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Posts Tagged ‘Spain

Merkel faces a Hobson’s choice on eurozone

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by Philip Aldrick
Telegraph Economics Editor
Posted 06 August 2011

Muggings have been on the rise on the streets of east London, Scotland Yard said this week. And blood-stained necklaces have been turning up in pawnbrokers with alarming frequency. It’s no coincidence, police claimed. The surge in snatch-and-grab is all to do with the soaring price of gold.

GOLD HAS BEEN HITTING RECORD HIGH AFTER RECORD HIGH because the precious metal is considered the ultimate safe-haven by nervous investors. And there are a lot of nervous investors in the markets. This week gold struck another record, at $1,681.67 an ounce. Nick Bullman, managing director of ratings agency CheckRisk, reckons it will not stop until breaking its inflation-adjusted peak of $2,300.

It’s not just the shoppers of Canning Town who are getting a mugging. Fear is stalking the markets. Fear of a US downturn, fear of a sovereign debt crisis in Italy or Spain – countries considered “too big to bail”, fear of another global recession. As those fears gathered into panic this week, the world witnessed an extraordinary series of events.

Stock markets did not just crash, they crumpled. Some £149bn was wiped off the value of Britain’s blue-chip stocks as the FTSE 100 suffered the fifth largest fall in its history. Trading in the shares of the country’s biggest banks were suspended after dropping more than 10pc. In just seven trading days from July 26, $4.5 trillion was wiped off the value of equities worldwide.

As investors fled to traditional safe-havens of the Swiss franc and the Japanese yen authorities were forced to act. So strong had panic buying made their currencies that it threatened growth. Both nations intervened. Japan sold about ¥4 trillion (£30bn) of its yen reserves and did ¥10 trillion of quantitative easing (QE). Switzerland cut rates to zero and launched Sfr50bn (£40bn) of QE. The moves bought temporary relief.

The hunt for safety created other bizarre distortions. Yields on US treasury bills – short-term government debt – turned negative. Similarly, Bank of New York Mellon, America’s biggest custodial bank, started levying a fee on deposits of over $50m as it was flooded with cash. Market norms were turned on their head. Investors were paying to lend money. “When you do that, you are saying everything else is just too scary,” said Mr Bullman.

What had the markets spooked was the dawning realisation that Spain and, in particular, Italy may not repay their debts. If that happened, the world would suffer another seizure. “It would be Lehman Brothers on steroids,” as some traders have put it. Italy has been worrying markets since mid-June, a month after Standard & Poor’s put its credit rating on watch. Its benchmark 10-year bonds have been creeping higher ever since – the clearest sign of a looming crisis.

This week’s panic, though, was the culmination of weeks of frayed nerves and political paralysis. “Politicians keep scaring the hell out of people as they seem to be burying their heads in the sand,” Mr Bullman said. Which is why, if there was an original tipping point, it can be traced to July 21. That was the day the second Greek rescue was agreed and further measures unveiled to prevent another eurozone country being sucked into the crisis – following Ireland and Portugal as well as Greece. The backstop was dangerously weak, though. The size of the eurozone bail-out fund, the European Financial Stability Facility (EFSF), was increased from €250bn to €440bn and the terms of its operations broadened to make it more nimble. But the agreement needed a vote, due in September, and seemingly ignored the risk of a Spanish or Italian crisis.

To provide a real firebreak, the EFSF needs about €2 trillion, analysts reckon. Italy’s national debts are €1.8bn, the third largest debt market in the world behind the US and Japan. Spain’s are €640bn. An EFSF with €440bn was woefully inadequate. Europe’s leaders, though, simply closed their ears to the siren voices and turned to planning their summer holidays.

Alarm bells should have already been ringing. At 4.8pc on June 21, Italian bonds had surged to 5.68pc shortly before the Greek bail-out. The lesson from Greece, Ireland and Portugal was that once bonds top 5pc, they soar to 7pc within 30 to 60 days without intervention. At 7pc, the debt problem becomes a full-blown crisis – as markets decide the country can no longer pay its bills. With no credible backstop, market fears were allowed to burn out of control.

Already wearied by the drawn-out deal to raise the US debt ceiling, which only entrenched political cynicism, and unnerved by evidence that the global recovery is stalling, the second tipping point came this week. First the President of the European Commission, José Manuel Barroso admitted in a letter to European heads of state that the size of the EFSF needed to be increased. Hours later, the European Central Bank intervened in the markets – but instead of buying distressed Spanish and Italian debt it targeted Portuguese and Irish bonds. Seemingly, political divisions within the ECB were neutering its powers.

Holger Schmieding, economist at Berenberg Bank, said the ECB’s move “may go down in history as its worst blunder yet”. “What would we make of a fire brigade that responds to a major emergency but then drives to the wrong place and refuses to turn around and douse the real fire?” Traders scented weak political will and rounded in fear on Italy. Its bonds rocketed to 6.189pc – a fresh euro record.

If it can’t raise funds, Italy has until the end of September before it runs out of cash or Europe comes to its aid. Spain has until February. The problem is now purely political. Italy needs more austerity to reduce its debt burden, and to push through structural reforms to make its labour market more competitive. Spain must recapitalise its banks, and accelerate its own austerity plans. In return, Europe has to make the EFSF a viable safety net.

As usual in Europe, it all comes back to truculent Germany. Only Berlin can provide the guarantees needed to restore confidence. But it is too late to buy confidence cheaply. Angela Merkel, the German Chancellor, faces a classic Hobson’s choice. Put taxpayer money on the line and lose her job, or risk a catastrophe. That’s a mugging in all but name. Unsettling parallels are being drawn between the current panic and the market meltdown in 2008.

Then, as now, oil had blown sky high. It hit $145 a barrel in July 2008 before coming back down. This time it struck $125. Inflation, too, was out of control – at around 5pc – in line with most economists’ forecasts for the next few months. Stock markets had moved sharply lower and growth had started to slow.

More pertinently, the country had been wrestling with a looming crisis for months – that time with the banks. Seized by similar indecision, policymakers took five months to nationalise Northern Rock and failed to recapitalise other lenders until too late. Then, a political decision not to bail out Lehman Brothers triggered panic that paralysed markets. This time, it is again in politicians hands. The parallels are not surprising. Ultimately, the current crisis is the latest manifestation of the last one.

Please Europe, either put up or break up

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by Ambrose Evans-Pritchard
Posted August 5th, 2011

THE DEBT CRISIS IS MOVING AT LIGHTNING SPEED. We must wait to see whether the ECB is really willing to sit back and let the whole edifice collapse. Are the Bundesbankers really so stubborn that they would rather bring down the European financial system, tank the world economy, and cause a deep global depression, rather than enter the bond market on a sufficient scale to back-stop Italy and Spain?

Tough call. 50:50, I’d say. The hardliners are seriously ideological people, and there seem to be some in the upper echelons of German policy-making (though obviously not the floundering bean-counter Schauble, or the battered Chancellor), who suspect that it might be better to lance the boil by forcing an immediate break-up of EMU.

I note that Belgium’s central bank governor Coene hinted that the ECB is withholding bond purchases to force Italy and Spain to push through – you guessed it – yet more growth-destroying austerity. Dangerous game. These 1930s deflationists really are a menace to society. In a nutshell, unless the ECB is willing to step in – I mean really step in, not piss in the wind – until such a time as the revamped EFSF bail-out is ratified by all parliaments and is ready to take the baton (say November), and unless the EFSF itself is quadrupled in size and given a €2 trillion mandate without all the German-imposed ifs and buts, then the game is up.

If the EU authorities refuse to do this, it is best for everybody that it is recognized immediately and that arrangements are made for the orderly break-up of monetary union…  not next year, or next month, but next week. There are two basic choices:

1) a spiralling crisis in the South, leading to a string of countries being blown out of EMU, causing a catastrophic financial collapse akin to 1931. As Citi’s William Buiter told me yesterday, the issue is not how long Italy and Spain can ride out the storm in bond markets. There would be a banking and insurance crisis long before sovereign defaults came into play, simply because the fall in bond prices on the secondary market is causing carnage to bank books (among other transmission mechanisms).

Or 2) Germany and its satellite economies withdraw immediately from EMU (let us say the Netherlands, Austria, Finland, Flanders and Luxembourg). This allows the South to enjoy a much-needed devaluation to restore competitiveness without going through a disastrous Fisherite debt deflation. Their contracts would remain in euros, so they would not need to default.

Temporary capital controls and some form of financial repression would obviously been needed for a few weeks. The German bloc would have to stand ready to recapitalize its banking system with €100bn perhaps (peanuts in the bigger picture) to offset the shock effect on sudden exchange losses on Club Med debt.

This would require French leadership. (I have almost given up on Germany.) Carried out with Napoleonic speed and determination, I think this could conceivably prove the game-changer that halted the downward global spiral. Markets would very quickly see that the greatest impediments to recovery had been removed. We could rejoice, and breathe a little easier again. My guess is that stock markets would surge in Milan, Madrid and Paris, as occurred in London and Milan after the ERM crisis in 1992.

Yes, I know, EMU is not the ERM, blah, blah, sanctity of the Project, blah, blah, blah. But just how different is it really? Will this happen? I don’t see much evidence that anybody is thinking along these lines. (The Buba men seem to want to expel Greece, Portugal, etc, which is not at all what I mean.) Just my instant thoughts on a story that is moving with lightning speed.

More later, after some Rioja, and a Vecchia Romagna to finish.

Portugal loses patience with Europe

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by Ambrose Evans-Pritchard
Posted July 18th, 2011

 

AT LAST, SOME RAW EMOTIONAL GAULLISTE PATRIOTISM FROM THE VICTIMS of Europe’s Maquina Infernal? Portugal’s new premier Pedro Passos Coelho — a free marketeer — began to growl over the weekend. “We want to take part in an ambitious European project and make our contribution so Europe can confront its problems in the most ambitious way, but as prime minister I will not stand by and wait for Europe to govern Portugal,” he told the party faithful.

For Portuguese readers: “Nós queremos participar num projecto europeu ambicioso e queremos dar o nosso contributo para que a Europa saiba encontrar respostas mais ambiciosas para os problemas, mas como primeiro-ministro nunca ficarei à espera do que a Europa tenha que fazer para governar Portugal”

Please correct me if my loose translation is wrong.

So, it has begun: last week Greece’s premier George Papandreou launched two angry broadsides against EU magnates. How could he do otherwise after Eurogroup chair Jean-Claude Juncker told a German newspaper that Greece’s sovereignty would be “massively limited”?

“Massively limited?” Mr Juncker should be clamped in irons if he dares set foot on Greek soil. Now the leader of what is arguably Europe’s oldest nation state (foundation 868, under Vimara Peres) has shown the first hints of frustration.

Just to remind you: unemployment in Portugal is 12.4pc (youth: 28.1) and about to rise much further as the fiscal punch hits. The figures for Spain are 20.9pc (44.4), Greece 15pc (38.5), Ireland 14pc (26.5), Latvia 16.2pc (32.9). Yet the these countries are all facing further headwinds of fiscal and monetary tightening.

For a serving prime minister to make such remarks at this delicate juncture might be taken by some as a cloaked threat  to walk away from the EU project, if the country continues to be treated in a humiliating and damaging fashion. Mr Passos Coelho is fencing with a double-edged blade. Even to hint at misgivings over EMU is to set matters in motion. The markets were very quick to pick up on political body language during the ERM crisis in 1992. The Portuguese leader also said there was a “colossal” €2bn hole in the public accounts left by… well, somebody. He refrained from blaming the outgoing Socialists. They are needed to help pass laws in the Assembleia. Any other skeletons to be uncovered?

I have great sympathy for Mr Passos Coelho and for the Portuguese people. The German-led creditor states have treated the EMU crisis as if it were a morality tale, castigating Club Med and Ireland for alleged fecklessness. All that is required — goes the argument — is further austerity, a dose of 1930s wage and debt-deflation, and virtue will be its own reward. The Left-wing Bloco calls it “social terrorism”.

Adding injury to insult, Germany has insisted that Portugal, Greece, and Ireland pay a penal rate of interest some 200 to 300 basis point over the cost of funding paid by the EU’s bail-out machinery, though this may soon be cut somewhat. As former US Treasury Secretary Larry Summers said this morning in the pink sheet, such penal rates play havoc with debt dynamics and are driving a string of countries into insolvency and depression.

This Germanic view of events is self-serving and intellectually dishonest. Southern Europe is in trouble because Europe’s monetary union is and always was dysfunctional. The Maastricht process caused interest rates to plunge in the Club Med bloc, setting off credit booms. Portugal’s rates fell from 16pc to 3pc in short order.

The ECB poured further petrol on the fire by tilting monetary policy to German needs in the middle of the last decade, when Germany was in trouble. The ECB breached is own eurozone M3 and inflation targets for year after year. In the specific case of Portugal, the boom occurred earlier, in the late 1990s. No doubt a great many foolish errors were made in those halycon days. (I wrote about them at the time or shortly after, and was roundly reproached for my insolence).

Yet over the last eight years Portugal has been relatively frugal. It did not have an Irish banking bubble, or a Spanish property bubble. It did let social transfer costs creep up to 22pc of GDP — when they should have been falling — but it also passed a string of fiscal austerity packages. Yet at the end of the day it was punished anyway. It has failed to reap any worthwhile benefits. There has been no economic convergence or EMU catch-up effect. Productivity has remained stuck at 64pc of the core-EU average. Portugal switched from surplus on its external accounts in the early 1990s to a deficit of 109pc of GDP today.

Public and private debt has ballooned to 330pc of GDP, one of the highest in the world. Portugal will still have a current account deficit of almost 8pc this year and the budget deficit was still running at a 8.7pc rate in the first quarter. Such a profile two or three years into draconian cuts and demand compression is almost tragic. And now they must implement yet further austerity, without debt relief or offsetting monetary stimulus or devaluation. This policy is a near certain formula for economic asphyxiation..

In Portugal — as well as Greece, Ireland, and perhaps Spain in due course — we are moving closer to the point where national leaders must decide whether to satisfy EU demands, or placate their own citizens, for is it no longer possible to serve these two masters at the same time?

Can there really be any doubt as to the outcome of this tug-of-war

Sovereign debt blows big holes in big banks

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by John Browne
– Euro Pacific Capital
Posted July 14th, 2011

THE PAST FEW DAYS HAVE BEEN VERY BAD FOR THE WORLD’S LARGEST BANKS. American behemoths Citigroup and Bank of America are down about 7% each. Across the Atlantic, things are far worse. BNP Paribas, Barclays, and Banco Santander are all down 13% or more… and Société Générale is down an astounding 16%! Some pundits warn of an overreaction and suggest this is a buying opportunity for the beat-up financials. I disagree. Rather, I think the financials should now be considered toxic assets. Caution is justified.

It was only a week ago that markets were preoccupied by a downgrade of Portuguese sovereign debt and renewed concerns that Greece will need about $100 billion by year’s end to remain solvent. Now, as eyes are quickly shifting towards the first tremors of financial crisis in Italy, concerns over Greece and Portugal seem rather quaint. With an economy roughly 7 times larger than that of Greece, Italy is simply too big to bail out. Its collapse, like the sinking of a great ship, could create a vortex that drowns Europe’s major banks in red ink.

In addition to exposure to sovereign debt from insolvent nations like Greece, Italy, Spain, and Portugal, major US and EU banks are also massively exposed to toxic mortgage debts, the value of which continues to be eroded by crumbling real estate markets across the West. Meanwhile, at the least opportune moment, the banks are being besieged by ill-targeted regulations devised by vindictive politicians. Finally, banks’ balance sheets are skewed by ultra-low interest rates and new rules that shield them from pricing their assets to market. Beneath a thin veneer of smoke and mirrors, serious risks remain.

Intractable budget negotiations in Washington and Rome have significantly increased the likelihood of default by the West’s two major economic blocs. It could be reasonably inferred that we are entering a new phase of sovereign decline: the US is within weeks of temporary default; Italy is teetering; and the consensus on Greece is shifting toward the ‘German fix’ of bondholder haircuts. What’s worse, there are no long-term solutions readily apparent. The EU is so rigid that it’s only option is to break into pieces, while the US is so pliant that its main political parties are allowed to waste precious time scoring political points at the expense of the greater good.

Since the EU does not have a formal mechanism for handling default, large European banks have been ‘persuaded’ for many months by the ECB and national governments to invest in the debt of financially challenged nations within the EU, most importantly that of Portugal, Ireland, Italy, Greece and Spain (PIIGS). This approach was considered more politically viable than direct investment by the ECB. Now, these European banks are left holding the bag. Since there is still no viable mechanism to deal with this debt at the sovereign level, it’s no surprise that EU banks are being hit hardest in this correction. The question remains: what were they promised in exchange for ‘walking the plank’ into the debt abyss?

American banks have a lesser exposure to sovereign debt of the European PIIGS, but many of these institutions have made massive profits by selling insurance derivatives known as credit default swaps to their European counterparts. This is the same strategy that brought down insurance behemoth AIG in the wake of the 2008 Credit Crunch. Therefore, major American banks are far more heavily exposed to PIIGS debt than first appears. It’s as if they have learned nothing. Even conservative, and supposedly bulletproof, money market funds have exposure to EU bank debt.

I do not expect all of these banks’ shares to go to zero. Powerful governments are likely to resort to almost any means to salvage their grotesque central-banking/fiat-money system. Likely, that will include eventually forcing their citizens to rescue their banks again — but this time from even larger losses. However, in the meantime, the financials’ earnings and share prices could suffer dramatically.

Moreover, Italy’s situation brings some larger questions to the forefront: what happens when the next round of bank bailouts bring major sovereigns to their knees? Where will you want to have your assets positioned if the EU comes apart at the seams, or the US stops paying its soldiers and seniors? What’s your plan if the central banks flood the market with even more cheap money?

Readers are strongly encouraged not to waste time gambling on shaky financials, but rather to build themselves an ark of hard assets and start rowing away from the sinking great ships of state. You don’t want to be caught in the vortex when they go down.

“Growing your way out of debt” is a fantasy

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by Charles Hugh Smith from Of Two Minds
Originally posted June 22, 2011

ADD RISING INTEREST PAYMENTS AND HIGHER TAXES to declining assets and incomes and you don’t get “growth,” you get insolvency. The Status Quo consensus is that “kicking the can down the road” a.k.a. “extend and pretend” will work because “Greece, Spain, Ireland et al. are going to “grow their way out of debt.” That is a fantasy.

Here’s why.

1. There’s a funny little feature of debt called interest. The Status Quo solution for Ireland, Greece, Portugal, Spain et al. is A) increase their debt load with more loans and B) roll over their old debt into new loans, without the old lenders taking any “haircut” on the principal. Both of these “solutions” add more interest costs. That means more of the national income stream must be diverted to pay the lenders their pound of flesh. That means there is less money in the national economy to buy goods and services, which means the economy must shrink to pay the higher interest costs.

This is why unemployment in Spain and Greece has skyrocketed and why 100,000 small businesses have closed in Greece in the past year.

2. A funny little feature of interest is that when people see you’re at risk of default, they start charging you more to borrow their moneyAnd it isn’t a tiny bit more interest, it’s a lot. Think subprime teaser loan at 3% shooting to 8%, or 28% if you’re trying to sell new debt on the open market. For the E.U. to “help” Greece and Ireland by rolling over their already crushing debt loads into new, higher interest loans is like “helping” a sick patient by sticking a knife into their back.

3. Governments over-promise future benefits to win elections in the here and now. This makes sense, of course, because you win the elections and power now and the problem of paying for these excessive benefits is left to future politicos and taxpayers. But when the phony “growth” (think metasticizing cancer) fueled by rapidly rising debt is finally cut off, then the government has no choice but to raise taxes, and keep raising them, to pay for the extravagant past promises made to citizens.

That means more of the national income is diverted to taxes, only part of which flow through as cash benefits to consumers. Much of the tax revenues flow to cronies, fiefdoms and of course those higher interest payments on the ballooning debt.

4. Cheap abundant credit has a funny little consequence: asset bubbles. When everybody can borrow vast sums of nearly-free money at costs much lower than the outlandish gains being reaped by real estate speculators and punters pouring cash into stocks and commodities, then of course it is a perfectly rational decision to leverage yourself to the max, borrow as much as you can and join the speculative frenzy.

So assets bubble up to frothy levels, and McMansions sprout by the thousands on Irish and Spanish soil. The “demand” is not for shelter; it was all speculative demand for something to flip and churn. So when the debt bubble pops, so too do all the asset bubbles.

5. Leverage has a funny little feature called collateral and that other peculiar feature, interest. The land and house are the collateral for a mortgage (debt). As the real estate bubble popped, then the value of the collateral plummeted. Now the collateral is worth less than the loan–the borrower is “underwater.” The lender foolishly reckoned this would never happen, and now taking the collateral when the borrower defaults is an unsavory option because the lender will have to absorb a huge loss (“haircut”) if they take the property.

So they choose to “extend and pretend,” offering the borrower new terms, lower payments, etc., anything to keep the loan value on the books at 100%.

All of this is just artifice, of course; the borrower is insolvent, and so is the lender. As long as the borrower has to pay interest and principal, then there is not enough income left to “grow” anything. As long as the lender keeps the impaired loan on the books at the bogus valuation, then the lender is treading on the thin ice of insolvency.

6. As the national income and asset valuations both decline, the government imposes “austerity” programs which further cut incomes. A funny little feature of government “austerity” is the cuts come from the citizen’s side of the expense ledger, not from the crony/fiefdom side. Here in the U.S., for example, the library hours are slashed and the parks are closed to save $22 million in a $100 billion annual budget (those are the numbers in California) while various favored fiefdoms continue to get their swag. The “pain” of austerity is anything but evenly distributed.

7. People facing financial uncertainty and duress have a funny little habit called saving. As the reality of instability becomes crystal-clear to all, then people rather naturally rally round and circle the wagons, i.e. start saving money to cushion them through the hard times. Trusting in future benefits and bubbles is obviously foolish, and the only avenue of relative safety is cash (or equivalent) in hand. As people save more of their declining income, there is even less national income left to be spent on goods and services.

8. These forces are self-reinforcing. The worse times get, the more people save. the lower the national income, the more taxes will be raised. The more visible these trends become, the more interest lenders demand as they see the positive feedback loops leading to insolvency.

Once a household or nation is burdened with stupendous debt loads and stagnating earnings, “growing your way out of debt” is impossible. The E.U. may succeed in strong-arming Greece into swallowing even more debt, more austerity and higher interest payments, but that will only speed up the self-reinforcing dynamics of insolvency, and guarantee the losses kicked down the road for a few months will be even more devastating.

Europe at the Abyss

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by Robert Samuelson
Posted originally May 30, 2011

IT HAS COME TO THIS. A year after rescuing Greece from default, Europe is staring into the abyss. The bailout has proved insufficient. Greece needs more money, and it can’t borrow from private markets where it faces interest rates as high as 25 percent. But Europe’s governments are reluctant to advance more funds unless other lenders – banks, bondholders – absorb some losses by writing down their debts.

This, however, would constitute a default, risking a broader banking crisis that might torpedo Europe’s fragile recovery in France, Germany and elsewhere. There is no easy escape.

WHAT’S CALLED A “DEBT CRISIS” IS INCREASINGLY A POLITICAL AND SOCIAL CRISIS. Looming over the financial complexities is the broader question of the ability – or willingness – of weak debtor nations to endure growing hardship to service their massive government debts. Already, unemployment is 14.1 percent in Greece, 14.7 percent in Ireland, 11.1 percent in Portugal and 20.7 percent in Spain. What are the limits of austerity? Steep spending cuts and tax increases do curb budget deficits; but they also create deep recessions, lowering tax revenues and offsetting some of the deficit improvement.

Just how long this grinding process can continue is unclear. In Spain, the incumbent socialist party lost big in recent elections. Popular unrest persists in Greece amid signs of a “resurgence of an anarchist movement” there and elsewhere.

Some causes of Europe’s plight are well-known: the harsh recession following the 2008-2009 financial crisis; aging populations coupled with costly welfare states. But there’s also another less recognized culprit: the euro, the single currency now used by 17 countries.

Launched in 1999, it aimed to foster economic and political unity. Economic growth would improve. Costly currency conversions would cease; money would flow smoothly across borders to the best profit opportunities. Using euros – and not marks or lira – Germans, Italians and others would increasingly consider themselves “Europeans.” For a while, it seemed to succeed. In the euro’s first decade, jobs in countries using the common currency increased by 16 million.

It was a mirage. The euro helped create the crisis and has made its resolution harder, as a new report from the International Monetary Fund shows. For starters, the euro fostered a credit bubble that led to booms in housing, borrowing and consumer spending. When each country had its own currency, the country’s central bank (its Federal Reserve) regulated local interest rates and credit conditions. With the euro, the European Central Bank (ECB) assumed that job. But one policy didn’t fit all: Interest rates suited to Germany and France were too low for “periphery” countries (Greece, Ireland, Portugal and Spain).

“Financial markets” – private investors – compounded the problem by assuming that the euro’s creation reduced risk. Weak countries would be protected by the strong. Money poured into the periphery countries. There was a huge compression of interest rates. In 1997, rates on 10-year Greek government bonds averaged 9.8 percent compared to 5.7 percent for similar German bonds. By 2003, Greek bonds fetched 4.3 percent, just above the 4.1 percent of German bonds.

“The markets failed. All this would not have occurred if banks in Germany and France had not lent so much,” says economist Desmond Lachman of the American Enterprise Institute. “It was like the U.S. housing market.” Both American and European banks went overboard in relaxing credit standards.

Now that the credit bubble has burst, the euro impedes recovery. One way countries revive from financial crises is by depreciating their currencies. This makes exports and local tourism cheaper, creating some job gains that cushion the ill effects of austerity elsewhere. But latched to the euro, Greece and other vulnerable debtors forfeit this safety valve.

Greece’s debt is now approaching an unsustainable 160 percent of its annual economy (gross domestic product). If it defaulted, investors might dump bonds of other weak debtors for fear that they too would default. That could send interest rates soaring and saddle European banks with huge losses. At the end of 2010, Europe’s banks had about $1.3 trillion of loans and investments – both governmental and private – in Greece, Ireland, Spain and Portugal, reports the Institute of International Finance, an industry research group. A banking crisis would imperil economic recovery.

So Europe is playing for time. It’s struggling to delay any Greek default long enough for other vulnerable countries to demonstrate they can handle their debts. The very process makes the euro – contrary to original intent – a source of contention, as nations shift blame and costs to others. Given Europe’s huge debts, even the holding action may fail. It may merely postpone a broader crisis. “They may dodge this bullet,” says Lachman, “but not the next.”

Copyright 2011, Washington Post Writers Group

Green Shoots, Exit Strategy, No QE3

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by Jim Willie, CB
Posted originally May 25, 2011

www.GoldenJackass.com

An historically unprecedented mess has been created by compromised central bankers and inept economic advisors, whose interference has irreversibly altered and damaged the world financial system, urgently pushed after the removed anchor of money to gold.

IT IS NOT CLEAR WHETHER THE AMERICAN FINANCIAL COMMUNITY HAS THE ABILITY to observe and conclude that the US Federal Reserve is adrift and relies upon deception as policy in revealing its directions. Its position is to hold steady, inflate to oblivion, support financial markets in heavy volume secretly, and lie about leaving its trapped policy corner. The USFed is a propaganda machine that deals with ruses as a substitute for transparent policy discussion in the public forum. Two years ago the ruse disseminated widely was the Green Shoots of an economic recovery that had no basis at all. The scorched earth showed more evidence of ruin than fresh business creation, at a time when the grotesque insolvency was spreading like a disease throughout the entire US financial system.

On one hand the USFed was busy operating numerous credit and liquidity facilities in order to prevent systemic seizure, busily redeeming the Wall Street toxic bonds at the highest possible prices. On the other hand they were talking about Green Shoots, as insolvency spread across the big banks to the household equity. They lost their credibility in the process. They have lost it completely after two full years of 0% rates, the ultimate in central bank shame. The Jackass dismissed the Green Shoots ploy quickly, regularly, and correctly, as whatever little shoots showing were probably mistaken for some toxic green runoff from a nearby financial office of a corporation.

One year ago the ruse disseminated widely was the Exit Strategy from the 0% monetary corner that had no basis at all. The USFed was well aware that 0% as an official rate was untenable, dangerous, and would produce different maladies. They promoted a phony story of a Jobless Recovery, an utter contradiction and bad joke played upon the American workers. To make the cost of money free encourages speculation in the most general systemic sense. The primary gold market fuel is the price of money being far below the current price inflation rate. Anyone who believes the CPI is actually 2% to 3% is braindead. Even USGovt statistics list the numerous categories with strong price increases, yet the overall CPI is lower than all components. Power to adjustments.

My description has been that the USFed is stuck in the 0% policy corner. The corner has been described since the start of 2009 when it was instituted. If the USFed raises rates, they torpedo the housing market left as derelict adrift at sea, listing badly, taking on more water, weighed down by the inventory burden. Given that the USEconomy was so dependent upon housing for three or four years, and that dependence has turned to deep vulnerability, they cannot hike interest rates and exit the policy corner without sending home prices into a fast acceleration downward. They will bottom out 20% to 30% below construction costs.

Worse, a rate hike would trigger a credit derivative series of explosions from the Interest Rate Swaps. These queer devices hold down long-term rates far below the prevailing price inflation level. That is why the USFed Chairman Bernanke insists on an undying focus of the inflation expectations, the USTreasury Bond yields and TIPS yields (both of which they purchase in monetization operations). They control them using IRSwaps. If the USFed holds steady, as they must, they generate significant rising costs for everything from food to energy to metals to cotton. Even scraps (paper, metal, plastics) are rising in price. Even the toys sector must contend with fast rising prices in time for the Christmas season. See the Li & Fund effect, also called Foxconn in China. They also make i-Pods.

The current path lifts the cost structure to such a level that both businesses and households are experiencing a pinch. The fast collapse of the Philly Fed index is testament to the pinch. Shelves at major retail chains are experiencing a slow decline in volume. It is called the profit squeeze. Business profit margins are shrinking, even as household discretionary spending funds are shrinking. The Jackass dismissed the Exit Strategy ploy quickly, regularly, and correctly, as the monetary policy corner was described consistently and clearly. It was a bluff, but a very bad one. The savvy analysts did not fall for it, since the consequences of ending the 0% rate would be like turning the lights off for the entire USEconomy.

THE BIG RUSE & THE BIG BIND

The USFed is caught in a gigantic bind, cannot raise rates, and must endure the global price inflation problem that festers on the cost side of the equation. They busily deny their role in producing price inflation from debt monetization coupled with 0% rates. They lost more credibility in the process. They are the object of global anger and ridicule. They must hope that the eventual rate hike will keep the speculative juices from overflowing. Gold & Silver do not rest, as they brush aside such a plain ruse of a threatened rate hike. The sovereign bond situation in the entire Western World (with Japan adopted into the fold) is horrendous and worsening. The government deficits are out of control. Few analysts prefer to point out how the foundation for the global monetary system is supported by the gaggle of crippled sovereign bonds. To be sure, the Southern Europe debt is in a ruined state. But the debt of the United States is no better and the same for England, when viewed as annual debt ratio to total budget, when viewed as cumulative debt ratio to GDP (economic size). The graph below shows those two dimensions, and how the United States and United Kingdom are positioned among Spain, Ireland, and Greece, apart from the mass of nations. In the full year since this graph was produced, the US debt situation has grown worse. The reckless socialists seem prudent.

The extended PIIGS pen of nations, fully ruined and recognized widely as ruined, do not have the tools to prevent rising bond yields. They uniformly rise versus the German Bund benchmark. Their differentiation actually permits the Euro currency to trade more freely, even to rise. The Chinese were responsible for much of the Euro rise from 130 to 150, as they dumped USTBonds in favor of discounted PIGS debt, later to be converted into shopping malls, commercial buildings, and factories. Somehow, that factor did not appear on the US news networks. The USGovt has tools, wondrous electronic tools, which enable them at zero cost to fight off the barbarians at the gate. It is the Printing Pre$$. Unfortunately, its backfire is a powerful rising cost structure that has shown visibly in the high food & gasoline costs. So hardly at zero cost!! A year ago, the USFed folded like a cheap lawn chair. Instead of exiting their 0% corner, and implementing the advertised Exit Strategy, they went one step deeper down the rathole. That was exactly the Jackass forecast, QE to follow 0% stuck. They combined the ZIRP with the QE. They added the debt monetization scourge of Quantitative Easing to the already reckless no cost money of the Zero Interest Rate Policy.

PURE QE3 DECEPTION

The current ruse disseminated widely is the End of QE2 and no continuation of Quantitative Easing (aka debt monetization). The ruse has no basis at all in reality. The USFed would have to find buyers for the USTreasury Bonds. They have been buying 75% to 80% of USTBonds since the end of 2010. They have been supporting the US housing market by purchasing mortgage bonds. In other words, they have been preventing the more complete implosion of the mortgage market. It is one thing for the USTBond to go No Bid. The USFed has the direct responsibility to cover that up quickly and proclaim every USTreasury auction a rip-roaring success with great 2.3 bid to cover ratio. But it is another matter altogether to permit the mortgage rates to fly upward from lack of bids. If mortgage rates move to 7% or the adjustable ARM mortgages reset 3% to 4% higher suddenly, then housing prices will descend by another 10% to 15% quickly, as in with lightning speed.

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