Europe.......the saga goes on!

Following up on from earlier in the week the press reports that the EU (not just the eurozone countries), but all 27 member states will agree to a stabilization fund to help weaker members in dire straits. 

So far so good, I suggested the ECB buying Greek, Portuguese, Spanish and Irish debt in the open market in significant size, however unappealing that may be, was the only solution to stop the rot right now. Having the EU guarantee issuance of bonds jointly and severally to then use the proceeds of buying up the debt of the weaker nations a huge spreads - Greece 10yrs at bunds +1000 - would work equally as well, it might not even have the QE stigma, which is probably a good thing.

Here is the rub - the proposed size of €60 bill reported on Bloomberg et al - if that is to be believed, at first glance I thought there was a ‘0’ missing, is completely and utterly insufficient. Have they learnt nothing from the last week’s reaction to the Greek bail-out package? As a €110 bill was deemed insufficient for Greece, why does anyone think that€60 bill will make any difference whatsoever?

If that is indeed what they come up with tonight - press conference to be scheduled at 6pm - then my suggestion is that the € will make new lows against the dollar and the yen and European stock markets will get hammered as well as the club med bond spreads and CDS making new highs.

Having read this month’s GMI which has a great deal of coverage of the Spanish situation (the author lives in Spain) the Spanish housing problem alone could use the €60 bill to bail out the Spanish lenders with them still asking for more. This analysis is my own but as the Spanish banks are not realizing any losses on 1 million empty units, just offering them at the old prices as they cannot afford to take the losses, when repossessed and continuing to keep developers alive that should be foreclosed as in not to show even more property on their own books. A quick back-of the-envelope calculation: 1 mill empty houses and flats at a conservative average valuation of €200,000 mortgaged at 80% or €160,000 with a value of €100,000 (no-one is even looking at property with 30% off so 50% should be the start of getting anyone interested) would equate to a loss of €60,000 per unit or - wait for it - €60 bill. Maybe that’s how they came up with the number? I know some of these properties are owned without mortgages, others are mortgaged less, but probably others are mortgaged more and some developments are completely worthless as they have been constructed without proper building permission and will be bulldozed and the land will be worthless as it will not have planning permission and probably not get it. So as it was a back-of-an-envelope calculation it may not be entirely accurate, but it gives you an idea of the size of the problem. Oh yes, I almost forgot: Spain is out of recession with positive growth of +0.1% in Q1.

What about the UK? With a budget deficit higher than any other larger nation and no government - I know the old team is still warming the seats for whoever may be taking over and that Alistair Darling is in Bruxelles today with the other EU finance ministers discussing the above mentioned bail out fund, but he has no real mandate without speaking to George Osborne and Vince Cable. Is the UK going to be the next in line for some real punishment? Well, if there is no deal between the Conservatives and the LibDems in the next day or two, then I would say that chances are we’ll see gilt spreads (against bunds) already at the highest since 1998 go higher, sterling will get pummeled against the dollar, the yen and the swissie.......

It looks like it could be a fun week!!!!

Europe

What a mess - this is the result you get after a €110 billion bail-out of Greece? 3 days later we are 5 big figures lower in €/$ (after the pop on Sunday night following the bail-out). Greek and Portuguese CDS spreads are hitting all-time highs, Spain’s prime minister is calling it madness that his country could be compared to Greece........!

Sadly the first casualties of the demonstrations in Greece have been incurred with 3 dead in Athens - and it does not look like it is about to stop.

Martin Wolf has a great piece in the FT today explaining both why Greece has no real option but to accept the austerity measures required, because the alternative is even worse, in at least the short term, but also that he doesn’t believe it will ultimately work.

The German professors are launching their lawsuit against German participation in the bail-out of Greece on Friday - the outcome from the constitutional court is always uncertain - so there is also plenty of political risk.

While Rome is burning politicians are arguing, thinking they have all the time in the world - they obviously didn’t learn a thing from having dithered all through Q1 with the Greek aid package, which may have been capped at €30 billion had the money been available immediately. Now even €110 billion is not enough and Portugal looks increasingly like they will also be in need of a bail-out. 

Even more interesting is reading that Portugal, Ireland, Italy and Spain are all contributing, and not in small amounts, Italy has been out announcing that their potential €15 billion commitment would not be financed through new issuance of BTPS, but rather drawn at the treasury - if they could just print the money I’m sure they would, which brings me to the point that the only thing that could stop the fire right now is a massive QE program from the ECB, focused on the countries in need of support i.e. The PIIGS. 

When it is obvious that the bail-out package only last so long and the country in question is effectively shut out of the capital markets (Greek 2 year debt at 15%) - the purchase of these bonds by the ECB would help in more ways than one, but it won’t happen any time soon, as the ECB doesn’t like the idea and the Germans probably like it even less......so wait and maybe the program will have to be €500 bill instead of lets say €250 bill today. 

It doesn’t pay to wait!!!!!!!

The € would take a bath, not that it isn’t already, but maybe it would help the European economies to have €/$ back to parity or even below. The ‘fantastic’ German retail sales -2.6% y/y and new car sales -32% y/y could surely do with being more competitive in the rest of the world, even if everyone is looking for an export led recovery.

However, a double-dip looks more and more likely - something that historians of the future will have field day analyzing and dissecting the causes of - political error?

Stupidity....

Anyone who has ever watched the Fed Chairman or the Treasury Secretary give testimony to congress and answer questions, in particularly once the chairman and vice-chairman of the committee have yielded to some of the other members and cringed at the ignorance, if not outright stupidity will find the following very funny, if not outright scary.

In particular notice that the writer does not know the difference between the sexes (or perhaps Mary is a boy's name where he comes from?), nor the difference between the Oracle of Omaha and Jimmy Buffet the musician (as far as I know they are not related)...

The letter is courtesy of Macro Man's blog today!

Mary L. Schapiro, Esq. 

Chairman Securities and Exchange Commission 

100 F Street, NE Washington, DC 20549 

rule-comments@sec.gov

VIA EMAIL Re: File No. S7-08-09

Chairman Schapiro:

April 20, 2009

On behalf of the great silent majority of American investors, I must point out that none of your proposals to reinstate the “uptick rule” goes far enough toward ensuring a perpetual rise in stock prices. Rather than tinkering with ad hoc half-measures, the SEC should be proposing the only practical, efficient and final solution to market volatility: a ban on stock selling altogether. A review of six time-honored truths makes this solution self-evident:

Truth #1: Stock Market Crashes Are Caused By Stock Sales.

It should be painfully obvious by now that the market’s decline since November 2007 was caused by stock selling. Not even pernicious speculators like George Soros would dispute this basic truth. Similarly, the market’s steep fall after several large bank failures and the deepening of the economic crisis in September 2008 also was the result of stock selling. We can safely conclude, therefore, that had stock sales been banned in 2007 the stock market crash of 2008-2009 never would have happened. Logically, it follows that banning stock sales would also prevent future market crashes.

Truth # 2: True Investors Buy And Hold. Forever.

Equities markets were never intended to be casinos where gamblers make wagers on or against a particular outcome. They are the mechanism for long-term investors to provide the capital that investment banks and brokerage firms need to grow profits. The only justifiable investment strategy from a policy standpoint, and the only strategy that any right-minded investor — as opposed to speculator — would employ, is the tried and true “buy and hold” strategy. Speculators trade; investors buy stocks and maintain them in their portfolios in perpetuity. As the Oracle of Omaha, Jimmy Buffett, has famously declared, an investor’s time horizon should be “forever.” Thus, there is no legitimate reason for an investor ever to sell a stock.Truth # 3: “Buy And Hold” Guarantees An Ever-Rising Market.

A large and growing part of individual Americans’ wealth is composed of equities. If all investors were simply required to adhere to the “buy and hold” strategy as they should, the market would rise without the interruption of “corrections” and bear markets. As all buyers hold, and new entrants buy, stock prices would move upward in a linear trajectory. Extensive research studies by large brokerage firms have proven that, over time, stock prices rise. For example, an investor who had bought the Dow Jones Industrial Average in 1932, when it was at 50, and sold it in November 2007, when it was over 14,000, would have realized a gain of approximately 28,000% — an annualized return of over 370%. A ban on stock sales would ensure an ever-rising stock market and thus greater wealth and prosperity for all Americans. Stock sellers, by contrast, are interfering with the market’s natural tendency to ascend.

Truth # 4: A Rising Market Makes People Happy.

Studies have demonstrated a marked correlation between the level of the Dow, on the one hand, and consumer and voter sentiment, on the other. The most recent University of Michigan Survey showed improving consumer sentiment as the Dow rose sharply after the announcement of the proposed re-instatement of the uptick rule, the modification of mark-to-market accounting, and the Treasury’s plan to subsidize the sale of banks’ toxic assets with taxpayer leverage. Similarly, polls have shown that voters are often less happy when the stock market crashes. They are also less likely to re-elect incumbents, including those who appoint the heads of regulatory agencies. A rising market also pleases investment banks and other firms in the financial services industry, including those that routinely hire former heads of regulatory agencies. Enough said.

Truth # 5: The SEC’s Job Is To Stay Out Of The Market When It’s Rising And Step In To Appropriately Alter The Rules

When It’s Falling.

The SEC’s regulatory mandate in a laissez-faire economy is two-fold. When stock prices are increasing, the SEC’s role is to ignore the market and market participants, thus allowing the invisible forces of the market to work their unregulated magic. When stock prices are decreasing, however, the SEC must intervene to stanch the loss of wealth that flows from a declining market. There is nothing “artificial” about selectively modifying rules that interfere with the market’s natural upward trajectory.

Truth # 6: Stock Sellers Are Short On America.

Speculators, short-sellers, long-sellers and other suspicious elements will spuriously claim that stock sales (and even short sales) are necessary for the efficient functioning of the market, and that asymmetrical transaction rules might actually exacerbate the problem by facilitating stock market bubbles. It suffices to note that these are the same people who caused the recent stock market crash (as well as every previous stock market crash in history). They are also the ones who sold stock in the wake of the September 11th attacks, thereby profiting from the nation’s tragedy. It is no exaggeration to say that those who oppose a stock sale ban are advocating nothing less than a form of economic terrorism.

I have no doubt that, as a patriotic American, you will see through the terrorists’ chicanery and lay the groundwork for a safe and prosperous America by banning stock sales.

Benjamin N. Dover III

China in a bubble???????

I had penned a long piece about the composition of Chinese FX reserves and gone into the Corriente Advisors argument about why China is in a bubble and the RMB is over-valued, when I came across this video:

http://www.pbs.org.pov.utopia/

Nothing I could have written illustrates the argument about over-investing and the "build-it-and-they-will-come" attitude better than this. Enjoy!

PIIGS.....

With all eyes are on Greece and the EU this week and the market taking the ‘support’ being offered with a ‘show-me-the-money’ attitude i.e. general scepticism to an attitude that while not completely similar is reminiscent of the one offered by Bear Stearns CEO Allan Schwarts and Lehman CEO Dick Fuld in the weeks and months before they went out of business: There is no problem, we are fine, it’s the market speculating against us by buying CDS on our debt, it’s unfair and someone should stop them! 

These are not exact quotes, but the kind of attitude offered by ECB governors, various EU top officials etc. Very much like Allan Schwartz and Dick Fuld they refuse to admit (at least in public) that there is a real problem. Leveraged firms as well as most countries with a borrowing requirement need to find investors to buy their debt as and when it needs to be sold, which for many countries is a very regular occurrence.

The PIIGS mnaged to hide quite well in the middle of the financial crisis, as they do not have national currencies, they did not suffer ‘runs’ on their reserves, they did not have to devalue, or defend their currency pegs with extreme interest rate hikes, which would have damaged their economies even further. Now, however, they have to face up to quite hard realities as the easy way out i.e. devaluation is not available, at least not without leaving the Euro. Years of excessive pay rises and erosion of competitiveness has to be paid for. 

A complete lack of fiscal discipline, that could easily be financed in the past, is now required on a level and a scale which is truly breathtaking. 

The only comparable situation in recent memory is Sweden in the mid-nineties. They tried to hold a peg to the Euro, defending it with o/n interest rates of 500% only to in the end give up defending the currency, completely restructure the banking system, and cut interest rates. They managed to do this better than anyone had hoped for at the time. The massive devaluation  did not lead to a lot of inflation, their big industrial manufacturing base became very competitive and it was at the beginning of a new boom in growth across the world.

The currency never recovered, growing up (in Denmark) the SEK was always in the 1.10 - 1.20 DKK range, while it has recently been as low as 0.70 it is now closer to 0.83 still a long way from it’s pre 92 highs, but that has not stopped the Swedes having a full recovery and a well functioning economy. So to all of those saying you cannot devalue yourself out of problems, I say have a look at Sweden (and probably the UK in the same period).

These options are not available to the PIIGS without leaving the Euro - the alternative is an internal ‘devaluation’ which is pay cuts across the board and probably in the 15-25% range depending on how bad the country in question's problems are and how they fare on a competitive basis. Ireland  as the only country in this group has taken steps in this direction, one of the consequences is a drop in inflation of more than 6% in January 2010 on a y//y basis.

How palatable these kind os measures will be in Greece, Spain and Portugal remains to be seen - the alternative is to leave the Euro - or face that the markets may stop funding their deficits and debt roll-over.

Greece is about 2% of EU GDP and it’s debt is a bit more than 2%, so from a strictly ‘how big a cheque do I need to write’ attitude it’s not that big - the problem when you get to Spain is much more significant and not something Germany can easily afford out of petty cash. 

The Spanish troubles are in some ways very deep - the housing market is still in deflating bubble being held from imploding by banks that refuse to take their losses on more than 1 million newly constructed houses and apartments as well as the repossessed properties they are not willing to take losses on, so keep on their books or release in sales at very high prices, but with VERY attractive financing packages, in order not to have to mark down the value of the assets. 

With unemployment north of 20% and the economy having been reliant on construction and tourism to a very high degree, it’s very difficult to see how Spain can work itself out of its current mess without draconian and unpopular measures.

In the mean time the EU leadership should own up to that this is a real problem and not dismiss it as mere market  ‘speculation’ and thinking about how they can do more to stop speculation. In their minds it’s like this: when the market buys member countries debt it’s investment when the market sells the same bonds short, or buy the CDS, then it’s speculation. Somethings never change......maybe they can get Dick Fuld to advise them on how to persuade the market that it is simply wrong......and they are right?

Climate Con?

This is obviously a very hot topic just weeks before the Copenhagen Summit in which the leaders of the world  will agree on a plan of action to save the world from all sorts of disasters......!

The most interesting part of this debate is how one-sided it is and how a few have rail-roaded the entire debate away from whether Climate Change is really caused by (man-made) CO2 emissions and that EVERY politician has jumped on the band wagon.

I’m no scientist but I have read a few of the books on the subject including Tim Flannery’s book, “The Weather Makers” and “The Chilling Stars” by Henrik Svensmark and Nigel Calder to mention a few. I am also not in favour of pollution or the destruction of the planet, making thousand of species extinct, but there is no longer a debate about how to utilize the available resources - it has been decided that this is the greatest threat to the planet AND that we can do something about it. It may well be a serious threat to our planet, but is it really something caused by man and is it really something we can do something about? If one is questioning this ‘fact’ then one is now considered on par with a holocaust denier!

Another interesting fact is that the scientists agreeing with this theory are granted loads of funds and resources and the ones questioning the theory are having their grants and funding taken away - it speaks volumes for ‘independent’ research.

Recently my godfather wrote a presentation on the subject which I found very insightful and interesting (he visited Greenland last year) and has seen first hand what is are called the frontier of Climate Change.

I will not re-write the entire piece but instead try and post it on my blog (unfortunately it’s written in Danish with a few quotes etc in English), but the main points are that the climate has always changed - we have data going back hundreds of thousands of years - but the entire theory is based on the development since 1850 and even in that period the majority of the change occurred between 1910 - 1940.

It has been much warmer in the past than it is currently (in the Bronze Age and in the Middle Ages from 900 - 1300 AD) and there are all sort of potential explanations, the sun and it’s activity being one of them as we should not forget that without the sun the temperature on earth would be -273C.

Since I started penning this piece the most interesting developments have taken place after the University of East Anglia’s servers were hacked and a great deal of email correspondence has been posted on the web. This calls into question whether the lead scientist(s) have abolished science for politics as they seem to have been as ivolved in dis-crediting anyone challenging their ‘beliefs’ as they have been in genuine research. 

What is even more disturbing (and completely new to me) is that the raw data used for establishing historical global temperatures has been deleted. The reason this is important is that the entire theory behind man-made climate change is based on this data which has then been ‘adjusted’ - the adjustment is a scientific one as the way in which the data was collected since 1850 has not been as consistent as it is today. There would have been a number of data points throughout the years for different days and different places around the world. Turning that into an average temperature for the planet is obviously not that straight forward. What we are now left with is the ‘adjusted’ data. Requests for the original data have been rejected and now appear to be impossible to satisfy as the data has been lost or destroyed.

The key reason this analysis is important is that earlier periods’ warming looked a lot like the current warming e.g. the medieval warm period. Research led by Michael Mann of Pennsylvania State University suggested that while the Atlantic (think vineyards in Britain and Vikings sailing everywhere in open long boats) was much warmer the Pacific had been cooler. Without this research there wouldn’t be a climate change movement, because there would be no scientific evidence to suggest that the period since 1850 is extraordinary. That the data on which this whole argument is based may be lost is beyond belief....! Is it just me or does it sound a little bit like the weapons of mass destruction that weren’t really there, but served a purpose in getting a particular course of action through?

The one piece of good news is that Nigel (now Lord) Lawson has announced the creation of the Global Warming Policy Foundation, a think tank, to bring “reason, integrity and balance to a debate that has become seriously unbalanced, irrationally alarmist, and all too often depressingly intolerant”. This is desperately needed and maybe the timing will enable it to have a better chance of getting media coverage, than it otherwise would have!

Strong dollar.....is it really good for the US?

Yesterday I was baffled (yet again) by a republican US politician on CNBC who claimed that the current weak dollar was the cause of manufacturing leaving the US, citing his experience from Michigan in the 80‘ies. So while I am that old and I do remember the 80‘ies, twenty-five years is obviously a long time - in the foreign exchange market it’s more like an eternity - and yes my memory served me correctly, the US dollar was anything but weak, peaking at a $/DM rate of around 3.45, which equates to a €/$ rate of 0.635 and only started to weaken after the Plaza accord in 1985.

If anything a weak US dollar helps investment in the US as it makes exports more competitive and imports less competitive, or reduces the profit margins for the manufacturer, which is why that in the last 20 years (ironically since the 80‘ies) BMW, Mercedes, VW, Toyota, Honda and others have opened production facilities in the US, partially as a hedge against a weak dollar, which could render them un-competitve or substantially less profitable in what still is, the wold’s largest market.

So if anything a strong dollar is not good for the domestic manufacturing industry. 

Obviously it has become one of the hot topics in the markets, with the odd politician jumping on the band-wagon, but as many of them are just jumping on the wagon without having done any analysis themselves it’s really rather embarrassing, but hardly new.

The scare mongers are calling for a collapse in the dollar and while I can clearly see the benefits (for the US) in a relatively weak dollar, it’s not beneficial to the Europeans (Germany’s August trade balance was +8 bill vs +12 bill expectation), nor to the Japanese whose export sectors are hurting because of the strong yen. In fact it’s hard to see who, apart from the Americans, it’s good for and while a true collapse wouldn’t be good for the US, it wouldn’t be good for anyone else either.

Oh, but is is inflationary I hear them say, well yes but some inflation is what is called for if the US (and the rest of the western world) is not to experience serious deflation and by the way, inflation is the cure for an overly indebted economy, as long as the economy’s liabilities are a) fixed rate and b) denominated in the same currency as the assets it holds. The US bond market does not seem to be overly concerned about the prospects of inflation and is taking down record issuance without any problem whatsoever, at least so far.

One of the true idiosyncrasies in this partially post-crisis world is the EVERYONE is looking for an export led recovery and clearly that is not possible.

At the moment the markets are hot on the ‘weak dollar stronger everything else trade’, but while there may be a an argument for holding gold against all (paper) currencies, the same does not necessarily apply to oil, base metals and everything else. What I see coming is a fast and furious correction to the weak dollar trade, as it is too heavily skewed in the direction of the weak dollar strong everything else.