22/1/2012: 'Markets are crazy', says market economy Ireland

So we used to have an 'Innovation Island' here that was run by the Deputy PM who confused Einstein with Darwin. She was directly in charge of Innovation policies.

Now we have a 'Competitive Market Economy' that 'Is Open for Business', as we constantly remind our potential foreign investors (domestic investors we have simply taxed into oblivion already and are even expropriating their wealth through Minister Noonan's 'levy' on pensions), run by the Minister responsible for the following statements (source here HT to @brianmlucey for flashing this one out):

"Michael Noonan, Ireland's finance minister, criticised the involvement of private creditors in the [Greek PSI] talks, arguing that it had made the crisis worse. Mr Noonan told the German newspaper Sueddeutsche Zeitung it had been a "fatal" mistake to involve the private creditors and this had "driven the markets crazy". He said that markets would only calm when they were convinced that eurozone countries were making serious efforts to solve their debt problems."

So, 'markets are crazy' and proper risk sharing with private investors in the case of insolvency is a 'fatal mistake'.

Does Minister Noonan believe in slavery? Because if he doesn't then there is no alternative in the case of Greek crisis resolution options to PSI. Of course, Minister Noonan believes in slavery - the modern variety of it - slavery that subjugates those who do not emigrate from Ireland to decades of involuntary repayment of privately accumulated debts they did not contract to accumulate. Minister Noonan has no problem with the Government of Ireland simply undertaking all private debts of a private insolvent banks and forcing ordinary people - not shareholders or lenders to these banks who were paid to take the risks in the first place - to repay them. Just like that. Without any consent: "Give us your money, granny, or else!"

But there's more to the statement above, which shows Minister Noonan in an equally unpleasant light. You see, Minister Noonan swears by the wisdom of the IMF and the ECB and the European 'partners' when it comes to his domestic policies. He did so officially earlier this week when he used Troika endorsement of Ireland's 'progress' in the programme as the reflection of their support for his policies. Yet, it is the very same Troika he so blindly follows into Ireland's economic oblivion which deemed Greek debt levels unsustainable - aka non repayable even were the modern day debt slavery terms (as imposed in Ireland) deployed in Greece as well.

So, for all our Irish concerns about the sanity of the Troika 'solutions' for Ireland, there's an even greater concern that should be preoccupying our minds - concerns for the positions taken by our own national leaders. And for all those would-be foreign investors into Ireland - please remember, you are about to invest in the economy run by those who think that 'markets are crazy' and contracts for risk pricing are 'fatal mistakes'.


PS: Never mind, Minister Noonan's only plan for Ireland is to attempt, asap, borrowing in the 'crazy' markets to finance his 'sane' fiscal management strategies.

31/10/2011: Bailout-3: The Gremlins Rising premiers

What a day this Monday was, folks. What a day. Just 4 days ago I predicted that the latest 'Bailout-3: The Gremlins Rising' package by the EU won't last past January-February 2012. And the markets once again cabooshed my perfectly laid out arguments squashing my prediction.

As of today we had:

• Italian bonds auctioned last week at 6.06% yield for 10 year paper, the most since 1999. The yield was up from 5.86% at the auction a month ago which marked the previous record high. For Italy, given its growth potential and debt overhang, yields North of 5.25-5.3% would be a long-term disaster. Yields close to 6.1% are a disaster! But things were worse than that last Friday: the Italian Treasury failed to fullfil its borrowing target of €8.5bn to be sold. Instead, the IT sold only €7.9bn worth of new paper. Boom - one big PIIGSy gets it in the 'off-limits' region!
• Also on Friday, Fitch issued a note saying that 'voluntary' haircuts of 50% on Greek debt will constitute... eh... a default / credit event (see report here). Which kinda puts a boot into the softer side of the 'Bailout-3' deal. Boom - Greece gets it in the gut!
• Today, Belgians went to the bond markets and got rude awakening: Belgium placed €2.155bn worth of bonds along 3 maturities: 2014, 2017 and 2021. The country wanted to raise €1.7-2.7bn (with upper side being more desirable), so there was a shortfall on allocation. 10 year bond yields for September 2021 maturity are at 4.372% against 3.751% for those issued in September 2011. Belgium is yet to raise full €39bn planned for 2011 as it has so far covered €37.517bn in issuances to-date. it will be a tough slog for the country with revised deficit of 5.3% of GDP in 2012 (assuming no new austerity measures) and debt/GDP ratio of 94.3% expected in 2012. Boom - a non-PIGSy gets a kick too.
• Also today, Germany marched to the markets with €1.933 billion in new 12-month bubills at a weighted average yield of 0.346% and the highest accepted yield of 0.354%. On September 26th, Germany sold same paper at an average yield of 0.2418%. Today, Germans failed to allocate €67mln of bills despite an increase of 40% in yields in just 5 weeks. Big Boom - the largest Euro area economy gets smacked!
• And for the last one - per reports (HT to @zerohedge : see post here): Europe, hoped to issue €5 billion in 15 year EFSF bonds. Lacking orders, it cut issuance volume by 40% to €3bn and the maturity by 33% to 10 years. As @zerohedge put it: "But so we have this straight, Europe plans to fund a total of €1 trillion in EFSF passthrough securities.... yet it can't raise €5 billion?" Massive Boom, folks - mushroom cloud-like.

So here we have it, a nice start for the first week post-'Bailout-3: The Gremlins Rising'...

26/09/2011: Greek crisis and exit strategy

At last - an excellent summary of the Greek crisis possible outcomes and exit strategies, courtesy of BBC (link here).

The bottom line is that no matter what Greece and Troika do or fail to do, the crisis will either move onto a full-blow economic implosion of Greece or global meltdown. This puts Greek dilemma, from euro area's perspective, squarely into the category of the choices faced by a patient with gangrened leg: to cut or to die. In other words, unless someone can find a node to hang a decent outcome on in the above - and I can't find one - the optimal policy mix from the point of view of both Greece and the euro area would be:

• Swap tranche release in October for commitment from Greece to exit the euro area under oversight from the IMF (staged exit with monetary support provided by the IMF and ECB). Future tranches should be tied to Greek Government progress on the bullet points below.
  
• Greece should default on sovereign and banks debts (60-70% writedown on sovereign and 50% writedown on banks), in part financed out of the current bailout package, in part netted through ECB (with ECB providing support for non-Greek banks and financial institutions writing down Greek assets on their balance sheets).
  
• Post-default, Greece should remain within the EU but outside the euro to avail of the benefits of free trade, labour and capital mobility.
  
• EU assistance to support growth via infrastructure investment should be extended to Greece in 2012-2017, in part to provide stronger foundations for growth and in part to provide an incentive to see through structural reforms in public sector and overall economy.

In effect, Greece will be incentivised via emergency supports and future investment assistance to exit the euro area voluntarily. There are no guarantees that post such exit Greek new currency and indeed its economy can gain a footing in the markets. However, retaining Greece within the euro zone does not appear to be a feasible option at this stage.


Note: The argument that Greece should default and exit euro is hardly a novel one. Nouriel Roubini recently made a very strong case for this here. Roubini also, in my view correctly, recognizes that transition from euro to domestic currency will require some financial supports from the EU.

Economics 09/05/2010: What sort of EU leadership?.. Part 2

Underlying the unworkable logistics of the Euro-bond that Brussels is planning to deploy to contain the spillover of the fiscal crises in PIIGS, there is a pesky issue of the past record of the currency block management of its finances.

Here are some historic comparisons from the IMF latest GFS report worth highlighting.
Now, spot the odd ones in the above chart? That's right - the non-Euro zone countries are the ones with the lowest indebtedness of households in their economy. In other words, no matter how much the Euro area leadership talks about the US being the cause of the current crisis, data simply shows that the US - despite all its problems - has had far less of a bubble in overall debt terms than Euro area. The only reasons Germany does not figure amongst the countries with the weakest households are:

1. Germany's exports oriented economy which in effect is a 'beggar thy neighbor' economy reliant on someone else assuming credit to buy German goods; and
2. Germany's costly reunification coupled with poor demographics, which assured that over the last 20 years German consumers had virtually no improvements in their standards of living.

But in assuming all this debt, were Euro area households buying productive assets (as opposed to the Americans, who, per our Europhiles' assertions were all playing a property Ponzi game)?
Oops. Not exactly. While Americans were buying homes (fueling their own bubble), Europeans were buying... homes and public sector spending goodies. But may be, just may be, Euro area members were more prudent in buying homes than the Americans, who stand accused of causing the financial crisis of 2007-2009?
It turns out that this was simply not true. Chart above shows just how far more leveraged were the Euro area states compared to the US in terms of two main parameters of house prices sustainability.

And the same is true for overall asset valuations.
Oh, and those prudent lenders - the Germans and the rest of the Euro pack banks?
It turns out the US banks were actually much better off throughout the bubble formation period in terms of their lending and profitability than... hmmm... Germany and Belgium. Who could have known, judging by Mrs Merkel's hawkish statements as of late?

Now, take a look at the total external indebtedness of the Euro area... Recall, the US and Euroarea both have relatively similar GDP...
So suppose the EU Commission issues common bonds (and assume it places them in the market) to underpin PIIGS plus Belgium, the Netherlands and Austria - the sickest puppies of the Euro area. That would require bonds issuance to the tune of 20-30% of these countries outstanding public debt. Which means that the unified bond issuance volumes will be in the region of USD1 trillion, pushing Eurozone's combined indebtedness to over USD25 trillion. Does anyone really think this is a 'solution' to contagion or a surrender?

Economics 09/05/2010: What sort of EU leadership?.. Part 1

Prepare to be afraid, ye the financial markets – those always-on-time and forever-effective super leaders of the Eurozone have concocted a Plan. A Plan to deal once and for all with the frightening levels of their own governments’ insolvency. A Plan code-named Bondzkrieg!

The troops of illiquid and insolvent PIIGS will be backed by the armies of the liquid, but pretty much nearly as insolvent the rest of EU. The attack, commencing possibly as early as on Monday next will be a two-pronged strategy: a pincers manoeuvre.

Part 1 will, per latest reports from the EU16 summit, require an issuance of Euro Commission Bonds. These will be backed by the EU16 states’ guarantees and something that is called ‘an implicit ECB guarantee’. Sounds terrifying, folks:

1. What is exactly an ‘implicit ECB guarantee’? A sort of ‘we might print mucho Euro notes, should Brussels default’ stuff? What kind of nonsense is this? The best the ECB can do is promise to monetize the EU Common bond in the same way it monetizes Greek junk bonds. Yet, the latter has not stopped contagion, only accelerated it by undermining the ECB credibility.
2. What will back these Common bonds? The solvency of the EU nations guaranteeing them? But wait – isn’t the problem the EU is facing is precisely the very lack of solvency? How is it going to work then? A severely indebted and deficit ridden pack of nations issues new debt to cover up the old debt problems? Well, that did work for the Russian Government a miracle back in 1998. Without actually resolving the problem of excessive and long-running deficits, and without either restructuring (default) or deflating (devaluation which is a de facto default) the existent pile of debt, the new EU-wide bond issue will simply transfer Greek-style problems of the PIIGS to the rest of EU. Given that we are talking about roughly a €1 trillion worth of junk, the entire pyramid scheme concocted by the EU is going to collapse unless Germany is good for underwriting the entire EU16 with its economic might. Trouble is – Germany can’t. It has little prospect of growth and its’ current economy simply cannot carry the burden of the rest of EU16 obligations.
3. What will be the seniority of these bonds? If the new bond is subordinated to the existent state bonds (as implied by a ‘guarantee’ proviso), these bonds will have no meaning. If it will be senior to existent member states’ debt, then issuing them to pay down sovereign debt will be equal to deflating seniority of sovereign issues already outstanding. Which, in common English, is called defaulting on existent debt.
4. How can these bonds be priced? Normally a bond is priced by a combination of factors. Some are exogenous – such as global liquidity and portfolio driven demand. Some are endogenous – such as analysis of what the sovereign deficit is for the issuer, what debt burden the issuer is paying and what prospects for economic growth (and other components of future default probability) does a sovereign face. Finally, expected Forex positions for sovereign currency in which the bond is denominated are taken into account. Care to guess what any of these endogenous variables might be for the EU16? Right – they are totally meaningless. Will EU bond be written against EU own debt (which is nil) or against guarantors’ debt (sovereigns already overloaded with debt)? Will the Forex rates relate to the ECB rate which the ‘sovereign’ issuing the bonds (the EU Commission) cannot control (due to ECB independence)? Will EU ability to repay these bonds rest on Euroarea economic growth? If so, what does this mean, since the EU Commission collects revenue from EU27, of which 11 member states are not a party to issuance of the bond! Will, for example, UK government assume liability to the Eurozone-issued bonds by committing its own economy to the risk of a call on the bond should, say, Belgium decide to default?

The second prong of the EU attack on the markets is the incessant blabber about the need to set up an EU-own rating agency. Here, the promised might is clearly unmatched by any sort of internal capability:

1. The EU itself cannot certify own annual accounts, despite having only in-house own auditors. Even these are refusing to sign off on EU accounts for over a decade now. How can the same institution produce a credible rating agency that will be entrusted with providing assessment of the EU credit worthiness?
2. Can the EU-imposed metrics be seriously treated as fundamental benchmarks for solvency? Give it a thought – the EU oversees a union of member states bound by own sovereign treaty to uphold the Maastricht Criteria targets. The EU has failed to enforce these in the case of Greeks, Portuguese, Spaniards, French, Italians, Belgians and so on. In other words, the EU cannot enforce its own rules, let alone police economic and fiscal performance parameters required to issue any sort of risk assessments. In fact, this year Euroarea deficit is expected to reach 6.6% of GDP and in 2011 -6.1% - way above the 3% the block set as its own rule. Debt to GDP is heading for double digits, before we add banks supports. Letting the EU run a rating agency is equivalent to letting an alcoholic run a bar!
3. The entire idea of an EU rating agency traces back to Merkel’s and Sarkozy’s desire to shift blame for the Greek (and indeed PIIGS) debacle off the shoulders of the European governments and Brussels and onto the shoulders of ‘speculators’ and the Big-3 rating agencies. Of course, the logical inconsistency of the EU attacks on the Big-3 is painfully obvious. The Big 3 are accused for failing to properly recognize and publicize risks to the systemic solvency of financial institutions in the case of ABS/MBS and so on. Yet, the minute the rating agencies actually do their jobs – as in the case of PIIGS in recent months – they are standing accused of… well… doing the jobs only to well? Can anyone have any trust in a ‘rating agency’ set up by the very people who are simply and evidently incapable of a simple logical argument?

Mrs Merkel have stated this Friday: "Those who created the excesses on the markets will be asked to pay up -- those are in part the banks, those are the hedge funds that must be regulated ... those are the short-sellers and we agreed yesterday to implement this more quickly in Europe." Obviously, over a decade of fiscal recklessness across the PIIGS was never a problem for Mrs Merkel. And she is supposed to be the reasonable one?

All I can say, folks, forget any hope for growth in Europe with this sort of leadership.

Economics 27/04/2010: Greece - the end is tragic!

2-year yields close of today:
EU = 0.7%
Ireland = 3.6%
Portugal=4.8%
Greece = 16.4%
This is it, folks. No where else to run. Greek interest on public debt would swallow over 19 percent of their GDP annually!

Clearly, Ireland should do what Greece did, according to the folks at Tasc, the Irish Times and in the Siptu building. Ramp up borrowing to stimulate economy...

Economics 23/04/2010: As Greece crashes, Finns are talking gibberish

Sometimes, it is wise for policymakers not to speak to the media. This is usually true when the policymakers have no idea what they are talking about. Case in point – FT’s story (here) about the Finnish PM backing German plan for a new treaty on tougher fiscal deficit and debt measures for the Euro area.

“Finland is sympathetic to controversial German proposals for a fresh European Union treaty if necessary to enforce fiscal and economic discipline in the eurozone after the Greek debt crisis.” Mr Vanhanen, PM of Finland, said “the priority should be to look for ways to tighten rules within the existing treaty, including the withdrawal of EU structural funds from countries that ignore official warnings from Brussels over excessive budget deficits”.

So far, so good.

Per FT, “his comments came amid the most serious crisis in the euro’s 11-year history, with Greece on the brink of a bail-out from the IMF and fellow eurozone countries. “Greek debt is not so big but there is a domino threat so we need to isolate the problem as early as possible,” said Mr Vanhanen” (italics are mine, of course).

Oops! Did he really say that? At 117% of GDP at the end of 2009, and pushing toward 130% by the end of this year, Greek debt is ‘REALLY BIG’, folks. This is precisely why Greek bonds are trading now at the yields close to those of junk-rated Pakistan!

Mr Vanhanen “insisted the crisis must not be allowed to disrupt plans by Estonia to join the euro next January and said the eurozone must keep its doors open to aspirant members.” Why not? He warned that “any delay would “send totally the wrong message” to other aspirant members, such as Latvia and Lithuania, which are making tough budget cuts and other reforms to keep alive hopes of euro entry.”

So hold on, Mr Vanhanen. You say that these countries are undertaking reforms only in order to comply with the euro entry rules, not because these are the right things to do? What hope do we, the Eurozone taxpayers, have that once admitted into the club these countries will not turn Greek? None, certainly, judging by Mr Vanhanen remark.

My humble advice – if you are a politician with no expertise in economics or finance, don’t give interviews.

Economics 16/04/2010: The incoming train II

It is a good feeling to be ahead of the curve, especially when the curve is drawn by the likes of FT. Per today's FT Deutschland report: the ECB is warning about a new crisis, a return of global imbalances in the coming years. In its monthly report the ECB warns: “At the current juncture, global imbalances continue to pose a key risk to global macroeconomic and financial stability . . . The stakes are high to prevent a disorderly adjustment in the future that would be costly to all economies.” Jurgen Stark is predicting that we have entered a new stage in the financial crisis – a sovereign debt crisis which means that “dealing with [the resulting severe macroeconomic imbalances] will represent one of the most daunting challenges for policymakers in modern history.”

My own take on the same topic was published here.

Another issue, also raised repeatedly on this blog, is discussed in Joachim Fels' (Morgan Stanley) piece on FT Alphaville (here). Fels makes a claim that countries with a high degree of inflation aversion (Germany) might have an incentive to quit. Fels suggests three warning points for the crisis to develop:

• First, any signs of moral hazard emerging in the fiscal policies in the euro area
• Second, ECB failure to raise interest rates on time to cut inflationary pressures, and
  
• Third, the political pressure rising against the Euro in Germany.

Hell, by these metrics, we are already in the midst of the euro collapse by 2 out of three measures (first and third). Alas, the second metric is a bogus one. There is plenty of evidence to show that ECB has not been an 'inflation hawk', acting often pro-cyclically before and targeting the likes of PMIs instead of hard inflation and monetary parameters. So the real question here is: What's the potential trigger for an exit?

Greece asking for the pledged money won't do. If you think in terms of game theory, once that happens in earnest (and it might be today or over the weekend), Germany will face the following two options:

1. Grant request for assistance in full and thus pre-commit itself to the common currency at the sunken cost of an exit of ca 10-12 billion euro that it will commit to Greek deficits financing;
2. Exit now, saving the aforementioned money, but destroying its political capital within the EU.

The problem is that the net cost of (1) is much smaller than the net cost of (2). And this means there has to be another - non-Greek - trigger. Italy or Spain?

Economics 15/04/2010: Greece problems back to the frontline

So, as I have predicted in the interview with BBC World Service (excerpt here), the markets have little faith in the Greeks and, indeed, in the EU’s ability to effectively underwrite Greek crisis.

Greek bond yields are now rising again on the investors’ view that German, French and Irish legislators might veto the deal. And in Germany there is a growing movement to challenge the Greek deal in a constitutional court, as being an illegal subsidy. The yield on Greek two-year bonds jumped 66bps yesterday reaching 6.99% and 5-year CDS rose 56bps to 436bps.

And FT’s Daniel Gros argues that the EU package is unlikely to solve anything, as the country needs about €30-50bn annually, depending on the future deficits path assumptions. Either way, 3-year package of up to €45bn won’t cut it. And the interest bill savings are also too thin – under the EU proposed deal, Greece will be facing an interest rate of ca 5%, which will provide the country with only €900mln in annual savings relative to market rates. Going lower to 4% - something opposed by Germany – will raise savings to ca €1,350 million per annum – still short of what is needed. Per Gros: the Greek problem is not one of liquidity but of insolvency.

And the IMF is severely constrained in what it can do in Greece by the fact that it can only lend 10-12 times the reserves position that Greece holds with IMF. And this means, at a maximum €15 billion.

So here we go – for all who thought the story is over, the most likely thing is that the actual story is just beginning.

Economics 05.03.2010: Greeks are paying the price

So you've heard by now that Greece 'escaped' the wrath of the market yesterday by placing €5bn worth of 10-year bonds. But don't be fooled - Greek's escape was nothing more than a respite: Greek taxpayers are now on the hook for paying a 6.3% yield on the 10-year paper - in line with near junk status of the bonds. This marks the highest spread for Greek debt since 2001.

Despite the issue being covered at 3x, there is a possibility for prices to tumble in the secondary markets (as happened with their 5-year paper last month) and there is an added concern that demand was underpinned by speculative investors with short-term horizons, as 'hold-to-maturity' types of investors (e.g insurance companies and pension funds) are cutting back on their holdings of PIIGS bonds. If the latter is true, then we can expect a serious pressure on yields to emerge in the next few days, with subsequent noises from the EU authorities about 'speculators' profiteering.

Big - albeit artificial - test for the euro will be March 16th when the EU Commission will rule on Greek fiscal consolidation plans. Expect approval, enthused speeches, and backroom talks on how to proceed forward with the country that

• plans to cut 2% of its GDP-worth off the deficit this year, but
  
• is unlikely to deliver on this target, whilst
• needing to cut a whooping double the planned amount just to stay afloat toward the 3% deficit goal for 2014-2015.
  

Meanwhile, Jean Claude Trichet went out of his way yesterday to tell the Greeks not to invite the IMF. During his press conference, Trichet repeatedly stressed that Europe has its own safety net for defaulting states (well, not quite in these terms) so no need to call in the big boys from the IMF. One wonders, what is Mr Trichet talking about. Papers quote Trichet saying that it is absurd to envisage scenarios of Greek exit from the euro.

All of this resembles the debates in the Afghan government in 1979 - to invite the Soviets or not... And the really, really, really funny thing is - IMF is EU-led organization (of the two supernationals: the World Bank is traditionally reserved as the leadership game for the Americans, while the IMF leadership goes to the EU appointees). While the Greek taxpayers are now set to pay over ten years €184.22 per each €100 borrowed last night - a steep price for not calling in 'Your Own Bad Guys' from Washington.

Now, put the Greek pricing into a perspective. On 14 January 2010 the NTMA issued €5 billion of a new bond, the 5% Treasury Bond 2020. If Irish debt was priced at Greek yields, the total cost to Irish taxpayer from this deficit financing would have risen €21.33 from €62.89 per €100 borrowed. In other words, our expected annual deficit for 2010 alone would be some €4,050 million more expensive over 10 years.

Economics 24/02/2010: Greeks, Germany and the euro

There is a fine mess going on in Athens. And it is both

• detrimental to the Euro; and
• predictable (see here).

Exactly a month ago to date, I have predicted that Greece is going into a Mexican standoff with EU. We now arrived at exactly this eventuality (see this link to a good summary of Greek Government views - hat tip to Patrick).

Back on January 24th, I wrote:

"The EU can give Greece a loan – via ECB... But the EU will have to impose severe restrictions on Greek fiscal policy in order to discourage other potential would-be-defaulters today and in the future. That won’t work – the Greeks will take the money and will do nothing to adhere to the conditions, for there is no claw back in such a rescue.

Alternatively, the EU might commit ECB to finance existent Greek debt on an annual basis. This will allow some policing mechanism, in theory. If Greeks default on their deficit obligations, they get no interest repayment by ECB in that year. ...but what happens if the Greeks for political reasons default on their side of the bargain?

If ECB enforces the agreement and stop repayment of interest, we are back to square one, where Greece is once again insolvent and its insolvency threatens the Euro existence. Who’s holding the trump card here? Why, of course – the Greeks. And, should the ECB play chicken with Greeks on that front, the cost of financing Greek bonds will rise stratospherically, and that will, of course, hit the ECB as the payee of their interest bill.

Thus, in effect, we are now in a Mexican standoff. The Greeks are dancing around the issue and promising to do something about it. The EU is brandishing threats and tough diplomacy. And the problem is still there."

There are three possible outcomes from the standoff:

• Greece backs down and Germany accepts an apology - which pushes us back to square one, with Greeks still in the need of funds and EU still without a plan;
• Greece goes for the broke and remains within the euro, implying a rapid and deep (ca 30%) devaluation of the euro; or
• Greece is forced out of the euro (there is, of course, no mechanism for such an action).

The first option is a delay in the inevitable; the last one is an impossible dream for fiscally conservative member states. Which leaves us only with the second option.

And incidentally, the only reason German bunds are still at reasonably low yields is because Germany is linked to Greece (and other PIIGS) only via common currency. Imagine what yields the German bunds might be at if a full political union was in place?

This, of course, flies in the face of all those who preach political federation as EU's answer to structural problem of hinging desperately diverse economies to common currency.

So hold on to your pockets - after the Exchequer raided through them via higher taxes; Greek default will prob their depths through devaluation. And then you'll still be on the hook for our banks claiming their share in an exercise of rebuilding their margins.

Economics 20/02/2010: Greeks ahead

Want to understand the extent to which politicians and the public sector workers are failing to understand the fundamental principles of the markets? Look no further than Greek debt issue looming on the horizon.

Some background first. Less than a month ago, Greece put on the market an €8 billion 5-year bond package at a 6.1% interest rate. Seemingly, it was able to attract initial interest of investors - the early bidders were keen on taking high yield paper. Of course, the country bond issuers had no idea why institutional investors had sudden interest in Greek bonds. And this led to a bottleneck emerging in later days of the placement.

Institutional investors, especially diversified portfolio managers, might want a bond for its default risk-adjusted returns. This hardly constitutes a significant proportion of the demand for Greek bonds in recent months. Alternatively, they might down-weight the consideration of the default risk and use the bond purchase to simultaneously hedge their FX exposure elsewhere and earn high returns. It is the second component of the market that drives most of the demand for Greek bonds, aka portfolio management side of demand. This second source of demand is by its nature extremely shallow – there are fewer investors in this complex hedging space and those that are in it have many alternative (to Greek bonds) strategies available to them. It does, of course, help the Greek bond issuers’ cause that their yields are the highest in the Eurozone, making their bonds a solid target for single risk hedging on FX side. But it does not help them that the Euro is at risk of substantial devaluation going forward against the dollar and sterling.

In short, the demand for Greek bonds is not fundamentally driven (i.e not based on pure default risk v yield analysis). Adding insult to the injury, if one should rationally anticipate that Euro is going to continue falling against the dollar in the current scenario of contagion from Greece to the rest of PIIGS, then less faint-hearted amongst us might want to take a short position against the Euro. This can be done by not hedging existent non-Euro exposures. The effect of such implicit shorting is to further reduce demand for Greek paper. The folks at the Greek Treasury have missed these simple points. Thus, the aforementioned issue was simply too large for the markets and failed to sustain prices achieved on placement – within just two days after the issue, price fell 3.5%.

Which brings us to the next week – it is expected that the Greeks will be at the markets again, this time with a €5 billion of new 10-year paper. Even to have a go, the Greeks will have to push spreads on their paper over the German bund to a stratospheric height. Currently – 10-year Greek bonds are yielding 6.5%, up from 5.8% back in the end of December 2009 and 1.5 percentage points above their levels in November 2009. But this will have to rise. 7% anyone? Possible.

Short positions in Greek bonds are also signaling that the demand for new issue will be weak. Shorts in Greek bonds have risen to 9.82% up 0.24 percentage points in the first two weeks of February and 1.58 percentage points relative to the end of December 2009. But now they are being closed off. Closing the short means that demand for bonds rises, artificially, in the market – as bonds are being withdrawn for a return to the lender. But this demand is not about market appetite for bonds. Instead it is about a technical need for a re-purchase. With this demand pathway becoming more exhausted in recent days, there will be added pressure on new bond pricing – another aspect of the market the Greeks seemingly do not take into account.

But politicians and their public servants, ignorant as they may be of the markets, might have something else on their minds. Greek’s reckless and silly issuance patterns are driven by more than markets considerations. They are driven by gargantuan deficits and debt overhang – with €20 billion of maturing debt that needs to be rolled over around April this year alone - and the willingness of the Greek Government to sacrifice its own taxpayers (remember – higher yields mean higher cost of borrowing, to be carried by the future taxpayers) in order to force the EU to bailout the country. This strategy, similar to the game of chicken in which both participants hold equivalently credible threats, but one faces asymmetrically higher costs in the case of ‘no bailout’ outcome) is something that the EU leaders themselves do not seem to comprehend.

While the EU is sitting on its hands and issuing conflicting and irresolute statements on the matter, the Greeks are heading straight into a fiasco, should they fail to place new bonds at yields proximate enough to the current 6.5%. At the same time, failure to place this issue will push the Greeks even closer to a direct default on debt, imposing even more pressure on the EU to urgently deal with the matter.

If the EU fails to bail out the Greeks on this round, the Euro will be equivalent to the Titanic grinding against the iceberg. The Greeks will always have an option to walk away from the common currency and default outright – the consequences will be tough, but more palatable than the ones which will hit the country should it go down alongside the Euro. First move advantage is real in the game of chicken.

Economics 12/02/2010: Crisis pressures in broader debt markets

And so the Greek saga continues, with yesterday’s announcement that the EU has a worked-out rescue package for the country now turning out to be yet another wishful thinking piece of poorly prepared PR. No package details, and the markets are not impressed.

But forget Greece for a moment. The good news is that just as in Autumn 2008, the last couple of months have been the case of “bad news = good news”. The markets have finally started to turn their attention to the completely reckless ways in which majority of Governments around the world have been managing their finances, both before the crisis and during it.

The new line of fire is now directed at Turkey and Japan.

Japan, pushing for well over 200% of GDP ratio of debt is in a league of its own. And the current Government is hell-bent on raising the debt limits higher with aggressive spending targets and Napoleonic plans for shifting even more public expenditure into largely unproductive investment (for a country with already extensive public capital stock, the diminishing marginal returns on new public investment have set in some time ago). Debt ratio to working age population is now well above USD100,000 and is rising at accelerating pace. Savings rate has fallen to below 4% while the fiscal deficits are now much higher than they were back in the days when the savings rate was around 18%. Current account balance has declined from the peak of 5% in 2007 to under 1.5% today and is set to fall further. With these dynamics in mind, Japan is going to account for roughly 11% of the total global expected issuance of new bonds in 2010.

Turkey is a serious basket case, although it might not appear to be such from the simple debt levels comparisons. Like Ireland, Turkey has low debt to GDP ratio (45% as opposed to Greece with 113%, Portugal with 77%, Spain with 54%), It is in line with Ireland current 46.2% debt levels (although in Ireland’s case, a GNP base would work much better, bringing out true public debt to a much more formidable 57% of GNP). But it is not the level of debt that is worrisome. The awesome rate of debt increase, along with hidden debts that the public sector underwrites are the real concerns here.

An interesting chart from Turkey Data Monitor:
shows just how bad Turkish debt dynamics are. In the environment where it is currently yielding over 8% with an average maturity being around 2 years, the problem for Turkey is the following:

• Can a country with history of past debt problems and rising deficits really roll-over some USD125 billion worth of debt? and
• Can such a country do this in the environment where worldwide, national governments are expected to issue some USD4.5 trillion worth of bonds in 2010 - three times the normal volume of global debt issuance?

Now, think of it this way – Turkey debt is held by domestic banks (roughly 60%) and the remainder – by foreigners. This, normally, presents the point of stability. Alas, if the banks are not operating in the liquidity saturated markets for funding (and they are clearly not doing so) the Turkish Government cannot default on the debt without risking destabilizing its banking system. And if it does destabilize the banks, the Government ‘solution’ to default will imply demand for massive banks rescue package, adding further to the debt mountain. In other words, unlike with other countries that have heavier exposures to international lenders, Turkey simply must refinance the roll-over debt.

So dynamics matter. And they matter for Ireland. Which got me thinking – just how bad is our debt position going to get and what costs will this impose on the economy. Here are few charts:
Start with gross debt as percentage of GDP and GNP. Above chart shows figures for the official debt estimates from Stability Plan Update, December 2009, issued by the Department of Finance. Additional lines show the ratio of debt to GNP and also extension of debt figures to include Nama's €59 billion allocation, plus expected €12 billion in post-Nama capital injections into the banks. Finally, the last line shows the above, accounting for a lower growth rate in GNP scenario than the one forecast by the DofF for 2012-2014 period. The important issue here is that our debt to GNP (the real measure of our economy) is going to breach 100% even under DofF own rosy assumptions.

Next, consider the growth rate in our debt:
Pretty dramatic, especially when you compare the rate of growth in 2009-2012 against the tiny rates of decline predicted for 2013-2014. The rates of decline in fact will be about half the rate of interest we will be paying on this debt.

So expect no respite in terms of the cost of debt financing in sight:
The above are pretty big annual numbers - up to €14 billion going to feed the debt monster annually! Crazy stuff for an economy worth around €130 billion in terms of its GNP. Alternatively, €14 billion is roughly 30% of the total Government expenditure that this country can afford if we were to stay on structurally balanced fiscal path!

And thus, cost of debt financing as percentage of our economy is going to be excruciating - up to 9.5% of the annual economic output at the peak (under the most pessimistic scenario). Which means the total cost of the current fiscal crisis is also going to be astronomical:
By the end of 2014, thus, we are looking to have wasted between €50 billion and €80 billion in total on sustaining that which is simply unsustainable - our gargantuan public sector overspending.


Incidentally, this pretty much explains why I do not believe that marginal reforms of the public sector, such as 'productivity improvements', 'reduced spending on external consultants' and 'staff re-allocations' will be enough to address the issue. In real world we inhabit, we need a massive cut in terms of overall spending on public sector and this can only be achieved by slashing numbers employed in the public sector and cutting pensions and wage expenditure on the remaining staff.


PS 1: given chronic lack of skills, aptitude and capabilities present in many areas of the public sector, an idea of using internal expertise to reduce reliance on external consultants advice and expertise, while hoping for improved efficiency is simply absurd.


PS2: A year ago, myself and Brian Lucey wrote an article for the Irish Times about the massive debt overhang in the Irish economy. Using IMF statistics we established that Irish economy stands out as the second most indebted economy in the world in terms of ratio of debts to GDP, the most indebted economy in the world when it comes to applying our real measure of economic activity - GNP, and one of the most indebted economies in absolute terms.

In response to the article, we were told by the Irish officials that 'total debts do not matter, only public debt does'.

In the real world, total debts of economy do matter because they show structural composition of economy itself, revealing the extent to which economic growth is being financed by reckless borrowing.

This month, Hayman Advisors weighted in on our side:
The above debts cover public debt, plus 5 top banks per country, with Iceland figure showing pre-crisis conditions. Forbes magazine reproduced this chart in their cover story for February 8 edition with a tag line saying "It's the Total Debt, Stupid".

I agree.

Economics 05/02/2010: Prepare for a new slide

Fasten your seat belts and prepare for a new round of bad news. Globally this time around.

All data for January-February is showing that the pressures of jobless recoveries around the world, coupled with continued weaknesses in financial sector and money supply (despite unprecedented stimulus deployment and helicopter drops - more like blanket bombings - of liquidity) are over-powering the weak positive momentum in growth.


December retail season was, officially, a disappointment – down 1.6% on 2008 season across the euro area. The headline Eurozone Manufacturing PMI reached 52.4 in January, highest reading for two years. The index stood at 51.6 in December, so the rise was marginal.

There were noticeable disparities in performance between national manufacturing economies. Countries reporting an increase in output were Germany, France, Italy, Austria and the Netherlands. All improved on December. Spain, Ireland and Greece all recorded lower output and faster rates of contraction.

Sector data indicated that capital and intermediate goods fared best in January. Growth consumer goods production is falling below that achieved in the previous month.

Growth of new orders was the strongest since June 2007 and faster than the earlier flash estimate. The gain in the index between its flash and final releases was the greatest since flash PMI data were first compiled at the start of 2006. New export orders rose at an above flash estimate pace that was the quickest since August 2007. See Ireland PMI in my Sunday Times article this week.

Despite rise in core PMI, manufacturing continued to shed jobs during January, across the Eurozone.

Core retail sales (ex-motors) in Germany were weaker in November than previously reported (down 1.7% mom) but rose 0.8% mom in December. Car sales are down 40% quarter on quarter –driven by the end of the scrappage scheme. Which, of course, shows that Irish experiment with temporary programmes of subsidies is unlikely to work. Interestingly, in Germany, scrappage scheme has benefited primarily foreign manufacturers. Of course, the reason for this is that German car makers are primarily at the top of the price proposition distribution and in a recession, subsidy or none, they will suffer. Foreign care makers sales rose 26% in December and 38% in January, before the scrappage scheme shut down. Domestic car sales were flat.

Sign of troubles ahead for exports growth – German manufacturing orders are down 2.3% in December while output contracted 2.6%.

Greece and Portugal are clearly in the news flow. Both have no market credibility when it comes to their deficits. And the reports from the ground are even worse with virtually all vox-pop reporting suggesting that populations of both countries are in deep denial of the reality. People are talking about ‘fat cat managers earning hundreds of thousand euros’ while ‘ordinary people are suffering’. Long legacy of communist and socialist politics in both countries is clearly evident in the popular unwillingness to face the music.

The next points of pressure will be Ireland and Spain.

On Ireland’s fiscal position and PMIs – read my Sunday Times article this weekend.

On Spain: the country is about 3 times bigger in economic terms than Greece and Portugal – accounting for roughly 11.8% of the euro area GDP. Troubles here will be a much bigger problem for the Eurozone than all the rest of the PIIGS (less Italy) combined. Meanwhile, Spain’s unemployment is rising (just as Ireland's), adding some 125,000 to the dole counts in January. 19% of Spaniards are now officially unemployed, as opposed to Ireland’s 12.7%. In terms of hidden unemployment, Spains problems are also much tougher than Ireland’s especially since grey markets for construction workers which sustained unofficial employment during the boom are now shut in Spain.


Credit is still tight in the euro area and the FX valuations are still around $/€1.36 – way too high for an exports recovery.

It is now painfully clear that the only thing that can resolve euro area’s problem would be a massive one-off emission of liquidity directly into the government budgets. To do this, the ECB can set a target of, say, €1,000 per capita for the eurozone economies, disbursed to each country based on their population. Anything else simply won’t do.

But even such a measure will not provide sufficient support for Greece, Portugal, Ireland and Spain – only a temporary reprieve.


UK’s economy is also in stagnation pattern with full-time employment still falling, individual, insolvencies up to record highs. The uptick in house prices in late 2009 is likely to have been temporary and driven by speculative ‘testing the water’ by international investors. Manufacturing PMI is up robustly January to 56.7, its highest level since October 1994, and from 54.6 in December. The increase was driven by new orders, which rose at the fastest pace in six years, as well as companies' efforts to clear backlogs of existent orders. It remains to be seen if this pace of improvements is sustainable. Services sector PMI meanwhile contracted rapidly from 56.8 in December to 54.5 in January, marking the slowest activity in five months.

Here is a little fact to put things into perspective – manufacturing accounts for less than 20% of the UK economy, while services account for 76%.


Overall, this recovery is coming along with more stress and strain on the labour markets. All global indicators are now appearing to have peaked back in Q4 2009, with the new year starting on downward trajectory. Inventory cuts passed in previous quarters are now being worked out and there is little sign this process will be picked up by a structural increase in new orders. All in, jobs growth is now severely lagging that achieved in the end of the previous recessions. In this environment, growth favours the US where jobs cuts were much more significant and early, allowing firms to rebuild their margins before the onset of any demand improvements. Eurozone is, in contrast, toast. Indicative of this is the volume of global trade – with Baltic Dry Goods index down to 2704 today as contrasted by 3335 reading 3 months ago.


Strategically – I would short Europe as an index, but look for low cost medium margin operations for a long position.