By Claus Vistesen, on October 15th, 2010
It is not that I don’t enjoy a good old bull/teflon run as much as the next guy but just to provide some form of balance to the current QEasy Money Hymn I almost choked on my oatmeal earlier this week when I loaded up Bloomberg and learned that everything suddenly was fine in the erstwhile whipping boy (alongside Greece) of the Eurozone as the economy apparently has the cash to starve off any foreign bond vigilantes;
(quote Bloomberg)
Ireland expects its 20 billion-euro ($28 billion) cash pile to stave off a Greek-style rescue, as the government taps the funds to avoid paying record rates to borrow. The government canceled next week’s debt auction and another scheduled for November after the yield on 10-year Irish bonds rose to a record 454 basis points above benchmark German bunds. Finance Minister Brian Lenihan has said Ireland is “fully funded” through the middle of 2011. The country has 4.4 billion euros of bonds maturing next year, compared with about 27 billion euros in Greece.
I find this fascinating for a number of reasons. First of all there is root of the problem itself in the form of Anglo Irish Bank which will cost Ireland perhaps up to 30 billion Euros and will be responsible for a fiscal deficit in 2010 to the tune of of an unbelievable 32% of GDP. Naturally, this is expected to be a one-off expense and the whole exercise on cancelling auctions is because Ireland feels that the yields it would be able to borrow for at the moment would not reflect the long term health of the economy.
This makes sense. Why borrow if you don’t have to and especially if you are not happy with the terms put forward by your potential creditor. On this point I am, in principle, on Ireland’s side as it were. But what if costs for bailing out Irish banks are understated? Indeed, what is the real cost of assuming the entire bad loan book of Irish banks with no haircuts to bondholders or no restructuring of any kind? I don’t know, but more importantly; I am not sure the people concerned in Ireland know either. After all, the fact we are now looking at a +30% deficit as % of GDP in 2010 was not part of any of the official rescue manuals I think.
Consequently, let me throw another number at you; 3 % of GDP which is the fiscal deficit targeted for 2014 and which the market is supposed to take as collateral for a lower yield on Irish debt offerings in 2011.
Yet, is this plausible?
Basically, you have a confirmed 32%/GDP deficit today and you are promising to bring this down to 3% in a manner of 3 years. What are your assumptions here? What kind of nominal growth in GDP is build into the model? How will national debt evolve over this period? I am sure the good people at the National Treasury Management Agency are busy calculating just that as I type, but the problem is more profound.
Ireland has basically made the bet that in using its remaining reserves today and thus avoiding going to the market it can bring back its house in order and then return to borrow at that time, but this is circular thinking. The main question is whether Ireland has enough money to bail out its banking system such as it is. Alan McQuaid, quoted by Bloomberg, puts it well;
“They are taking a gamble that the budget will deliver and get spreads down,” said Alan McQuaid, chief economist at Bloxham Stockbrokers in Dublin. “If that doesn’t happen, maybe you skip a few auctions at the beginning of the year. But at some point, you have to go to the market. If you can’t go to the market, then you have to look at outside aid.”
And Danske is even more sanguine, but then again they would be wouldn’t they as they own National Irish Bank and thus effectively depend on this gamble to succeed (at least in terms of the health of their Irish operations).
“The government has a significant problem” unless yields fall, said Soerensen of Danske Bank, which owns Dublin-based National Irish Bank. “But it isn’t under any immediate pressure to raise cash, and even in the unlikely event that the government had to call upon IMF/EU aid, investors would still get paid. There isn’t going to be a default.”
But I think that we are still missing the main point here. This is not only a question of how dubious it is that Ireland can get its house back in order (and what kind of economic pain it will take) it is also a matter of whether it is in Ireland’s interest to enter the market at all. Essentially, the current interest rates are unpayable for Ireland today but also in the middle of 2011 since this is where, presumably, the full force of fiscal contraction will be put on the Irish economy.
So, my reading of this is that Ireland has now played itself into whatever deal it can broker with the IMF and EU and while I may be persuaded otherwise by a credible fiscal plan it is not the actual promise I will be looking at but the assumptions of debt/gdp and nominal GDP growth which underlies it.
Until then, Ireland can continue to heed the old proverb that cash is king; it sure is … until you run out.
By Claus Vistesen, on October 5th, 2010
The Eurozone has its “does not compute” moment
First, it was there, then it left and then suddenly the Spanish prime minister Zapatero assured us that it was gone, but somehow the lingering European crisis of confidence in relation to the status of sovereign and private debt sustainability in key membership economies never seem to have gone away.
Now, please don’t think that the headline above is in any way related to the flurry of whether Spain has been faking its GDP numbers. FT Alphaville ran the story, got cold feet and took it down (although I reckon you can easily find the report if you try). Now, the flurry was real and the questions asked by the report fair I think. Clearly, if it was such nonsense it should be easily refutable and while some of the explanations I have seen for the the sudden dis-correlation between the Market Services Gross Value Added (GVA) and the Indicator of Activity in the Service Sector (IASS/SSAI) make sense (especially the import component point) the Spanish statistical office is still mute and the ministry of finance is just playing the part of an insulted child. So, if those of us who are skeptic are so stupid then really, now is the chance for those much more clever than us to give us a lecture.
But I digress.
Moving on, Ireland has recently been at the center stage of things and the latest number from the finance ministry is that the butcher’s bill for bailing out Anglo Irish amounts to more than 30% of GDP in the form of a running deficit in 2010. That is a almost unbelievable number by any standards and I would take very little comfort here in the fact that Ireland remains fully financed until mid 2011. What really matters here is that with this amount of debt overhang that needs to be transferred to the government’s balance sheet and ultimately over to the private sector in the form of taxes Ireland is being played straight into the hands of the IMF and the European Stability Fund. But this is not only about Ireland since the all the fundamental questions are still left unanswered.
- How do you correct external competitiveness deficiency from within a currency union at the same time as implementing fiscal austerity without risking debt levels to spin out of control?
- How long should Southern Europe and Ireland endure deflation relative to the core to restore external competitiveness (will Germany accept a lower external surplus as result)?
- How might a sovereign restructuring in a Eurozone economy play out?
The last one is particularly important since no official inside the Eurozone has even begun to voice an opinion on this even if it is blatantly obvious that this is where we are headed. I mean, I am not talking about the entire stock of PIGS bonds being wiped out and marked to 0, but merely of a reasonable and fair estimate of the haircut we all know that is coming. Yet, so much water has gone under the bridge that it is difficult to see how such a memo would look. For starters, the stress tests carried out recently on Eurozone banks would have to be, uhm, redone with proper assumptions of haircuts and impairment in the context of real sovereign stress in the Eurozone.
However, what really clinched it for me and what leads me to note that we have now had one of (several to come) those does not compute moments was Wolfgang Munchau’s basic bond arithmetic of the the European Stability Funds lending conditions and the means with which it allows access to its funds. From FT Alphaville …
Münchau comes up with a rough estimate that borrowers could end up paying a total interest rate of about 8 per cent — far above and much more than the 5 per cent Greece paid when it tapped its €110bn European Union emergency loan back in May.
BarCap’s back-of-the-envelope calculations has the total borrowing cost above 8 per cent. That’s about 80bps (3m Euribor) + 300bps (EFSF mark-up) + 150bps (due to the fact that the interest has to be paid on the whole loan) + 300bps (service fees). As BarCap also note, requesting EFSF funds would also likely entail some strict policy conditions, similar to IMF conditionality.
Now, let me be quite clear here. 8% or even anything in that vicinity makes the whole exercise quite pointless since there is no way that any of the Eurozone economies would be able to pay off their debts at these conditions. So, if one or more Eurozone economies were to find themselves in a situation where they could no longer tap international bond markets due to the yield on offer, the alternative would be no better. I called this a catch 22 recently and even wrote a paper, in part, about it. However, Munchau’s article makes it all so clear. Whatever funds that are paid out of the stability fund at these conditions would in itself be subject to a haircut in the context of an inevitable sovereign debt restructuring and thus it is really and ultimately a question of on whose balance sheet the final loss will be put. One would only hope that this soon will come to compute a little better with the agenda that will and has to emerge in the Eurozone at some point.
Some (academic) food for thought
As many of you might have noticed I am about to start my research degree here in the UK and while I am in general surprised and disappointed about the utter lack of creativity on the part of the economic faculty in terms of constructing a curriculum with the sole purpose of testing your abilities in math (rather than you know, uhm economics!) I hope and believe it will be fun. On that note and while the cracks have clearly not yet transcended to the way underlings such as myself are treated, I found the following paper (The Dahlem Report) interesting and important (thanks Scott for sending it over).
The economics profession appears to have been unaware of the long build-up to the current worldwide financial crisis and to have significantly underestimated its dimensions once it started to unfold. In our view, this lack of understanding is due to a misallocation of research efforts in economics. We trace the deeper roots of this failure to the profession’s insistence on constructing models that, by design, disregard the key elements driving outcomes in real-world markets. The economics profession has failed in communicating the limitations, weaknesses, and even dangers of its preferred models to the public. This state of affairs makes clear the need for a major reorientation of focus in the research economists undertake, as well as for the establishment of an ethical code that would ask economists to understand and communicate the limitations and potential misuses of their models.
Now, as an immediate testament to the importance of this paper and echoing my points above I can say for certain that my generation of economists will be trained no differently on a PhD level than they were, I suspect, 30 years ago. Same old axioms, same old models, same booring (and often stupidly difficult) math problems. Two of the co-signers of the paper are David Colander and Alan Kirman and I recommend readers to have a look at their work if you want a good critique of the way we (still) do economics today (don’t forget James E. Hartley too). I don’t want to be a cry-baby, but surely; running through the proof of why a utility function should and might exist (in mathematical terms) is not only waste of good time, it is an insult to any serious economist eager to get on with some real work. But now, I really(!) digress.
To balance things a bit I did actually find much enjoyment in Oded Galor’s recent synthesis of what really kicked off the demographic transition back in the days of the industrial revolution.
This paper develops the theoretical foundations and the testable implications of the various mechanisms that have been proposed as possible triggers for the demographic transition.Moreover, it examines the empirical validity of each of the theories and their signi
cance forthe understanding of the transition from stagnation to growth. The analysis suggests thatthe rise in the demand for human capital in the process of development was the main triggerfor the decline in fertility and the transition to modern growth.
Here in the 21st century such a paper essentially reads as a piece of economic history as the demographic transition never really ended and whereas some form of the quantity/quality tradeoff might have started the whole process, we are now dealing with a much more complicated process in which both a quantum and tempo effect acts as a driver of the fertility decline (and eventual or potential(?) catch-up as the tempo effect fades). However, Galor’s recent paper provides an important finetuned representation of the way we think about the quantity/quality trade off and as such it is important.
I also take more than a passing interest here since it is after all my field and while I eventually opted for the original quantity/quality model by Becker and Lewis in my thesis I have almost been turned to Oded Galor’s theory with this recent paper. Yet, the two theories are still ultimately very close to each other and for laymen the finer grained theoretic subtleties of the trade-off are not important.
Perhaps you should read Oded Galor first and then the Dahlem paper afterwards. Actually, yes you definitely should!
By Claus Vistesen, on May 17th, 2010
If an ECB in QE mode, €60 billion in cash, €440 billion from a pooled EMU effort and €220 billion from the IMF only lasts a week, then I’d humbly submit that we have a problem.
(Screenshot from Bloomberg, click for better viewing)
It is difficult to say whether it was former Fed chairman Volkcer’s comment on Euro breakup which set alight the initial fire, but what is certain is that it does not seem that markets have calmed down. And they shouldn’t be. The package may be impressive, but the growth prospects of the Eurozone has now been moved down more than a couple of nudges and still there is looming and large risk that debt restructuring will come eventually (I believe so for example).
As ever, I should point out that in my world slumping stocks do not constitute a problem as such, but volatility is rising and with it, risks of a veritable rout against which it is difficult to see where policy makers will find the tools prevent a sea of red turning into severe bloodletting.
By Claus Vistesen, on May 14th, 2010
As we are about move into the fourth day of the week where EU policy makers together with the IMF and the ECB launched an unprecendented series of aid tools to combat the mounting risk of a collapse in Greece and elsewhere in the European periphery I am finally ready to move in with some comments. First of all, there has been no shortage of comments, opinions and market calls on the back of the bailout package and while risky assets have indeed rallied, it is if the underlying reality of the situation looms ever more prescient underneath the surface than what one would have expected from such a collosal dose of stimulating policy.
And for good measure, let us re-cap the list of stimulating efforts taken by Europe and the IMF based on, no less than, Macro Man’s last post as a financial blogger;
* €60 billion in cash from the European Commission, funded by bond sales
* €440 billion in loan guarantees, via pooled support of member governments
* Up to €220 billion from the IMF
* Outright bond purchases from the ECB, to be sterilized (this has evidently already started)
* 3m and 6m full-allotment LTROs
* Reactivation of FX swap lines
This is an impressive laundry list if there ever was one and among the points is the very, very interesting u-turn at the ECB which will now, albeit sterilised, be buyers of real assets. This last change of policy and the effectual skydive by part of the Trichet and his accomplished out of the ivory tower may be what eventually clinches it for Europe. Together with the most recent news this week that Portugal and Spain now seem to be getting the message in the form of introducing some very own austerity measures of their own (which as the song goes are of course complete voluntary and preemptive [1]) this might just be the combination of policy moves that Europe needs to see this through without a nasty default of a further intensification of the crisis.
But then again, it might not. I am sceptical here although I concede that if it is backed up by serious and real measures to rein in deficits I might just be turned into a believer here. However, there are some things that still bugs me.
Firstly, it should not escape us here that what our dear policy makers effectively are doing is to fight fire with fire. More debt will thus be substituted with even more debt and it is not clear just what the end game is supposed to be. However, one thing which is now crystal clear to me is that if there is any way that the EU and the Eurozone are to make out of this in one piece it will mean a much tighter coordination of fiscal policy. This will require a monumental rethink of the EU setup and while I believe that the joint effort of EU policy makers could indeed be pooled to make this happen the chance of it actually materialising is slim. In this sense it will be interesting to see what exactly it will mean for the fiscal coordination (if any) that Eurozone economies are now jointly asking the market for funds to pool in that loan guarantee entity.
Secondly, the introduction of implementation of all these so-called austerity measures are not linear and we can’t feed them into linear models and expect these models to come up with usable results. In this sense, and abstracting a minute from the general risk of doing too little too late, the road ahead is very difficult. On the good side it now appears that Spain and Portugal have awoken to the fact that they too need to turn on the screw and that what ultimately distinguishes them from Greece is merely market timing. This is universally good news, but it this is only the statement of intent. In fact, before we close the book on 2010 this is all we are going to see since the 2010 budgets (already passed) are thoroughly in the red. The biggest problem here is simply that for all the good intentions in various EU commission and IMF proposals the actual process of implementation on the ground may proove near impossible. And here I am not talking about some innate laziness or non-voluntarism by part of the Greek, Portuguese and Spanish people; I am simply talking about the near impossibility of letting the entire burden fall on internal price and competitiveness adjustment from within an fixed currency union, but this of course has been the main issue all along. As I noted in another context, any state can only take so much of having to fight its own citizens with water and teargas week in and out even if they are trying to do good.
The considerations above have slowly, but surely convinced me that while I support the efforts by EU policy makers (both in spirit and in terms of the technical measures) I have increasingly converged on the idea that some form of debt restructuring in Greece (and possibly elsewhere in EMU) has to be included in what we could call the main scenario going forward. In coming to this conclusion of course, I am met with formidable resistance.
Take for example the IMF’s communiqué on the situation in Greece and why a debt restructuring would be a very bad idea (see also Emmanuel’s take).
Restructuring debt would not help Greece’s capacity to grow. The type of fiscal and structural reforms being put in place under the Government’s program are designed to do that – to bring down costs, to make the labor market more flexible and to improve the business and investment climate.
The web of economic and political inter-linkages—including that Greek bonds are held by a wide variety of private investors and public entities—severely complicates alternatives to the program the government has put in place. Any perceived positive near term effects of a debt restructuring need to be weighed against contagion effects.
Most of the adjustment in Greece is needed to eliminate its large primary deficit (the deficit net of interest payments). This is the main issue for Greece, not the level of the debt.
My main problem here is simply I think the IMF misses the main point by a mile. It is thus exactly the combination of too high interest rates and negative nominal growth rates (deflation) which make the situation in Greece unmanageable and also why I believe it was a mistake not to include some form of hair cut on Greek sovereigns (up front) as part of the Sunday’s shock and awe move. Now, I don’t dispute the point that the fiscal and structural reforms wouldn’t help, but the numbers just don’t add up. Greece is currently running a fiscal deficit to the tune of 12-15% and even if we assume that this will come down during the envisioned horizon Greece will still be caught in a debt trap once we are done. For a lack of a better comparison, Greece will come to resemble the Baltics and trust me, this is not a comparison you would like to be branded with. In this way, it is in fact the level of debt that will eventually force a debt restructuring in Greece and it will do so exactly because the terms with which Greece is about to embark on her structural adjustment are unsustainable from within a monetary union.
This brings us to the newfound QE profile by the ECB which could, in theory, make a lot of the problems of Greece (and Spain and Portugal) go away. However, we are alo moving into uncharted territory here. Consequently, echoes from Japan are coming closer and it is not altogether clear how the ECB would deal with the fact that it would have to permanently [2] massage the yields of Greek sovereign bonds in order keep the boat afloat. I emphasise permanent here since there is a real risk that the ECB has now decisively had its Japan moment and should the ECB commit to unwavering support for the Eurozone periphery it would not be a misnomer to dub the Eurozone Japan 2.0.
Among the long list of comments and analysis that has so far been ditched up to provide a view on the situation, I think that the one by John Hussmann comes very close to an adequate picture of the situation where you will forgive me, I hope, the following lenghty quote;
Looking at the current state of the world economy, the underlying reality remains little changed: there is more debt outstanding than is capable of being properly serviced. It’s certainly possible to issue government debt in order to bail out one borrower or another (and prevent their bondholders from taking a loss). However, this means that for every dollar of bad debt that should have been wiped off the books, the world economy is left with two – the initial dollar of debt that has been bailed out and must continue to be serviced, and an additional dollar of government debt that was issued to execute the bailout.
Notice also that the capital that is used to provide the bailout goes from the hands of savers into the hands of bondholders who made bad investments. We are not only allocating global savings to governments. We are further allocating global savings precisely to those who were the worst stewards of the world’s capital. From a productivity standpoint, this is a nightmare. New investment capital, properly allocated, is almost invariably more productive than existing investment, and is undoubtedly more productive than past bad investment. By effectively re-capitalizing bad stewards of capital, at the expense of good investments that could otherwise occur, the policy of bailouts does violence to long-term prospects for growth. Looking out to a future population that will increasingly rely on the productivity of a smaller set of younger workers (and foreign labor) in order to provide for an aging demographic, this is not a luxury that our nation or the world can afford.
“Failure” and “restructuring” mean only that bondholders don’t get 100 cents on the dollar. We can continue to bail out the poor stewards of capital who voluntarily made bad, unproductive investments, and waste our future productivity in order to make those lenders whole, or we can turn the debate toward deciding the best strategies for restructuring existing debt.
I agree with all of the above and it echoes my general sentiment which is not that Europe is about to sink into a hole, but that a real hard look at the face value of the obligations in Greece and elsewhere is needed. Naturally, and as a counter argument to this point is the increasingly worrying barrage of numbers purporting to show the exposure of European and US banks to Greek sovereign bonds and indeed the bonds of the Southern Europe. No matter where you look, the numbers aren’t small and it does not take a lot of imagination to see how this could very easily turn into a Lehman 2.0 moment for banks and thus the real economy. The only problem this time would be that we would be, for the most part, all out of firepower. It is important for me to point out that it is not because I discount this event too easily that I am calling for a preliminary look into debt restructuring. It is simply because I believe that with the current road map, the end game is given in advance. This won’t of course make the exposure any less grave, but did we really think that a haircut on the debt could be avoided here?! Especially, if we are talking about banks playing the funky chicken on the short end of the Greek yield curve (is there any other?!)by sucking up liquidity in Frankfurt only to park it a couple of thousand kilometers further south, then it really escapes me if people had seriously imagined that this would not unravel at some point.
We all know that it will be a regime change when the first OECD economy pushes the restructuring button, but it was bound to happen at some point. I’d thus recommend that we stopped kicking the can down the road and in stead picked it up and threw it away; only in doing so will be able to say that we are indeed still standing.
—
[1] – This is pooh-pooh of course, but as long as they believe it themselves I am happy to indulge them.
[2] – Let us say for 10 years to begin with.
By Claus Vistesen, on April 26th, 2010
Earlier this week Edward mused about whether we were about to see movements in the Greek trenches as yields on 10 year bonds rose to a record 7.76 per cent at one point and closed up 26 basis points on the day. Today, as yields on 2 year bonds flirted with the 10% marker Greece opted to call in the outstanding favor from the IMF and the EU at about as 45 billion euros ($60 billion) put up as a financial lifeline (and in an attempt to calm markets) a little over a week ago.
(quote Bloomberg)
Greece called for activation of a financial lifeline of as much as 45 billion euros ($60 billion) this year in an unprecedented test of the euro’s stability and European political cohesion. The appeal for help from the European Union and International Monetary Fund follows a surge in borrowing costs to what Greek Prime Minister George Papandreou called unsustainable levels that undermine efforts to cut a budget deficit of more than four times the EU limit. Greek bonds and stocks rallied after the announcement.
“There was no response from the markets, either because they didn’t believe in the political will of the EU or because they decided to go on with speculation,” Papandreou said today. “The situation threatens to demolish not only the sacrifices of the people but also the regular course of the economy. All the efforts by the Greek people are in danger of being in vain.”
With national debt of almost 300 billion euros and investors demanding almost triple what they charge Germany for its 10-year bonds, Greece faces a fiscal mess that threatened to spread to Spain and Portugal, forcing the EU to set up a standby aid facility. At stake is the future of the euro 11 years after its creators gave the European Central Bank responsibility for interest rates while leaving budget policy in national capitals.
Obviously, this is more like to be the end of the beginning than the beginning and as Greece readies itself to receive the loan (which will be tallied at 5%) other countries are sitting in the holding room waiting for the doctor to call them. Spain and Portugal come immediately to mind here and it remains to be seen whether Germany or indeed the EU or the IMF have the will and capacity to take another tête-a-tête with the market as Portuguese and Spanish spreads begin to widen. Of course, we are not there yet and it is still highly doubtful that the current plan will help Greece to avoid a default.
Activating the aid and turning over economic policy to EU and IMF oversight was “a new Odyssey for Greece,” Papandreou said. “But we know the road to Ithaca and have charted the waters,” referring to the return of mythological hero Ulysses to his island home.
We should consequently remember the debt snowball here and my guess is that 5% is still way too high a levy to pay for Greece with the nature of nominal GDP growth the country can expect in the coming years as deflation is imposed on the economy. We will see soon enough, but my feeling is that part of the whole policy rigamole that will now unfold, Greece will have to “restructure” notable chunks of her debt.
Finally and on a brighter note, markets do not seem to be able to decide whether this is good or bad for the Euro. Consequently, Bloomberg’s ever flashing newsstream today pitted CMC Markets’ chief market strategist Ashraf Laidi predicting the Euro to move down to 1.27 to the USD against Commerzbank analyst Ulrich Leuchtmann who predicted the Euro to gain on the “successful” bailout.,
Well, well … place your bets accordingly gentlemen. Unlike in Greek’s case he who ultimately raises the white flag should be able to live another day.
By Claus Vistesen, on April 1st, 2010
It was hard not to sense that part of the IMF’s recent inquiry into Germany’s economy was also aimed at asking the country to eat a little bit of humble pie in the context of the ongoing difficulties facing the Eurozone. Consequently, Germany has been the poster child for the good pupil in class and an example to follow as the world seemed to have come to a near end in Greece, Spain and elsewhere. Today’s hint from the IMF should alert us to the fact that all is not well in the so-called engine room of Germany.
(quote Bloomberg)
The International Monetary Fund cut its growth forecast for Germany after a recovery in Europe’s largest economy came to a halt, and said the government needs a “credible” plan to reduce its deficit. The IMF expects the German economy to expand 1.2 percent this year and 1.7 percent in 2011, the Washington-based lender said in a report published today. In January, the fund forecast growth of 1.5 percent in 2010 and 1.9 percent next year.
(…)
The IMF urged the German government to foster domestic consumer spending. “Strengthening domestic sources of growth will help cushion the German economy against external shocks as well as benefit the euro-area countries and the global economy by reducing trade and payments imbalances,” according to the report.
(…)
Germany mustn’t lose sight of its goal of fiscal consolidation, and policy makers must be careful as they exit from the economic support measures put in place during the global financial turbulence, the IMF said in the report.
“The authorities face the challenge of sustaining recovery while preparing to exit, as part of an international coordinated strategy, from the extraordinary measures introduced during the crisis,” it said. “Over time, fiscal policy will have to transition from support to credible consolidation.”
There are two concrete points of note above the first about how Germany should see to it that it expanded domestic demand has already gotten plenty of air time not least in the context of Merkel’s continuing nein to any suggestion that Germany should aid Southern Europe in their plight through giving a little back in terms providing demand for imports.
The problem is of course that Germany is structurally positionend to be a supplier of a excess savings to the global economy through an external surplus. And the reason, well try almost four decades worth of below replacement fertility and next to non net migration, but I guess most of you know my rant here.
More importantly, this points us to the real underlying issue in the context of a global economy. In a recent very astute comment, Martin Wolf coined the concept Chermany to signify the folly of Germany and China in believing that they can demand that hitherto prolifigate deficit nations scale down while they continue ramping up external surpluses. This simply does not add up. Wolf really manages a home run with the following observation;
Behind all this is a fundamental divide. Surplus countries insist on continuing just as before. But they refuse to accept that their reliance on export surpluses must rebound upon themselves, once their customers go broke. Indeed, that is just what is happening. Meanwhile, countries that ran huge external deficits in the past can cut the massive fiscal deficits that result from post-bubble deleveraging by their private sectors only via a big surge in their net exports. If surplus countries fail to offset that shift, through expansion in aggregate demand, the world is inevitably caught in a “beggar-my-neighbour” battle: everybody seeks desperately to foist excess supplies on to their trading partners. That was a big part of the catastrophe of the 1930s, too.
So, Germany suffers from a bit of delusion here. However, what caught my eye in particular was also the IMF’s subtle but firm indication that Germany also has to tend to its public finances and now that growth seems to be less vibrant than initially assumed, it is all the more important that Germany takes proactive action sooner rather than later. And herin lies of course the rub since Germany is only surpassed by Japan when it comes to demographic ageing and thus the future liabilities of Germany are substantial.
True; Germany is moving into this with an overall lower level of debt/gdp and if there is something the Germans take pride in, it is their ability to impose self-inflicted pain and austerity to correct and to increase competitiveness and achieve growth from external sources. Yet, this brings us right back smack into the wall here since this is exactly where we don’t want Germany to go, but exactly because of the demographic prospects, it is where Germany must go. In this way, Germany needs an external surplus for the same reason that Japan needs one; the expected return in the German economy and the underlying future government liabilities would not allow Germany to finance an external deficit at “acceptable” yields. This is curious in light of that that the yield on German bonds are used as benchmarks for the obvious reason that Germany is a net external lender, but what if this changed?
Of course, this is not only about Germany, but also about the majority of the Eurozone edifice which leaves, yet again the tricky question of just how we are to find those brave economies willing to stand on the opposite part of the scale as ageing and overleveraged economies crowd the savings surplus side.This is really the question we must answer (c.f. Wolf above) even if it is indeed tempting to rely on Germany to do the heavy lifting. So far, the signals from Germany have suggested that this won’t happen with the good will of the German government, but ultimately it won’t happen because Germany is fundamentally unable to step up to the plate and provide the capacity for the surplus of others.
One would hope that as Germany slowly wakes up to this reality and the limitations of its own economy, it will hopefully bring the country and her politicians back down to earth.
By Richard Daughty, on March 23rd, 2010
There are those (me) who think that the International Monetary Fund (IMF) is a huge load of worthless, corrupt crap, not only because their dismal record pretty much shows that they are miserable failures, but because that is the way things always end up when someone is given power and money in huge amounts, or even in moderate amounts.
Or, it turns out, even in small amounts, as I prove each week when the kids, over whom I have absolute, awesome power right up until the exact moment when the social workers and/or cops come roaring up, bursting into the house and are literally standing between me and the whining kids to face me down, so I have to explain to them, too, how “The foul Federal Reserve is creating so unbelievably much money (so that the loathsome Obama administration can borrow and spend it) that inflation in consumer prices is going to destroy the buying power of the dollar, and that is why this week, just like last week, I don’t want to give these whining kids their paltry allowance, let them eat anything that is not on sale at the grocery store, or drive them anywhere, except maybe to a military recruiter or a bus out of town, but especially not to see their hoodlum friends!”
I suddenly realize, to my horror, that I am standing there drinking coffee out of one of my many “World’s Worst Father” coffee mugs that the kids always give me as a present for every Father’s Day, and I instantly knew that explaining the essence of the Austrian theory of economics as a rationale for being stingy and cruel by withholding money and benefits from my own kids was certainly not going to fix this mess.
So, I decided to appeal to the innate greedy investor that is in all of us, and I said, “I’m going to take this little bit of money, see, that still has some buying power left in it, although less and less each day which is why prices go up and up each day to make up for it, and I am going to add it to the little bit of money I have already accumulated and secretly squirreled away so that none of these little leeches can get their hands on it, and I realize that leeches don’t have hands, so don’t bother pointing it out to me that the metaphor is not entirely apt, but you get the gist of it, and then I am going to use the money to buy some more silver, which is so seriously under-priced that the opportunity thus afforded to the astute investor far outweighs the whining demands of, ugh, children.”
There was a kind of stunned silence in the room when I had finished, and so, eager to get the conversational ball rolling again, I said, “And anyway, the whole thing started out as just another Angry Mogambo Tirade (AMT) about, this time, the International Monetary Fund (IMF), which invented their own money, the Special Drawing Right, which had the effect of expanding the world money supply so as to prop up idiot countries that have bankrupted themselves and who mostly deserved to be destroyed, and it does so at the cost of permanent inflation in prices so that poor people, around the world, suffered more and more as prices constantly went up faster than their incomes, and who suffer a lot more than these stupid, whining kids here and their so-called ‘psychological trauma’!”
Well, it got ugly from there, it’s all over now, and there is nothing more about it except planning my revenge, court appearance dates, and attending some stupid “Good Parenting Course” being taught by some nitwit “counselor” half my age, whom I exposed in the very first class as a low-IQ loser when I asked him, “Have you told your children to buy gold, silver and oil to protect themselves against the inflationary horror caused by the Federal Reserve creating so impossibly much money so as to allow the lowlife Congress and the idiot Obama administration to deficit-spend us into the hellish oblivion that is, in two words, our future?”
He replied, real intelligent-like, “Huh?” which told me, loud and clear, that this guy was an idiot, which was soon proved when he instructed us to (get this!) “listen” to our children, like I haven’t heard them crying and whining and saying, “Gimme, gimme, gimme!” and, “I hate you!” their entire lives, seemingly every freaking minute of every freaking day of my life, sometimes even when I am – horrors! – completely sober, which makes it all much, much worse. Moron.
But as far as bad ideas like the IMF goes, it just gets worse until you are screaming, “No! No! No!” in your nightmares because TheDailyBell.com noted that the German finance minister, Wolfgang Schäuble, “floated the idea of a European Monetary Fund (EMF) to act as a lender of last resort to euro-zone countries that could not raise funds in capital markets on tolerable terms. He offered few details about how an EMF would be financed or how it would operate.”
Creating more money out of thin air, so as to increase the worlds’ money supply, to bail out more corrupt, incompetent deadbeats, at a cost of higher prices for everybody? Yikes!
See what I mean? We’re freaking doomed!
Knowing that, I wonder what the little counselor thinks about gold, silver and oil now! Hahaha! I wonder if he is saying, “Whee! This investing stuff is easy!”
The IMF, the EMF and All the Worthless Money In Between originally appeared in the Daily Reckoning.
By Trace Mayer, on March 12th, 2010
The IMF gold has serious geo-political ramifications in the background because of the nature of foreign exchange reserves, credit default swaps and gold. Wikipedia:
South Korea and Japan are both home to large numbers of United States troops and neither are going to invite a nuclear attack. The Kuomintang, which the US backed, retreated to Taiwan when they lost power and China still asserts their ownership over the tiny island and the US continues to honor their agreement to defend Taiwan. Russia has been discharging dollars and acquiring gold while Brazil is bucking the buck. Neither China nor India have significant reported physical gold holdings; they need a hedge to the major currency illusions. In my book The Great Credit Contraction the liquidity pyramid represents the FRN$ will be the last major currency to evaporate.
The Euro’s evaporation has increased and ultimately has only one outcome. Sure, Germany wants to retain its voice on the world stage and is faced with a Hobson’s choice of bailing out Greece and eventually the other unproductive free-riding members of the Euro or let the Euro evaporate and lose their relevance on the world stage because Germany only matters if Europe as a whole matters.
CREDIT DEFAULT SWAPS
But the Damocles sword of credit default swaps, which is falling toward’s Greece, can, ultimately, be measured only against gold because gold is no-one’s liability. Just like the Chinese have feigned their interest in acquiring gold; many sophisticated investors have feigned ignorance of gold’s monetary role. Many sophisticated investors, like George Soros who broke the Bank of England doubled his gold position in Q1 2010, Paul Tudor of Tudor Investments, John Paulson, David Einhorn, Eric Sprott, Jim Rogers, Peter Schiff, John Embry and many others are likewise allocating their capital based on the premise that gold is a major world currency.
Even Janet Tavakoli, a former adjunct associate professor of derivatives at the University of Chicago’s Graduate School of Business, and author of six books on derivatives recently wrote:
U.S. credit default swaps currently trade in euros. After all, if the U.S. defaults, who will want payment in devalued U.S. dollars? The euro recently weakened relative to the dollar, and market participants are calling for contracts that require payment in gold. If they get their way, speculators on the winning side of a price move will demand collateral paid in gold.
The market can create an unlimited number of these contracts very rapidly. The U.S. wouldn’t have to ever default to trigger a major disruption in the gold market.
The fiat currency and fractional reserve banking system is merely a confidence game built on an illusion and fraud. Fiat currency is to be valued like the common stock of a government and in gold. As such the current system will end and holder’s of capital will demand to be shown the money. Just ask Harry Reid about karma.
The price of gold in evaporating currencies would not so much create a disruption in the gold market as cause a serious loss of confidence in the current system which would result in a tremendous increase in gold’s liquidity, hopefully through use by individuals in ordinary daily activities like what happened in Zimbabwe last year. After all, who really needs to use fiat currency illusions and why? In this case, we are seeing both China and India demanding to see the IMF’s gold, the Damocles sword jitters and there is only one protection. Assets with intrinsic value.
By Claus Vistesen, on March 9th, 2010
Well, it might appear that my smug headline in the post below may not have been so appropriate after all. At least I find the news from the FT today that Eurozone members, headed by France and Germany, are considering to set up an internal IMF type fund very significant.
(from the FT)
Germany and France are planning to launch a sweeping new initiative to reinforce economic co-operation and surveillance within the eurozone, including the establishment of a European Monetary Fund, according to senior government officials.
Their intention is to set up the rules and tools to prevent any recurrence of instability in the eurozone stemming from the indebtedness of a single member state, such as Greece. The first details of the plan, including support for an EMF modelled on the International Monetary Fund, were revealed at the weekend by Wolfgang Schäuble, the German finance minister.
“I am in favour of stronger co-ordination of economic policies in the EU and in the eurozone,” Mr Schäuble told newspaper Welt am Sonntag.
If France and Germany can agree on such proposals – long urged by Paris – they are likely to set the basis for the most radical overhaul of the rules underpinning the euro since the currency was launched in 1999. The German thinking emerged as George Papandreou, the Greek prime minister, flew to Paris to seek the support of Nicolas Sarkozy, French president, for his government’s drastic austerity programme.
“We must support Greece, because they are making an effort,” Mr Sarkozy said before the meeting. “If we created the euro, we cannot let a country fall that is in the eurozone. Otherwise there was no point in creating the euro.”
His words appeared to underline the greater readiness in France than in Germany to provide some sort of financial support or guarantee for the Greek economy. Angela Merkel, the German chancellor, insisted that no such support had been sought or discussed when she met Mr Papandreou on Friday.
Both France and Germany agree Greece should not turn to the IMF for support, so the idea of an EMF has clear attractions for Paris, though it could hardly be set up in time to help Greece. Mr Schäuble said: “We are not planning a competitor . . . to the IMF, but we do need an institution for the internal equilibrium of the eurozone that would have at its disposal both the experience of the IMF, and comparable intervention mechanisms.”
According to German thinking, the plan could include tough penalties for eurozone members that fail to curb deficit spending or run up excessive government debt. Ideas include cutting off countries that fail to curb deficit spending from EU cohesion funds, temporarily removing their right to vote in EU ministerial meetings and suspension from the eurozone.
Those may prove very difficult for France to swallow, given its own record of greater fiscal laxity than Germany.
Needless to say, this would draw the wrath from Euro skeptics and those, in general, opposed to tighter cooperation among Eurozone member countries. However, as Munchau argues splendid in another FT piece today; a monetary union needs a tight political and fiscal supranational framework to really make it work. Now, we must choose which solution we prefer.
By Claus Vistesen, on November 10th, 2009
Update: Mr. Singh posts the third and, as far as I know, last installment in the series on Asia’s outlook written on the basis of the Regional Economic Outlook for the Asian and Pacific Region. The topic is perhaps the most interesting of all aspects of Asia’s aggregate economy, the high prevalence of savings and its excess over investment which produces a corresponding external surplus which, I’d might add, is structural at this point. See below for more comments.
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In case you had not noticed, the IMF is blogging and it is not “merely” the garden variety IMF staffers they are rolling out to fill the pages; nope here we are treated to the likes of Blanchard, Atkinson, Lipsky, Cottarelli and a host of other of the Fund’s A-listers. Consequently, it would seem that in an already (over)crowded world of econblogging, the IMFdirect blog merits more than a little bit attention.
In the past week, the dual post coverage by Mr. Anoop Singh of the recent Regional Economic Outlook for the Asian and Pacific Region caught my attention in particular. In the first, Mr. Singh invokes among other things the puzzle of Asia’s relatively sharp recovery given the notion that the region is largely dependent on exports to grow. Two reasons especially are important here. One is the simple fact that as these economies moved into the crisis with bulging coffers (especially on the reserves vis-a-vis the rest of the world), the room for fiscal manoeuvre was greater and it was used decisively. According to calculations by the IMF, the collective stimulus programs in the Asia-Pacific region added 1.75% to GDP growth in the first half of 2009 and it makes the programs even more generous than those observed in the OECD and other emerging markets. Secondly, Asian economies has benefited from the, so far, V-shaped comeback by part of the global economy and key regions who are likely to grow smartly in h02-2009.
In general, Mr. Singh’s analysis appears cautiously tied to the great unknown of 2010 where it appears that we will see whether all those battered economies of the world will be able to hold their own in a world where quantitative easing from central banks and lax fiscal policies are withdrawn rather than enacted. Here, Singh’s remarks echo the general discourse where the the underlying tone is one of skepticism. A long period of risky asset buoyancy coupled with upbeat economic data releases have proved before to be crying wolf of an impending recovery and policy makers are advised to take this into account.
It is hard for me to disagree with Mr. Singh that the green shoots observed in the Spring of 2009 seem way too shaky a foundation on which to build a narrative of recovery. Yet, this is exactly what has happened and the famous inflection point will be reached when we discover that the recovery observed thus has been because of and not despite monetary and fiscal stimulus which makes the enforcement of exit strategies going into 2010 a very interesting experiment in the making. Some will make it, some won’t and some will inevitably fall back into recession (not just in Asia).
However, the most important part of Singh’s argument and indeed the most important part of IMF’s analysis in general is the question of whether Asia’s economic trajectory, in a post stimulus/recovery context, will be driven by domestic demand or not? To put it in the most reductionist form. Will Asia be a provider of net capacity to the global or economy or not? If yes, it would mean that a post crisis Asia had truly emerged as something new in the form of a force of a real addition to total demand. If not, it would mean that Asia would revert to old tricks and habits of relying on exports and foreign asset income to propel growth in national income.
Now, leaving the question of the number of export dependent economies the world economy can muster neatly to the side, I am not so optimistic here on Asia’s contribution to the rebalancing of global imbalances through a net expansion of domestic demand. Yet, let me also immediately qualify here that I am not very comfortable with talking about Asia/Pacific in one both because of the obvious heterogeneity amongst the economies, but more importantly; also because I am not really an expert here. I have done the analysis on Japan though and on this I can say with unequivocal certainty that we won’t we seeing any provision of excess domestic demand from this side.
Ultimately of course, Japan is of little real importance here and so is the rest of Asia really. What really matters on this topic is China and all the hopes currently pinned on her shoulders in the form of the ability of the economy to pull the global economy out of the mire. Traditionally, this has boiled down to a rather technical discussion about the RMB and an almost perennial Becketian wait for the shackles to break and an appreciating RMB to solve all problems. While I concede that the RMB should rise, it won’t solve any of the underlying problems inherent in China’s investment driven economy. Basically, chalk it down to culture and institutional specificity in the origin, but the simple fact remains I believe that just as China may evolve to become the economy we all hope and believe her to become (say in a 2020 context) the one child policy will have done its work so to speak and China will be sporting an OECD like age structure and is likely to even surpass many of OECD’s economies.
This is no recipe for an axis of rebalancing and although China will be the main story to follow for the immediate future I think we should look elsewhere to find the potential rebalancing candidates. This may indeed involve other parts of Asia (India for instance and Indonesia), but in the current discourse the likes of China, Japan (and Korea) hold little promise in terms of providing a decisive engine for rebalancing through sustainable growth in domestic demand which exceed the investment rate.
In this sense I remain cautious on the overall sustainability of the recovery in Asia mainly because of my skepticism towards the sustainability of overall global momentum where I acknowledge that I may be very wrong. Watch out for 2010 and all those exit strategies is what I say and particularly for the “post fiscal stimulus” world. This also means that I am more than a little bit skeptical on the prospects of a sustained recovery across Asia driven by domestic demand, especially in relation to Japan and China.
At least, this would be my humble argument here a murky Monday morning in Copenhagen. In any case, you might want to punch the IMFdirect blog into your RSS reader, just to make sure that you know what the IMF is up on a daily “research” basis.
It is interesting that Mr. Singh chooses to put his focus on corporate governance and, by derivative, the inability of Asian households to extract value from companies through dividends (because companies pay none) and the reluctance of households to leverage their assets to consume. The solution, according to Mr. Singh, is an improvement in institutional quality and essentially a two-pronged strategy in which corporate governance and financial market development are evolved, essentially, into a more Anglo-Saxon variety (or at least, this is underlying narrative I take from it).
This is also where I have, rather decisively, to part ways with Mr. Singh. It is not that I don’t recognize the basic intuition but the implicit idea that it would serve Asia, and the rest of us through rebalancing, better by moving in the way of an Anglo-Saxon institutional setting is too simple a discourse; in fact, I think it is flawed.
Consequently, I think it is important to note that while it sure may seem inefficient for all these savings to be sitting around in the coffers of companies as well as in the asset holdings of households, they do actually serve a purpose. More specifically, they finance investment elsewhere and through this, they act as an important contribution to national output in the absence of growth in domestic demand. Now, I am full well aware that it is exactly this we would like to change, but can we?
To some extent I am sure we can, but for example in Japan I can tell you that you better forget, very quickly, about any kind of surge in domestic demand (because of demographic reasons) and in this way, the excess savings over investment become important for the maintanance of output growth. Is this the same for China?
Hardly at this point, but the inflection point is coming nearer due to the one child policy.
In fact, if you extrapolate to the entire Asian edifice I think it is safe to say that if you peel away the excess investment that creates the external surpluses the nature and momentum of growth that could be sustained on the basis of domestic demand alone would dissappoint and make Asia’s recovery, well not a recovery at. And in this of course lies the rub.
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