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Thursday, August 02, 2012

The Day of The Dragon

A short note: If you think China is going to save us all, contemplate the Chinese McD's value meal menu, and repent your wicked ways. End note.

That's the big news today. ECB is on the hook. What will they do? What will they promise? How much will they throw in the kitty?

Monti of Italy is running around putting the arm on everyone, and he has the leverage. The German economic travails are beginning to be felt, so now the negotiations get serious. An Italian comedian named Beppe Grillo really does have more power right now than the chancellor of Germany. Folks, this is history in the making. It's not happy history, but it's fascinating beyond compare. You might as well pull up a chair and enjoy the show. It's free. They haven't figured out how to tax it yet. 

The real battle now is not whether there will be an intervention to push down Italian and Spanish bond prices. There will be. These two countries have Europe by the nads, and they are squeezing. The battle is whether Spain and Italy will have to accept some external control in exchange, and both Italy and Spain are playing hardball right now on that issue. They say no. The northern bloc is saying yes. I think Italy and Spain will win, but your guess is as good as mine.
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Draghi announces a strong guidance for strong measures to do whatever is required, with committees to be meeting and said strong measures to be completed by committee in the coming weeks. In other words, a fat lot of nothing.

Mr. Market is probably going to fart collectively in his direction.

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I'm watching the press conference. Now it's a war on financial market fragmentation. How does the ECB expect to deal with that? 

ESM will be denied banking license, according to Draghi. The strong measures will include bond buying, it seems, but there's an awful lot of hedging going on. 

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We usually don't act under terror, but as a result of cool analysis. That's a quote!  

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Strong guidance = "May undertake" additional bond-buying, if conditions warrant.

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OMG, Draghi dropped a bomb in response to questioning - he said and reiterated that bond buying from the funds would be conditional only - that the countries would have to apply and accept conditions. If you are a Mr. Market participant, this is a red flag. Is he trying to get German 10 year bond yields down to 60 bps?

Last update on news conference - in a stunningly weak response to questioning, Draghi asserted that the meaning of his earlier speech and today's guidance is that the Euro is not going to go away and that it is useless to short it, because it is a strong currency. Now he's bouncing around yelling, "Hit me, ya big bully! I dares ya!" This is excruciating - I can't watch any more.  

Link to published Draghi statement:
The Governing Council extensively discussed the policy options to address the severe malfunctioning in the price formation process in the bond markets of euro area countries. Exceptionally high risk premia are observed in government bond prices in several countries and financial fragmentation hinders the effective working of monetary policy. Risk premia that are related to fears of the reversibility of the euro are unacceptable, and they need to be addressed in a fundamental manner. The euro is irreversible. 

 In order to create the fundamental conditions for such risk premia to disappear, policy-makers in the euro area need to push ahead with fiscal consolidation, structural reform and European institution-building with great determination. As implementation takes time and financial markets often only adjust once success becomes clearly visible, governments must stand ready to activate the EFSF/ESM in the bond market when exceptional financial market circumstances and risks to financial stability exist – with strict and effective conditionality in line with the established guidelines. 

The adherence of governments to their commitments and the fulfilment by the EFSF/ESM of their role are necessary conditions. The Governing Council, within its mandate to maintain price stability over the medium term and in observance of its independence in determining monetary policy, may undertake outright open market operations of a size adequate to reach its objective. In this context, the concerns of private investors about seniority will be addressed. Furthermore, the Governing Council may consider undertaking further non-standard monetary policy measures according to what is required to repair monetary policy transmission. Over the coming weeks, we will design the appropriate modalities for such policy measures.
Reuters summary article that is good. The reason that questioning verged on hostility is that Draghi baited Mr. Market and then failed to produce, and this is a recipe for losing market trust, which is the greatest asset any central banker has. Not a good day for the Dragon. Last week he gave Mr. Market what seemed to be an open-ended, unconditional guarantee. Today he comes to the table with no concrete current measures, explicit statements about conditionality for acting, and a promise of committees. Bad, bad, bad, bad - this is very bad. Central bankers cannot afford to do what the Dragon just did, and most definitely not in the circumstances that the ECB faces.

Comments:
Draghi was under intense pressure from investors, European leaders and even the United States to deliver on Thursday on his pledge to do whatever it takes to save the euro by bringing high borrowing costs down and salving the debt crisis.

He can't DO anything.

It's been 5 years. If you haven't found any new suckers yet, then you are the bag holder and the pressure is on YOU, not the fairy godbanker.

The can gets bigger every time you kick it.
 
That's not a can, Charles, that's a blivet.

The situation may get explosive from here.

Rammstein - Benzin.

The Chinese are now selling exploration rights for the disputed South China territories.

There's a lot going on, and ain't none of it good.
 
I think mutualization of political power and debt is a big mistake. Every country then gets pulled down by those who believe in a café society to an egalitarian average. Better to let the over indebted countries default on 50% of their debt and let the market prices of their new bonds determine the level of reforms (austerity) each country must take. I am done with bailouts and moral hazard. If you want to make government employees a privileged class you should be allowed to (the way we do here if California). If it is a problem, then you should pay for it, not everyone else.
 
The bottom fell out of everything this morning, market-wise. Draghi missed the can and tripped over it, which was bound to happen eventually.

So now we find out what deflation looks like in the 21st century.
 
MoM,
Agree that Draghi's insistence on Monti/Rajoy asking for a bail out was key. The whole secondary mkt. bond purchase idea was to help these two out so that they didn't need to ask for a bail out. If they ask for one, they are done politically, and we don't know what will replace them.

Europe is cycling through center-left and center-right gov't's right now. Soon it will realize none have the answer, and will turn to the fringes. Too bad. We could use a few Teddy Roosevelts, but instead we'll get populists of another stripe(s).
 
David - yeah, thanks for clarifying that for me. I was too staggered this morning to make sense. My jaw dropped on that one. The other issue on the "asking for a bailout thing" is that retail investors are afraid of being stuck with the bill for the intervention, and without very explicit guarantees as to the exact mechanism by which this will be prevented, they will naturally be wary.

I'm not looking forward to what happens next, and I am badly shaken by this morning's events.

The Sicilians and Beppe got handed the ball this morning, and that was not what I expected.
 
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