FedUpUSA

Archive for the ‘Eurozone’ Category

By Katrina Nicholas

June 8 (Bloomberg) — Europe’s 750 billion euro ($900 billion) aid package might fail to save the 11-year-old monetary union and usher in an “extended period” of market stress and disorder, according to Royal Bank of Scotland Group Plc.

“Maybe we reach the point where this Herculean effort works and enough policy stimulus is provided so countries can fly again,” David Simmonds, global head of research and strategy at RBS, said in Singapore today. “However I do not subscribe to this view because one cannot treat a debt-fuelled over-consumption problem with a lot more debt.”

European finance ministers yesterday put the finishing touches on a rescue fund designed to combat the region’s fiscal woes and end speculation the euro area might break apart. The crisis is threatening to slow global economic growth, pushing the euro down 17 percent against the dollar this year.

The benchmark Stoxx Europe 600 Index has retreated 11 percent from this year’s high on April 15 as Spain, Portugal and Greece had their credit ratings downgraded. The region’s economy expanded 0.2 percent in the first quarter, strained by the highest unemployment in the euro’s history, and spending cuts.

“The buck stops with the sovereign,” said Simmonds, who is based in London and is visiting the city-state to meet with clients. “There isn’t going to be some intergalactic force that comes to bail out sovereigns, and that nervousness will weigh on the market for some time.”

Financial institutions globally have combined exposure to Portugal, Spain and Greece of more than 2 trillion euros, about half taken up by banks, Simmonds said.

“About 500 billion euros or so is held by French and German banks, so the point to stress is there will be a Herculean effort to hold this thing together,” he said.

–Editors: Ed Johnson, Tom Kohn

To contact the reporter on this story: Katrina Nicholas in Singapore at knicholas2@bloomberg.net

To contact the editor responsible for this story: Will McSheehy at wmcsheehy@bloomberg.net

Bloomberg Businessweek

Albert Edwards: At 500% Net Liabilities To GDP, It Is Too Late To Prevent The Collapse Of The G-7; Greece Is Irrelevant, We Are All Now Insolvent

Submitted by Tyler Durden

For Greece, with on and off balance sheet liabilities at over 800%, it’s game over. For the Eurozone, with the same ratio at about 500%, it is also game over. For the US, at 500%+, it is, you guessed it (sorry Joseph Stiglitz), game over, but since we have the printers, it will simply take a little longer. Following up on yesterday’s popular post on prevailing delusions as captured by Albert Edwards’ colleague Dylan Grice, we present Albert’s latest outlook. Please don’t read this if you want to keep believing there is any hope left for the (developed) world.

But first some aeral photography from Dylan Grice, indicating just how far the US government is willing to go to get the population stoked about owning fixed (shouldn’t it be called broken really?) income. With British QE over, and the country still to implement the same criminal annuitizing of 401(k)s that Uncle Sam is contempltating in order to make “Buy Bonds” a “voluntary” option one can’t really decline, maybe letters on modern architecture building blocks is all that would works. As Edwards says: “I’m not sure leaving man-sized building blocks around the City of London is really going to make an awful lot of difference, but I suppose when your public sector deficit is around 13% of GDP, every little bit helps!”

So back to Greece, the Eurozone, and policy response in general, Edwards places the causes (and “solutions”) of the escalating problem precisely where it belongs: at the core of the Keynesian systemic outlook flaw.

A major divergence of views in the market at the moment concerns what governments should be doing with their outsized fiscal deficits. Economists seem to be polarised between those who think governments should be rapidly cutting fiscal deficits to avoid impending insolvency and/or a surge in bond yields, and those who believe this will be totally counterproductive and that deficits should stay very large. Behind this controversy probably lies the key to the economic outlook.

To Edwards, and to ever more hedge fund investors judging by the jump back in Greece Bund spreads which just broke the most recent technical resistance level of 300 bps, Greece is nothing more than Russia and LTCM (or Bear Stearns as the case may be).

The situation in Greece following hard on the heels of similar solvency issues in Dubai feels to me very much like the Russian default and LTCM blow-up in 1998. For the blow-ups that year were a direct follow-on from the Asian crisis a year earlier a different chapter in the same book. There will be more crises to follow Greece, both inside and outside of the eurozone.

The outcome of broken Keynesian policy (by definition) will be ugly, and will destroy the eurozone. We said it some time ago, and SocGen has now also confirmed this bearish perspective.

My own view of developments, for what it is worth, is that any “help” given to Greece merely delays the inevitable break-up of the eurozone. But, for me, the problem is not the size of the government deficit and the solvency or otherwise of the governments in the PIGS (Portugal, Ireland, Greece and Spain – we deliberately exclude Italy).
The problem for the PIGS is that years of inappropriately low interest rates resulted in overheating and rapid inflation, even though interest rates might well have been appropriate for the eurozone as a whole. Rapid inflation has led to overvalued bilateral real exchange rates (they do still notionally exist) for the PIGS and in most cases yawning double-digit current account deficits. With most trade done with other eurozone countries, the root problem for the PIGS is lack of competitiveness within the eurozone – an inevitable consequence of the one size fits all interest rate policy. Even if the PIGS governments could slash their fiscal deficits, as Ireland is attempting, to maintain credibility with the markets in the short term, the lack of competitiveness within the eurozone needs years of relative (and probably given the outlook elsewhere, absolute) deflation. Hence the PIGS public sector deficit will inevitably remain large as a direct consequence of this weak growth outlook.

As noted earlier on Zero Hedge, in Europe the population is a little less brainwashed by the moronic happenings on prime time TV, so while in America the destruction of the economic system, as trillions are transferred to the kleptocracy which knows fully well the end game is nigh, results in some sighs of desperation at best, in Europe the outcome will be somewhat more violent.

In my opinion this will not be tolerated by the electorates in these countries. Unlike Japan or the US, Europe has an unfortunate tendency towards civil unrest when subjected to extreme economic pain. Consigning the PIGS to a prolonged period of deflation is most likely to impose too severe a test on these nations. And the political “consensus” within the PIGS to remain in the eurozone could falter in the face of another of Europe’s unfortunate tendencies -the emergence of small extreme parties to take advantage of any unrest. My own view is that there is little “help” that can be offered by the other eurozone nations other than temporary confidence-giving “sticking plasters” before the ultimate denouement: the break-up of the eurozone.

And in case you were wondering why all European leaders are powerless to provide a bailout proposal that actually has a snowball’s chance in hell of doing something/anything to help Greece, read on. Alternatively, if you want to find out why any plan suggested on Monday will be thoroughly useless and once digested by the market will cause another major crash, read on as well.

The pressure to tighten fiscal policy from current nose-bleed levels of deficits is not just an issue for crisis hit Greece. It is an issue for virtually all economies. It is a particular issue for the US and UK with structural (cyclically adjusted) general government deficits of almost 10% of GDP (according to the OECD)! There is a ferocious debate ongoing between those who believe there needs to be a rapid reduction in these deficits to avoid some combination of insolvency/default/rapid inflation and those who believe that there should be even more fiscal stimulus. The debate is loud and opinions are tending to be polarised.
My own view on this is that obviously we should never have got into this wholly avoidable mess in the first place. But having got here, there really is no way out that does not trigger a major market-moving upheaval. Ultimately economic prosperity over the past decade has been a sham: a totally unsustainable Ponzi scheme built on a mountain of private sector debt.GDP has simply been brought forward from the future and now it’s payback time. The trouble is that, as the private sector debt unwinds, there is no political appetite to allow GDP to decline to its “correct” level as this would involve a depression. So burgeoning public sector deficits and Quantitative Easing are required to maintain the fig-leaf of continued prosperity.

And here is the topic that will dominate over all pundit round table discussions in the next weeks: the entire world is insolvent, although some are more insolvent than others. Greek total net liabilities (on and off balance sheet) to GDP are 800%! EU: at 470%, the US, at over 500%. There is no way out but default.

Edwards’ poignant summation.

I am persuaded by my colleague Dylan Grice’s analysis that, including unfunded liabilities, most governments are already insolvent with debt to GDP ratios closer to 500% of GDP instead of around 100% for most G7 countries . It is too late.
Nor were Dylan and I persuaded by recent comments from Nobel Prize Winner Joseph Stiglitz that it is absurd to suggest that the US and UK governments might default on their debts as they could just print money. Indeed. But a client pointed out to us that Weimar Germany did not default on its debts during its hyper-inflation. How reassuring!
I am persuaded though by Richard Koo’s book about the lessons from Japan’s balance sheet recession. The crux of his analysis is that governments have no option but to stimulate aggressively all the while the private sector is de-leveraging. ANY attempt at fiscal cuts simply results in renewed recession and a further loss of confidence, thus making it even harder and more costly to sustain any subsequent recovery – and hence the budget deficit ends up bigger than before (e.g. see chart below). This is exactly the outcome I expect.

The take home is very, very simple: we can delude ourselves that the game can be won (it can’t), or we can prepare for the imminent collapse when delusion finally fails.

ECB Prepares Legal Ground For Euro Rupture As Greek Crisis Escalates

Fears of a euro break-up have reached the point where the European Central Bank feels compelled to issue a legal analysis of what would happen if a country tried to leave monetary union.

By Ambrose Evans-Pritchard

“Recent developments have, perhaps, increased the risk of secession (however modestly), as well as the urgency of addressing it as a possible scenario,” said the document, entitled Withdrawal and expulsion from the EU and EMU: some reflections.

The author makes a string of vaulting, Jesuitical, and mischievous claims, as EU lawyers often do. Half a century of ever-closer union has created a “new legal order” that transcends a “largely obsolete concept of sovereignty” and imposes a “permanent limitation” on the states’ rights.

Those who suspect that European Court has the power pretensions of the Medieval Papacy will find plenty to validate their fears in this astonishing text.

Crucially, he argues that eurozone exit entails expulsion from the European Union as well. All EU members must take part in EMU (except Britain and Denmark, with opt-outs).

This is a warning shot for Greece, Portugal, Ireland and Spain. If they fail to marshal public support for draconian austerity, they risk being cast into Icelandic oblivion. Or for Greece, back into the clammy embrace of Asia Minor.

ECB chief Jean-Claude Trichet upped the ante, warning that the bank would not bend its collateral rules to support Greek debt. “No state can expect any special treatment,” he said. He might as well daub a death’s cross on the door of Greece’s debt management office.

This euro-brinkmanship must be unnerving for the Hellenic Socialists (PASOK). Last week’s €1.6bn (£1.4bn) auction of Greek debt did not go well. The interest rate on six-month notes rose to 1.38pc, compared to 0.59pc a month ago. The yield on 10-year bonds has touched 6pc, the spreads ballooning to 270 basis points above German Bunds.

Greece cannot afford such a premium for long. The country must raise €54bn this year – front-loaded in the first half. Unless the spreads fall sharply, the deficit cannot be cut from 12.7pc of GDP to 3pc of GDP within three years. As Moody’s put it, Greece (and Portugal) faces the risk of “slow death” from rising interest costs.

Stephen Jen from BlueGold Capital said the design flaws of monetary union are becoming clearer. “I don’t believe Euroland will break up: too much political capital has been spent in the past half century for Euroland to allow an outright breakage. However, severe ‘stress-fractures’ are quite likely in the years ahead.”

As Portugal, Italy, Ireland, Greece, and Spain (PIIGS) slide into deflation, their “real” interest rates will rise even higher. “It is tantamount to hiking rates in the already weak PIIGS,” he said. This is the crux. ECB policy will become “pro-cyclical”, too tight for the South, too loose for the North.

The City view is that the North-South split may cause trouble, but that there will always be a bail-out to prevent a domino effect. “If a rescue turns out to be necessary, a rescue will be mounted,” said Marco Annunziata from Unicredit.

It comes down to a bet that Berlin will do for Club Med what it did for East Germany: subsidise forever. It is a judgement on whether EMU is the binding coin of sacred solidarity, or just a fixed exchange rate system like others before it.

Politics will decide, and in Greece it is already proving messy as teams of “inspectors” ruffle feathers. The Orthodox LAOS party is not happy that an EU crew dared to demand an accounting from the colonels. “The Ministry of Defence is sacrosanct,” it said.

Greece alone in Western Europe treats the military budget as a state secret. Rating agencies guess it is a ruinous 5pc of GDP. Does the country really need 1,700 battle tanks, 420 combat jets, and eight submarines? To fight NATO ally Turkey? Merely to pose the question is to enter dangerous waters.

Who knows what the IMF surveillance team made of their mission in Athens. The Fund’s formula for boom-bust countries that squander their competitiveness is to retrench AND devalue. But devaluation is ruled out. Greece must take the pain, without the cure.

The policy is conceptually foolish and arguably cynical. It is to bleed a society in order to uphold the ideology of the European Project. Greece’s national debt will be 120pc of GDP this year. S&P says it will reach 138pc by 2012. A fiscal squeeze – without any offsetting monetary or exchange stimulus – will cause tax revenues to collapse. Debt will rise higher on a shrinking economic base.

Even if Greece can cut wages without setting off mass protest, it lacks the open economy and export sector that may yet save Ireland in similar circumstances. Greece is caught in a textbook deflation trap.

Labour minister Andreas Loverdos says unemployment would reach a million this year – or 22pc, equal to 30m in the US. He broadcast the fact with a hint of menace, as if he wanted Europe to squirm. Two can play brinkmanship.