Category Archives: ECB

European Debt/GDP ratios – the core issue

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Review:

Financially, the euro zone member nations have put themselves in the position of the US States.

Their spending is revenue constrained. They must tax or borrow to fund their spending.

The ECB is in the position of the Fed. They are not revenue constrained. Operationally, they spend by changing numbers on their own spread sheet.

Applicable history:

The US economy’s annual federal deficits of over 8% of gdp, Japan’s somewhere near there, and the euro zone is right up there as well.

And they are still far too restrictive as evidenced by the unemployment rates and excess capacity in general.

So why does the world require high levels of deficit spending to achieve fiscal neutrality?

It’s the deadly innocent fraud, ‘We need savings to have money for investment’ as outlined in non technical language in my book.

The problem is that no one of political consequence understands that monetary savings is nothing more than the accounting record of investment.

And, therefore, it’s investment that ’causes’ savings.

Not only don’t we need savings to fund investment, there is no such thing.

But all believe we do. And they also believe we need more investment to drive the economy (another misconception of causations, but that’s another story for another post).

So the US, Japan, and the euro zone has set up extensive savings incentives, which, for all practical purposes, function as taxes, serving to remove aggregate demand (spending power). These include tax advantaged pension funds, insurance and other corporate reserves, etc.

This means someone has to spend more than their income or the output doesn’t get sold, and it’s business that goes into debt funding unsold inventory. Unsold inventory kicks in a downward spiral, with business cutting back, jobs and incomes lost, lower sales, etc. until there is sufficient spending in excess of incomes to stabilize things.

This spending more than income has inevitably comes from automatic fiscal stabilizers- falling revenues and increased transfer payments due to the slowdown- that automatically cause govt to spend more than its income.

And so here we are:

The stabilization at the current output gap has largely come from the govt deficit going up due to the automatic stabilizers, though with a bit of help from proactive govt fiscal adjustments.

Note that low interest rates, both near 0 short term rates and lower long rates helped down a bit by QE, have not done much to cause consumers and businesses to spend more than their incomes- borrow to spend- and support GDP through the credit expansion channel.

I’ve always explained why that always happened by pointing to the interest income channels. Lower rates shift income from savers to borrowers, and the economy is a net saver. So, overall, lower rates reduce interest income for the economy. The lower rates also tend to shift interest income from savers to banks, as net interest margins for lenders seem to widen as rates fall. Think of the economy as going to the bank for a loan. Interest rates are a bit lower which helps, but the economy’s income is down. Which is more important? All the bankers I’ve ever met will tell you the lower income is the more powerful influence.

Additionally, banks and other lenders are necessarily pro cyclical. During a slowdown with falling collateral values and falling incomes it’s only prudent to be more cautious. Banks do strive to make loans only to those who can pay them back, and investors do strive to make investments that will provide positive returns.

The only sector that can act counter cyclically without regard to its own ability to fund expenditures is the govt that issues the currency.

So what’s been happening over the last few decades?

The need for govt to tax less than it spends (spend more than its income) has been growing as income going to the likes of pension funds and corporate reserves has been growing beyond the ability of the private sector to expand its credit driven spending.

And most recently it’s taken extraordinary circumstances to drive private credit expansion sufficiently for full employment conditions.

For example, In the late 90’s it took the dot com boom with the funding of impossible business plans to bring unemployment briefly below 4%, until that credit expansion became unsustainable and collapsed, with a major assist from the automatic fiscal stabilizers acting to increase govt revenues and cut spending to the point of a large, financial equity draining budget surplus.

And then, after rate cuts did nothing, and the slowdown had caused the automatic fiscal stabilizers had driven the federal budget into deficit, the large Bush proactive fiscal adjustment in 2003 further increased the federal deficit and the economy began to modestly improve. Again, this got a big assist from an ill fated private sector credit expansion- the sub prime fraud- which again resulted in sufficient spending beyond incomes to bring unemployment down to more acceptable levels, though again all to briefly.

My point is that the ‘demand leakages’ from tax advantaged savings incentives have grown to the point where taxes need to be lot lower relative to govt spending than anyone seems to understand.

And so the only way we get anywhere near a good economy is with a dot com boom or a sub prime fraud boom.

Never with sound, proactive policy.

Especially now.

For the US and Japan, the door is open for taxes to be that much lower for a given size govt. Unfortunately, however, the politicians and mainstream economists believe otherwise.

They believe the federal deficits are too large, posing risks they can’t specifically articulate when pressed, though they are rarely pressed by the media who believe same.

The euro zone, however has that and much larger issues as well.

The problem is the deficits from the automatic stabilizers are at the member nation level, and therefore they do result in member nation insolvency.

In other words, the demand leakages (pension fund contributions, etc.) require offsetting deficit spending that’s beyond the capabilities of the national govts to deficit spend.

The only possible answer (as I’ve discussed in previous writings, and gotten ridiculed for on CNBC) is for the ECB to directly or indirectly ‘write the check’ as has been happening with the ECB buying of member nation debt in the secondary markets.

But this is done only ‘kicking and screaming’ and not as a matter of understanding that this is a matter of sound fiscal policy.

So while the ECB’s buying is ongoing, so are the noises to somehow ‘exit’ this policy.

I don’t think there is an exit to this policy without replacing it with some other avenue for the required ECB check writing, including my continuing alternative proposals for ECB distributions, etc.

The other, non ECB funding proposals could buy some time but ultimately don’t work. Bringing in the IMF is particularly curious, as the IMF’s euros come from the euro members themselves, as do the euro from the other funding schemes. All that the core member nations funding the periphery does is amplify the solvency issues of the core, which are just as much in ponzi (dependent on further borrowing to pay off debt) as all the rest.

So what we are seeing in the euro zone is a continued muddling through with banks and govts in trouble, deposit insurance and member govts kept credible only by the ECB continuing to support funding of both banks and the national govts, and a highly deflationary policy of ECB imposed ‘fiscal responsibility’ that’s keeping a lid on real economic growth.

The system will not collapse as long as the ECB keeps supporting it, and as they have taken control of national govt finances with their imposed ‘terms and conditions’ they are also responsible for the outcomes.

This means the ECB is unlikely to pull support because doing so would be punishing itself for the outcomes of its own imposed policies.

Is the euro going up or down?

Many cross currents, as is often the case. My conviction is low at the moment, but that could change with events.

The euro policies continue to be deflationary, as ECB purchases are not yet funding expanded member nation spending. But this will happen when the austerity measures cause deficits to rise rather than fall. But for now the ECB imposed terms and conditions are keeping a lid on national govt spending.

The US is going through its own deflationary process, as fiscal is tightening slowly with the modest GDP growth. Also the mistaken presumption that QE is somehow inflationary and weakens the currency has resulted in selling of the dollar for the wrong reasons, which seems to be reversing.

China is dealing with its internal inflation which can reverse capital flows and result in a reduction of buying both dollars and euro. It can also lead to lower demand for commodities and lower prices, which probably helps the dollar more than the euro. And a slowing China can mean reduced imports from Germany which would hurt the euro some.

Japan is the only nation looking at fiscal expansion, however modest. It’s also sold yen to buy dollars, which helps the dollar more than the euro.

The UK seems to be tightening fiscal more rapidly than even the euro zone or the US, helping sterling to over perform medium term.

All considered, looks to me like dollar strength vs most currencies, perhaps less so vs the euro than vs the yen or commodity currencies. But again, not much conviction at the moment, beyond liking short UK cds vs long Germany cds….

Happy turkey!

(Next year in Istanbul, to see where it all started…)

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Ireland Seeks Rescue for Banks as EU Struggles to Stem

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Letting the banks fail would have been a highly deflationary event, that presumably has been discounted to some degree by markets. This would include depreciation of Irish bank financial assets, etc.

This helps remove that deflationary risk, and in that sense is ‘inflationary’ in that it works against those deflationary forces.

Also, as you pointed out, there is as yet no new austerity required for this package.

Also reinforced is the notion that any member nation can have a banking crisis that’s too big for it to support.

This further reinforces the notion that the entire euro zone is ultimately supportable only by the ECB.

In any case, it looks like the will is still there to keep the euro zone muddling through at some minimal degree above crisis level, whatever the cost.

Ireland Becomes Second Euro Nation to Seek Aid

By Joe Brennan and Dara Doyle

November 22 (Bloomberg) — Ireland became the second euro country to seek a rescue as the cost of saving its banks threatened a rerun of the Greek debt crisis that destabilized the currency. The euro rose and European bond risk fell.

A package that Goldman Sachs Group Inc. estimates may total 95 billion euros ($130 billion) failed to damp speculation that Portugal and Spain would need to tap the emergency fund set up by the European Union and International Monetary Fund after the Greece rescue. Moody’s Investors Service said a “ multi-notch” downgrade in Ireland’s Aa2 credit rating was “most likely.”

“Speculative actions against Portugal and Spain are not justified, though it can’t be excluded,” Luxembourg Prime Minister Jean-Claude Juncker said today on RTL Luxembourg radio. “In a moment where financial markets have an excessive tendency to punish those countries that didn’t stick 100 percent to an orthodox consolidation, one can never exclude that similar things will happen.”

The aid, which Irish officials said as recently as Nov. 15 they didn’t need, marks the latest blow to an economy that more than doubled in the decade ending in 2006. The bursting of the real-estate bubble in 2008 plunged the country into a recession and brought its banks close to collapse. With Irish bond yields near a record high, policy makers are trying to keep the crisis from spreading.

Threat to Euro

“Clearly because of the size of their loan books, the huge risks they took, they became a threat not only to the state but to the” entire euro region, Lenihan told Dublin-based RTE radio in an interview today. “The banks will be downsized to the real needs of the Irish economy” to “Irish consumers and Irish businesses. That has to be the primary focus of Irish banks.”

Ireland will channel some aid to lenders via a “contingent” capital fund, Finance Minister Brian Lenihan said.

The euro rose 0.5 percent to $1.3740 at 10:30 a.m. in London. Irish 10-year notes rose, sending the yield down 24 basis points to 8.11 percent. Ireland led a decline in the cost of insuring against default on European debt, according to traders of credit-default swaps. Contracts on Irish government bonds dropped 28.5 basis points to 478.5, the lowest level since Oct. 29, according to data provider CMA in London.

“Ireland had no choice,” said Nicholas Stamenkovic, a fixed-income strategist in Edinburgh at RIA Capital Markets Ltd., a broker for money managers. “The market will still be waiting for the details of the assistance and the conditionality, but there should be a relief rally.”

U.K., Sweden

The U.K. and Sweden may contribute bilateral loans, the EU said in a statement. Lenihan declined to say how big the package will be, saying that it will be less than 100 billion euros. Goldman Sachs Chief European Economist Erik Nielsen said yesterday the government needs 65 billion euros to fund itself for the next three years and 30 billion euros for the banks.

Talks will focus on the government’s deficit cutting plans and restructuring the banking system, the EU said in a statement. Irish Prime Minister Brian Cowen, who spoke at the same press briefing as Lenihan, said the banks will be stress tested. Ireland nationalized Anglo Irish Bank Corp. in 2009 and is preparing to take a majority stake in Allied Irish Banks Plc, the second-largest bank.

Lenihan and Cowen appeared minutes after finance chiefs issued a statement endorsing an aid request to calm markets. Allied Irish emphasized the fragility of the system on Nov. 19, reporting a 17 percent decline in deposits this year.

Stabilizing Situation

“In the short term, it will stabilize the situation, there’s no doubt about that,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc in London, who estimates a package of between 80 billion euros and 100 billion euros. “But as we’ve seen in the case of Greece, uncertainty will remain.”

The package for Ireland will total as much as 60 percent of gross domestic product, compared with 47 percent for Greece.

Cowen plans to announce the government’s four-year budget plan this week and said an agreement with the EU and the IMF will come “in the next few weeks.” Cowen also faces an election in Donegal in northwest Ireland on Nov. 25 to fill a vacant parliamentary seat. The vote threatens to erode Cowen’s majority. He has the support of 82 lawmakers, including independents, compared with 79 for the combined opposition.

The bailout follows two years of budget cuts that failed to restore market confidence as the cost of shoring up the financial industry soared.

Merkel’s Trigger

Lenihan cancelled bond auctions for October and November and announced 6 billion euros of austerity measures for 2011 on Nov. 4 in a bid to restore investor confidence. Those efforts failed after German Chancellor Angela Merkel triggered an investor exodus by saying bondholders should foot some of the bill in any future bailout.

The risk premium on Ireland’s 10-year debt over German bunds, Europe’s benchmark, fell to 523 basis points today. It widened to a record 652 basis points on Nov. 11, with the yield reaching a record 9.1 percent. In 2007, it cost Ireland less than Germany to borrow. Its 10-year spread then fell to as low as 77 basis points less than bunds. The ISEQ stock index has plunged 70 percent from its record in 2007.

Ireland will draw on the 750-billion-euro fund set up by the EU and IMF in May as part of the Greek bailout to protect the currency shared by 16 countries.

Irish Reversal

Irish officials initially resisted pressure from the EU to take any aid, saying they were fully funded until the middle of 2011. European leaders sought to head off contagion from Ireland and reduce pressure on the European Central Bank to prop up the country’s lenders by providing them with unlimited liquidity.

Cowen defended his reversal on the need for aid. “I don’t accept I’m the bogeyman,” he said. “Now circumstances have changed, we’ve changed our policies.”

Yields on bonds of Spain and Portugal have jumped amid concern that fallout from Ireland would spread. The extra yield that investors demand to hold Portuguese 10-year bonds instead of German bunds climbed to a record 484 basis points on Nov. 11.

“It probably won’t halt contagion. The sovereign crisis isn’t yet over,” said Sylvain Broyer, chief euro-region economist at Natixis in Frankfurt. “Ireland is in the middle of a difficult crisis.”

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A failure of theory and practice- comments on Fed Chairman Bernanke’s speech

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Emerging from the Crisis: Where Do We Stand?

Chairman Ben S. Bernanke

November 19, 2010

The last time I was here at the European Central Bank (ECB), almost exactly two years ago, I sat on a distinguished panel much like this one to help mark the 10th anniversary of the euro. Even as we celebrated the remarkable achievements of the founders of the common currency, however, the global economy stood near the precipice. Financial markets were volatile and illiquid, and the viability of some of the world’s leading financial institutions had been called into question. With asset prices falling and the flow of credit to the nonfinancial sector constricted, most of the world’s economies had entered what would prove to be a sharp and protracted economic downturn.

By the time of that meeting, the world’s central banks had already taken significant steps to stabilize financial markets and to mitigate the worst effects of the recession, and they would go on to do much more. Very broadly, the responses of central banks to the crisis fell into two classes. First, central banks undertook a range of initiatives to restore normal functioning to financial markets and to strengthen the banking system. They expanded existing lending facilities and created new facilities to provide liquidity to the financial sector. Key examples include the ECB’s one-year long-term refinancing operations, the Federal Reserve’s auctions of discount window credit (via the Term Auction Facility), and the Bank of Japan’s more recent extension of its liquidity supply operations.

He still doesn’t understand that the obvious move is to lend unsecured to member banks in unlimited quantities. The liability side of banking is not the place for market discipline; it’s the asset/capital side.

To help satisfy banks’ funding needs in multiple currencies, central banks established liquidity swap lines that allowed them to draw each other’s currencies and lend those funds to financial institutions in their jurisdictions; the Federal Reserve ultimately established swap lines with 14 other central banks.

He still doesn’t realize what the fed did was to lend approx $600 billion unsecured to foreign governments, for the sole purpose of bringing down LIBOR settings, and that there are far more sensible ways to bring down LIBOR settings. Nor has he realized the public purpose behind prohibiting us banks from using LIBOR in the first place.

Central banks also worked to stabilize financial markets that were important conduits of credit to the nonfinancial sector. For example, the Federal Reserve launched facilities to help stabilize the commercial paper market and the market for asset-backed securities, through which flow much of the funding for student, auto, credit card, and small business loans as well as for commercial mortgages.

Nor has the fed understood how to utilize its member banks, which are public private partnerships, to further public purpose. Rather than buy the collateral in question for its own portfolio, the Fed could have empowered its member banks to do it by such means as, for example, allowing them to put that specific collateral in segregated accounts where the fed would cover losses. This is functionally identical to the fed buying for its own account, but without the costly need for the fed itself to establish trading desks, back office operations, and other associated support structure.

In addition, the Federal Reserve, the ECB, the Bank of England, the Swiss National Bank, and other central banks played important roles in stabilizing and strengthening their respective banking systems. In particular, central banks helped develop and oversee stress tests that assessed banks’ vulnerabilities and capital needs. These tests proved instrumental in reducing investors’ uncertainty about banks’ assets and prospective losses, bolstering confidence in the banking system, and facilitating banks’ raising of private capital.

They did this entirely because they were concerned about the banks’ ability to fund themselves, which again misses the point of the liability side of banking not being the place for market discipline. Again, the right move was to lend fed funds to the banks in unlimited quantities on an unsecured basis.

Central banks are also playing an important ongoing role in the development of new international capital and liquidity standards for the banking system that will help protect against future crises.

Again, misses the purpose of capital requirements, which is the pricing of risk. Risk itself is controlled by regulation and supervision.

Second, beyond necessary measures to stabilize financial markets and banking systems, central banks moved proactively to ease monetary policy to help support their economies. Initially, monetary policy was eased through the conventional means of cuts in short-term policy rates, including a coordinated rate cut in October 2008 by the Federal Reserve, the ECB, and other leading central banks. However, as policy rates approached the zero lower bound, central banks eased policy by additional means. For example, some central banks, including the Federal Reserve, sought to reduce longer-term interest rates by communicating that policy rates were likely to remain low for some time. A prominent example of the use of central bank communication to further ease policy was the Bank of Canada’s conditional commitment to keep rates near zero until the end of the second quarter of 2010.1 To provide additional monetary accommodation, several central banks–among them the Federal Reserve, the Bank of England, the ECB, and the Bank of Japan–purchased significant quantities of financial assets, including government debt, mortgage-backed securities, or covered bonds, depending on the central bank. Asset purchases seem to have been effective in easing financial conditions; for example, the evidence suggests that such purchases significantly lowered longer-term interest rates in both the United States and the United Kingdom.2

Yes, with little or no econometric evidence that lower rates added to aggregate demand. Nor is there any discussion of this controversy.

In fact, it looks to me like lower rates more likely reduced aggregate demand through the interest income channels, and continues to do so.

Although the efforts of central banks to stabilize the financial system and provide monetary accommodation helped set the stage for recovery, economic growth rates in the advanced economies have been relatively weak. Of course, the economic outlook varies importantly by country and region, and the policy responses to these developments among central banks have differed accordingly. In the United States, we have seen a slowing of the pace of expansion since earlier this year. The unemployment rate has remained close to 10 percent since mid-2009, with a substantial fraction of the unemployed out of work for six months or longer. Moreover, inflation has been declining and is currently quite low, with measures of underlying inflation running close to 1 percent. Although we project that economic growth will pick up and unemployment decline somewhat in the coming year, progress thus far has been disappointingly slow.

Yes, the Fed continues to fail to deliver on both of its dual mandates.

In this environment, the Federal Open Market Committee (FOMC) judged that additional monetary policy accommodation was needed to support the economic recovery and help ensure that inflation, over time, is at desired levels.

That is, they were concerned about falling into deflation.

Accordingly, the FOMC announced earlier this month its intention to purchase an additional $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee also will maintain its current policy of reinvesting principal payments from its securities holdings in longer-term Treasury securities. Financial conditions eased notably in anticipation of the Committee’s announcement, suggesting that this policy will be effective in promoting recovery. As has been the case with more conventional monetary policy in the past, this policy action will be regularly reviewed in light of the evolving economic outlook and the Committee’s assessment of the effects of its policies on the economy.

Note that comments from FOMC members have repeatedly shown they lack a fundamental understanding of actual monetary operations, and are promoting policy accordingly

I draw several lessons from our collective experience in dealing with the crisis. (My list is by no means exhaustive.) The first lesson is that, in a world in which the consequences of financial crises can be devastating, fostering financial stability is a critical part of overall macroeconomic management. Accordingly, central banks and other financial regulators must be vigilant in monitoring financial markets and institutions for threats to systemic stability and diligent in taking steps to address such threats. Supervision of individual financial institutions, macroprudential monitoring, and monetary policy are mutually reinforcing undertakings, with active involvement in one sphere providing crucial information and expertise for the others. Indeed, at the Federal Reserve, we have restructured our financial supervisory functions so that staff members with expertise in a range of areas–including economics, financial markets, and supervision–work closely together in evaluating potential risks.

Systemic liquidity risk comes from the fed not realizing it should always be offering fed funds at its target rate in unlimited quantities.

That limits risks to bank shareholders (and unsecured debt which is functionally part of the capital structure), and to the FDIC/taxpayers where it has failed to adequately regulate and supervise and losses exceed private equity.

Second, the past two years have demonstrated the value of policy flexibility and openness to new approaches. During the crisis, central banks were creative and innovative, developing programs that played a significant role in easing financial stress and supporting economic activity. As the global financial system and national economies become increasingly complex and interdependent, novel policy challenges will continue to require innovative policy responses.

Unfortunately, it also demonstrated the consequences of not understanding monetary operations and bank fundamentals. For example, there was and continues to be a complete failure to recognize that the treasury buying bank capital under tarp was functionally nothing more than regulatory forbearance, and not an ‘expenditure of tax payer money’

Third, as was the focus of my remarks two years ago, in addressing financial crises, international cooperation can be very helpful; indeed, given the global integration of financial markets, such cooperation is essential.

It is not. This is another example of failure to understand banking fundamentals and monetary operations. The US is best served by independent banking law, regulation, and supervision.

Central bankers worked closely together throughout the crisis and continue to do so. Our frequent contact, whether in bilateral discussions or in international meetings, permits us to share our thinking, compare analyses, and stay informed of developments around the world. It also enables us to move quickly when shared problems call for swift joint responses, such as the coordinated rate cuts and the creation of liquidity swap lines during the crisis. These actions and others we’ve taken over the past few years underscore our resolve to work together to address our common economic challenges.

Sadly, it’s the blind leading the blind, and we all continue to pay the price.

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risk off Friday

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Looks like a big ‘risk off’ day coming up.

The authorities are embodying uncertainty at a time when it’s ‘their move’

Where things go is not about market forces, but about what politicians and their appointees do next.

The competence of the G20 is looking much like that of the FOMC, and it’s not a pretty sight.

We can do nothing but ‘wait and see.’

For example, will they or won’t the fund the euro members?
The mixed message is both no, and they will do what it takes to ensure solvency.
And taxpayers don’t want to pay for it, whatever that means.

And the same time the US authorities are being exposed as, to be kind, being on the sidelines.

President Obama has both nothing of substance to add to the debate, either in the euro zone or domestically.

The Fed itself said QE does nothing but modestly lower rates (Bernanke speech, Carpenter paper) which hopefully boosts asset prices which hopefully adds to aggregate demand. Hasn’t worked in Japan, (even with the net exports we also aspire to) but hopefully here. And skeptical markets that fear the Fed is engaged in ‘irresponsible money printing’ are coming around to the reality.

The sustainability commission has reported and recommended ways to reduce the deficit and ensure unemployment rises and our standard of living falls.

The theme continues- by fearing we are the next Greece, we are turning ourselves into the next Japan. Including burdening ourselves with an export driven economy.

So on an otherwise quiet post holiday Friday I look for a risk off rush to the sidelines, and a continuation of illiquidity in general.

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John Taylor (Mr Hedge Fubd FX — not Mr. Hoover Institute Economist :))

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The highlighted part is what I was getting at previously.
The idea that QE does nothing is now reasonably well distributed.
Those holding positions include a lot of managers who highly suspect QE does nothing.
But they believe others who do believe QE is ‘inflationary money printing’ will keep driving prices.

Same with austerity. The idea that it makes things worse is taking hold, but those who believe it is a good thing- that govt borrowing takes away money from the private sector and all that nonsense- still have the upper hand.

But ‘reality’ is working against those out of paradigm, as the dollar is firming and the rest showing signs of coming apart as well.

As for Europe, it all holds as long as the ECB keeps buying bonds in the secondary market in sufficient size to keep shorter term yields reasonable. And comes apart when they don’t.

The problem is politically it isn’t ‘fair’ to spend euro resources on targeted nations, which carries with it the notion that all the others are ultimately paying for it, though they don’t know exactly how that will play out. So you see the core addressing that with loud noises of restructuring, etc. which may or may not happen. But the real possibility is there.

My proposal of the ECB making per capita distributions to all the member nations of, say 10% of GDP in the first round, would not carry that notion of ‘unfairness’

And as long as member nation spending was appropriately constrained politically there would be no inflation or monetary ramifications, apart from better credit ratings and the ability to fund existing deficits at lower risk premiums.

But it’s still not even a consideration, best I can tell.

Fasten Your Seatbelt
November 11, 2010
By John R. Taylor, Jr.
Chief Investment Officer, FX Concepts

‘… Although the world believes that QE2 is there to push the dollar sharply lower, Bernanke argued that his goal was something else. On the day after the Fed’s move, he wrote in a Washington Post editorial piece that QE2 would push up the equity market, bonds, and other risky securities thereby stimulating consumption and economic activity. Even Greenspan did not publicly proclaim his “put,” but now Bernanke has made it the centerpiece of US strategy. Equities are already overpriced, with profit margins at all-time highs and PE ratios far above average. Speculation is now more American than apple pie – but this is a very risky time to practice it. As one highly respected analyst noted about Bernanke’s article, “these are undoubtedly among the most ignorant remarks ever made by a central banker.” As we and many others have noted that QE has shown little or no positive impact on actual economic activity, so the Fed has taken a big gamble, and if it fails as we expect it will have nowhere else to go. With the Republican victory tainted by the Tea Party “starve the beast” mentality, austerity has come to Washington. This next year will be a terrible one for the world’s biggest economy, so we would go against Bernanke on the equity side, but buy government bonds along with him…’

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France Joins Germany Ganging Up on Bondholders

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It does look like they are trying to cause markets to discount a very high probability of restructuring.

Any restructuring losses are reductions in financial assets and ultimately deflationary, as former bond holders
have less spending power. Unless the restructuring somehow results in more govt spending on goods and services, which, in this case, it clearly won’t. In fact, it will most likely be followed with additional austerity.

So looks like another whipsaw for the euro- down as people flee the currency over fears of losses due to restructuring
as well as fears of officials willing to restructure doing some other unknown thing that could cause losses, followed by a strong currency once it’s sorted out and considered ‘safe’ from default risk.

France Joins Germany Ganging Up on Bondholders to Share Pain

By Mark Deen and Francine Lacqua

November 11 (Bloomberg) — French Finance Minister Christine Lagarde said investors must share the cost of sovereign debt restructurings, backing a German call that helped send yields on Irish and Portuguese bonds to record highs.

“All stakeholders must participate in the gains and losses of any particular situation,” Lagarde said during an interview yesterday in Paris for Bloomberg Television’s “On the Move” with Francine Lacqua. “There are many, many ways to address this point of principle.”

Irish 10-year bonds dropped for a 13th day, driving the yield up 19 basis points to 8.95 percent and the risk premium over benchmark German 10-year bunds to a record 652 basis points. Ten-year Portuguese yields rose 9 basis points to 7.27 percent, while Greek and Spanish bond yields also climbed.

Lagarde’s comments mark France’s most explicit backing of German proposals to make bondholders contribute in bailouts, which deepened the slump in bonds of the so-called euro peripherals. Risk premiums that investors demand to buy their debt have risen since an Oct. 29 European Union summit when German Chancellor Angela Merkel sparred with European Central Bank President Jean-Claude Trichet over forcing bondholders to take losses in restructurings, so-called haircuts.

“We do have differing approaches,” Merkel told reporters after the summit.

The clash continued during the past two weeks, pummeling European bond markets.

‘Nail in the Coffin’

“Lagarde’s comments mentioned restructuring, and that’s another nail in the coffin” for peripheral debt, said Steven Major, global head of fixed-income research at HSBC Holdings Plc in London. “There’s still a big constituency of investors and traders who have not recognized until now that restructuring could happen.”

The spread between yields of Irish 10-year bonds and German bunds has widened more than 200 basis points since Merkel began her push for burden sharing.

German officials are sticking to their guns amid the bond market rout.

“We do also need creditors to be involved in the costs of restructuring,” Merkel said today in Seoul, where she’s attending a summit of the Group of 20 leaders. “There may be a conflict here between the interests of the financial world and the interests of politicians. We can’t constantly explain to our voters that taxpayers have to be on the hook for certain risks, rather than those who make a lot of money taking those risks. I ask the markets sometimes to bear politicians in mind, too.”

Trichet’s Stance

Trichet says such talk risks exacerbating the situation for indebted nations as they struggle to cut their budget deficits.

“The more you talk about restructuring debt, the harder it is to obtain debt,” Irish Finance Minister Brian Lenihan said Nov. 2. “That is the reality.”

“They are making it more likely that countries like Ireland and Portugal will be forced to restructure their debt,” said John Stopford, head of fixed income at London-based Investec Asset Management Ltd., which oversees $65 billion. “There should potentially be some conditionalities, otherwise it will become a self-fulfilling prophecy.”

The cost of insuring Irish debt gained 20 basis points to a record 617 basis points, according to data provider CMA. Credit default swaps for Portugal added 17 basis points to 494. Fallout from the slump in Ireland and Portugal pushed up the default risk on Spanish debt 12 basis points to 289.

Irish and Portuguese debt has suffered the biggest declines this month among the world’s government bonds. Ireland has dropped 8.6 percent since the Oct. 29 EU summit and Portuguese bonds have shed 5.9 percent.

Portugal Bid

Portuguese Finance Minister Fernando Teixeira dos Santos urged the EU yesterday to clarify how the so-called crisis mechanism will operate.

EU leaders plan to map out by December how a permanent bailout facility might work, and also study how to treat private bondholders and whether to involve the International Monetary Fund. The new system would kick in when temporary measures, set up this year to rescue Greece and protect the euro, expire in 2013.

“We have to make an appeal at the European level for the European institutions to rapidly, with the greatest possible urgency, clarify the terms in which this mechanism will function,” Teixeira dos Santos told reporters in Lisbon.

Lagarde cited several ways in which investors would share the losses in a bond scheduling with taxpayers.

“I’m not specially focused on haircuts,” she said. “We can insist on having in any issuance and in any agreements a collective action clause under which any lender agrees that if something goes wrong, the lender will actually participate in the plan that will solve the difficulty, in the same way that you can have rescheduling over time.”

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Consumer Borrowing Posts Rare Gain in September

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This is how it all starts.
The $10.1 billion gain in non revolving is the key.
That, along with housing, is the borrowing to spend the drives consumer credit expansions.
And the ongoing federal deficit spending continues to add to savings via less credit card debt that’s generally used for current consumption.

It’s only one month, and the series has volatility, but it does fit with the financial burdens ratios.

Without the external risks, the Obama boom that began in Jan 09 (before he added a bit with his fiscal package) looks intact and ready to accelerate.

Unfortunately there are risks.

Taxes are scheduled to go up at year end if gridlock isn’t broken. And even if they do extend the current tax structure, it’s not a tax cut, just not an increase.
Congress is bent on ‘paying for’ everything and proactively reducing the federal deficit, one way or another, including paying for not letting taxes rise should that happen.
The sustainability report is due Dec 1 which could further scare everyone into more proactive deficit reduction.

This kind of stuff. There are probably enough votes for the balanced budget constitutional amendment to pass Congress:

Sen.-elect Paul: GOP must consider military cuts

November 7 (AP) — Republican Sen.-elect Rand Paul says GOP lawmakers must be open to cutting military spending as Congress tries to reduce government spending.

The tea party favorite from Kentucky says compromise with Democrats over where to cut spending must include the military as well as social programs. Paul says all government spending must be “on the table.”

Paul tells ABC’s “This Week” that he supports a constitutional amendment calling for a balanced budget.

The rising crude oil price is like a tax hike for us.

The $US could head north in a ‘hey, QE doesn’t in fact weaken the dollar and we’re all caught short with no newly printed money to take us out of our trade’ rally, further fueled by the automatic fiscal tightening that comes with the modest GDP growth reducing spending via transfer payments and increasing tax revenues, making dollars ‘harder to get.’

Also an even modestly growing US economy does attract foreign direct investment as well as equity investors in a big way.
And, real US labor costs are low enough for us to be exporting cars- who would have thought we would have sunk this low!
On the other hand, higher crude prices does make $US ‘easier to get’ overseas and tend to weaken it fundamentally.
The falling dollar was supporting a good part of the latest equity rally- better foreign earnings translations, more exports, etc.- so a dollar reversal could create a set back for the same reasons.

China is looking at maybe 10% inflation, and their currency fix seems to be closer to ‘neutral’ as their fx holdings seem to have stabilized.

It’s possible their currency adjustment has come via internal inflation, and now the question could be whether and how they ‘fight’ their inflation. In the past inflation has been a regime changer, so political pressures are probably intense.

Euro zone austerity is resulting in ‘political imbalances’ as Germany sort of booms and the periphery suffers.
It’s all muddling through with high and rising over all unemployment, modest growth, and the ECB dictating terms and conditions for its support.

Conclusion- clear sailing, Obama boom intact, unless the ‘external’ risks kick in. The most immediate risk is a dollar rally, closely followed by fiscal tightening

Consumer Borrowing Posts Rare Gain in September

November 5 (AP) — Consumer borrowing increased in September for the first time since January even though the category that includes credit cards dropped for a record 25th straight month.

The Federal Reserve said Friday that consumer credit increased at an annual rate of $2.1 billion in September after having fallen at a rate of $4.9 billion in August. It was only the second increase in the past 20 months.
Americans have been reducing their borrowing for nearly two years as they try to repair their balance sheets in the wake of a steep recession and high unemployment.

For September, revolving credit, the category that includes credit cards, fell for a record 25th consecutive month, dropping by an annual rate of $8.3 billion, or 12.1 percent.

The category that includes student loans and auto loans, rose by $10.4 billion, or an annual rate of 7.9 percent.

The $2.1 billion rise in overall borrowing pushed consumer debt to a seasonally adjusted $2.4 trillion in September, down 2.9 percent from where consumer credit stood a year ago.

Analysts said that consumer credit is continuing to be constrained by all the problems facing households, including high unemployment and tighter lending standards on the part of banks struggling with high loan losses.

Households are borrowing less and saving more and that has acted as a drag on the overall economy by lowering consumer spending, which accounts for 70 percent of total economic activity.

The economy, as measured by the gross domestic product, grew at a lackluster annual rate of 2 percent in the July-September quarter, up only slightly from 1.7 percent GDP growth in the April-June period.

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European Output Growth Quickens More Than Estimated

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The core seems to be doing well by their standards, while the Greece and periphery GDP’s struggle, keeping overall unemployment just over 10%.

Overall deficits still high enough for modest overall growth.

Germany helped by exports to the other euro members, which means support of Greek and Irish finances which keeps them all solvent ‘helps’ Germany the most.

So Germans continue to work and export to the others who consume, as has been the post WWII case.

An outsider might call it a clever arrangement to extract war reparations, though wonder why the ‘winners’ continuously forgo untold trillions in lost output due to universal unemployment that dwarfs the benefits of receiving net German exports.

EU Headlines:

European Output Growth Quickens More Than Estimated

German VDMA Machine Orders Growth Slowed to 28% in September

German Machine Makers Say Strong Euro Hurts Competitiveness

Greece rules out restructuring its massive debts

Greece Could Extend Repayment of IMF Loans to 2021, Ta Nea Says

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