Tag Archives: politics

And So It Begins…

I asked people about a scenario like this unfolding two years ago and was looked at like I had three heads…

The financial calamity of the European Union’s sovereign debt woes has shaken the pillars of the postwar ideal of a united Europe. The debt crisis and the global downturn have left many European countries looking inward these days and viewing Brussels as increasingly irrelevant.

Germany, long a postwar champion and financier of European integration, is flexing its muscles more independently. And more of its citizens are questioning the country’s leading role in the European project.

On a recent day, Christian Gelleri buys a sandwich and a glass of Hefeweizen at a rustic, sun-filled outdoor beer garden along the Inn River in the Upper Bavarian town of Stefanskirchen.

But the 40-year-old isn’t paying with euros. The bar also accepts chiemgauer, the thriving local currency named after a region in Bavaria.

via From Stalwart To Skeptic, Germany Rethinks EU Role : NPR.

Me and my other two heads aren’t looking so out of place anymore, I gather…

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While Euro Libor Gently Weeps

In my mind there’s not much else to say about Libor in the Eurozone.  The charts do all the talking for me:

The curve is shifting out at a rapid pace, in a bear steepening fashion.  Looks like liquidity situation in Europe is getting worse, which keeps the Libor rates moving upward rapidly. And the Euro has followed suit:

This brings up an interesting point about the risk-on/risk-off trade: it depends on who you’re talking about.  For most people in the world, the risk-on trade is to hold anything except dollars.  Risk-off is to convert those holdings into dollars. For European banks, however, they have to convert everything back into Euros.  So with the removal of Euro-denominated liquidity facilities, “risk-off” takes on a different meaning.

Regardless, the funding squeeze continues…

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How Do You Say “Negative Basis” In Mandarin? We Might Need To Learn It

The decision by China to “enhance RMB flexibility” is big news.  I’m re-posting the announcement here (emphasis, yours truly’s):

In view of the recent economic situation and financial market developments at home and abroad, and the balance of payments (BOP) situation in China, the People´s Bank of China has decided to proceed further with reform of the RMB exchange rate regime and to enhance the RMB exchange rate flexibility.

Starting from July 21, 2005, China has moved into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. Since then, the reform of the RMB exchange rate regime has been making steady progress, producing the anticipated results and playing a positive role.

When the current round of international financial crisis was at its worst, the exchange rate of a number of sovereign currencies to the U.S. dollar depreciated by varying margins. The stability of the RMB exchange rate has played an important role in mitigating the crisis´ impact, contributing significantly to Asian and global recovery, and demonstrating China´s efforts in promoting global rebalancing.

The global economy is gradually recovering. The recovery and upturn of the Chinese economy has become more solid with the enhanced economic stability. It is desirable to proceed further with reform of the RMB exchange rate regime and increase the RMB exchange rate flexibility.

In further proceeding with reform of the RMB exchange rate regime, continued emphasis would be placed to reflecting market supply and demand with reference to a basket of currencies. The exchange rate floating bands will remain the same as previously announced in the inter-bank foreign exchange market.

China´s external trade is steadily becoming more balanced. The ratio of current account surplus to GDP, after a notable reduction in 2009, has been declining since the beginning of 2010. With the BOP account moving closer to equilibrium, the basis for large-scale appreciation of the RMB exchange rate does not exist. The People´s Bank of China will further enable market to play a fundamental role in resource allocation, promote a more balanced BOP account, maintain the RMB exchange rate basically stable at an adaptive and equilibrium level, and achieve the macroeconomic and financial stability in China.

via The People’s Bank of China–News.

I don’t know, maybe it’s just me.  But if I look up “Chinese real estate bubble” and get this many results, and see articles like this, this and this in the process, I don’t see that as a sign of stability.

And with data points like this from the Straits Times…

China posted a trade surplus of US$19.53 billion (S$27.54 billion) in May, compared with a trade surplus of US$1.68 billion in April and a deficit posted in March – the first in six years.

via China trade surplus soars.

It’s hard to see how equilibrium can be used to describe well, anything.  Volatility seems to be the watchword, in my view.

Then there’s this from Bloomberg Businessweek (emphasis mine, again):

June 18 (Bloomberg) — China’s finance ministry offered higher-than-expected yields at bond auctions today as a shortage of cash in the banking system damped demand for the 43.8 billion yuan ($6.4 billion) of notes it was selling to raise funds for local governments.

The 28.6 billion yuan of three-year notes sold drew bids for 1.02 times the amount offered and the 15.2 billion yuan of five-year debt was subscribed 1.06 times. The average ratio at previous treasury bond auctions this year was 1.7 times.

via China Sells 3-, 5-Year Debt at Higher-Than-Expected Yields – BusinessWeek.

A shortage of cash in the Chinese banking system?  The Bloomberg piece continues:

The seven-day repurchase rate, a measure of lending costs between banks, rose eight basis points to 2.68 percent, according to a daily fixing rate published by the National Interbank Funding Center. It’s averaged 2.6 percent this month, up from 1.9 percent in May.

A 70+ basis point move in a month?  That’s a lot in such a short time.  There’s a funding squeeze now in China to go along with the one in Europe.

Which leads me to one conclusion: this isn’t a Yuan appreciation story, but a Yuan depreciation story.  With real estate lending teetering and possible deflation in real estate assets, a Yuan appreciation will kill their internal economy and banks.  All at the same time China is getting ready to list quite possibly the biggest IPO ever?  This story can’t get any more tantalizing, can it?

Well, maybe.  If the Yuan depreciates, it won’t be because China is deliberately setting a peg or a managed float.  Because, as this piece from Bloomberg Businessweek points out:

June 21 (Bloomberg) — Chinese President Hu Jintao may have succeeded in removing the yuan’s valuation from debate at this week’s Group of 20 leaders’ summit, economists and political analysts say. How much time he’s bought depends on how flexible the currency will become.

via China’s Hu Buys Time With Yuan Announcement Before G-20 Summit – BusinessWeek.

If the enhanced flexibility means the Yuan goes lower, the Chinese would’ve pulled off a brilliant coup: a depreciating currency with little to no interference from the government.

But if it goes higher, we’ll add China to the list of countries that will be coping with deflation on top of the US, Europe, Japan and the Middle East (yes, they’re fighting it, which I’ll hopefully explain over the next few weeks).  But more importantly, China’s credit risk will increase as a result of such a scenario unfolding.  All while people keep talking about “rebalancing” as the needed outcome of this quagmire we’ve all found ourselves in.  If deflation starts to take hold in China, that would leave India, Australia, New Zealand, Russia and Brazil as the only countries with any real economic firepower left that aren’t dealing with the deflation phenomenon.

This is starting to look like a big, elaborate domino set-up to me…

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Domo Arigato, Governor Paterson: New York Is Turning Japanese

It’s official: New York state is turning itself into a Japanese prefecture.  Well, at least fiscally they are:

ALBANY — Gov. David A. Paterson and legislative leaders have tentatively agreed to allow the state and municipalities to borrow nearly $6 billion to help them make their required annual payments to the state pension fund.

And, in classic budgetary sleight-of-hand, they will borrow the money to make the payments to the pension fund — from the same pension fund.

via State Wants to Borrow From Pension Fund, to Pay the Fund – NYTimes.com.

Go ahead and read it again.  New York State might as well go to JP Morgan Chase, Bank of America, Citi, Wells Fargo, Barclays, Cap One, and a host of others and get credit cards from each of them, paying off the balance each month with a different credit card.  We all probably had friends that did this in college.  Maxing out the line, getting another credit card, and repeating the process all over again. And now we see that’s what municipal finance has turned to: a pathetic scheme most of us probably tried in college.

Indeed, the issue New York is grappling with is one that we’re going to read and hear more about: underfunded pensions.  Governments and businesses alike which have defined pension schemes are all facing challenges when you have more flowing out than you have flowing in.  Part of it is a demographic change.  Western countries have seen birth rates decline for the past couple of decades while the number of retirees is ballooning.  As a whole, we’re getting older, faster.

Japan is already having to face this:

But pension funds also have to deal with another issue: outflows. They are pensions after all, paying out defined cash amounts to beneficiaries after they’ve fulfilled years of service requirements, etc. to get it. The country is getting older, the birth rate is abysmal, and they have the one of the longest life expectancies on Earth. But don’t take my word for it, look up Japan from the CIA Factbook, which is a great source for info.

For a pension fund manager, this is a demographic nightmare. Long life expectancies lead to long cash payouts. More people getting older means more to pay out at each payout. The lack of younger workers means funds aren’t coming in for the pension fund manager to invest, which implies the fund is falling behind is underfunded. Because people age faster than money accrues interest.

via I Believe the Word is ‘Toki’ « Deep Thoughts by Professor Pinch.

Make no mistake about it: underfunded pensions are a serious problem.  Borrowing your way out of the problem won’t help.  Especially since this scheme will probably be a drag on asset returns one way or another.  The NY Times piece continues:

Another oddity of the plan is that the pension fund, which assumes its assets will earn 8 percent a year, would accept interest payments from the state that would probably be 4.5 percent to 5.5 percent.

A significant drag, indeed.

The focus then has to turn to how to deal with this from an risk/return perspective.  In my mind, it will only prompt more risk chasing, which may not be the best idea for a pension fund.

But meanwhile, it looks like the state government is having trouble calling a spade, well, a spade.  Again, from the article:

“We’re not borrowing,” said Robert Megna, the state budget director and one of the governor’s top advisers.

Mr. DiNapoli, the comptroller, said: “We would view it more as an extended-payment plan.”

Asked about the pension plan, Mr. Ravitch said, “Call it what you will, it’s taking money from future budgets to help solve this year’s budget.”

Messrs. Paterson, Ravitch and DiNapoli, your VIP suites at the Borgata are waiting…

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Buckle Up For Safety: Liquidity (Or Lack Thereof) In CDS

The issue of liquidity in CDS has been many people’s minds of late, myself included.  This piece from FT Alphaville, written by Gavan Nolan at Markit, is exceptional.  First, we have the ways market liquidity in CDS can be measured:

These are all important indicators in determining liquidity.  I, along with other folks, have talked about liquidity issues in the CDS arena before:

But isn’t the 83.7% of trading by dealers “real”? If there are only 6 firms in the United States controlling the credit derivatives market and slightly more than that internationally, how can that be “real”? Since CDS positions are a zero sum game, all dealers combined can only be net long what non-dealers are net short, and vice versa. Just as in the used car analogy, we care only about the trading by retail car buyers, not the movement of volume between dealers, who still need to sell whatever cars they buy en masse. Moreover, we want as many price points from retail car buyers as we can get, so we want the www.kbb.com Kelly Blue Book prices, not the prices from one dealer’s lot.

via Kamakura Blog – Kamakura Blog: Sovereign Credit Default Swaps and Lessons from Used Car Dealers.

My hope is that the data from Markit will begin to get at the heart of some of these issues.  It looks like it will because a bunch of that data will show market breadth and depth.  Which many folks believe to be shallower than a kiddie pool.

But there’s also some disturbing – but expected – trends we see taking shape:

However, if we look at the bid/ask spreads this week, we can see that they have widened dramatically. This is to be expected – the CDS spreads of all five countries have widened sharply. But the expansion of the bid/ask spreads outpaces the widening in CDS spreads.

via FT Alphaville » CDS liquidity update: Focus on European sovereigns.

Why?  Call this a consequence of the BaFin ban.  And I don’t think it was unintended.  Indeed, as the Alphaville piece continues:

It is also evident that there was a big jump in the bid/ask spreads on May 19. This was after the German regulator Bafin announced a ban on naked CDS referencing eurozone sovereigns. The move created some uncertainty in the market and appears to have led to a disruption in liquidity. Overall, the disproportionate widening in bid/ask spreads in recent weeks suggests that liquidity has fallen.

This is just more of the same government heavy handedness directed at symptoms instead of diseases.  Don’t like reading about CDS quotes screaming higher on a day-to-day basis?  Ban their use; that will sort it all out.

Right.

Because as I pointed out before, viewing CDS strictly as “insurance” is wrong:

Liquid credit indices are just like liquid stocks.  You can buy/sell them in size, and pay very little for the privilege.  Illiquid credit protection, however, is a whole other ballgame.  You can’t get in/out of positions easily even in good times and you’re going to pay through the nose to do it.  And if you try to do a trade in size?  Puhleeeze…

This also illustrates why it’s laughable to think CDS have anything to do with making the sovereign credit situation worse. These are synthetic shorts when you buy them. If they didn’t exist, there would only be one option: sell the cash bonds and watch the yields & spreads blow out even higher than where they are.

via On Goldman, Synthetic Longs & Shorts, and S_ _ _ Sandwiches « Deep Thoughts by Professor Pinch.

So what are we going to be in for?  Most likely, reduced liquidity in the market.

And with reduced market liquidity, we get things like this

Again…

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The OECD’s Demographic Problem (i.e. We’re Turning Japanese)

Y’know, we’ve all been talking about Europe’s fiscal challenges quite a bit, myself included.  The deficits.  The retirement ages.  The entitlements.  And all during what may be shaping up to be a pretty good Formula 1 season…

But I digress.  We’ve all seen the charts:

But this excellent post over at Edward Harrison’s Credit Writedowns blog written by Edward Hugh from A Fistful of Euros (I love that name.  Where’s Sergio Leone when you need him?) really hits at the bigger issue at work:

The backdrop to the whole debt issue is the underlying problem of rapidly rising elderly-dependency ratios (and increasing population median ages) across the developed economy world. Normally this means the imminent arrival of a wave of heavily underaccounted-for-liabilities which will produce a massive pressure on the underlying structural (rather than cyclical) deficits in the worst affected economies. The strange thing is that this development had in principle been long foreseen, and indeed formed part of the underlying raison d’être for drawing the 3% deficit/60% debt Maastricht line-in-the-sand. The other part was, of course, an attempt to stop spendthrift governments being spendthrift. As is now abundantly clear, in neither case can the Maastricht package be said to have worked, but the unfortunate historical accident is that we have come to realise this in the midst of the worst global economic crisis in over half a century (indeed arguably the second worst one ever, and – disturbingly – it is still far from being over).

via Much Ado About (Some Of) The Wrong Things – Credit Writedowns.

And here’s some compelling data which tells the story.  It’s from the CIA Factbook.  Let’s take population growth rate.  Here’s a snapshot of the top 20 countries in this category.  You’ll see I pulled up Greece as an example.  It came in 188th:

France ranked 152nd while Germany ranked 210th and its growth rate is actually negative. So Sarkozy has it really easy: put Germany’s money where his mouth is while there are fewer Germans to yell at him for doing so.

Let’s look at birth rate.  Here, Greece came in 206th:

France?  They were 162nd while Germany was 220th.  I should point out the CIA tracks this data for 233 countries.  So to be ranked so close to the bottom consistently in these categories is of some consequence.

Last but not least, here’s a look at death rates:

Yes a lot of the names are the same, but the fact is birth rates among the top 20 are about double of the death rate the top 20.  That means net-net, population is growing.

Which brings me to this chart:

A flat-lining labor force will happen in most of the developed world given its demographic characteristics, it’s just a matter of time.  The question is do we measure it in years or decades.  My guess is years.  Eventually the confluence of declining birth rates, rising average median ages and declining population growth rates (in total, including immigration) will take its toll.

So total debt may not be the metric we need to watch.  It may be debt per capita.  My sense is this will only increase and continue doing so until the OECD countries collectively wake up and realize unfunded liabilities, bloated entitlements and other government transfer schemes won’t work.  Not because there won’t be enough money, but there won’t be enough people to earn money.

But we have countries led by people who only grew up with government expansion post-World War II.  They don’t know any better.  The older folks?  Well they kind of pushed us in that direction as a reaction to the Great Depression.  Policy in the US became about establishing safety nets and transfer mechanisms.  And it worked…

Until now… those programs were all based on two premises: an expanding population and marginal increases in labor would produce expanding GDP.  I don’t think they ever envisioned a world where you’d see slack in a labor market.  But because of technological advances, we’re here.  Productivity can still increase even though we’ve had a persistently soft labor market.

But meanwhile, those unfunded obligations keep increasing because compounded interest doesn’t care a wit about population growth.

Restructuring is needed, to put it mildly…

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A Broken Currency, A Broken Continent, A Broken Concept

The first part is easy.  The euro, at this point, is a broken currency:

For the carry traders, it’s a chart of what the Bataan death march looks like.

Then, there’s this report, courtesy of the intrepid journalism of the Sunday Times:

The tension between Germany and France threatened to spill over at a Brussels summit last weekend when Merkel and Sarkozy had a furious row. According to observers, it ended with Sarkozy threatening to leave the euro.

“It was a stand-up argument,” an official told El Pais, the Spanish newspaper. Sarkozy, furious at Merkel’s reluctance to sign up to a safety net of €750 billion (£644 billion), was shouting and bawling at Merkel and smashed his fist on the table. “It was Sarkozy on steroids,” one witness said.

via ‘Mummy’ Merkel battered as Germans lose faith in EU – Times Online.

France and Germany, the two biggest countries and economies on the continent, having it out – literally – in Brussels.  It’s easy for Sarkozy to demand that Merkel put her money where his mouth is.  It’s her money.  And he doesn’t have to face a screaming, jeering chorus of anxious Germans who are deathly afraid of inflation, besides.

Then there’s the various tensions David Ignatius noted in his WaPo piece.  First, between the savers and spenders:

The problem with the European package is that it postpones problems rather than resolves them. It will delay Eurobond defaults another year or two, and it will add some fiscal discipline that could eventually make the 16 eurozone nations operate more like one economy.

But there’s nothing to address the deeper structural imbalances between high-saving northern Europe and the spendthrift “Club Med” countries of southern Europe that used the euro as a credit card. Basically, the north’s abundance created a low-interest Eurobond market that underpriced the risk of investments in the south.

via David Ignatius – European bailout only postpones day of reckoning.

Then of course, there’s the tension between governments and the people:

But the austerity measures have two big drawbacks, one economic and the other political. The economic problem is that imposing harsh budget cuts and other belt-tightening on the “Club Med” countries, while appealing to German workers, may not make sense when the European recovery is so fragile.

The trickier problem is building political support for the austerity measures that are coming. Looking at Greek rioters chanting about demon bankers and government ministers who threaten their pensions is a reminder that Europeans believe in the welfare state as a matter of social entitlement. A different social contract may need to be written, more in line with economic and demographic realities. But that won’t be any easier in Europe than in the United States.

This seems to be very much a conflict between the governors versus the governed, the haves versus the have-nots.

So suffice it to say, the EU model of a single currency to be used by many countries that have differing views on government, government spending, and as a result, differing credit risk profiles, doesn’t work.  Things may have been very different had the EU put the principles of fiscal conservatism ahead of the goal of getting the Euro-zone started on time, nixing requirements to restrict deficit spending  and other requirements all for the sake of achieving a timeline.

But now we see it was never going to work.  Not with flimsy governance, no enforcement of Maastricht Treaty rules and the like.

The bomb has already gone off.  Yet the Eurozone leadership is still trying to defuse it…

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