Euro Area

 

The 'Great Stretch'

Last week the Greek government celebrated its return to the bond market, selling 3 billion euros in five-year bonds at a yield of 4.95 percent. Reportedly there was great demand for the issue, which should be no surprise given the current propensity of investors to buy all sorts of junk debt as long as it yields more than just a smidgen.

Reuters report on the backdrop that made this successful auction possible:

 

“Call it the Great Stretch. Two years ago, Greece's debt crisis almost brought the euro zone crashing down. Now European partners are preparing to ease Athens' debt burden without writing off their loans but by stretching them out into the distant future, extending maturities from 30 to 50 years and further cutting some interest rates, EU officials say.

Greece made a successful, if artificially engineered, return to the long-term capital markets last week for the first time since its international bailout in 2010, and just two years after imposing heavy losses on its private creditors.

But with its economy shattered, the country is still a long way from being able to fund itself unassisted in the market. The International Monetary Fund says Greece is likely to need further financial help from the euro zone over the next two years.

One reason why the sale of 3 billion euros in five-year bonds at a yield of 4.95 percent went so smoothly, on the eve of a support visit by German Chancellor Angela Merkel, was that investors are widely anticipating official debt relief.

"That has been quite substantially priced in, and the market is also expecting Greece to be quickly upgraded by the credit rating agencies," said Alessandro Giansanti, senior rate strategist at ING bank in Amsterdam.

"In a second stage, the market is also expecting a reduction in principal on official debt, and no private sector involvement (write-down) in the coming years," he said.

Whether such expectations are fully realized will only become clear later this year, when negotiations start with the euro zone and the IMF on Greece's longer-term funding, and the end of its wrenching bailout program.

But EU leaders share an interest in helping conservative Prime Minister Antonis Samaras' shaky coalition cling to office rather than seeing leftist anti-bailout firebrand Alexis Tsipras sweep to power demanding a massive debt write-off.”

 

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A Word to the Wise

Readers may remember former BuBa board member and ECB chief economist Otmar Issing, who probably like few others personified the image of the stern, conservative German central banker (Jürgen Stark and Axel Weber were also people in this mold). Issing now and then still offers his opinion to those interested, most recently in an editorial in the FT, entitled “Get your finances in order and stop blaming Germany”.

As one might expect, Issing is no fan of 'euro-zone bonds' and similar ideas attempting to create shared responsibility for the debts of independent sovereign countries running their own fiscal policy. Several of his points are worth commenting on.

 

Germany Shoots Own Goal

Issing starts out by noting that Germany should best lead by example – and not by throwing money at the euro area's problems. He also reminds us that Germany's economic success is not irrevocable, and that there is a threat it won't be preserved:

 

“Germany is not only the biggest economy in Europe, it is also the best performing – and it would be in everyone’s interest if the country led by example. Unfortunately, it may be undermining its economic dominance by undoing past reforms and reinforcing labour market regulations. It is perhaps not too pessimistic to argue that the time will come when Germany’s economy is no longer the subject of envy.”

 

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Illustration of Economic Interdependence

RT and Der Spiegel have recently published a few infographics on trade between the EU and Russia, respectively Germany and Russia, which we reproduce below. This shows why tit-for-tat sanctions could be a really big problem for Europe and why the EU's leaders are probably quietly praying for the crisis to simply go away. The associated article in Der Spiegel on the high price German business may end up paying is worth looking at in this context.  As an aside, we recently chided Stratfor a bit, but this article on Putin's motives and options is actually well worth reading as well (apart from the once again personified countries). Similarly, there are a few well-considered comments on the situation in this article at Bloomberg, which attempts to decipher Putin's motives by bringing them into a historical context. We don't necessarily agree with everything that is said in these articles, but they are different from the usual fare and all make for interesting reading. On to the trade infographics:

 

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Matteo Renzi Proposes Sweeping Tax Cuts

Italy's new prime minister Matteo Renzi is reversing some of the worst aspects of the legacy of the Brussels-approved professional bureaucrat Mario Monti by proposing a package of tax cuts, which is mainly going to be financed by spending cuts. This is of course what should have been done from the very beginning. Better late than never though. However, there is one slight flaw that is rightly criticized by some observers:

 

“Italian Prime Minister Matteo Renzi on Wednesday presented a sweeping package of tax cuts, saying they could help economic recovery in the euro zone's third largest economy without breaking EU budget deficit limits.

Renzi, in his first full news conference since taking office last month, said income tax would be reduced by a total of 10 billion euros ($14 billion) annually for 10 million low and middle income workers from May 1.

"This is one of the biggest fiscal reforms we can imagine," he told reporters after a cabinet meeting that approved the measures.

The cuts will be financed by reductions in central government spending, extra borrowing and by resources freed up thanks to the recent fall in Italy's borrowing costs, he said.

Daniel Gros, the head of the Brussels-based think tank CEPS, said it was worrying that Renzi appeared to be back-tracking on previous pledges to finance any tax cuts entirely with structural spending reductions.

"This is not what Italy needs," he said. "We don't know what bond yields will do in the future and, with its huge public debt, the government cannot afford more deficit spending."

Economy Minister Pier Carlo Padoan said the government would have to evaluate the effect of its measures on public finances and would need to seek EU approval if deficit and debt targets appeared in doubt. Renzi, the 39-year-old former mayor of Florence, said his agenda to stimulate the economy and reform Italy's political system was the most ambitious Italy had ever seen as he reeled off tax-cutting plans that he insisted were fully funded.”

 

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Will Austrian Bank Woes Be Again the Catalyst for a European Kondratieff Winter?

Sad affairs have been heating up in the tiny Alpine republic in the center of the European Union. While Austria experiences record unemployment at record growth rates and tax revenues  have fallen behind optimistic projections, the looming bankruptcy of a mid-sized regional bank, Hypo Group Alpe Adria (HGAA), may propel the country to the disdained position of being the catalyst for a new round of bank failures due to interwoven banks risks on both the domestic and the international level.

Austrian politicians are up in arms since a third-party expert opinion that recommends to wind down the bank at a cost of €18 billion has been leaked to the media, but keep on marching on the most fatal route that will not dissolve the problems: They keep flogging the dead horse HGAA with taxpayer's millions in a monthly money injection routine that has cost so far around €4.5 billion.

Current talks involving politicians appear to be more adequately suited for the Vienna opera house, but not for a rolling high finance train wreck that needs more than montlhy band aids.

On Monday Austrian financial market authority FMA publicly said what the official Austria never wanted to hear as it is now confronted with a widening public discussion on a problem it had surrealstically hoped to brush under the carpet. FMA head Harald Ettl warned that any further delay would make the – in this blogger's humble opinion doomed HGAA – an incalculable risk and that Austria should consider no option as a taboo anymore.

Nothing could be more true. An unorderly liquidation of HGAA will not only push Austria from the throne of the best economy in the Eurozone, pushing its public debt to GDP ratio well over 100%, but will also have continent wide reverberations.

 

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A 'Flood of Good News'

As der Spiegel recently reported, the Greek government is intent on smothering its reluctant creditors with good news (in order to be able to accumulate a reasonable amount of such, the last 'troika' assessment has apparently been subject to numerous delays):

 

“A SPIEGEL report that German Finance Minister Wolfgang Schäuble is considering a third rescue package for Greece has electrified the struggling nation. Athens wants to impress its creditors with a stream of good news. But it still has a long list of unkept promises. New loans are welcome, but don't ask us for any new austerity measures. This pretty much sums up Athens' reaction to Germany's reported willingness to approve further loans to Greece to cover the country's multi-billion euro projected financing gap in 2015-2016.

Although there was no official reaction to SPIEGEL's report, published on Monday, government sources say that Berlin's intentions were known to Prime Minister Antonis Samaras, adding that Germany will not pull the rug from under Greece's feet, especially with the European election due in May.

But the Greek government has also made clear that it will not accept a new round of measures or a continuation of what are perceived by many in Greece as the asphyxiating and humiliating controls by the troika of European Commission, European Central Bank and International Monetary Fund.

Finance Minister Yannis Stournaras is preparing Greece's position ahead of the troika's arrival. With a fresh round of bargaining looming on the new loans, he promised an avalanche of "impressively good news" in the coming days to show that Greece doesn't need any further belt-tightening. It only needs to press on with its structural reforms, he said.

According to a Greek Finance Ministry official, the good news will include the first increase of retail sales in 43 months, and the first rise in the purchasing managers' index in 54 months. The "super-weapon" in Stournaras' arsenal, however, is the hefty 2013 primary budget surplus, now estimated at €1.5 billion, well above the official budget forecast of €812 million.

The same official said the expected good news was the reason why Athens doesn't want the troika to return earlier to conclude a much-delayed round of inspections that started in the autumn. Stournaras is expected to present Greece's accomplishments to German officials when he visits Berlin later this week. The final details of his trip are still being worked out. Athens also plans a return to the markets by the end of 2014 in what it believes will be a definitive sign that the Greek economy is out of the woods.

With the leftist opposition alliance Syriza leading most opinion polls, some observers say the Greek government needs to be able to show success soon. Athens was therefore quick to react to the reports about new loans, telling the public it should not fear a new wave of measures.

 

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Spain to Include Prostitution, the Drug Trade and 'Other Illegal Activities' in GDP

We only noticed very recently that after including various 'intangibles' in GDP a few years ago (similar to what the US has recently done), a number of European countries have added the estimated value of criminal activities to GDP as well. We have noticed this because a friend pointed out to us that Spain is going to add prostitution, drug dealing and smuggling activities to its GDP from 2014 onward. A link to a Google translation of an article in the Spanish press announcing this change can be  found here.

 

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Government Spending and Growth

French president Francois Hollande seems to have realized that something needs to change in France, as the economy continues to remind one of an overcooked vegetable – limp, soggy and all around unappealing.

As a reminder, when Hollande ran for the presidency, he was trying to pass himself off as the coming 'growth president'. The growth miracle was going to be achieved by adopting an 'anti austerity' stance, so in essence, Hollande propagated the theory that deficit spending by government creates economic growth. This economically illiterate position is also held by many prominent economists, so one can probably not blame a professional bureaucrat-politician for believing it. The vagaries of the market are unknown to him – he has been a government apparatchik throughout his career.

Aggregate economic statistics make it appear as though government consumption contributes to growth, but that is mainly a case of 'garbage in, garbage out'. Just because a nonsense number is added to some other numbers, one cannot assert that the resultant new nonsense number represents 'growth'. Imagine for a moment that government could only spend what it receives in tax revenue. It would be perfectly clear to everyone in that case that government can only spend what it first takes from someone else, who in turn can no longer spend it. If one looks at it that way, the argument is immediately reduced to its essence: namely the question, who is more likely to allocate the funds in a manner conducive to growth: government bureaucrats or the private sector?

 

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The New Yen! Quelle Horreur!

The euro's recent strength has been met with a mixture of incredulity and trepidation. No wonder, considering a full 83% of the world's largest fund managers were bullish on the US dollar (according to the quite comprehensive Merrill fund manager survey) as of late July this year. So they were certainly not positioned for a stronger euro at the time, although the mantle of 'most hated major currency' has been handed over to the yen since late 2012. Given where the dollar was trading at the time and given the continued popularity of 'taper' fantasies, sentiment has probably not changed all that much.

The WSJ has recently reported that the 'euro could be the new yen', or if you like that comparison better, the equivalent of Bruce Willis in the 'Die Hard' movies:

 

“It’s a currency equivalent of Bruce Willis in the Die Hard movies. Whatever bad news gets thrown at the euro, it keeps bouncing back, stronger than ever. Unfortunately, what’s a crowd pleaser in the cinemas doesn’t work so well for flagging economies. As, in fact, a 1990s Japanese version of the same script shows. The euro is up 8% on where it was twelve months ago and up 14% from lows hit during the summer of 2012, on a trade-weighted basis. Some of that gain represents relief that the euro zone seems to have survived its sovereign debt crisis and that recession is finally over. But the currency’s upward trend is hard to square with the worries that remain.

The region’s wider economy may no longer be contracting, but it’s barely growing and, based on very weak October industrial production data, is vulnerable to a relapse. Resolution of key matters, not least a banking union–never mind a fiscal union–remain a long way off. Throw in issues like very high unemployment rates in Greece and Spain, current account imbalances and the lack of obvious sources of stable growth and it’s not hard to see why some continue to question the single currency’s viability.

True, euro-zone countries’ efforts to export their way to growth, a la Germany, partly underpins the single currency. The region’s overall current account had broadly been in surplus in the years before the financial crisis, but has since become an ever larger surplus. But there’s another reason the euro been so persistently strong. In a word: deflation.”

 

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They're Not Taking It Anymore

France's socialist president Francois Hollande, the 'welfare State incarnate' (h/t Gaspard Koenig), is in trouble. Not only has he has become the president with one of the lowest ever recorded approval ratings at a mere 15%, he apparently even feels it necessary to dispatch jackbooted goons to oppress those who are expressing their disapproval of him publicly. Incredibly, if one demands Hollande's resignation, one seems to be guilty of the crime of insulting the president as Mish reports.

Nevertheless, the French have never been known to take any unpopular policies dished out by their politicians lying down. Few people are as quick as the French to take to the streets to make their displeasure known. This is both a blessing and a curse, as it sometimes stands in the way of unpopular, but necessary reforms.

However, this time, the French are demonstrating over an issue that is well worth their displeasure: namely the relentless increase in regulations and taxes Hollande's government has subjected them to. According to a recent Bloomberg report, farmers are but the latest group to rise up in protest:

 

“French farmers snarled traffic into Paris as they drove tractors onto highways to protest against taxes and new regulations.

A total of seven roadblocks were up in the Paris region, according to the website of DiRiF, which runs the area’s road network, and which advised commuters to take public rail transport. Television news channels showed long lines of blocked traffic under rainy skies and near-freezing temperatures.

“I don’t think this is the right way to express one’s views,” Agriculture Minister Stephane Le Foll said in an interview in Le Figaro newspaper. “We are always open to dialogue.”

The action is the latest in tax revolts in France, which in recent weeks has seen horse-riding clubs, truckers and small retail outlets protesting against increased levies by President Francois Hollande’s government. Hollande, who’s seeking to narrow the government’s budget gap, has become the least popular French leader since 1958.

Today’s protest was called by farming associations in the Paris region. In addition to nationwide issues such as a proposed trucking levy and a higher value-added tax on fertilizer, the farmers are angry about anti-pollution laws that would limit tractor use on certain days. They’re also opposing changes to the European Union’s Common Agricultural Policy that will increase spending on livestock to the detriment of cereal farms, which predominate in the Paris basin.”

 

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A 'Bought Deal' Refinancing for the Government

In late October, the IMF warned that Slovenia must recapitalize its insolvent banks 'immediately'. The governor of the country's central bank countered that  the result of 'stress tests' had to be awaited first (due in late November).

In the meantime, the current government (a diverse and somewhat unruly coalition) led by Alenka Bratusek has survived a confidence vote in parliament and has managed something of a financing coup, namely the sale of €1.5 billion in new government debt to a single, anonymous investor. It is quite a generous investor to boot, who has accepted a yield way below recently prevailing market yields. In other words, it is a 'bought deal' financing:

 

“Slovenia's government won a confidence vote and raised 1.5 billion euros in a bond issue on Friday, offering the euro zone country some hope it can still steady its finances and avoid an international bailout.

The dawn vote, by 50 to 31 after a marathon debate, shores up political backing for Prime Minister Alenka Bratusek's disparate alliance as the republic struggles with its worst crisis since seceding from Yugoslavia 22 years ago.

The country later said it had made a private placement of three-year notes worth 1.5 billion euros ($2 billion) to a single investor at a yield of 4.7 percent. "This issue shows that the financial markets are open to Slovenia," Bratusek told a news conference, saying she did not know the identity of the investor. Her foreign minister, Karl Erjavec, said: "Today it is absolutely clear that the government can succeed.”

 

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What the Ice Cream Scooper Told Me in Venice

I’m blessed to be able to travel to Europe once or twice a year. I use the trips as an opportunity to see how the economies are faring over there. And I can tell you this first-hand: the economic situation in Europe is much worse than what we’re hearing from the mainstream media in the U.S. economy.

Here’s just one small story that paints the picture…

A couple of weeks back, while in Venice for four days, I walked into my favorite ice cream store for my daily fix of Italian ice cream. I’m chatty wherever I travel, as I want to get the locals talking so I learn what’s going on.

After engaging the store’s only employee in conversation (I’m fluent in Italian), the young man, who was between 25 and 30 years old and educated, told me how happy he was to have his job as an ice cream scooper at this particular location of a well-known chain of Italian ice cream stores. “Jobs in Italy are very hard to come by,” he told me.

But what he said next really got me thinking …

 

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Martin Wolf Complains About Germany

Few writers produce erudite-sounding nonsense with such unwavering regularity as Martin Wolf, an establishment-approved scribbler for the Financial Times. When he is not screeching for more money printing, he is belly-aching about 'trade imbalances', which allegedly condemn the world to economic hell. The latest example is his article 'Germany is a Weight on the World'.

This was written after the misguided Mercantilists apparently still populating the US treasury department (after decades of US trade deficits that have somehow completely failed to matter all this time) decided to complain about Germany's allegedly unconscionable trade surplus.

So here we are, more than a century after the fallacies of Mercantilism have been disproved by a plethora of economists, and people still allege that there is something evil in trade that requires even more government intervention than there already is.

Wolf writes:

 

“The criticisms that hurt are those one suspects might be fair. This might explain the outrage from Berlin last week over the criticism by the US Treasury of Germany’s huge and vaunted trade surplus. But the Treasury is to be commended for stating what Germany’s partners dare not: “Germany has maintained a large current account surplus throughout the euro area financial crisis.” This “hampered rebalancing” for other eurozone countries and created “a deflationary bias for the euro area, as well as for the world economy”. The International Monetary Fund has expressed similar worries.”

 

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Mortgage Delinquencies Swept Under the Rug

Back in August of 2012 we wrote about “Spain's Curiously Low Mortgage Defaults” and noted that the CEO of Santander essentially accused doubters of being retards. Here is how he explained the phenomenon at the time:

 

JPMorgan Chase & Co. (JPM), the world’s largest bond underwriter, predicts that Spanish mortgage arrears will surge as unemployment rises. That’s also the view from the international debt market, which has driven up yields on Spain’s bonds in a bet the country will have to bail out banks.

In Spain, Banco Santander SA Chief Executive Officer Alfredo Saenz said yesterday that’s nonsense. “Mortgages get paid in good times and in bad,” he said in a news conference at the bank’s headquarters outside Madrid. “Anyone raising this problem as one of the issues for the Spanish financial system is saying something stupid.”

 

(emphasis added)

Not everyone was taken in though. As one observer noted:

 

“There does seem to be a strange contrast between the high level of unemployment and the surprisingly low level of delinquencies on mortgages,” said Georg Grodzki, who helps oversee $515 billion as head of credit research at Legal & General Plc in London. “This raises the issue of whether loans have been amended to make them look current when in fact they are distressed.”

 

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Winners and Losers

In a recent editorial at German newspaper Frankfurter Allgemeine Zeitung (FAZ), Hans-Werner Sinn, president of Germany's IFO Institute and a prominent critic of the ECB and the euro area bailouts, revisits the topic of the euro-systems payment imbalances that are expressed in TARGET-2 claims and liabilities.The reason why Sinn felt compelled to write this editorial is that another economist, Marcel Fratzscher of the DIW in Berlin (another economic research institute), recently asserted that 'Germany is the big winner' in the events surrounding the TARGET system.

The main reason why there is even a debate over the euro-system's payment procedures is in fact that Sinn pointed out two years ago that the system was abused as a 'stealth bailout' mechanism for the euro area periphery and that Germany was exposed to huge risks because of it.

This provoked angry reactions from courtier economists and even the Bundesbank, who tried in vain to put the genie back into the bottle by arguing that it all didn't matter. It was merely an accounting artifact, and no further implications were to be inferred. Naturally, even people who don't understand how exactly the system works were compelled to ask: if it 'doesn't matter', then why does the chart look like this?

 


 

TARGET-2

TARGET-2 imbalances in the euro-system – click to enlarge.

 


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