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

Europe’s at it again…

Key European CDS are starting to turn in the more northern direction again, as the German-French ‘pact for competitiveness’ faces near-unanimous pushback across Europe.

Credit default swaps (CDS) are a market security used by investors to buy 5-yr protection (in this case) against default (or the like). As the spread rises the implied probability of default does too. Current market values imply a 39% probability of default by the Irish sovereign (listed in legend), 20% by that of Spain, and 14% by the Italian sovereign, etc. Cash bond spreads are blowing out again, too, where Spain now must pay a 216 bps premium over Germany on a 10-yr loan (the sovereign bond). I’d say that’s not totally irrational.

I completely understand why these negotiations are stalling. I’m Spain – it’s not clear that Spain commented against the pact based on this article, but I digress – why would I agree to a deal that forces more ‘competitive’ measures, which really just means quashing indexed wage growh, reducing the government deficit, adhering to a fiscal policy rule (which, by the way should be modeled after Germany’s debt brake), and adopting a standardized tax rate? Okay, I will if you (Germany) will. Meaning, I’ll increase my competitiveness by stripping away aggregate demand if you allow prices to rise. I’m Germany – no way. (Please see my previous post which argues that a successful transition to a more stable Eurozone depends on higher Germany inflation.)

Der Spiegel spells it out pretty succinctly in an article that is now two weeks old but still totally relevant:

Germany will only agree to additional guarantees for the euro rescue fund — as the Commission and other parties have called for — if its partners approve its competitiveness pact.

Simply put: we (Germany) will only agree to eventually bail you out if you agree to our harsh demands at that time, or you agree to our harsh demands now. You’re choice.

This political drama is far from over. (More exciting analysis below the jump)

(Dan here…Kantoos responds to Rebecca… )

Here’s another little fact to think about: The price to buy protection against a default by the Japanese sovereign is just 77 bps, that’s only 23 bps above that for the German sovereign. This is ironic because Germany is the premiere demander of fiscal austerity, while Japan is not (to say the least) with gross debt equal to 221% of GDP (according to the IMF) – or is it?

The table below lists common characteristics usually associated with rising CDS spreads (CDS spreads are current as of 4pm today and may vary according to pricing source): the stock of debt held by foreigners (any currency denomination) and the stock of gross public debt. The final column illustrates the ability of a country to print fiat currency that is not backed by anything but government decree.

I think it’s pretty clear: Japan and the US have very elevated government debt, but low external holdings AND can print their own money to finance liabilities (which by the way are in most part denominated in their respective currencies). Clearly markets’ attach weight to this simple fact via low CDS spreads.

To be continued….

Rebecca Wilder

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Third Time, Someone Will Believe: Manage Risk or It Manages You

As the late Allison Snow-Jones noted, economics depends on working mathematics. Mathematics, in turn, depend on the conditions being described correctly. If I build a model in which two things are independent, they have to be independent for my model to work. Or, to quote a quoting:

Many months ago, I quoted the brilliant Janet Tavakoli‘s book Credit Derivatives and Synthetic Structures:

The trader then went on to tell me that Commercial Bank of Korea would sell credit default protection on bonds issued by the Commercial Bank of Korea.
“That’s very interesting,” I countered, “but the credit default option is worthless.”
“But people are doing it,” persisted the trader.
“That’s because they don’t know what they’re doing,” I affirmed. “The correlation between Commercial Bank of Korea and itself is 100 percent. I would pay nothing for that credit protection. It is worthless for this purpose.”
The trader mustered his best grammar, chilliest tone, and most authoritative voice: “There are those who would disagree with you.” (p. 85)

That apparently includes the Spanish government:

The Frob capital injection comes in the form of convertible preference shares from the Frob, or Spain’s Fund for Orderly Bank Restructuring. As a reminder, the Frob itself has lending capacity of €15bn and can leverage itself to €99bn by issuing bonds — guaranteed by the Kingdom of Spain — to private investors.

And the equity it lends to banks really resembles more of a subordinated loan than actual loss-absorbing capital. What’s more, it pays a coupon and is excluded from core Tier 1 calculations under incoming Basel III rules for this very reason.

Did we mention the Frob is also backed by Spain?

I realise all the attention is on Egypt right now—and it should be&mdaash;but the rest of the world is going to be there on Monday, too. And traditional “sovereign risk management” still has a ways to go.

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European policy…really?

This week Trichet laid down the ECB’s hand, (effectively) announcing his intention to maintain inflation at the ECB’s target rather than allow it to overshoot. For all intents and purposes, 2% inflation stabilizes the real exchange rate rather than furthering real depreciation in the Periphery and real appreciation in Germany (or the Core).

Ambrose Evans-Pritchard agrees with my interpretations of Trichet’s speech:

Mr Trichet’s fire-breathing rhetoric can be taken as a signal that the ECB will continue to run monetary policy for German needs and tastes, refusing to accommodate a little slippage on inflation to let Club Med regain lost competitiveness without having to endure the agony of debt-deflation. Indeed, the ECB seems to have picked up some of the worst habits of its mentor.

Only the rebalancing of inter-euro current accounts will bring stable fiscal finances for debtor and creditor countries alike, something made more difficult with 2% average inflation! Trichet, in an interview with German newspaper,, doesn’t acknowledge this fact (bolded by RW):

Let me be very clear: this is not a crisis of the euro. Rather, what we have is a crisis related to the public finances of a number of euro area countries. All governments have to put their finances in order, and above all those governments and countries which have lived well beyond their means in the past.

Really? On the aggregate, Euro zone economies ‘living well beyond their means’ are now doing so in two respects: the current account deficit and public deficits. They’re not the same. Don’t even start with the ‘twin deficit’ story – Rob Parenteau refuted that some time ago.

It’s not about government dissaving, per se. For countries like Spain, or any other Euro area economy with years of accumulated private sector leverage, the only way for the public sector to simultaneously reduce fiscal and private deficits is for Germany foreigners to dissave (foreigners run large CA deficits). (See a previous post of the 3-sector financial balances model here.)

Given the close trade ties in the Euro zone, growing income from abroad effectively means a transfer of saving from the Eurozone Core to the Periphery via the current. This requires real appreciation in Germany, for example, and real depreciation in Spain.

First, real appreciation/depreciation could have been given a fighting chance with a lapse of the inflation target. Trichet made it quite clear where the ECB stands on this front: NEIN.

Portugal, Greece, and Spain have essentially no chance if left to their own accord.

Spain along with other Periphery economies are relatively “closed” compared to the German export powerhouse; that needs to change.

The chart above illustrates the degree of openness across the Eurozone, as measured by (exports + imports) divided by GDP. Spain, Greece, Italy, and France (expected to run budget deficits the size of Spain this year) are the most ‘closed’ of the Euro area (16, not including Estonia). In Greece, Spain, and Italy, the GDP share of export income has decreased over the last decade; furthermore, it’s imports, rather than exports, that make the larger contribution to economic openness.

Export share
(Q3 2010)
Import share
(Q3 2010)
Greece 20.2 26
Spain 26.1 27.5
Italy 27.0 28.5

Even if Spain was more ‘open’, real appreciation is ingrained in the economy, as represented by unit labor costs. Structural reform is required on many fronts, private and public.

Since 2001, Spanish unit labor nearly doubled, +46%, while those in Germany grew just 17%. Recently, unit labor costs in Spain have stabilized. This is due to the contraction of the construction sector, which dragged productivity in recent years. Going forward, more is needed.

The EU made several recommendations in their 2010 Surveillance of Intra-Euro-Area Competitiveness and Imbalances (pg. 78):

Enhancing productivity in a more sustainable way would involve further investment in and enhancing the efficiency of expenditure in research, development and innovation, as well as improving the efficiency of R&D expenditure are crucial for achieving productivity advances. Further improvements of the education and life-long learning systems and investment in human capital should also be envisaged. This may be achieved inter alia, by ensuring the effective, implementation of widespread education reforms in addition to upgrading the skills and increasing mobility of the labour force to promote a swift transition into employment, and reducing segmentation in the labour market.

Nowhere does the report say that competitiveness should be achieved by getting public finances ‘in order’. In fact, I’d deduce from these comments that more, rather than less, government spending is needed.

Without > 2% inflation, these countries don’t stand a chance.

Rebecca Wilder

Appendix: Another measure of relative price competitiveness, the GDP deflator.

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A Diverging Eurozone

I am sick today and had to cancel plans with a friend tonight. I decided to look at Eurozone unemployment rates to pass the miserable time.

According to the Friday Eurostat press release,

The euro area1 (EA16) seasonally-adjusted unemployment rate was 10.1% in November 2010, unchanged compared with October4. It was 9.9% in November 2009. The EU271 unemployment rate was 9.6% in November 2010, unchanged compared with October4. It was 9.4% in November 2009.

The Eurozone started growing again in Q3 2009. But since then, the regional labor forces show a sharp divergence in resource utilization, as measured by the unemployment rates: the weak (Periphery) from the strong (core).

Here’s how it looked in 2007 before the Eurozone entered recession.

The 2007 unemployment rates were quite similar in levels, where the differences in unemployment rates across the Eurozone are defined primarily by structural, rather than cyclical, factors.

Here’s how it looks now, where the weakness in resource utilization due to cyclical factors is hitting the Periphery hard compared to the core countries, especially Germany.

The chart above illustrates the change in the unemployment rate over the last two years using the September-November 3-month average for comparison. The countries are ranked from largest to smallest percentage increase in the unemployment rate over the two periods.

All of the PIGS (Portugal, Ireland, Greece, and Spain) have seen their unemployment rates rise by 57% (Spain) or more (+82% for Ireland). To the right of the Euro Area average, you have Germany and Luxembourg seeing their unemployment rates decline over the same period.

The divergence in labor force deterioration across the Eurozone since 2007 is quite striking.

Rebecca Wilder

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Steve Randy Waldman Explains It All to You

Not certain this link will work, but at Interfluidity, SRW replies to Karl Smith, closing with a sentiment with which I am very much in sympathy:

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

Read the whole thing, even if this link doesn’t work.

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Joachim Voth Tells the Truth and Shames the (German) Devil

Echoes of Japan, echoes of the Great Depression. One of the few economists who knows history closes a post by presenting the proper context for the choices:

A quick exit [by Ireland, from the Euro] may still be better than a decade of slow, grinding deflation combined with Zombie banks and Zombie household balance sheets being kept on artificial life support before the inevitable rise in interest rates at some point pulls the plug.

When Britain left the gold standard in 1931, the governor of the Bank of England famously declared (having been aboard a ship and out of contact when the decision was made): “I didn’t know we could do that.” Leaving the euro may seem similarly unimaginable to many, but it may be just as feasible. In the 1930s, cutting the link quickly led to a recovery of demand, by reducing deflationary pressures. Far from the shattering blow to confidence feared by many, exiting the gold standard was actually great for business. Leaving the euro may be every bit as good.

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Can Someone Please Explain Germany’s Reputation for Fiscal Conservatism to Me?

Assume I believe in risk-adjusted return on capital. That is, I don’t buy a bond yielding 12% instead of one yielding 6% without first considering that the yield difference is affected by the likelihood of Principal return being lower. (But I will buy the 12% bond if I believe the risk premium is too high relative to the 6% bond.)

In short, I fit the second—not the more accurate “traditional” or the current even-more-bollixed “risk management” definition—of the Prudent Investor.

I can watch my neighbor buy more and more expensive gadgetry, while knowing that s/he makes no more than I do, has some old debts, and doesn’t not have dynastic wealth (i.e., the possibility of inheritance or some other deus ex machina) to save himmer. And I notice that hisser buying is growing greater over time.

My neighbor decides to borrow money from people to support hisser ever-more-extravagant lifestyle. S/he offers rates slightly higher than the rate at which I can borrow. (That is, I can borrow money, take the interest payments from himmer, and pocket the difference—if the Principal is paid back on schedule.)

Do I loan the money to—effectively, buy bonds from—my neighbor?

My instinctive answer is “No,” but I am a Prudent Investor. So perhaps I give my neighbor some money—monies I can afford, not something I need to borrow—as a token.

Under no condition do I become—by a margin of more than 2:1—the largest creditor of my neighbor’s lifestyle. Not, at least, if I want to maintain my reputation as a conservative (“prudent”) investor.

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Ireland is Bankrupt…a letter from an Irish citizen

A letter sent from Ireland (updated):

For less than what the US spent to save AIG, a corporation, with relatively easy terms; a country sinks below the financial waves. TBTF reaches across the ocean. As posted by Zeus-boy, his comments on his homeland of Ireland. (introduction by run75441)

Ireland is Bankrupt

Herman Van Rompuy, President of the European Council, warned that if Ireland didn’t apply for an EU/ECB/IMF bailout for its failed banking system, its soaring budget deficit and its colossal national debt, then the European single currency might collapse [the bond markets have already panicked and cashed in], and if the International markets lost confidence in the Euro, then the dissolution of the Union would quickly follow. He said the future of the Eurozone depended on stemming the tide of market distrust caused by the tanking Irish economy. He feared contagion, that Portugal and Italy and Spain would soon follow.

Ireland is not only insolvent because it has no liquidity, no way of meeting its debts. The government decided to link the economic future of the country to a failed banking system and now the two are inextricably intertwined. No amount of raised taxes can bail out the banks and still pay the day-to-day running expenses of our welfare state. The famed ‘Celtic Tiger’ boom economy was always a high-risk, dangerous fiction. Someone dubbed Ireland the ‘Wild West of Economics’. Our illusory wealth was tied to a property bubble that was as unsustainable as it vacuous, and all the money was borrowed, primarily from German savers. We were hooked on credit like it was crack cocaine. We binged but never purged and we stayed high to postpone the inevitable hangover. Everybody was in cahoots, from corrupt local governments, driving through emergency rezoning laws, to rogue bankers financing the criminal inflation of developments and shoveling billions to builders, to newspapers cashing in on their property advertising to regulators asleep at the wheel. Our mafia don cum Taoiseach, Bertie ‘Gombeen-Man’ Ahern, invited critics of the system to commit suicide. Nobody left the orgy. Nobody wanted to leave. Planet Hollywood had finally come to Planet Ireland!

But inevitably the whole house of cards would come crashing down, and Bertie [who tendered his timely resignation just before the collapse] soon got his wish as the suicide rate started to climb to the highest in Europe. The government panicked. The Minister for Finance, a barrister by profession, got a crash course in national and global economics. He learned about markets and budgets and bonds and gilts on the job, on a need-to-know basis. He instituted an abstraction called N.A.M.A. , The National Assets Management Agency, whose remit basically is to buy up all the debt and properties left unfinished and unpaid for by the construction moguls [developers & builders] and their bankers, to transfer them to a national trust, cue Irish tax-payer, as if we owned them, or even wanted them, or could avail of them in any way, and to pay off the outstanding loans. All over Ireland, in every town and village, are these unfinished ghost estates. These now belong and do not belong to the Irish taxpayer. This offense was compounded by the decision to bail out the very banks [like Anglo Irish and Irish Permanent, really, all of them] that got us into the mess. The banks were hemorrhaging money [and still are] and the government was on hand to provide on-the-spot triage, a botched stitch-up job if there ever was one, a cluster-fuck of cosmic proportions.

The government, Fianna Fáil in coalition with The Greens and a few independents, lied through their teeth and kept telling the Irish taxpayer that exports were up, that the revenue would come in once the austerity budget was passed, once the 4-year plan was unveiled and ratified and that no bail-out would be necessary. Reduce public spending, they told us, tighten our belts; cut the public sector; Trim this, give a haircut to that and all would be hunky dory. Well, the same shower of gangsters who gave the green light to sub-prime lenders and hedge-fund speculators-gamblers went to the ECB/IMF with cap in hand this week and begged for a bailout. Then they came on TeeVee to announce the done-deal. Ireland will borrow over 85 billion from its partners in the EU and the IMF and, depending on the repayment interest, 5 -7%, we could be paying back upwards of 4 billion a year. That’s about 1/4 of the Tax intake. The debt is completely beyond our means as Constantin Gurdjiev, and David McWilliams are trying to point out.

Ireland is used to erosions of its sovereignty ever since we joined the European Union. We, we had our first referendum on the Lisbon Treaty in June 2008 and it was defeated. Sarkozy told our Taoiseach that he delivered the wrong result and to go back to the people and get the right result next time, so that’s exactly what happened and so in April 2009 the treaty was finally passed in Ireland. So much for Irish sovereignty. Our membership of the single currency in 1998, as part of our EU obligations under the Maastricht Treaty, further compromised that independence. Now ceding control to the IMF — to save the Eurozone — is the final nail in the coffin of that putative myth known as Irish sovereignty. We gave away so glibly what we fought so hard to achieve.

Was it for this the wild geese spread
The grey wing upon every tide;
For this that all that blood was shed,
For this Edward Fitzgerald died,
And Robert Emmet and Wolfe Tone,
All that delirium of the brave?
Romantic Ireland’s dead and gone,
It’s with O’Leary in the grave.

I’m afraid the verdict isn’t very flattering. Ireland is indeed a banana republic, a land full of cronyism, wink and nod business deals, insider trading, nepotism, feather your own nest and forget about the next guy, take all you can as quickly as you can no matter who gets hurt, ostracize the whistle blowers and critics, advance number one every time and keep the circles closed. There’s no sense of civitas here, no notion of self-sacrifice, no pride in history, culture, nation; it’s all up for grabs to the highest bidder. It doesn’t matter that we struggled for 800 years to achieve independence, that millions died in the process; it doesn’t matter that the folk memory of harsher times is still very much alive; none of this mattered to the few generations that have dismantled our country institution by institution and thrown the Irish people to the wolves, the bean counters in the IMF who will now control our destiny. Our political system is in ruins. The people have lost all faith in their elected representatives. They feel that welfare for the wealthy, bailouts for crooked corporations and rewards instead of punishments for embezzlement and thievery is the rule of the land. And what the British and the world said about us, all the stereotypes, seem to be true after all and maybe were always true: we were never equipped to govern ourselves, we’re a nation of drunks, peasants, irresponsible wasters and chancers addicted to violence and quick fixes. Our independent republic is less than a century old and already it’s in smithereens — we’re in the gutter and being dictated to by the UK, Germany, France and the IMF. Mr. Ajai Chopra is our new vice-chancellor, our new Taoiseach, our new overlord and big boss and we’ve just been recolonized, first by our own brood of inbred gangsters and now by international bankers. We didn’t deserve any better. It’s our own damn fault.

By ‘we’ I mean the select few that got our country into the financial mess. But the blame game serves no useful purpose now: we’re all fucked, not equally, mind you [but when are people ever fucked equally?], and the nation has no option now but to drive through a draconian austerity budget and then take the bailout and let our affairs be run by outsiders. Could we say ‘Fuck You’ to the Euro and go back to the punt? Could we say ‘Fuck You’ to Germany and all our debtors? Could we say ‘Fuck You’ to the EU and let the Eurozone fall? Our politicians tell us we have no choice. It would be therapeutic to tell the lot of them to piss off and to return to hunter-gatherer status but how feasible is that? Kids think beef patties are really square and grow on trees. They wouldn’t know how to pluck a chicken let alone sow and reap a harvest. Everything’s in the grocery store and they’re too busy playing play station, twittering and gabbing on Facebook to worry about the right time of year to plant a tuber. The EU is run by neo-liberalist economic policies and if Ireland doesn’t play ball the multi-nationals will up and relocate to cheaper labour markets. They’re already doing just that. They’re encouraged to do it by Merkel and Sarkozy and Cameron.

And then there’s always the fear that this crisis will inaugurate excessive nationalism, that the Provos will exploit civil unrest and lack of confidence in the government to push their demented and deranged United Ireland bollocks. Gerry Adams has already announced his candidacy for a seat in Co. Louth which, if elected, will find him in Dáil Éireann. This would be disastrous for Ireland. Ireland doesn’t need Sinn Féin’s brand of patriotism. People should remember Gerry Adams’ devolvement announcement for the Good Friday Agreement: He said he was now ready to pursue through the political process the same agenda he failed to achieve through armed struggle, that is, a United Ireland. If Sinn Féin ever gets a foothold in Irish politics there will be a return to the rule of the gun; if his bunch of murderous, terrorist thugs are ever allowed to exploit the political vacuum in Ireland there will be a bloodbath. Adams has always preached against the EU and partnership with Britain. He’s still the same dickweed that did time in Long Kesh and had Jean McConville a widowed mother of 11 children murdered because she administered last rites to a British soldier who died on her footstep. His brand of fascistic nationalism is no good for Ireland. We must reject him and what he stands for.

As a nation we’re a joke, a laughing stock, and now it’s time to become a colony of the IMF under the direction of the same cowboy outfit that brought peace and prosperity to Argentina and Iceland. O Joy, I just can’t wait. We the Irish People have our asses greased for yet another bout of sodomy. We’re used to it. It feels good. And this time we walked right into it. Heck, we can always get drunk afterwards, have a rare old session and weep and wail over our Fenian dead.

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Irish Bailout–impact on taxes uncertain

by Linda Beale

Irish Bailout–impact on taxes uncertain
crossposted with Ataxingmatter

As plans for the $100 billion bailout of the Irish economy and banking system by the European Commission, International Monetary Fund and European Central Bank continues, Ireland’s downtrodden prime minister (who will call elections after the budget is finalized) has said that it “will not” change its corporate tax haven status–its corporate tax rate of 12.5 percent will remain for now.  At the same time, however, Daily Tax RealTime reports this evening comments today by Eurogroup President Juncker that discussions about Ireland’s low corporate tax scheme are ongoing, Both France and Germany would like to see Ireland raise its rate closer to the average 25% EU rate.

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Ireland Will Apply for Bailout Package

The NYT notes this morning:

Ireland Will Apply for Bailout Package

Irish finance minister Brian Lenihan confirmed today that
Ireland had formally applied to Europe and the International
Monetary Fund for a bailout package.

He would not give an exact figure but said the amount would
be in the tens of billions of euros and that the final figure
was still subject to further negotiations.

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