A Little Goosing of the Money Supply and the World is Alright Again
We have pointed out for several months in these pages that the increase in the euro area's true money supply (+8% year-on-year) would likely produce further improvements in PMI data and other measures of economic activity in the euro zone. See for instance our June 5 article “Euro-Area PMI Data Improve as Money Supply Growth Accelerates”.
This is not rocket science to be sure, but we have noticed that very few economists actually look at these data. In fact, if they look at monetary developments at all, most of them employ money supply measures that are essentially useless, as they include components that are not money. This is why they are continually 'surprised' when economic data are released.
In recent months the expected improvement in the data has indeed occurred, and now mainstream economists and sell side analysts are falling over each other adjusting their forecasts (which means in practice, shifting their rulers to extrapolate the most recent data points). One of the more extreme examples has just been delivered by Den Danske bank, which is 'calling off the euro area debt crisis due to improving PMI data'.
Come again? We have news for the analysts at Den Danske: the governments of the European welfare states are even more insolvent today than they were back when the crisis was still acute. They have all seen their debt loads increase further, in many cases at a stunning clip. Absolutely nothing has happened to alter this fundamental fact of de facto insolvency. A few months of improving PMI data are the functional equivalent of spitting into a hurricane in this context. Similarly, with their sovereigns bankrupt, virtually the entire euro area banking system, which sports uncovered deposit liabilities amounting to € 4 trillion, is just as bankrupt. These four trillion euros are overnight deposits the fractionally reserved banks owe to their depositors on demand and for which no reserves exist. If they are not insolvent, what are they?
Here are excerpts from Den Danske's assessment – at least they acknowledge in passing that there has been no reform worth mentioning yet, but as noted above, they are confusing a cyclical improvement in 'economic activity' that is largely due to a bout of credit expansion ex nihilo with an 'end to the debt crisis'.
“There are increasing signs that Europe currently is leaving the crisis behind much faster than most had expected … Today’s PMI data signal growth in both Italy and Spain. It’s now only Greece that appears to be stuck in recession for some time,” said Frank Øland Hansen, one of Danske Bank’s Europe analysts, in a note.
“It’s our assessment that the debt crisis is over. With that, we think there will be no more market panic, where uncertainty about one country spills over into others and creates fears for the entire survival of the euro zone,” he added.
“There will still be bumps along the road, but we’ve seen the euro area able to handle large obstacles, so we don’t expect smaller bumps will trigger renewed panic on the financial markets in the future.”
“The recovery is fragile and largely reflects that the rest of the world currently is improving. If the global recovery derails, it will look bad for Spain and Italy,” Hansen said.
“Reforms are still necessary, and there is in both countries a long way to go before the government-debt situation is under full control.”
Allow us to point out that the 'government debt situation' in these countries is not under any kind of 'control' at all – it is in fact completely out of control, especially in Italy.
And while Spain has seen an improvement in its competitiveness in terms of unit labor costs and an easing of current account related pressures, the housing bust continues. There is one home for every 1.7 inhabitants in Spain – it will be a long time before it lives down the after-effects of the bubble. Meanwhile, both Spain and Italy are facing ever more dire demographic challenges as well.
Both CDS spreads on sovereign debt and government bond yields in the 'periphery' have recently begun to rise again from a higher low.
Portugal has seen a sharp rise in its CDS spread to 520 basis points. This is actually level indicating intensifying crisis conditions. Moreover, the markets are increasingly wary of Eastern European countries in view of the recent currency and debt convulsions in a number of emerging market countries.
Below are a few charts illustrating the situation. As usual, charts and price scales are color coded (readers should keep the different price scales in mind when assessing 4-in-1 charts). Where necessary we have provided a legend for the color coding below the charts. Prices are as of Tuesday's close.
10 year government bond yields on the same four countries. Note, Italy's yield shown here is the generic bid, the actual yield is at 4.56%, higher than Spain's – see the next chart – click to enlarge.
10year yields on UK gilts (yellow line), German Bunds (orange line), Austria's 10 year government bond (green) and Ireland's 10 year government bond (cyan). Gilt yields continue to misbehave and ignore Mr. Carney – click to enlarge.
And lastly, here are the 5 year CDS spreads on Morocco, Turkey, Saudi Arabia and Bahrain – with Turkey still the obvious standout. The rest of the region seems to be in the grip of Syria-related worries – click to enlarge.
Things are not as calm in the credit market arena as one would expect if all it took to take the crisis off the table were a few improving PMI data. The surge in euro area money supply growth over the past year is already being undermined again, as bank credit growth has recently stalled and reversed, shrinking by 5.1% annualized over the past trimester. As Sean Corrigan recently pointed out, the improvement in PMI data likely also owes much to the inventory cycle, which is well known for delivering false dawns (just look at Japan's post bubble history).
We would argue that the crisis continues to be on an extended 'pause', but it may well flare up again once the troika's bean counters take their next close look at Greece, Portugal and Slovenia after Germany's election. In our opinion, the major wild card and probably the place that is most likely to create a serious aggravation of the euro area's simmering problems remains Italy. In Italy, no discernible improvements in the most important data points, namely public debt growth and unit labor costs, are in evidence yet. France will also continue to hover over the proceedings like the proverbial sword of Damocles unless its political leadership gathers up the courage to deliver much-needed drastic economic reform – an unlikely prospect considering the appalling economic illiteracy of Hollande and company.
Lastly, Germany may very well become the center of a new bubble if growth in credit and money picks up again (for details on this, see this previous article on Germany's bubble potential). Such a development would imply an even longer crisis pause, but it would be followed by an even worse bust once the boom falters. No credit expansion-induced bubble ends well.
Charts by: Bloomberg, Tradingeconomics, BigCharts
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