America, Greece and a World on Fire

Gideon Rachman wrote a truly excellent article in the Financial Times today entitled America, Greece and a World on Fire. The article reviews the role of the United States in declaring the Truman Doctrine in 1947 as a result of the Greek Civil War, which led to the Marshall Plan for Europe. It contrasts the fact that at present, European leadership of the Greek debt crisis has proved extremely disappointing.

An extract is below: please check the link for the full article.

“It took an economic crisis in Greece in 1947 to force the United States to assume world leadership. Now, more than 60 years later, another Greek crisis is showing what the world feels like without US leadership.

In February 1947 the British government – bankrupted by the war and beset by a harsh winter – told America that it could no longer afford to aid Greece, which was on the brink of economic collapse and civil war. A British diplomatic cable at the time recorded a belief in Washington that “no time must be lost in plucking the torch of world leadership from our hands”.

President Truman went before Congress and requested $400m in aid for Greece, pledging that America would now “support free peoples who are resisting attempted subjugation”. A few weeks later, the US announced the Marshall Plan – a huge programme of financial aid, aimed at stabilising the whole of western Europe.

The contrast between then and now is stark. Once again, an economic crisis that began in Greece is threatening Europe. But this time there is no question of America assuming the central role in the management of the crisis.”

America, Greece and a World on Fire

Financial Times – 16 January 2012

The Troika, the Reform Programme and the Missing Labour Reserve

The other news from Greece this past week was the fact that the phantom labour reserve programme was officially shelved.

Minister of Administrative Reform Dimitris Reppas announced on Tuesday, 10 January that the labour reserve policy “bordered on the absurd and the ridiculous.” This policy, designed to place 30,000 public sector workers in a 12-month “labour reserve” at 60% of their pay, was designed under former Prime Minister George Papandreou as a means of avoiding, or at least minimizing the impact, of public sector cutbacks.

Minister Reppas further stated that firings of public sector personnel were not on his agenda. As quoted by Kathimerini’s English edition:

“We did not expect anything significant from a fiscal aspect and on the other hand there was the danger of public administration being unable to operate because of the loss of key personnel,” he said.

At the same time, Greece has clearly committed to downsizing the public sector by 150,000 workers by 2015.

So far, it is estimated by various sources that up to 10,000 public sector workers were placed in the “labour reserve” in 2011. Other sources claim that in fact many of these people claimed early retirement. Yet other sources say that the number of people placed in the reserve were in fact far less – on the order of 1,500 – 2,000 people.

While I share certain misgivings as to the efficiency of the labour reserve scheme, it is hard to underestimate just how much of an operational and public relations disaster this is for the Greek government.

On the one hand, Greece has committed to the labour reserve scheme since early 2011. This is the first step of a far larger public sector cutback.

Yet on the other hand, Minister Reppas is on public record disparaging the entire scheme, and abandoning it.

This clearly indicates that PASOK is still not behind the “reform” effort it has put it signature to, and indeed, has for the most part crafted. And apparently, Prime Minister Papademos is unable to enforce any sort of collective discipline on the matter.

Yet the commitments were made. If they were not the right commitments, they should have been refused at the time of their agreement. Not agreed to, and then rejected over one year later. This is otherwise known as hypocrisy.

With the Troika visiting Athens, I expect one or more of the following scenarios to unfold in the next few weeks:

a.     There is a strong chance that the Troika will break off the monitoring visit over lack of progress, repeating the scenario seen in August/September 2011. This will create yet another delay, exacerbated by the delay in agreeing to the PSI conditions.

b.     Prime Minister Papademos will force the restructuring the cabinet, removing certain “deep PASOK” ministers and installing “technocrats” in their place.

c.     Prime Minister Papademos threatens to resign, or resigns, on the lack of support for his premiership, and for the agreements that Greece itself has signed and agreed to implement. An election is then held, creating yet another self-destructive round of politicking and delay.

The self-destructive tendencies of the Greek political class should be manifest to everyone. Unfortunately, they threaten to drag everyone else in Greece down with them.

Related Post:

Public Sector Cutbacks and Political Paralysis in Greece

December 19, 2011

© Philip Ammerman, 2012

Navigator Consulting Group

 www.navigator-consulting.com

Explaining the Carry Trade

I received several comments on yesterday’s post that the concept of the carry trade was either unknown, or too complicated to understand. Apologies for this: I’ll try to explain this in simpler terms here.

In the currency carry trade, an investor takes out a loan in a stable currency at a low interest rate. For years, the Japanese Yen was the main source of such borrowing.  

The investor then converts these funds into an investment in another, higher-interest currency or deposit account. His/her benefit is the margin between the two interest rates, less any transaction fees or exchange rate losses

Let’s take an example: I borrow EUR 1 million in Japanese Yen at an annual interest rate of 1%.

I take this amount and invest it with the Bank of Cyprus, which is offering 1-year deposit rates of 5%.

At the end of the year, I’ve gained EUR 1,050,000 (or EUR 50,000 of interest), less capital gains tax in Cyprus. I have to re-pay the loan in Yen, which had a rate of 1%, so I have to repay EUR 1,010,000, less any currency exchange losses.

My profit for 1 year is a little less than EUR 40,000.

We have a similar carry trade going on right now with low-cost European Central Bank loans. In Cyprus, for instance, a bank can loan money from the ECB at 1%, and lend the money onward to a company at 7-8%. It can do the same by lending to the Italian government at 7%, if it wants a higher risk. It can lend to consumers via visa card interest rates of 12-14%.

My point is not to minimize the risk of sovereign lending, which is mounting*. My point is that banks benefit from 1% repo lending rates for 3-year loans from the ECB, while the large majority of citizens in the Eurozone typically pay far higher rates.

If the objective were to have banks by government bonds using a share of this ECB funding, it would be far better for the ECB to lend directly to governments, cutting out the banking middleman. This “standard” quantitative easing would send a stronger signal to financial markets and would eventually lead to lower interest rates (although it would also lead to political risk and potentially higher inflation and/or a weakening Euro).

Given that the ECB is ultimately guaranteed by the central banks of the Eurozone central banking system, it seems incredible that private citizens in the Eurozone are essentially guaranteeing the expansion of the ECB’s balance sheet, so that the ECB lends to banks, which in turn either sit on the money (credit expansion has slowed everywhere), or are supposed to “recycle” this money into government bonds.

This will result in outsize profits for the private banking sector. There are also simpler work-arounds to getting the ECB or the national central banks to buy government bonds or provide working capital to companies, which is what this whole process is supposed to result it.

* It is interesting to note that while banks borrowed EUR 498 billion in late December, in early January they had nearly the same amount on deposit with the European Central Bank, in an apparent “flight to safety”.

Related Posts

The Mother of All Carry Trades

January 14, 2012

© Philip Ammerman, 2012

Navigator Consulting Group

www.navigator-consulting.com

The Mother of all Carry Trades

The ECB’s decision to lend EUR 498 billion at an average rate of 1% for 3 years to European banks is turning into the mother of all carry trades.

The unspoken premise behind these loans was that banks would use part of these loans to re-invest in sovereign debt. As Bloomberg stated

Italian two-year notes rose for a third day and Spanish securities rallied on speculation the European Central Bank’s provision of three-year loans is boosting demand for the two nations’ debt.

Given that recent Italian and Spanish bond auction rates exceeded 6%, this amounts to a margin of just under 5% for banks which took out ECB loans and re-lent to these two governments. 

The Standard & Poor’s downgrade of 9 Eurozone countries yesterday evening, among them France and Italy, raises sovereign interest costs still further. This comes on the heels of a successful Italian bond auction last week

Italy issued 12 billion euros of Treasury bills, meeting its target as its borrowing costs plunged. The Rome-based Treasury auctioned 8.5 billion euros one-year bills at a rate of 2.735 percent, down from 5.952 percent at the last auction.

With Italy now downgraded to BBB+, we can expect another spike in interest costs next week.

All this has been financed by the European Central Bank and the Eurozone central banks. According to Reuters

Due to the generous liquidity provision and a bond-buying programme, the balance sheet of the ECB and euro zone national central banks has ballooned by more than 600 billion euros to 2.688 trillion in the last four months.

It is extremely doubtful whether the European Union’s citizens are aware of what this means. The ECB, in an effort to solve the banking and sovereign liquidity and solvency crises, has expanded quantitative easing (QE) of a very different sort. In “standard” QE, the [national] central bank “expands its balance sheet” and buys the bonds of its national government directly.

The ECB, however, is prevented by its charter from doing so. As such, it can only intervene on the secondary market, in this case by loaning money to banks, hoping that the banks will in turn loan money to governments.

But what does this mean in terms of costs? A standard, national central bank would lend to Italy at a rate of 2-3%, driving sovereign lending costs downward. Under current legislation, the ECB is forced to  “recycle” the loan at 1% through a bank, which lends onward to Italy at a substantially higher rate. Add a rating agency downgrade and a liquidity crisis into the mix, and the bank soon gains a 4-5% margin.  

This exposes (once again) the flaw in the design of the European currency, as well as the risks in pooling sovereignty in a global world.

This also means that the democratic deficit and moral hazard are increasing to unprecedented levels. There has been no public referendum on whether or not the European Central Bank should deliberately enrich the banking sector through what amounts to a massive expansion of cheap credit, which is ultimately borne by the European taxpayer. 

Ironically, while public sector rates will increase, we can also expect a declining Euro currency value, which may result in higher inflation in some countries and segments. (The decline in consumer income due to public sector austerity will probably offset this inflationary trend).

It remains to be seen when the Tea Party will emerge in Europe, but I cannot imagine that the mainstream political parties in most countries can continue to remain unscathed in light of what we are seeing. While few European voters appear to realize what’s happening, it is only a question of time before they do.

© Philip Ammerman, 2012

Navigator Consulting Group

www.navigator-consulting.com

Athens - A Little Great City

Athens I The Little Great City from emmanouil papadopoulos on Vimeo.


Congratulations to Emmanouil Papadopoulos on this fantastic clip. 

The European Debt Crisis in 2012

The year 2012 will be critical to the resolution of a number of economic issues, primarily in Europe. Unfortunately, it is highly likely that whatever solutions will be found will be very temporary in nature, and will address symptoms rather than root causes. At least in Europe, there is critical awareness that these issues will have to—at some point—be resolved. In the United States or Japan, where much the same problems exist, the recognition of even the symptoms of the problem does not appear to have reached a societal critical mass.

The headlines in Europe will continue to be dominated by the need to address two critical issues: the refinancing of sovereign debt, and the inability of the banking system to do so in parallel with private sector obligations and their own recapitalisation needs.

Unfortunately, the relatively simple process of refinancing is exacerbated by the normal political fragmentation and duplicity, but also by electoral interests. The example of Greece, where a caretaker Prime Minister had to once again implore his cabinet for cooperation and real progress, is indicative. Yet the same paralysis is in effect in Spain, Italy, France, Belgium and even Germany.

As a result, we can a “crise du mois”, a monthly crisis, or perhaps even a crise du jour, in the Eurozone each month in 2012. In Greece, the crisis has already been planned, given the need to refinance EUR 15 bln of bonds in March, and with the Troika already indicating that the first bail-out installment plan will be delayed by 3 months. Either Greece will have to raise short-term funds via high-interest treasury bills (as it did in December to stave off default), or it will have to raid its bank stabilisation fund, to reach this amount.

The problems in Italy are far higher: Italy needs to refinance EUR 300 billion in 2012, with about half of this occurring in the first six months. Total Eurozone refinancing needs are estimated by Citigroup at EUR 1.1 billion in 2012.

So far, both France and the EFSF have been able to complete bond issues in the past week, but for very low amounts and with lower debt covers. Italy and Spain return to the markets in the week of January 9^th and thereafter. The real test will occur in January and February.

In December, a long-expected scenario materialised as the European Central Bank lent nearly EUR 500 billion in 3-year, low-interest loans to European banks. Together with its limited interventions in sovereign finance, this was enough to close December without a meltdown, which is something most desperate bankers were looking for. Yet it is unlikely to persist into 2012. If it does, it will require a massive expansion of the ECB’s balance sheet, which at some point will exceed the limits of credibility.

The Eurozone system will be tested, possibly to the breaking point, in the next 3-4 months. Only non-sovereign lending by the ECB, the IMF and possibly the EFSF remain to save the situation. The breaking point will be illustrated by events:

·       At least two failed Eurozone national bond auction, meaning debt cover ratios below 50%

·       Sustained yields above 7% for Spain and Italy

·       A downgrade of two or more Eurozone countries, placing the EFSF’s rating in jeopardy.

These events will have inevitable consequences, chief of which will be a financial panic. To avoid this, it is likely that the seven “grand bargain” conditions I mentioned in my post of December 2^nd will be put into effect, namely:

1.     Extending ECB lending as well as maturity terms to banks. This would require quantitative easing for the private sector by the ECB, and also extending maturities from 1 year to possibly 5 years. 

2.     As part of such an agreement, banks agree to repurchase a certain share of Eurozone sovereign debt, most likely in the range of 60-65% of total outstanding debt.

3.     The IMF steps in with a formal austerity programme for Italy and Spain, enabling them to refinance part of their needs using ECB-IMF resources. It is likely that IMF-ECB resources of at least EUR 200-250 billion will be needed. 

4.     The ECB is given limited authority to continue secondary market sovereign bond repurchases, perhaps by another EUR 100-150 billion. 

5.     The banks agree to participate in the European Financial Stability Facility (EFSF) capital increase, perhaps to EUR 800 billion. This adds about EUR 400 billion to the fund, which is then used to repurchase sovereign bonds as well as possibly bank refinancing. 

6.     The Eurozone adopts much stricter rules on the public finances of its member states. It is not impossible that a "new Eurozone" emerges. 

7.     The European Banking Association (EBA) delays its core capital increase, or alternatively allows an exemption for central bank guarantees or ECB credit lines. It is difficult to see exactly how this would work, but some solution will no doubt be found. 

Conditions 1 and 4 have already been implemented in whole or in part, and will almost certainly be extended.

Again, it is worthwhile to emphasize that these “solutions” address the symptoms of the problem, not the root causes. These root causes are familiar, and include:

·       A paradigm shift in the economic model of the “West”, from a producer of goods and services, to a consumer of goods and services using loan finance. This has in turn been further exacerbated by the implementation of unrealistic free trade agreements which have destroyed any vestige of competitiveness in many manufacturing segments.

·       Excessive reliance on a few consumption-based economic sectors such as retail, catering, tourism, finance and the still over-valued real estate/property sector.

·       Demographic decline, exacerbated (or “leveraged”) by the implied or legal acceptance of millions of low-paid immigrants who can no longer be accommodated under prevailing economic conditions.

·       A burgeoning public sector, which is based on the direct provision of services and future benefits (such as pensions) and which can no longer be maintained. 

It remains to be seen whether the policy recommendations we see made at the European or national levels will be sufficient to address these root causes. I do not believe they will. In general, European elected officials are using first generation policy tools to fight what amounts to third generation policy problems. It’s a bit like giving the captain of the Titanic a teaspoon to bail out his 46,326-tonne vessel after it hit the iceberg.

There are very few countries in Europe today that have unlocked a “golden mean” for managing their economic competitiveness, and unfortunately this number is declining, because of Eurozone and EU obligations, because of declining national and international economic conditions, or because their own societies are ageing.

As a result, I am extremely bearish on 2012, although it is possible a short-term compromise is reached which enables the Eurozone to keep ticking over long enough. It will be necessary for everyone, whether a company or an individual investor or wage-earner, to prepare for far worse trading conditions than 2011.

Related Posts

Toward a Grand Deal on Bank Refinancing and Sovereign Loans

December 2, 2011

The End of Leverage

November 25, 2011

© Philip Ammerman, 2011

Navigator Consulting Group

www.navigator-consulting.com