Euro Area

 

The Bad News First – Greece is Crashing Again

We only recently reported on the ludicrous idea of Greek prime minister Antonis Samaras to pretend that the Greek government is suddenly not bankrupt anymore (see: “Greece Tries to Escape Bail-Out” for details). Note that non-performing bank loans in Greece stand at an estimated €90 billion, so it should also be kept in mind that the banking system remains de facto insolvent as well – in spite of having been bailed out once already.

It is probably getting more so in recent days – Greek stocks and bonds have essentially crashed, with government bond yields back at levels that normally indicate severe crisis conditions (in other words, they are way above the level that would allow for what is generally considered “sustainable” refinancing of the government’s debt). The Greek stock market meanwhile is very close to getting cut in half once again:

 

AGTThe Athens General Index has been in free-fall lately – click to enlarge.

 

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Firmly on the Road to Ruin

Well, we warned them not to do it. You can read it all in “How to Destroy Germany’s Economic Gains” and “Germany Rolls Back Labor Reforms”. As we pointed out on these occasions, economic laws cannot be suspended by political fiat. Germany has managed just fine for hundreds of years without a legislated minimum wage. However, when the new coalition agreement between Germany’s pseudo-Conservatives and the Socialists was made, the socialist faction finally saw an opening to push the minimum wage through.

The consequences were easy to predict: many unskilled workers would lose their jobs and become wards of the State forever. Minimum wages are not only truly hair-raising economic nonsense, they are moreover a violation of people’s right to freely enter into contracts. An unskilled worker is no longer even allowed to offer his labor at less than the minimum wage, since that would amount to “unfair competition”. A new underclass is thus created in Germany, and the country’s hard-won gains in terms of labor productivity are endangered. We can expect further side effects from this, such as e.g. rising crime rates.

Of course the socialists love it (even if they would never say so out loud). Higher unemployment means more people will depend on handouts from the State – and these people are regarded as a natural reservoir of votes for the socialists. Apparently they have forgotten that there was once a time when precisely such an underclass actually chose quite a different kind of political party, one that eventually made short shrift of all socialists.

Now we have the first empirical confirmation that the minimum wage is indeed about to wreak economic havoc on a breath-taking scale.

 

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Greek Government Worried About Its Survival

Antonis Samaras has a problem: just as the relatively tough austerity medicine Greece was forced to take seems to be beginning to bear some fruit (Greece is the one euro area country where nominal government spending has indeed declined significantly), his shaky coalition government may soon be stumbling over the country’s upcoming presidential election. The problem in a nutshell is that if Samaras fails to get his presidential candidate elected, new parliamentary elections would be triggered – and according to current polls, the coalition would lose against SYRIZA.

 

1-greece-government-spendingGreek government spending has declined significantly in nominal terms (though not as a percentage of GDP, as GDP has declined a lot) – click to enlarge.

 

SYRIZA as readers may recall, once was a smallish coalition of tiny left-wing parties to the left of the social democrats that didn’t really have a lot of electoral support. After the financial crisis and the bankruptcy of the Greek government, it quickly became the country’s largest party. SYRIZA is anti-bailout, whereby we are not quite sure what this stance actually entails. Presumably, a SYRIZA victory would mean a Greek exit from the euro, as Greece’s creditors would have to accept the country’s bankruptcy, and its banking system would lose the ECB’s support (since it would be instantly bankrupt, and hence no longer eligible to receive ECB funding). Moreover, tearing up the agreements with the “troika” would definitely lead to Greece being made into a pariah, so as to discourage others from following suit.

 

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A Comprehensive Interview with the ECB Dissenter

Jens Weidmann, president of the German Bundesbank, is well-known for his disdain of the ECB’s unconventional policy measures. He continues to believe that the way forward does not require ever looser monetary policy, but economic reform. On these points we tend to agree with him; however, just as other central bankers, he of course supports the nonsensical ECB “price stability target”.

Needless to say, if the money issued by the central bank were to lose 2% of its purchasing power every year as planned, we would say that this would not represent price stability by any stretch of the imagination. However, we are actually not really critical of the precise “target” of the policy, but of the entire concept as such. It is a dangerous concept even if it were to target 0% price inflation. It has produced untold mischief over the past century, mainly in the form of major booms and busts (we have detailed the problems in “The Errors and Dangers of the Price Stability Policy”).

Anyway, Weidmann has recently given an interview to German news magazine Der Spiegel, which is well worth reading in its entirety. Weidmann evidently does not trust the calm in the financial markets and definitely does not believe that the euro area crisis is over and done with just because sovereign bond yields have declined a lot. Below are excerpts containing the parts we found most interesting:

 

SPIEGEL: Mr. Weidmann, you are notorious for being a tough critic of European Central Bank President Mario Draghi. But the euro crisis seems to be over, largely thanks to ECB intervention. Has he not been proven right?

Weidmann: It’s not about being right or a personal confrontation. When it comes to extremely important monetary policy decisions, the ECB Governing Council does its utmost to find the correct path. And the decisions are so difficult because the crisis is not yet behind us, even if the current calm on the financial markets might suggest as much.

SPIEGEL: Yet Spain, once wracked by the euro-zone crisis, can today borrow money more cheaply than ever before in the history of the monetary union. Do you not think that is a consequence of Mario Draghi’s 2012 pledge to save the euro “whatever it takes”?

Weidmann:You shouldn’t mistake the thermometer for the illness. I have never disputed that the ECB could impress and move the markets with the announcement that it would make massive purchases of sovereign bonds if necessary. But such measures focus on the symptoms and don’t cure the causes of the crisis. As such, the current calm is misleading and even dangerous, because it takes pressure off of the governments to implement badly needed reforms. If they are not undertaken, investors could quickly change their risk evaluations.

SPIEGEL: But if the ECB hadn’t intervened, the euro zone patient may well have died from its 2012 fever.

Weidmann: I don’t believe that is the case. In reaction to the crisis, policymakers established a multibillion euro bailout fund to assist the crisis countries in exchange for their adherence to certain stipulations. That was the correct, democratically legitimate path. Even more so given that the bailout fund can also purchase sovereign bonds. The central bank in the euro zone, by contrast, is forbidden from providing credit to countries and from purchasing sovereign bonds on the primary market. By making targeted bond purchases on the secondary market, the ECB opened itself to accusations of skirting this ban.

SPIEGEL: Since the beginning of the financial crisis, the European Central Bank has injected liquidity into the markets at decreasing intervals. It is a bit reminiscent of a junkie who has to continually up the dosage to have the desired effect.

Weidmann:It is certainly true that after each loosening of monetary policy, the public immediately begins speculating about what might come next.

 

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Flash PMI Disappointment

Markit released its euro area composite Flash PMI and the Flash PMIs for the “core” countries Germany and France on Tuesday. The data once again showed that economic growth in Europe is not much to write home about. Germany’s data look superficially good, but there is a widening gulf between manufacturing and service sector data, with the former weakening markedly.

The euro area composite output index fell to a 9 month low, the manufacturing PMI to a 14 month low – at 50.5 it remains barely in positive territory. Note in this context that in spite of the popular myth that manufacturing is only an insignificant part of the economy, it is actually its largest and most important part. In GDP accounting, almost the entire production structure is ignored (only investment in fixed capital assets is considered). And yet, if one looks at industry gross output tables, it becomes clear that this ignored portion of the economy actually represents the bulk of economic activity. Properly considered, consumer spending amounts only to about 35%-40% of economic activity, not 70% as is generally assumed. In short, manufacturing PMI data are actually a rather important gauge of an economy’s health.

France’s PMIs remain in contraction, even if it is mild at this point. However, it is not surprising that French unemployment remains near multi-year highs and that the government consistently fails to meet its budget deficit targets.

 

1-EZ-PMI and growthEuro area, Markit composite PMI and GDP growth – click to enlarge.

 

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Central Planners and Untenable Theories

The European Central Bank again cut the interest rates it controls. Notably, the deposit rate was moved deeper into negative territory. It is now -0.2% (minus 20 basis points, that is not a typo). The ECB says it’s trying to nudge prices higher, but it’s actually feeding the cancer of falling interest.

The linked article above, like most, is focused on the quantity of euros and the presumed direct relationship to price. The following bit of editorializing from that article is uncontroversial in Frankfurt, London, New York, Mumbai, or Shanghai.

“Inflation weakened to a five-year low in August, just 0.3% in annual terms. That is far below the ECB’s target of a little under 2% over the medium term, raising fears that the region could face a debilitating stretch of weak or falling prices that hampers debt-financing and investment. Those fears intensified as market-based measures of inflation expectations weakened, too.”

 

Mario DraghiThe chart shows the 5yr./5yr. swap rate, a.k.a. the 5 year forward inflation breakeven rate. This is the “inflation rate”, or rather the annual rate of change in harmonized euro area CPI, which market participants expect to reign 5 years hence over the following 5 years. This inherently imprecise datum is employed by the ECB as a measure of whether long term inflation expectations are “well anchored” (chart caption by PT).

 

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The Man with Nothing to Lose

France’s president Francois Hollande these days finds himself at a similar crossroads as another French socialist president once upon a time: Francois Mitterand. After nationalizing vast swathes of industry and introducing all sort of policies favored by the Left, Mitterand was eventually forced to do an 180 degree turn to avoid inflation spiraling out of control and in order not to suffer the embarrassment of the French franc falling out of the ERM (European Exchange Rate Mechanism). Mitterand later was forced into cohabitation with a conservative parliamentary majority, and concentrated on foreign policy and defense, leaving economic policy to Jacques Chirac.

Mr. Hollande these days enjoys the relative freedom that comes from being the most despised French president in all of history. The “welfare state incarnate” as Gaspard Koenig once called him, has seen his approval rating plunge to 13% in September. Ironically, if one adds up the approval ratings of Hollande and the reportedly evil Vladimir Putin, one gets 100%. And yet, it is Hollande who is now the relatively more unconstrained of the two, after all, no matter what he does from here on out, things simply cannot get much worse.

A first sign that Hollande realizes that different economic policies are required was his appointment of the centrist Manuel Valls as prime minister about six months ago. The recent “purge”, that saw former economy minister Arnaud Montebourg, minister of culture Aurelie Filipetti and education minister Benoit Hamon replaced by people more in line with Valls’ new course was an even stronger sign. Montebourg specifically was highly influential early in Hollande’s term and as might be expected, pursued policies extremely hostile to business. All three of the ministers that were replaced were considered “Socialist rebels” – i.e., far to the left of Mr. Valls. Montebourg was replaced by his polar opposite, someone on the very right of the Socialist Party,  former investment banker Emmanuel Macron. How did Valls survive the confidence vote the purge necessitated? In spite of the rebellion of the left, French socialist parliamentarians are well aware that a new election would sweep most of them out of the halls of power. It is this fear Hollande and Valls gambled on, and they were proved right.

 

Readers may recall that earlier in Hollande’s term, we often argued that Hollande’s baffling reluctance to embrace reform could be explained by his fear of being overtaken from the left – not only the extreme leftist wing of his own party, but also the La Gauche party led by Jean-Luc Melenchon. However, recent polls in France seem to suggest that Melenchon’s outfit is facing a lot of competition from another radical party, namely the Front National (FN). To be sure, the FN is likely to steal votes from every quarter, but for a small party like Melenchon’s this can conceivably mean total wipe-out. And so it comes that Hollande is now embracing Valls’ reform course, which aims to slash government spending, lower business taxes and introduce some badly needed deregulation.

 

manuel-valls-et-francois-hollande-10975172oxxld_1713Manuel Valls and Francois Hollande, thinking things over …

(Photo credit: AFP)

 

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AfD Wins Big In Another Two German State Elections

We recently pointed out that Germany’s EU-skeptic AfD party has the potential to become a serious political force (see “22% Can Imagine Voting for the AfD” for details). Over the weekend, two further German state elections in Thuringia and Brandenburg confirmed this assessment. In both elections, the AfD was by far the biggest winner, going from zero to 10.6% of the vote in Thuringia and from zero to 12.2% in Brandenburg. We prefer to refer to the party as EU-skeptic rather than simply “euro-skeptic”, although the latter is the label most often used in the mainstream press. While the euro-area’s sovereign debt crisis was the main motivation for the party’s establishment, its ideas had already come in favor among a growing number of people before the crisis. There merely was no party-political platform available to them previously – now there is.

Once again the Free Democratic Party was essentially wiped out in both states (which we believe is unfortunate), but the AfD also seems to have attracted voters from the left – from the Left Party in Brandenburg and the SPD (social democrats) in Thuringia. This is an interesting development, as the party is certainly not leftist in its outlook.

Although the party has gained a respectable percentage of the vote – beating e.g. the Green Party handily – it will be spared from taking part in a coalition government, as majority governments can be formed in both states without its participation and the establishment refuses to have anything to do with the AfD. We say “it will be spared” because experience has shown that being the junior partner in coalition can be deadly. The junior partner as a rule loses much of its base, which tends to be unhappy with the compromises that need to be made in order to join a governing coalition. The opposition role by contrast allows for the party’s stance to be pursued with the same undiluted vigor as before. Voters often see participation in coalitions simply as a way to gain well-remunerated posts by essentially selling out.

 

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It Wasn't Always Easy …

“What’s the secret?”  We had decided to put the question directly. Why not? How often do you have dinner with a Rothschild, much less dozens of them? 

Today, one of Bordeaux’s most notable winemakers goes to her grave. Philippine de Rothschild was already stone cold when we arrived in town on Saturday; she died last week at 80. Today, she will be buried. 

But we came not to bury a Rothschild, but to praise one. That is to say we came not for an unhappy occasion, but for a happy one: the marriage of one of Philippine’s cousins. 

“She was so loved and respected in the wine industry here in Bordeaux,” a relative reported, “that the other winegrowers, merchants, and even the field hands lined the road and took off their hats when they brought her body back from Paris.” 

Philippine told the French leftist newspaper Libération that, despite the family name and the family fortune, she had not always had an easy time of it. During World War II, being a Rothschild in France was hazardous. Philippine’s mother was sent to a concentration camp near Berlin, where she was murdered in 1945. 

Philippine used her mother’s maiden name, escaped the deportations and, after the war, she went onstage in Paris as Philippine Pascal. Then in 1988, her father died. And she came back to Bordeaux to run the famous Château Mouton Rothschild wine estate. 

 

James_Mayer_de_Rothschild_by_Southworth__Hawes-231x300James Meyer de Rothchild

 

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Comprehensive Assessment Paranoia

The ECB is currently busy stress-testing all “systemically relevant” banks in the euro area, the supervision of which it is going to take over as part of the banking union plan later this year. This stress test has given birth to new acronyms, such as “AQR” (asset quality review) and “CA” (comprehensive assessment). Banks that are found to be short of sufficient tier 1 capital will have to submit a credible  recapitalization plan very quickly after the CA has been concluded, and thereafter will have several months to implement it. 

As a result of the massive carry trade in government bonds of the periphery initiated by the LTROs and Draghi's OMT promise (as we have previously mentioned, the timing and sequence of events suggests that there were sub-rosa agreements between governments, the ECB and large commercial banks, with the caveat that this is impossible to prove), a number of bank balance sheets in countries like Spain and Italy probably look significantly improved  simply due to their vast accumulation of zero risk-weighted government debt. Moreover, the ECB's war on savers has clearly served as a redistributive device in favor of banks.

Nevertheless, the recent downfall of the Espirito Santo empire including the bank (Banco Espirito Santo) of the same name in Portugal, was a reminder that there may still be skeletons in a number of closets (an interesting backgrounder on the Espirito Santo affair can be found here by the way). A recent report in the NYT's dealbook suggests that there is a growing consensus that the ECB's stress test will discover many a bank balance sheet falling significantly short.  The Texas ratio has emerged as the analytical tool of choice for guessing which banks will be found wanting:

 

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Angry Young Roofers

It is another cool, cloudy day in Poitou. The whole summer has been like this – like a winter in Georgia, with hardly a single warm day. Vacationers head back to Paris with the same white skin they came with. Beach resorts empty out… embarrassed at the way they treated their loyal customers.

But the roofers have liked it. No hot sun has beat down on them. We are redoing the roof of one of the barns. Alas, it is a slate roof, which costs a fortune. But at least you only have to replace it once a generation. Slate roofs last for 60 to 70 years.

 

Flag_of_France.svg_

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Montebourg Gives a Speech – to Unexpected Effect

It all started harmless enough. The economically illiterate French “industrial renewal” minister Arnaud Mounteba…sorry, Montebourg, delivered one of his usual fiery addresses on the alleged evils of non-existent “austerity” imposed by the stingy and small-minded Germanic tribes across the river Rhine.

As a brief reminder: France's economy has entered a downward spiral as a result of its sclerotic body of regulations, overly high taxation and the imposition of a quasi-Zwangswirtschaft by president Hollande and his socialist buddies. As a result, the country continues to be unable to deliver on its promises with respect to the EU's stability pact, the rules of which were tightened in reaction to the euro area's sovereign debt crisis.

Here is what Montebourg had to say:

 

“The time has come for France to resist Germany's "obsession" with austerity and promote alternative policies across the euro zone that support household consumption, firebrand French Economy Minister Arnaud Montebourg said on Sunday.

Deficit-reduction measures carried out since the 2008 financial crisis have crippled Europe's economies and governments need to change course swiftly or they will lose their voters to populist and extremist parties, Montebourg told a socialists' meeting in eastern France.

"France is the euro zone's second-biggest economy, the world's fifth-greatest power, and it does not intend to align itself, ladies and gentlemen, with the excessive obsessions of Germany's conservatives," Montebourg said. "That is why the time has come for France and its government, in the name of the European Union's survival, to put up a just and sane resistance [to these policies]."

Montebourg said consensus was growing among economists and politicians worldwide on the need for growth-oriented policies and mentioned his German socialist counterpart Sigmar Gabriel and Italy's premier Matteo Renzi as potential allies. He cited former president Charles de Gaulle and former British prime minister Margaret Thatcher as having effectively spoken up to change the course of EU policies they opposed.

Montebourg said he had personally asked President Francois Hollande for "a major re-direction of our economic policy". The government should now focus less on cutting debt than on supporting households to revive consumption, a traditional economic driver, he said.

Montebourg, who makes no secret of his own presidential ambitions, is known for his frequent attacks on austerity, but his latest comments are likely to embarrass Hollande, who despite mounting pressure said just days earlier he would not back away from his policy based on spending cuts and corporate tax breaks.

Hollande's business-minded policies have alienated many left-wing lawmakers and voters already frustrated with his failed pledge to curb unemployment. He is now the most unpopular president in over half a century, with an approval score of 17 percent in the latest Ifop poll.

Hollande's office declined to comment on what Montebourg said. A source close to Prime Minister Manuel Valls said Montebourg had gone too far.

 

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When One Central Bank Slows its Destructive Policies, Another Must Step Into the Breach …

We could call this the summary of Lorenzo Bini Smaghi's views, who frets in a recent FT editorial about the effects the Fed's decision to 'taper' its 'QE' operations may have on the moribund euro area economy.

In about two thirds of the editorial, Bini Smaghi lists the ways in which a slowdown in monetary largesse across the pond might impact financial markets in Europe. There is nothing wrong with this analysis, in fact, a similar impact will likely also be felt in the US and elsewhere. After burdening the economy with the biggest money printing and deficit spending orgy in post WW2 history, we must expect all the economic errors these policies have induced to become visible as soon as the inflationary policy is actually slowed down sufficiently.

However, the problem is that Bini Smaghi thinks that therefore, we need more of the same, only this time, the ECB is supposed to take upon itself the role of chief money printer. Naturally, there is not a single word about the causes of the last crisis, which was caused by a boom triggered by the very same loose monetary policies Smaghi once again supports. Smaghi not only thinks the ECB should print money in reaction to the turbulence the Fed's tapering may cause, but it should do so “preemptively”.

An excerpt:

 

“The only way to avoid such a scenario is for the ECB to counteract the restrictive effects produced by the combination of a US monetary tightening and renewed market turbulence. The measures announced so far do not seem to be sufficient, as their effectiveness largely relies on the prevailing demand for bank financing coming from European companies, which currently seem to have little incentive to invest and still need to deleverage. The ECB’s balance sheet might thus continue to shrink, while the economic recovery slows down. Forward guidance, which aims primarily at short-term policy rates, may lose credibility as it is unable to prevent the rise in long-term rates.”

 

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Loans to the Private Sector Keep Declining, Money Supply Growth Slows

We want to briefly update the most important credit and monetary data of the euro area, which we last briefly discussed in March (see: “Overview of Recent Monetary Trends”, which focused however more on the US than on Europe).

In spite of the ECB cutting interest rates to the bone and offering new “targeted long term refinancing operations” to banks (see “European Credit Dirigisme” for background information), neither lending to the private sector nor money supply growth have so far picked up in the euro area as a whole (there are of course differences between the individual member nations).

Generally we would regard this as a positive development, insofar as it should help to minimize capital malinvestment. Unfortunately, we can infer from the fact that money supply growth remains in positive territory, that lending to the private sector has been replaced with lending to governments, so the economy continues to be exposed to the burden of deficit spending by governments. This is probably not particularly surprising, but we would be remiss not to mention it.

Below we show three charts, consumer credit, loans to non-financial corporations and the euro area's true money supply (currency plus demand deposits). The red lines show the absolute numbers in millions of euro, the blue lines show the annual rate of change in percent.

 

chart-1-Euro area consumer credit

Consumer credit has taken a dive, and the slump has recently slightly accelerated again – click to enlarge.

 

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Europe's Cage is Rattled a Bit

The little disturbance in Portugal's banking landscape hasn't been entirely overcome yet. New management has been installed at Banco Espirito Santo, but the problem is that the bank apparently sits on quite a few dubious assets, and the new management cannot wish them away. BES appears to have sunk a lot of money into former Portuguese colony Angola, and these loans are the subject of growing concern. On Tuesday, the stock of BES collapsed to a new low, but the losses have been recovered in Wednesday's trading session.

In parallel with the still growing worries about BES, Germany's ZEW institute issued its economic confidence indicator, which showed the 7th monthly decline in a row. Wasn't there supposed to be a recovery?

A few excerpts from a Reuters summary:

 

“European stocks and the euro fell on Tuesday after shares in Portugal's biggest listed bank hit a record low, while a plunge in German economic sentiment pushed up borrowing costs for some peripheral euro zone countries.

Global stock markets have recently been supported by dovish policy measures from major central banks and signs that economies are recovering, though worries persist over the pace of growth in Europe and the health of the region's banks.

[…]

The banking sector was a sharp underperformer, with Portugal's Banco Espirito Santo  slumping 17.5 percent to a fresh record low. Traders blamed concerns over the bank's Angolan loan portfolio and the sale of a stake at a low price by the bank's founding family on Monday.

[...]

"The key takeaway is that the banking sector globally continues to struggle despite time having been bought, and policy being tremendously supportive," said Jeremy Batstone-Carr, head of private client research at Charles Stanley.

"The sector feels like a minefield."

 

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