UK Cannot Take Iceland's Soft Option
The Euro Is A Torture Instrument For Spain
Biblical Debt Jubilee May Be The Only Answer
Help Ireland Or It Will Exit Euro, Economist Warns
Monetary Union Has Left Half Of Europe Trapped In Depression
Shipping Rates Hit Zero As Trade Sinks
By Ambrose Evans-Pritchard | 21 January 2009
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Britain has foreign reserves of under $61bn dollars (£43.7bn), less than Malaysia or Thailand. The foreign liabilities of the UK banks are $4.4 trillion— or twice annual GDP— according to the Bank of England. The mismatch is perilous. It is why sterling has crashed 10 cents from $1.49 to $1.39 against the dollar in two days. The markets have given their verdict on Gordon Brown's latest effort to "save the world".
Credit default swaps (CDS) measuring risk on British debt have reached an all-time high of 125 basis points, just below Portugal. The yield spread on 10-year Gilts over German Bunds has doubled to 53 basis points since last week. Standard & Poor's has quashed rumours that it will soon strip Britain of its AAA credit rating— an indignity averted even after the International Monetary Fund bail-out in 1976. But there was a sting yesterday as it responded to the Treasury plan for the banks.
"Market confidence in the sector has eroded to such a degree that it is not clear whether these measures by themselves will bring about a material improvement," the IMF said. "As a result, full nationalisation of some banks remains a possibility in our view." Spain was [downgraded] from AAA to AA+ on Monday, and Spain's public debt is a much lower share of GDP.
"If Spain can get downgraded, then the risks for the UK are self-evident," said Graham Turner, of GFC Economics. "The increase in the UK gross public debt burden— 11.8 percentage points in just one year— is troubling. The market rightly fears the long-term fiscal costs of a collapsing banking system. Rising Gilt yields are the main impact of the botched move from the UK Treasury."
Mr Turner said the British Government had taken far too long to resort to quantitative easing— printing money— and had wasted months with fiscal frippery as debt deflation throttled the banks. The parallels with Iceland are disturbing. The country was ruined by the antics of its three big banks. They built up foreign liabilities equal to 900% of GDP. Operating as hedge funds, they borrowed in dollars, euros and pounds to speculate. However, the state lacked the foreign reserves to match this leverage.
But Iceland at least had the luxury of letting banks default— shifting losses on to the rest of the world. It [simply] refused to honour foreign debts. "They drew a line," said Jerry Rawclifffe, who tracks Iceland for Fitch Ratings. "They created new banks, parking the old losses in 'resolution committees'. It is not easy for other governments to walk away. They have a duty of care."
Indeed, if Britain walked away from UK banks' $4.4 trillion of foreign liabilities— worth eight times Lehman Brothers— it would destroy the credibility of the City and take the whole world into deeper depression. "The UK cannot go down that route because it would set off an asset price death spiral," said Marc Ostwald, a bond expert at Monument Securities. "The Western banking system is already on life support. That would turn it off altogether."
So whatever the temptations, and whatever the feelings of righteousness over the follies of the RBS leadership in its debt-driven campaign of Napoleonic expansion, the Treasury is wedded to the banks and all their sins. Chancellor Alistair Darling cannot copy Iceland. S&P's lead UK analyst, Trevor Cullinan, said the Government faces a "severe test" and will be judged by its actions, but he doubts whether matters will reach such a dangerous pass.
"The challenges to UK banks are significant amid a correction in property prices and a contraction of GDP. Nevertheless, the situation is very different from Iceland. The UK benefits from sterling, which is a major global funding currency. UK access to external funding is far more secure. In a worst-case scenario we estimate the cost of recapitalising the UK banking system to be in the region of £83bn (5.7% of GDP)," he said.
The Government can take out derivatives contracts on currency markets to hedge the foreign debt risk. Perhaps it already has. The banks have $4.4 trillion foreign assets to offset their liabilities, of course. But what is their real value in this climate? Britain is not alone in its current distress, although the fall in sterling speaks for itself. The sovereign debt of Russia, Ukraine, Greece, Italy, Belgium, Austria, The Netherlands, Ireland, Australia, New Zealand and Korea is all being tested by the markets. The core of countries deemed safe is shrinking by the day to a half dozen. Sadly, Britain is no longer one of them.
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The Euro Is A Torture Instrument For Spain
Ten Years Of Euro Membership Have Lured Spain Into A Terrible Trap.
By Ambrose Evans-Pritchard | 20 January 2009
Real interest rates of -2% set by Frankfurt for German needs led to a Spanish property bubble of fearsome scale. Construction rose to 16% of GDP, trumping the British and US bubble by large margins. Spanish companies tapped the euro capital markets as if there was no tomorrow. Reliance on foreign borrowing reached 10% of GDP, among the world's highest. Wages went up and up. The result is a current account deficit that is also 10% of GDP.
Now what? A country with full control over all levers of economic policy can claw its way out of such a hole. Spain can do almost nothing. A key reason why Standard & Poor's has stripped Spain of its AAA credit rating is that the country no longer sets its own interest rates and cannot devalue its currency to restore balance.
S&P did not say explicitly that EMU has become an instrument of debt-deflation torture for Spain. That would be breaking the great euro taboo. It insisted that EMU provides an anchor of stability. But that is pro-forma dressing. The sub-text is that Spain cannot recover until it breaks its chains.
It is true that Germany regained competitiveness by screwing down wages in the early part of this decade, but it did so when southern Europe was inflating merrily. Spain faces a much harder task. It has to claw back 20% to 30% in labour competitiveness against a stern Germany that will not inflate. Therefore, Spain must deflate. It must embark on a 1930s policy of draconian wage cuts.
It remains to be seen whether this will be tolerated by a democracy. Brussels expects Spanish unemployment to reach 19%— or 4.5m people— by late next year. That is a depression.
Workers are already rising up against the ruling socialists. An angry march by trade unions in Zaragoza on Sunday is the first shot across the bows. As yet, no Spanish heavyweight has questioned the orthodoxy of EMU membership. That may change, as it is changing in Ireland. The euro system is starting to inflict very grave hardship on ordinary people. This is exactly what critics always feared. In the end, it will breed conflict.
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Biblical Debt Jubilee May Be The Only Answer
Once Again, Britain Leads The World In The Macabre Speciality Of Saving Banks.
By Ambrose Evans-Pritchard | 19 January 2009
The Treasury's £200bn plan to soak up toxic debt will be followed within days by a US variant from the Obama team. Germany cannot be far behind. As one bail-out succeeds another at ever more inflated price tags, rescue fatigue is becoming palpable. People are bewildered, fearing that good money is being thrown after bad.
The doubts are understandable but there are tentative signs of a thaw in the global credit system. Libor lending rates in the US, Britain and Europe have fallen sharply. US mortgage rates have dropped from 6.5% to 4.88% since October. Companies can issue bonds again.
"It is easy to conclude that none of the Government's policies are working," said Professor Peter Spencer from York University. "We must not lose sight of the fact that they have prevented the collapse of the monetary system." This does not mean that recovery is imminent. Nothing can prevent a long purge as years of credit leverage give way to debt deflation.
It means only that the downward spiral— the "adverse [or negative] feedback loop" feared by central banks— has been arrested. The first three pillars of the global bail-out are in place. Government money is rebuilding the annihilated capital of banks. This has further to run.
Core lenders in the US, Europe and parts of Asia will be 'nationalised', but that is a detail at this point. It scarcely matters who owns the banks— unless you are a shareholder— so long as they lend. The Fed has cut rates to zero. It is buying mortgage securities on the open market, and eying Treasury debt next. Fellow central banks are exploring their own ways to print money.
The $3 trillion (£2 trillion) fiscal blitz by the US, China, Japan and Europe plugs an emergency gap. With luck, it will keep the world economy on life-support just long enough to stop recession and banking crises from feeding on each other with lethal effect, as they did in 1930-33. The latest plans to "ring-fence" bad debts into "septic tanks" puts in place the fourth pillar. The UK Treasury's version involves a state insurance scheme, letting banks shuffle off their crippling loans and escape mark-to-market torture.
The US version is a "bad bank" for mortgage debt. It is more or less the old "TARP" passed by Congress— before the funds were diverted into bank recapitalisations. This method worked after the Savings & Loan crisis in the 1980s. The market found a floor. The Treasury even made a profit.
German finance minister Peer Steinbrück said he "could not imagine" a bad bank in his country. Time will tell. Der Spiegel reports that Germany's top 20 banks have €300bn (£270bn) of bad debt, booked at "illusory" prices. They have written down just a quarter of their losses.
Taken together, the rescues may make the difference between global recession and a deeper slump that causes mass unemployment and social turmoil, perhaps destroying the open global order we take for granted. We can only guess. There is no guarantee that the measures will succeed. The vast scale of government borrowing may exhaust the stock of global capital.
Markets are already beginning to question the credit-worthiness of sovereign states. The Fed may find it harder than it thinks to disengage from colossal intervention in the bond markets. In the end, the only way out of all this global debt may prove to be a Biblical debt Jubilee.
Creditors are not going to like that.
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Help Ireland Or It Will Exit Euro, Economist Warns
A Leading Irish Economist Has Called On Dublin To Threaten Withdrawal From The Euro Unless Europe's Big Powers Do More To Rescue Ireland's Economy.
By Ambrose Evans-Pritchard | 19 January 2009
"This is war: countries have to defend themselves," said David McWilliams, a former official at the Irish central bank. "It is essential that we go to Europe and say we have a serious problem. We say, either we default or we pull out of Europe," he told RTE radio.
"If Ireland continues hurtling down this road, which is close to default, the whole of Europe will be badly affected. The credibility of the euro will be badly affected. Then Spain might default, then Italy and Greece," he said.
Mr McWilliams, a former UBS director and now prominent broadcaster, has broken the ultimate taboo. He has raised threats to precipitate an EMU crisis, which would risk a chain reaction across the eurozone's southern belt, where yield spreads on state bonds are already flashing warning signals. The comments reflect growing bitterness in Dublin over the way the country has been treated after voting against the EU's Lisbon Treaty.
"If we have a single currency there are obligations and responsibilities on both sides. The idea that Germany and France can just hang us out to dry, as has been the talk in the last couple of days should not be taken lying down," he said. Mr McWilliams cited the example of New York's threat to default in 1975. President Gerald Ford "blinked" at the 11th hour and backed a bail-out to prevent broader damage.
As yet, there is no public support for withdrawal from the euro. A Quantum poll published by the Irish Independent yesterday found that 97% reject such a radical move. Three-quarters are in favour of a national government, an idea floated by Unilever's ex-chief Niall Fitzgerald.
"The economic disaster we are facing is unlike anything which has happened in my lifetime. It is a national crisis and needs a government of national unity," Mr Fitzgerald said. Mr McWilliams said EMU was preventing Irish recovery. "The only way we can win this war is by becoming, once again, an export country. We can do what we are doing now, which is to reduce our wages, throw more people on the dole and suffer a long contraction. The other model is what the British are doing. Britain is letting sterling fall so that the problem becomes someone else's. But we, of course, have ruled this out by our euro membership.
"We are paying twice for the euro: once on the exchange rate and once more on the interest rate," he said. By keeping with the current policy, the state is ensuring that Ireland turns itself into a large debt-repayment machine. "Is this the sort of strategy to win wars?" he asked.
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Monetary Union Has Left Half Of Europe Trapped In Depression
By Ambrose Evans-Pritchard, Telegraph, UK | 18 January 2009
Events are moving fast in Europe. The worst riots since the fall of Communism have swept the Baltics and the south Balkans. An incipient crisis is taking shape in the Club Med bond markets. S&P has cut Greek debt to near junk. Spanish, Portuguese, and Irish bonds are on negative watch.
Dublin has nationalised Anglo Irish Bank with its half-built folly on North Wall Quay and €73bn (£65bn) of liabilities, moving a step nearer the line where markets probe the solvency of the Irish state. A great ring of EU states stretching from Eastern Europe down across Mare Nostrum to the Celtic fringe are either in a 1930s depression already or soon will be. Greece's social fabric is unravelling even before the pain begins, which bodes ill.
Each is a victim of ill-judged economic policies foisted upon them by elites in thrall to Europe's monetary project— either in EMU or preparing to join— and each is trapped. As UKIP leader Nigel Farage put it in a rare voice of dissent at the euro's 10th birthday triumph in Strasbourg, EMU-land has become a Völker-Kerker— a "prison of nations", to borrow from the Austro-Hungarian Empire. This week, Riga's cobbled streets became a war zone. Protesters armed with blocks of ice smashed up Latvia's finance ministry. Hundreds tried to force their way into the legislature, enraged by austerity cuts.
"Trust in the state's authority and officials has fallen catastrophically," said President Valdis Zatlers, who called for the dissolution of parliament. In Lithuania, riot police fired rubber-bullets on a trade union march. Dogs chased stragglers into the Vilnia river. A demonstration outside Bulgaria's parliament in Sofia turned violent on Wednesday.
These three states are all members of the Exchange Rate Mechanism (ERM2), the euro's pre-detention cell. They must join. It is written into their EU contracts. The result of subjecting ex-Soviet catch-up economies to the monetary regime of the leaden West has been massive overheating. Latvia's current account deficit hit 26% of GDP. Riga property prices surpassed Berlin.
The inevitable bust is proving epic. Latvia's property group Balsts says Riga flat prices have fallen 56% since mid-2007. The economy contracted 18% annualised over the last six months. Leaked documents reveal— despite a blizzard of lies by EU and Latvian officials— that the International Monetary Fund called for devaluation as part of a €7.5bn joint rescue for Latvia. Such adjustments are crucial in IMF deals. They allow countries to claw their way back to health without suffering perma-slump.
This was blocked by Brussels— purportedly because mortgage debt in euros and Swiss francs precluded that option. IMF documents dispute this. A society is being sacrificed on the altar of the EMU project.
Latvians have company. Dublin expects Ireland's economy to contract 4% this year. The deficit will reach 12% of GDP by 2010 on current policies. "This is not sustainable," said the treasury. Hence the draconian wage deflation now threatened by the Taoiseach (Irish 'Prime Minister').
The Celtic Tiger has faced the test bravely. No government in Europe has been so honest. It is a tragedy that sterling's crash should have compounded their woes at this moment. To cap it all, Dell is decamping to Poland with 4% of GDP. Irish wages crept too high during the heady years when Euroland interest rates of 2% so beguiled the nation.
Spain lost a million jobs in 2008. Madrid is bracing for 16% unemployment by year's end. Private economists fear 25% before it is over. Meanwhile, Spain's wage inflation has priced their workforce out of Europe's markets. EMU logic is wage deflation for year after year. With Spain's high debt levels, this is impossible.
Either Mr Zapatero stops the madness, or Spanish democracy will stop him. The left wing of his PSOE party is already peeling off, just as the French left is peeling off to fight "l'euro dictature capitaliste". Italy's treasury awaits each bond auction with dread, wondering if can offload €200bn of debt this year. Spreads reached a fresh post-EMU high of 149 points last week. The debt compound noose is tightening around Rome's throat. Italian journalists have begun to talk of Europe's "Tequila Crisis"— a new twist.
They mean that capital flight from Club Med could set off an unstoppable process. Mexico's "Tequila Crisis" drama in 1994 was triggered by a combination of the Chiapas uprising, a current account haemorrhage, and bond jitters. The dollar-peso peg snapped when elites began moving money to US banks. The game was up within days.
Fixed exchange systems— and EMU is just a glorified version— rupture suddenly. Things can seem eerily calm for a long time. Politicians swear by the parity. Remember John Major's "soft-option" defiance days before the ERM blew apart in 1992? Or Philip Snowden's defence of sterling before a Royal Navy mutiny forced Britain off the Gold Standard in 1931.
Don't expect tremors before an earthquake— and there is no fault line of greater historic violence than the crunching plates where Latin Europe meets Teutonia. Greece no longer dares sell long bonds to fund its debt. It sold €2.5bn last week at short rates, mostly 3-months and 6-months. This is a dangerous game. It stores up "roll-over risk" for later in the year. Hedge funds are circling.
Traders suspect that investors are dumping their Club Med and Irish debt immediately on the European Central Bank in "repo" actions. In other words, the ECB is already providing a stealth bail-out for Europe's governments— though secrecy veils all. An EU debt union is being created, in breach of EU law. Liabilities are being shifted quietly on to German taxpayers. What happens when Germany's hard-working citizens find out?
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Shipping Rates Hit Zero As Trade Sinks
Freight Rates For Containers Shipped From Asia To Europe Have Fallen To Zero For The First Time Since Records Began, Underscoring The Dramatic Collapse In Trade Since The World Economy Buckled In October.
By Ambrose Evans-Pritchard, Telegraph, UK | 14 January 2009
The cost of shipping goods from Asia to Europe has tumbled
"They have already hit zero," said Charles de Trenck, a broker at Transport Trackers in Hong Kong. "We have seen trade activity fall off a cliff. Asia-Europe is an unmitigated disaster." Shipping journal Lloyd's List said brokers in Singapore are now waiving fees for containers travelling from South China, charging only for the minimal "bunker" costs.
Container fees from North Asia have dropped $200, taking them below operating cost. Industry sources said they have never seen rates fall so low. "This is a whole new ball game," said one trader.
The Baltic Dry Index (BDI) which measures freight rates for bulk commodities such as iron ore and grains crashed several months ago, falling 96%. The BDI— though a useful early-warning index— is highly volatile and [often greatly] exaggerates ups and downs in trade. However, this latest phase of the shipping crisis is different. It has spread to core trade of finished industrial goods, the lifeblood of the world economy.
Trade data from Asia's export tigers has been disastrous over recent weeks, reflecting the collapse in US, UK and European markets. Korea's exports fell 30% in January compared to a year earlier. Exports have slumped 42% in Taiwan and 27% in Japan, according to the most recent monthly data. Even China has now started to see an outright contraction in shipments, led by steel, electronics and textiles.
A report by ING yesterday said shipping activity at US ports has suddenly dived. Outbound traffic from Long Beach and Los Angeles, America's two top ports, has fallen by 18% year-on-year, a far more serious decline than anything seen in recent recessions. "This is no regular cycle slowdown, but a complete collapse in foreign demand," said Lindsay Coburn, ING's trade consultant.
Idle ships are now stretched in rows outside Singapore's harbour, creating an eerie silhouette like a vast naval fleet at anchor. Shipping experts note the number of vessels moving around seem unusually high in the water, indicating low cargoes. It became difficult for the shippers to obtain routine letters of credit at the height of financial crisis over the autumn, causing goods to pile up at ports even though there was a willing buyer at the other end. Analysts say this problem has been resolved, but the shipping industry has since been swamped by the global trade contraction.
The World Bank caused shockwaves with a warning last month that global trade may decline this year for the first time since the Second World War. This appears increasingly certain with each new batch of data. Mr de Trenck predicts Asian trade to the US will fall 7% this year. To Europe he estimates a drop of 9%— possibly 12%. Trade flows grow 8% in an average year.
He said it was "illogical" for shippers to offer zero rates, but they do whatever they can to survive in a highly cyclical market. Offering slots for free is akin to an airline giving away spare seats for nothing in the hope of making something from meals and fees.
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Normxxx
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