Monday February 20, 2012

Greece, Greece, Greece...  Every week we think that some other topic must surely float to the top of the agenda, and every week it doesn't happen.  As we write this commentary, Europe's finance ministers are meeting, late at night of course, to conclude their discussions about the vexing €130bn bailout allegedly required to sort out that country's finances.  Two thoughts spring immediately to mind.

First, the pretence has long been abandoned that one cent of this money will ever find its way across the Balkans to help the Greeks through their desperate times.  Even a month ago, such suggestions were largely found on the fringes of journalism, but today internationally respected commentators are happy to state this obvious fact.  The money that is not immediately paid out to creditors will be put into escrow accounts, or controlled by representatives of foreign powers stationed in Athens.  Second, the idea that even this sizeable sum, combined with debt renegotiation, could ever bring Greece back to economic viability is a complete joke.  Even 100% debt forgiveness would only be a start, from which the euro would steadily drag them back into the mire from which they had been struggling to escape.  The only future for the Greeks lies in a complete default, followed by a return to the drachma which worked perfectly well for them, but this would not suit the Northern European banks at all, and that is the reason why this "bailout" is still being discussed.

All the same, we have the feeling that the agreement which all of the important players ( not including the Greeks, of course ) want so badly, may yet not happen.  Our reasoning is that the common interests of France and Germany, with the US as a more than interested bystander, seem to have been overtaken by mutual loathing.  There has been a fascinating story going the rounds this week, at first on blog sites but since taken up by some of the mainstream media, that the Americans and the Germans had got together to fix an early timetable for Greek default and exit from the eurozone.  The object was to "amputate and cauterise", on the basis that the damage from a quick end to the whole problem could be contained.  We're not so sure about that last bit, and it's no surprise that M. Sarkozy, the French leader, was nowhere mentioned among the collaborators.  His banks would be the worst hit, right in the middle of his uphill struggle to achieve re-election.  The suggestion is that the Germans, who are heartily sick of him, would take delight in this, while the White House, which is not at risk to the voters until November, would be happy to see any unpleasantness out of the way early.

Mario Monti, whom the Germans recently installed as their prefect in Rome, has come up with an interesting idea.  Why waste the money on a lost cause like Greece, he asks, when the funds could be put to much better use in Italy?  Superficially, this might make sense, except that he clearly expects the €130bn actually to be spent, rather than passed through to the Paris banks, so there may be a misunderstanding to be sorted out.  All the same, the Germans, who have formed a high opinion of Super Mario, for some reason seem quite taken with the idea - could they have put it into his head?

We're not hearing much about credit default swaps any more, which is rather a shame because they raise fascinating issues, and we do not believe they will stay out of the limelight.  It is quite clear that the ISDA, the body responsible for declaring when a default event has occurred, have looked into the abyss and are so frightened by the consequences of making such a declaration that they have found increasingly contorted ways to insist that events which walk like a duck, quack like a duck and taste like a duck are in reality daffodils.  However, last week's announcement that in the coming voluntary ( but somehow mandatory ) bond swap, the ECB intends to give itself bonds which are senior to everyone else's, will surely prove the final straw, and there will be lawsuits.  In fact, so discredited are the Greek CDSs that it is suspected that as little as €10bn of open interest remains, but all the same, we suspect that a trigger of the default mechanism would rattle the cages of the big sellers of the instruments on other shaky sovereign credits.  Italy has one of the world's largest bond markets, with CDS coverage to match, and the Wall St banks are reportedly very keen to see those remain dormant.

Meanwhile, global stock markets are in full risk-on mode, since they can famously focus on only one event at a time, and the whole Greek mess is about to be solved once and for all, isn't it?  Or is it just that the central banks continue to believe that the solution to any problem is to print more money, and it has to be spent somewhere?  Of course, this could have nothing to do with the fact that the cost of living seems to go up ever month, because people would think that was inflation, which we know will never threaten our planet again.  If you need any further explanation of the constant barrage of non-inflationary price rises, you'll have to ask as expert.

And meanwhile, Athens burns.  Over the past two centuries, the population has suffered under, and freed itself of, the Ottomans, the Nazis, the Communists and the Colonels.  Now it is the EU, and make no mistake, there is a widespread belief around the Aegean Sea that the forces based in Brussels and Berlin are no less malign than their predecessors.  Seventy years ago, they had their revenge when the German capital was reduced to rubble, and many hope they will live to see the same result again.  The grand experiment of European Union had not led to a story of happy families.

 

 

Monday February 13, 2012

Annoyingly, we have yet again no choice but to start with Greece, since on Sunday evening the government in Athens finally rammed through its parliament the austerity measures demanded by the outside world.  43 MPs from the two bigger parties in the "governing" coalition - we all know the real government is in Berlin - refused to toe the line and were summarily expelled, while the third party left the ruling group en masse.  Faced with buildings in flames across central Athens, Prime Minister Lucas Papademos warned that Greeks did not have the luxury of protest open to them.  Reviewing the list of financial horrors he feels are necessary for Greece to do its part in saving the euro, they may well conclude that very few of life's other luxuries will remain either unless they, like their Goldman Sachs trained jetsetting leader, can retreat to their main home in New York if things get too hot ( literally ) in the land of their birth.

Stock markets in the Far East rose on the news, generally a sign nowadays that something has happened which will not benefit most of the population.  Which brings us, rather clumsily, to what appears to have been the main news in the UK this week, and not just in the financial pages ( we are ignoring football ).  Barclays Bank declared its annual profits and, while slightly down on the year, they still came in at a very healthy figure just shy of £6bn.  There was universal jubilation in the media that a leader of British industry could perform so well in these difficult times, even if it was marred in some quarters by unseemly niggling at the continuing high level of bonuses.  Nowhere did we see any discussion of how a bank is able to make so much money, beyond the general assumption that its managers must be terribly clever.

Those running small businesses understand the issue much better.  From their viewpoint they pay their taxes ( which already puts them ahead of Barclays as national heroes ), which the government immediately hands out to the banks, via opaque and incomprehensible mechanisms such as Quantitative Easing, at near-zero interest rates and with no questions asked.  Their bank will then, if they are very lucky, lend the same money back to them at an extortionate rate, secured upon the directors' homes.  Do you really need to be a genius to do that?  By the way, their loan officer may seem disgruntled and unhelpful because he is disappointed by the size of this year's bonus, the cash element of which may be not much more than the businessman's total earnings.  As we said before, these are difficult conditions indeed.

The other main news out of London was that the Monetary Policy Committee decided to create another £50bn of QE, to add to the earlier £275bn which seems to have disappeared without trace.  It was notable that rather than the trickle of disapproval which has greeted previous tranches of this benevolence to the banks, this time there was, if not a flood, at least a river.  The prime proponent of the policy on the MPC is Adam Posen, who last year famously described anyone who did not share his views on this topic as "misguided or delusional".  In these times that is of course the normal reaction of an academic who cannot find a shred of evidence to support his pet theory, but on this occasion he has run into some heavyweight opposition who do not readily fit into his characterisation.   The latest entrant is Rachel Lomax, who served as Deputy Governor of the Bank of England until 2008 and whose sensible influence has been sorely missed since then.  She came out into the open last week, criticising the whole QE concept as a stealth tax on savers.  The accuracy of this description is hard to deny, and we should very much like to witness the debate in which Dr Posen attempted to do so.

 

Monday February 6, 2012

It seems necessary to start as usual with a summary of the week's events in Greece, but this should not take long, since little has changed.  The anti-government riots and strikes continue unabated, though there seems to be an agreement among the foreign press to play this down.  The talks between Greece and its bondholders are mired in the mud, while Prime Minister Lucas Papademos insists that only a few minor details remain to be resolved - this might be more convincing if the various parties were talking to each other, or if they were even in the same time zone.  His Finance Minister, Evangelos Venizelos, was insistent this weekend that finality was vital by Sunday night to ensure the survival of his country, but at the time of writing he seems to be destined for a disappointment.  In support of this theory, the meeting of finance ministers scheduled for Monday, to discuss their triumph in bullying the parties into some "voluntary" agreement, has been postponed until further notice.

We should mention that there has been one change in that wretched nation's prospects, which is that the size of the bailout which is contingent upon the successful conclusion of these talks has increased over the past seven days from €130bn to €145bn, as further murky elements of financial affairs in Athens have floated to the surface.  They really need to nail this down soon, or it could start to get expensive.

Meanwhile, our attention has been drawn this week to comments made by Adam Posen, the multi-chinned American academic who for some reason finds himself on Britain's Monetary Policy Committee.  He is mostly noted for his unqualified support for the notion, popular in his own land, that unlimited printing of money is the single and complete solution to all the ills of the world.  This has led him to press for even greater disbursements to the bankers, leading people to suspect a soft spot for the class of person currently finding its knighthoods under threat, but on one of Rupert Murdoch's TV channels he made some surprisingly, and accurately, disparaging comments about them.

Prof. Posen has noticed that the London banks have been cutting back, rather than increasing, their lending to small businesses.  This fact is so obvious that only a politician or a central banker could fail to notice it, but it is still encouraging to hear it spoken.  The trouble is that his solution appears to be to give them so much more money that they cannot think of anything else to do with it besides traditional banking business.  If we force feed them another £100bn in addition to the £275bn already disbursed, he seems to suggest, they may decide to allow, say, one fifth of that sum to trickle down to their small business customers - indeed, he would be very critical of them if they did not.

We can inform the good professor that, while such a policy might have some small chance of success in the US, where there remain a huge number of medium sized banks, across the Atlantic it has none whatsoever, since the bankers, central and quasi-private, have lost all connection with the real world.  In the latter, £20bn is still a huge amount of money.  100,000 small businesses could be provided with £200,000 each in working capital, enough to kick-start the whole economy.  Looked at another way, it is far more than is likely to be realised by the end of this year from the budget cuts which are causing so much pain, resentment and social unrest.  However, if you give the banks the same sum they will pay some bonuses, write off a few bad derivatives bets and after a couple of months be back asking for the same again.

The return of the banking system to a traditional model whereby it lends and borrows responsibly, building up long term relationships which help to achieve reasonable and sustainable spreads between the two, will be a major challenge.  Worse, it takes many years to produce returns, so nobody in a senior position at any UK bank expects to be around for long enough to see the benefit, and in any case they know there's still a lot of nasty stuff to come out before they can think about anything but getting their hands on more taxpayers' money, so the process hasn't started and isn't likely to do so soon.

Nothing will improve until the government decides whether to concentrate its support on the bankers or on small businesses.  No, that's wrong, because they have quite clearly already made this decision, and they will need to change it.  Given the record to date of senior members of the present administration, we're not holding our breath.

 

Monday January 30, 2012

We may have been a little flippant in our commentaries in recent weeks, but have to confess that the trait is now coming back to bite us. You just can't do satire any more, true life quickly exceeds your most surreal excesses.
We're talking particularly about Greece, whose future was set out this weekend in a leaked but clearly genuine proposal out of Berlin, to the effect that this supposedly sovereign nation would no longer be allowed to control its own finances. All decisions involving money ( and which don't? ) should henceforth have to be approved by central European authorities, and a glance at a map tells us the location of the centre of the continent. Crucially, all revenues successfully collected by the Greek government must be applied to paying the interest owed to foreign banks before they can be considered for any other purpose. In what way does this differ from the state of affairs pertaining in 1942?

To their credit, the Greeks did not take this lying down. First, there were unattributed comments from government sources that any such idea was totally unacceptable. Next, the name of Pantelis Kapsis surfaced as the spokesman, a well known and seemingly principled chap whom one might not expect to find in such company. Much more significantly, on Sunday finance minister Evangelos Venizelos broke cover to denounce the plan as an affront to his nation's dignity. It seems that there may yet be some fight in Greece's rulers to match that of the people they are supposed to represent.

Nothing has yet been heard, though, from local big boss Lucas Papademos, the Goldman Sachs "technocrat" installed in Athens by the Germans, who is waiting to see which way the wind blows. Don't be fooled by the final syllable of his surname, he is Greek in name only, and is well aware that if he can subdue the Hellenes he could be set to move on to a bigger gig running Spain or, looking further ahead, maybe Poland. If it all goes pear shaped, he can always retreat to his natural habitat of a Park Avenue penthouse.

You may wonder why we have brought the Poles into this, given that they have managed to stay clear of the great eurozone disaster. The answer is, astonishingly, that their government has reaffirmed its desire to dive in as soon as can be arranged. Are they mad? We cannot comment on that, but have to mention the Hedge Fund Formerly Known as Iceland, another nation which has expressed such a wish. Icelanders, based on the sample we know personally, rarely think inside even the most spacious box, and we can only assume that they have identified some arcane arbitrage opportunity within the wretched currency. We wish them well.

To bring to an end a somewhat abbreviated commentary this week, we cannot let pass an official complaint made by Michel Barnier, the European commissioner for the internal market ( a very important and well remunerated job, whatever it is ) to Tim Geithner, the US Treasury Secretary, regarding the proposed Volcker Rule. This eminently sensible scheme aims to prevent deposit taking banks from placing huge bets in the financial markets, protected by their taxpayer guarantees. But that isn't fair, argue the EU officials, if you take them out of the game who will buy all the toxic debt? They have a point.

 

 

 

Monday January 23, 2012

At last, a week with no news from Europe demanding our immediate attention.  Of course, we were assured that there would be a solution to the Greek debt conundrum to be analysed, or just celebrated, but mysteriously those talks appear to have stalled.  With our bookie's hat on, we would be inclined to bet that some deal with the private bondholders will be done, leaving the Greeks themselves in an even more hopeless state than they are already.  However, it is not clear that the EU finance ministers, who get together in Brussels on Monday for their first pow-wow of 2012, will have much to discuss relating to the first item on their agenda.

This gives us the opportunity to mention a fascinating story brought to light earlier this month by Reuters, to the effect that the number one lender to Italian small businesses is now the Mafia.  The wire service, as one of the banks' most reliable mouthpieces, naturally presents as a terrible development, and so it is, but they have their logic backwards.  The reason struggling Italian shopkeepers and artisans find themselves financing their working capital by paying triple figure rates of interest to outlets of organised crime is that the big name banks will not provide them with credit at any price.  The bankers are outraged - is it not their birthright that if they choose to starve their customers of credit then they should stay starved, rather than look elsewhere?  The report estimated that "200,000 businesses were tied to extortionate lenders and tens of thousands of jobs had been lost as a result".  Well, yes, but could they guess how many more would have disappeared if their employers had been unable to borrow on any terms at all?  No such figure was put forward.

The Mafia were claimed to have €65bn in lendable funds, a tidy sum ( not by bank bailout standards of course, but this is real money ).  Any readers in the UK attempting to run a small business will be wondering whether a little of it might perhaps be persuaded to leak across the English Channel.  However tight money may be in Italy, it seems unlikely things are any easier in Britain, where the big banks have all informed their branch managers that lending money to any local enterprise is a crime punishable by instant dismissal, with no possibility of appeal or clemency.  How this fits in with "Project Merlin", the government's pact with the bankers under which they promised to increase their lending, is unclear - there are suspicions that the reported numbers are not prepared in the way you might expect.

The real point here is that the traditional banking model, with those institutions taking in retail deposits and doling these out to borrowers with sound business models, appears to be terminally broken.  A bank is now just a box, with government money going in one end and executive remuneration coming out of the other.  It seems to be immaterial that the banks are without exception supported by the taxpayers, and are in some cases owned by them.  Bob Diamond, the chief executive of Barclays and close personal friend of finance minister George Osborne, has said publicly that he does not need retail deposits, and why should he?  With his free government guarantee, he can fill his borrowing needs in the wholesale markets without dirtying his hands with the nuisance of small accounts.  Equally, he can use this money playing the deep capital markets, where billions can be shunted in and out at the touch of a computer key.  What public service is he then performing to justify the huge benefits resulting from his status as a clearing bank?  That must be where it helps to have friends in high places.  By the way, this leads us to another reason why you might prefer to do business with Cosa Nostra, which is that they tend to be more pleasant people.

Staying in the UK, there now seems to be a consensus that the economy is heading towards a "double-dip" recession.  This will naturally be blamed on the eurozone shambles, but the 80% of the country not within easy commuting distance of the City of London could be forgiven for thinking that they were yet to emerge from the first dip.   Fortunately they have little lobbying power and, while they do get to vote, no such opportunity will be available to them for more than three years, so that technical problem can also be ignored for now.  The unemployment figures are already pretty bad, and there was a story this week that they have lately been massaged by reallocating some of the jobless into an ill-defined category involving training.  This was convincing enough that the authorities have not even tried to rebut it.  The country really needs the banks to do their job, but is likely to be disappointed.

Our final thought from the British Isles concerns Scotland, where independence seems to be a live issue, and we have followed the discussions regarding that nation's economic viability with some interest.   It should be remembered that the nationalist prescription has been for the new entity to adopt the euro as its currency, and we ask ourselves how that would have gone, had the move taken place, say, five years ago.  The answer has to be, not very well.

As seen from London, neither that country's p&l nor its balance sheet looks great.  There would naturally have been huge arguments in European courts regarding the history of the North Sea oil proceeds, but only the lawyers would have got rich out of those, and in any case there would now be countersuits relating to the grotesque and expensive misdeeds in England of the Royal Bank of Scotland.  Meanwhile, it seems likely that the Scots would have struggled to keep up with the payments on their debt and, as with Greece and Italy, the Germans would have installed a prefect in Edinburgh ( no doubt they could find one with a Scottish name ) to oversee a period of brutal austerity.

Could England tolerate this?  Could the North of the country, already something of an economic wasteland, cope with a million refugees fleeing from food riots and the inevitable reprisals?  Britain's island status has left it unaccustomed to the idea of a land border with a hostile European power, and on those occasions when this has been threatened in history there has always been trouble.  When Frau Merkel warned last year that the eurozone problems might lead to war we were inclined to accuse her of hyperbole, but perhaps this is a recipe for that result.  She was warning of chaos resulting from the collapse of the euro, whereas we think it is more likely to come from excessive zeal in salvaging it, but the result could be the same.

 

 

Monday January 16, 2012

We would really like to produce a light hearted commentary about some obscure corner of the financial world, but after a week in which half of Europe's sovereign debt has been downgraded, and Greece has moved still closer to the vortex leading inexorably down the plughole, what are we supposed to write about?  At least the slow motion train wreck that is the eurozone has its funny side, in a black sort of way, and we shall try not to ignore that.

On the question of S&P's downgrade of nine sovereigns, with France at the top of the list, the only question should be "what kept them?".  It has been obvious for at least four years, and arguably since day one of the euro, that the French Treasury's ability to repay long dated debt in a currency which it is unable to print could hardly be described as a certainty - lest we forget, that is what AAA means.  The predictable outcry from Paris to the effect that the UK should have been downgraded too, reminiscent of a soccer manager screaming that an opposing player should be shown a red card, is quite misguided.  Joining the common currency was probably the only policy error avoided by Gordon Brown during his long and disastrous tenure as Finance Minister, but it was a very big miss indeed.  If gilts were denominated in euros or dollars, then we would suggest that a downgrade of several notches might be justified, but they are not, and for such time as all obligations can be satisfied by the creation of new pounds, that is what will happen.  As one caveat, we are less sure about this when discussing the inflation-linked variety of bonds, which can always get completely out of hand, but S&P do not appear to trouble themselves with such detail.

At the bottom of the pool, Greece has not been downgraded since it has nowhere to go, but the Portugese have been stripped of their investment grade status.  With their ten year bonds yielding more than 1000 basis points over what passes for a risk free yield in the eurozone, and this despite central bank buying, you have to think that the ratings agency is not the first to form this opinion.

Another complaint in Europe is that the downgrades were politically inspired, and they highlight as evidence the fact that Fitch, described as the only independent agent among the big three, has not only refrained from such action, but has singled out France with a remarkable vote of confidence, confirming that they do not see themselves taking any action on that credit during at least the next twelve months.  By "independent", they presumably refer to the fact that Fitch is French owned, which might not fit with everyone's use of the term - perhaps it doesn't translate well.  Funnily enough, China has joined in the criticism of this latest piece of American financial imperialism, even though their own ratings agency downgraded France by several notches some time ago.  Of course, such rhetorical support is cheap, and they have no intention of buying any of the bonds.

One big casualty is the proposed grand bailout fund, the EFSB, which is only as good as its supporting nations.  A mere four of these now retain the necessary top rating, and both Holland and Finland have expressed deep reservations about getting involved.  This leaves the burden shared between Germany and, er, Luxembourg.  It is clearer every day that saving the eurozone will fall entirely on the shoulders of the Berlin treasury.  Despite the best efforts of Chancellor Merkel and her sidekick Wolfgang Schauble, the Germans have woken up to this and are not keen.  Anyone interested in guessing what happens next would do well to keep an eye on the German press.

So, what about the German province which used to be the sovereign nation of Greece?  The failure of the talks regarding a debt deal, which is being spun by its governors as a unforeseeable bolt from the blue, was of course precisely the opposite.  While we hold no brief for the handful of hedge funds which have derailed the plan, and whose contribution to global financial stability is similar to that of Somali pirates to shipping security in the Indian Ocean, you have to see their point.  The banks which hold most of the debt are being told to take their haircut and don't worry, more taxpayers' money will be shunted to you via the back door.  The central bank itself is reported to be immune from any reduction in the value of its own holdings - the legality of this might seem suspect, but probably there is some provision which says that they can do whatever they like.   If the funds intend to push hard for their share of the gravy which seems to be flowing in all directions, it is hard to blame them.

In any case, the big story is that Greece is sunk.  Forget about haircuts, even given total debt forgiveness and a clean slate the Greek economy is simply not viable based on the euro.  The IMF has worked that out, as have the better brains in the ECB.  The Bundesbank was there some time ago.  The best hope now is for an "orderly default", which is a challenge in itself, given that it is in the nature of defaults to be highly disruptive.

For relatively light relief, we are indebted once again to The Slog, who has uncovered a curious story which has unaccountably been missed by the major information providers.  It appears that Greece has orders in place to pay more than €10bn to France and Germany for state of the art military equipment.  You might think that in the context of a collapsing social fabric across the country the government would be seeking to put a line through that, and indeed that the occupying powers running the brutal austerity program would make the removal of such profligacy a first requirement.  Au contraire, it turns out that all parties are insistent that these deals will survive as signed, with payment on time and in full.

After all, Greece is Germany's second most important armaments market behind only  - wait for it - the eurozone's other junk-rated member, Portugal.

 

Monday January 9, 2012

It's confirmed, Friday's payroll numbers were unreservedly fantastic.  Felix Salmon, a transplanted Brit who writes for Reuters in New York, screams out the headline "Unmitigated Good News on Jobs", and states in his first sentence that "America's employment situation turns out to be rosier, at the end of 2011, than anyone had dared hope".   Other well known White House mouthpieces, such as the NYT in print and the Huffington Post online, are singing from the same hymn sheet.  So, can this interpretation be defended and, assuming that this is an early co-ordinated shot in the Obama re-election campaign, have they gone too early?

Of course, Salmon writes for the Manhattan community, so the great majority of Americans will not need to ask themselves why his view is at such variance to their own experience, since they will never read it.  The same can probably be said for the other sources mentioned above.  All the same, the mainstream media will certainly take over the baton, so it is worth looking a bit deeper.

200,000 more people in work in December was certainly much better than most people's predictions - even if, in the context of 13.1 million officially unemployed ( we'll return to the "official" bit ) it represents a pretty poor rate in what is supposed to be an economic recovery.  However, a number of less partisan observers, including the diligent chaps at Zero Hedge, have taken a closer look at this number, as well as those which preceded it, and find a less encouraging trend.  As a first step, they ask the awkward question of what all the people in these new jobs were doing.

First of all, about 40,000 of them were working for the likes of UPS, handling the distribution resulting from the burgeoning online retail sector.  It turns out that this was generally unforeseen ( how? ) or that it was assumed they would be covered by the seasonal adjustments ( they're mostly not ).  Anyway, those jobs have already disappeared, as has much other holiday related employment which should be corrected for.  As we've written before, the Department of Labor's seasonal adjustments have proved increasingly unreliable, to the extent that we might be better of without them altogether.  If the trend is to be maintained, further manipulation of the data will be required, and it will have to accelerate in the run-up to November's elections.

At least they have plenty of battle tested ways of doing this.  The headline unemployment rate must be one of the most systematically abused economic numbers in the world, making comparisons with previous eras meaningless.  Once upon a time, if you asked someone whether they were unemployed and they replied that they were, it was pretty certain that they would be counted in the numerator of the jobless rate.  No more.  At last count, there were 2.5 million Americans "marginally attached to the labor force", meaning that they had not worked for over a year, but were not believed to have searched for employment in the past four weeks - presumably because, despite the bruited recovery, they no longer saw the point in doing so.  This number is not coming down, but is a double-edged sword.  If it stays where it is or rises, and if the government cannot continue to suppress its significance, it gives the lie to the whole "happy days are here again" narrative.  On the other hand, the last thing they need is for these millions to believe the story they're pushing and start hunting for nonexistent work.  Probably they would need yet again to redefine their parameters.

This could be done.  As recently as 2007, the definition of "looking for work" was pretty much what you would expect.  If it remained as it was, today's unemployment rate would stand at a depression level of 11 per cent, which is clearly could not be accepted, so it had to be made more palatable.  Similarly the U-6 number, which used to be an honest attempt to measure the unemployed plus underemployed population, has just fall to 15.2%, which makes no sense when you consider that a poll of employed people shows that a quarter of them consider themselves to be underemployed.  The must be scope for further dishonesty, and we have now to live with the fact that, as in the old Soviet Union, all economic statistics must be regarded as, at best, a mix of reality and political propaganda.

Coming to this issue from another direction, one of the merits claimed for the recent quantitative easing programs is that they provide a boost to securities markets ( and, it appears, do little else! ).  Interestingly, authorities in both US and the UK have been retreating from their earlier assertions that this effect would be long lasting, and they have come to admit that, failing renewed stimulus, the elevated stock prices produced are likely to temporary in nature.  Nonetheless, they insist that even this is beneficial, helping banks to raise fresh capital on better terms than would otherwise have been possible.

What's that again?  They really believe that big investors will pay a higher price on the basis of a market which is admitted to have been temporarily manipulated upwards?  Well, yes, they appear to believe precisely that, and they may well be correct.  Of course, nobody in their right mind would invest their own money in this way, but not much of that goes on any more.  Most investment nowadays is done by "professional" managers, and all they require is a story plausible enough to justify their management fees.  Give them a world awash with liquidity, combined with an economic outlook buoyed by dubious official statistics, and they will willingly spend their clients' money on just about anything.  Of course, no market has ever walked on air forever, and it feels as though an awful lot could happen in the next ten months, but failing any wild cards markets may yet rise between now and November, and Obama could just get re-elected.

 

Tuesday January 3, 2012

As the season of goodwill comes to an end, we feel compelled to draft the traditional summary of the events of the past year, and prospects for the next.  Our main thesis will be that while 2011 was by most standards quite tumultuous, there are reasons to suspect that its successor may leave it in the dust in that respect.

If we had to find one hackneyed term to characterise 2011, it would be the sound of a can being kicked along an asphalt surface.  This is most obvious in the eurozone, which should logically have already collapsed but has been supported by a succession of Sunday evening summit meetings, each resulting in a press release hinting just heavily enough at some non-existent grand plan to keep the financial markets supported for a few more weeks.  It is also heard clearly in the US, where the oncoming fiscal crisis, as blinding as the headlights of an oncoming truck, is met by the leaderships of the two parties ( if the Republicans can be described as having any such thing ) positioning themselves to look concerned while ensuring that nothing is done which might upset their most sensitive pressure groups.

We're concentrating on money matters, as befits this site, but should also mention that other significant global issues are also being approached using the time honoured method of ostriches.  The Middle East is in flames, Russia heading back to the days of Stalin, democracy suspended in Greece and Italy ( who knows who will be next ) and maniacal administrations control nuclear weapons, or will shortly do so, in North Korea, Pakistan and Iran.  In all cases, the main hope of Western leaders is that nothing will go bang in a big way before their next national elections.

So the question is, can this same behaviour get us through the next twelve months without a major explosion?  Nothing is certain, but with our bookmaking hats on, we have to say no.  For it to succeed, the first requirement is the compliance of central bankers, but that is the easiest part.  In the Anglo-Saxon world, Fed Chairman Ben Bernanke and Britain's Mervyn King remain thrilled with their discovery that there is no economic problem which cannot be solved by printing a trainload of money.  Of course, this policy has been known for centuries to lead to unmitigated inflationary disaster, but this could take several years to develop, which is acceptable to all major parties, who seem to accept that nothing beyond the horizon of the next electoral cycle should be their concern.  Never mind that opinion polls repeatedly show that rising prices are near the top of the general population's fear list, the monetary technicians are working day and night to ensure that their rate of increase does not fall below the optimal level.

The bigger problem is that even our leaders' Alice in Wonderland plans cannot come to fruition without significant economic growth, but that looks set to progress in a backwards direction across the world.  Europe is particularly hampered by the austerity imposed by the renewed leadership of the Germans, who have decided that the real trouble with the rest of the continent is that it is not German enough and that it is their job to put that right.  Some people with long memories recall that this approach has been known to lead to unpleasantness, and were not cheered by Chancellor Merkel's warning that the collapse of the euro "could lead to war", but for now they are just waiting to see how matters progress.

Given the widespread assumption that the rate of economic growth will be turning negative this year, where does that leave the rest of the world?  The Americans, whose penchant for blaming someone else appears in spades in today's White House, naturally point to Europe to explain their impaired prospects ( blaming the Bush administration is finally getting old ).  Never mind that the whole crisis was launched by the behaviour of their own banks in the subprime market and, to say the least, aggravated by their provocative suggestions to European sovereigns regarding the handling of their own debt.  They are also upset by the fact that China's own double digit growth may be stalling, and also, somewhat inconsistently, by that nation's reluctance to see its exchange rate appreciate.

Nothing looks good, but we shall end our prognostications with the thought that it's worrying enough if the US economy only works when China ( and probably the rest of Asia ) is growing at breakneck speed, but far worse if China itself, like a bicycle, will fall over if not moving fast enough.  This is a huge unknown, since there is much anecdotal evidence that the 21st century version of the Middle Kingdom is built upon huge levels of debt, used for redundant infrastructure, which can be supported only by yet more debt and capital spending.  The details are vague, given the uncertain nature of Chinese statistics - should we be encouraged by the fact that their monthly numbers appear after only a couple of days, or sceptical? - but if   two decades of Western prosperity really have been built on nothing but the relentless progress of globalisation, we should be very wary of any reversal in this area.

 

 

Monday December 19, 2011

Before we start this week's regular commentary, we should like to share a joke, with the usual apologies to those who have heard it before.

A Greek village finds itself twinned with a small town in Spain.  The local Greek dignitaries naturally make a publicly funded visit to their counterparts, and are impressed by the sumptuous villa occupied by the mayor, asking how this was possible on his limited budget.  He explains, "You see that bridge over there?"  "Yes."  "Well, the European Union gave us finance for a four lane structure, but there is very little traffic, so instead we put up a single lane bridge with a traffic control.  The money saved paid for our town hall and the mayor's accommodation."
The following year the Spaniards visit their new Greek friends, and find the mayor living in a veritable palace of marble and cedar, with gold fittings wherever appropriate.  Naturally they ask how this has been paid for.  "You see that bridge over there?".  "No".

The real point of this joke it that we have run it by several people who inhabit the Alice in Wonderland world of the EU, and without exception they found it so precisely accurate as to be not particularly funny.

Back to business, we have heard of no major developments out of Europe this week.  However, that is very interesting in itself, even sinister, since we recall being promised that details relating to the plan agreed by the EU nations last week ( with the noted and obstinate exception of the UK ) would be fleshed out by their technicians in a matter of days.  It appears that, yet again, they have failed to put any flesh on the bones because, upon closer inspection, there turn out to be no bones.

We worry that we are becoming tedious on this point, but the eurozone faces two problems.  The first, which is has for a while been understood by most of the players and commentators  in Europe and is now even starting to be recognised in the US, is that if the problem can be solved by a deluge of money, nobody wishes to step into the role of unselfish benefactor.  The second, studiously ignored by almost everyone in any position of authority, is that even an unlimited injection of liquidity would only buy the system a few years before it was hit by an even larger crisis, since it is fundamentally unsuited to any stable universe.  Those rioting across Europe against public sector cuts, and in the US against capitalism, do not generally hold doctorates in economics, but they may have a better, if more visceral, understanding of what is wrong with the global financial system in the 21st century than is shown by most central bankers, let alone by their political masters.

We could go on at length, indeed we have done so before and shall no doubt do so again, about how no part of the world will fully avoid the backwash of the last two decades of excess, excused in the name of globalism.  However, we cannot fail to ask ourselves where we would especially prefer not to be, and the answer is that the nation most clearly in the crosshairs of the coming disaster is France.

The first strike against that historically significant nation is that their President, Nicolas Sarkozy,  is a preening and self-important idiot.  They are of course not alone in suffering such an affliction, but the immediate problem is that he faces a re-election battle next summer, and will sacrifice anything, at home or abroad, in order to increase his seemingly miniscule chances of success.  His standing in the opinion polls gives him no better than a fifty-fifty chance of even making the final runoff against the resurgent but rudderless Socialists, and he is flailing around in search of an ogre to vilify.  The latest target is the community of ratings agencies, whose right to an independent existence might reasonably be questioned after several years in which they seemed willing to give their treasured AAA rating to any collateralised security, provided only that it was sufficiently complicated that nobody could work out who owed what to whom.  However, last week's downgrade of Belgium ( for American readers, if you want to consider the economy of Belgium without the full EU bureaucracy in Brussels, try to imagine Washington DC without the federal government - would you lend money to that? ) and the clear and present danger of France's demotion from the top tier, look like just a case of too little, too late.

It is interesting to note that Sarko's Finance Minister during the period when his country's economy was experiencing its steepest trajectory into the mire was Christine Lagarde, who remains a vital element of his re-election team even after she was parachuted into the IMF following the abrupt expulsion of Dominique Strauss-Kahn, the manner of whose departure still hides many unanswered questions.  One undisputed fact is that whatever role the IMF may have held in the saving of the euro is utterly compromised by their new boss's partisanship towards Europe, France and Sarkozy, not necessarily in that order.  However the professional staff may have felt about DSK's repellent personal habits, they never disputed his ability as an economist, and morale in Washington has been ruined by the imposition of a newcomer for whose intellectual powers they have no respect.

To recap : the European Central Bank is clearly forbidden by its statutes from lending directly to sovereign governments ( they are already sailing close to the wind on that one ), so last week's plan was to arrange for IMF member states to fund that organisation, so that it could achieve this aim through the back door.  Unfortunately, many major nations, including the UK, the US and Germany, have expressed reservations regarding this dubious plan.  China just looks on with an inscrutable expression.  Sarkozy must find another way to save his big banks, which have for practical purposes been agents of the French government for decades, and which are now so insolvent that on a true mark-to-market valuation they would take the nation's investment grade credit rating and much of its gold reserves with them.

The latest new idea is attractively simple.  The ECB will lend unlimited funds to all eurozone banks, but notably to those of the French persuasion, at a rate of, say, 1 per cent per annum.  They will lend on to the government of Italy, which currently has to pay about six times that rate for its financing needs.  Meanwhile, by a side letter, the ECB promises the banks that they will never suffer a loss.  Voila, they make an annual turn of around 5 per cent, or several billion euros, with no risk.  The new Italian Prime Minister, Mario Monti, is an unelected puppet placed in power by Brussels, so he certainly won't utter a peep of protest on behalf of his people, who bear the cost of this scam.

The real speculation is that it will prove sufficiently obscure that the Italians themselves fail see through it.  We should not have long to wait before events on the streets of Rome give us a clue as to how this subterfuge is working out.

 

Monday December 12, 2011

This week's comment from our Naked Guest

Britain's Prime Minister, David Cameron, is probably feeling quite pleased as we write this commentary.  He is widely viewed in his own country, and particularly within the Conservative Party he leads, as a hero, which has not typically been the case since he formed the ruling coalition last year. Furthermore, he is being presented in Germany, and even more so in France, as the devil incarnate, the man who has wrecked the euro, and that never does an English politician any harm. The truth about the veto which he is supposed to have wielded is somewhat different.

First of all, it is not clear just what effect this "veto" has had. Certainly, it means that the 27 members of the European Union cannot move unanimously towards their revised treaty, which sets rules for closer fiscal harmony, since one of them has stated its refusal to go along. However, there is nothing to prevent the other 26 from following the proposed course, and that is now the declared aim of the central authorities, although several governments have expressed reservations and many more know that they can expect trouble from their parliaments and voters.

The EU has now clearly fractured into many parts. Even the decision-makers of Germany and France, with their mythical leader The Great Merkozy, must be seen as two separate factions, since one will be the primary donor of funds in any ( temporary ) final solution for the euro, while the other will be the largest recipient - what is remarkable is that they have managed to maintain a united front this far. The PIGS ( not sure about Ireland ) will stay in the euro as long as it seems possible that there may be massive debt forgiveness, for them and/or their banks, but once it is clear that isn't happening their populations will use whatever degree of violence is necessary to shake them free. A few others, such as Estonia and Slovenia, still seem keen to be seen as good European citizens, even though Merkozy completely ignores them and cannot understand why they are not still part of some real country's empire. Finally, there is the UK, and those others who have in reality seen enough. This one is not going to get stuck back together.

Getting back to Cameron's role in Brussels, in the medium term it may not do him as much good as the current glow suggests. He travelled with the clearly expressed intention of offering the central axis of the EU concessions by way of submission to budget commitments and bureaucratic red tape, provided only that they kept their hands off the City of London. This was a generous offer, which the Germans were evidently happy to accept, and it is the UK's enormous good fortune that French President Nicholas Sarkozy refused to consider it, seemingly out of personal spite. However, once it sinks in that, veto or not, the British are still subject to all of the EU's current and future absurd regulations, with no prospect of any input, and will still be forking over more than $20bn per annum in membership dues, the perennial questions about the right of voters to express their view on the matter will be redoubled. The fact that the banking industry emerges unscathed may not turn out to be as high a trump card quite as he believes.

Is it possible that we're being uncharitable regarding M. Sarkozy's behaviour? This is always tempting, since he is a totally vile individual, even by the standards of French politicians ( what is it about them? ). However, the man does have real problems. His country benefits more than any other from the workings of the EU -  it should do, since they were devised specifically with that in mind - and any disruption of this gravy train ahead of his re-election campaign next year would be most unwelcome. Prospects for his political future do in fact look bleak, with his standings in the polls and their direction suggesting that he might even fail to make it through to the final runoff, and the man needs a miracle. While waiting for one to come along, it might at least help to have someone to blame, and the City of London is an ancient and worthy foe. As it happens, there is even some justice in the suggestion that the UK banks have been a destabilising influence in global finance in general and the eurozone in particular. The same is of course even more true of their Wall St cousins, but they are off limits for criticism since they work very closely with ( as in, own and operate ) the US Treasury, which is the only institution likely to provide the Paris banks with the phenomenal quantities of money they require every week in order just to stay afloat.

What happens next? A snap opinion poll held over the weekend in France suggested that 81 per cent of the population could see no reason for Britain to stay in the EU. A similar result might be expected in the nation being discussed. Such overwhelming opinion cannot be ignored forever, and it will be Mr Cameron's task over the next three years, whether or not he likes it or even yet accepts it, to manoeuvre his country out of the Union. The effect on the UK may perhaps be severe, even if some can still remember the days before the big European experiment when the country did manage to survive. More interesting will be the results seen across the Channel, since France and Germany have for some years been relying upon their mutual dislike of all things British to paper over their deep rooted mistrust of each other. When those two return to their traditional antagonistic ways, their smaller neighbours will have reason to fear the future.

 

Monday December 5, 2011

This week we return to our compulsion to write about Europe, but from a rather different perspective, since our views have been focussed by a remarkable interview given to London's Daily Telegraph by the euro's founding father, Jacques Delors.

This name may not resonate with American readers, but it certainly will with those who lived in England in the early 1990s.  He was President of the European Commission from 1985 to 1994, and made strenuous efforts to drag the UK deeper into the quicksand of Europe, with that nation's popular response being summarised in one of the most famous headlines of all time, The Sun's "Up Yours, Delors".  Unsurprisingly, he has had little contact with the London press since then, so it was interesting that he chose a week ago to speak to The Telegraph, a more upmarket publication than The Sun but one which generally shares its political views.

The statement which hit the rest of the press was that he declared the euro experiment to be doomed.  This is the first comment we have ever heard him make with which we wholeheartedly agree, and were wondering whether to revise our opinion of the man, but this turned out to be unnecessary.  Did he feel at all at fault for the failure of his pet project?  Not at all, he had told the nations at the time that they would be required to surrender much of their sovereignty, and if they insisted on hanging on to old-fashioned notions of national identity it was hardly his fault.

Regarding the current crisis, he is critical of Germany, though that is standard fare nowadays among everyone except Germans.  Europe ex-Germany appears to be insolvent to the tune of a few trillion euros, Germany has through diligent working habits built up a savings account of roughly that magnitude, so why isn't the solution obvious?  He also feels that the UK is getting off lightly, even though her population were led to believe that the whole point of avoiding the euro like the plague was that they would never be on the hook for this sort of shambles at all.

Is he troubled by the fact that democratically elected governments in Greece and Italy have been summarily removed, to be replaced by technocratic administrations imposed by the Great Powers of Europe?  Not in the least, for as he puts it, "the markets are reassured that there is a man in place who knows what he's doing".  A strong man, presumably, who can make the trains run on time.  Delors is an avowed socialist, so his indifference to the rights of the electorate comes as no surprise, but he is also one of those modern socialists who worship at the altar of the financial markets.  At the age of 86, he retains the ability to send a shiver down the spine of anyone with a vestigial fear that fascism has never been properly laid to rest.

M. Delors is of course not the only politician who has been making apocalyptic  pronouncements regarding the evident need to prop up the euro, at whatever cost.  Poland's finance minister, who seems to have closer links to Western bankers than might be considered desirable, has warned that allowing the wretched currency to follow its natural course into the ditch might bring about a continental war.  What is he saying, that the Germans might feel so depressed that they would be impelled to compensate for this by invading his country one more time?  He did not amplify his point.

Speaking of statesmen all of whose close friends appear to inhabit the financial industry brings us back to the United Kingdom.  The Prime Minister faces a conundrum.  If the euro fails, he understands that we face decades during which the four horsemen of war, pestilence, famine and death will roam freely across all of Europe, and maybe further even afield.  But on the other hand, if the European Central Bank shoots its silver bullet, a eurobond guaranteed jointly and severally by all zone members (ie by Germany, the only one with any real money) there is a real danger that the trading of these instruments may move away from London to Frankfurt, or even to Paris.  How should he react to these dual threats?  We understand that David Cameron's city friends have kept him fully briefed, and they are confident that he will make the right decision.

By the way, when we first saw the panic (sorry, responsible) decision of the Fed last week to flood the entire world's banking system with dollars, we floated the guess that the immediate crisis was the imminent failure of SocGen.  Other, probably better informed, suggestions put BNP in the frame.  The signals from people who really sound as though they know are now that it was Credit Agricole that was about to go under.  We're sure that readers will be able to spot the common thread.  There is a big country in Europe whose banking system is seriously rotten.

 

Monday November 28, 2011

After a welcome break last week, we have no choice to return our focus to Europe, which is where everything is happening  - or, more accurately, not happening.  So far, all the politicians' best efforts to conjure a few trillion euros out of thin air have been stymied but, to give them credit, they don't give up, and we heard this week about a new and particularly devious scheme, which is evidently to be discussed at meetings of the region's finance ministers in Brussels next Tuesday.  The latest idea is that the banks should be excused from any haircuts on their sovereign debts, these being covered by insurance provided from some central fund.

This "solution" does of course beg all the usual questions, the most prominent being, where will the money come from?  According to Bloomberg, "the insurance would be in the form of tradable partial protection certificates, to be issued by an independent Luxemburg-based special purpose vehicle".  Well, it's nice to know that at least it's nothing like the funky derivatives that got us into this mess in the first place, but otherwise we're not much the wiser.  We know that a selection of eurozone countries, including some big ones, have no realistic chance of repaying their existing debts, let alone those which they will be taking on in the future, so if the banks are to escape losses, who will step into their shoes?

We can rule out the "emerging" economies, even as we find this an odd way to describe the nations which own so much of the world's money.  The Europeans, and even more the Americans, have still failed to grasp the depth of the contempt in which they are held in Asia for their feckless ways, but do at least seem to understand that hopes of a huge bailout from that source should be abandoned.  The next port of call is the IMF, somewhat more promising since no daft idea is likely to be resisted by their new leader Madame Lagarde.  The problem there is that the fund's own money has to be found somewhere, and most of the more prosperous club members are yet to sign up.

So we're back where we always end up, with the ECB having to fill the gap by printing a trillion or two of their currency units.  But wait, you say, we know all about this, it would require EU treaty changes taking years, and the German constitutional court would give it the thumbs down.  It seems that this one is different, in that it might require the support of only a majority of eurozone members, and they could avoid the annoyance of asking their populations what they think about it.  As to the judges, they are not as easily ignored as was arrogantly assumed by US Treasury Secretary Tim Geithner (he was presumably confusing the German constitution with the serially abused document produced by his own nation's founding fathers), but they will rule strictly on the letter of the scheme, and this one might squeak past.

So who is in favour of this latest wheeze?  The banks, clearly, since their free ride continues indefinitely.  The dodgy sovereign borrowers would also come out of it quite well, since their credit would look much better, at least for a while.  The French, who see themselves very close to joining that group, are particularly keen.  Germany is crucial, and there opinion is split.

Angela Merkel and her sinister sideman Wolfgang Schauble are on board.  The finance minister believes that Europe's problems stem directly from the fact that some nationalities are less industrious than his own, and that it falls to the Germans to see this rectified.  We believe he would accept this as a fair representation of his views, and that he would see no humour in it - if indeed he understood that concept, since it seems possible that generations of Schaubles could have established the Germans' reputation for lack of frivolity without the assistance of any other family.  As to the Chancellor, we no longer know what to say, since she seems to have made the progression from an intelligent and well grounded hausfrau to a megalomaniac nutcase in record time.  

Of course, none of this explains how the proposed scheme could help the underlying economies, and it would not.  On the contrary, the need to levy further taxes on already overburdened populations in order to fill in the bankers' losses would most likely cause at least a decade of depression, and many local politicians are on to this, notably in Germany and most particularly in Merkel's own party.  However, the continent's big names appear to have reached the conclusion that nothing good is going to happen within their own political horizons, so their best chance is to throw in their lot with the most likely survivors.  When your political career is over, the undying gratitude of Deutsche Bank and JP Morgan is better than nothing.  A lot better.

 

Monday November 21, 2011

We decided that this week's commentary would for once not reflect the current obsession with Europe, and intend to stick to that, but cannot help starting with a roundup of politics in the Mediterranean region.

In both Greece and Italy, the elected governments have been successfully removed by the European Union, and replaced with two of the senior eurocrats who oversaw the policies which have brought us to this sorry state.  In Athens, Lucas Papademos has already run into a bit of trouble, with the right wing party represented in his government refusing to sign a pledge to do whatever the Germans tell them for the rest of time.  They are obviously trying to make a point, since otherwise they would simply do what so many have done before them, and sign it with no intention of honouring it.  The Greek puppet's counterpart in Rome, Mario Monti, has managed to form a government, but does not appear so far to have broached the question of anyone signing anything.  With a crucial chunk of his "support" coming from deputies who still owe allegiance to his ousted predecessor Silvio Berlusconi, we wish him luck when that time comes.

Meanwhile, if all the exit polls are to be believed, the Spanish people appear to have elected a new government of the conservative Popular Party, headed by Mariano Rajoy.  He and his followers will be watching the yield on the nation's 10 year obligaciones very closely, for if they inch towards the dreaded 7 per cent level his leadership could be one of the briefest in history, before he is replaced by another Berlin approved stooge with close links to Goldman Sachs.

This brings us neatly to our main topic for this week, which concerns the corruption, fraud and insider dealing endemic in the United States.    We could of course write about this at any time, but the trigger is the fascinating news that the lawyers acting for Rajat Gupta, currently defending himself against charges of fraud and conspiracy, intend to call as witnesses some of his most senior colleagues from the days when he was on the board of the Vampire Squid.  Mr Gupta stands accused of, among other offences, passing on price sensitive information to his hedge fund friend Raj Rajaratnam relating to, for instance, Warren Buffett's proposed capital injection into Goldman.  Without wishing to prejudge anything, we would mention that RajRaj has already been sent down for eleven years for receiving and acting on such tips, and some fairly explicit tapes were played at the trial, so this won't be an easy one to shake off.  It is therefore interesting that RajGup, who would know plenty about the inner workings of Goldman Sachs, has opted to call for testimony from MD David Loeb and President Gary Cohn, and not in a friendly way.  We look forward to whatever morsels may drop to the ground when that tree is shaken.

Once a GS man, always a GS man, so this brings us to their ex-CEO turned New Jersey politico Jon Corzine, who took over the relatively sleepy futures clearer MF Global last year with the expressed intention of making some waves.  He certainly did that, and the company has gone under with something like $600m of client money missing.  We never believed the vague suggestions that these sums were hiding somewhere in the vaults of JP Morgan (particularly after the bank itself said they weren't) and it is becoming more likely with every passing day that the money, which was certainly transferred improperly to the clearer's own account, was then punted with massive gearing in the sovereign debt market and lost.  Why would Corzine do such a thing?  Because, we suggest, it would never cross his mind that there was anything wrong with such action unless you get caught, and he was really only placing a bet on that not happening.  With other people's money, yes, but on Wall St that's the name of the game.

Unsurprisingly, Washington doesn't seem to be any better, but the interesting thing is that they've also found themselves on the front pages, via the Stock Act.  This proposal, which has evidently been kicking around unnoticed for years, would make it illegal for congressmen and their staff to trade in the financial markets on the basis of information gleaned through their legislative work.  It might surprise you, as it did us, to learn that this is not already the case - you might also have hoped that they would recognise that their ethics should forbid such a course, though that would be a bit naive.

Anyway, various examples of dubiously motivated trading are now coming into the daylight.  Near the top of the list is Spencer Bachus, now chairman of the House Financial Services Committee - that's the one they all seem to want to be on more than any other, for some reason.  Back in the dark days of 2008, it turns out, he was privileged to be present at a top secret briefing from Hank Paulson and Ben Bernanke, who explained that life as we knew it was about to end if the Wall St banks weren't given all of the country's money.  He evidently believed this rubbish, and immediately rushed out to buy something called Proshares Ultra-Short QQQ, a day-trading product the world really doesn't need which goes up twice as fast as the stock market goes down.

You're likely to read more about this one, not just because it is so egregious but also as Bachus is a Republican, a member of the party the media loves to hate - if they could ever find a Tea Partier with their snout in the trough, or even within sniffing distance of it, they wouldn't have a font big enough for the resulting headline.  However, and needless to say, the Dems are no better, with their ex-Speaker Nancy Pelosi leading from the front.  Was it wrong for her to accept a big slug of the priced-to-sell Visa IPO, and did she have reason to believe that the House she controlled was going to treat the company as gently as it did?  She says no and no, indeed she fails to understand why anyone would even ask, but people have learned to be sceptical.

The worst of it is, these examples are only the tip of the iceberg, since there is a huge DC industry devoted solely to obtaining information before it is widely known and selling it to trading operations.  It even has a name, "political intelligence".  It clearly ought to be illegal, but instead it is accepted as just as normal as retail banks mis-selling financial products, investment banks creating derivatives which they know to be poisonous and hedge funds trading on advance corporate information.  We're all in favour of free market capitalism, but it doesn't work when the only rule is that everyone does whatever they can get away with.  The futures industry has been dealt a terrible blow by the MF Global disaster, where clients believed that the heavily budgeted industry regulator was at least checking that their money was not getting stolen, and now learn that their faith was misplaced.  Which shoe will be the next to drop?

 

Monday November 14, 2011

At last.  This weekend's big get-together of global leaders didn't take place in Europe, or to discuss the eurozone, and wasn't even billed as a crisis meeting.  The trouble is that the bigwigs present at the Asia-Pacific Economic Cooperation summit in Honolulu couldn't seem to find much to talk about other than, you guessed it, Europe.  Not that they had anything new to contribute, perish that thought, but they were all of the view that their own heroic efforts to maintain global prosperity were endangered by events in the Old Continent, and that these need to be sorted out as a matter of great urgency.

It must be noted that none of those present has yet suffered much direct damage from the current round of sovereign debt problems, with their biggest banks appearing to have avoided getting up to their necks in this toxic waste.  Wall Street's great institutions are unwilling or unable to reveal even to their own regulators the quantum of their exposure to credit default swaps, which isn't a good sign, but they remain convinced that these can never be triggered - it will be interesting to see how that one unfolds.  For now, the relatively puny MF Global is being described in the financial media as "the first American victim of the European crisis", even though this would be more accurately "the nth American victim of hubris, greed and spineless regulation".

President Obama has evidently been better briefed since his clueless performance at the G20 meeting in Cannes, and is now aware that the immediate danger to the system comes from the direction of Italy.  He urged Europe to provide "strong" assurances that such countries will be able to finance their debt.  The trouble with that, Barack, is that anyone on the right hand side of the pond can give you a pretty strong assurance that they won't, so where does that leave us?  The various Asian leaders were more realistic, confining themselves to comments confirming that, while the sovereign issues are certainly a nuisance, they intend to watch these events from a safe distance.

For us, the most interesting matter under discussion in Hawaii ( the President's place of birth, as was stressed for the benefit of anyone who still thinks that birth certificate has a suspiciously Microsoft look about it ) was the question of currencies.  Regarding the prevailing yuan exchange rate, the Chinese as usual did not give an inch.  They do not accept that enduring high rate of unemployment in the US, and the even worse problem of underemployment, can be laid at China's door.  They prefer to focus on the dismal management of that nation's monetary and fiscal affairs, and are not shy of saying so.  However, their longer term plans for their currency are becoming clear, and the Americans should be a great deal more worried than they seem to be.

Donald Tsang, the effective leader of Hong Kong, is unlikely to make any statement which is in conflict with the thinking of his bosses in Beijing, so it was interesting that he mentioned that he looked forward to the euro gaining a place as a reserve currency alternative to the dollar.  This is not as daft as it at first sounds, since the current mess is bound to disentangle in due course, and the means of exchange operated by Germany will return to favour even ( or especially ) if it is once again generally known as the deutschemark.

What was even more informative, however, was his thinking on the subject of the yuan.  He sees no reason to hurry with increases in either its convertibility or its value, but these will proceed remorselessly at the pace decided by the Chinese leadership.  By the end of this decade, he expects their currency to join those of Europe and the US in a tripod reserve system.  To a US administration obsessed with next year's elections this seems an eternity away, but in China it is the near future - admittedly, politicians there are not hampered by even a flawed democratic process.

Anyway, that's the idea being put forward.  We can't help wondering why an international investor, given the opportunity to own the currency of the world's fastest growing and most solvent economy, would wish to balance it with holdings in that of a nation running the biggest budget and current account deficits in history.  Policymakers in Washington, if there are people in that hall of distorting mirrors who can even be dignified with the description, who are demanding that China take more of a leading role in the global financial framework, should perhaps be careful what they wish for.

 

Monday November 7, 2011

It feels like Groundhog Day.  Once again, a report on the past week's politico-financial events shows only that we remain pretty much where we started, an outcome so predictable that these words could safely have been penned seven days ago.  Perhaps they were.

It will not have escaped readers' attention that the leaders of the 20 great nations of the industrialised world were ferried to the glitzy resort of Cannes, venue of the famous film festival.  French President Nicolas Sarkozy is noted for his hospitality, and prepared his guests for the rigours of the coming austerity with two days of the finest foods and wines, served by carefully selected young ladies in fetching uniforms - not that this prevented Italian leader Silvio Berlusconi from rather obviously eyeing up Cristina Kirchner, the visually pleasing president of Argentina, but that's another story.  Since many of their finance ministers had only a week earlier taken part in their own big meeting, where absolutely no progress was made, you might have expected that the Cannes get-together would prove an equal waste of time, and you would have been correct.  This gist of the lengthy communiqué put together by their assorted civil servants was that our leaders are in full agreement that the financial problems of the eurozone are very serious, and that somebody needs to do something about it very soon or it the consequences for the world will be dire.  There must be a plan, because the alternatives to having a plan are too awful to contemplate, and they will let us know what it is when they've found one.

One of the details that has not changed since last weekend is that the Greeks will not be permitted a referendum to vote on whether they really want the austerity measures upon which they are about to be crucified.  The Greek prime minister, and socialist party leader, George Papandreou, did at one point make the bombshell announcement that such an exercise in democracy would take place, and we wondered briefly whether we had misjudged the man.  However, his own people clearly know him better, and were not at all surprised when it was revealed that the whole episode was just a hoax, designed to raise his profile with the big fish in Euroland.  BBC News asked a sample of Athens residents for a view of their leader, and "I hope he dies" seemed to sum up a popular strand of opinion.

In similar vein, both the British Prime Minister and his financial sidekick George Osborne assured the public in no uncertain terms that not a penny of their money would be thrown down a well in support of the single currency experiment of which the British had always been so deeply suspicious.  It now turns out that this was untrue, and that the UK will play a substantial part in any fundraising  taken on by the IMF for this purpose - probably there was some earlier misunderstanding on that point, or maybe they simply had their fingers crossed behind their backs when the original statements were made.  Much as with Greece, there would be greater outrage on the streets of London if such behaviour were not by now considered totally normal.

With inevitable turmoil to come across the globe, we should like to attempt an analysis of the hopes and fears of some of the major players in this great tragicomedy.

German Chancellor Angela Merkel wants to see a great united Europe, with Berlin at the centre of it.  Its people will all be honest, diligent and hard-working, and under German guidance they will all prosper.  She does not want Southern Europe to decide that this isn't the way they want to live their lives and to peel off, particularly if this causes Germany to eat a great deal of their bad debt.  She also does not want her own people to decide that they do not share her vision, since they have seen this movie before ( or their parents and grandparents have ) and it doesn't go well.

Sarkozy has still not realised that his nation faces an even larger worry, which is its continuing existence as a significant player on the world stage.  He wants to keep his job after next year's elections, a prospect which seems quite unlikely.  His country's real problem is that it has prospered internationally by offering a sheen of culture to add to Germany's economic power, but that may no longer be sufficient.  He does not want the Paris banks to have to confess the true depth of their bankruptcy, which would reduce France to the same circle of Dante's inferno as Spain and Italy.

Cameron wants to cement himself in perpetuity as the leader of a centrist and elitist British government.  The socialist opposition being a shambles, he has to fear only his own party, who are highly suspicious of all things European.  He does not want the UK population, 75 per cent of whom have little or no enthusiasm for British membership of the European Union, to be given any way to express that view.

This being a site open to readers of all ages, we shall not go into what Berlusconi dreams of.  He does not want to go to prison, and is confident that for as long as he can cling on to power in Italy, that will not happen.

Obama wants to be re-elected next year, and US economic numbers, particularly anything involving employment, look awful, so he needs someone else to blame.  Blaming Bush is getting old, and it's annoying that Japan seems to be shaking off the effects of their tsunami faster than the US, so the travails of the euro are an obvious candidate.  Furthermore, he has been warned that if the inevitable default on Greek sovereign debt cannot be categorised as "voluntary" ( as in "this knife, your throat" ), then it will be back to the dark days of 2008 for the Wall St banks who wrote copious insurance on that debt, and who are expected to bankroll his 2012 campaign.  This is his nightmare and, having little else to contribute to eurozone discussions, he went to Cannes primarily to head it off.

The Chinese leadership wants a stable world in which they can export and import to suit their needs.  They are patient people, and expect matters to turn out to their advantage.  They don't want to lend money to a bankrupt financial system which cannot pay it back, but that's not a problem, since they have never had any intention of doing that.

We were intending to finish with a summary of the aspirations of the people of these various countries, but are running out of space.  These are of course regarded by all those mentioned above as matters of minimal importance, but perhaps one day they will be forced to adjust that view.  However, we do feel confident that discussions of any global popular uprisings against our incompetent and larcenous political leadership can safely be deferred until next week.

 

Monday October 31, 2011

Guess what, for the first time in months there's been no crisis summit meeting of our leaders this weekend.  This is, of course, only because it was a mere three days ago that Europe's finest got together to save the euro once and for all, and at 4am local time ( say what you will, they can certainly do drama ) the great breakthrough was duly announced.  As our readers will certainly have noticed, global equity markets took this as all the excuse they needed for an explosive rally, although it was interesting that bond markets, which might have been expected to benefit most from the end of credit risk as we knew it, did not join the party.
We are very happy to say that we do not intend to explain at great length why the celebrated agreement amounts to nothing - not "not much", but zero, zilch, nothing.  The welcome reason for this self-denial is that most of the mainstream outlets have already explained its overwhelming reliance upon smoke and mirrors, with only a small rearguard of establishment loyalists, led by the Financial Times and CNBC, editorialising that something of huge importance has taken place.  To summarise, the major lies are as follows.
1.     The banks have not been given 106 billion euros, they have been told to go out and find this sum, and have until 1st July next to do so.  Yes, it is suggested that if they fail, and their national government also declines to cough up the money, then it may become available from some central source, but the idea that any financial institution in this state could survive the coming eight months is clearly absurd.
2.    Greece's creditors have not agreed to a 50 per cent reduction in the amount of their loans.  It is true that the Institute of International Finance, which is in some sense the banks' and insurers' trade union in these matters, has agreed to such a proposal, but even that is subject to further negotiations which must determine its real effect.  In any case, many bondholders, particularly those who have purchased insurance protection, will prefer to take their chances in a default.  By the way, this haircut leaves Greece in just as hopeless position as it is now, but nobody has cared about that for ages.  However, you have to assume that some bright sparks in the Italian Finance Ministry are reworking their spreadsheets on the basis of a halving of the nation's debts, and may be finding a viable economy.   
3.    The EFSF has not been expanded , by the clever use of derivatives, to a nice round trillion euros - this will only happen if buyers of the toxic stuff can be found.  The only people known to have that kind of money lying around are the Chinese, and in the euphoric early hours of Thursday morning it was suggested that French leader Nicolas Sarkozy would travel to Beijing to make the pitch, since he is well known there.  Later that day, after more mature reflection, it was decided that he would be excused from the trip, presumably for the same reason.
While the belated realism of much of the press has give some cause for optimism this week, this cannot compensate for the depressing evidence that Europe's politicians have abandoned any idea of representative democracy.  In nation after nation, it is clear that the population would willingly impeach their leaders rather than allow them to continue with their ruinous policies, but they have no way, other than civil disobedience, to express their wishes.  Even though Greece and Germany appear to be at opposite poles of the present controversy, this applies equally in both countries.  One reason that the streets of Berlin, unlike those of Athens, are not filled with rioters may be that the highly respected German Constitutional Court  continues to do what it can to rein in Angela Merkel's rush to single-handedly unite Europe.  Most recently, they have rejected her attempt to take ratification of the current plans out of the hands of the parliament, and into those of a small sub-committee, whose members could more easily be targeted for bullying, bribery or blackmail, as appropriate.  
This follows the Chancellor's grossly irresponsible suggestion that her scheme for the future of the continent must be followed, or the region might be plunged into war.  It is difficult not to remember which nation has launched the wars which have ravaged Europe over the past century, so what is she saying?  To be honest, she has never appeared to us to be a particularly bad person, and is certainly no Hitler, but there is clear evidence of cracking up.
More generally, a clear majority of both her party and her country have quite simply had enough of the grand European experiment, which has so obviously failed.  This is true across the continent, and was tested spectacularly this week in London, where Prime Minister David Cameron chose to take on those members of his own party who feel that the population should at some point in the future be allowed a referendum on whether to stay in the European Union.  Parliamentarians of his own party were warned that if they failed to support his insistence that this would not happen, they could never be considered for any post in his administration, and an astonishing half ignored the threat and voted with their consciences.  The government's attempts to pass off this brutal rebuff as a minor tiff have completely misfired, and Cameron must regret having sacked his brilliant, if ethically challenged, spinmeister Andy Coulson - after all, the man isn't even in prison yet.

 

Monday October 24, 2011

EUROMESS

For longer than we care to remember, every one of our weekly commentaries seems to have centred upon some crisis meeting of world leaders, so it comes as a great relief that the pattern has finally been broken.  True, this weekend's scheduled tryst between Angela Merkel and Nicolas Sarkozy did take place, but it was openly admitted that this was no more than a photo-op for the French leader, and that his German counterpart would have much preferred to stay at home working on her stamp collection, or whatever else she does for relaxation.  Officially, the grand plan to sort out the Euromess unravelled during the course of last week, and will now not be ready for its coming out party until Wednesday - if any reader had the partially ravelled version in their sight for long enough to discern its general shape, we should we very grateful to hear from them.

Our general impression is that, to the astonishment of all the major players, the necessary two trillion euros have somehow still failed to drop out of the sky.  The French would like nothing more than to donate the funds for the general good, but sadly they are broke, and therefore unable to follow their natural generous impulses.  Meanwhile the Germans, who do have the money, are being typically selfish with it.  There was a further disappointment this week when the IMF, while keen to help, had to confirm after checking at the back of every drawer and behind all of their filing cabinets that they, too, had failed to find the necessary funds.  You have to sympathise with the guardians of our global economy as they reel under this succession of unforeseeable misfortunes, but the good news is that everything will be sorted out in the next three days.  No, really, that last part must be true because that is when the final plan is going to be presented to the European Council.  We can't wait.   

We presume that our readers are keen to hear an update on the unfolding Greek tragedy, so here is an abbreviated version.  The officials from the troika ( the European Commission, IMF and ECB ) now helping  out with the local economy, or "the Nazis", as they are known colloquially in Athens, have formed the view that the nation's rate of progress towards its avowed financial targets is approximately not much, and backwards.  However, they will continue to get their regular payments of 8bn euros, because otherwise they would have to go into something resembling Chapter 11, and the continent's banks aren't ready for that.  In any case, the matter is moot, since the present rate of subsidy will not be nearly sufficient to keep the country afloat in the medium term.

You all no doubt all remember the recent stress tests for European banks, which were made on the basis that Greek ( and other ) sovereign debt could never fail to pay on time and in full - the Belgian lender Dexia almost immediately went bust for a completely different reason which nobody saw coming, but that's another story.  Anyway, since then a haircut of 21 per cent seems to have been generally accepted, but it is becoming evident that this number is nowhere close to what will be required for Greece ever to be financially viable.  A range of 40-80 per cent looks more plausible, with the wind blowing in the direction of the high end.  This prospect, which bankers are refusing even to discuss openly, raises several interesting issues.

First, the big French banks are deeply enmeshed in Greece, and while their exposure is not sufficient to bring them down by itself, their credit ratings, and most likely that of the sovereign which stands behind them, would certainly be affected.  Hence M. Sarkozy's need for constant hand-holding across the Rhine, see above.  Then, there is the question of how such a large writedown could be presented as something other than a default, which would bring credit default swaps into play.  This is of vital importance because the US banks, which have little direct involvement in Greece, are believed to be on the CDS hook in a serious way.  They do not need yet another drain on their finances quite yet, since even in Washington the traditional bankers' cycle of {major accident -> taxpayer bailout -> apparent recovery -> record bonuses -> next major accident -> .... } is considered slightly indecent if it takes place within a total period of less than four years.

Finally, and by far the most important, the better brains in Europe, and there are some, particularly at the Bundesbank, have noticed that Greece is really of interest primarily as a dry run for Italy.  The Italian bond market is huge, bigger than its German counterpart - that should probably come as no surprise, since the government in Berlin also has a real economy with which to fund itself.  When Rome starts to talk about paying its loans back on friendly terms the whole world will shudder, and Frau Merkel's handlers are wise to ensure that she, or whoever they have chosen by then as her replacement, will not be hampered by a precedent of reckless generosity.

 

Monday October 17, 2011

Another weekend, another international crisis meeting, it really is getting difficult to keep track.  This time it was the turn of the G20, who have been out of the spotlight lately, since it became clear that their radically divergent interests made it unlikely that they would ever agree on anything.  To their credit, they were able to put together a joint statement in which they confirmed that Europe must take swift and decisive action to sort out the crisis facing its banks.  This is certainly true, their belated recognition that time and money really are running out is right on the mark, so we now look forward to the next panicked convocation of big names, which will address the detail of where the required trillions of euros are going to come from.

Every little helps, and Western banks can at least be assured that a contribution will be received from the small and impoverished nation of Slovakia, which briefly threatened to derail the whole process.  A minority in the governing coalition (and a majority of the general population, not that this matters any more in Slovakia than it does anywhere else) could not understand why it was necessary for their nation's finances to be sucked dry in order to pay off SocGen's gambling debts, and had the nerve to vote against the plan.  Prime Minister Iveta Radicova then had a choice - she could accept the result, or seek the support of the leftist opposition, causing her government to fall.  She chose the latter course, presumably cutting short her own domestic political career.  If she were one of the vermin currently in charge of the big Western nations this would come as no surprise - the British people, just to give one example, and wait to hear the explanation of how they will be on the hook for the salvation of the euro even though they were told that they had avoided any such liability -  but Mrs Radicova had seemed better than that.  If she turns up with a well padded job in Brussels, or in a senior position at JP Morgan, we shall have to admit that we got that wrong.

Meanwhile, EU life goes on as if none of this chaos were taking place.  It was announced this week the Montenegro will be following Serbia in entering discussions which should lead to their accession to this benighted organisation.  Do you laugh or cry?  Just as these people should be enjoying their first taste of independence, their government is conniving to have the new nation fattened up for slaughter by the big banks.  EU Enlargement Commissioner Stefan Fule praised the little country for its "genuine commitment, proactive approach and good progress", even as he polished up his knife and fork. The only hope for them is that the whole pack of cards will have collapsed before they can be installed in their intended position at the bottom of it.

To summarise, what has happened this week?  To go back to where we started, everyone now seems to understand that Western banks, headed by but by no means limited to those of the French persuasion, really are in a shocking mess.  They need massive donations from the more productive sectors of the global economy, but given the size and urgency of the problem, the idea that matters will be sorted out in a conventional fashion by organic growth is a joke. The money could come from some part of the world which has run its affairs responsibly over the past decades and has built up a treasure chest, but the sums are so huge that only China and Germany need be taken seriously.  After a brief period of misplaced excitement among the more deluded officials and bankers, the Chinese have made it abundantly clear that any deal they drive will be very harsh, and not based on unsecured IOUs.  As for Germany, Frau Merkel, might well be willing to abandon every principle her people elected her to stand for, but there is a formidable array of domestic power ready to stand in her way.

Therefore the money will have to be created by some magic trick. The is of course the course favoured by Tim Geithner, the US Treasury Secretary and bankers' runner, and this weekend he was still pushing for some plan involving unimaginably huge and unstable financial derivatives.  Goldman Sachs are well placed to help here, having devised the scheme which allowed the Greek government to look as though they were staying within the EU's financial guidelines for years, when in fact nothing could have been further from the truth.  Those Europeans who do not see merit in filling the can with nitro-glycerine before kicking it down the road, particularly those in residence at the ECB, have been alerted to the danger. They are digging moats and preparing the boiling oil. To give one example, the Bundesbank has allowed word to leak out that deutschemarks are once again rolling off the printing presses, just in case....

Clearly, the stakes in this game have just got even higher.

 

 

 

Monday October 10, 2011

At the time of writing, a piece of news has just hit the wires which we have no choice but to describe as incredible.  Regular readers of this commentary may understandably be surprised by our use of this adjective, which we have made a policy of avoiding, along with such other journalistic stalwarts as "going forward" and "if you will".  It is generally used on NBC to describe such astonishing events as the NFL team winning the Superbowl, or indeed their AFL opponents doing so, and on their sister financial channel whenever Procter & Gamble beat their quarterly number by a penny, or miss it by the same margin.  We, however, continue to utilise the term in its traditional sense of being impossible to believe, and therefore rarely.  What event, you ask, has impelled us to such extreme language?

It has been reported by Reuters, and now by numerous other sources, that Europe's terrible twins, Angela Merkel and Nicolas Sarkozy, have found a mutually acceptable way to stabilise the EU economies and save its financial institutions.  They are reportedly " in total agreement on the recapitalisation of European banks".  To be fair, this was only a provisional statement before they adjourned for dinner, where more concrete details were expected to be discussed, and it seems that we may not discover what was settled over the port and cigars until Monday.  So, in the true sense of being impossible to believe, is this latest stuff incredible?

You bet it is.  So far, Europe's politicians have been running around in circles, heads attached or otherwise, in the firm belief that they must  eventually stub their toes on a treasure chest which would, upon opening, be found to contain a couple of trillion euros.  What is "show us the money" in Esperanto?  M. Sarkozy is desperate for his country's banks to be given huge sums when they are rendered bust by Europe's coming wave of sovereign defaults.  The Wall St banks which, while not overly exposed directly to Southern Europe, are massively stuck into their French colleagues, feel much the same way. Unfortunately, France herself has nothing resembling the amounts of cash needed for this purpose, and the spotlight switches back to Frau Merkel, who has enough left in the kitty to see everyone through for two or three years. She, in turn, would love to oblige ( it seems to be a European leader thing ), but is deterred by her lack of enthusiasm for being put through a meat grinder by her own supporters and made into frankfurters.  Hold the sauerkraut.

In all probability the Western stock markets will tick up on tonight's shock developments.  Are they incapable of learning?  There's a saying about bears and woods, though we suspect the early buyers would claim that their behaviour has more to do with bigger fools.  Either way, we judge the likelihood of a fully formed solution to Europe's problems being found in time for presentation to the G20 meeting in the plush resort of Cannes, at the beginning of November, to be close to zero.

On the subject of the G20, the non European members of this fractured body have been reduced lately to increasingly unhelpful noises off.  The developing nations ( a definition which still seems to include Russia, even as that country slides back into the Middle Ages ) are no doubt being disingenuous, highly entertained by the travails of the old colonial masters.  However, it is quite likely that the White House, educated in economics by Messrs Geithner and Bernanke, ( and still, amazingly, by Buffett and Greenspan ) genuinely fails to understand why the Europeans, more accurately the Germans, are reluctant simply to pay off all the banks' debts simply by printing the necessary money.  What's the worst that can happen?  Just a bit of inflation, and that's never hurt anyone, has it?  The Atlantic Ocean has never seemed wider.

 

Monday October 3, 2011

The Anglo-Saxon world worked itself into a state of great jubilation last week, as the German parliament gave its approval to the revised use of the €440bn EFSF, the euro rescue fund.  We should probably give their public figures credit at least for understanding that the result was never in doubt, given that the main opposition parties were in support, and the real question was whether Chancellor Angela Merkel could obtain votes from a majority of her own party.  In the event that was achieved with a degree of comfort, but they made it clear that, sufficient or not, this was the end of the line when it came to Germany's subsidy of her neighbours to the South.

French president Nicolas Sarkozy has lost none of his enthusiasm for the Greek bailout, since he has evidently been warned that the consequences for his nation's banks of a default would be even more horrific than is generally assumed.  He insists that future tranches of international funds must be shipped to Athens as scheduled, and has publicly congratulated Greek premier George Papandreou on meeting the austerity targets imposed upon him, even though nobody believes they have come anywhere close.  This seems a good bet, if only because they are quite impossible to achieve, but the EU experts sent to check the figures ( or gauleiters, as they were described in the Greek press, in reference to the equally unpopular Nazi occupation ) have been prevented by demonstrators from reaching their desks.

Merkel and Sarkozy are reportedly getting together for yet another chat next weekend, but this time it isn't clear what the lady will be able to offer, with so many sharp objects being directed at her back.  The idea of a two trillion euro structured derivative product, which briefly got Wall St into a tizzy of excitement, has been given an unequivocal thumbs down.  So the Goldman Sachs team can go home, then?  That must be a disappointment, since even a modest percentage on that sort of money will pay a lot of bills.  Finance Minister Wolfgang Schauble, even though he gave great offence to the Americans by describing their pet scheme as "a stupid idea", is probably the only member of the German government who would still try to slip this one past a suspicious population.  However, his habit of saying one thing to his fellow countrymen and another to his international peers has been rumbled, and if caught again he would be lucky to escape with his limbs intact, let alone his career.

What has happened, on several fronts, is that the German nation has decided that enough is enough, and they are no longer required to carry the entire European economy on their back.  You can argue that it has been in their own best interest to do so in the past, but it isn't now, and it's over.   The president of the constitutional court, a position accorded the highest respect in postwar Germany, has expressed deep concerns that the financial concessions already made come dangerously close to eroding the rule of law.  Remember that we're not talking here about the US, whose constitution is routinely bent beyond recognition, or the UK, which famously does not have one.  In Berlin, no means no.

It comes as no surprise that the US administration still hasn't got the message, with both Obama and Geithner "exerting pressure" on Europe to solve its problems, which they claim disingenuously are at the root of their own country's economic malaise.  The president is said to be "impatient".  His patience may be tested a good deal further, since the truth is that they have no pressure to exert - the much bruited dollar lines of support are in place not because the US Treasury is helpfully strengthening the euro, but because it is desperate to keep its own currency weak.  Even Nobel prizewinners Joseph Stiglitz and Myron Scholes recently expressed puzzlement that local political problems could not be steamrolled for the general good, and these are smart guys, they got their awards back when the Economics prize still had something to do with economics.  The fact that political events in Europe are a lot more weighty than an argument between Illinois and Texas has yet to be fully grasped across the Atlantic.

It hardly needs saying that the UK government, despite being separated from continental Europe by only twenty miles of water, is equally clueless.  Nick Clegg, deputy Prime Minister and leader of the imploding Liberal Democrat party, was in Warsaw last week, explaining to his fellow Europeans that they must solve the crisis by standing shoulder to shoulder.  They would no doubt have preferred a cash contribution, but fortunately for his country he is not a signatory on the national chequing account.

The message for anyone handicapping a resolution to Europe's difficulties based on all parties getting together and working things out is very clear.  It isn't going to happen.  The idea that this is bound to come about because the alternative is so awful does not wash, it goes against all human history ( was there, for instance, no more rational alternative to the American Civil War? ).  In this case, it is not even so clear that some outcomes are much better than others.  The wealth is already gone, and the arguments concern the question of who takes the biggest hit.  None of this is to say that the second decade of this century will be pleasant, the developed world has lived beyond its means for too long, and the emerging economies will as usual be caught in the backwash.  Perhaps, this time, even the political and banking classes ( if they can be separated ) will not escape unscathed.

 

Monday September 25, 2011

SHOW ME THE MONEY, JOUYET

After several weeks of continual eurotrash, we hoped that it might be possible to devote this week's commentary, by way of a change, to the Fed's latest effort to spur their domestic economy through the widely heralded twist operation.  Sadly, when Ben Bernanke finally pulled this rabbit out of his hat, it was mocked as being an example of some lesser species, and a sickly beast at that.  T-bonds of differing maturities moved as predicted - with 72 per cent of the float in the hands of US and foreign official authorities, you have to respect their ability to manipulate that market - but across the globe, equities took a major nosedive.

The problem seems to have been that, in their statement explaining why they were taking extreme steps to get the US economy out of its current hole, the Fed governors chose to confess that it was ( gasp ) in a hole in the first place.  Of course, this would not come as news to most members of the general public, even if for some reason they had nothing better to do than to read FOMC statements.  However, investment managers on Wall St and around the world have evidently been taking seriously the monthly rubbish about risks being finely balanced and the likelihood of something good happening two years out, so the admission that the future is looking seriously pear-shaped came as an unexpected blow.

The banks quickly launched a PR blitz to insist that the twist operation, which bore all the hallmarks of being their own device, would in fact impact negatively upon their profits.  We heard this at least six different times on CNBC ( though three of these may have come through the mouth of the ubiquitous banker-booster Jim Cramer).  Readers should be aware that this claim is open to doubt, since one effect is that the yield curve at the short end should be pushed up by a few basis points - not insignificant when you consider the outlandish size of the big banks' holdings in that region.  Furthermore, there has very conspicuously been no cut in the rate paid on their excess reserves, a source of income which might reasonably be expected to be zero in current conditions.  Forget "Let's Twist Again", the Fed's continuing refrain from that era is Bo Diddley's "Who Do You Love?", and we all know the answer.

On the subject of media credulity, we have no choice but to return to the bother in Europe, where we're convinced that even the politicians and central bankers cannot be dumb enough to expect the things they say to be taken seriously ( we may have to make an exception for Mme Lagarde ).  However, even a relatively sensible outlet such as London's Daily Telegraph felt able to report without a hint of scepticism this week's practical joke regarding a $3 trillion ( yes, with a t) "plan" to save Europe's banks.  One minor detail yet to be ironed out is where the money would come from - our leaders all agree that it must, and will without question, be found, with the direst consequences to follow if somehow it were not, and then they look expectantly at each other.

We have room for only one more from the recent stock of things you simply cannot believe you're reading, so here is a gem from France.  "French market regulator Jean-Pierre Jouyet Friday said between 15 and 20 banks in Europe need recapitalization as a result of financial problems, but none of them are French".  That one got into the Wall St Journal on the day when senior BNP Paribas executives were returning to Paris, tails between legs, after a failed attempt to find a bit of money in the Middle East - just as well they didn't need it, then.  It seems that M. Jouyet is more focussed on a bank in Slovenia which may have got itself trouble, but we need not worry, they're on that case.

What can you say any more?  One day, and its getting closer, something has to happen, but meanwhile they can probably keep digging the hole a bit deeper, so tune in next week to read about what is most likely to be even more excruciating nonsense.

p.s.  It's difficult to keep trillions in perspective, but recall that $3tr means $3 million million.  Suppose that there are 15 million households in the solvent parts of the EU in a financial position to offer assistance to the banks - we've plucked that number out of the air for the purposes of this example, but it seems more likely to be high than low.  They would need to contribute $200,000 each to get these deadbeats back on the road.  Sorry, but we don't see that happening.

 

Monday September 19, 2011

Tim Geithner has certainly done his frequent flier account no harm lately.  Only a week ago he was in the South of France, haranguing the wealthy European nations ( for practical purposes, Germany ) on their moral duty to send out as much money as their Mediterranean neighbours needed.  At least he does not appear to have repeated his boss's demand that, while they're doing that, they should expedite Turkey's entry into this mess, but that is the only good thing to be said.  His hosts heard him out politely, then briefed the press about his shortcomings.

So why, on returning to the safety of US soil, did he almost immediately turn around and head off to Poland, for an unprecedented appearance at a meeting of EU finance ministers?  Either they were panicked or he was, most likely both.

Why would the US be so concerned about the chaos unfolding in Europe?  The administration is allegedly worried that a collapse in the economy across the Atlantic would impact on them, but it is supposed to be the American consumer which will lead the world out of its current state of doldrums.  The truth is more simple, that a percentage of the money being thrown onto the EU bonfire will, if they aren't careful, be traced back to the US Treasury, and thence to the nation's taxpayers.  We can see two clear routes for this.

First, the US is the largest contributor to IMF funds, and they are getting in up to their necks.  Say what you like about Dominique Strauss-Kahn's personal habits, he is a responsible economist, a member of an endangered species on today's  world stage.  As a trustee of the IMF's assets, he could hardly be more different from his featherbrained replacement, Christine Lagarde, who has destroyed the finances of France ( admittedly from a low base ) and now has greater fields to conquer.  With the new management in place, Geithner can be confident that a stream of requests for topup funds will ensue.

The other is probably even more serious, since it involves his first loves, Wall St banks.  Nobody knows, including their own senior executives, what would happen to worthy institutions such as JP Morgan if some European sovereigns were to go down.  They may have some idea of their direct exposure but, as this week's news from UBS shows ( last week's news for Kweke Adoboli's Facebook friends ), their derivatives positions are, to coin a phrase, a closed book.  If the Treasury Secretary has one primary role, it is to protect American investments banks from the consequences of their actions.

So, our hero overcame his jetlag and headed east to Wroclaw, with financial markets bouncing on the prospect of his keynote speech.  His fellow finance ministers listened with equal excitement as he explained that quick and decisive action was needed to increase the size of the Great European Slush Fund, and were agog to hear how much the Americans intended to contribute.  Imagine their disappointment as it slowly dawned upon them that the magic number was zero.  The man who has sprayed around as much US currency as all of his predecessors combined could not find a cent for them.  Suddenly, with nothing left to lose, all of the old prejudices came flooding out.   Jean-Claude Juncker, the important Luxemburger ( really ) told the press that "we are not discussing the …. EFSF with a non-member of euro area".  So why had Geithner been invited?  Didier Reynders of Belgium returned fire, questioning how the US intended to solve its own deficit problem.  That man should be a senior member of his nation's government - oh, wait, they haven't got one.

As we always seem to ask at this point, what happens next?  Greek PM George Papandreou has cancelled a proposed trip to Washington, a sensible decision since it was obviously going to be a waste of time.  Leaving aside the fact that this applies to anything involving Mme Lagarde, the IMF has no interest in Greece, indeed nobody has any more.  They will be kept in the game for as long as it suits the banks, and then unceremoniously thrown out.  Mr Papandreou himself describes next week as "particularly crucial", quite a statement given his nation's recent history.  However, he misinterprets the coming discussions with the international auditors.  They have no intention of trying to measure the country's likelihood of approaching its economic targets, which everyone knows is zero, but wish only to maintain a pretence for as long as the markets will allow.  There is nothing the Greeks can do to assist.

The Merkel Sarkozy double act insist in increasingly shrill terms that the idea of Greece leaving the euro cannot be mentioned, a clear sign if ever there were one that it's going to happen.  Will they manage to keep up the façade long enough to ensure that when the break comes it will bring the whole European edifice falling down?  Perhaps we're there already, but if not the obduracy of the continent's leaders makes it a very good bet.

 

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Monday September 12, 2011

STARK, RAVING MAD

A more exciting week, but what really happened?  All the usual stories about Greece defaulting and, far more significantly as it seems, some big name European banks in trouble as a result.  An emergency G7 meeting (but not the more fashionable G20,  we'll return to that) and, by far the biggest news in our view, Jurgen Stark hands in his cards.

First to the weekend get-together in Marseilles, which the Wall St Journal describes as involving the G8, though we cannot identify the final participant.  Madame Lagarde found her way into the photoshoots, so perhaps it was the IMF.  Anyway, they announced in their communique that they had agreed to work together towards a solution to their problems, though according to other sources they couldn't quite agree on whether it was actually a communiqué or perhaps something less definitive.  This sounds so vacuous that it might reasonably have emanated from the larger group, so why were the others not invited?

The answer seems to be that the two groups within the G20 have understood the truth, which is that they have nothing in common.  The developed economies have managed the last few crises which they have created by transferring the damage to the emerging markets, but this ruse has finally been spotted, and the likes of China and Brazil no longer seem content to suck it up.  Their presence in France would not have been helpful, so they were not invited.

This leaves Germany as the only major solvent economy with which the debtor nations are on speaking terms.  Europe at least now has a plan, which is that they will live off German money until it's all gone - on reasonable estimates this will take about five years, so easily long enough to see all of today's big names out of their current offices and into important positions in some supranational body.  However, while Angela Merkel may have sold out her country, in the footsteps of Tony Blair ( yes, that was a cheap shot at the lady, we're just making a point ),  her central bankers are refusing the follow the same path.  At what was admitted by officials to be "an embarrassing moment", the EBCB's Chief Economist, has resigned for personal reasons.

What might these be?  Perhaps Herr Stark wishes to spend more time with his family, or is finding that he cannot combine his official duties with keeping the weeds in his garden under control.  More likely, we think, he is personally affronted by the depths of financial depravity to which his employer has been required to stoop.  After all, he was previously Vice President of the Bundesbank, working with the great Axel Weber, who earlier this year infuriated Frau Merkel by signaling that he had no desire to be associated with the ECB.  It should come as no surprise that they cannot stand for the new bred of central bankers, as exemplified by Jean-Claude Trichet.

To reprise, the European banks now all distrust each other and, given that they have no appetite for lending to companies or individuals, their normal reason for existence, they choose instead to park their funds with M. Trichet's ECB.  He, however, then lends their money on to Greece and Italy, in the full knowledge that they have no means of repaying it.  What will happen in January, when Deutsche Bank, for instance, asks for a few billion back because they have some bonuses to pay?  Will he say sorry, I don't seem to have it to hand?   Certainly not, since nothing in the banking system is more sacred than its executives' bonuses, but he will have to print the money.  Jurgen Stark has evidently made the decision that he does not wish to be around when this day arrives.

The Bundesbank would never have behaved in this way, which is why the German people have retained their trust in that institution, in a way that the Bank of England and the Federal Reserve lost long ago, and the ECB never enjoyed from the start.  Now German central banking has lost its two greatest names in the space of a year, with both appearing to have been forced out in the name of political expediency.   In the current undeniable financial crisis, Europe could do with just one major leader who enjoyed the support of their electorate, but there appears to be no candidate for this title still standing.

 

 

Monday September 5, 2011

ARE WE MISERABLE ENOUGH YET?

The big stories in global financial markets have rumbled along for the past week, but there have been no major developments.  Perhaps we shall discover after the final holiday weekend of the summer whether Bank of America and/or some French banks really need a another big bailout, or whether the one in progress for Greece will collapse, but for now there is nothing new to say.

This break gives us the chance to comment on a topic which has held our interest for some time, the misery index.  This evocatively named economic statistic, which came to the fore in the dark days of the late 1970s, is obtained very simply by adding the unemployment rate to the 12 month rate of price inflation.  Given that these twin ogres feature regularly at the top of the list of the greatest fears in the minds of the general population, it comes as no surprise that the index correlates well with measures of consumer sentiment, and onwards to consumption.

Bloomberg have taken up the baton, and with their usual attention to detail calculate values each month for sixty economies around the world.  We're always fascinated by the quirks thrown up in these reports - would you have guessed that Slovenia enjoys price inflation of less than 1 per cent, but more than one in nine of its workforce is unemployed? - but the real point is found in last month's figures relating to the big developed economies, as follows

US                          12.7%
Eurozone               12.6%
UK                         12.7%
Japan                     4.8%

There is no misprint here, the Western numbers are in a remarkably tight pattern, with Japan fixed at not much more than a third of those.  So why, you ask, are the Japanese so persistently miserable about their economic lot, and a living example of the fate which we in the West must at all costs avoid?  The answer is that, apart from those who have travelled overseas to obtain MBAs, they are not.  When any survey seeking to discover people's greatest worries is carried out in the West, it seems to go without saying that the leading candidates will be of a financial nature, even though those societies hardly lack other difficult issues.  The Japanese, however, seem more likely to feel that they have enough money to live as they desire, and that this happy state of affairs will persist into their retirement.  How can they fail to grasp the danger posed by their massive national debt, and the terrible scourge of deflation?

The answer to the first point is that, while the debts owed by the Japanese government are indeed prodigious, superficially far most serious than those of the US, there is a big difference.  The Americans are in hock to China ( and to Japan ), and one day payment will be demanded in some form.  However this happens, the result will not be pretty.  The Japanese debt, by contrast, is mostly funded by the home population and, while they may well be unimpressed by their serially dysfunctional government ( which has just got its sixth new leader in five years ), they do still seem to buy into the concept of Japan Inc.   By contrast, when George Osborne, now Britain's Finance Minister, said two years ago that "we're all in this together" there were guffaws all round, and the phrase remains constant fodder for cartoonists as he uses his position to shovel money from taxpayers to the banks, and thence directly into the pockets of his friends who run them.

The crucial difference between East and West is that successive Japanese administrations have carried out their side of the contract they have with their people.  Yen invested in government bonds may provide paper thin yields, but they are returned with their purchasing power intact.  The Japanese do not feel the need to risk their hard earned savings in speculative investments in order to defend against their rulers' determination to debase their currency.

This brings us back to where we started, the misery index.  When Barack Obama moved into the White House the US version stood at 7.8, represented entirely by the unemployment rate.   The Federal Reserve Board saw this data, concluded that the part they didn't like was the zero inflation, and constructed their policy accordingly - since then inflation has accelerated to 3.6%, with unemployment also on an upwards trajectory, currently standing at 9.1%.  The governors presumably consider this to be an acceptable tradeoff, and either do not know or do not care that, out in the real world, both numbers are regarded as a thoroughly unwelcome increase in misery.

(Click table to enlarge)

 

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Monday August 29, 2011

THE THREE STOOGES

There's no alternative, this week we have to comment upon Ben Bernanke's speech to the Jackson Hole assemblage of the great and the good, even though he was, as we expected, careful to avoid saying anything.  In fact, such is the extent to which the man has left the confines of this planet that he may really believe that his comments represented a valuable contribution towards the solution of global economic problems.  For instance, he strongly recommended that Europe's leaders should take all necessary and appropriate measures - why hadn't they thought of that?  For some reason, even though they have seen their path ahead lit up so clearly by this pearl of wisdom, the present weekend turns out to be one of the few in recent memory which has not featured an emergency meeting of the Old Continent's senior politicians and bankers.  Perhaps they recognize that they need more time to digest the full depth of his advice.

There is certainly no doubt, because he said it several times, that the current travails may be laid at the door of the Eurozone, and in particular their banks.  He saw no need to consider the origin of the exotic financial instruments which have laid low the Landesbanken - when US citizens rush to destroy their own lives by purchasing copious quantities of cocaine, which is for some reason allowed to cross the nation's borders, any fault can quite clearly be laid at the door of the Bolivians, but when naïve German banks buy ludicrous toxic derivatives peddled by Goldman Sachs and JP Morgan, they have nobody to blame but themselves.  The US economy, he assured his listeners, is fundamentally in fine shape ( AAA, as his boss in the White House would describe it ).  He even had the nerve to brag that the country's current account deficit was showing signs of reducing, though with most of the population too busted to buy any imported goods that is hardly a great surprise.

The Wall St community was momentarily distressed to have heard nothing that explicitly underpinned their own future remuneration, but within minutes they realized that, far more importantly, there was nothing to suggest the contrary.  September's FOMC meeting will be extended to two days, and members will obviously be discussing continuing support operations for the stock market, because nothing else is on the table.  The banking system remains broken, but any of the radical measures which might fix it, and in the process bring its employment costs closer to those of any other industry, may not be contemplated.  Even with more than a year to go, the President has clearly concluded that his re-election prospects are tied to the S&P 500 index, rather than the employment numbers, and the Fed, like the Supreme Court, watches the electoral returns.  The last thing the Chairman needs is to have pesky right wing Republicans in a position to quiz him on price inflation, which he may vaguely remember is supposed to be one of his concerns.

Speaking of Obama's roll of stooges, Mr. Buffett has of course been at it again, investing $5bn in Bank of America.  Never mind that he got in on terms that, after proper valuation of embedded options, represent a discount of about 40 per cent to market value and which would in less easygoing jurisdictions be in breach of securities law.  The fact is that he does not make such investments unless his friends in high places have assured him that his target will be the beneficiary of generous official treatment in the not too distant future.  He must be quite annoyed that, within hours of the announcement, the resulting boost to share prices was stalled by rumours that certain European banks were in even deeper trouble than had been widely assumed.  How dare they not warn him?

This brings us to the third outsized target of the week, Christine Lagarde, who has somehow moved with great speed from her previous position as French Finance Minister to Managing Director of the IMF.   Obviously she was one of the stars at Jackson Hole, and was vigorous in her insistence that European banks are in urgent need of recapitalisation, and that no excuses may be tolerated.  Yet it seems only a few months ago ( because it was ) that in her previous job she made a bitter personal attack upon the head of the UK's supervisory body for daring to suggest that the last generation of "stress tests" was unfit for purpose, in that they did not allow for the possibility of sovereign default.  Did he not understand that such a possibility could not be taken into account, or even breathed, for fear of unmentionable consequences?  It comes as no surprise that, at the top of the list of banks seriously under threat from such an eventuality, are at least two which were at that time under her purview.

So, at a time of historic financial crisis, the leading figures include a starstruck academic who seems puzzled to find herself in a position of great power, an octogenarian billionaire who hopes to get himself into the history books while trousering  a bit more along the way, and an ambitious politician who should be the world's most influential economist but sadly has no grasp of economics.  We haven't even mentioned the Western world's leaders of state, who are without a single significant exception despised by their own electorates.  You couldn't blame the Chinese for thinking that the whole mess is just falling into their lap.

 

Monday August 22, 2011

We have to confess that we're not among the most diligent readers of the New York Times, and in particular tend to avoid the work of their star columnist Thomas L. Friedman, but one particularly unsettling example did come to our attention last week.  It is of the "I have a dream" species, and imagines President Obama able to persuade Democrats and Republicans to set aside their narrow prejudices ( presumed to be respectively unlimited spending and balancing the budget ) and work together towards a better future.  Some of us are doubtful that merely splitting the difference between these two opposing views will put right the massive damage which has been done to the global economy over the past two decades, but Friedman's punch line leaves us in no doubt as to his value judgement - the reverie ends with the Dow Jones Industrial Index rocketing by over a thousand points after the announcement is made, providentially at 9.29 in the morning.

That's it?  There is a once in a lifetime peacetime consensus of political forces in the US, and the big deal is that the stock market has an instant recovery of 10 per cent, back to where it was a few weeks ago?  Is the point that the bears would get killed, with no chance to escape?  Sadly, this view of life does seem to have attracted a lot of support in high places.

Is there nobody left with any influence who cares that the great majority of the population who are wondering which of their routine monthly expenses should be the first to go, as rising prices overtake static incomes ( if they are fortunate enough to retain their employment ) do not own a stock portfolio and do not care about the famous indices.  It comes as no great surprise to learn that the NYT assumes that the only purpose for which its nation exists is to maintain the lifestyle to which denizens of lower Manhattan have become accustomed, nor that London's Financial Times has expressed its enthusiasm for the UK version of this view, but don't both of these organs operate in democracies?  Where are the representatives of the majority?

Perhaps they were heard in the recent riots across England, where the looters, though generally incoherent, may be presumed to have noticed that nothing in the management of the country's economy appears to have their benefit in mind.  However, when Finance Minister George Osborne addressed the major issues in a speech to Parliament, he laid great stress upon on the problems in equity markets, and made no mention of the runaway price inflation which kicks his constituents in the teeth every week.  Similarly, the minutes of the latest meeting of the UK's Monetary Policy Committee lamented the fall in the prices of bank stocks, and those institutions' difficulties in raising capital at affordable rates, but their attitude to price inflation ( supposedly their primary responsibility ) remains, "if we ignore it, it will probably go away".  Maybe they feel that a policy which has failed for so long must surely have its day.

Even though we do not share the view held unanimously by our leaders that stock market levels are all that matters in the world, let's take a look at them anyway.  After last week's drops, the major indices in New York, London and Frankfurt are all within a few percentage points of where they stood one year ago, and also two years ago.  Is this so wrong, why should they be higher?  Twelve months ago, it was generally accepted ( though not here ) that the global economy was rebounding from its technical problems, and that the unpleasantness in the Eurozone had been confined to its periphery, and successfully isolated.  A year before that, we had already seen a 50 per cent bounce from the bottom, and equities appeared reasonably priced in the absence of any accidents.  The problem appears to be that, even with dividend yields exceeding risk free returns - we shall overlook the question of what that means nowadays -  static prices simply are not good enough.  Today's giant global Ponzi scheme requires that central bankers and finance ministers feed their paymasters with double digit annual returns, or the system just doesn't work.

If you think that suggests a return to the era of rampant price inflation defeated thirty years ago, and at such cost, by the great Paul Volcker, you're talking our language.  It is frightening that supposedly mainstream economists are now suggesting that what we need is a few years of "controlled" inflation - we don't just mean Prof. Bernanke, who famously boasted of his unique ability to turn this scourge on and off like a tap.  Don't these people ever learn from history?  On both a fundamental and a technical basis, we cannot help feeling that the price of gold has run ahead of itself, but if the buyers are reading the same newspaper stories that we are, it's hard to say that they're doing anything foolish.

 

Monday August 15, 2011

It cannot have escaped the notice of readers that global stock markets suffered a jarring fall on Monday, causing Ben Bernanke's committee to announce a support operation - sorry, that should read "a reaction to their downward revision of prospects for the US economy".  Eurozone problems may also have played a role in the decision, although that was not made explicit.

CNBC naturally spent the rest of the week telling their viewers every five minutes that there is now an irrevocable promise that dollar interest rates will remain nailed to zero for the next twenty four months.  In the UK, where there is no TV channel controlled by the banking community, it was necessary to read the Financial Times to discover what they want you to believe.  A typical comment, presented as reporting rather than editorial opinion, was "the US Federal Reserve has attempted to tackle a rapidly weakening economy by freezing short-term interest rates for two years".

We have come to accept that there are probably few investors or traders who really care about the precise wording of the statement, but shall assume that own readers are a select bunch who defy this stereotype.  For your benefit, here are the important words.

"The Committee currently anticipates that economic conditions - including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013."

If taken literally, this means almost nothing.  The futures markets were already assuming very little by way of rate movements by then, and were seemingly taking a more dismal view of the US economy, aka "resource utilization", than anything to which the Fed had previously confessed.  Supposing that resources turn out to be utilized to the extent widely assumed only a couple of months ago, should we assume that all promises relating to interest rates no longer apply?

Then there is the inflation question.  A "subdued outlook" is a given only if you assume that that the statisticians can be brutalized into continuing to produce figures which bear no relationship to the experience of the general population in their weekly expedition with a shopping cart.  If inflation, and the public's expectations thereof, cannot be contained, how will the FOMC justify continuing to set rates for the advantage of the banking community?

Finally, what are "exceptionally low levels" anyway?  We should not forget that we are looking at the first time that central banks have experimented with the policy of keeping real interest rates far below the prevailing rates of price inflation for extended periods.  At any previous point in history, an official rate of 100 basis points above the level where it now sits would be considered exceptionally low.  Perhaps Dr Bernanke has discovered, with his scheme to distribute currency from helicopters, the holy grail of eternal prosperity missed by the likes of Paul Volcker, Montagu Norman and Karl Otto Pohl.  If so, he and his colleagues must be recognized as the most brilliant members of their profession ever seen.  However, given that these were the men who failed to foresee the most devastating financial storm in living memory, we feel that judgement in this matter must be deferred.  Whatever is meant by the FOMC statement, which must as always be assumed to have been presented in code, it is important to note that three members took the step of disassociating themselves publicly from it.  They will surely be quick to comment when the premises upon which it is based no longer apply.

We have been a bit Eurocentric lately, and it is time to correct that, ignoring CNBC's insistence that the problems in US equity markets can be traced entirely to that source.  We note that the UK riots have little to do with any foreign influences, despite the fact that Chancellor George Osborne, on being dragged back from his holidays, made a speech to Parliament which depended heavily upon the comparisons of equity prices on the London Stock Exchange with those overseas.  Somehow, we doubt that small businesses whose premises had been destroyed found much comfort from these statistics, or that the rioters themselves are primarily upset about the drop in value of their equity portfolios..  

Please understand that we have zero sympathy with the hooligans in London and elsewhere who have spent the past week systematically destroying their own neighbourhoods.  We merely observe that in a society where a) a satisfactory lifestyle is defined by the ownership of financial assets and b) government policies are designed to ensure the existence of a huge underclass which can never aspire to such status, there is inevitably more trouble coming.  Furthermore, the ruling Coalition, perhaps because of the nature of such beasts, has done everything possible to demoralise its own Army and police force at the very moment when they will be needed to maintain control of the populace.  There are so many national societies challenging to be the first to collapse into chaos that it's hard to know which way to look.

 

Monday August 8, 2011

Our leaders are in the habit of treating August weekends as one time of year when nothing can deter them from taking a well earned rest.  Their various parliaments are not in session, the newspapers are settled in for the "silly season" of universally vacuous stories, and in any case the public have better things to do than read them.  So why is it that central bankers have broken into their holidays, under great pressure from their own political masters, to indulge in emergency conferences from which, we have been assured, will emerge radical new solutions to the great issues of the day?


To be sure, there have been some superficially significant economic developments during the past couple of weeks.  For the first time in decades, a substantial minority in the US Congress felt the need to draw attention to the fact that their nation is hopelessly broke, and they concluded that the best way of doing so was to use a procedural process involving the "debt limit", a notion introduced as an attempt to put a cap on the US Government's indebtedness but which has always proved utterly toothless, since it is raised at will.  In the event, these worthy souls were sold out by their own leaders for a mess of commitments relating to major spending cuts that will be made after 2017 by whomever happens to hold the purse strings at that time, unless those bodies feel then that it would not be expedient to honour such promises.  However, their voices have been heard, to the extent that S&P have finally recognized the obvious fact that US sovereign debt is unworthy of AAA status.


The Administration has reacted as you would expect, telling the rating agency that their numbers are wrong by $2 trillion, and they should withdraw their decision accordingly.  Even if the White House is being honest with its numbers ( a six sigma event if ever we saw one, but you can't rule out anything nowadays ),  a few trillion is quite insignificant in the context of the US's inability to pay its way over the course of a long dated T-bond, and S&P are standing their ground.


It is important to note that for the politicians, the importance of this issue evidently rests upon the effect it will have on financial markets when they reopen in the Far East on Monday morning.  The facts that their nation is bankrupt, with long term unemployment and price inflation high and rising, and that millions of families are struggling to keep a roof over their heads and food on the table, are matters that they are able to contemplate with equanimity, if indeed they recognise them at all.  However, let an adviser whisper in their ears that the 50 day moving average of the VIX index is approaching an important Fibonacci level, and all leave for their PR spinners is abruptly cancelled until the danger is seen off.  Just when you thought that global financial governance could not become any more surreal, it now appears that the hedge funds are in the driver's seat.


We cannot ignore Europe, much as we would really like to.  The ECB is believed to have held its own top secret crisis meeting on the issue of avoiding contagion of creditworthiness to Spain and especially ( as diligent readers of this column saw coming ) to Italy.  We have to say that any promises of massive central support will suggest to us that the feared contamination must already have taken place, but perhaps we're too cynical.  We also wonder whether their indebtedness is calculated before or after the contributions which they are themselves being required to make towards the bailouts of Greece and Portugal but again, do not wish to be accused of asking meaningless questions.  In any case, Italy's beleaguered Prime Minister, Silvio Berlusconi, rushed out a speech on Friday in which he promised that his nation's budget would be balanced not by 2014, as he had previously claimed, but a year earlier.  This is in fact barely less plausible, given that there is nothing recognisable as a plan to meet either of these deadlines.   In any case, the Euro crowd dutifully cheered, and Angela Merkel was given a fig leaf behind which she could agree to the use of German money to fund this latest venture.  The poor lady is obviously beyond caring how her electorate will react, the next time they have an opportunity to express their opinion.  To put the matter in context, the sums for which the Germans are likely to be on the hook in support of Italy will far exceed the cost of integrating East Germany, and there was, to say the least, far greater sentimental attachment to that operation.  There was also at that time, or at least there seemed to be, much more available wealth to spread around.

 

Monday August 1, 2011

There can be no argument this week about the hottest topic in the financial markets, since there has been something of a cessation of hostilities in Europe, while the fighting in Washington over the debt ceiling has developed from a skirmish into a pitched battle.   We do not set ourselves up as experts on US politics, so shall only say how encouraged we are that all sides finally appear to be agreed that accelerating deficits of trillions of dollars per annum are not a good thing.  The point of difference appears to concern whether the attempt to address this problem should start now, or whether this is not the best time, what with the economy being a bit soggy, and the process should be be deferred until a more propitious moment.  Perhaps we're naïve, but the latter idea seems to summarise pretty clearly how the US has got into its current mess.

The more financially motivated of our readers, which probably means all of you, will be more interested in the practical question of how the markets might react to a failure to approve this year's requested increase to the limit on the Government's credit card.  As avid CNBC watchers, we haven't seen anything like this since the days of the TARP bills, when bankers, hedge fund managers and Washington insiders formed an orderly queue to explain the ways in which the world as we know it would end if the requisite blank cheque were not signed.  Then, as now, we got the feeling that they were perhaps pushing their own personal interests rather than those of the nation as a whole.

Much has been made of the fact that the return on one month T-bills has soared by eight full basis points.  To be sure, this is a big proportional move based on near-zero levels, but we should not forget that it amounts to additional income of less than $70 per $1m invested.  No fortunes are being made or lost here.  Potentially much more significant is that fact that the yield on the 10 year bond has fallen quite sharply as the crisis has deepened.  This is at odds with the claim that the US Government would have to pay much more for its borrowing needs if it were to lose its treasured AAA rating, and needs careful explanation.  The preferred spin out of Wall St is that the markets are taking the view that a failure to reach agreement to raise the debt limit would cause a major depression, with low interest rates for years to come and therefore elevated bond prices.

This is, of course, nonsense.  The truth is that dollar based money managers, faced with uncertainty, are doing what they always do, and fleeing to the only safety they know.  The fact that their security blanket consists of the very investment which may be about to be declared more likely to default may seem illogical, but should not surprise us.  Nobody would invest their own money in this way, but the vast majority of investment decisions are made by people to whom the assets do not belong.  Their prime motivation is to avoid losing their franchise, and until holding US treasuries becomes a sacking offence we should not expect to see a change in their behaviour.

The performance of other asset classes has been a bit more rational.  The dollar has shown short term weakness within its miserable long term trend, and would doubtless have fared even worse if all of its major competitors did not have problems of their own.  Gold, viewed in some quarters as a currency without the dead weight of a national banking system hanging around its neck, has been famously strong.  US equity prices have fallen, admittedly from nosebleed inducing levels, partly on the "Great Depression" theory alluded to earlier, but also, it seems, on the even nuttier idea that multinationals will have to pay more to borrow money, as their own credit ratings will necessarily fall in line with sovereigns.  There is no theoretical basis for this  ( except in the case of the financial sector, which seems to be a more or less permanent ward of the state ), and nor does it have historical support - this looks like just another scare tactic.  Indeed, the suggestion has been made quite openly that the sight of a collapsing stock market will push Republican representatives to abandon their principles, just as the falling price of Goldman Sachs shares did to their predecessors in 2008.  Perhaps the 2010 input are made of sterner stuff, but we have not yet seen how they perform under heavy fire.

In any case, as this is being written the wire services are full of stories that a deal will be stitched together just in time to beat the Tuesday deadline.   The Nikkei is racing back up to 10000, with the S&P futures keeping pace.  If the deal fails, there will clearly be disappointment, but what if it goes through?  When it is revealed to be just another fudge, as it surely will be, will the markets manage to overlook this long enough for it to be overtaken by the next crisis ( Italy, anyone? ).  Events move fast nowadays, so we may know more answers in weeks rather than months.

 

Monday July 25, 2011

Where to start?  It seems there's little progress on the strange dance going on around the US debt limit - unless the politicians find a way to stop the clock, or some similar trick, this will most likely be next week's story - and the eurozone's troubles have got to the point of being really tedious.  However, we probably have to join every other financial blog on the planet by reporting that the latter issue appears to have been solved.  Again.  Unless it hasn't.

The euro deal on Greece is a complicated one, but in essence holders of Greek sovereign debt have given the opportunity to take a 20 per cent writedown on the face value of their assets and a lengthening of their term.  What happens if they spurn this tempting offer?  For those that are banks, they will incur the wrath of the European Central Bank, which can be visited upon them in a variety of unspecified ways and which you really don't want.  Anyone else, however, is free to keep the bonds on their current terms, with no reduction in seniority and no plans to default.  Indeed, there is a commitment as solid as the Acropolis not to do so.

Nobody really believes that Greece will in fact ever be in a position to repay all of its restructured debts, any more than the old ones.  For that, an 80 per cent writedown might be more realistic.  All the same, a fund which has taken a punt on 2 year Greek paper yielding an annualized 25 per cent will surely be tempted to see whether it might actually survive intact to maturity.

What of the other basket cases?  Portugal and Ireland ( and Cyprus, rarely mentioned but teetering on the edge of bankruptcy? ) will be offered short term official funding at bargain rates, possibly cheaper than those available to Spain and Italy - who, to add insult to injury, could do with this help themselves but look instead as though they will be required to do a bit of the heavy lifting on the lending side.  Other countries which may express displeasure are the small but solvent nations, such as Finland, Holland and Slovakia.

Without the approval of these countries the deal cannot go ahead, and their populations are mad.   Germany and France are appalled the opinions of these minnows could possibly be an issue, since the one point upon which they can always agree is that nobody else in Europe counts for much - the Germans aren't even sure what the French are doing in that club.  So far in the history of the European Community it has indeed been possible to railroad the smaller nations, but that was before they found themselves being asked to distribute taxpayers' funds to their larger neighbours, so there could be trouble.  Chancellor Merkel may even face a little local difficulty herself, since these disbursements of German cash around Europe are probably disallowed by her own nation's constitution.  The word "probably" may be an understatement.  So far, her top jurists have shown more bark than bite on these matters, but they cannot be taken for granted


The European common currency put in a predictable bounce on Thursday's announcements, as did its stock markets.  There was talk of "risk on", which seems to explain most moves nowadays.  While we cannot recommend fighting against this herd mentality, it makes little sense, since it is clear to everyone that nothing has been done to solve the issues underlying the ongoing instability of the continent.  One day, there must either be closer political union, as desired by national leaders, or monetary divergence, which is more likely to find favour with their electorates.  For now, the politicians and their allies in the vast Brussels bureaucracy must be relieved that any such day of reckoning has been put off a bit longer, and will be working hard on preparing their spin machines for when it can finally be avoided no longer.

 

Monday July 18, 2011


"Greece has gone a bit quiet for now, therefore also the euro…."  That's how we started last week's commentary, unaware that even as we were penning those words the rating agencies were announcing that any default by a European sovereign borrower would be treated as - well, a default.  Even though our claim that the big new news was to be found in the implosion of the Newscorp empire has been vindicated on a daily basis by further major revelations, we must now return to the eurozone crisis if we are to retain full credibility with our readers.

That simple comment from the rating agencies ignited a firestorm in Europe.   German Finance Minister Wolfgang Schaeuble was apoplectic, saying that it was time to break the power of the ratings agencies ( even as the European Central Bank continues to base its operations entirely and voluntarily upon them ).  He added that it was perhaps time for Europe to set up its own agency, which would presumably solve the crisis at a stroke by rating all of their sovereign credits AAA.   It was even hinted that their pet institution could retaliate against the hated Americans by downgrading their debt - that's what we need more of, serious constructive thinking!  Perhaps the next step would be for their governments to order tit-for-tat expulsions of selected executives from each other's rating agencies.

Meanwhile, the ECB itself has tried to patch over the problem in an imaginative and only slightly less dubious fashion.  Under their own rules, they can accept as collateral only bonds which attract an A rating.  This would appear to rule out Irish debt, to which all three of the big name agencies deny such status.  Luckily, they have discovered a Canadian firm called DBRS which is more charitable, and on that basis the problem is solved.  The world must hope that this happy state of affairs can be maintained.

It's almost possible, though not really, to feel a bit sorry for this beleaguered industry.  They have quite rightly been excoriated for their apparent willingness during the boom years to anoint any unsigned IOU scribbled on the back of a beer mat with AAA status.  Now they encounter fury and thinly veiled threats for mentioning the rather obvious fact that a wide variety of debtors looks likely to default.  None of this changes our view that the world would probably be a better place if the ratings agencies did not exist, so that custodians of other people's money, from the central banks down ( up? ) were required to do the job for which they are paid and perform a little of their own due diligence.

Moving along to this weekend's developments in Europe, everyone is talking about the results of the banks' "stress tests", which according to the European Banking Authority show that nine out of the 91 banks tested are in need of additional capital, totalling €2.5bn.  Bearing in mind that no Irish bank failed last year's edition, but only a few months later the entire sector had to be nationalised, the markets hoped to see results which they found convincing, but they appear to have been disappointed.  Analysts at Credit Suisse, working from public information, estimate that 14 banks should have failed, with a total shortfall of €45bn.

The EBA's chairman, Andrea Enria, attempted to assuage their fears by explaining that he would have preferred to make the tests more stressful, but sadly had been unable to do so.  Furthermore, much of the data provided was suspect - some had been changed materially when challenged, leaving questions over how much incorrect information had managed to slip through.  He seems to have been hoping for a general response of "oh well, that's all right then", but he may be disappointed.

One glaring hole in the tests is of course the treatment of the sovereign debt which these banks have been encouraged, even forced, to hold in great quantities.  The official worst case scenario remains far more optimistic than the market's central estimate.  An issue which is less well ventilated is that of credit default swaps.  There are vast open positions here, more than sufficient to ruin even the biggest players in the market, but European officials despair of taking these into account, since the individual banks and their national regulators are not helpful in providing the necessary information.  They lament that there is nothing they can do.  Given that all of these institutions exist to varying degrees on the courtesy of the continent's taxpayers, we have some ideas, not all involving pliers or thumbscrews.  However, it's probable that all they could reveal, even under extreme duress, is that they really have no idea of how much they stand to lose in such market turmoil, only that it would be way beyond their ability to pay.  Perhaps we are all better off in our current state of blissful ignorance.

 

 

Monday July 11, 2011

Greece has gone a bit quiet for now, therefore also the euro, so it's lucky for us that another storm is brewing on the eastern side of the Atlantic.  In case anyone hasn't noticed, the News Corp scandal in London will have very, very major repercussions.

To reprise the facts, Rupert Murdoch, the Australian media owner who has for tactical reasons acquired American citizenship, has for four decades enjoyed the power to make and break British governments.   No Prime Minister has been elected over the opposition of his titles, and they knew it.  Unsurprisingly, this fact has not been widely aired in public, and it has been minuted that members of a commission charged with investigating the excesses of his empire declined to do so for fear that their own personal lives would be shredded.

As seems to happen with people who have come to consider themselves omnipotent, he went too far.  Murdoch's journalists hacked into the cellphones of murdered girls and dead soldiers, causing great distress to their families.  You can get away with many things in England, but that is over the line.   So, why is this of such importance to the future of Britain?  For those who have not been following politics in those little islands off the NW coast of Europe, stand by, you couldn't make this stuff up.

The editor of the News of the World when it was doing the phone hacking ( at least, they were the ones who got caught ) was called Andy Coulson.  He was forced to resign, despite having had no idea of what his subordinates were doing to raise the paper's circulation numbers, and was in need of a job, so what could be more natural than that he was offered the post of communication director for the Conservative Party, then in opposition.  When David Cameron became Prime Minister ( with the editorial support of the Murdoch empire, surprise! ) Coulson became his most influential and highly paid special adviser.

This week it finally all fell apart.  Coulson has been arrested, he is at present out on bail but must be looking forward to some time behind bars.  The spotlight has turned to his superiors at the time, Rebekah Brooks and Murdoch's favourite son James.  The latter lives and works in the US, and is likely to stay there in the hope that extradition proceedings will fail.  The official story regarding Brooks is that the octogenarian publisher has fallen under the spell of a flame-haired temptress ( in her dreams, though she does have a ridiculous amount of red hair ), and cannot bring himself to fire the woman responsible for the potential downfall of his empire.  His treatment of earlier wives ( the incumbent is a Chinese lady half his age ) casts some doubt on this sentimental theory, but the real reason why he cannot throw her to the wolves will hopefully be revealed at some point, perhaps in court.  She must surely know where some bodies are buried.

This is all hugely entertaining but why, you ask, is it of more than passing interest to the financial markets?   The answer is that, since his election, Cameron has quite cynically pursued policies designed to impoverish the middle class which elected him.  His administration has allowed price inflation to rise without limit while keeping returns on savings close to zero, for the benefit of his true friends, the bankers.  Even if he understands that there are people in his country who are struggling to buy food to feed their children, he just doesn't care.  He didn't do to school with them, he has a suspicion that they don't smell very nice, and if they can't cope with the free market then they probably deserve what is happening to them.  The Murdoch press has so far been crucial in putting out the opposite message, but this defence is about to fall apart.

Before long even someone as divorced from reality as the Prime Minister will notice that he has a real problem, and will recognise that he needs a big name to throw off the train.  The obvious candidate is young George Osborne, the Chancellor and the biggest booster of Andy Coulson within the inner circle.  But with him would go the greatest support for the give-the-bankers-whatever-they-want line of thinking to which Cameron is naturally attracted.  The Tory heartlands have never liked either of them much anyway, and a new Chancellor might not feel able to react to the quarterly letter from Bank of England Governor Mervyn King saying "inflation's out of control but you don't care, do you?" with the same stock reply "of course not, keep doing what you're doing".

The fate of Rebekah Brooks, friend of the great and powerful, may have far greater significance than her miserable persona deserves.  Watch this space.

 

Monday July 4, 2011

Well, it's all over.  Greece and the euro have been saved.  Again.  For some reason the Greek people don't seem altogether happy about it, if the count of flying paving stones is any guide, but the stock prices of Western European banks have enjoyed their best rally in months.  Anyone would think they had just been given a year to bleed Greece dry before slitting its throat.

The funny thing is that the above analysis, which would normally pass for a conspiracy theory ( not that this makes it wrong ) seems to be accepted by just about everyone in Europe as close to the truth.   The markets continue to price Greek sovereign debt on the basis that default is a matter of when rather than if, and they are unimpressed by Clintonian parsing of the meaning of "default".  To the marginal buyer, a default is when you don't get what you were told you would get, and even the rating agencies can see that coming.  The IMF and ECB will be sending their most expensive people to Athens every few months to confirm that they are following the economic path laid out for them, which everyone knows they won't because the numbers simply make no sense.  The difference from a year ago is that there are political forces in Europe which have no interest in maintaining the cover-up.  The Goldman Sachs team which unashamedly travelled to Greece in 2010 with briefcases full of FX derivative ideas to hide the deficit will need disguises this time.

The only group to have swallowed whole the official story that the Greeks are somehow being saved is the financial media in the US.  Even the more intelligent elements tend to be clueless when it comes to matters outside their own borders, so it comes as no surprise to hear read and hear a constant stream of misinformation on the subject of European politics, fiscal policy and inflation.  To take the last one, perhaps it's true that American consumers are untroubled by price inflation - we're not totally convinced by that claim, but will let it pass - but those in Germany and the UK certainly are not.  For those living on the Mediterranean Sea, chronically rising prices have always been a normal part of life, but only in the context of a currency which their government could debase at will, which is why they were always so unsuited to their new common currency.

So what happens next in Euroland?  As we've said, Greece is as good as gone, but perhaps that doesn't matter.  There is probably a good reason why only one Balkan country was considered for membership, and it appears this was one too many.  Ireland is also expendable, in fact if that nation were to take the obvious step of returning to monetary union with its main trading partner across the Irish Sea everyone would be happier.  However, that is where the line must be held if the grand experiment is to survive.  It is ridiculous to suggest that the Portugese could escape the yoke of the euro without the Spanish public insisting upon similar consideration, and that would be the end of the great Merkel-Sarkozy scheme to create a power bloc able to challenge the US and China.

All the same, this is supposed to be a financial commentary, and we feel that the inference of sell signals for the euro is misplaced.  For sure, nobody will want to hold their euro accounts with a Greek or Portugese bank, and banknotes bearing likenesses of Vasco da Gama or the Acropolis may be suspect.  However, as we have said before, in the bigger picture anything which makes a euro more like a deutschemark works for us.

 

Monday June 27, 2011

It's difficult to write about anything but Greece at the moment, even though their problems might appear to be of the greatest insignificance to anyone outside the nation's borders.  How has it come to pass that, much like the assassination of an archduke in 1914, not so far away in Sarajevo, these events may pose an existential threat to the global order?

Let's start with a few salient facts.  The Greeks joined the eurozone in 2002, on the basis of financial statistics which everyone involved pretended not to recognise as a complete work of fiction, and thereby replaced their untrustworthy drachma with the gilt-edged euro.  Until the financial crisis struck, this enabled them to borrow in quantities, and at interest rates, of which they could not previously have dreamed.  Both the public and private sector duly gorged themselves.  It now emerges, to the genuine surprise of nobody except perhaps the Greek electorate, that they have no visible way of ever paying the money back.  One way or another, this will leave the general population impoverished, but nobody seems to care about that, not even their own government, which is why paving stones are being hurled in downtown Athens.

On a global scale, this should not be a major problem.  Greece is a small country, far less significant than some Latin American nations which have been in this position more than once, and according the normal rules it should simply declare itself in default, come to an arrangement with its creditors and then get on with its new life.  However, the position is clouded by political issues, since if even one peripheral economy were permitted to escape from the burden of the euro there is a terrible fear that the floodgates would open.  Portugese voters, seeing the celebrations of freedom far to the east, would almost certainly demand similar treatment and, far more seriously, Spain and even Italy might follow.

Such a turn of events is inconceivable to the great men and women of Europe for two reasons, which are entangled.  The first is that they have always seen monetary union as the first, unpublicised step on the way to political union - indeed, neither can really work without the other, which is precisely how they have got themselves into this mess.  They therefore have no choice but to present any individual exit as unthinkable, since as soon as anyone is permitted to think about it the merits will become irrefutable.  "No economy can ever leave the Eurozone because there is no mechanism for this to happen", we are constantly told.  Well, returning to our earlier parallel, there was probably no mechanism for the breakup of the Austro-Hungarian Empire, but that did not prevent it from taking place.

The second problem is the power of the banks.  Think about it, if Western Europe's leading food retailers had made huge investments in Greek olive groves, and were now faced with having to write off these assets, would the taxpayers in their home countries be told that they must reach deep into their pockets to make good these companies' losses?   Of course not.  However, when it is the region's banks, it goes without saying that there can be no question of their having to meet the cost of their own bad bets.  Their head offices include some of the world's most expensive buildings, and they have to pay their staff huge salaries and even greater bonuses, or else they will leave and make the next batch of bad bets somewhere else.  These bills must be paid.  The trouble is that their friends in government cannot always get away with a simple donation from public funds, especially when there is an election around the corner, so they have to find other ways to achieve this end, or at least put off the problem until the return of happier times.

To be sure, putting off the problem is now the order of the day.  One interesting idea is that some "voluntary" arrangement might be organized which is identical to an old-fashioned default except that banks would be allowed to carry the loans on their balance sheets as though they were still fully performing and, as a bonus, no payments under credit default swaps would be triggered.  This is handy, since nobody knows ( and the regulators admit they cannot find out ) which banks may have placed bets in that market which they cannot afford to lose.  Of course, such chicanery would bring the viability of the whole CDS market into doubt, but that might not be such a bad thing, since the big winners there have already taken their profits and moved along to the next game.

Such egregious bad faith might seem unprecedented, but there is nothing new under the sun.  We recall that the long Malayan civil war which started in 1947 was only ever officially described as an "emergency", in order that the plantation owners, who carried considerable political clout, could claim losses on their insurance.  Lloyds' insurers wrote their policies with great care after that experience, and any who remember those times would surely have known to steer clear of today's markets in exotic financial derivatives.

 

Monday June 20, 2011

Near Zero Interest Rates, Part Deux

In last week's commentary we discussed the absurdity of a strategy of large and negative real interest rates, and hinted that we had a theory as to why the world's central banks persisted in pursuing this course.  We do intend to reveal our secrets, but even in the past seven days there have been new developments in the UK, which is leading this ludicrous experiment.

It appears that there are going to mass strikes by public service workers this summer, in protest against the austerity measures imposed by the Coalition Government in an attempt to bring the nation back from the brink of bankruptcy.  In some ways it is hard to feel much sympathy, since they are only being invited to share the pain already visited upon the private sector.  Furthermore the unions' complaint that their members are having to pay for the sins of others applies equally to 99.9 per cent of the population.  We all know who brought down the nation's finances, and they continue to enrich themselves from it, but they are officially fireproof.  However, the outrage that nominal wages are being held static while price inflation is allowed to run rampant does carry weight, and can be traced back to the relatively arcane issue of short-term interest rates.

To the best of our knowledge, the idea of keeping real interest rates at around minus five per cent has never before been tried in any financial system.  Either Mervyn King and his colleagues on the MPC have discovered a previously unsuspected secret of eternal prosperity, or they are pursuing a policy which has until now been correctly dismissed as stupid.  We shall try to explain our view, which is that these ( mostly ) rational men have found themselves in a hole in which they feel that they have no choice but to keep digging.

We all learned at some point in our youth the maxim that if you owe your bank a thousand dollars you have a problem, whereas if you owe a million dollars they have a problem - add a few zeroes, and that seems to form the entire basis of today's financial system.  It is common knowledge in the UK that lenders have been moving financially stretched property owners onto easier repayment terms, purely to avoid recognising that the loans have no realistic chance of ultimately being repaid.  However, the banks themselves are playing the same game with the Treasury.  They accrue interest rate risk in the normal course of their business, but rather than hedging this, they have been doubling down, by placing huge bets that the MPC will keep rates close to zero for the foreseeable future.  They then explain that they cannot begin to pay should they lose on these bets, so they had better win.  So far, the Bank of England has shown itself to be amenable to this sort of coercion.  When you remember that all of these banks owe their existence through the past few years to taxpayers' support, and that some of them are still publicly owned, the story turns from surreal to hallucinogenic. The huge game of chicken is also being played out at the international level.  Greece, which is apparently being force fed another €100bn about now in loans which they have no hope of ever repaying, comes to mind.  Whoever may gain from this ( could it be the European banks? ), it is certainly not the Greek populace, who are rioting with renewed enthusiasm.  As one of our favourite bloggers paraphrases it, 'FUHRER LIBERATES SUDETEN GERMANS - AND STILL THE CZECHS AREN'T HAPPY'.  We can't beat that, and instead direct you to The Slog at:

http://hat4uk.wordpress.com/2011/06/15/crash2-its-here-and-the-slog-will-be-recording-it/

It looks as though Greece will be the story of the coming week - after all QE2 doesn't end until June 30th, so it's far too early to worry about that - but who knows what may happen to displace it from the headlines.  Maybe, although this is a long shot, there may be some event which the English speaking press does not interpret as requiring even lower rates for even longer.  Whatever does transpire, we look forward to passing on our views.

 

Monday June 13, 2011

We're starting to feel that the key to all financial markets at the moment really can be found in the usual suspects, short term interest rates.  However, it seems a bit more complicated than the knee-jerk "don't fight the Fed" so beloved of commentators, since the crucial point is that it really isn't clear any more who is setting these levels.

Let's take a look at the futures markets, which are about as transparent as anything in this arena gets.  Starting with the dollar, let's follow Tony LaPorta in considering EDU2, the three month Libor rate expected to apply in September 2012.  We should remind ourselves that this contract takes into account all rises in overnight rates ( they can only go up, right? ) for the next year and a half.  Last week it crept up to 9930, or an interest rate of 0.7%.  How much upside can there be for buyers at this level?  However, as Tony also pointed out, shorting this instrument has not been a satisfactory experience lately - he of course expressed it somewhat differently.

The current level requires two assumptions.  The first is that the Fed funds rate will not even reach the extraordinarily low level of ½% before the end of next year, but to us this is not even the more remarkable feature.  It is also assumed that there is almost no chance that the spread between Libor and Fed funds will expand, as generally happens when credit markets freeze up.  We should remember that three month Libor is the rate at which banks say they are willing lend to each other, for three months, on an unsecured basis.  Of course, it is several years since any real lending has been done in this way, so perhaps the sellers, assumed to be the banks themselves, are relying on their ability to keep the settlement price up by quoting low offers, in the knowledge that they will not be called on it.  They are even now under subpoena by the SEC for doing precisely that in previous years, but probably don't take that too seriously.  Given past experience, they're probably right not to.

Without going into full detail, the same pattern can be seen in both sterling and the euro, and these are in some ways even more odd.  While US inflation is now certainly more than just a cloud on the horizon, in the UK it is heading up through 5 per cent, and clearly out of control.  The Bank of England is tasked explicitly with keeping inflation within sight of 2 per cent.  All the same, the market is apparently looking for a rise in their base rate to no more than 1% over the next twelve months.  In Europe, inflation is above the 2 per cent permitted ceiling and, unlike their girlie men counterparts in London, the bankers at the ECB remain firm that fighting this scourge is their first priority.  Still, only a very slow rise in rates is discounted.

What is going on?  One thing we know is that the world contains as much uncertainty as we have seen in a while - we present as evidence the US finally starting at least to consider the possibility that the nation may be bankrupt, even as the eurozone tries to cope with the fact that some of its constituents, and therefore many of its banks, most certainly are.  For some reason the big players are taking the view that, whatever financial chaos we may see over the next few years, the only possible result for interest rates will be that they stay low.  They are also convinced that the various spreads built into the framework will remain tight.  It is safe to say that this has never been a good assumption before, and it seems almost insane in a system of floating exchange rates, so why are they behaving in this way?  We have some ideas, but they will have to wait for a future commentary.

Monday June 6, 2011

Lately we've been writing quite a lot about the UK economy, even though it may appear no more than a sideshow to the great events taking place in the wider world.  However, we never forget that the pound sterling was the forerunner of the dollar as the global reserve currency, and that Britain's subsequent decline may offer lessons to the nation which has followed in its footsteps.

This weekend's London press has been full of stories about a bunch of "leading economists" who have already formed the view that the barely begun process of reducing the crushing level of national debt goes too far and too fast.  It turns out that their ringleader is a chap called Jonathan Portes, who is best known as the top financial adviser to the government during the creation of the debt.

You have to dig a bit deeper to discover that Mr. Portes earned his master's degree at Princeton and then spent several years in the US Treasury Department.  Furthermore, he has US nationality.  Armed with the knowledge, it came as less of a surprise to hear him on UK television, explaining in rich Mid-Atlantic tones that Britain should simply spend more and charge it to the national credit card.  This has worked well in the States, what could go wrong?

Please don't think that we're motivated in these comments by any unfashionable lack of enthusiasm for the multicultural approach to the world's financial challenges.  Indeed, if a couple of economists of the Austrian persuasion were drafted into the FOMC to provide a new perspective, we would be the first to lead three rousing cheers.  Sadly, the usual comparison with flying pigs seems apposite.

Compounding our gloom regarding the future of Britain, we were also treated on Sunday morning TV to a learned discussion of ways to get the next generation "onto the housing ladder" or, as it is otherwise known, into debt from which they have no clear way of ever escaping.  Their immediate predecessors, many of whom have seen their homes repossessed, will presumably have to stay in credit purgatory for a good deal longer.  Still, if this Ponzi scheme can serve to maintain the fictional high level of house prices, then the banks will be able to avoid booking losses on their loan portfolios, and that's what really matters.  Nothing changes.

Tuesday May 31, 2011

Where has all the risk gone?  While headlines scream of potential chaos in economies around the world, the conventional measures of uncertainly in the Anglo-Saxon markets, and via correlation trades in all others, continue to register low readings.  How can this be?

Let's start with short term interest rates.  It is believed with increasing confidence that, irrespective of the normal constraints of inflationary pressures, these will be maintained at unusually low levels.  This may be true, but it has long been understood that this is a hazardous strategy, and that when it goes wrong it goes badly wrong, with rates resurfacing at a bends-inducing pace.  So why are out-of-the-money options so cheap, where is the tail risk?  We can only assume that the players who would suffer the worst from such a rise, the banks and quasi-banks, understand that they would be in such deep structural trouble that no amount of hedging would help them.  Instead, they're saving their money for lobbying efforts to stop the tide from coming in.  In the mean time, they're probably selling the very options which they should be buying.

Long term rates are even more interesting, in that the level of the market itself is suspect.  Think about it, who is lending their own money to Uncle Sam for 30 years, for a rate of interest of 4 1/2 per cent?  Answer, nobody, you would obviously have to be mad.  The marginal buyer of the long bond isn't looking for a great investment, he's putting on a convexity trade or trying to execute a short squeeze.  The market in index linked instruments is still worse, as we pointed out in a recent commentary it has almost nothing to do with genuine inflation expectations.  

It's true that the price of gold, which is known to be a popular haven in times of uncertainty, has been finding consistent bids for some time now, but we don't think people are buying gold because they cannot see the future.  We think they're buying it because they can.

If we move to the definitive "fear index" ( if you believe CNBC ), the VIX, we find a level which, while not a historical low, certainly indicates a degree of complacency.  This is a measure of volatility on a index which is itself a measure of the future income stream, discounted at a changing rate, of a select group of companies with US dollar, and to some extent foreign currency, earnings…. yes, it's a stretched proxy for the American economy, but even so Fed governors who ought to know better evidently take comfort from its continuing low levels.  

The truth is that the market's "expectation" of volatility over the next three months has little to do with any considered view of the future, but is mostly based on computer analysis of what happened over the past ninety days.  If the competing effects of higher bond yields and a weaker dollar conspired to produce a standoff, with generally stable equity prices, then our silicon friends will predict that this condition is likely to persist, and their human slaves will trade accordingly.  Anyone trading against this trend must be prepared to lose on the first trade or two, but with patience should be amply rewarded.

Monday May 23, 2011

Interesting times at the IMF.  Their erstwhile leader, the French reptile Dominique Strauss-Kahn, has been sprung from Riker's Island, but is confined to his luxurious Manhattan apartment with a security bracelet on his ankle.  This makes it difficult for him to maintain his lifestyle, based as it is on private jets and lavish parties with the world's richest and most famous, and he has finally agreed to resign.  Officially he will be spending more time with his family ( little choice in that regard should they choose to join him in New York ) and working on his defence against the various rape charges he faces.  Probably this will indeed be a full time task, with his best shot lying in the suggestions buzzing around in France that he has been set up by his political opponents.  Interestingly, while nobody there seems to have any evidence that some very senior politicians have behaved in this way, neither are there many doubts that they would.  The French take a refreshingly realistic view of their leaders.

Anyway, the Fund needs a new boss, and quickly.  Given the fate of the previous one, it comes as no surprise that the hot favourite, quoted by the bookies at a prohibitive 10-1 on, is…. another French politician.  True, Christine Lagarde, who currently occupies the post of finance minister, in unlikely to prove to be a  serial attempted rapist, since she is female and has herself complained of the effects of excess testosterone on the decisions of her colleagues.  She does however carry the other form of baggage which comes with the territory in Paris, being deeply immersed in a scandal.  In this case it involves the flamboyant tycoon Bernard Tapie, whose chestnuts she appears to have pulled out of the fire in a long running dispute with Credit Lyonnais, the state owned bank.  Based on all previous experience, we doubt that this will prove a major impediment to her ambitions.

There are less trivial reasons why this lady might not seem an obvious choice.  First of all, even when her predecessor got the gig, there were already suggestions in several European capitals that the French had enjoyed something of a stranglehold on the position.  However, Germany's Angela Merkel is clearly taken with the idea of having more women in positions of power, and is still on the rebound after the decision of her favourite central banker ( and ours, as it happens ) Axel Weber to abandon public service.  Meanwhile, Britain's David Cameron would support Attila the Hun if that was what it took to keep out Gordon Brown, and all of Northern Europe is agreed that they don't fancy the idea of putting in a banker from the irresponsible Mediterranean.

The most interesting question is why the newcomer has to be a European at all.  Of course no American need apply, since they get the World Bank, but there are rumblings that a candidate from the emerging nations, who do much of the bankrolling nowadays, might perhaps be considered.  Not a bad idea, say the old imperialists, but this isn't the time.  Europe's finances need to be sorted out, and the person at the helm must be someone with first hand knowledge of the problems which need to be overcome.  Somehow this view was never expressed when the boot was on the other foot, and the primary role of the IMF was to lend Western money to the developing world on terms which frequently turned out to be ruinous.  One day there will be payback, but for now the West seems to have the votes to fight it off.

 

Monday May 16, 2011

For anyone interested in the future course of sterling interest rates, and maybe also those of the US dollar, the big event last week was the publication of the Bank of England's latest quarterly Inflation Report, or more specifically the press conference which launched it.  Like all good commentators, we downloaded the transcript in order to write with total accuracy, and like many we started off by accidentally getting the wrong one, the May 2010 edition.  It was interesting that we read most of the way through before realising the mistake.

Governor Mervyn King acknowledged that growth in the economy was running below their projections, and inflation significantly above them.  He could not promise that matters would get better within a year, but year two should be fine ( something to do with the elusive "output gap" ).  He must have this part of his comments down pat by now, it changes little from one briefing to the next.  He expressed satisfaction that the ECB had seen off the problems in Greece - that was the giveaway, this time around he was sensibly more reluctant to comment on eurozone matters.  

However, the real excitement was buried in answers to seemingly more technical questions about bank reserves.  Boiled down, Mr. King's view is that as far as monetary policies go, he doesn't really care about inflation, and neither does he really care about economic growth.  He is the central banker, and what he cares about are his banks.  For so long as they struggle to establish reserves on favourable terms, the risk free rate upon which the whole structure is built will remain historically low.  He briefly moved markets with some comments about their supposedly pricing in a longer wait than might turn out to happen, but it is clear that he can have no better idea on this than anyone else.

The Governor's real problem is that while he is evidently willing to ignore his committee's remit to keep the UK's rate of consumer price inflation within sight of the 2 per cent target, and the Coalition government may continue to look the other way, other members are growing restive.  The future course of interest rates will depend upon how long he can maintain the support of his colleagues in putting the needs of the banks above those of the rest of the country.

 

Monday May 9, 2011

As last week drew to a close, the markets were rattled by a report in the online edition of the influential German news magazine Der Spiegel that a group of  leading finance ministers were descending on Luxembourg to discuss the desires being heard in Greece for an exit from currency union.  The politicians' attempts to deal with this embarrassing leak did not inspire confidence.  To begin with, the office of the prime minister of the Grand Duchy, which would presumably have organised such a high level get-together, flatly denied that any such event was taking place.  They must have understood that they would immediately look rather foolish, as the various luminaries showed up at the local airport.  Luxembourg is quite pleasant in early May, and perhaps they each decided independently to choose this destination for a weekend away.  In any case, when they discovered the happy accident that they were all staying at the same hotel, they did decide not to waste the opportunity for an evening discussing matters of mutual interest.

What do you think was discussed, did they perhaps consider whether Greek sovereign debt might be restructured?  Absolutely not, they all insisted, but that seems as unlikely as the earlier denials that they would be meeting at all.  Why would a group of such busy chaps miss an opportunity to consider all possible options, including even the question of a Greek exit from the euro?  They probably did all agree that these things were highly undesirable and should be avoided if possible, but it must be clear to everyone that if events get out of control, some contingency planning will come in handy.

All we have learned, and this is hardly new information, is that when faced with any officially forbidden topic our leaders will simply lie, no matter how easily they can be caught out.  When the Greek finance minister says that leaving the euro is the furthest thing from his mind he may be telling the truth, but how would we know?  It is commonly argued that the possibility of default must not be breathed for fear of precipitating a panic that would bring about that very result, but with two year bonds yielding 23 per cent it must be assumed that the markets have already come to terms with that thought.  The main result of Friday's meeting appears to have been that a high level group of auditors will descend upon Athens to make sure that their economic numbers are genuine and their plans realistic.  Nice work if you can get it, but we must hope that they will perform their duties more diligently than their predecessors did when admitting Greece to their euro in the first place, and then when certifying that last year's bailout was just what the doctor ordered.

All this excitement has taken attention away from what had appeared to be the "crisis du jour", currently on view in Portugal.  There, the lame duck premier has been crowing ( quacking? ) that he has obtained much less onerous bailout terms for his nation than those provided to Ireland and Greece - even though this is a clear lie, it has not furthered the cause of European fellowship.  Curiously, a major player in this game is Finland, which retains one of the world's few undisputed AAA ratings.  As luck would have it, their constitution requires the approval of parliament for any cross-border bailout, and they have just had an election in which the nationalistic True Finns party campaigned hard against handing over their nation's hard earned wealth to profligates on the far side of the continent.  They make the good point that twenty years ago their own country was led by its bankers into a financial abyss, but they pulled themselves out.  The True Finns polled astonishing well, and insist that they are in a position to derail the whole process, and have every intention of doing so.

We can't be sure that the euro would necessarily spring a leak if some of the weaker peripherals jumped, or were pushed, off the boat.  However, if it is true that markets hate uncertainty, then last Friday's pullback was more than justified.

 

Monday May 2, 2011

We don't like to disappoint readers on Monday morning but really, what do you write about a week when nothing happened?  Most financial markets rumbled along in the same direction they've been travelling for a while - hold on, that reminds us of the Federal Reserve, so let's talk about Ben Bernanke's much hyped press conference.  To be fair to the Chairman, his words were less obscure than they have been during some of his previous experiments in public speaking.  This may even have been a mistake, since it's possible that people like him better when they can't understand what he's talking about.  Still, we have to admit that he got through the ordeal without making himself look any more foolish than was inevitable.

He was fortunate not to be questioned more closely regarding the wretched state of the US dollar, the currency of which he is supposed to be the custodian ( yes, we know that strictly speaking that's the responsibility of the Treasury Department, but we gave up on them five Secretaries ago ).  He seems to believe this represents nothing more than a reversal of the "flight to safety" which occurred during the darkest days of the banking crisis.  This would hardly seem to justify exchange rates which are either moving rapidly towards all time lows or are creating new ones on a daily basis, but the question was not pursued.  On the closely related matter of inflation - at least, we think it is - he is confident that the rate of price increases will slow.  Indeed, if the method of calculation can be continually adjusted until it consists of nothing more than the price of flat screen devices, adjusted for the number of pixels, he is probably correct.  Otherwise, given that even the US now exists in a global economy, the arithmetic that a weaker dollar leads to higher dollar prices cannot be denied.  

For all the polite questioning regarding the great issues of the day, the only topic Wall St really cared about was QE.  You can't blame them, this is their bonus fund we're talking about.  Here he was somewhat reassuring, confirming that even when the new money stops flowing the stash will be topped up as it naturally expires.  All the same, he did seem to suggest the some net withdrawal might commence within the next six months.  We can expect the banks' PR machine to move into overdrive to head off that ugly prospect.  Meanwhile, leaders of the financial world formed an orderly queue to express their admiration of the Chairman's wisdom, while instructing their subordinates that all bets against the dollar could safely be doubled down.

Thus, a fixed quantity of dollars now buys even fewer euros, ounces of gold, stock ETFs, barrels of oil or sacks of rice than it did before.  This afflicts not only US citizens, but also those in countries whose currencies are effectively linked to the dollar - most notably China, where there really is going to be trouble.  But it won't be Mr. Bernanke's fault, that is one point upon which he is absolutely clear.

 

Monday April 25, 2011

Early last week we all heard some truly shocking news - the S&P rating agency had, in their infinite wisdom, chosen to maintain the US Government's AAA status, but had downgraded its outlook from stable to negative.  This appears to mean that, unless the nation's finances improve over the course of the next couple of years, a change to AA+ may be on the cards, which would in turn mean that S&P rated the chance of Treasury bonds failing to make their coupon payments as due being greater than zero.

We're no long term bulls of T-Bonds, but still see some questions raising their heads here.  What exactly does this agency think it's rating?  Do they really believe that the Treasury would default on its obligations rather than simply print the money in one form or another?  After all, they've shown no compunction about that sort of thing before.  One of S&P's flacks appeared on CNBC and was asked approximately that question, but he waffled about AA+ still being a very superior rating, and didn't really seem to grasp the central point at all.

We also have a rather philosophical point, which is that a AAA rating is generally taken to imply that the credit is impeccable.  If the rating of a thirty year bond is considered to be in danger of losing its impeccable status within the next couple of years, doesn't that mean that it isn't impeccable now?  We're just asking.  Anyway, whatever the logic of the downgrade, if such it was, it led to even stranger developments in the financial markets.  T-Bonds ( yes, the very financial instruments which are for the first time seen as liable to default ) went better, evidently on the theory that S&P's insight would provide the wake-up call which would cause those in Washington to set aside their differences and solve the deficit problem.  In case you're wondering, we don't believe that either.

Various ramifications have been built upon this news which strike us as highly dubious.  The yields on government bonds around the world are being compared with T-Bonds, as if this provides a useful measure of credit quality.  Of course it does nothing of the sort, since the developed nations borrow mostly in their own currencies, which may be expected to offer different risk free returns.  It would be most interesting to discover the rate the US Treasury might have to pay to borrow long term euros ( or yuan! ), but they're unlikely to provide us with that insight in the near future.  Another claim is that Washington is by definition the best credit for US dollars, so if they're not AAA then nobody else can be.  We dispute that - if we owe you $50 and the US government chooses not to honour its obligations, is it so obvious that we shall necessarily default on our debt to you?  We would be sorry to think that our own standards of financial propriety could not be higher than those of the occupant of the White House.

On that subject, have you noticed that Donald Trump is quoted at 15/1 to be the next President of the United States?  The bookies are obviously happy to cover that bet, so it must be assumed that there is real money backing him.  This commentary has a policy of never offering investment advice, but for full disclosure, the Nakedtrader.com syndicate are up to their self-imposed shorting limit on this one, and are seriously tempted to increase it.

 

Monday April 18, 2011

We're indebted this week to a remarkable piece of journalism posted on our site by George Cavaligos - http://tinyurl.com/245m7wh There seems to be strong evidence that not only has the Fed printed trillions of dollars to buy up most of the Treasury bonds issued each month, but that it has augmented this operation by selling huge quantities of put options on derivatives based on those bonds, with the intention of pinning their price to the strike level.  This is not a new idea - it is similar to the "doubling up" strategy in roulette, which works well until the occasion when you run out of money.  The difference here is that the Fed may have calculated that running out of money is not a problem about which they need to worry.

This concept is quite mindbending for anyone proposing to participate in the financial markets, and gives a whole new meaning to the old canard "don't fight the Fed".  Their purchases of government debt are properly publicised ( we think! ) but if they can play the markets anonymously, and on margin, their competitive advantage becomes quite ridiculous.  Come to think about it, do they even have to put up margin?  This could be the biggest yet of the serial scams perpetrated during the financial crisis by branches of the US Government.

The most frightening feature is that the people running this show would proudly point to any such profits as evidence of how well they're representing the interests of their taxpayers, in the same way as every increase in the market value of bailed out banks is celebrated as a victory.  Never mind that the only reason for their greatly increased revenues, some of which are indeed passed on to the shareholders after executives have taken their cut, is that the rules of the system have been bent even further than previously to allow the big banks to pick the pockets of the general population.  Ultimately, the fruits of any manipulation of the derivatives markets would originate from the same source, but that fact will as always be ignored.

What can be done about this outrageous fraud, a hundred times the size of anything contemplated my Bernie Madoff?  Well, at least it's now out in the open, ( tell your friends! ) and it may be hoped that new information will be sought on a regular basis.  There's no point asking the Fed chairman, since he wouldn't give an answer and you wouldn't understand it if he did, but is it too much to expect that one of his more amenable fellow governors might be quizzed on this issue during their next visit to CNBC?  You would think that viewers might be interested in whether their next futures trade is likely to find their own government on the other side.  There seem to be a few members of Congress who don't mind asking unpopular questions, such as where did the bailout money go, and at last a bit of progress is being made on that one ( $22 billion to the Central Bank of Libya!? ).  Let's all hope that this ball keeps rolling.

 

Monday April 11, 2011

The 2011 Masters may have been dominated by a group of remarkably young golfers, but as we watched we were struck by the recollection that in the world of high finance, octogenarians continue to hog the headlines.  This is true not just in the Middle East, where leaders from this generation are typically succeeded upon their death by relatives not necessarily their junior, but even in the USA, where youth has traditionally been worshipped.

We shall start our celebration of the ancients with 85 year old Alan Greenspan, who may have passed his money printing wand to Ben Bernanke but can still pen a mean op-ed in the Financial Times.  Unfortunately, though not before time, his self-serving attack on the fairly toothless Dodd-Frank proposals drew mostly guffaws from his audience.  Untrammelled free markets, "with notably rare exceptions", have delivered financial stability?  So if the world's economic system only implodes once per generation, that's a good result?  And how about the idea that it may not be possible to maintain today's levels of productivity and standards of living without the current level of financial complexity?  The Chairman's insistence that the instruments which blew up so spectacularly in our faces were previously responsible for all that was good in the world seems to have impressed very few neutral observers.

Another icon to have looked a bit foolish in recent weeks is investing legend Warren Buffett, who turned 80 last year.  A vast number of lesser mortals have for decades regarded him as a financial hero, but this image was tarnished during the credit crisis, when he profited mightily by investing on favoured terms in companies which benefitted from federal bailouts - whether even Berkshire Hathaway would have survived the storm had its counterparties not been supported from taxpayers' funds is far from clear.  However, the final nail in Buffett's pristine reputation may have banged in by David Sokol, who had been seen as the frontrunner for the top job at Berkshire until he was apprehended in an act which looked suspiciously like a different sort of frontrunning, at the expense of their shareholders.  The trouble was, his boss doesn't seem to understand why the world thinks that he did anything wrong, insisting ( questionably ) that his actions were "not illegal".  It didn't help when Buffett's long time business partner Charlie Munger ( age 87 1/4 ) said he didn't see the problem, and he'd done the same himself - even veteran investment bankers agree that you can't really get away with this sort of thing any more, and you certainly shouldn't get caught!

We can't end without mentioning a final member of this generation, 83 year old Paul Volcker, who is best remembered as the Fed Chairman whose heroic efforts rolled back the double digit inflation rates of the Carter years.  Contrary to the infatuation with financial complexity exhibited by his successors Greenspan and Bernanke, Volcker has expressed the opinion that the only useful banking innovation was the invention of the ATM.  In recent years he allowed himself to be drawn into the Obama administration, with the important sounding title of "Chairperson of the President's Economic Recovery Advisory Board", but his sensible views have predictably been ignored.  His place at the Round Table now seems to be have taken by the CEO of GE, Jeffrey Immelt.  With that company notable nowadays mainly for prodigious receipts of taxpayers' money, and for an exceptional ability to pay no federal taxes, Immelt must fit in much better at White House gatherings.

 

Monday March 28, 2011

The financial markets are truly climbing the wall of worry.  If the television business shows are to be believed ( and we would never suggest otherwise ) investors are eyeing up terrible news from Europe to the Middle East to Japan, taking the resultant risks into full consideration, and then concluding that the world will emerge from these temporary problems as a better and more profitable place.  Common stocks will appear to have been trading at bargain basement levels which will not be seen again in our lifetimes.

It doesn't seem to matter that the commentators' bullishness often seems inversely proportional to their understanding of the matters on which they speak.  Observers in Europe must be growing tired of hearing expert opinions on the issues facing the Eurozone, uttered by pundits who couldn't find Portugal on a map - in case that seems unduly harsh, please recall the shambolic global warming summit in Copenhagen, when for a whole day CNBC referred to the venue as "the land of tulips and wooden shoes".  It is an article of faith in North America that a rupture in Europe's monetary framework would be a disaster for the euro, and depending upon how it was handled that might be true.  However, it is also the case that a lot of people would be delighted if it meant that they got their deutschemarks back - the question deserves more rational consideration than it has received.

The financial networks' thinking seems even more confused regarding the current state of affairs in North Africa and the Middle East, though here they may be excused, since reasoned discussion is hard to find anywhere.   Concentrating on Libya, since that is this week's centre of attention, it appears that the "rebels" are taking control of the ports from which that country's vital oil supplies are sent overseas.  This is perceived in the West as a good thing, since we do not like the government of Colonel Gaddafi at all ( although that was far from clear as recently as a month ago ).  What is certain is that we have next to no knowledge about his opponents, many of whom come from the part of the country where al Qaeda has recruited most successfully.  The colonel himself insists that his enemies are led by that terrorist organization, and the fact that he says so does not necessarily make it untrue.  Leaving aside the moral confusion involved in providing NATO support to a group responsible for bombing buildings in the US and public transport across Europe, it is far from clear that, if installed in Tripoli, the rebels would be as friendly to Western multinationals as their share prices suggest.

Finally we look at Japan, where the West has already decided to view the recent tragedy as less of a setback than an opportunity.  It is argued, particularly in the US, that this is the catalyst which will finally cause the authorities to print a hundred trillion yen which, as everyone now understands, is the one sure path to eternal prosperity.  Suffice it to say that, like so many of the casual assumptions presently in vogue, this one strikes us as representing a rosier view than some others which are equally plausible.

 

Monday March 21, 2011

For the past week, financial markets have been dominated by consideration of the effects of the terrible disasters in Japan.  In case this seems callous, we should remember that this is what they are supposed to do, but it is remarkable how ill-informed most of the conventional wisdom appears to be.

First of all, can we please stick a fork in the ludicrous notion, popular in the English speaking world, that we're talking about an impoverished nation.  Japan Inc, defined as the government plus the population, entered this difficult time in rude health, in terms of both p&l and balance sheet.  True, the large internal debts between the two sectors give offence to Western eyes, but if the Japanese don't think it's a problem ( and only those who have been exposed to US business schools do ) then it isn't one.  As to the terrible forecasts of demographic problems thirty years ahead leading to pensions proving to be inadequately funded, that is surely a problem Americans would love to have - their Social Security system doesn't appear to be funded at all.

If the aftermath of the disaster could be handled by cash alone, this would be no more than a blip in the nation's history, solved by the sale of part of their mountainous stash of T-bonds.  What's more, they now have the perfect excuse for this highly rational decision, which only a month ago would have brought accusations of attempting to destroy the dollar and the global financial system.  Perhaps they should cash in a few extra ones while they have the opportunity.

Next, what about the yen?  On the day of the earthquake, Western media leapt on the idea that the Japanese currency would collapse, and very briefly there was heavy selling.  However, it was quickly realized that the reverse should be true, as trillions of yen would need to be repatriated, and within a week we witnessed concerted international action to manipulate ( they used a different form of words ) the currency downwards.  One unintended (?) consequence of this policy is that the carry trade has been reinstated as a risk free winner, underwritten by the world's monetary authorities.  Of course this will in due course go wrong, but it will be taxpayers who foot the bill, it always is.

What, indeed, is the logical consequence of the disaster for interest rates?  There are effects on price levels, in Japan and elsewhere, working in both directions, but the net effect will be inflationary.  However, this is not preventing bankers everywhere from insisting that it would be a terrible thing to move the unprecedented low rates from which they profit so greatly, at a time when the Japanese economy is struggling to recover. It's difficult to construct an argument that the reconstruction efforts will be hampered by higher dollar interest rates, or assisted by price inflation, but we should stand by for precisely these claims from Washington, New York and London.

Monday March 14, 2011

LET THEM EAT IPADS


We never thought we would be writing this, but we really have to give thanks this week to the President of the New York Fed, and previously partner in Goldman Sachs, William Dudley.  Last Friday he made what may come to be seen as a crucial contribution to the ongoing debate over inflation.

He had taken the fateful step of leaving the safety of lower Manhattan, venturing out to address the Queens Chamber of Commerce.  There, he was able to assure his listeners that inflation was not, and never again could be, a problem, since he and his colleagues had the brains and the weapons to keep it in check.  This argument is taken as a known fact among his circle of friends, so he was puzzled when some of the audience suggested that price inflation was even now quite evident.  "When was the last time, sir, that you last went grocery shopping?", one of them had the nerve to ask.

To give him credit, he had come prepared with an answer to that.  Were they aware that for every price that went up another was coming down, for instance the new iPad2 was selling for the same price as its predecessor, which was only half as powerful?  Unfortunately, somebody else explained to him that he and his family could not eat an iPad.  This was new and unwelcome information, are there really people who have to worry about the cost of buying food?  He would take this concept under advisement.  Meanwhile, the Fed's policies were certainly causing the stock market to shoot up, making everyone wealthier, surely they appreciated that?  It seems to have been around this point that the meeting broke up and he headed back to his limo, perhaps with a police escort.

Mr. Dudley is a very useful caricature of the fat cat central banker, but the sad fact is that, at least in the Anglo-Saxon world, even his less cynical colleagues seem genuinely unaware that price inflation has already built up a head of steam.  His comment about iPads is quite telling - note that he did not claim that its price has fallen, merely that it is a better product at the old price.  Within the price index calculations, however, this does indeed come through as one of those deflationary effects which have caused Ben Bernanke and his colleagues so many sleepless nights.

They insist that the food prices about which the inhabitants of Queens seem so upset are not their concern, since they result from higher commodity prices ( and who printed all the dollars to facilitate that? ).  The truth is that for over a decade the cost of living enjoyed in the West has been subsidized by cheap imports from the emerging markets. This huge but temporary effect is coming to an end, and the opportunity to use it to build up defences against a challenging future has been lost.  Large, negative real rates of interest have never been a solution to any nation's problems, and our bankers have not repealed the laws of economics.  Accelerating price inflation is here is stay, even if Mr. Dudley and his Wall Street circle will be the last to notice.  The longer they manage to put off doing anything about it, the harsher the eventual remedy will have to be.

 

Monday March 7, 2011

We've been wondering for some time when the various financial markets would get around to wondering where the buying would come from after 30th June, when the Fed's second round of quantitative easing is due to come to an end.  Of course, for most of the players three months is way beyond the normal definition of long term, but last week no less an authority that Bill Gross did ask what might replace Mr Bernanke's monthly $50 bn support operations.  The short answer, at least in the case of US treasuries, was that he couldn't think of anything.

One rather obvious way to fill the gap would be QE3, probably followed by QE4 and so on for as long as the dollar's credibility survives.  The Fed Chairman has been indicating that this is not the plan, and despite his record we are inclined to believe him on this occasion.  There is another interesting potential source, which is that under the deal hammered out between Obama and the new Republican leadership, the rest of 2011 will see corporate capital expenditures expensed immediately, rather than over the normal period of years.  This all sounds rather technical, but people who understand these things tell us that the amounts funnelled to multinationals' balance sheets via this route will be of QE magnitude.  Of course, the beneficiaries in this case are not primarily the banks, but perhaps that doesn't make much difference nowadays - in both cases we're talking about vast and largely unaccountable institutions which have greater influence in Congress and the White House than is healthy for the rest of us.

Arguably, this massive production of dollars is blowing up the prices of everything they can buy, be that stocks, bonds, property or commodities.  We are in no doubt that this must eventually end, and ask ourselves which of the above will suffer particularly badly.  At the top of the list we find T-bonds, which after all are the asset class officially identified as being presently kept at levels otherwise impossible.  Not far behind are equity markets in both the developed and emerging markets, where a high proportion of the newly minted dollars do appear to have washed up.  Property is difficult to assess - people will always need places in which to live and work, but the extent to which this simple requirement has become subject to a mass of financial engineering is quite frightening.  Finally, while it does seem clear that the dollar printing presses have facilitated the runup of prices seen in all basic commodities, from foodstuffs to oil to gold, it is less obvious that they are likely to fall as quickly as they rose.  Contrary to some opinions, emerging market equities are not essential products in quite the same way as rice or soybeans, or possibly even dollars.

Monday February 28, 2011

More than 100 staff at state-owned lender Royal Bank of Scotland earned more than £1m last year, despite Government attempts to restrict bankers' pay.  Thus screamed the London headlines last week, giving vent to the outrage felt by almost their entire readership - the exceptions, of course, being those City bankers who still bother to read newspapers.  It comes as small surprise that chief executive Stephen Hester felt that his bank had in fact exercised commendable moderation in this matter, and that his seven-figure teams feel "beleaguered" and generally dispirited by the attention to which they are subject.  Equally unsurprising, and only slightly more disappointing, is the evident willingness of Britain's Coalition government to take this sad tale at face value, and to do nothing more that might upset the delicate sensitivities of its highest paid employees.

This all leads us to dust off a parable we briefly considered a while ago, investigating how the bankers' seemingly unique status might be reproduced in other industries.  We selected the UK's food retailing sector, which still seems an inspired choice.  Like the banks, the sector is dominated by four of five big players, which have periodically been investigated for cartel behaviour though, in their case, generally acquitted.  They perform a vital and valuable function, ensuring that food ( as opposed to credit ) finds its way into the hands of those who need it.  But let's suppose that one day they decide that simply selling food, while very profitable, just isn't enough of a business in the modern world and they need to hire a lot of very clever people to expand their opportunities.  Probably these Ph.Ds would recommend that steps should be taken to augment profitability with large scale trading in many basic foodstuffs.  Their models would identify areas where arbitrages could be found, markets could be cornered.

To begin with the process would go well, although shareholders might be a little disappointed that most of the increased top line revenues were somehow diverted before reaching their dividend payments.  Inevitably, though each new generation of whizz-kids has to learn this the hard way, the new business plan would go well only until it went very, very badly.  Then what?  The answer is clear, the storekeepers would announce that they needing to be bailed out with billions of taxpayers' money, since otherwise the nation would be unable to buy food, and the population would starve.  In the face of this unanswerable argument the government of the day would have no choice but to pony up, and having entrusted all this money to the companies they would naturally approve the continued compensation of a hundred times the average wage to a battalion of employees, since who else would be smart enough to make sure that their investment was properly handled?

Does this sound plausible?  No, we don't think so either.  Even the most dimwitted administration would quickly put its civil service in charge of sourcing our means of sustenance, and if the retailers' managements refused to allow their big trucks to be used for deliveries they would be requisitioned, and if necessary driven by Army personnel.  None of this sounds difficult, because it isn't, which returns us to the real point - why has nothing similar even been contemplated in the case of the banks?  The answer can only be that governments have a connection with their banking industries that they have with no other.

Think about it.  If Tim Geithner were running Citigroup and Vikram Pandit had the hot seat at Treasury, who would notice the difference?  It hardly stretches credulity that they might one day somehow switch places.  The good news is that until the same can be said of the leaders in the food industry, we shouldn't need to worry about any traumatic disruption to our regular menus.

Monday February 21 2011

We hope readers will forgive another commentary centred upon the rather parochial topic of UK interest rates.  While the pound no longer occupies the proud place that it once did, the decisions which must now be made by the Monetary Policy Committee foreshadow the weightier ones which will in due course face the custodians of the euro, the dollar and even, one day, the yen.  In London the debate is heating up, with last week's quarterly inflation report representing the latest piece of evidence for the prosecution.  In the dock is Bank of England Governor Mervyn King, on the charges of gross incompetence and dereliction of duty.


First, let us consider the incompetence.  The MPC's remit is to maintain stable  price inflation, defined as an average rate of increase of 2 per cent, taken on a two year view.  Famously, UK CPI has outstripped this for several years, and is currently running at double that rate and rising.  The scholarly inflation report  does forecast that the target will be hit, as it always does, with the benefit of a remarkable turnaround in year two, brought about by the magic properties of the "output gap".  This is an economic concept developed by academic economists to show that whenever they follow all the actions prescribed in their textbooks  ( eye of newt, toe of frog, etc ) and the expected results do not materialize, this is merely the result of a temporary imbalance.  Unfortunately, like the Higgs boson, it has never been observed outside the papers of university theorists.  Despite this, Mr King continues refuses to accept the possibility that his models may be wrong.


This leads us to the second charge.   It seems highly unlikely that he is still kept awake at night by fears of deflation, if he ever was.  He grew up as a schoolboy in the Midlands, and cannot have lost the ingrained understanding that the British disease, only ever kept temporarily at bay, is price inflation.  Nonetheless, he will not accept that it is time for a change of policy.  Two of the three independent members of his committee have already parted company with him ( we no longer even count the American representative, who has no grasp of British economic traditions ), but so far none of the Bank's employees has broken ranks with their boss.  When they do, we may expect fireworks.


Finally, there was some sad news out of Germany last week.  Axel Weber, Bundesbank president since 2004, has resigned in somewhat obscure circumstances.  Crucially, this takes him out of the frame as potentially the next ECB Governor.   This is already being celebrated by the world's commercial bankers as a great victory, and the end of the last bastion of financial responsibility.  We must hope that Jens Hartmann, his successor, and whoever takes over from Mr. Trichet at the ECB, will prove them wrong.

Tuesday February 15, 2010

The news that Mr. Mubarak really is leaving the helm in Egypt, after a rather confusing false start, led to a worthwhile rally last week in financial markets around the world, and it is worth asking how this knee-jerk reaction could have been justified.  One claim is that, if the disruption in that country really is over ( and subsequent strikes and protests relating to pay and working conditions cast some doubt on that ) we may expect the trouble brewing elsewhere in the region to calm down.  But why should that be?  It might be more plausible that the public in Algeria, Yemen, Jordan et cetera will view the successes of their peers in Cairo as an encouragement to cause disruption of their own.  Whatever you see as a likely new economic order, there would surely be much wasteful dislocation along the way.

This is of course part of a pattern which has been seen on many occasions in the past year, as any economic or optical event with murky consequences is seen primarily in a positive light.  Any improving economic numbers are celebrated with a worthwhile rise in stock markets, while poorer ones produce only a brief "buying opportunity" before it is agreed that they can be blamed on a variety of seasonal factors ( which never seem to distort data in a positive direction ) and that an improvement must be around the corner.  Could it be that the world's investing institutions are so awash with cash, demanding a benchmark return, that they must put it to work somewhere, and are therefore forced to create optimistic scenarios to justify their actions?  

Empirical evidence does give strong support to this heretical theory.  The current global bull market can be dated quite precisely to Professor Bernanke's first suggestions of Quantitative Easing, aka massive money printing, paused during its hiatus and the took off again on the announcement of QE2.  He claims that this is a total coincidence, though puzzlingly he also suggests that a rising stock market is both a driver of, and as evidence of, economic recovery.  So circular are the man's arguments that he sometimes seems in danger of consuming his own tail.

So, should one ride this great inflationary rise in asset and commodity prices?  Another argument from the Fed Chairman suggests that the effect of QE is dependent upon the total stock of QE rather than the rate at which it is being created, but this seems very dubious, and is contradicted by the evidence.  It is therefore reasonable to assume that the valuation put on paper assets will continue to rise for as long as massive quantities of liquidity continue to be injected into the system, and that this will end rather abruptly when the programs stop.  In truly efficient markets everyone would know this, and prices would cease to rise well in advance of such an anticipated event, but in the modern world money managers cannot afford to underperform even for a few months, and the minority who act in this apparently rational fashion are made to suffer for it.  For now, the only advice one can give to short term investors ( ie 99 per cent of the population ) is to stay on board for now, but be sure to get off just before the music stops.  This is of course just what most of them are doing anyway, and it will be interesting to watch events when everyone tries to exit at the same time.

Monday February 7, 2011

We hope readers will forgive a localised approach to events this week, but it seems to us that the developed world's monetary problems will be neatly summed up at the meeting of the UK's Monetary Policy Committee which takes place in London next Thursday.  Europe's Jean-Claude Trichet understands very well the threat of inflation, but recognizes that he may still have a few months' grace before having to address the problem.  Across the Atlantic, Superbanker Ben Bernanke remains convinced that the cloak of his reserve currency will protect him from all evil, and closes his ears to those who warn him of kryptonite.  In London, however, the clear and present danger of rampant price inflation confronts an economy still showing few signs of life.

For those not steeped in Bank of England mythology, the MPC has nine members, five of whom are BoE employees and four outside appointees.  One of the latter is an American academic, Adam Posen, who has an agenda entirely his own and can barely be considered a part of the committee at all.  Of the others, Andrew Sentence has argued for months that the danger of price inflation is too great to be ignored, but has failed to swing the opinion of his colleagues.

Among the professional central bankers the chairman, Mervyn King, continues to insist that the inflation numbers, while worrying, are the result of events beyond his control and therefore don't count.  Both elements of this argument are controversial.   First, the increases in commodity prices which he insists should be seen as an Act of God might reasonably be connected with the massive money printing exercise which has taken place on his watch.  Second, the idea that exceptional events should be discounted does not seem to be applied symmetrically - during the decade or more when import prices were kept low by the new effects of globalization we were never told that this should be seen as a special event and therefore compensated by tighter monetary policy.

So, what will it take for the MPC to raise its Bank Rate from 0.5%, with CPI running above 4% and RPI, which more accurately reflects the general population's cost of living, higher than that?  Mr King will not change his mind because he cannot, he is at heart an academic and to admit that his theories are wrong would be worse than death.  However, his fellow bankers, including both Deputy Chairmen, have indicated in recent speeches that it is only a matter of time before they will have no choice but to take seriously their committee's commitment to keeping inflation within striking distance of the 2 per cent target.  Next Thursday's decision will be interesting, and the minutes, which are published two weeks later, will be even more so.

Monday January 31, 2011

Suddenly we're hearing a lot about anarchy.  Perhaps this exists largely in the eye of the beholder - comparisons may be drawn with the UK of the 1976 Sex Pistols, (see video: http://tinyurl.com/36vojch ) when the nation's youth were as angry about being unemployed as today's are about having to repay the cost of their university education.  Going further back, we may consider the student/worker uprising of  Paris 1968 or indeed, for historically informed readers, the events across Europe in 1848.  Since the Naked Trader's primary intention is to think up advantageous ways to invest, we must shamelessly reflect upon the financial implications of those chaotic times.

Before we start, where does anarchy stand this week?  It seems to be thriving in Egypt, not primarily on account of the hundreds killed and injured by live ammunition - this has been the standard fare of dictatorships - but as a result of the apparent lack of significant input from any organized opposition party.  A group of people who defy a military curfew and organize themselves through the social facilities of Facebook & Twitter may reasonably be described as a modern day "mob".

As in Egypt, so matters have developed in Tunisia, where the recently ex-president has already fled, and in Jordan and Yemen.  But everyone knew those places were waiting to erupt, just waiting for the right decade, so why now?  We suggest that it is no coincidence that these events are taking place at the time of a seismic shift of wealth from the First World to the Third (in case you've forgotten, the derivation of these terms left space for the Soviet Empire, which suffered a setback in 1991 but may now be embarking on a comeback).  Therefore, the problem is not so much that the populations of these nations are becoming poorer, as that they are not becoming richer, or at least are doing so more slowly than they have been led to expect.  In the absence of official opposition parties, they resort to anarchic methods.

The response of international investment analysts is interesting.  Having enthused over investment opportunities in North Africa, they have now all turned cautious, and recommend an "underweight" position, whatever that means.  Who, we wonder, will help them out by choosing to be overweight?  The bigger question concerns the next destination for these redirected funds, and it turns out that markets such as Indonesia and the Philippines remain in favour.  In other words, nations where food riots have, for the time being, been successfully put down and the political leaders will remain in place until the next crisis.  If financial markets are supposed to be ruled by any kind of common sense, perhaps they now represent another form of anarchism.

Monday January 24, 2011

Readers may be starting to feel that these commentaries are obsessed with interest rates in general, and with the eurozone in particular, but once again these issues have provided the biggest financial news of the week.  Even though the markets have shown slightly less volatility than of late, all the signs suggest that this is a temporary lull, as supporters of the various possible routes out of the current mess continue to exchange opinions and insults.

Regarding Europe, there has been a certain amount of relief that some of the weakest economies have succeeded in floating sovereign bonds.  However, there may be less to this development than meets the eye, since the terms they have been forced to take are not viable on a continuing basis, and in any case are assessed by investors primarily on the perceived likelihood that, in the event of things going wrong, they will be bailed out by someone's taxpayers.  They might as well have borrowed from the Stability Fund, whose terms were deliberately set at an expensive level in order to deter its use.  Inevitably, there are now suggestions that these should be made much cheaper, and so represent a transparent subsidy from stronger EU nations and the IMF, though in that case demand would certainly exceed supply.

So, how are Greece, Ireland, Portugal and other parties yet to be named going to survive inside the framework of the EU?  There are no new answers to that, but we are starting to see mainstream commentators entertain the idea, previously expressed only by wild-eyed extremists such as the Naked Trader, that maybe there is no way in which this circle can be squared.  To give one example of intractability,  Greece in 2010 suffered from high inflation and a contracting economy - whatever you think caused this lamentable state affairs, the solution can hardly lie in the high interest rate which now pertain there.  Meanwhile, Germany exhibited a booming economy and tolerable but rising inflation, a state of affairs in which all-time low rates are evidently inappropriate.  It is absolutely clear that any attempt to maintain these two nations in economic union will necessitate major transfers of funds from one to the other, not once but on a regular basis into the indefinite future.  It is much less clear that the German electorate, or possibly even their Greek counterparts, would accept such an outcome.

- - - - - - - - - - - - - - - - - - -

Stop the presses, it has just been announced that talks between the British Government and the big UK banks, regarding the vital need to revive the economy by restoring some degree of lending to small businesses, have broken down.  Yes, you did read that correctly.  The bankers who brought the nation to its financial knees, enriching themselves massively in the process and then seeing their institutions bailed out with unthinkable quantities of taxpayers' money, are now called in to discuss the terms upon which they might be willing to allow some of these funds to find their way into the hands of people who are not bankers.  It may seem surprising that they are even being invited to negotiate on this issue, rather than simply being told what they are going to do, but it gets worse - they say the inducements on offer are not sufficient and they will not co-operate.  Until the government decides to take grip of this rogue group it is safe to assume that the UK, outside the charmed circle of the City of London, will remain set solidly on the doldrums.

Monday January 17, 2010

Foreign observers of the Eurozone would be well advised to pay close attention to recent comments by Jean-Claude Trichet, the president of the European Central Bank.  Indeed, while many commentators are still struggling to interpret his controversial series of insights, the financial markets wasted no time in assuming that he probably meant what he said, marking the euro up and its risk-free bonds ( whichever they are ) quite sharply down.

So, what did he say last week?  He expressed concern that price inflation in his jurisdiction is running at an annual rate of over 2 per cent, when his remit is to maintain it below that level, and seems likely to rise further.  He is aware that there is a debt crisis going on, but that is not his problem, nor does he have the tools to fix it.  He seems to be on a roll, for over the weekend he went on to describe his own prescription, though this seems unremarkable, involving mostly a stiffening of the Stability Fund - it's hardly a secret that in its present form and size the fund would be swamped by any call on it from a major nation.

None of this sounds especially radical, but he then rubbed in the point with a reference back to August 2008, when the ECB mistakenly raised rates in the midst of turmoil in the credit and commodity markets.  At least that's the Anglo-Saxon folklore, but Mr. Trichet will have none of it - he stresses they did it because it was the right thing to do, and given their time over again they would do the same.  The implication is that, if inflation needs to be tamed, the tantrums of market traders will not stand in his way.  The reaction of Wall Street, whose every whim is pandered to by the dutiful Professor Bernanke, can only be imagined.

This does not mean that we should expect euro rates to be raised straight away.  Unlike their neighbours in the UK, where inflation is double the recommended number an rising towards the stratosphere, the eurozone's inflation problem is not yet close to escape velocity.  However, we have been warned that the ECB will not feel bound to wait until their economy returns to full health, which will indeed probably take years.  With some members of Britain's MPC making similar noises, and the developing world already putting their rates up on a regular basis, the US may soon feel rather lonely in their policy of eternally low rates ( of course, they do share this with Japan, but nobody wants to be compared with them ).



Ultimately, as becomes clearer with every passing week, the USA's unique approach to monetary policy is viable only when underpinned by a reserve currency which continues to be bought unquestioningly by the rest of the world.  It is true that there are no immediate signs that this is unraveling, but when it does events may be expected to move very fast.

Monday January 10, 2010

Last week the Financial Times published the results of an unusual survey in which 68 City of London economists ( so not just the usual suspects ) were asked the question " to what extent has the bank of England ( deliberately or accidentally ) lost control of inflation?  Has it lost credibility in its forecasting?".  A few, although surprisingly only a few, answered with words to the effect "what credibility would that be?".  Rather more felt that, while the Bank's models could probably stand some improvement, they were still in a position to control inflation as required, though why they would make the necessary adjustments when their output was telling them that inflation would fall under its own weight is unclear.

A very popular comment was that the Bank should not be criticised too harshly for its failure to forecast the continuing rise in inflation when most of their counterparties in the private sector had made the same mistake.  However, we have to wonder whether this means not that the error should be overlooked, but that the blame should be spread more widely.

We are constantly told that economics is not an exact science, and that it is unreasonable to expect precise accuracy from its predictions.  All the same, wouldn't you expect the experts' forecasts to be better than those of the general population?  The Bank of England carries out regular surveys of, among other things, the public's inflation expectations, and these have consistently shown higher ( and therefore better! ) estimates of future CPI figures than those of the experts.  This has been explained in the past by the argument that those surveyed have been asked only about their expectations over the coming twelve months, whereas the MPC are taking the more sophisticated view that inflation may race ahead in the near term but will then recede.  However, to its credit, the Bank has recently added a question about longer term expectations, and it turns out that these are even higher.  It turns out that the public believes that Gilts offer a negative real return all along the curve.

The difference in opinion appears to stem from the fact that the professionals have total belief in their theories, which tell them that price inflation should not be happening, whereas the public cannot shake off the idea that it is endemic to the UK, a national sickness which will never be eradicated and can at best be controlled with constant vigilance.  This folk wisdom evidently extends to those too young to remember the 1970s and 1980s, the last time this scourge struck with full force.  We shall see in due course whether the annual rate soars through 4% to much higher levels, or drops back to an acceptable 2%, but in this argument the man in the street has the better track record.

Monday January 3, 2010

As we head into 2011, the world seems beset by even more ugly economic problems than usual.  The Eurozone is in disarray, Britain is suffering the worst social disorder in decades before the promised budget cuts have even started to bite, while price inflation runs out of control, and Japan's national debt has ballooned to a level where even their peculiar financial structure cannot continue to support it.  The US leads the way, as the only nation whose political leaders refuse even to accept that any problem exists, as they continue to charge everything they can think of to the "reserve currency" credit card, which they confidently assume can be rolled over forever.

So, which issue is causing the most heat in public opinion?  Strangely, none of the above, but rather the vexed question of the huge lump sum payments being paid out to plumbers.  Yes, that's a joke, and in fact an unfair one, since plumbers perform a valuable public function.  We refer of course to bankers' bonuses, which would cause even senior drug dealers to turn a deep shade of green.  Which may not be so unreasonable, since over the past decade the banking community has wrought far more damage upon more lives than purveyors of illegal narcotics could ever dream of.

Many politicians are publicly wringing their hands over this question, but they are universally missing the real point.  Why is it that there is even any question of paying huge bonuses to the denizens of banks' trading rooms, as opposed to airline pilots, research scientists or even the aforementioned plumbers?  The answer is that banks are reporting huge profits, and this is routinely ascribed to the cleverness of their employees, who must be rewarded accordingly.  It is worth looking more closely at the source of these gains.

What makes this such an interesting exercise is that the banking industry is conspicuous for creating nothing of any value, they make their money by moving money from A to B, then to C, then back to A again, taking a turn at each stage.  The best they can claim is that they ensure an efficient allocation of capital, but this service can hardly be worth the hundreds of billions of dollars that they take out every year, and in any case the capital allocation which they have brought about in recent years has been very far from optimal.  The truth is that their profitability depends entirely upon the oligopolistic power granted to them by governments around the world to take a tithe on any and all financial transactions.

This is seen in its most extraordinary form in the recent Quantitative Easing merry-go-round.  Trillions of dollars are being produced by one arm of the US government and quickly finding their way to another, but not before passing through the private banking system, which takes its usual turn.  This seemingly inexplicable detour comes as less of a surprise when you realize that the Treasury Department, when considering how best to implement their new QE experiment, sought the learned advice the commercial banking fraternity.

To be fair, we are not the first to notice this outrage.  Public figures scattered around the globe ( with the notable exception of the United States ) have commented upon the remarkable rewards now accruing, as a direct result of the financial crisis, to those who played a large role in causing it.  In the UK both Adair Turner, the current boss of the industry regulator, and Mervyn King, who will take over from him in the re-organized framework, have drawn attention to this injustice, but it comes as little surprise that their bleatings have been ignored.   Their political masters in the Coalition government would probably be bankers themselves if they had not gone into politics, and find no difficulty in believing that their two groups are fully deserving of their power and money.  In the US, matters have reached the point where one might be puzzled not to find the Treasury Department shown in Goldman Sachs' annual accounts as a subsidiary.

What will it take to get this cuckoo out of the nest?  Probably, another bank-induced crisis, even more serious that the last.  The good news, if you see it that way, is that the bankers, their spirits fortified by the confirmation of their priceless too-big-to-fail status, are clearly working on that even as these words are written.

Monday December 20, 2010

It scarcely seems possible that earlier this year we celebrated the tenth anniversary of the final liquidation of Long Term Capital Management.  For those whose memories are hazy at such distances, this was the billion dollar hedge fund set up in 1993 by John Meriwether and a bunch of his hotshot ex-colleagues at Salomon Brothers, several of them university professors.  Adding further academic weight were two legendary economists, Robert Merton and Myron Scholes, whose theories had revolutionized the valuation of financial assets, and who were keen to test their latest ideas in the markets.

Together, they set out to profit from the use of risk arbitrage strategies that, as exhaustive testing had proved, could fail only if some event occurred the like of which had never been seen before.  The large point which they failed to notice was that there was indeed an unprecedented event taking place, which was that a fund with almost unlimited resources ( "almost" is important ) was making huge bets that history would repeat itself.  In 1997 Merton and Scholes were awarded Nobel Prizes, and the following year LTCM blew up - the proximate cause was the Russian debt crisis, but it could have been anything.  At the behest of the Federal Reserve, ten banks put in $300m apiece to bail out the fund, and in return monetary policy was loosened for their benefit, though at incalculable cost to the broader economy.

Why are we reminded now of these historic events?  Well, for a while after the LTCM debacle some faith in complex mathematical modeling of economic events was lost, a most welcome development.  However, this lesson has clearly been forgotten, since we are once again held in the grip of academics keen to test their most outrageous theories on the real world.  The difference this time is that they are central bankers and their associated finance ministers, and instead of punting in billions of dollars their interest is piqued only by trillions.  Here's a Christmas trivia question, which of these three would blend most easily into a contemporary LTCM?  Is it a) Ben Bernanke, b) Tim Geithner or c) Adam Posen?

A very reasonable answer might be d) all of the above, but we shall consider them in turn.  The Fed Chairman is happy to bet his nation's economy on the untested concept of Quantitative Easing, and able to base his belief that it works solely on the unprovable fact that we would be in an even bigger mess without it.  He clearly has what it takes, and could yet be a Nobel candidate himself.  Also, there's a reason why a majority of Americans polled believe that the Treasury Secretary used to work at Goldman Sachs, even though that isn't true.  Still our favourite is the lesser known member of the UK's Monetary Policy Committee.

Dr. Posen is noted for his strongly held view that UK price inflation, even though it is running hot and getting hotter every month, is in fact in imminent danger of dropping below the critical annual level of 1 per cent ( you'll have to ask an economist why that's such a terrible thing ).   The most recent Bank of England survey of inflation expectations shows that Britons expect prices increases averaging 3.9 per cent over the coming twelve months, a level just high enough to remind them of the inflationary spiral which gripped the nation thirty years ago.  Of course, Adam Posen would know little of the fears which haunt the public in the nation whose monetary policies he helps to frame, since he is American researcher working on an EU grant.  The UK economy must be a fascinating project, and if it goes terribly wrong there is an important paper to be written.  Who knows, maybe a Nobel prize.

Monday December 13, 2010

What's the biggest news of the week for global investors?  Probably it concerns the delicate mechanism of Eurozone policy, as it has for months and will for most of the coming year.  However, there were no startling new developments in the past seven days, and long-term investors are notorious for their limited attention span, so we shall look for an alternative focus of interest.
Fortunately, there have also been interesting developments in the United States, where a landmark bi-partisan agreement has been achieved between the White House and the new Republican leadership of the House of Representatives.   This has resulted in highly generous treatment of those who have lost work and will never find it again ( the President's constituents ) as well as those who work hard and are rewarded egregiously for their efforts ( those of his opponents ).  From neither side can we see any interest in reducing, or even stabilizing, the massive budget deficits which pose the greatest threat to the future of the US economy.
A painful symmetry is offered by the fact that, in the same week, the recommendations of the President's own commission on fiscal responsibility failed to garner sufficient majority support from its own members to require Congress even to consider its conclusions.   Everyone accepts that the economy's structural problems represent a clear and present danger, but now is not a good time to think about that, with the 2012 elections looming.  Perhaps one day we shall wake up and find that they have gone away.
All of this puts the Treasury Bond market, and the dollar, on centre stage.  We have long believed that the greenback is supported only be its status as a reserve currency, but that is not a unique insight and has no date attached.  The recent nasty weakness in the 10 year bond, targeted for special support by Prof. Bernanke, may however be significant.  Perhaps this could reflect a general belief that his adventurous policy of Quantitative easing is indeed set to bring about an economic recovery, which will cause interest rates to return to more normal levels.  Unfortunately, this theory receives no support from movements in yields on TIPS, which might be expected to rise in these circumstances, nor from those on other dollar denominated bonds.  It appears that investors are peculiarly concerned with the creditworthiness of instruments issued by the US Government.  This is not a worry which may be expected to disappear.

Monday December 6, 2010

Does anyone still remember the BTP convergence trade?  Those who worked on the LIFFE floor surely will, since it was probably the easiest way to make lots of money ever offered by that market.  Simply put, it involved a bet that, as individual currencies became subsumed by the newly minted euro, their interest rates of all maturities would necessarily be identical.  This applied even to those such as the Italian lira, which had throughout its existence served as a medium through whose regular devaluation the Italian economy could survive - these banknotes were suddenly to be turned into a store of value as secure as the deutsche marks managed so soundly by the mighty Bundesbank.  The idea seemed absurd, but numerous London traders took it at face value, backed their judgement and made their fortunes.

The naysayers of 1992 may now feel that they are finally being proved right, but this is cold comfort for missing out on such rich pickings.  It must even be admitted that the specific bet being made in those days, that Italian debt would pay as reliably as its German equivalent over a period of ten years, has already come good.  Truly, things that cannot go on forever don't, but they can persist for a remarkably long time.  So, now that the tide does appear to have turned, how should we handicap the prospects of the shakier constituents of the eurozone over the next ten years?  This is currently the question vexing the world's financial leaders and great investors more than any other, but there seems no reason for us not to search for an independent viewpoint.

Cutting straight to the point, it is becoming clearer every day that the whole euro project is dependent, and always has been, upon Germany.  The West Germans took in their cousins in the East on terms which made no economic sense ( parity with the hopeless ostmark ), but did so with their eyes largely open.  It now emerges that they did a similar deal with much of the rest of Europe, but were until now less than fully aware of that fact.  The future of European monetary union, and perhaps of the continent itself, depends upon how they react to this realisation, and we should look carefully at their leaders' public pronouncements.  As recently as a month ago there was a united front denying the possibility that the future of the euro was under discussion, though even that suggested to suspicious observers that it might be, otherwise why would it be denied?  Since then Angela Merkel, stung by nasty opinion polls and some worrying regional elections, has made increasingly hawkish noises about peripheral nations following common rules, where previously a blind eye had been turned.  

She is not alone.  Mr Bruederle, her Economics Minister, has declared publicly that the eurozone can be saved only by co-operation between France and Germany, but that this could only happen on terms decided by the major paymaster.  Mr. Bofinger, an influential member of the Council of Economic Experts, has suggested that a debate should take place on the subject of whether Germany has the stomach for such a huge task - while he appears willing to speak in favour, he also seems aware that he might not carry the house.  It is in this context that we now read about Finance Ministers discussing the enlargement of the bailout fund, which is deemed inadequate to handle the coming demise of the Iberian peninsula, possibly followed by Belgium and Italy.  In true democratic fashion everyone has their say, but it is increasingly clear that only one nation's decision really matters.

Monday November 29, 2010

In any discussion of monetary policy, it is never long before a divide appears between hawks and doves, East and West, borrowers and savers or some such clearly defined pair of opposites.  However, it occurs to us that the clearest distinction between today's economists is defined by whether they operate in academia or the real world - increasingly, these two groups appear barely to share a common language.

The most prominent advocate of zero interest rates, Quantitative Easing and unlimited use of the printing presses is of course the Chairman of the FOMC, Ben Bernanke.  While the framers of the US constitution ensured that the fiscal side of economic management in their nation was managed by a careful set of checks and balances involving the President and two Houses of Congress, they evidently viewed their currency as a technical matter which could safely be left to a small group of private citizens.  Little did they realise that one day this would assume an equally important role, operated by a tightly knit group with little external oversight.

Professor Bernanke has qualified himself for the job of running the monetary policy of the United States with a long career of teaching and research at Princeton, making the Great Depression his special subject.  He has formed strong views on the ways in which it might have been handled better, and was thrilled to find an excuse to test them when the world was perceived to be on the brink of a rerun of the 1930's.  The fact that this fate has so far been been avoided is considered to prove that the medicine has been successful, and by some circular logic to prove that the dose must be repeated to keep the disease at bay.  It should be noted that the growing strain of scepticism on the FOMC is coming not from the seven members of the Board, who tend to be creatures of Washington, but rather from the twelve presidents of the regional Reserve Banks, whose jobs require them to keep in closer touch with the outside world.  

It's a similar story in the UK, where the Governor of the Bank of England, Mervyn King, had prior to his current posting never had a job outside academia.  This probably explains his obstinate insistence that price inflation is not only desirable in itself, but that there is currently not enough of it.  His regular letters to the Chancellor explaining why the annual rise in the CPI has yet again exceeded its 2 per cent target by more than the permitted margin remind us of a football manger who has insisted for two years that, while the fans have a right to be disappointed with the team's results, improvements are at hand which will bring results, if not next season then in the one after that.  Except, of course, that the wretch would have been sacked some time ago.

Surprisingly, while Mr. King's beliefs have met with criticism verging on derision from many private sector economists, the most brutal attack upon him has been launched by one of his colleagues on the Monetary Policy Committee, Adam Posen, who has publicly accused him of misrepresenting his own views as those of his committee.   Dr. Posen is a lifetime economic researcher, and an American one at that - we wondered whether some exchange program might be in action, but have searched in vain for a British representative on the FOMC.  This disagreement is an interesting exception to the general rule that spats in academia get nastier as the issues involved become more trivial, since here the stakes are very high indeed.

Monday November 22, 2010

NAKEDTRADER COMMENTARY

What's going on in Ireland?  The EU, the IMF and the British Government are
all turning up with huge quantities of money to help the locals out of their
difficulties, yet Dublin seems determined to spurn their advances.  Is this
really just an example of the quixotic behaviour for which the Irish have
got themselves a bit of a reputation?

No, it isn't.  It is important to understand that these generous offers are
not motivated by any desire to help Ireland - some of them are prompted by
outright malice, while in most cases the welfare of the recipients is a
matter of indifference.  We can be sure that all of the participants are
acting with their own best interests at heart.

By far the largest player in the hoped-for bailout is the EU. They are
desperate to avoid the ignominy of a sovereign default by one of the
eurozone members, which they feel ( no doubt rightly ) would cast doubt upon
their grand experiment.  If the vast Irish debts could be moved onto the
EU's balance sheet, then it would subsequently be possible to present the
inevitable default as something more palatable, and to use it as a weapon to
brutalise the Irish into abandoning the fiscal policies which have made
them, curiously, at the same time very prosperous and very broke.

We have been waiting a long time for the IMF to say or do something
sensible, but their contribution to the discussion does not end the
suspense.  Of course, they are a predominantly American institution, so it
is not much of a surprise that their advice on this matter is particularly
clueless.  Suffice it to say that the absorption of Ireland into a
superstate whose government resides in continental Europe is none of their
business, and will in any case not be countenanced by the electorate.

Finally, there is the reaction from the UK, where we find such solidarity
with their neighbours across the Irish Sea that the authorities are willing
to commit billions of pounds from public funds to a support operation - even
though the previous administration had been careful to avoid the need for
any such outlay by staying well clear of the euro.  Of course, the truth is
that British financial institutions are on the hook for even larger sums in
the event of a default, and not for the first time their government is happy
to use taxpayers' money to protect its bankers from the results of their
irresponsible lending.

Monday November 15, 2010

NAKEDTRADER COMMENTARY

The G20 meeting in Seoul is over, having produced the usual communique about agreeing to work together for a better future.  The Financial Times has offered an opinion along the lines that the meeting should be considered a success on the grounds that physical blows do not appear to have been traded.  As Winston Churchill noted, better jaw, jaw than war, war.  Unfortunately, in macroeconomic terms it is quite possible to conduct a full-scale war while insisting in public that nothing of the sort is going on, and it seems likely that the participants accused each other of precisely this behaviour.

Our prediction was that the delegation from the US would be a lonely group, receiving support only from the British.  The most conspicuous source of disagreement concerns the question of whether QE addresses a nation's economic stagnation ( assuming it does so at all ) by some direct mechanism rather than solely through its devaluing effect on the currency.  Treasury Secretary Tim Geithner naturally insists that there is no weakening of the dollar going on here - indeed, there cannot be since QE is an FOMC decision and the currency is outside their remit - but his credibility has reached the point where such a statement is widely taken as confirmation that the opposite must be true.  With such disingenuous comments, he can hardly complain.  The new British Finance Minister is still not taken very seriously, so the spotlight falls on the Governor of the Bank of England, Mervyn King.

Mr King's reputation, which reached great heights during the good times, has taken a hit recently.  Even the Queen has felt the need to ask why nobody foresaw the disaster which has befallen her nation's banking system, and could be forgiven for thinking that he was the man in charge of preventing it.  He remains insistent that the UK's first dose of QE was both justified and successful, a claim which can of course never be proved or disproved.  His political masters ( unless the Bank really is independent? ) have validated this view by making clear that if their austerity programme causes serious distress, then he will just have to compensate for this by printing even more money.  However, he is now under fire from commentators, and even members of his own committee, following the November 2010 issue of the Bank of England's closely followed Inflation Report.

Readers outside the UK may need to be reminded that the Bank's remit there is to maintain price inflation at an annual level close to 2 per cent.  By the way, this does make more sense than the Fed's additional requirement to maintain an appropriate level of employment, for which their monetary tools are hardly appropriate.  Of course, prices have been rising a good deal faster than that, but the Bank has insisted that this is a temporary state of affairs, and that their greatest fear was that prices would rise at a dangerously slow rate.  The new Inflation Report officially abandons this point of view.  Superficially there may appear only a few minor changes in wording from the August version, but Mr King must feel that they have been torn out with pliers.  In the tight-knit world of central bankers, Ben Bernanke now cuts a lone figure.

Monday November 8, 2010

NAKEDTRADER COMMENTARY


We suspect that Ben Bernanke, a cultured man who pays attention to the world's press, is puzzled by international reaction to last week's dose of Quantitative Easing, also known as QE2.  All he is trying to do is save the US, and therefore the global economy, from a looming depression, yet the emerging nations accuse him of attempting to derail their progress towards prosperity and the German Finance Minister describes his policies, with all due respect, as "clueless",  How can such terrible misunderstandings have come about?

Let us attempt to understand how the facts appear through his eyes.  First, he believes unconditionally that QE1 saved the world last time around, and that its efficacy has therefore been verified.  This is a view popular among American academic economists, and the supporting logic appears to run as follows.

1.  Prior to QE, the world was heading for a depression on the scale of the 1930's.

2.  This did not happen, and the threat has passed.

3.  The explanation for our salvation can only be found in the monetary activities of the central banks.

It must be said that, of these statements, only the first part of (2) may be described as an evident truth.  It may well be that the world's biggest was heading for a terrible fall - indeed, given the excesses of the previous decade it might be surprising if it were not.  However, even if QE1 did have some effect, it is not yet clear whether it achieved any more than a delay of the inevitable.  Much of the evidence is not yet in, but it is normal for the architects of a controversial policy to claim early vindication.  It is only a short step to the next stage of the argument, which is that if the performance of the economy still leaves much to be desired, then necessarily the QE policy, which has been established as correct, needs only to be pursued in greater size.

Mr Bernanke has explained several of the ways in which he expects the new tranche of $800bn to work its magic.  Some are highly dubious, for instance the corporate sector will not be tempted by even lower rates to make greater capital investments when they are already sitting on a trillion dollars of cash.  Equally, why would banks start lending again when the profits from making one-way bets in the bond markets can be taken in time for the calculation of year-end bonuses?  His assertion that if mortgage rates follow treasuries down ( though he may have to corner the 30 year market for that to happen ) then house prices could regain their former levels nmay have some validity, but whether that is a reliable route to recovery is less clear.

For us, his most telling comment was that he expects to see some of his generosity causing a rise in the stock market. He views this as a good prospect, auguring a return to growth and happy days. Evidently it's as easy as that.  From a recipient of the most expensive education money can buy this is a rather disappointing analysis, the sort of thing that Will Rogers must have had in mind when he asked "if stupidity got us into this mess, why can't it get us out?".

In any case, the rest of the world has noticed that there isn't much in the US that the owners of all these newly minted dollars want to buy, and that an avalanche will be coming their way.  They've seen that movie before, and this time seem determined to repel efforts to make them pay the price for American profligacy.  It will be interesting to see whether the USA still has the muscle to turns its domestic problems into a nightmare around the globe.

Monday November 1, 2010

NAKEDTRADER COMMENTARY

Say what you like about the Irish, they certainly produce original thinkers.  This week's example is Mike Soden, whose enforced departure from the top spot at Bank of Ireland, before the wheels fell off his nation's banking system, may not have served him as badly as appeared at the time.   Mr Soden has now been appointed to a position on the new Central Bank Commission, which has caused light to be shone on some of his recently expressed views regarding Ireland's monetary future.  Most notably, that the nation would be well served by abandoning ties with Europe, and instead applying for admittance as the 51st constituent of the United States of America.

We suggest that, though the author may not have seen himself in such exalted company, this is as significant a satire as his countryman Jonathan Swift's "modest proposal" from three centuries earlier.  Let's think about it.  Ireland's banks are wrecked, their nation has picked up the tab and is as a result bankrupt, and the debts must be paid off in rock-solid euros.  But each evening, as the sun sets on this westernmost outpost of Europe, they sip their whiskey and look across the Atlantic, to where matters are superficially no better, yet the the legislators and bankers ( to the extent that the two groups can be distinguished ) continue to party like it's 2006, or 1999 or 1928, you pick the year.

So who is right?  In Europe, central bankers take the view that nations, just like the individual families which constitute them, must one day face up the the fact that they have lived beyond their means.  No, say the Governors of the Federal Reserve Board, the great difference is that if you're an independent nation you simply print unlimited quantities of your own currency, distribute it from helicopters, and the problem is solved.  Evidently when your seven year old child proposed this solution, and you patiently explained why it wasn't that simple, you were wrong and they were right.

In the face of this challenge to everything in which we believe, we are relieved to note that there does appear to be a fault line running through the Fed, and that the majority is dominated by members who might be described as academic economists.  Those who have in recent comments dissented from the view proposed by Chairman Bernanke have included the presidents of the regional Feds in Kansas City, Minneapolis, Dallas and Philadelphia, who may be presumed to have at least one foot in the real world.  The exchange of views between these individuals and the Washington / academic axis will be interesting to watch over the coming months.

Monday October 25, 2010

NAKEDTRADER COMMENTARY

Can it really be only four weeks ago that the Brazilian Finance Minister Guido Mantega caused a furore by putting forward the view that "we're in the midst of an international currency war"?  This was supposed to be one of those facts that are so obviously true that every responsible figure is required to deny them, but after only a few days of ritual rebuttals by world leaders it entered the general consciousness, and the blanket hostility towards the very idea was replaced by a more nuanced approach of blaming other people.

So it was that the meeting of G20 finance ministers and central bankers in the South Korean city of Gyeongju was forced to make the central point of their final statement an agreement to renounce the competitive devaluations that, until so recently, they had all insisted did not and could not happen.  Never mind that Yoshihika Noda, Japan's finance minister, immediately added that his nation's own currency had become particularly overvalued and that he would take whatever steps were necessary to correct this problem.  Nor that Sr. Mantega, who set this ball running, said nothing to suggest that he had changed his own similar view regarding the Brazilian real.  Meanwhile, the Chinese continue to insist that their currency's international value is nobody else's business and the Americans, as always most self-righteous in these matters, will go home to devise the next round of quantitative easing, the transparent aim of which is the devaluation of their own dollar.

It is interesting that George Osborne, representing the UK, was among the most enthusiastic ministers leaving the meeting.  Of course he is new in his job, and no doubt quite excited to have been there at all ( unlike Mervyn King, the veteran Governor of the Bank of England, who sensibly sent a deputy ), but he must also be aware that Britain remains ahead of the currency game, having surreptitiously slipped through a major devaluation of the pound over the past three years.  Indeed, when political historians comb through the record of his predecessor Gordon Brown in search of actions which were not damaging to his country's economic wellbeing, this may be their sole find.

Privately at least, the G7, perhaps apart from Germany, do seem able to agree on what is wrong with the world, this being that the terms of international trade cannot indefinitely allow them the enjoy a vastly higher standard of living than the emerging nations while no longer producing much more (that's the trouble with emerging nations, one day they emerge).  The old powerhouses have finally noticed that they face the choice of hanging together or hanging separately, but this understanding has come too late.  The US, in particular, has a history of sustaining itself with asset bubbles and exporting excess liquidity to less financially developed parts of the world - the wreckage this causes has always been seen as acceptable collateral damage.  This time it may not work, as the economies which have been previously been used as escape valves now know enough to put up capital controls or even to devise their own trading blocs, operating independently of the dollar.  If the US really has to sort out its own combination of inflated asset values and depressed activity, without being able to use the economies of its trading partners as a buffer, the future could be highly unstable.

Monday 18th October 2010

NAKEDTRADER COMMENTARY

This week, we would have liked to refer readers to a video of a very interesting conference held on 8th October, entitled "IMF Asia and Pacific Department Seminar: Reviving the Animal Spirits: Strategies for Promoting Growth and Stability in Japan".  It could be found at  http://www.imf.org/external/mmedia/view.aspx?vid=629531125001, but at the time of writing appears to have become unavailable.  Perhaps too many people are watching it.  In any case, you may be wondering how listening to a bunch of talking heads reworking such a hackneyed topic could possibly be worth eighty minutes of your time, but on this occasion the panel of speakers included Japanese who wish foreigners to understand better how their nation really works, as well as that even rarer species, Western commentators with first-hand knowledge of Japan.  The seminar was moderated by Gillian Tett, who writes some of the Financial Times' more intelligent commentaries and is the reason why we gave this event a look.

It must be admitted that none of the panel asked one obvious question, whether the animal spirits deemed to be so lamentably lacking in the Japanese economy might be the same ones which impelled the senior executives of Western banks to ruin their own institutions as well as the economies of their home nations, and therefore a good miss.  We excuse this oversight by noting that the conference was hosted by the IMF, whose failure to see any sign of this problem must still be a sore point, and the speakers probably hope to be invited back.  They were, however, much more insightful on the keynote local topic of deflation.

The point of the presentation which must have caused a sharp intake of breath among the gaijin audience was the result of a 2009 survey of Japanese consumers, asking how they felt about deflation, in which it was revealed that they regarded it as "favourable" rather than "unfavourable" by a 2-1 margin, with about 30% indifferent.  Pity the poor Tokyo central banker.  He has his shiny new toys, which say on the box that they counteract deflation - as a matter of fact they're the only toys he's got, the old ones are all broken - and cannot wait to compare notes with his international friends about how well they work, but the subjects of the experiment say they're fine as things are.  What can he do?  So far his plan has been to play the game, but on a limited scale which has brought quiet contempt from his less inhibited Anglo-Saxon peers.

In an effort to learn more about attitudes on the other side of the world we searched the web, and one of the hits was the following Reuters headline from earlier this year, "BOJ survey shows Japan deflation worry growing".  Needless to say, the survey showed nothing of the sort.  Yes, the percentage of Japanese who expected prices to fall over the coming twelve months had risen to 18 per cent, but the news service failed to mention that the percentage who wished for such an outcome was over 40 per cent.  On balance, therefore, the populace were not worried about deflation, they were worried about the absence of it.  All the same, it would be unfair to criticise the English speaking Reuters editor who wrote the headline - even if they were aware of the survey showing public approval of deflation, this group has such ingrained prejudices that the new information simply could not have been processed, and would have been shrugged off as an error in translation.

It's worth asking the heretical question of whether attitudes in the West are really so different.  The American answer to the bald enquiry "Do you want deflation?" is predictable enough, since anyone watching network news has been conditioned to equate this with "Would you like huge snakes to emerge from the earth and devour your children?".  But how about "Would you be happy if $100 bought as least the same basket of groceries in twelve months' time as it does now, bearing in mind that your income is unlikely to go up by much?".  That might receive a lot more votes, and the enthusiasts would be astonished to learn that they were supporting the same deflation that untold billions of taxpayers' ( ie their ) money are being deployed to resist.  

The truth is that governments like inflation because it reduces the value of their huge debts.  Banks welcome it because it increase the value of their collateral.  The general public, however, does not like inflation for the obvious reason that if prices rise, then their money doesn't buy as much stuff.  This has always been true, and always will be.  The idea that inflation is not only a good thing, but worth making great sacrifices for, is one of the great confidence tricks of all time.

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