveraging. The sovereign debt crisis in Greece tells you that. More likely, the western world’s collective public sectors will attempt to pull this off. But, at some point debt revulsion will force a public sector deleveraging as well.

And unfortunately, a collective debt reduction across a wide swathe of countries cannot occur indefinitely under smooth glide-path scenarios. This is an outcome which lowers incomes, which lowers GDP, which lowers the ability to repay. We will have a sovereign debt crisis. The weakest debtors will default and haircuts will be taken. The question still up for debate is regarding systemic risk, contagion, and economic nationalism because when the first large sovereign default occurs, that’s when systemic risk will re-emerge globally.

Ireland's reparation burdens. Barry Eichengreen.

The Irish “rescue package” finalized over the weekend is a disaster. You can say one thing for the European Commission, the ECB and the German government: they never miss an opportunity to make things worse.

The rough politics of European adjustment. Michael Pettis.

I have no doubt that enormous amounts of scotch tape, paper clips, and chewing gum are going to be deployed quickly to hold the whole thing together, and that perhaps in a week or two we will be all throwing sighs of relief as policymakers firmly announce that Europe was put to the ultimate test and proved itself manfully. But does that mean we can stop worrying – was this really the ultimate test? No, of course not. If previous history is any guide, this crisis will re-emerge in different places every few months until it is truly resolved...

Unfortunately it is going to require a lot more than emergency liquidity loans, no matter how plentiful, to arrive at a final resolution. These loans simply paper over the financing gap until the next big refinancing exercise, and each new loan effectively shortens the duration of the debt or claims a higher level of seniority, so that the capital structure becomes increasingly risky. As the capital structure becomes riskier, it takes a smaller and smaller event to set off the next crisis.

Hangover theory and morality plays. Steve Waldman. 

Austrian-ish “hangover theory” claims, plausibly, that if for some reason the economy has been geared to production that was feasible and highly valued in previous periods, but which now is no longer feasible or highly valued, there will be a slump in production.... There is no school of economic thought I know of that suggests increased prosperity and consumption in and of themselves require a painful purge. The claim is that some patterns of economic activity create the appearance of prosperity and enable temporary consumption that cannot be sustained, and that moving from a period during which such patterns obtain to a more “sustainable pattern of specialization and trade” involves adjustments that are difficult.... 

It is not technocratic economists who will win the day and pull us out of our cul-de-sac, but angry Irishmen and Spaniards who challenge, on moral terms, the right of German bankers to impose vast deadweight costs on current activity because they lent greedily into what might easily have been recognized as a property and credit bubble.

European Leaders Should Focus on the Banks, Not the Sovereigns. Peter Atwater.

The market is saying “when” not “if” any more. To stop the spreading contagion, European leaders need to stop focusing on the sovereigns and start focusing on the banks. As we have already seen, troubled sovereign nations can be kept alive for an extended period of time, but banks can’t. But rather than growing sovereign double leverage even further -- in which a troubled nation, like Ireland, borrows from the EU to put equity capital into its banks -- if the EU is serious about stopping the growing banking contagion, it is going to have to consider its own pan-European TARP/FDIC program for Europe’s largest banks. And whether Europe has the stomach for that we’ll soon find out. But until Europe divorces banking strength from sovereign strength, they will both go down together.

Bankers gone wild... in Ireland AND Germany. Marshall Auerback.

Much ink has been spilled in the press over the Irish problem and the laxity of the country’s southern Mediterranean counterparts in contrast to the highly “disciplined” Germans. But perhaps we have to revisit that caricature. Not only has the Irish crisis blown apart the myth of the virtues of fiscal austerity during rapidly declining economic activity, but it has also illustrated that Germany’s bankers were every bit as culpable as their Irish counterparts in helping to stoke the credit bubble.....

All of the rescue plans that have been introduced in Ireland or Greece thus far rest on the assumption that, with more time, the eurozone’s problem children could get their fiscal houses in order — and Europe could somehow grow its way out of trouble. But the fiscal austerity being offered as the “medicine” is turning out to be worse than the disease. It has exacerbated the downturn and unleashed a horrible debt deflation dynamic in all of the areas where it was reluctantly implemented.

‘Insolvent’ Portugal Needs Loans Soon, Buiter Says. Bloomberg.

“Despite the recent drama, we believe we have only seen the opening act, with the rest of the plot still evolving,” Buiter wrote. “Accessing external sources of funds will not mark the end of Ireland’s troubles. The reason is that, in our view, the consolidated Irish sovereign and Irish domestic financial system is de facto insolvent.”

Why the Irish crisis is such a huge test for the eurozone. Martin Wolf, FT.

So what, against this background, needs to be done by individual countries and the eurozone? Not what was done in Ireland, is one answer. The Irish banking system is worse than too big to fail; it is too big to save. The first duty of the state is to save itself, not to load its taxpayers with obligations to rescue careless lenders. If the eurozone is not a “transfer union”, that has to work both ways: taxpayers of one state should not rescue those of others from having to save their banks from their follies.

The Irish state should have saved itself by drastic restructuring of bank liabilities. Bank debt simply cannot be public debt. If bank debt is to be such debt, bankers should be viewed as civil servants and banks as government departments. Surely, creditors must take the hit, instead.

That leaves the sovereigns. What is needed here, as eurozone leaders recognise, is a combination of generous funding with restructuring: the former is to reverse self-fulfilling panics; the latter is to recognise the realities of insolvency. Managing this combination would be very tricky.

Endgame. Eurointelligence.

The EU’s credibility is sinking with each agreement. We are now fast approach default time... We at Eurointelligence consider a default of Greece, Ireland, and Portugal a done deal. The question is only now whether Spain can scrape through.

Can the eurozone afford its banks? Robert Peston, BBC.

For Europe's very biggest banks, the ratio of their assets to their equity capital is 50% greater than for the UK's banks and 100% in excess of the so-called leverage ratio of big US banks, according to Bank of England calculations. Or to put it another way, Europe's giant banks appear to be taking far bigger financial risks than US and UK banks in relation to the reserves they retain as protection against potential losses.

So here's the big question. O'Neill may well be right that a reformed, integrated eurozone could cope with the aggregated sovereign debts of its members. But it is altogether another question whether even Germany could afford to underwrite the liabilities of the eurozone's monster banks, if creditors started to seriously question whether those banks have sufficient capital.

If Ireland doesn't take the bailout. Gonzalo Lira.

the problem in Ireland really isn’t so much the state’s deficits—rather, it’s the state’s guarantees of the Irish banks. That is what led to this mess. Yes, the Irish public sector is bloated, but it’s the banks that are busting the fiscal budget.

The Irish government allowed the banks to grow too big for too long, and to get mixed up in too many dicey deals—and so when the crisis hit in 2008, instead of letting them fail, Brian Cowen and his Fiana Fáil government backstopped those banks.

Much like in the United States in 2008, the Irish confused an insolvency issue with a liquidity issue. They thought their banks were having a cash crunch, when really, they were broke.

Cowen is reaping what he sowed: Even if the 2008 crisis had been a cash crunch and not an insolvency issue, Cowen never should have backstopped those banks—not when their combined liabilities were twice the GDP of Ireland...

Right now, the Irish people know that they are footing the bill so that British, German and American banks don’t suffer for having been foolish enough to be caught with Irish bank bonds. Rightfully, the Irish people are pissed.

November 15

A PIGS 5-fer:
Europe stumbles blindly towards its 1931 moment. Ambrose Evans-Pritchard.
love this quote:

“This is a breath-taking mixture of suicidal irresponsibility and farcical incoherence”

which for some reason reminds me of Martin Luther King, Jr.'s quote:

"Nothing in all the world is more dangerous than a sincere ignorance and conscientious stupidity."

Sovereign default system makes sense. John Dizard, FT.

Within a month or so, the seize-up in the peripheral bond markets will lead to serious and immediate operating issues for the financial system. So the political leadership has no choice but to clarify how Europe will deal with sovereign default, and banking system insolvency.

Europe’s Monetary Cordon Sanitaire. Simon Johnson and Peter Boone, Project Syndicate.

Given the vulnerability of so many eurozone countries, it appears that Merkel does not understand the immediate implications of her plan. The Germans and other Europeans insist that they will provide new official financing to insolvent countries, thus keeping current bondholders whole, while simultaneously creating a new regime after 2013 under which all this debt could be easily restructured. But, as European Central Bank President Jean-Claude Trichet likes to point out, market participants are good at thinking backwards: if they can see where a Ponzi-type scheme ends, everything unravels.

Portuguese hint at euro exit as cost of debt soars and Greek debt crisis 'worse than ever'. both from the Independent.


Wow -- Check Out How Blatantly Our Government Misled Us With The October Jobs Numbers! Henry Blodget. NFP surprised to the upside because BLS changed its seasonal adjustment factor

Open letter to Ben Bernanke. WSJ. the authors of this letter lost all credibility once they included Malpass as a signatory! and (Dow 36,000) Kevin Hassett! And Michael Boskin (who blamed Obama in late 2009 for the stock market crash)!

other fare:
Obama to switch party. Michael Collins.

Euro Crisis Links

The difficult choices still facing Europe, Mohamed El-Erian, FT Alphaville.

The beneficial impact of last weekend’s $1 trillion “shock and awe” intervention by Europe to save Greece and safeguard the Euro is fading-even more quickly than officials had feared.

The Euro has weakened dramatically in the last few days. Sovereign risk spreads have started to widen again despite considerable (and noisy) buying by the European Central Bank (ECB). And equity markets have given up part of the dramatic gains that followed the policy announcements.

All of this is the result of two main factors: First, having analyzed the news out of Europe in depth, markets recognize that the liquidity-based approach cannot sustainably address what is at heart a solvency problem.... Second, markets are worried about the collateral damage and unintended consequences of the “shock and awe.” Most importantly, they dislike the extent to which the standing and integrity of the ECB are in the process of being sacrificed....

A key dynamic of the past few years-namely, the serial contamination of balance sheets-is hitting the reality of scarcity. Industrial countries are running out of balance sheets that can be levered safely in order to minimize the disruptive impact of past excesses....

Absent a significant change in the European policy mindset, officials will find themselves pulled even more into multi-round dynamics that support debt with more debt and, in the process, contaminate the good with the bad.

The Very Bad Luck of the Irish. Simon Johnson and Peter Boone at The Baseline Scenario.

With the European Central Bank announcing that it has bought more than $20 billion of mostly high-risk euro zone government debt in one week, its new strategy is crystal clear: We will take the risk from bank balance sheets and give it to the central bank, and we expect Portugal-Ireland-Italy-Greece-Spain to cut fiscal spending sharply and pull themselves out of this mess through austerity.

But the bank’s head, Jean-Claude Trichet, faces a potential major issue: the task assigned to the profligate nations could be impossible. Some of these nations may be stuck in a downward debt spiral that makes greater economic decline ever more likely....

There is no simple escape, but if the government hopes to avoid a sovereign default, the one overriding priority should be to stop bailing out the banks. Instead, the government should wind down existing banks in a “bad bank,” while moving their deposit base and profitable businesses into new, well-capitalized banks that can function without a taxpayer burden. This will be messy, but it is far better than a sovereign default.

Two Choices: Restructure Debts or Debase Currencies. John Hussman.

Presumably, the ECB hoped that the 750 billion euro figure would inspire shock and awe, but after a quick rally on Monday, the markets were neither shocked, nor durably awed, as investors began figuring out that the ECB was essentially promising to buy Euro-debt with Euro-debt, and to defend euros with euros.

In the end, as I've argued repeatedly over the years, monetary policy is only as good as fiscal policy. A central bank does not have wealth of its own. It is a zero-sum entity that can only enrich those from whom it purchases debt by debasing the relative wealth of people who hold the existing stock of currency. If a government insists on running deficits, engaging in wasteful spending, and dissipating public resources to bail out private bondholders, it has to find somebody willing to buy its
debt. If it does not, the central bank buys it, and dilutes the currency by doing so. The situation is particularly insidious when the central bank buys low-quality debt, because there is no taxing authority behind it to provide a basis for confidence in the currency.

The End of Fiscal Sovereignity in Europe. Michael Spence, Project Syndicate.

The eurozone’s immediate challenge is declining fiscal stability in a subset of countries whose credit ratings are falling and debt-service costs rising. Absent external assistance and a credible plan for restoring fiscal order, Greek sovereign debt could not be rolled over, forcing a default, probably in the form of a restructuring of Greek debt. Even with external assistance, many view default as a near certainty, because the arithmetic of restoring fiscal balance is so daunting.

Eurozone membership precludes inflation and devaluation as adjustment mechanisms. An alternative is domestic deflation combined with extreme fiscal tightening – that is, a period of slow or negative growth in wages, incomes, and some prices of non-traded goods. But deflation is painful and cannot realistically be pursued for political reasons....

If the EU wants a monetary union in which sovereign debt is relatively homogenous with respect to risk, fiscal discipline must be similarly homogenous. But that also means that it will need a more robust mechanism for countercyclical responses to
shocks.... That will involve a loss of full fiscal sovereignty, but facing up to that reality is required to sustain the monetary union.

But, as Martin Feldstein says in The Washington Post (For a solution to the euro crisis, look to the states):

There is now political consensus in Europe that new rules are needed to prevent large deficits, but there is no agreement on what should be done. The European Commission ... proposed last week that the national budgets of each country be examined by the others before they are approved.

It would clearly be anathema to the German government to have its spending and tax policies approved by France, let alone by Greece and Portugal.

I just don't see that changing.

Return to the abyss. Nouriel Roubini, Project Syndicate.

History ... suggests that financial crises tend to morph over time. Crises like those we have recently endured were initially driven by excessive debt and leverage among private-sector agents... This eventually led to a re-leveraging of the public sector as fiscal stimulus and socialization of private losses – bail-out programs – caused a dangerous rise in budget deficits and the stock of public debt.

While such fiscal stimulus and bailouts may have been necessary to prevent the Great Recession from turning into Great Depression II, piling public debt on top of private debt carries a high cost. Eventually those large deficits and debts need to be reduced through higher taxes and lower spending, and such austerity – necessary to avoid a fiscal crisis – tends to slow economic recovery in the short run. If fiscal imbalances are not addressed through spending cuts and revenue increases, only two options remain: inflation for countries that borrow in their own currency and can monetize their deficits; or default for countries that borrow in a foreign currency or can’t print their own.

Thus, the recent ... global financial crisis is not over; it has, instead, reached a new and more dangerous stage.... Governments that bailed out private firms now are in need of bailouts themselves. But what happens when the political willingness of Germany and other disciplined creditors – many now in emerging markets – to fund such bailouts fizzles? Who will then bail out governments that bailed out private banks...? Our global debt mechanics are looking increasingly like a Ponzi scheme.

Enough said.

Its not ABOUT the markets

I keep hearing from investment managers and dealer desks that Merkel and other politicians should just shut up; that their constant verbal commentary just creates more volatility and worsens the situation.

For instance, Merkel was quoted as saying "We need the financial industry to be honest with us. If we don't get honesty, then we might not do the right thing technically, but we will do the right thing politically."

I don't see anything wrong with those comments of hers. And any criticisms seem based on the premise that politicians should be worried about the markets. Or about banks. American politicians (as long as Geithner & co. are around) may still be inclined to cover-up the problems on TBTF banks' balance sheets and to safeguard those banks' self-interests, but that's been part of the problem for all too long. Its a very good thing that Europeans have a different perspective.

This is a good, constructive process that Europe is going through now; its necessary for their economies.... and its not about the markets.

And anyone who thinks this is just a European problem and shouldn't affect North American valuations likely have another thing coming. This is and always has been about too many people (& too many countries) living beyone their means, borrowing from the future, wracking up too much debt. When you keep borrowing from the future, ultimately the debt has to be paid. Time's up. The global economy has been too Ponzi-like for too long. And the fix won't be short, nor will it be isolated: the problems are systemic, so the solutions will have to be systemic too. And that means not isolated to Europe. Nor China. And that means N.Am. economies are not immune.

In fact, a case could be made that the Canadian economy is more bubblicious than any but China (and probably Australia) right now. Too many consumers living off their "home equity". Why is it we didn't learn anything from the experience of U.S. and European housing markets?! Why are Canadians so inclined to get further into debt to buy bigger houses at bigger prices?! (Did they not read U.S. newspapers/magazines in 2009?)


Despite the sell-off in recent weeks, stock markets remain overvalued. I continue to look for a sub-1000 S&P before reducing some of my hedges; will reduce more at 950 and again at 900 if we get there. Still think fair value is 850 or so, but willing to go to neutral from net short at the 900-level --- but will not go long stocks until at or under 850.

As for the economy, well, headline CPI may be at 2.2%, but core is under 1%, and the Cleveland Fed median CPI is at 0.5%; though the housing market had a nice winter (existing home sales are up about 16%YoY through March), we'll have to see how that evolves now that government inducements have wound up; meanwhile, jobless claims remain resolutely north of that key 400k level (latest at 471k); and delinquencies keep rising (and theres a whole lot of foreclosures in the pipeline and shadow inventory to deal with). As Rosenberg points out, there's some "Scary Math" involved here:

1 in every 10 American homeowners missed a mortgage payment in Q1 (a record)
1 in 6 Americans are either unemployed or underemployed
Over 4 in 10 unemployed Americans have been out of work for at least six months.
1 in 4 Americans with a mortgage have negative equity in their homes.
1 in 10 Americans believe their income will rise in the next six months.
1 in 5 Americans see business conditions improving in the next six months.
1 in 50 Americans plan to buy a home in the next six months.
1 in 8 Americans believe that current government policy is actually helping the economy.
1 in 10 American small businesses have a job opening.
1 in 10 American’s credit card usage is being written off (a record).
There are 5 unemployed workers competing for every job opening (hence downward pressure on wage growth).

Not a pretty list. Despite short-term (sub 1 year) cyclical movements, the mid-term and long-term prospects for the economy and therefore the markets remains down. Down for stock prices and down for government bond yields.


postscript (added May 21)

One of Merkel's other most notable recent comments was "First the banks failed, forcing states to carry out rescue operations. They plunged the global economy over the precipice and we had to launch recovery packages, which increased our debts, and now they are speculating against these debts. That is very treacherous. Governments must regain supremacy. It is a fight against the markets and I am determined to win this fight."

Jesse, from Jesse's Cafe Americain, like me, also approves:

I would that Obama and the Congress had half the courage of Merkel. And that commentators and the middle class would realize the sorry state that their economy is in, held hostage by a bunch of spoiled brats and well heeled thugs, and a government by and for the highest bidder.

"Gentlemen, I have had men watching you for a long time and I am convinced that you have used the funds of the Bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst yourselves, and when you lost, you charged it to the Bank... Beyond question this great and powerful institution has been actively engaged in attempting to influence the elections of the public officers by means of its money...You tell me that if I take the deposits from the Bank and annul its charter, I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin. Should I let you go on, you will ruin fifty thousand families, and that would be my sin. You are a den of vipers and thieves. I intend to rout you out, and by the grace of the Eternal God, I will rout you out."

Andrew Jackson on The Second Bank of the United States which was the Central Bank of his day. A dangerously simplistic view? More like common sense, and the plain spoken truth, at last.