Relevant and even prescient commentary on news, politics and the economy.

Will the Euro survive,,,

Yves Smith asks

…I’ll throw it out to you: what do you deem the odds of Euro breakup to be (with “breakup” defined as at least one country exiting the Eurozone) in the next month? In the next six months? And if you think it will come apart, but later, guesstimate how much later and why you think it will occur later rather than sooner.

How about the AB crowd?

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European Daily Catch: Retail Sales Stabilizing?

by Rebecca Wilder
European Daily Catch: Retail Sales Stabilizing?

Today’s real retail sales gave the ECB and EU heads of state another reason to keep their fingers crossed for stability of the Euro area economy (.pdf of release). In January, volume adjusted retail sales increased 0.3% in the Euro area (EA) and broke a 4-month trend downward. On a 3-month annualized basis, though, real retail sales are falling at a 2.2% pace. Therefore, on a trended basis the second derivative may be stabilizing but the first derivative remains conspicuously negative.


I suppose that the ECB and EU heads of state will take this month of reprieve to pat themselves on the back for policy well done. However, in looking at the cross section of the monthly gains, France was the primary driver of the regional improvement, +2.1% over the month. We’re not out of the woods yet.

Greece, Spain, and Italy haven’t reported for January, so we’ll have to wait on the over or under regarding revisions. I’ll take the under, however, given that Spanish and Italian service PMIs are in the low 40′s with the employment component a serious drag (.pdf of the Markit release).

originally published at The Wilder View…Economonitors

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A oh, Some in Europe can’t take the pressure

Seems the austerity thingy is starting to hurt where it really counts. Just read via the AP:
… and amid growing concern in Europe that austerity aimed at cutting ballooning deficits may also be choking growth.
A dozen European Union leaders, including British Prime Minister David Cameron and Italian Premier Mario Monti, called Monday for an open-markets strategy to stimulate growth and jolt the region out of its economic doldrums.
“We meet in Brussels at a perilous moment for economies across Europe,” the leaders said. “Growth has stalled. Unemployment is rising. Citizens and businesses are facing their toughest conditions for years. ”
Of course their solution is “Free the Kraken!*“: 
The letter urges European nations to deregulate their service, research and energy sectors, forge trade ties with growing markets including China, Russia and South America — and even contemplate a free trade agreement with the United States.
How scared are they? They are this frightened: 
“Implicit guarantees to always rescue banks, which distort the single market, should be reduced,” the letter said. “Banks, not taxpayers, should be responsible for bearing the costs of the risks they take.”
Be still my beating heart, be still.

Of course, all of this is related to Greece. I found that the British paper, the Daily Telegraph is liveposting daily on the Debt Crisis:
“Live coverage of the international debt crisis and rollercoaster financial markets in the eurozone and US.” From today’s postings:
20.06 Jeremy Warner [financial editor] writes that the US has proved that the brutality of hire and fire really does work:
It is a simple fact of life that business is more prone to hire if it is allowed to fire. The major risk to business investment, which is that of an ongoing workforce liability, is thereby removed.
Vince Cable’s proposed shake-up of employment law is in truth of much more importance to the future of the UK economy than faffing around either with credit easing or squandering £12bn on a temporary tax cut. It’s vitally important that the task is not ducked.
And yet, considering the 12’s concern about austerity to cut debt and banks taking the hit, there was this today: 
22.02 Here we go. Eurozone ministers agree on ways to cut Greek debt to 123/124pc of GDP by 2020, aiming to go close to 120pc. Eurozone in talks with representatives of private sector about finding further debt relief. Issue of ECB forgoing profits on its holdings of Greek bonds remains a sticking point.
Coming soon to a theater near you!  The Son of Austerity.
*Kraken: In modern German, Krake (plural and declined singular: Kraken) means octopus but can also refer to the legendary Kraken.

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Expect Neither ‘Sustainable’ nor ‘Comprehensive’ From Euro Area Leaders

by Rebecca Wilder

Expect Neither ‘Sustainable’ nor ‘Comprehensive’ From Euro Area Leaders

On Sunday, Merkel and Sarkozy promised a “sustainable and comprehensive” solution to the euro debt crisis ahead of the November 3-4 G20 meeting. Along with this rather grand announcement are absolutely no details on their plan. However, Van Rompuy today pushed back the European Summit, which convenes now on October 23, to ‘finalise our comprehensive strategy on the Euro area sovereign debt criris’. Perhaps a real plan is in the works. I think not.

In the back of my mind, I have 5 necessary conditions that must be satisfied in order to achieve a ‘comprehensive and sustainable’ policy response to the Euro area debt crisis. None of these conditions will be satisfied in full, critical conditions not even partially (namely 3. and 4. below). I can only conclude that any response/strategy negotiated at the October Summit will be neither ‘comprehensive’ nor ‘sustainable’.

The 5 elements of a resolution to the European debt crisis:

  • Element 1. There’s too much debt, and it must be written down. Banks are exposed to insolvent governments and defaults from a decade of leverage built in the private sector (Spain, Ireland, and Portugal). Europe is at just the initial stages of this process.

Expectation for October 23rd: Partial response. This may be partially addressed if they include significant haircuts to Greece’s debt as part of the bank recapitalization effort. However, there are no details as to how the bank recapitalization efforts will transpire (except for the elusive word ‘comprehensive’). And if they address Greece restructuring only, then we’ll likely be here again in coming quarters – Europe is a few years behind the US in their deleveraging cycle.

Furthermore, unless the bank recapitalization effort is done by some pan-euro body and ALL banks are forced to take capital jointly (not unlike TARP), I view any lesser, nationalistic effort, as a net-negative for medium-term market sentiment. Another positive response, in my view, would be a joint guarantee of bank deposits, which would require coordination at the supranational level. Full coordination would be welcome but is unlikely.

  • Element 2. Near-term liquidity needs to be provided to those sovereigns/banks that are solvent but face funding pressures. The ECB has addressed the funding pressure for the near term and is likely to continue to do so.

Expectation for October 23rd: Partial response. This is only a partial response because the ECB has already sufficiently addressed fixed term liquidity operations. Currently, European banks hold about €200 billion in excess reserves (7-day average), up from roughly €25 billion spanning the bulk of 2011, and unlimited FX funding is available through March of 2012. The ECB continues to purchase Italian and Spanish bonds on the secondary market through its SMP in support of two arguably solvent sovereigns.

Notably, though, there’s still a large hole in the capacity of the EFSF to do it all: recapitalize the banking systems, provide emergency lending to national governments, and backstop Spain and Italy. Addressing the insufficiencies of the EFSF, either as a structure and/or a policy response-tool (or the permanent ESM counterpart), would entail a full response. However, I expect nothing to be announced regarding the capacity of the EFSF to address all efforts. An announcement that does alleviate the capacity problem of the EFSF would be a net-positive.

  • Element 3. A move toward more fiscal interconnectedness should be more decisively established, including a fiscal ‘lender of last resort’. This function may be performed by ECB, but presumably a fiscal institution should act in this role.

Expectation for October 23rd: No response. In fact, this is the part of the ‘comprehensive solution’ that will likely require an acute worsening of economic and financial conditions (interrelated).’

  • Element 4. Switch to 1st gear in the drive for fiscal austerity and competitiveness. True, some countries could benefit greatly from reform, which buffets long-term growth potential. However, fiscal and institutional reform to increase competitiveness takes years to pass through to potential growth, and the timeline needs to be extended.

Expectation for October 23rd: No response. This is the most challenging piece of a comprehensive solution. Martin Wolf calls it fostering a ‘credible adjustment’ of the flows (i.e., macroeconomic imbalances). Under a credible Euro-area adjustment plan, reform from ALL parties involved, rather than just by the weaker nations, must be implemented. Until Germany and the core ‘exporters’ (all of the core countries except for France run current account surpluses) institute reform alongside the weaker debtor countries, adjustment has no hope.

  • Element 5. Macroprudential policies and new infrastructure needs to be erected in order to address and enforce macroeconomic Treaty rules.

Expectation for October 23rd: Wildcard, but probably nothing substantial. This would require (probably) amendments to EU Treaties and/or mandates for current institutions (like the EBA or the ECB).

In conclusion, markets may be making a mountain out of what is likely to be a molehill response to the current crisis, one that’s neither ‘comprehensive’ nor ‘sustainable’. If, however, we do get some response by way of required actions 3 or 4, that would be a great leap forward for the sustainability of the Euro area.

originally published at The Wilder View

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Greece – GIIPS – Eurozone – Big Problem

O.K., Greece is now “high yield”, “junk”, “below investment grade”, at least according to S&P. What I mean by that is S&P now rates Greece’s foreign and local currency sovereign debt at the BB+ level (with a negative outlook), below the sometimes-coveted investment grade status, BBB- is the minimum. Why did S&P feel the need to do this now? Just covering its _ss – Greek debt was rated A- as recently as December 2009.

On to the Germans. What they are doing is actually quite striking: offering a bailout in order to appease markets so that international investors will pick up the Greek bill (never was going to happen anyway); and then telling markets that bond investors in Europe will take a haircut so that international investors won’t pick up the Greek bill. I guess the light-bulb finally went on that there is a contagion brewing here because bunds are tight, while all Peripheries are wide.

The original bailout will likely be offered to satisfy Greece’s near-term obligations. However, in the meantime the probability that the liquidity crisis spreads across the GIIPS (Greece, Italy, Ireland, Portugal, and Spain) – especially Portugal with a 2009 current account deficit equal to 10.3% of GDP, making it shockingly susceptible to capital outflows – is rising.

We’re in crisis mode – the calm before the storm. I see the Eurozone disaster happening in three waves:

First, there is a liquidity crisis in Greece (already underway).

Second, it turns into a full-fledged financial crisis for the GIIPS. The capital account drops precipitously with investor confidence in GIIPS markets, leaving the very vulnerable countries, like Portugal and Spain with current accounts very much in the red, seriously short of cash.

What Germany wants out of Greece (and any bailout thereafter) is the equivalent of an economic anaconda. It will force Greece to meet the limits of the EMU Stability and Growth Pact (3% of GDP) by some period, let’s say 2012.

Of course that cannot happen without an epic surge in exports. Here’s the death spiral: sharp austerity measures translate into unemployment, economic contraction, deflation, and yes, higher deficits. There’s just no way out of it.

So what is the be all and end all policy script? Regain competitiveness in world markets, no less. The Economist on Portugal:

Low growth reflects a disastrous loss of competitiveness since the country joined the euro. Portugal has lost export-market share to emerging economies (including those of eastern Europe) that churn out similar low-value products. This is largely due to a steady rise in unit labour costs, as wage increases outstripped productivity growth (see chart).

The IMF’s consultation on Italy, as per its latest Article IV report:

Economic rigidities, along with Italy’s specialization in products with relatively low value added, have also been contributing to a steady erosion of competitiveness. Consequently, Italy has been losing its market share of world trade.

And my favorite part of the Italy Article IV:

In the past, other countries have overcome similar challenges from very difficult starting positions with comprehensive policy packages.

Note the very incriminating term, “comprehensive”. That usually includes expansionary monetary policy and the depreciation of a currency to drive export income, both of which elude any of the GIIPS countries.

The Economist portrays Portugal’s path away from depression-land via export income by lowering ridiculously high labor costs (i.e., productive labor as measured by the unit labor cost index) relative to those in Germany. As such, Portugal should be able to pick up exports while the government drops the deficit and constricts domestic demand. Notice the catchy title!

But what they fail to illustrate is the fact that all of the GIIPS are in EXACTLY THE SAME UNCOMPETITIVE BOAT!

So we get to the final stage, GIIPS go depressionary, and the economic contagion spreads across the Eurozone, hitting yes, Germany. Notice that Ireland is the only GIIPS with a fighting chance, according to the Eurostat’s forecast.

I’m married to a German – I understand stubbornness. But this time, being stubborn is just going to get the Germans in trouble.

The GIIPS are 34% of Eurozone GDP – try to export your way out of that one when 1/3 of the “Zone” is reducing costs and cutting wages. It’s a fallacy of composition to assume that the GIIPS are cutting spending while the aggregate remains intact. Furthermore, each EU country exports an average of 68.6% within Europe, so Germany’s clearly going to feel this, too – at least if the “Zone” gets past the immediate liquidity crisis.

Nobody talks about this – but Greece can secede from the Eurozone as per the Lisbon Treaty.

Rebecca Wilder

Update: It should be noted that Lisbon allows a country to leave the EU, of which the Eurozone is (effectively) a subset.

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Catch-Up Links

I have been a Bad Blogger this week. (As opposed to my usual practice, which seems to be described as Blogging Badly.)

While I intend to continue the New Tradition (think of me as Waylon, without the speed), following are Snow Day Links:

D-Squared was on fire on Wednesday: both Bank Lending Channel and The Foundations of Mathematics and the Roots of Finance are essential.

For all those of you—looking straight at you, o six-footed one—who believe TARP was the right idea to save the economy, here’s another data point: “Overall bank lending in the US economy shrank 7.4% in 2009 — the sharpest drop since 1942.”

James Hamilton looks at Those Other Programs that support the banks without providing any funds to the rest of the economy (though I don’t think he put it that way).

With all the talk of Liquidity needs and Greek bonds, jck at Alea posts an essential chart.

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The Greek Squeeze

I feel like I am living in a “Choose Your Own Adventure” book. What global shock comes next? The air of uncertainty remains. This morning an imminent (but questionably so) bailout is across the news wires. From the WSJ:

Germany is considering a plan with its European Union partners to offer Greece and other troubled euro-zone members loan guarantees in an effort to calm fears of a government default and prevent a widening of the credit woes, people familiar with the matter said.

and later…

It is unclear how the debt guarantees under consideration might be structured, but with any aid, the EU will be walking a delicate line between forestalling a greater disaster and letting chronic overspenders like Greece off easy, which could further damage trust in the euro.

“As long as it is very clear that any support only comes with very, very stringent conditions attached, it would not affect the moral-hazard question,” said Fabian Zuleeg, chief economist at the European Policy Centre, a Brussels think tank. Still, he said, “It is a choice between two evils.”

Obviously, markets see this deal getting done, however, you know what they say about the fat lady… This morning 10-yr bond spreads over German bunds were down across all of the PIIGS countries, where Greek spreads dropped almost 100 bps over two days (76 bps now).

The moral hazard implications are clear. If Germany bails out the Greek government – the Greek government has a €53bn financing needs this year – then what next? Saving rates in Europe look a little bi-modal, with the big savers clustered at the top of the spectrum, Switzerland, Austria, Germany, and Finland, and the big dissavers at the bottom, Portugal, Greece, Italy, et al.

Spain and Italy account for 29% of 2008 Eurozone GDP and Greece just 2.5%. Spain’s debt metrics pale in comparison to Greece’s (see WSJ link), but remain well outside the Maastricht Treaty limits. Allowing Spain and Italy to fail is obviously “too big”.

Another question out there is future membership requirements. Bulgaria (not currently in ERM II)? Latvia? The benefits to joining the Eurozone are obvious (there are costs, too, like relinquishing monetary autonomy); notice how Greece’s borrowing costs plummeted following its 2001 venture into the Eurozone. S&P upgraded Greece’s rating from A- to A in March 2001.

Skepticism over the Eurozone will likely last for some time. Two days ago, the FT ran an article titled Traders make $8bn bet against euro – sentiment is very negative, and the EUR/USD is off around 9% from its 2009 peak (November). Although key economies, Germany, likely welcome a weaker euro, the region as a whole is certainly being tested.

Personally, I think that the IMF should be involved. But here’s a great piece over at the Baseline Scenario listing why that is not a possible/probably outcome. Hmmm, wonder how China and Japan will react to this news? Yup, buy dollars.

Added link: You all might find this article interesting.

Rebecca Wilder

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This week’s Greek tragedy

This week, the single most important event in global bond markets was the S&P downgrade of Greece’s long-term debt obligations, A- to BBB+. Moody’s is the last of the major rating agencies to hold Greek debt in the A-category of investment grade (currently at A1); but a major decision from Moody’s could come within weeks. This would make Greece the lowest-rated country in the Eurozone, and the only one with 6-B status.

Since the beginning of the month, the Greek 5-Yr government bond jumped over 1% to 5% by Friday.

The chart illustrates comparable 5-yr government bonds across the Eurozone. Interestingly, the region (ex Greece) remained rather resilient to the news. However, Greece is not alone; and its growing government financing problems are in good Eurozone company.

According to the European Commission’s autumn 2009 Economic Forecast, only 5 of the 16 Eurozone countries are expected to remain below the 60% debt limits of the Treaty on European Union in 2010, while just 3 will satisfy the 3% deficit limits.The most imminent issue for Greece, with its new BBB+ status, is eligibility for ECB’s collateralized loans. In October 2008, the ECB dropped the minimum credit rating for eligible collateral on its credit facilities from A- to BBB-. However, Greece’s downgrade to the next tier of investment grade status (BBB+ by S&P) now makes it ineligible for the ECB’s credit programs if the temporary measure is repealed. Obviously, this is a problem for Greece; but it is a growing problem for the ECB as well.

I see two problems forming. First, the pressure to drop deficits and leverage will be overbearing in Europe, especially in the UK. Dropping debt levels will be important after the recovery is well underway; but before that, and a fledgling economic recovery may be cut short. Second, if investors do start to question the ability of governments to service debt (recently in Greece), financing costs in other struggling countries, like Spain, Portugal, or Italy (and some of the others circled above), could rise swiftly and pressure budgets further.

The Wall Street Journal wrote a nifty little article about the time spent trying to regain a higher rating after a downgrade occurred:

Sovereign upgrades, meanwhile, can take a long time: Greece’s rating took nine years to move one notch upward to triple-B in the 1990s; Australia lost its triple-A rating in 1986 and saw 17 years pass before it was restored.

Years, that’s how long it will likely take Greece to “implement a credible medium-term fiscal consolidation programme”. And it is very possible that Greece will see further downgrades before upgrades.

This is a problem for the ECB – it will be interesting to see the ECB push a credible exit with Greece’s credit rating squelching the expiration of the temporary collateral requirements. Fun times ahead!

Rebecca Wilder

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