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Monday, November 29, 2010

Blasted Euro Monday

Over the weekend the Irish bank bailout was announced, and it was impressively sized. The Greek deadline for repayment has been extended. So now it is seven years of bad luck, followed by broken investing mirrors.

Nonetheless, it is not helping, and Italy's and Spain's bonds are once again taking a licking. More here.

The healthier Euro countries can't keep bailing out other countries. Greece will default. Ireland maybe not or only marginally. But it seems clear that Europe can't shore up Spain if it needs to do so, and Italy looms like a specter on the horizon.

The only thing that will really drive these bond yields down is if the European Central bank starts buying a lot of them. Perhaps it will, but even that has its limits. They can get the private money in there only by guarantees, and the more solvent countries are on the hook for the guarantees. So I think a lot of these bonds will be repudiated to some extent. Italy? It might only need to knock 10% off if it does so soon. Greece? 30-40%, at least, but the longer they extend and pretend, the greater the eventual loss. Going out seven years might take it to 60-70%.

The entire situation is not at all helped by the fake Euro bank stress test earlier this year, which was supposed to test European banks ability to survive another recession. The results were announced at the end of July. Seven banks failed the stress test; five of those were Spanish savings banks which were already in the consolidation pipeline. One was German (Hypo) and the last was Greece's ATEbank. You will notice that there were no Irish banks on the list. At the time, the European finance honchos were claiming that the Euro test was much more rigourous than the US test.

So, less than six months later, with the European economy growing relatively well, it is costing over 100 billion USD just to shore up Irish banks. Realizing the problem, Europeans are now planning a new round of stress tests. These, we are assured, will be really, really strict. Probably the official announcement will be made on a state with a troupe of clowns performing in the background.

The EU has tremendous value to its participants as a free-trade district, and countries next to the Soviet Union are undoubtedly very thankful for the mutual defense pact. I expect the EU to continue, but it is clear that it must abandon the current strategy and work out a way for countries to mutually default on their debt. This would not be that much of a problem, except that Germany doesn't have any trading cards of bad debt, so it is not going to be pleased, and France will be positively enraged because it does need to destroy public debt and Germany doesn't.

The magic of mutual debt destruction is that if I owe 50K to everybody, including 10K to you, and you owe 70K to everybody, including 15K to me, and if you and I both agree to destroy 10K of mutual debt, the transaction is basically a net zero for each of us, but suddenly both you and I look a lot better to the other creditors.

In the meantime, the Euro is dropping which helps the Germans quite a bit. If the Germans were to go along with another of these bailouts, their accumulated liability would push German public debt into French territory. I cannot see how this is in their interest. I expect that either the German High Court will rule in favor of the bailout dissidents or that the German voters will pull the trigger.

The end is certain already. There will be multiple defaults on Euro-denominated sovereign debt. The French strategy appears to be aimed almost solely at maneuvering Germany so that in the end it appears to be in the same shape as France, rather than changing the eventual outcome.

In the meantime, this will generate accumulating effects for US states. Up until the November election, the quietly floated idea was that the US federal government would pick up a good chunk of the unfunded state government retirement costs. Now this is less plausible. The idea of the average taxpayer paying to continue much-higher-than-average retirement funding for government workers while Social Security and Medicare are being cut is a bad one, and it is one that the taxpayers will never knowingly accept.

However this places increasing pressure on states to get their own finances in order, and over the next two years states that seem weaker than average are going to start being pushed over.

In China, bank reserve ratios were increased twice in a month, and that seems to be having an effect. Margin requirements on Chinese commodity exchanges were raised. Calibrating all this is going to be a challenge for China's internal economy. It will constrain stock prices in the short term, and it is definitely going to exert downward pressure on most commodities globally. Most seem to expect China to raise interest rates. It did in October, but I am guessing China can maybe raise interest rates only once more. The last government bond sale wasn't fully taken up.

More broadly in Asia, the first signs of a synchronized slowing have emerged. This is not near a contraction, but it is a slackening in the pace of growth across countries such as Japan, Malaysia, and Indonesia. As a result of apparently slowing exports, Malaysia and Indonesia are expected to stop their campaign of slowly raising interest rates to more normal levels. Japan - well, Japan is an ongoing, quiet tragedy. Japan's domestic economy just keeps chugging downhill. Thus exports and yen-selling have to pull an ever-longer train. Japanese exports are still rising, but most recently at a somewhat disappointing pace.

Indian stats are erratic, but the Indian CB has correctly targeted inflation with a tightening campaign which is having some marginal effect so far. PMI stats for India are great, but actual industrial output growth slowed in September mostly on a decline in capital goods. So I do not know. Money is relatively tight in India due to large business purchases of rights from government.

My hunch is that we are in a worldwide inventory cycle adjustment, and these are quite unpredictable. Generally it is easiest to sort out trends in this environment by looking at edge areas. For Asia, the two most reliable edges are Singapore and Australia. Singapore's leading growth rates appear probably to be slowing, but not in any dire way. Australia was growing very fast, but the current indications are that Q3 will come in much slower. Negative adds to inventory are not as serious a problem as one might think as long as the situation rebounds in the next quarter, and it may.

My guess, therefore, is that China is in something of a pickle. It is very serious about trying to slow inflation, but it probably doesn't have a lot of wiggle room to do so. It will have to act cautiously; the stunning disparity between urban building sales rate growth and urban building growth rates is something of a blinking warning light, especially when one looks at starts and completions. Stats here through October.

Given the situation in Europe, exports to the US have been very important for Asia. We are doing our spending thang the best our little shop-until-you-drop hearts can imagine, but we are not going to be able to maintain the growth pace. Incomes, baby. Incomes. Incomes after taxes.

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...maneuvering Germany so that in the end it appears to be in the same shape as France...

...while Germany is maneuvering to make bailouts into the new feudal relationship. Banks get bailed out, and the price is to "normalize" the small economies versus Germany's economic policy, turning them into cheap labor and a market for German capital goods. China on the Liffey, but with no back-talk.

It's a race to see if France can hold its own...
Income after taxes, after health insurance, and energy
costs. Not enough disposable income nor enough jobs
to carry the world. Think how tired you are from work
and life in general. Can you squeeze out another 20%
productivity increase to receive nothing back from your employer ? Much easier to cut spending. So much for
the velocity of money.


"Not enough disposable income nor enough jobs to carry the world."

I had similar thoughts today. Sigh.

Cyber Monday

The more the Ben Bernanke's and the Paul Krugman's of the world try to push up the price of oil to create the inflation they so desperately seek, the bigger the discounts shopping malls will need to offer to entice shoppers to actually spend money on gasoline.

And since online retailers only employ a fraction of what brick and mortar retailers do per shopping dollar spent, that is a bit of a problem when it comes to employment.
Abbot and Costello did a routine on Mutual Debt Destruction:

Abbot meets Costello and demands the two dollars he is owed. Costello has one dollar; Abbot takes it.

A mutual friend walks onscene. Abbot owes him two dollars. He takes the one dollar from Abbot. But he owes Costello two dollars, so Costello takes the dollar from him.

Now they each owe one dollar. Abbot takes the dollar from Costello. Friend takes the dollar from Abbot. Costello take the dollar from friend.

All three debts paid, and Costello still has the dollar.
"Not enough disposable income nor enough jobs to carry the world"

I thought about that after college on one of my trips to the mall. Then I guess we would live a more simpler life ( those without I mean) shop only for what you need etc.) But I guess that becomes depressionary after a while unless the excess from the others goes through in social programs.

Neil - eventually I think the Europeans will wise up and get cracking.

Capitalism in the US wouldn't have survived without bankruptcy. Unpayable debts become a burden to everyone.

We probably have bankrupt states in the US too. It's tempting to look at each of these states and attribute their situation to individual errors and mismanagement, and while to some extent that is correct, the underlying tide sweeping the entire west is the influence of demographics.

Smaller states, whether in the US or in Europe, do not have the chance to be "balanced" economies. Their natural resources are often somewhat limited (some may be fortunate, others unfortunate). They have to do what they do well.

Nor can we all be Germany; they are a high-end manufacturing powerhouse, but there is limited demand in the world even for what they make so well.
This was a nice succinct comment on the state of the world economy. But, everything keeps coming back to the banks (and China with the disconnect between building and selling will become a bank problem). Countries are going to great lengths to save the banks, even going so far as to levy long term burdensome taxes on the population. Mish has the Irish bailout costing the their taxpayers about $1422 in additional annual taxes for forever. Plus pension money is now going into additional debt. France did that yesterday. Both Pelosi and a couple of Senators are talking about "helping" us by seizing the 401K's and putting them into special Treasury Bonds and "guaranteeing" an annuity. Where have we heard of that type of plan before?

Is saving the banks really worth that much? Won't either the banks or the country default anyway? Are we just throwing good money after bad, extending the problem, and causing massive pain for no benefit? We have a counter example in Iceland. Has defaulting their bank's debt freed the economy or not?

The other day, Arnold Kling said we are witnessing a brawl between the politicians and the financial guys. His money is on the financial guys. I am not sure I agree. I think we are seeing a brawl with the financial guys and politicians on one side and the taxpayers on the other side. Except the taxpayers don't realize yet they are in a brawl. It is hard to win a brawl when you haven't yet begun to brawl.
I have been looking for a new place to live here in Sonoma county,my landlords daughter (master's degree,early 30's) took a 30% pay cut and will be moving into my little cottage in the woods. There is little available that is affordable,but the eye opener has been discovering that pretty much every remotely habitable pool house,storage shed and chicken coop is occupied. I am also seeing a lot of trailers on country properties being rented out in addition to house sharing (illegally) which is overloading the septic systems.These are not sleazy landlords either, these a re frequently older professionals who are desperately trying to make ends meet and keep their homes. It ain't pretty.
It was not Arnold Kling. It was Tyler Cowen:


Also, Ken Pierce has a comment which is pretty good.
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