The Bundesbank says the ECB is out of line

Further proof that those in charge of the financial levers in Europe have little understanding of the consequences of their actions comes from the latest pronouncements by the president of the German Bundesbank. According to FT.com.

The president of Germany’s powerful Bundesbank has firmly rebuffed international demands for decisive intervention in the bond markets by the European Central Bank to combat the eurozone debt crisis, warning that such steps would add to instability by violating European law.
Bundesbank president Jens Weidmann told the Financial Times that only politicians could resolve the crisis, and he rejected the idea of using the ECB as “lender of last resort” to governments. He also criticised actions taken by eurozone governments as “inconsistent”, and warned that their plans to involve private sector banks in rescue plans for Greece could add to the eurozone’s woes. Such private sector involvement, he said, could undermine market confidence in the eurozone’s crisis-fighting tools such as the rescue fund, the European financial stability facility.

It’s hard to guess why Jens feels that he has to make the point (repeatedly) that the ECB is legally unable to take further action to drive down bond yields of euro-zone countries (perhaps he wants his old authority over German monetary policy back). He must know that the ECB is now the only solution to the euro-zone crisis, the only other possible outcome being the collapse of the euro. It can’t all be explained by Germany’s traditional anathema to money-printing and fear of hyperinflation (which is not a certainty even if the ECB did begin to monetise euro-zone debts on a massive scale). The US Fed has been doing exactly what Jens insists the ECB cannot do and there is no sign of runaway inflation in the US (in fact quite the opposite).

Unfortunately Europe has gone beyond a political problem, it’s too late for new governments or new austerity plans. The ECB is literally the line in the sand, but will it stand or will it let the euro experiment collapse?

The Greek referendum: the beginning of the end or just the end?

When the Greek PM George Papandreou announced that Greece would hold a referendum to decide whether or not to hand over its economic sovereignty to (principally) Germany and France, you can only imagine what the reaction would have been in Paris and Berlin (assuming of course they weren’t aware of Papandreou’s plans).

All the hard work of the most recent summit undone in less than three working days. Presumably Papandreou either feels confident that Greeks want to remain in the EU and keep the euro (which is presumably how the referendum question will be structured) or else he simply cannot bring it upon himself to cede away Greece’s economic sovereignty for the best part of the next 20 years. It’s possible too that he sees the referendum as a means to ending the violence and rioting by those protesting against the austerity measures demanded by the euro-zone leaders. Public tolerance and support for the demonstrations will fall away quickly if the country backs Papandreou’s decisions through the referendum.

For a particularly interesting view of the Greek and general euro situation, read Ambrose Evans-Pritchard’s recent column from The Telegraph.

Europe’s inspectors will henceforth establish an occupation office in Athens to ensure the “full implementation” of austerity policies, for as long as it takes. Greece has been stripped even of the pretence of sovereignty.

Stirring up some not-too distant feelings no doubt, but he makes a valid point in that Greece cannot repair itself without devaluing its currency (or unless Germany and France effectively write Greece a blank cheque, which isn’t going to happen). And the same applies to Portugal, Spain and Italy. Their only salvation lies in currency devaluation, which is not going to happen while they remain part of the euro.

Perhaps Papandreou has thought it through and has had enough. Perhaps he doesn’t want to be remembered as the man who surrendered Greece’s economic sovereignty (all of us, particularly politicians, give some thought to the legacy we leave behind) and reckons Greece’s interests in the long run would be best served by leaving the euro, accepting the short term pain and looking ahead to a restructured economy in ten years time? Perhaps a hard default and a severe but shorter recession is better than this death by a thousand cuts?

The euro solution: the wash-up

It’s been an eventful past few weeks, capped of course by the summit to end all summits last week, where euro-zone leaders unveiled the plan to solve the region’s financial crisis (again).

Perhaps it’s nasty to be too critical. This plan does contain many of the steps which markets wanted to see; principally a Greek bond haircut, a bank recapitalisation plan and the beefing up of the bailout fund, plus there’s another 130 billion euros for Greece. But as has been the case with previous solutions put forth by euro-zone leaders, the devil is in the details and it doesn’t look pretty.

The primary concern is the expansion of the bailout fund. Instead of contributing further cash to the fund (which might have justifiably impaired the credit rating of France and others), it will be ‘leveraged’ up to four or five times its present size (implying an increase in its capacity to around 1 trillion euros), and will be used to provide insurance for new bonds issued by struggling euro-zone economies. The obvious question is: what about the existing bonds? If any new bonds carry the insurance but not any existing bonds, why would you want to hold the existing bonds? Presumably any existing bonds will trade at a significant discount to reflect the lack of insurance, though that would probably only concern existing bond holders. The other concern is the reliance on ‘private investors’ to step up and put money into the fund – also quite unlikely to materialise. Despite China repeatedly stating it would help bankroll Greek and euro debt, there has been little sign of actual $$.

Other criticisms concern the size of the bailout fund and the bank recap. There was an expectation for an increase in the bailout fund to 2 trillion euros, and the 100 billion euro bank recap is also seen as about half of what was needed. The markets were expecting a bazooka, and what they got was more akin to a heavy-duty shotgun.

And within days of the announcement of the plan, the markets have begun to react negatively. Italian bond yields have continued to rise, and at an auction on Friday of 6 billion euros of bonds Italy had to accept a 6.06% interest rate – simply unsustainable. So despite having just had the 13th summit to fix the euro-zone, it looks like the issue hasn’t gone away.

Chart below of Italy’s ten year bond yield illustrates what the markets think of the plan:

Greece reaches breaking point

It appears that Greece has now entered the final stages of its debt-induced crisis.

From http://www.euronews.net/business-newswires/1097767-analysis-greece-euro-exit-talk-grows-but-would-it-help/

“Ladies and gentlemen, the situation is serious in Greece,” German finance minister Wolfgang Schaeuble , who has been at the heart of trying to resolve the crisis for the past two years, stated simply as he began a speech to Germany’s Bundestag on Thursday.

Greek bond yields have continued to rise as talk spreads that it will not be getting the next stage of bailout funds, having failed to meet requirements for access to the funds. Greek 2 year bond yields are now at 53%, while even the 10 year yield is pushing 20% (see chart below).

It could be that Greece has only a week or two at best before financial implosion, probably culminating in a voluntary exit from the euro. Certainly it could be days if the next tranche of funds are withheld.

Eurobonds: only as good as the weakest link?

This hasn’t yet been confirmed, but in the latest letter from commentator John Mauldin, he includes this tantalising paragraph:

From Dennis Gartman: “Finally… and we shall cover this at some greater length tomorrow… S&P has said over the weekend through one of its senior spokespeople in Europe that if a EUR-bond is underwritten it shall have the rating of the lowest rated constituent country involved and thus will have coupon far, far above that of Germany, or France or Belgium et al. A EUR-bond would thus have the credit rating of Greece!”

So it comes from an unknown senior S&P employee to Dennis Gartman to John Maudlin and now to you, so its provenance is somewhat murky, but anyway….

It does seem hard to believe that S&P would rate eurobonds at the lowest level of any country involved in the scheme – are they being deliberately obtuse? How does a bond backed by Greece have the same rating as a bond backed by Greece, Germany, France, Spain etc etc etc? Does the additional backing provided by the other countries make no difference as to the credit-worthiness of the bond? Seems impossible. Even S&P, who have shown themselves to be well off the pace in recent years, would have more sense than this quote suggests.

Time for the ECB to buy again?

The programme by the European Central Bank (ECB) to buy the bonds of various European countries has been largely successful, pushing down bond yields in most countries, except it seems, those of Greece.

As the chart below shows, Greek bond yields are on the rise again and have surpassed their level prior to the initiation of the ECB purchases. Ireland, Italy, Spain and Portugal have fared better, with yields substantially lower and remaining there. The chart also shows that the ECB purchases have in fact been relatively modest, especially when you compare it to action taken by the US Fed. So it seems that the biggest obstacle to further purchases by the ECB is political, not financial.

As has become very common over the past few years, political concerns have tended to acerbate crises, not resolve them. When we look back at this period at some stage in the future, it may well be viewed as (hopefully) the nadir of global political leadership.

The IMF and ECB fall out

From FT.com:

IMF and eurozone clash over estimates
International Monetary Fund staff have provoked a fierce dispute with eurozone authorities by circulating estimates showing serious damage to European banks’ balance sheets from their holdings of troubled eurozone sovereign debt. The analysis, which has been discussed by the IMF’s executive board, has been strongly rebutted by the European Central Bank and eurozone governments, who say it is partial and misleading. The IMF’s work, contained in a draft version of its regular Global Financial Stability Report (GFSR), uses credit default swap prices to estimate the market value of government bonds of the three eurozone countries receiving IMF bail-outs – Ireland, Greece and Portugal – together with those of Italy, Spain and Belgium.

That’s an interesting decision, to use CDS prices to calculate the market value of government bonds, and clearly one which paints PIG bonds as practically worthless. Is it reasonable though? CDS prices are incredibly volatile and subject to manipulation, they may not necessarily be a true indication of price. But how else do you value government bonds? It’s really another version of the whole mark-to-market argument. If you are a long-term holder of any asset, should you be required to value it at current prices or prices inferred by say CDSs? Interesting.

Gold de-flated: pretty ugly

You would’ve had to have spent the last two years in a cave to be unaware of gold’s meteoric rise over the past years, driven largely by investors concerned by US dollar debasement by the Fed. The seemingly inexorable rise of gold has attracted the gold bugs out of the woodwork, with predictions of $3,000 or $5,000 an ounce in the next year or so thrown about wildly.

And you can’t argue with the returns either – buyers of gold have done very well over the past few years: investing at the start of 2009 would have seen a return of nearly 100% (in USD).

If you look at the long term performance of gold however, it’s not such a happy story, particularly if you de-flate the gold price by CPI and consider the real gold price, as opposed to the nominal gold price. After, it’s real returns that matter, not nominal returns.

The CPI-deflated gold price sits just under $600, about $50 less than where it was over 30 years ago. Pretty dismal really.

The biggest lender to the US? Itself.

Interesting chart below, which paints quite an interesting picture of the three largest holders of US debt. Step forward the US Fed, which has surpassed even China, and now holds around $1.6 trillion of US treasuries.

Does it matter? Well it’s hard to say really. In an ideal world the Fed would hold very small amounts of treasuries, but clearly we’re not quite ‘situation normal’.

Holders of US Debt

European rescue plan in doubt

From Reuters come this short report on the problems facing the latest plan to save the euro-zone from collapsing.

In a nutshell, Finland asked for and received special conditions to be attached to its share of the bailout funds for Greece, specifically that Greece would ring-fence Finland’s contribution and back it up with cash collateral. The obvious problem with this development is that you would reasonably expect other countries to demand the same treatment, as exactly was done by Austria, the Netherlands and Slovakia. Such much for ‘one for all and all for one’.

Greek collateral deals put bailout at risk – Moody’s
Euro zone states seeking collateral for aid to Greece should think again if they want its bailout to stay on track, a rating agency said, as one of them said it would only press for such guarantees as a last resort. Greece agreed last week to provide AAA-rated Finland with cash collateral for its loans to Athens, in a bilateral agreement that sparked requests for similar treatment from Austria, the Netherlands and Slovakia. As finance ministry experts said Greece faced a deeper than expected recession, Moody’s warned that by trying to secure collateral, its euro zone peers risked delaying the debt-mired state’s next bailout payment and driving it into default. The rating agency also said it expected other euro area members to block the agreement with Finland, and Dutch Finance Minister Jan Kees de Jager said suggestions the bilateral deal was lawful were incorrect. Moody’s became the first rating agency to warn that the row over collateral could scupper payouts to Greece, saying a proliferation of such deals would be credit-negative for a nation it currently rates at Ca, just one notch above default. Meanwhile, a German government spokesman said he could not say whether other countries in the euro zone had bilateral agreements with Greece similar to that of Finland, which has demanded collateral for loans under the euro zone bailout plan.

This is dire news for the future of the euro. Political will to do whatever it takes to save the euro seems to be ebbing away as voters in Germany and France express their displeasure at the prospect of bailing out their southern cousins. As a political construct the euro was a great idea, as an economic one it has been a disaster.