France: On the Edge of the Periphery By John Mauldin

Sunday, September 1, 2013

(…) I've spent a good deal of time this past month reviewing the European situation, and I'm more convinced than ever that France is on its way to becoming the most significant economic train wreck in Europe within the next few years. (…) I think I need first to acknowledge that the market clearly doesn't agree with me. The market for French OATs, their longer-term bonds, sees no risk. (…) France's neighbors, Italy and Spain, have rates that are roughly double France's. But as we will see, the underlying economics are not that much different for the three countries, and you can make a good case that France’s trajectory may be the worst. (…)
We will start with a remarkable example of both hubris and economic ignorance published earlier this year in Le Monde. Under the headline "No: France Is Not Bankrupt," Bruno Moschetto, a professor of economics at the University of Paris I and HEC, made the following case. : “No, France is not bankrupt .... The claim is untrue economically and financially. France is not and will not bankrupt because it would then be in a state of insolvency. A state cannot be bankrupt, in its own currency, to foreigners and residents, since the latter would be invited to meet its debt by an immediate increase in taxation. In abstract, the state is its citizens, and the citizens are the guarantors of obligations of the state. In the final analysis, "The state is us." To be in a state of suspension of payments, a state would have to be indebted in a foreign currency, unable to deal with foreign currency liabilities in that currency….Ultimately our leaders have all the financial and political means, through the levying of taxes, to be facing our deadlines in euros. And besides, our lenders regularly renew their confidence, and rates have never been lower.”
Let’s look at few facts, Prof. Moschetto :
·        France is in recession and has been for almost two years. Even the government is beginning to acknowledge that growth is and will be flat. Standard & Poor's thinks your growth rate may be as low as -1.5%. Jean-Michel Six of Standard & Poor's recently noted, "The current account deficit is growing month after month, and this means it is depending more and more on the rest of the world to finance its growth. In my view, France has got just one more year to sort itself out." One of the ways to deal with a debt crisis is to grow your way out of it. You are not doing that. The number of new industrial plants created by foreigners fell 25% last year, and new job creation fell 53%.French industrial output is still falling, and both your manufacturing and service PMIs are among the worst in Europe—far worse even than those of Italy and Spain, both of which are clearly in financial disarray. The following PMI chart is from March, but August was still in negative territory (chart courtesy of Josh Ayers of Paradarch Advisors).

·        Your debt growth is unsustainable. France is currently enjoying the lowest effective borrowing rates it has had for 30 years, allowing the interest you pay to fall even as the total debt rises. Both interest payments and interest as a percentage of GDP are at all-time lows.
Here is a summary analysis from just about the best research team around, at Bridgewater:
France is approaching the point in its debt expansion phase in which debt service costs will rise faster than incomes causing a squeeze. France's debts are rising relative to incomes while interest rates are falling so that debt service expenses are falling relatively despite the greater debts. When debt service expenses fall relative to income, that leaves more money for spending which is stimulative for the economy. Both the risk-free rate and credit spreads have fallen just about as far as possible. As a result, the net relief in debt service payments that has come from the interest rate decline will be removed. If interest rates rise, particularly if both the risk-free rate and the credit spreads rise, the debt service bill will have to increase more.
That means that either (a) debt service expenses will increase as a share of income, thus squeezing consumption and lowering economic growth (b) there will be an acceleration of indebtedness in order to pay for both the increased debt service requirements and increased consumption growth (which is a sure sign of an unsustainable bubble) or (c) incomes from some other sources have to rise. Since income growth is a function of productivity growth and competitiveness in global markets, and France is not doing much to improve productivity and competitiveness, we do not expect incomes to benefit from changes in these. That means that debt and debt service growth will either accelerate until the debt bubble pops or debt growth and economic growth will slow which will be painful. Since painful slower growth is not an option, it is more likely that debt and debt service growth will accelerate until the bubble pops. That will have important implications for the whole Eurozone.
France is getting close to the end of its ability to play games with its debt. Though France moved a lot of its debt to off-balance-sheet accounts for its social programs, the total debt is growing so much that the rating agencies will have to start taking notice.
  1. The level of French debt is at postwar highs and is beginning to approach that of the peripheral countries. Note in the chart below from Bridgewater that in Germany total nonfinancial debt has been decreasing the past few years, the debt of peripheral Europe in the aggregate has gone roughly flat, but France's debt is increasing dramatically. At the pace France is accumulating new debt, it will not be long before your financial situation looks quite similar to that of your peripheral neighbors.

Your fiscal deficit this year is likely to be well north of 4%, far above the level specified in your commitments to the Eurozone. The budget watchdog of France, the Cour des Comptes, is calling for much deeper budget cuts than Mr. Hollande is proposing. The unions and government employees, as well as much of Mr. Hollande's party, are in very vocal rebellion. France deeply needs labor reforms to make itself more competitive, but there is simply no political will or ability to do so.Your social budget (entitlement spending) is currently 35% of your total GDP. (…)  
In France, the percentages of both payers and beneficiaries are now moving the wrong way. While the blue-haired beneficiary-intensive percentage of the total population has been consistently increasing over the last 25 years, the percentage of payers began declining. Is it any surprise then that the two major explosions in French fiscal deficits coincided with both the decline of the 30-49 year-old demographic in the mid-1990s and then later with the percentage acceleration of the 60+ demographic in the late 2000s?
  1. France is in a profound economic funk, and this is not the stuff from which significant recoveries are made. Consumer confidence in your country, Professor, was at a 40-year low in June. A recent study by the Pew Foundation said French support for the European Project has crashed from 60% to 40% over the past year. Just 22% now think EU economic integration is positive.The French unemployment level is at a 15-year high of 11.2% and has risen for 26 consecutive months. French youth unemployment stands at 25.7%. The IMF recently issued a report which suggests that the proposed economic reforms of Mr. Hollande do not go deep enough and will not cut unemployment from double-digit levels by the end of the decade. France has seen a chronic erosion of labor competitiveness against Germany under monetary union due to higher wage deals. Pay has jumped 53pc in France and 35pc in Germany since 1999. French hourly wage costs are now 5pc higher at €36.40, even though German productivity is better.  The IMF said the new twist is that France has begun to lose ground to Italy and Spain as they shake up their systems or cut wages. The chief worry is "a steady loss of market share, both globally and relative to peers.(The Telegraph)
6.Foreign holdings of French debt are 50% higher than those for Italy and four times higher than those for Spain. As investors became concerned about Spanish and Italian debt, they rotated into over $1 trillion of French government debt on the assumption that the French debt was safer. The simple fact is that France can't print its own currency, so it is therefore dependent upon the kindness of strangers. Bridgewater estimates that if France were judged solely on its fundamentals, its spread to Germany should be about 3.5% rather than the current 50 basis points. If that kind of differential were realized by the marketplace, France would have no hope, under the current regime, of getting its deficit under 3%, let alone below nominal GDP growth, which is the more important number.
7.Like the peripheral Eurozone countries, France has started to run a significant trade deficit. Without going into the math, in very general terms, you cannot reduce your debt and run a trade deficit the same time. That has been one of the key problems in Greece, Portugal, Spain, and Italy. Restructuring a trade deficit is painful in that it requires either a downward currency adjustment or a reduction in labor costs (or an increase in labor productivity). When currency devaluations are not possible, the adjustment is typically borne on the shoulders of workers in the form of reduced wages and layoffs. That of course means lower tax revenues and larger deficits, coming at a time when they are the most difficult to handle. France has simply become uncompetitive. New businesses are not being created, and existing businesses are leaving. (…)
8.French government spending is already at 56% of GDP, and debt-to-GDP is over 90%. At what point will the market begin to worry about a debt trap? How much more can you tax? And do you really want to raise taxes with the economy as weak as it is? You can't print money without the agreement of Germany and the rest of the European Union. Cutting spending by 4 to 5% over the next few years will result in a far more serious recession than what you've been experiencing. (Just ask Greece or Spain.)
  When I look at your options in France, Professor, I see nothing but bad choices. Perhaps you can talk Germany into writing a check to cover your deficits, but I for one wouldn't hold my breath. Ask Cyprus how that went. The only way you're going to get the rest of Europe to write checks is to agree to give up your budgetary sovereignty. (And they in turn will have to give up theirs in a massive fiscal experiment—more on that below.) Given the mood of the French public as expressed in the polls, how likely is it that France will agree to such terms? But then, if you don't want to deal with enforced austerity, what choice do you have? Foreign creditors are not going to continue to extend loans to France simply because it is France.

So What Is the Catalyst for a French Crisis?

 So why does France enjoy such low interest rates? The simplistic answer is that the market simply doesn't see the risk. But then again it didn't see the risk in Greece or Italy or Spain prior to their crises, either. I think the catalyst could come during the latter part of this year or in the first half of 2014. There are two events that might serve.

First, something has to be done very soon about Portugal. The Portuguese are going to need another infusion of capital. Their economy is upside down; their debt relative to GDP is still growing faster than income; and the simple fact is that they need to default on part of their debt. Call it debt forgiveness or apply whatever euphemism you want, it will be default. Otherwise, Portugal will slowly suffocate under the massive interest payments required to service its debt. The problem is that any haircut on the debt would put Portuguese banks (which are the largest holder of Portuguese debt) into insolvency. The only guarantor of Portuguese banks under the current structure is the Portuguese government, which means that in order to take a haircut on the debt it already owes to creditors, the government would have to borrow more money to give to the banks. They would be taking two steps backward for every step forward. After Cyprus, it is now apparent that the EU and the ECB are perfectly willing to see large depositors and subordinated bondholders of banks take rather large haircuts rather than assume a mutual liability. If the same principles are applied to Portuguese banks as were applied to those of Cyprus, it would make a bad financial situation in Portugal even more desperate. And yet if the ECB bails out Portuguese banks under some legal fiction, Cyprus would have a real justification for possible lawsuits. There are simply no good or easy solutions for Portugal without someone incurring a great deal of pain. But a Portuguese banking crisis would mean a run on Italian and Spanish banks. It is really that simple.
Everyone was told, and the market obviously believes, that Greece was "one-off" and that no other country would need to take a haircut on its debt. If Portugal does, then the contagion factor that Europe was worried about with Greece will really come into play. If Germany and the other core countries allow Portugal to default in some manner, what does that say about their willingness to fund even larger sums for Italy and Spain? What will France do? Will it support further austerity for Portugal, or will the French argue for generalized European taxpayer support of Portugal (thereby implying that France should be able to access the same funding at some point in the future)? Portugal has plunged itself into what can only be called severe austerity and is suffering economically for it. How much more can the Portuguese be asked to endure? The answer could be, quite a lot more, unless Germany and others want to write a rather large check. Italy, Spain, and France will be watching If private investors in Portuguese banks are forced to take losses, that will make Italian and Spanish bank depositors nervous. Anyone paying attention to French fundamentals will begin to question the current low interest-rate regime there as well.
And then there are the European bank stress tests that are scheduled for early 2014. These have been postponed so that the ECB can do its own analysis, but the time for them is fast approaching. Regulators want to have a uniform methodology across the Eurozone for calculating bad loans, which will keep banks from using "local practices" to hide bad debts. Further, it is not yet clear how the new bank stress tests will treat sovereign debt. Heretofore, sovereign debt in Europe has been considered risk-free, and banks have levered up as much as 40 to 1 on sovereign debt. Portuguese banks, for instance, don't have to reserve against the purchase of Portuguese debt, and neither do Italian or Spanish banks when they purchase their own country's debt. Any modest restructuring of national debt will result in massive bank insolvencies, not just in the peripheral countries but throughout Europe. There is some talk of beginning to require reserves against sovereign debt, but this would mean that banks would have to raise significant amounts of capital in order to bring their required Tier 1 ratios into compliance. Good luck raising the tens of billions of euros that would be required in the present market environment. The bank stress tests that were administered a few years ago were a joke, and everybody knows it. It was all wink, wink and nod, nod and figure out how to finesse the obvious. In order to sustain any credibility, the next round of stress tests will have to be far more serious. How the new regulatory regime of the ECB deals with sovereign debt will to a great extent tell the world how serious they are about stress testing. After Greece, and after looking at the ongoing problems of Portugal and Spain (and especially Spanish banks), who can say with a straight face that there is absolutely no risk in sovereign debt? But if there is some risk, then there must be reserves against it. 
These two events—dealing with Portugal and undertaking the European bank stress tests—will focus the attention of the markets back on the fundamentals of European debt and the euro. It is quite possible that the French fiscal deficit will be over 5% in 2014. In a speech last week, Hollande talked about how France will have full employment, a third industrial revolution, and affordable housing within 10 years. Social justice will be achieved, and climate change will be dealt with. There was a lot of happy talk about how wonderful the future will be but not many details on how to get there. At some point the market will no longer be content with happy talk: it will demand action. That action is going to be difficult to produce, given the internal politics of France. The decisions France makes, along with those of Germany, will determine the future of the euro experiment. And the situation is not as simple as asking whether France will get its fiscal house in order or whether Germany will write a check.
Indulge me for a moment as I offer a very speculative but interesting scenario. German exporters would like to see a weaker euro, but Germany does not want to allow the European Central Bank to print money. However, German leaders recognize that at some point, if the Eurozone is to maintain a currency union, it must also have a fiscal union. A breakup of the Eurozone would be disastrously expensive for everyone but especially for Germany. There will be a live-or-die effort by all parties to maintain the euro. If Germany and the other fiscally sound members of the European Union can persuade the peripheral countries to adopt rules that require fiscal restraint in return for mutualization of debt, then that would allow the ECB to monetize deficits in the interim—and thus potentially weaken the euro.
This scenario would require members of the Eurozone to give up a great deal of their fiscal autonomy to Brussels. This will become the central question with regard to the existence of the euro within a few years. In an odd sort of way, the Eurozone is going to enter into its own internal currency war as the peripheral nations continue to have debt problems. The situation will be exacerbated by the fiscal crisis that will soon engulf France. It will come precisely at the moment when Germany will be asked to allow the ECB to accommodate the French bond market, as it has done for Italy and Spain, and when France will in turn be asked to enter into a period of austerity, as both Italy and Spain have done (very painfully). It is at that moment that the ultimate survival of the euro will be decided.
While I do think the euro will survive, I have to admit that I'm not strongly convinced of it. The euro has never been a truly economic currency; it was created as a political statement, and is a political currency. The problem for Europe is that a currency union ultimately requires a fiscal union. Just as the various states within the United States have to balance their budgets, that is what might be required of countries that are part of a European fiscal union. Given that most of Europe has entitlement-spending problems just as severe (or worse!) than those of the US, there will not be a European fiscal union without a great deal of political contention. Will Germany be willing to pick up the tab for the rest of Europe, given the serious fiscal constraint that will impose on its own budget? Will France be willing to give up control of its budget process to Brussels? These are the questions on which the future of the euro hinges.
Charles de Gaulle said that "France cannot be France without greatness." The current path that France is on will not take it to renewed greatness but rather to insolvency and turmoil. Is France destined to be grouped with its Mediterranean peripheral cousins, or to be seen as part of the solid North Atlantic core? The world is far better off with a great France, but France can achieve greatness only by its own actions.
READ MORE - France: On the Edge of the Periphery By John Mauldin

The Reformed Broker: Enter the financial Blogosphere

Tuesday, December 25, 2012

A big thank to Joshua Brown from the Reformed Broker Blog. In his latest post Joshua published the entire guide to economic and financial blogs.

Most of the blogs Joshua listed are already referenced by Hedgeyourmind in the financial or economic sections.

The links are updated automatically through RSS feeds.

READ MORE - The Reformed Broker: Enter the financial Blogosphere

Latest presentation from David Rosenberg: Navigating the New Normal

Friday, November 9, 2012

The New Normal is not a new concept. Render therefore unto Caesar what belongs to Caesar, this concept was invented in september 2009 by Bill Gross from Pimco.

As a reminder, here is the first paper on the new normal by Pimco.

Pimco New Normal

 Business Insider Blog has just published the latest presentation from David Rosenberg. The entire feature reproduced with permission is presented on this link

Link to David Rosenberg Presentation

READ MORE - Latest presentation from David Rosenberg: Navigating the New Normal

Sunday Amusement: The Vickers Report

Sunday, November 20, 2011

Some readings for this sunny sunday morning:

The Vickers Report:  According to the UK Independent Commission on Banking which issued its much-anticipated report in mid september,  if its recommendations — which the government has pledged to adopt — had been in place before 2007 they would have helped prevent the run on Northern Rock and the collapse of Lehman Brothers, three years ago this week, which led to the 2008 banking crisis.

This report addresses more especially the UK banking sector but it provides an insightful analysis of the problems the european banking sector has to cope with.

An interesting post about the impact of regulation on the banking sector published on Zerohedge.

READ MORE - Sunday Amusement: The Vickers Report

New blogs referenced on Hedgeyourmind

Saturday, November 19, 2011

I just added some very interesting blogs on Hedgeyourmind:

Sovereign Speculator: part of the disclaimer speaks of itself... "The securities markets are dangerous, and these days, with systemic risks everywhere, they are dangerous for even the most prudent. The only advice I am not afraid to give is my strongest advice: get out of the markets and stay out! This means to invest only in the safest cash equivalents until true value is restored elsewhere by a long secular bear market."

Kimble Charting Solutions: All about technical analysis

Ed Yardeni's Blog : Some interesting charts...

Reality Lenses: All about macro economics and financial markets

News from 1930:  Very original and as history repeats itself.... Daily summary based upon the reading of the Wall Street Journal from the corresponding day in 1930.

Georges Soros official website: a link to his articles and essays

And last but not least, for the french speakers and readers, a link to La Bourse et la Vie, a Web Tv that is the first in France with high level content in videos about companies, markets and economy, giving you a unique view for French market.

With more than 800 videos in 2011, is the first database for listed companies in videos.

I am going to create a Fund Managers Newsletters section. You will have access to the archives of the newsletters written by highly regarded fund managers.

I wish you a good week end and enjoy your readings!



READ MORE - New blogs referenced on Hedgeyourmind

RIP Steve: How to live before you die

Thursday, October 6, 2011

I won't comment on the fantastic turnaround story of Apple since the comeback of Steve Jobs. I prefer to focus on his personality.

"Your time is limited, so don't waste it living someone else's life. Don't be trapped by dogma - which is living with the results of other people's thinking. Don't let the noise of other's opinions drown out your inner voice. And most important, have the courage to follow your heart and intuition. They somehow already know what you truly want to become. Everything else is secondary." Steve Jobs

Playboy Interview With Steve Jobs
READ MORE - RIP Steve: How to live before you die

Time to return to basics: Bob Farell's 10 market rules to remember

Friday, September 23, 2011

This post is an excerpt from an article published on marketwatch in June 2008. Bob Farrell was a legend at Merrill Lynch & Co. for several decades. Farrell had a front-row seat to the go-go markets of the late 1960s, mid-1980s and late 1990s, the brutal bear market of 1973-74, and October 1987's crash. He retired as chief stock market analyst at the end of 1992.

1. Markets tend to return to the mean over time

By "return to the mean," Farrell means that when stocks go too far in one direction, they come back. If that sounds elementary, then remember that both euphoric and pessimistic markets can cloud people's heads. "It's so easy to get caught up in the heat of the moment and not have perspective," says Bob Doll, global chief investment officer for equities at money manager BlackRock Inc. "Those that have a plan and stick to it tend to be more successful."

2. Excesses in one direction will lead to an opposite excess in the other direction

Think of the market as a constant dieter who struggles to stay within a desired weight range but can't always hit the mark.

3. There are no new eras -- excesses are never permanent 

This harkens to the first two rules. Many investors try to find the latest hot sector, and soon a fever builds that "this time it's different." Of course, it never really is. When that sector cools, individual shareholders are usually among the last to know and are forced to sell at lower prices. "It's so hard to switch and time the changes from one sector to another," says John Buckingham, editor of The Prudent Speculator newsletter. "Find a strategy that you believe in and stay put."

4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways 

This is Farrell's way of saying that a popular sector can stay hot for a long while, but will fall hard when a correction comes. Chinese stocks not long ago were market darlings posting parabolic gains, but investors who came late to this party have been sorry.

5. The public buys the most at the top and the least at the bottom 

Sure, and if they didn't, contrarian-minded investors would have nothing to crow about. Accordingly, many market technicians use sentiment indicators to gauge investor pessimism or optimism, then recommend that investors head in the opposite direction.

6. Fear and greed are stronger than long-term resolve

Investors can be their own worst enemy, particularly when emotions take hold. Stock market gains "make us exuberant; they enhance well-being and promote optimism," says Meir Statman, a finance professor at Santa Clara University in California who studies investor behavior. "Losses bring sadness, disgust, fear, regret. Fear increases the sense of risk and some react by shunning stocks."  To counter those insecure feelings, practice self-control and keep long-range portfolio goals in perspective. That will help you to be proactive instead of reactive. "It's critical for investors to understand how they're cut," says the Prudent Speculator's Buckingham. "If you can't handle a 15% or 20% downturn, you need to rethink how you invest."

7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names

Markets and individual sectors can move in powerful waves that take all boats up or down in their wake. There's strength in numbers, and such broad momentum is hard to stop, Farrell observes. In these conditions you either lead, follow or get out of the way. When momentum channels into a small number of stocks, it means that many worthy companies are being overlooked and investors essentially are crowding one side of the boat. That's what happened with the "Nifty 50" stocks of the early 1970s, when much of the U.S. market's gains came from the 50 biggest companies on the New York Stock Exchange. As their price-to-earnings ratios climbed to unsustainable levels, these "one-decision" stocks eventually sunk.

8. Bear markets have three stages -- sharp down, reflexive rebound and a drawn-out fundamental downtrend

9. When all the experts and forecasts agree -- something else is going to happen

As Stovall, the S&P investment strategist, puts it: "If everybody's optimistic, who is left to buy? If everybody's pessimistic, who's left to sell?" Going against the herd as Farrell repeatedly suggests can be very profitable, especially for patient buyers who raise cash from frothy markets and reinvest it when sentiment is darkest.

10. Bull markets are more fun than bear markets

No kidding, no comment...
READ MORE - Time to return to basics: Bob Farell's 10 market rules to remember

IMF Autumn 2011 World Economic Outlook Report

Tuesday, September 20, 2011

Here is the latest report on the World Economic Outlook Report published by the IMF. No new news. We are entering the "new normal" era best described by Bill Gross at Pimco. IMF
READ MORE - IMF Autumn 2011 World Economic Outlook Report

Sushi Macro-Economics: Food for thoughts

Monday, September 5, 2011

I re-publish today an interview with Richard Koo from Nomura edited in September 2009. I strongly recommend reading his book "The Holy Grail in Macro Economics: Lessons from Japan's Great Recession" along with the Kenneth Rogoff's book "This Time Is Different: Eight Centuries of Financial Folly" for all who wish to understand the big picture for the years ahead.

I strongly believe that Macro-economics and History should represent a major part of the CFA curriculum.... I will argue later on this point.

Last September 2010 I was very sceptical regarding the effectiveness of a Quantitative Easing Policy when Bernanke launched the QE 2.0 in september 2010 (Read my article Effectiveness of a Quantitative Easing Policy In a Balance Sheet Recession context: a must-read with Nomura's Richard Koo).

Unfortunately, my feeling was right as I wrote at that time "the belief that QE2 is coming and will be successful at reflating the economy and asset prices is pervasive. If QE1 was successful at reflating wall street, it never succeeded in reflating main street.

Here is an insightfull interview of the famous Richard Koo from Nomura who explains the Balance Sheet Recession in Japan and the effectiveness of fiscal and monetary policies. Financial markets need a QE2 because the first one failed and the recovery is one of the weakest we noticed since WWII.

We are in a consumer recession: the balance sheet of households need to be repaired, the output gap is massive, massive spare capacities are available, the U6 underemployment rate has stabilized at 16,5%. How can the QE2 be effective? This interview of Richard Koo is a must-read. It was published in september 2009. It is not obsolete at all. Please note the similarities between Japan and Europe and the USA: if it is not so amazing, it is defintitely, frightful... koo
READ MORE - Sushi Macro-Economics: Food for thoughts

James Montier: The seven laws of investing

Tuesday, May 17, 2011

A must read from James Montier on the seven laws of investing.

The Seven Laws of Investing
READ MORE - James Montier: The seven laws of investing

Must Read from GMO Jeremy Grantham: "Night of the Living Fed"

Thursday, October 28, 2010

If you still wonder what could be the effectiveness of a new quantitative easing policy in a balance-sheet recession, please read carefully this paper of GMO on the ruinous cost of Fed manipulation of asset prices on th economy.

READ MORE - Must Read from GMO Jeremy Grantham: "Night of the Living Fed"

Remember the 10/19/1987 crash

Tuesday, October 19, 2010

At that time electronic trading was in its infancy. No sophisticated algorithm, no flash trading, no high frequency trading, but it happened!

READ MORE - Remember the 10/19/1987 crash

Effectiveness of a Quantitative Easing Policy In a Balance Sheet Recession context: a must-read with Nomura's Richard Koo

Thursday, October 7, 2010

The belief that QE2 is coming and will be successful at reflating the economy and asset prices is pervasive. If QE1 was successful at reflating wall street, it never succeed in reflating main street.

Here is an insightfull interview of the famous Richard Koo from Nomura who explains the Balance Sheet Recession in Japan and the effectiveness of fiscal and monetary policies. The financial markets need a QE2 because the first one failed and the recovery is one of the weakest we noticed since WWII.

We are in a consumer recession: the balance sheet of households need to be repaired, the output gap is massive, massive spare capacities are available, the U6 underemployment rate has stabilized at 16,5%. How can the QE2 be effective?

This interview of Richard Koo is a must-read. It was published in september 2009. It is not obsolete at all. Please note the similarities between Japan and Europe and the USA: if it is not so amazing, it is defintitely, frightful...

READ MORE - Effectiveness of a Quantitative Easing Policy In a Balance Sheet Recession context: a must-read with Nomura's Richard Koo

Martin Wolf on Greece and Eurozone: The beginning of the end

Wednesday, May 5, 2010

Here is the article from the Financial Times. Dear European citizens, please fasten (oups!!!! tighten...) your belt and go straight away at the top of the Olympus Mont to pray for our future (before Greece auction all its inventory of gods)........

From the Financial Times

Desperate times; desperate measures. After months of costly delay, the eurozone has come up with an enormous package of support for Greece. By bringing in the International Monetary Fund, at Germany's behest, it has obtained some additional resources and a better programme. But is it going to work? Alas, I have huge doubts.

So what is the programme? In outline, it is a package of €110bn (equivalent to slightly more than a third of Greece's outstanding debt), €30bn of which will come from the IMF (far more than normally permitted) and the rest from the eurozone. This would be enough to take Greece out of the market, if necessary, for more than two years. In return, Greece has promised a fiscal consolidation of 11 per cent of gross domestic product over three years, on top of the measures taken earlier, with the aim of reaching a 3 per cent deficit by 2014, down from 13.6 per cent in 2009. Government spending measures are to yield savings of 5¼ per cent of GDP over three years: pensions and wages will be reduced, and then frozen for three years, with payment of seasonal bonuses abolished. Tax measures are to yield 4 per cent of GDP. Even so, public debt is forecast to peak at 150 per cent of GDP.

In important respects, the programme is far less unrealistic than its intra-European predecessor. Gone is the fantasy that there would be a mild economic contraction this year, followed by a return to steady growth. The new programme apparently envisages a cumulative decline in GDP of about 8 per cent, though such forecasts are, of course, highly uncertain. Similarly, the old plan was founded on the assumption that Greece could slash its budget deficit to less than 3 per cent of GDP by the end of 2012. The new plan sets 2014 as the target year.

Two other features of what has been decided are noteworthy: first, there is to be no debt restructuring; and, second, the European Central Bank will suspend the minimum credit rating required for the Greek government-backed assets used in its liquidity operations, thereby offering a lifeline to vulnerable Greek banks.

So does this programme look sensible, either for Greece or the eurozone? Yes and no in both cases.

Let us start with Greece. It has now lost access to the markets (see chart). Thus, the alternative to agreeing to this package (whether or not it can be implemented) would be default. The country would then no longer pay debt interest, but it would have to close its primary fiscal deficit (the deficit before interest payments), of 9-10 per cent of GDP, at once. This would be a far more brutal tightening than Greece has now agreed. Moreover, with default, the banking system would collapse. Greece is right to promise the moon, to gain the time to eliminate its primary deficit more smoothly.

Yet it is hard to believe that Greece can avoid debt restructuring. First, assume, for the moment, that all goes to plan. Assume, too, that Greece's average interest on long-term debt turns out to be as low as 5 per cent. The country must then run a primary surplus of 4.5 per cent of GDP, with revenue equal to 7.5 per cent of GDP devoted to interest payments. Will the Greek public bear that burden year after weary year? Second, even the IMF's new forecasts look optimistic to me. Given the huge fiscal retrenchment now planned and the absence of exchange rate or monetary policy offsets, Greece is likely to find itself in a prolonged slump. Would structural reform do the trick? Not unless it delivers a huge fall in nominal unit labour costs, since Greece will need a prolonged surge in net exports to offset the fiscal tightening. The alternative would be a huge expansion in the financial deficit of the Greek private sector. That seems inconceivable. Moreover, if nominal wages did fall, the debt burden would become worse than forecast.

Willem Buiter, now chief economist at Citigroup, notes, in a fascinating new paper, that other high-income countries, notably Canada (1994-98), Sweden (1993-98) and New Zealand (1990-94), have succeeded with fiscal consolidation. But initial conditions were much more favourable in these cases. Greece is being asked to do what Latin America did in the 1980s. That led to a lost decade, the beneficiaries being foreign creditors. Moreover, as creditors are now paid to escape, who will replace them? This package will surely fail to return Greece to the market, on manageable terms, in a few years. More money will be needed if debt restructuring is unwisely ruled out.

For other eurozone members, the programme prevents an immediate shock to fragile financial systems: it is overtly a rescue of Greece, but covertly a bail-out of banks. But it is far from clear that it will help other members now in the firing line. Investors could well conclude that the scale of the package required for tiny Greece and the overwhelming difficulty of agreeing and ratifying it, particularly in Germany, suggest that further such packages are going to be elusive. Other eurozone members might well end up on their own. None is in as bad a condition as Greece and none has shown the same malfeasance. But several have unsustainable fiscal deficits and rapidly rising debt ratios (see chart). In this, their situation does not differ from that of the UK and US. But they lack the same policy options.

This story, in short, is not over.

For the eurozone, two lessons are clear: first, it has a choice – either it allows sovereign defaults, however messy, or it creates a true fiscal union, with strong discipline and funds sufficient to cushion adjustment in crushed economies – Mr Buiter recommends a European Monetary Fund of €2,000bn; and, second, adjustment in the eurozone is not going to work without offsetting adjustments in core countries. If the eurozone is willing to live with close to stagnant overall demand, it will become an arena for beggar-my-neighbour competitive disinflation, with growing reliance on world markets as a vent for surplus. Few are going to like this outcome.

The crises now unfolding confirm the wisdom of those who saw the euro as a highly risky venture. These shocks are not that surprising. On the contrary, they could have been expected. The fear that yoking together such diverse countries would increase tension, rather than reduce it, also appears vindicated: look at the surge of anti-European sentiment inside Germany. Yet, now that the eurozone has been created, it must work. The attempted rescue of Greece is just the beginning of the story. Much more still needs to be done, in responding to the immediate crisis and in reforming the eurozone itself, in the not too distant future.
READ MORE - Martin Wolf on Greece and Eurozone: The beginning of the end

How Goldman Sachs helped Greece mask its true debt!

Tuesday, February 9, 2010

From Spiegel Online you will find this not-so astonishing news:

Goldman Sachs helped the Greek government to mask the true extent of its deficit with the help of a derivatives deal that legally circumvented the EU Maastricht deficit rules. At some point the so-called cross currency swaps will mature, and swell the country's already bloated deficit.

Greeks aren't very welcome in the Rue Alphones Weicker in Luxembourg. It's home to Eurostat, the European Union's statistical office. The number crunchers there are deeply annoyed with Athens. Investigative reports state that important data "cannot be confirmed" or has been requested but "not received."

Creative accounting took priority when it came to totting up government debt.Since 1999, the Maastricht rules threaten to slap hefty fines on euro member countries that exceed the budget deficit limit of three percent of gross domestic product. Total government debt mustn't exceed 60 percent.

The Greeks have never managed to stick to the 60 percent debt limit, and they only adhered to the three percent deficit ceiling with the help of blatant balance sheet cosmetics. One time, gigantic military expenditures were left out, and another time billions in hospital debt. After recalculating the figures, the experts at Eurostat consistently came up with the same results: In truth, the deficit each year has been far greater than the three percent limit. In 2009, it exploded to over 12 percent.

Now, though, it looks like the Greek figure jugglers have been even more brazen than was previously thought. "Around 2002 in particular, various investment banks offered complex financial products with which governments could push part of their liabilities into the future," one insider recalled, adding that Mediterranean countries had snapped up such products.

Greece's debt managers agreed a huge deal with the savvy bankers of US investment bank Goldman Sachs at the start of 2002. The deal involved so-called cross-currency swaps in which government debt issued in dollars and yen was swapped for euro debt for a certain period -- to be exchanged back into the original currencies at a later date.

Fictional Exchange Rates

Such transactions are part of normal government refinancing. Europe's governments obtain funds from investors around the world by issuing bonds in yen, dollar or Swiss francs. But they need euros to pay their daily bills. Years later the bonds are repaid in the original foreign denominations.

But in the Greek case the US bankers devised a special kind of swap with fictional exchange rates. That enabled Greece to receive a far higher sum than the actual euro market value of 10 billion dollars or yen. In that way Goldman Sachs secretly arranged additional credit of up to $1 billion for the Greeks.

This credit disguised as a swap didn't show up in the Greek debt statistics. Eurostat's reporting rules don't comprehensively record transactions involving financial derivatives. "The Maastricht rules can be circumvented quite legally through swaps," says a German derivatives dealer.

In previous years, Italy used a similar trick to mask its true debt with the help of a different US bank. In 2002 the Greek deficit amounted to 1.2 percent of GDP. After Eurostat reviewed the data in September 2004, the ratio had to be revised up to 3.7 percent. According to today's records, it stands at 5.2 percent.

At some point Greece will have to pay up for its swap transactions, and that will impact its deficit. The bond maturities range between 10 and 15 years. Goldman Sachs charged a hefty commission for the deal and sold the swaps on to a Greek bank in 2005.

The bank declined to comment on the controversial deal. The Greek Finance Ministry did not respond to a written request for comment.
READ MORE - How Goldman Sachs helped Greece mask its true debt!

From Calculated Risk: Fed Economic Letter: "Global Household Leverage, House Prices, and Consumption"

Monday, January 11, 2010

One of the most interesting post of early 2010.
Fed Economic Letter: "Global Household Leverage, House Prices, and Consumption"
Source: sent this using ShareThis.
READ MORE - From Calculated Risk: Fed Economic Letter: "Global Household Leverage, House Prices, and Consumption"

Greece: Let's dance sirtaki on the liquid dance floor!!!

Wednesday, November 25, 2009

You'll find the ever widening CDS on the fast-growing hellenic debt. Rather frightening considering that CDS are revisiting march levels (remember: markets were scared by the slump in eastern europe economies and numourous rumours on the blast of the euro were flourishing).

Today it seems that those fears are materialising: Ukraine is in a deep syncope (borders have been closed for two months due to the H1N1 pandemia) and Greece could be deeply impacted by the unwinding of the liquidity-driven ponzi on the hellenic market. While this piece of news could be harmless for HFT or robot traders, it is also completely put aside by fat portfolio managers happy to eat up low priced turkeys for thanksgiving (-30%!!!). The EURUSD is flirting with recent highs (like a turkey dazzled by the headlights of the euphoria-maniac rallye car).

The excellent Researchahead blog was the first one to highlight the greek fire (please read for a very interesting comment on the latest Sirtaki dancefloor):

The underperformance of Greek assets has continued over the past days. In the bond market, 10y GGB-Bund spreads have widened sharply to currently around 174bp from 132bp just two weeks ago and a low of 108bp in early August. As the chart below shows, this spread widening has been mirrored by wider CDS spreads for Greece. Interestingly, the absolute level of the Greek CDS seems to top and bottom ahead of the GGB-Bund spread. In early March it peaked 9 days ahead of the top in the 10y GGB-Bund spread and in early August it bottomed 7 days ahead of the low in the cash-bond spread. What is more, the relative performance of equities seems to lag the developments in the bond markets (I used the difference in the percentage-performance since the lows in the equity indices on March 9). Greek equities have only really started to underperform since late October, i.e. more than two months after the outperformance of Greek GGBs came to a halt and started to revert.

This highlights once again that equity investors ignore the developments in bond markets at their own peril. Furthermore, given that the underlying problems responsible for the latest underperformance are also present in a host of other countries, bond and equity investors should take note. First, Greece is suffering from a structural weak economic position (significant imbalances, low relative competitiveness etc.) coupled with limited room for an ongoing environment of stimulative fiscal as well as monetary policies. Fiscal policy is seriously constrained by the high level of indebtedness and the exorbitantly high budget deficits. In turn, fiscal policy needs to be tightened significantly just to stabilise the deficit near 10%. This, however, will further harm the economy. Moreover, monetary policy is far from exerting the same level of accommodation as in other countries. The level of longer-term interest rates is higher with 10y Greek government bonds yielding 170bp more than their German counterparts (vs. a pre-crisis level of roughly 35bp) whereas the inflation differential has decreased (currently 1.2% difference in headline inflation rates vs. an average of 1.55% over the past 10 years). In turn, the monetary environment for Greece is significantly less accommodative than it is for Germany. Moreover, Greek banks seem to rely relatively more on the ECBs liquidity providing measures. As this FT article suggests - citing a BNP Paribas research piece - 7% of excess reserves provided by the ECB have gone into Greece which only represents 0.9% of EMU GDP. Furthermore, Greek banks seem to have used this liquidity to buy local government paper helping sovereign spreads come down.

However, similar problems (significant structural imbalances, high deficits which will need to be reduced via fiscal tightening, lower level of monetary policy accommodation than for the Eurozone average, high reliance on ECB liquidity providing measures) are apparent in a host of Eurozone countries. I continue to see the largest problems - besides Greece - for Ireland, Portugal and Spain. I still remain a little less worried with respect to Italy (largely because the deficit still appears relatively low which means that there is no need to actively tighten fiscal policy as of yet).

Given the structural economic imbalances coupled with the need to tighten fiscal policy, monetary policy would be more important for those countries to deliver ongoing policy support. But again, the level of interest rates in these countries is significantly higher (especially in Ireland) than in the core of the Eurozone. Coupled with lower inflation rates than for the Eurozone average (-1.5% for Portugal, -0.7% for Spain,-6.5% for Ireland vs. -0.1% for the Eurozone) this means that real yields are much higher. Furthermore, this high level of real interest rates is especially apparent at the long end of the curve given the high level of credit spreads on top of the already steep undlerying yield curve (as measured via Bunds or swap rates). This renders it much more attractive for the banks located in these countries to use the short-end of the yield curve to refinance than locking in rates at the longer end. As a result, I assume that the dependency on the ECBs liquidity provision measures tends to be higher in those countries on average (this is not to say that for example also some weak German Landesbanks do not rely extensively on ECB liquidity). In turn, as the ECB starts to withdraw this liquidity, it will be especially the banking sectors in those weak countries which will suffer significantly, leading to further underperformance of respective bond and equity markets.

Given that the ECB should start to embark on its exit path - even if only at a gradual pace - it becomes even more important to shy away of investments in the structuraly weak Eurozone countries such as Greece, Ireland, Portugal and Spain, be it in sovereign or corporate bonds as well as in equity markets.
READ MORE - Greece: Let's dance sirtaki on the liquid dance floor!!!

Tracking the latest trends in the US consumer behaviour

Monday, October 12, 2009

I have found a very useful way to track in an almost real-time way the behaviour and the appetite of the US consumer using the Google Domestic Trends . Capitalizing on its notoriety, Google Domestic Trends track Google search traffic across specific sectors of the economy. Changes in the search volume of a given sector on may provide unique economic insight.

The 23 sectors tracked are the following ones (please click on the link to download the chart):

It could be very interesting to manage a correlation analysis with real economic indicators published on a monthly basis in order to check for the predictive abilities of those series. This analysis is coming as soon as I will be able to find some time on my agenda.

With all the cautiousness required without such a statistical analysis, we can observe a stabilization of the trends at a very low level (except for unemployement and the search for a job). Regarding consumer buying intentions, it confirms the stabilization at a low level of the ABC Consumer Index. No V-shape recovery in the buying mood of the US consumer recorded in early october (this is not a scoop). Welcome in the era of frugality! The best way to raise the buying power of the underemployed US consumer is to drop prices. Isn't it?

I don't hold any Google shares for my own account or for the funds I manage.
READ MORE - Tracking the latest trends in the US consumer behaviour