Kicking euro IED Down the Road & Global economy: Radio Appearance July 7, 2012

In a radio appearance on Saturday Session with Bishop on July 7, 2012, we talked about how the eurozone is no longer kicking a can down the road but it is kicking an IED down the road and when it explodes it will have global repercussions.

We discussed the Libor scandal and the banks involved.

We discussed US unemployment and how the Fed's warning on the "fiscal cliff" is not just about revenue but the need of the government to spend if continuing high unemployment is to be lowered.

We discussed how the Fed minutes from the preceding month which would come out in the week of July 9th would not show any inclination towards QE3 and would show concern about the potential economic impact of the eurozone currency crisis blowing up and the continuing threat of US fiscal contraction (the need for government to spend to address the unemployment problem).  And we were right on as the minutes show.  The Fed FOMC meeting statement in July continued its reluctance to do anything which might place it in a political cross fire during an election year.

Here is Part 1 of the interview.

Here is Part 2 of the interview.

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Radio Interview 2/25/2012: Greek Bailout, Europe, and Federal Reserve QE3

We were interviewed on Saturday Session with Bishop about Greece and the proposed bailout and how it forces Greece to relinquish its sovereignty.  The details of the proposed bailout, which would include new restrictive laws, more pension reductions and spending cuts, the prohibition against any Greek political action contrary to the bailout, and the requirement to make debt payments before any public spending in Greece would be allowed, and the need for resolution prior to March 20th, which is the date on which Greece must pay maturing debt.  Greece is already in technical default.  We discussed the imposed austerity programs and how they are making Greece's economy even more unsustainable.  We discussed how Greece will inevitably face the choice of default within the euro or default with abandonment of the euro which is a choice between economic slavery as a colony of the eurozone (Germany) with foreign EU/ECB technocrats running the Greek government or the harsh new beginning of freedom with a new sovereign currency which could devalue up to 80% after a fixed exchange from the euro to the new currency and the redenomination of  all Greek public and private debt into the new currency and the possibility of economic growth.

While it may appear that the United States has decoupled from the developing storm of Europe, the consequences of a currency union without a fiscal transfer mechanism, recession in Europe, eventual Greek default, and the pressure on European banks and other eurozone peripheral countries will have global consequences on financial liquidity and the world economy including the United states and China.

We also went over the minutes of the last Federal Reserve Open Market Committee (FOMC) meeting in which most members are not inclined to initiate a QE3 unless disinflation reasserts itself and economic growth weakens in the future.

An MP3 of the interview is here.  The European situation and the tragedy of Greece have been unfolding in very predictable and obvious fashion for a few months.  Even Wolfgang Munchau has finally acknowledged that Greece needs to default.

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Blogging, Clients, and the Impending European Implosion

In the first week of October, it became obvious that what needed to be done in Europe to avoid a financial crisis which will become a global financial crisis will not only not be done -- it is being ignored and economic history denied in immoveable Orwellian terms.  The EU Summit was a colossal failure and, despite media reports to the contrary, nine countries, other than the UK which opposes the Treaty changes, must consult their parliaments and Ireland may need to seek public approval.  Since the euro has never survived a public vote, it will be interesting to see to what extent the EU will go to suppress any public vote in Ireland or elsewhere as it did in Greece prior to staging its coup d'etat and deposing the democratically elected government of Greece.

To hear more of my analysis, including my concern that the euro has become an enemy of democracy, of the European economic crisis, listen to my most recent radio interview here.

It became my duty to serve my consulting and advisory clients to get them to position themselves appropriately consistent with their business model and to rebalance individual portfolios defensively.   Anyone who has not taken by advice or implemented my advice: Good Luck.  Desired results require decisive and informed action.

Consequently, I have not been blogging despite have several large articles researched which I have not had the time to write.  I would like to write everyday.  However, I do not like to write just to write but when I have something substantive to say.  What little advertising is on this blog site is obvious and minimal.  The links --- all links --- within my blogs are substantive sources and often offer different views.  No links within my blogs are advertising, which I find a repugnant practice.  Blogging is not about making money; it is about ideas and communication and discussion.  Other bloggers, not all, have found my practice of link referencing sources, much as academic papers would be referenced, and providing extended reading material through those links as impediments to cross publication.  On the other hand, individual opinions without substantiation seldom rise to Proustian levels. It also means I do not close my mind to different viewpoints and attempt to remain true to the data and the developing macroeconomic environment.  I have never been a joiner of cliques and have been schooled in critical thinking in which no one's opinions, including my own, are sacrosanct.  If this offends others, so be it.


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Is the Euro Steeped in Self-Deception and Suicidal Delusion?

After only one day, the Euro Deal of the recent EU Summit began to wilt under the bright heat of the flood lights of rational scrutiny.  On Day 2, we saw a repetition of how the German Constitution is a fundamental stumbling block to a politically united eurozone fiscal union with additional pleadings which could force Bundestag approval of EFSF bond purchases (not the bond purchase program but the actual individual purchases themselves).

We also saw on Day 2 the Erste Group bank of Austria suddenly writedown its CDS portfolio by 1.49 billion euro creating a a 750 million euro shortfall just two weeks after projecting a profit and reducing its 2010 profit 12%.  It reduced its CDS portfolio to 300 million euro yesterday from 5.2 billion euro as of the end of September.  It also announced it was cancelling its repayment of 1.2 billion euro in State aid, while proclaiming it had no intention of requesting new State aid as it would cover the loss with a 35% (only) return of executive bonuses and the use of retained earnings over the next three quarters.  It should be noted that the Erste Group had substantial exposure to Eastern Europe as do Greek bank Subsidiaries in Eastern Europe.

Worse, not only is Sarkozy seeking China's investment in EFSF bonds or the SPV to be created (Van Rompuy is on record from earlier in the year favoring consideration of Chinese investment), but Klaus Regling, the executive director of the EFSF, was not only already talking with the Chinese but even suggesting that EFSF debt could be issued in Yuan.  It is economically incompetent for a sovereign nation with its own fiat currency to issue debt denominated in a foreign currency.  For a monetary union with no fiscal transfer mechanism to issue debt in a foreign currency (Yuan), when its member nations are under credit attack for debt already denominated in a foreign currency (euro), is beyond incompetent; it is economically suicidal.

The surplus countries of the eurozone have the money to invest in the deficit countries; there is no need for foreign investment in eurozone debt which will cause the euro to be sold and dollars purchased by the eurozone countries which will strengthen the euro and make eurozone exports more expensive.  The surplus eurozone countries, in order to economically correct trade imbalances within the eurozone, should be using the current account surplus funds to invest in the infrastructure and manufacturing of the deficit countries. The Euro Deal of this past week has not increased the equity stake of member nations; it only has the member nations providing insurance guarantees. 

The one size fits all approach of the eurozone just does not work.  The deficit countries cannot export and privatize their way into surplus under austerity.  The current account surpluses needed to drive down the existing high private sector leverage and public sector deficit in the deficit countries is too massive (even in Ireland) to be obtained from export growth and the privatization of public assets.

Yet, the mantra of convergence, competitiveness and austerity remain as the key mistakes enshrined as European Monetary Union holy grails carry forwarded from the EMU 1991 currency crisis.  Convergence never happened.  Kantoos Economics, a German economics blog, has had two recent posts which exemplify the group think mindset of the European Monetary Union. One was on competitiveness in which a post by Kash Monsori is used in an attempt to show how misunderstood the European concept of "competitiveness" is and that imposed austerity in the deficit countries is not a self fulfilling economic disaster. The second post on Kantoos Economics is on the "necessary" rigidity of currency unions and internal devaluation as the only method of adjustment for trade imbalances with a currency union.  If Kantoos Economics wants to take on a non-European on competitiveness, then Kantoos would be well advised to take on Rebecca Wilder who has shown the "competitiveness" concept as promulgated in the eurozone is a chimera in which all countries must be like Germany in which the concept has become to mean the efficiency of the economy as a whole involving "...strong macro-prudential policy, infrastructure, efficiency and income gains, savings, etc."  In fact, the concept of competitiveness more generally describes and reflects data from a variety of factors such as education, infrastructures, institutions, technological development, health, macroeconomic environment, market efficiency, labor efficiency, and innovation to name a few.  It is always best when theory adapts to the reality of data rather than morph data to fit a phantasmagorical theory.

When one looks at worker statistics, the Greek worker works longer hours for less money than workers in other EU countries.  However, most Greek workers are involved in agriculture and the worker productivity has a smaller euro value.  For productivity to improve, there needs to be technological improvement within Greece.  In fact if you look at the northern and southern eurozone countries, there is no evidence of profligacy and laziness.  What you will see is, the creation of the euro lead t a massive flow of capital from the northern countries to the southern countries, because it was profitable for the northern countries.  Marshall Auerback and Rob Parenteau have provided a concise and strong economic criticism of the Greek myth of profligacy and the ultimate self-destructive nature of austerity not only on the deficit countries but also on the surplus eurozone countries.  They paint a convincing picture of the need for a more coordinated mutually beneficial growth option involving direct investment by the surplus countries in the infrastructure, technological development, and manufacturing of the deficit countries.

The Australian economist, Bill Mitchell, who has been a long time critic of the euro, sees the Euro Deal as one which solves nothing, continues all of the same problems, intensifies the anti-democratic policies of the eurozone, and increases the pressure on the surplus countries to suffer the same fate as the deficit countries.

What does this leave us with?  Desperation, human suffering, failed nations, a breeding ground for authoritarian regimes, economic collapse?  Or does it leave us with an existential epiphany of NO HOPE and the recognition of a common humanity and purpose that digs down and comes up with the political will to get things done for the best interests of the many and a respect for individual freedom which promotes unbiased, empirical analysis of economic data, the needs of aggregate demand, and recognizes the economic growth power of full employment?

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Euro Deal Euphoria or Wake?

The announcement of a euro deal emerging from the EU Summit on the "debt" crisis yesterday pleased the markets, but it has solved nothing  and appears to have a 100% chance of failure.  In fact the deal only further exposes the the fundamental construction weaknesses and limits of the euro which has doomed it to failure.

How far can you kick a can down the road with a dead cat inside?  Apparently, only one day.  Italian bond yields exceeded 6% at auction today.

Auerback, Wolf, and De Grauwe, among others, have called for the ECB to step up and be a lender of last resort consistent with the role of a central bank.  Unfortunately, the ECB by Treaty construction and ECB rules and establishment is not a real central bank and does not have the independent authority to buy bonds, issue currency (the NCBs issue currency under a rigid ratio per nation with the ECB limited to 8% for clearing purposes), or provide liquidity without difficult collaterization guidelines being met.  The ECB in setting interest rates has shown an inclination to be overly concerned with headline, rather than core, inflation which has caused rates to raised at least one time to far and maintained unchanged rather than lowering rates which has primarily served Germany and France at the expense of the deficit countries.  The ECB can only buy bonds on the secondary market and only of prescribed credit quality.  In its attempts to buy bonds on a limited basis to assist in relieving credit pressure and yields, it has faced significant political opposition from surplus countries which has caused it to act as a Fiscal Enforcer and threaten and/or hold back needed liquidity to NCBs in Ireland, Greece, Portugal, and Italy to force national politicians to enact budget cuts and austerity measures despite no public support in those countries.  The role of a real central bank is monetary policy with the ability to provide liquidity, buy bonds, set interest rates, and promote monetary stability as well as act as a clearinghouse.  To get the ECB to act as a real central bank would require Treaty changes and a complete change in the rules and functions of the ECB.  There is not enough time.

Trichet has even recommended a Finance Ministry for the eurozone, but what good would a Finance Ministry have if there is no fiscal transfer mechanism, eurozone taxing authority, and relinquishment of national sovereignty by member countries?  The EU and the eurozone has suffered for too long the determination of sovereign policy in member countries by an elite which is defiant of democratic approval.

Munchau has repeatedly expressed doubts on the leveraging proposed for the EFSF and the SPV which will apparently be created.  Has everyone forgot how disastrous the big banks SPVs were going into the recent Great Financial Crisis?

Sarkozy is promoting the involvement of China when this would only worsen the economic problems as I and Tim Duy have written citing Michael Pettis.

The 50% "voluntary" haircut is not enough and it is unlikely there will be 100% private participation and 1.4 trillion euro EFSF funding is not enough, particularly if European bank's liquidity and recapitalization is eventually challenged.  Additionally, it is popular to overlook the very negative direct effect these haricuts would have on Greek banks if Greece stays in the eurozone.

Many commentators have questioned the jury-rigged euro deal's attempt to structure 50% haricuts as not a defined default triggering CDS.  In fact, in just one day, Fitch has said the 50% haircuts do constitute a default and will affect Greece's credit ratings send the euro down.

The eurozone crisis band aid approach of temporary patches is not sustainable and is just setting the stage for recession and the eternal re-emergence of the very same problems.

Is the eurozone a monetary union with a stable currency benefiting all of its members or is it a tontine in which the last remaining country becomes the Imperial power and the other countries its colonies?  Meanwhile, Greece, Ireland, Portugal, Italy, and Spain are being repeatedly raped and France has been moved to the credit rating coming attraction.


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BRICS to the Rescue? Kiss Eurozone Growth Goodbye

In September, when Michael Pettis' private newsletter discussed how destructive a BRICS rescue of the eurozone or any eurozone country by buying bonds would be, his observations and conclusions were too obvious to justify further comment.  Here is a shorter public version of the newsletter.

Bottomline, if China and Brazil were to buy sovereign bonds in the eurozone or EFSF eurobonds (if any are ever approved), it would would mean the eventual shift of financial flows to the BRICS from the eurozone stifling eurozone economic growth, because, as Pettis said, "foreign investment simply replaces domestic savings, undermines the manufacturing sector, and raises unemployment or debt."  As the BRICS bought European bonds, the Europeans would be forced to buy United States bonds, US dollars would be sold to buy euro and the euro would strengthen while trade balances would shift to the BRICS, particularly China.  This is the consequence of foreign investment.  To make matters worse, as Pettis points out, the foreign investment is not needed as Europe is awash  in capital in the surplus countries.

Yet, as the trade surplus nations of the eurozone continue to avoid the trade imbalances within the eurozone, this possible scenario is being floated as the EU Summit  draws out with France and Germany unable to agree and the UK demanding all EU countries participate.  This will only seriously aggravate the eurozone problem as, according to Pettis, "the increase in foreign investment would simply be matched either by an equivalent reduction in domestic savings or an equivalent increase in domestic debt to counteract the rise in unemployment. Rather than ease the burden, in other words, foreign investment simply replaces domestic savings, undermines the manufacturing sector, and raises unemployment or debt."

If the BRICS want to help Europe then they need to invest in infrastructure and manufacturing in the eurozone and, particularly, in the peripheral countries.

If BRICS buy eurozone peripheral sovereign nation bonds through the EFSF or individually, the eurozone can kiss economic growth goodbye and the currency problems of the euro multiply with decreased savings, increased debt, increased unemployment, and loss of trade surplus to non-eurozone countries.

As we indicated in our last post, the eurozone needs to decide if it will be a fiscal European Union or if it needs to break up. 


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Has Germany Castrated the Euro?

The German Bundestag now has the legal authority to require the German government to submit all EU proposals which will have budgetary effect to the Bundestag for approval prior to negotiation committing Germany to any agreement.  This virtually prevents the German executive from negotiating any substantive EFSF or other economic support for the eurozone as a whole, or particular member countries, through the EU, ECB, or EFSF.

Despite early French-German discord, there was some renewed hope that a 3 trillion euro package could be put together for the EFSF only to have the German Finance minister quickly and very publicly state that no miracle cure will emerge from tomorrow's EU Summit on the eurozone's sovereign debt crisis and further stating that the process for resolution will take much longer into next year, which has again placed focus and pressures on bank credit and liquidity rather than the more centrally important issue of sovereign risk in a monetary union without any fiscal transfer mechanism.

The EU Summit tomorrow will not only be a disappointment, but it could well be the ultimate stone thrown on the victim of European union.  The 3 trillion euro package has been reduced to 2 trillion and now they are again talking of 1.3 trillion with no additional public sector haircuts beyond 50%, when it is obvious is needs to be much larger if not 80% or more, at the insistence of the ECB, although that would only amount to a 22% writedown of Greek debt and far too little money to provide bank recapitalization and sovereign credit support.  European banks alone face a potential 7 trillion loan contraction.  A conservative economic stabilization fund would need at least 10 trillion if bond buying to support sovereign credit is included to provide some (this is an off the cuff figure and would only be a temporary solution as the political problems will lengthen the process) time to politically provide either the necessary treaty changes with democratic approval for fiscal union or a planned orderly default and withdrawal of Greece from the eurozone.

Already France is being threatened with a ratings downgrade by Moody's and the S&P is warning of an EMU downgrade blitz.  European officials and economists have lost focus on the big picture in attempts to defend cherished political and economic policies which defy real economic data.  While Munchau has maintained the optimal fix would be a democratic fiscal union with the alternative an unacceptable public recapitalization of European banks, this, in my opinion, would only further the depth of sovereign risk and potentially endanger democratic rule.  Munchau has asserted that the choice will be between fiscal union or break up.  Martin Wolf has essentially agreed in the need for fiscal union as first aid will not remedy the eurozone internal balance of payments crisis which is at the heart of the euro currency crisis, as Michael Pettis has clearly described as an economic imperial and colonial relationship.

The European Commission's assessment report has been leaked which shows the total unsustainability of current program and proposals and further discloses the ECB does not agree with the private sector involvement scenarios.  The full leaked version can be found here.   As Rob Parenteau and Marshall Auerback have asserted in private email communications (of which I was a copied recipient), this document substantially documents not only the unsustainability of current programs but refutes current austerity economic polices as indefensible.  In another private email to them from Martin Wolf, he has indicated that Greece's present problem is one of economic flows, which is correct for the current situation in which Greece's debts are denominated in a foreign currency (euro) and default would gain Greece little.

However, any planned, orderly default by Greece would require an immediate take it or leave it redenomination of all Greek debt, public and private, into the new Greek currency.  This would establish an economic stock in which the economic flows are secondary as a fiat currency sovereign nation which taxes cannot become insolvent. The market would decide the haircuts and devaluation.  Most economic speculation has assumed any Greek default would be within the euro which would be suicidal sacrifice on the alter of European union on the part of the Greece, whose citizens do not appear to want to slink into the darkness of slavery quietly.

The EU Summit tomorrow will not only be a disappointment, it may well be a defining moment of existential despair.  In that despair, what choices will the different people of Europe make?

UPDATE:

Here is a post by Rob Parenteau entitled "Leaked Greek bailout document: Expansionary fiscal consolidation has failed" which can be found at Credit Writedowns here.


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Michael Pettis on the Euro, Swiss Franc. RMB trading, and Chinese Debt

In a very long private newsletter received on September 13th, Michael Pettis began with "Slow growth is embedding itself solidly into the US economy and the bond mayhem in Europe continues. The external environment for China is getting worse. This will almost certainly make China’s adjustment – when Beijing finally gets serious about it – all the more difficult. With still weak domestic consumption growth, and little chance of this changing any time soon, weaker foreign demand for Chinese exports will cause greater reliance than ever on investment growth to generate GDP growth.

"Europe’s travails in particular can’t be good for exports. What’s worse, it’s now pretty much official that the euro will fail soon enough."  Pettis saw Merkel's assertion that the euro will not fail as an official government denial confirming that it could fail as in the political maxim, "The first rule of politics is never believe anything until it is officially denied."  Pettis then proceeds to discuss in depth Otto Henkel's proposal ( "A Sceptic's Solution - A Breakaway Currency") for a two currency euro.  Although Pettis thinks there is little likelihood of the creation of two euro currencies dividing the deficit and surplus eurozone countries, he likes the idea, because all the deficit countries will not adjust fast enough as long as they maintain the euro and their economies will continue to contract and debt grow until their electorate rebels.  If those countries will then leave the euro and default and the surplus countries will eat the losses, why shouldn't the surplus countries force the deficit countries to leave the euro now?  Pettis answers his own question.

If a deficit euro country leaves the eurozone and adopts its own fiat currency, Pettis believes it would be caught in a downward currency spiral such as Mexico in 1982 and 1994 and Korea in 1997 suffered, because a substantial portion of Mexican and Korean debt was denominated in foreign currency.  A deficit euro country leaving the eurozone would have its debt denominated in euro.  This would be a foreign currency.


My comment in response to Pettis on the above scenarios is the High euro and Low euro bifurcation would merely create to stage productions of the very same play; one with a short and the other a longer audience length of the play.  Both would suffer the same, inevitable fate of the exporting country economically subjugating the importing countries with no fiscal transfer mechanism to resolve the current account imbalances creating an inevitable currency crisis as the deficit countries are challenged by the bond market one by one since they cannot guarantee payment under such a system.  Any eurozone country which withdraws from the euro must default on all euro debt and immediately redenominate all public and private debt at a fixed conversion to the new fiat currency on a take it or leave it basis and then let the new fiat currency trade freely with the market deciding the devaluation, which must occur.  The euro is a foreign currency to all eurozone countries and it would be irresponsible to leave debt in euro when exiting to a fiat currency; yet, almost all scenarios of such exits assume the debt would remain in euro.  That would be a fatal economic error.


As Pettis well knows, as he continues, to leave debt in a foreign currency means the devaluation may well not be in line with estimates of overvaluation.  It could cause a devaluation of 50% or more, when the overestimate might be only 15-20%.  The external debt would rise as its fiat currency devalues, because it would remain denominated in an appreciating foreign currency.  The credibility question of bond payment would rear its ugly head again and financial distress cost would rise just as they are now.  As domestic borrowers try to hedge the currency risk, investors would flee the new fiat currency in a self-defeating currency crisis involving foreign currency debt.  Default would be unavoidable.


For Pettis, this is not an argument for a deficit country to stay in the eurozone, because, if the deficit country "stays in the euro, we will still arrive at default, but much more slowly, and mainly at first through a grinding away of wages and economic growth over many, many years and a gradual building up of debt as Germany refinances Spanish debt at interest rates that exceed GDP growth rates. The default will occur anyway, but only after years of high unemployment."  He leaves unstated the likelihood of growing social unrest and intra eurozone national distrust of the surplus eurozone countries.


This is why he likes Henkel's two euro currency idea, but with the surplus country (such as Germany) leaving the euro as Marshall Auerback has repeatedly suggested.  The new fiat German currency would immediately appreciate while the euro depreciates, but their banks would still have loans in euro which would cause them significant losses.  Pettis thinks the losses would be less and more orderly than a deficit country leaving the euro.  Either way the surplus country leaving the euro would take a big hit and it is a waste of time trying to avoid it and it is better to face it and deal with it and "as any good Minskyite would tell you, that means we have to pay special attention to the balance sheet dynamics."  Pettis also believes this would set up a two entity Europe of Germany and its associated countries and France and its associated countries.

With respect to the Swiss franc, Pettis believes the Swiss National Bank has decided to become very serious about currency wars.  Switzerland is enduring a large inflow of foreign currency and appreciation of the franc with significant negative impact on Swiss exports.  "The world is seriously deficient in demand compared to capacity and every country is going to try (has already tried) to capture as large a share of that demand as it can. This means every country is going to try aggressively to export capital or limit capital imports."

"But of course it doesn’t work that way. If capital-exporting countries want to increase capital exports in order to acquire a bigger share of global demand, and capital-importing countries want to limit or reverse capital imports, something has to give way. This is basically what we mean by trade and currency wars."

Switzerland has chosen to slow or eliminate foreign capital inflow by capping the rise of the franc.  Pettis believes it cannot work and there will be massive speculative inflows in the Swiss franc on the expectation the inflows will cause the Swiss National Bank to revalue.  In a few months the SNB will have to take even more forceful measures.  When countries continue to desperately export capital to each other while continually crying foul at attempts to import capital, currency wars will roll on as he explain in his recent Foreign Policy article. 

This also means we should not get too excited about news London may become an offshore trading center for the Chinese RNB currency.  Every time the suggestion is made that the renminbi will become more international, excitement sweeps the world, although nothing ever really happens.  One only has to look at the developing currency wars and understand everyone wants to export capital and no one wants to import it so why would China want its currency to evolve into a reserve currency by trading internationally.

There has also been speculation that a country like Nigeria would want to diversify reserves and hold renminbi, but Pettis thinks this is only a speculative idea based on the renminbi price being heavily subsidized by the PBoC and, therefore, only likely to appreciate.  China is unlikely to allow any but the financially small countries to attempt this and does not want to see it at all, since "The PBoC is required to buy up all the dollars offered in exchange for RMB in order to keep the value of the currency where it is, and any increased foreign demand for RMB bonds automatically means that the PBoC must take the other side of the trade. Its reserves will have to increase by exactly the amount of dollars that Nigeria (or any other foreigner) uses to buy the RMB. And the faster China’s reserves rise, the greater than domestic monetary mayhem and the greater the losses the PBoC will ultimately take on the negative carry and the revaluation of the RMB."  The short version of his discussion of this in his mid-May newsletter was "...that once you exclude intercompany transactions, nearly all the trade activities denominated in RMB consist of Chinese imports, and almost none of it consists of Chinese exports. Why is this important? Because Chinese imports denominated in RMB result in long RMB positions in Hong Kong, whereas exports result in short RMB positions."  Once the speculative demand dries up, there is little real demand for RNB transactions and the off shore RNB market would be very small.

Speculative demand will begin to dry up when the perceptions on the total amount of debt on the Chinese national balance sheet begin to improve.  However, debt levels continue to rise and rise very rapidly.  Most analysts have downplayed the resulting credit impact of China's spectacular growth.  Such an analysis implies China has an infinite debt capacity, which Pettis finds impossible.  What concerns Pettis now is that as analysts have caught on to this, the "horror" stories have begun to multiply out of control about "...cash flow squeezes among SOEs and the smaller banks, about unrecorded guarantees and lending by SOEs, about highly pro-cyclical lending by banks, about a huge variety of dubious transactions in the informal banking sector, with non-transparent links to the banking sector, and so on and so on. Everyone nowadays seems to have horror stories.  For this reason, Pettis advises we remain skeptical.  We should not scare ourselves into overreacting.  Pettis does not see China reaching its "... debt capacity until one of three things has happened:

1. Depositors flee the banking system because of uncertainty about repayment prospects. I think this is unlikely to happen unless inflation rises sharply and, because of the highly adverse cash flow impact of high nominal rates, the PBoC is unable to raise deposit rates sufficiently.

2. Household transfers are too high. Debt servicing costs should be met out of the increased economic activity generated by the debt. If they aren’t, the balance one way or another must result in a transfer of wealth from one sector of the economy – usually the household sector. As these transfers rise, the ability of that sector to generate growth becomes smaller and smaller. At some point the transfers are too large to be managed, and investment growth must stop. Of course if the government begins to privatize assets and uses the proceeds to clean up the banks and repay loans, this problem need not happen.

3. The private sector becomes so worried about the possibility of financial instability and rising of financial distress costs that they disinvest faster than the government can invest."
   Another way to extend debt capacity limits, according to Pettis, would be similar to Brazil in the mid 1970's when it was "saved" by massive petro-dollar recycling and a subsequent lending boom switching domestic debt to external debt, which allowed Brazil to keep investing and growing until the 1982 crisis and a lost decade.  In principle, China could do this, but it is unlikely to become a net foreign borrower as it would also have to reverse its huge current account surplus into a current account deficit.  He thinks there would institutional impediments preventing this from happening.
   
   
   Everyone knows by now that Chinese inflation is down to 6.2% in August, but he finds these numbers to be so much within expectation that he has nothing to add.  Inflation appears to have peaked, but the numbers require another month or two of observation and Pettis believes the PBoC also believes this.  There is also growing concern among economically literate policymakers about rising debt and weak consumption, because these are basically the same problem.  He expects to see comments back and forth on inflation, but a number of policymakers are reluctant to support more expansionary credit growth as a credit contraction is politically very unlikely.
   Pettis remains concerned that the Chinese consumption imbalance remains a fundamental problem despite Yukon Huang writing in the Wall Street Journal that consumption is in fact far higher than official government figures and takes issue with Huang's interpretation of the studies cited, because one study actually shows 2/3rds of hidden income accruing to the top 10% wealthiest and almost all to the top 50% and, since the wealthy a much smaller share of income than the poor, it would suggest the consumption imbalance is actually much larger.  Pettis also finds the reported size of the imbalance by Huang to be astonishing.  Just because the NBS data is awfully wrong, this would not increase China's invulnerability from crisis.  In the end, all the possible arguments against the dismissal of the fundamental consumption imbalance problem need not be made, because the balance of payments tell us it is extraordinarily low.  "... China doesn’t have either a current account deficit or a balance of zero. It has instead one of the highest current account surpluses ever recorded. This can only happen if the savings rate exceeds by a huge margin the investment rate – which, remember, was itself by 2008 the highest we had ever seen, and which has soared even further in the past few years
   
   
   "By definition, then, China’s savings rate must be extraordinarily high to allow it both a huge investment rate and a huge current account surplus. Since savings is simply the difference between total production and total consumption, China must also have an extraordinarily low level of consumption in order for the balance of payments to balance. I would argue that it almost certainly does."

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Edward Hugh Links: On the Eurozone Crisis

Despite the misplaced hope of the stock markets this past week, the eurozone is headed towards a decision point the leaders of the eurozone do not want to face.  I heavily research the eurozone macroeconomic issues as well as China, because they have global implications.  The eurozone could quite easily unravel with a Greek default within the euro or the need to bailout Spain or Italy.  A currency crisis would ensue and European banks and, quite probably, banks globally could have significant liquidity problems as the interbank market freezes up with the possibility, if nations are not prepared to fund liquidity through their central banks and governments, of some banks failing.

Edward Hugh is an intellectually eclectic British born macroeconomic economist who lives in Barcelona.  Whether one agrees with his conclusions or not, he always has something important worthy of consideration to say.

Here are some observations on eurozone and China PMI showing slower growth.

Ireland is being advertised by the eurozone as a success story to sooth the egos of the newly indentured (to European banks) Irish people.  What is going to happen to Ireland, which is a trade surplus exporting country dependent on exports for its economic recovery, as the global economy continues to slow down?

High Noon is approaching for Greece

Italy has low growth, an aging population, and is the third largest economy in the eurozone.  Can they make the penalty kick?

I have repeatedly stated privately that the breakup of the eurozone into a High euro and a Low euro will only create two stage productions of the same play with different lengths of production and the same tragic ending.  Here is Hugh's take on the subject.

Here he discusses recession risks in Germany.

Here he reviews the recession warning on the eurozone periphery.

Here he covers the flashing red lights for eurozone growth.

Hugh correctly identifies Italy, not Spain, as the elephant in the room.

How can Greece devalue?

Eastern European growth is very dependent on Germany.

Why Spain's economy is more different than you think.

The eurozone crisis is imploding.  If it will not accept a democratic fiscal transfer mechanism the euro is doomed and the international bond markets have recognized this for some time.  The euro is not a fiat currency which can be devalued and as such is a foreign currency, economically, for each and every eurozone country, which means their national debt is denominated in a foreign currency (the euro).  Consequently, no eurozone nation can guarantee its debt.

Being informed on the issues involved requires reading many different viewpoints.  There is a debt crisis, because this is a currency crisis and it could lead to a bank liquidity crisis and potentially to a global depression.

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Guest Blogger: Warren Mosler With Economic Speech for President Obama

Warren Mosler is an economist, former hedge fund manager, and institutional investment advisor with his own broker/dealer and investment management firms.  This article was first posted on his blog The Center of the Universe.  I have my own concerns and thoughts on what President Obama should do to create jobs and economic growth with less systemically dangerous financial activity which I intend to write this weekend.  Different opinions and analysis are always useful in developing one's own analytical conclusions.

                                        PRESIDENT OBAMA --- USE THIS SPEECH

This is the speech I would make if I were President Obama:

My fellow Americans, 

let me get right to the point.

I have three bold new proposals to get back all the jobs we lost, and then some.

In fact, we need at least 20 million new jobs to restore our lost prosperity and put America back on top.

First let me state that the reason private sector jobs are lost is always the same.

Jobs are lost when business sales go down.  

Economists give that fancy words- they call it a lack of aggregate demand.

But it's very simple.  

A restaurant doesn't lay anyone off when it's full of paying customers, 

no matter how much the owner might hate the government, 

the paper work, and the health regulations.

  

A department store doesn't lay off workers when it's full of paying customers,

And an engineering firm doesn't lay anyone off when it has a backlog of orders.

Restaurants and other businesses lay people off when their customers stop buying, for any reason. 

So the reason we lost 8 million jobs almost all at once back in 2008 wasn't because all of a sudden 

all those people decided they'd rather collect unemployment than work.

The reason all those jobs were lost was because sales collapsed.  

Car sales, for example, collapsed from a rate of almost 17 million cars a year to just over 9 million cars a year.

That's a serious collapse that cost millions of jobs.

Let me repeat, and it's very simple, when sales go down, jobs are lost, 

and when sales go up, jobs go up, as business hires to service all their new customers.

So my three proposals are specifically designed to get sales up to make sure business has a good paying job for anyone 

willing and able to work.

That's good for businesses and all the people who work for them.

And these proposals are bipartisan.  

They are supported by Americans ranging from Tea Party supporters to the Progressive left, and everyone in between.

So listen up!

My first proposal if for a full payroll tax suspension.

That means no FICA taxes will be taken from both employees and employers.

These taxes are punishing, regressive taxes that no progressive short ever support.

And, of course, the Tea Party is against any tax.  

So I expect full bipartisan support on this proposal.

Suspending these taxes adds hundreds of dollars a month to the incomes of people working for a living.

This is big money, not just a few pennies as in previous measures.

These are the people doing the real work.  

Allowing them to take home more of their pay supports their good efforts.

Right now take home pay is barely enough to pay for food, rent, and gasoline, with not much left over.

When government stops taking FICA taxes out of their pockets, 

they'll be able to get back to more normal levels of spending.

And many will be able to better make their mortgage payments and their car payments,

which, by the way, is what the banks really want- people who can make their payments.

That's the bottom up way to fix the banks, and not the top down bailouts we've done in the past.

And the payroll tax holiday is also for business, 

which reduces costs for business, 

which, through competition,

helps keep prices down for all of us, which means our dollars buy more than otherwise.

So a full payroll tax holiday means more take home pay for people working for a living,

and lower costs for business to help keep prices and inflation down,

so sales can go up and we can finally create those 20 million private sector jobs we desperately need.

My second proposal is for a one time $150 billion Federal revenue distribution to the 50 state governments 

with no strings attached.  

This will help the states to fill the financial hole created by the recession, 

and stay afloat while the sales and jobs recovery spurred by the payroll tax holiday

restores their lost revenues.

Again, I expect bipartisan support.  

The progressives will support this as it helps the states sustain essential services, 

and the Tea Party believes money is better spent at the state level than the federal level.  

My third proposal does not involve a lot of money, 

but it's critical for the kind of recovery that fits our common vision of America   

My third proposal is for a federally funded $8/hr transition job 

for anyone willing and able to work, 

to help the transition from unemployment to private sector employment.

The problem is employers don't like to hire the unemployed, 

and especially the long term unemployed.

While at the same time, 

with the payroll tax holiday and the revenue distribution to the states,

business is going to need to hire all the people it can get.

The federally funded transition job allows the unemployed to get a transition job,

and show that they are willing and able to go to work every day,

which makes them good candidates for graduation to private sector employment.

Again, I expect this proposal to also get solid bipartisan support.

Progressives have always known the value of full employment, 

while the Tea Party believes people should be able to work for a living, rather than collect unemployment.

Let me add here that nothing in these proposals expands the role or scope of the federal government.

The payroll tax holiday is a cut of a regressive, punishing tax, 

that takes the government's hand out of the pockets of both workers and business.

The revenue distribution to the states has no strings attached.  

The federal government does nothing more than write a check.

And the transition job is designed to move the unemployed, who are in fact already in the public sector,

to private sector jobs.

There is no question that these three proposals will bring drive the increase in sales we need to 

usher in a new era of prosperity and full employment.

The remaining concern is the federal budget deficit.  

Fortunately, with the bad news of the downgrade of US Treasury securities by Standard and Poors to AA+ from AAA,

a very important lesson was learned.

Interest rates actually came down.  And substantially.

And with that the financial and economic heavy weights from the 4 corners of the globe 

made a very important point.

The markets are telling us something we should have known all along.

The US is not Greece for a very important reason that has been overlooked.

That reason is, the US federal government is the issuer of its own currency, the US dollar.

While Greece is not the issuer of the euro.

In fact, Greece, and all the other euro nations, have put themselves in the position of the US states.

Like the US states, Greece and other euro nations are not the issuer of the currency that they spend.

So they can run out of money and go broke, and are dependent on being able to tax and borrow to be able to spend.

But the issuer of its own currency, like the US, Japan, and the UK, 

can always pay their bills.

There is no such thing as the US running out of dollars.

The US is not dependent on taxes or borrowing to be able to make all of its dollar payments.

The US federal government can not go broke like Greece.

That was the important lesson of the S and P downgrade, 

and everyone has seen it up close and personal and they all now agree.

And now they all know why, with the deficit at record high levels, interest rates remain at record low levels.

Does that mean we should spend without limit and not tax at all?

Absolutely not!

Too much spending and not enough taxing will surely drive up prices and inflation.

But it does mean that right now, 

with unemployment sky high and an economy on the verge of another recession,

we can immediately enact my 3 proposals to bring us back to 

a strong economy with good jobs for people who want them. 

And some day, if somehow there are too many jobs and it's causing an inflation problem,

we can then take the measures needed to cool things down.

But meanwhile, as they say, to get out of hole we need to stop digging,

and instead implement my 3 proposals.

So in conclusion, let me repeat these three, simple, direct, bipartisan proposals

for a speedy recovery: 

A full payroll tax holiday for employees and employers

A one time revenue distribution to the states

And an $8/hr transition job for anyone willing and able to work to facilitate 

the transition from unemployment to private sector employment as the economy recovers.

Thank you.

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Uncertainty and European Bank Risks

The stress of the global financial crisis continue to haunt European banks as the economy continues to slow and bond vigilantes target sovereign debt of countries (such as the countries of the eurozone) who do not have their own fiat money.  The emergency lending facilities of the ECB have become more important for many European banks. On last Monday, banks deposited 128.7 billion euro with the ECB and borrowed 555 million euro overnight from the ECB Marginal Lending Facility, which was up from 90 million the prior day.  As Greek default becomes more inevitable and other eurozone countries struggle with sovereign debt financing, the interbank lending market has shown increasing stress as the skepticism about bank liquidity throughout Europe grows.  On Tuesday, European banks borrowed 2.82 billion euro overnight from the ECB, despite the stigma attached to the Marginal Lending Facility.

As the result of increasingly perceived risk by investors, European banks will pay more for the $100 billion of cash they need to raise by the end of the year.  Banks are hoarding cash, depositing it with the ECB, rather than lend it to other banks as political leaders squabble and preach deficit reduction which will only slow the economy faster.  Credit Agricol, with significant Greek exposure, posted profits which beat forecasts and felt compelled to complain about unjustified market irrationality and volatility.  A Bundesbank board member stressed in public comments that recent dollar money market tensions were far from the 2008 crisis levels and European banks are not facing a funding crisis as the result of U.S. money market funds becoming more selective to whom they lend.  The Bundesbank board member emphasized the liquidity available through repos and the ECB's readiness to mitigate problems with the swap agreement with the Fed. On Thursday, the Greek central bank (Bank of Greece) announced it had activated an Emergency Liquidity Assistance program to insure liquidity funding and all small, medium, and large Greek banks, except the National Bank of Greece, have indicated they will participate.  A Fitch survey of U.S. money funds showed a 9% decreased exposure to Europe last month and significant caution with respect to Italy and Spain.  Bankers have estimated that Italy lost $40 billion worth of money market funding in July.  While these figures are miniscule compared to the 8000 billion euro funding of the 91 eurozone banks, it does show the true state and reliance of eurozone banks on short term funding with some 58% of that funding needing to rolled over in two years and 47% in less than one year, but the official line is that there is nothing really wrong with the eurozone banks.

Today, Christine Lagarde of the International Monetary Fund, in a speech at Jackson Hole, said that European banks may need urgent forced capital injections to stem the eurozone's sovereign and financial crisis as they must be strong enough, in her words, to withstand the risks of sovereigns and weak growth.  She indicated that while private funding should be the priority, public funding, perhaps through the EFSF, should be ready.  She emphasized the IMF's change from immediate fiscal tightening to fiscal programs which allow spending to continue now while economies stay weak and reduce deficits over the long term.  This speech occurred at the same time as the second and third largest Greek banks announced an all share merger to be followed with a 500 million euro capital injection.

This IMF changed emphasis which acknowledges the need for public spending to feed growth during periods of declining aggregate demand is a refreshing change from the 1997 austerity mistake the IMF imposed on Japan which stifled growth.  Eurozone banks will remain key indicators in a global economy which is slowing down and economic contraction which eurozone austerity has accelerated.

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European Bank Liquidity

Starting last week we started seeing questions surfacing regarding the liquidity needs of European banks as a result of the volatile swings in the stock markets (if bank stock equity goes down they face the need to raise more capital) and potential opening market attacks on French banks (which I find hard to believe resulted from misinterpretation of a fictional series in a French newspaper). On August 10th, ECB overnight lending facility use jumped $5.75 billion dollars (4.058 billion euro), although it could have been from timing issues as banks awaited the arrival of ECB six month funds.  It was noted last week that the LIBOR-OIS (bank credit risk) spread with EURUSD basis swaps was widening but differently than it did in 2008.  The LIBOR-OIS was due to a rise in the LIBOR which would indicate the gap is being driven by liquidity measures, but the EURUSD basis swap was increasing on the short end implying near term caution rather than systemic risk.  Short term wholesale funding problems are magnified when access to long term funding in senior unsecured debt markets become more independently difficult for banks.  Nomura  noted the net stable funding ratio shows CASA, SocGen, Bankia, UniCredit, Commerzbank, and Intesa with the lowest ratios, but no European banks have reserve problems and, as of last week, no European bank had gone to the ECB for USD liquidity.  In relation to the short term liquidity functions last week, it also appeared that the peripheral eurozone countries were having a collateral crunch as well as a credit crunch.

Yves Smith at naked capitalism noted this week that mid-tier banks are finding it harder to get funding in interbank markets, that five year CDS of eurobanks are trading wider than they did in 2008m U.S> money market funds have cut back on exposure to European banks, eurobanks are have a harder time borrowing euro from the ECB to swap for US dollars, and the eurozone is not prepared for any large scale recapitalization of banks program.

On Wednesday of this week, one European bank borrowed $500 million, which was an unusually large amount for one bank, from the ECB in US dollar liquidity for the first time since February.  This would indicate it was probably a larger European bank under temporary stress.

Today, the Wall Street Journal wrote that the New York FED is meeting with the U.S. offices of large European banks to gauge their vulnerability to to escalating financial conditions and potential funding difficulties as U.S. branches of foreign banks became net borrowers of dollars from their overseas affiliates for the first time in a decade.  The New York FED President, Dudley, was quick to publicly state this was just a standard FED review.

On this Wednesday, excess liquidity in money markets actually rose 167 billion euro as Euribor lending rates went down.

This has led to a renewed discussion, involving nerves, noise and funding fears, of what level of funding stress European banks may or may not be facing.  While there are indications of stress in the wider markets, the spread on the three month Euribor rate and the overnight  index swap OIS rates has widen but nowhere near the post-Lehman 2008 peak.  What is interesting is the spike is from a drop in the OIS rate not the Euribor, which implies banks think the swap rates will drop and liquidity improve.  This would indicate the situation is not one of extreme stress, but an evolving situation which requires watching.

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Links 8/16/2011: Eyes on Growth

These are links from last week through 8/13/2011.  A little hindsight never hurt objective analysis.

Hussman's market commentary beginning of last week.

Grantham last week on global economy, seven lean years, and investing in a corrupt world.

Kudlow Comedy Capers.

Facing reality

Investor flows and 2008 Oil prices.

Index funds and commodity prices.

Equity prices and growth scares.

Down stock market not S&P downgrade but lack of growth.

S&P decision irrelevant.  Bill Mitchell

David Levey on S&P downgrade as unwarranted.  Rajiv Sethi

Defining economic interests.

Limitations of ECB are its failures.

Market reaction and default. Paul Krugman

Eurobonds or bust.

Slithering to the wrong kind of union.

Stagnant and paralyzed.

Tax Expenditures are big government and should be cut (what the rich do not want to hear).

Target2 & ECB liquidity management.

An experiment in austerity. Bruce Bartlett

An alternative to austerity.  L. Randall Wray

Bank of England's substantial risks.

Deficits and defense spending.

The many ways to count Chinese debt.

Eurocrisis reaches the core.

We don't have a long term debt problem.  James Galbraith

It is a weak economy not a AAA credit rating downgrade.

Illinois budget does not address pension payment backlog.  Moody's

Still waiting for expansionary contraction in UK.

The crisis is unemployment not debt.

Income inequality is bad for rich people.  Yves Smith

The FED dissenters.

Failed monetary policy created this crisis.  Joseph Stiglitz video interview

The return of the Bear.  Steve Keen

Debunking demand and supply analysis.  Steve Keen

Fractious national leaders cannot lend stability to Europe.

Irish NAMA bad debt assets.

Freedom is not built on free market corruption.

Europe's rational idiocy.  Yanis Varoufakis

Why ECB must issue eurobonds for its own survival.  Yanis Varoufakis (I have long advocated need for eurobonds but I do not believe the ECB would be the proper issuer)

Chaos is dawning on dysfunctional governments.  Andy Xie

German taxpayers willingly subsidize bankers.  Michael Hudson

Germany must defend the euro.

Tea Party not factually correct; a conservative criticism. Simon Johnson

Shorting ban on euro banks and macroeconomic threats.


Will the Swiss franc be pegged to the euro?

Swiss franc exposes foreign currency denominated debt exposure of Hungarian banks.

Unofficial U.S. problem bank list at 988.


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Were UK Riots Symptoms of Larger Global Unrest With Austerity and Inequality?

The UK recent riots have been characterized as nihilist acts of thugs, looters, and common thieves, yet, they lasted four days and spread to other neighborhoods in London and other cities and the participants crossed racial lines.  Much like the UK riots in 1981, there was a general dislike and distrust of authority and the police.  The authorities and mainstream media played the riots as criminal anarchy resulting from poor parenting and a history of government coddling which should be suppressed and order restored in order to proceed with government austerity programs supported by the financial services sector which is seeing a concentration of power in their protected status from failure without regard to systemic risk.

Austerity deepens and intensifies social-economic inequality, which brings into question government austerity programs which slow and destroy growth.  As is being seen in Greece, Spain, and Italy, as well as Israel, where protests and demonstrations are becoming common, as well as past UK demonstrations over social and education cuts; just as protests in Egypt, Tunisia, Yemen, Bahrain, Libya, and Syria sought social justice, democracy, and opportunity, when the concentration of power increasingly disenfranchises citizens and/or fiscal consolidation intensifies the likely reaction against corruption and self-serving elitism, historically, is social unrest.  Global economic uncertainty in one form or another is a breeding ground for social unrest.  When it gets so bad it seems as if you have nothing more to lose and you hate the life from which you have no opportunity to improve, civil disorder gets the attention of those in authority and privilege and it then becomes a question of whether they will eventually listen or if they will keep cutting of the heads of the people to restore order.

Living standards and social-economic inequality have been bad in the UK and austerity has magnified the problem.  These UK rioters are being brought before Magistrate's Court for a few minutes of summary hearing before a judge.  Some are as young as 11 and many are over 35 years of age; some young adults are voluntarily surrendering when they realize they looted and not just protested as everyone who thinks is asking why rather than condemning.  During the riots and currently, there are those in the media, politics, and UK government who are attempting to minimalize and paint the rioters not just as thieves and thugs but leaches on the public dole.  This serve no good public purpose in a democracy.  The global financial crisis, protection of financial interests, continuing high unemployment,  social service, health care, and education cuts limiting survivability, much less quality of life, and access to opportunity and the level playing field of a free society not only breed social unrest seeking justice and equality of opportunity, it also breeds right wing extremism.

Edward Harrison of CreditWritedowns has elegantly summarized the the right wing threat and growing crisis in Europe succinctly in the failure of the EU and the eurozone to confront the obvious defects of the euro and act democratically in unity for a common purpose and common safety to provide eurobonds and insure liquidity in a monetary union in which necessary fiscal transfers and fiscal union are perceived as "taxes" and "costs" rather than the normal resolution of current account trade imbalances within the monetary union.

My graduate and post graduate work has concentrated on social economic changes, not just the turning or tipping points, but the periods immediately prior and after.  We are in a period in which the actions of our politicians in all the countries of the world and the citizens of those countries are going to determine in society continues to evolve democratically or if it prefers the neo-feudalism of a corporatist state in which the government and the private financial sector have the same interests.  The economist Nouriel Roubini in a recent interview not only assessed the probability of recession at 50%, but also observed that we are at a stage where it is possible that capitalism could destroy itself.

What do you choose?  Freedom or security?  Access to opportunity or special privilege? 
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