By Don Miller, Money Morning | 21 January 2010
As the European Commission holds its regular monthly meeting in Brussels this week, ministers find themselves debating what to do about the Greek debt crisis— the biggest credibility test the Eurozone has faced since the single currency was created. The question is whether the 16 countries that share the European Union's (EU) currency can force a rogue member with a weak economy to take drastic measures to cut its budget deficit without calling in the International Monetary Fund (IMF) or sparking social unrest. Still in the depths of recession, Greece is plagued by a spending deficit that rose to 12.7% of gross domestic product (GDP) last year, far in excess of the 3% ceiling permitted to countries in the union.
It's also saddled with debt amounting to 113% of GDP, which prompted Moody's Corp. (NYSE: MCO) to downgrade its debt to A2 from A1 on December 22. The credit ratings agency also changed its outlook on Greece to negative, saying the Greek government's long-term credit strength was "eroding materially". The deterioration of public finances also cost Spain and Ireland their top ratings last year.
That was followed by a run on Greek government bonds by traders who doubt that the country will be able to unload their bad bonds on the EU, sending yields over 6%— about twice what Germany pays. The cost of insuring against losses on Greek government bonds last week rose to a record of 344.5, according to CMA DataVision prices. Further downgrades by credit ratings agencies would mean Greek government bonds will no longer qualify as collateral to borrow cheap European Central Bank (ECB) funds starting in 2011. That would raise government borrowing costs, cripple hard-hit Greek banks and also hurt other holders of Greek debt.
Across Europe, there is concern that serious fiscal problems in Greece could threaten the credibility of the Eurozone and set off similar debt crises in other weak European economies. "The Greece example is putting us under great, great pressures," German Chancellor Angela Merkel told AFP. "The euro is in a very difficult phase for the coming years."
Fiscal Discipline On Shaky Ground
Like any other major currency, support for the euro relies on fiscal responsibility. But, unlike any other major currency, the euro is issued by 16 autonomous countries largely beyond the reach of European Union rules. In other words, if any individual member such as Greece wants to run up debts that threaten its credit rating, Eurozone members have very little recourse.
"Who is supposed to tell the Greek parliament that it needs to carry out pension reform?" Merkel said at a recent meeting, according to The Wall Street Journal. During this week's meetings, Greece's Prime Minister George Papaconstantinou will brief his counterparts on his plans to cut the country's giant deficit. The three-year budget plan includes more than $14.4 billion (10 billion euros) in deficit-reduction measures for this year, and promises to bring the deficit down to the EU's 3% ceiling by 2012.
But financial markets and many EU officials don't believe he can achieve that based on the budget plans that have been announced so far and are pressuring Athens to make deeper spending cuts. Papaconstantinou is afraid of the potential for social unrest if Greece were to issue huge cuts at once, a source close to Papandreou, who spoke on condition of anonymity, told Reuters. "We're going to have to salami-slice our way into it," the source said. "The EU pressure is helpful to provide an alibi for the next round of measures, because everyone in Greece realizes that the EU is our lifeline."
Most economists view the statistics underlying the fiscal reform package that the government has proposed with skepticism, as well. The EU last week diplomatically referred to its "statistical irregularities". For instance, the government's plan suggests that it can slash the country's budget deficit over the next year or two, while also projecting that the economy will continue growing through 2011.
Unless Athens takes swift action to slash spending and raise revenue, it risks costly EU sanctions and further downgrades by credit ratings agencies that would sharply raise its borrowing costs and deepen its economic recession. EU officials say Greece alone is responsible for its current plight. The newly elected Socialist government stunned the EU last October when it revealed the giant deficit— announcing that the previous Conservative administration had under-reported the deficit by more than twice.
"Because of the history, there is not much sympathy out there for Greece," a European Commission official involved in the drive to enforce fiscal discipline told The Journal. "There is a very strong determination to apply the rules."
EU Has Few Options
The Greek government will submit a new three-year fiscal plan to the European Commission this month and EU finance ministers could issue an ultimatum in mid-February giving Greece four months to take corrective action or face sanctions. One solution to resolve the whole issue would be to revoke Greece's EU membership. But such a drastic measure could put the euro itself at risk and was quickly ruled out by ECB President Jean-Claude Trichet, who called the notion "absurd" when he was questioned on the matter last week.
However, Trichet also said that the ECB wouldn't be rushing to Greece's aid with any "special treatment". That's not surprising since the central bank would undoubtedly come under pressure to offer similar bailouts to other debt-ridden members such as Italy, Portugal, Spain and Ireland, which have already been forced to swallow tough spending cuts to reduce their deficits. The anti-bailout stance was reiterated last week when ECB executive board member Juergen Stark, a German deficit hawk, bluntly stated that markets were deluded if they thought other member countries would reach for their wallets to save Greece.
If the excessive deficit remains uncorrected, the EU could also punish Greece by forcing it to make a huge, nonrefundable deposit with the European Commission. But that would only reduce market confidence and multiply Greece's economic troubles. Neither kicking Greece out of the EU or a fine makes economic sense.
But letting Greece flaunt the rules could do irreparable harm to the credibility of the euro as a sustainable currency. Olli Rehn, the newly installed European commissioner for economic and monetary affairs, expressed fears of a potential "spillover effect for the entire euro area" during his European parliamentary confirmation hearing. The whole Greek issue also underscores the Eurozone's generally tepid recovery from the recent global recession.
Even the notion that Greece could default on its debt is not out of the realm of possibility. But Citigroup Inc.'s (NYSE: C) Global Markets analysts said that although political pressure from the European Union "will likely remain high… we reckon that the probability of a Greek default remains very small."
Former IMF and Wall Street analyst Desmond Lachman, however, was much more pessimistic when he raised the idea of Greece defaulting in a piece for Financial Times last week. "Much like Argentina a decade ago, Greece is approaching the final stages of its currency arrangement," he predicted. And added that "after much official money is thrown its way, Greece's euro membership will end with a bang."
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The Euro's Turn In The Doghouse— And The Next Key Level For The Dollar
Click here for a link to ORIGINAL article:
By Chris Temple | Wednesday, 20 January 2010
During most of 2009, there was essentially just one currency story: the U.S. dollar. From March through the rest of the year, the dollar was relentlessly sold off as part of the Federal Reserve's "reflation" scheme, designed to save the financial markets (NOTE: I said the financial markets, NOT the economy) from a complete implosion.
Punctuated by the greenback's new role as the world's carry trade currency of choice, the scheme has thus far worked. The dollar declined for almost all of the year. Other currencies— and virtually all the so-called risk assets out there, from emerging market paper to commodities— rose. One of my ANTI-predictions for 2010 that I released on New Year's Day was that 2010 would witness a decidedly different currency story.
I believe the U.S. Dollar will now rise for the foreseeable future for many reasons. Not the least of these is that it will benefit from troubles elsewhere. Indeed, once this year is over, I think we'll be compiling a short list of those currencies that did NOT have troubles during 2010.
At the moment, it's the euro's turn to be in currency traders' dog house. The common currency peaked at around $1.52 (per euro) back around the first of December amid some predictions that it was on its way to test its all-time high of around $1.60 against the greenback. Since then, the euro has unraveled spectacularly for a variety of reasons; chief among them are the implications of the debt troubles of euro members Greece, Portugal, Spain and Italy.
Germans who used to enjoy the continent's strongest currency seem to be having their worst fears realized; their polygamous "marriage" to other European countries is serving, they'll be quick to tell you, only to risk destroying everyone's financial standing. The dollar was already adding to its own upward momentum apart from the euro's woes. This was for two reasons.
First— and the one most animating commentators this morning— was the win last night by Republican Scott Brown in Massachusettes' special election to fill the Senate seat of the late Ted Kennedy. Apart from the obvious fact that this takes away the Democrat Party's 60th seat, the broader message being taken from this by the markets is that President Obama will be less able everywhere (not just where health care is concerned) to act as though his ability to borrow and spend is unlimited. As a result, long-term interest rates continue their New Year's decline (another of my Jan. 1 ANTI-predictions) and the dollar's bid strengthens.
Reason No. 2— China. That nation today has reportedly ratcheted up its efforts to curb lending in order to keep inflationary pressures from getting out of hand. Regulators there have now ordered some banks not to lend at all for the balance of the month. This has the markets hammering both stocks and commodities this morning, taking some of the steam out of the newest 15-month highs for the former. As a consequence, the dollar's rally this morning has turned white hot.
At least some of the dollar's strength of the last several trading days has come, as partly explained above, as a courtesy of other factors, rather than of traders' outright bullishness for the greenback (for example, as gold weakens and violates some traders' stop loss levels, it is sold, with some of the proceeds going into dollars.) But no matter how much we might argue with some over whether the dollar's move right now is more chicken or egg, a key test for the greenback's nascent cyclical rally looms.
Just before Christmas, the U.S. Dollar Index reached a level of around 78.5 before pulling back. It is moving back toward that level again. If it moves decisively (and closes) above that 78.5 level, it will be the newest confirmation that the greenback's secular bear trend HAS been interrupted by a cyclical bull market.
What might this mean? Well, until now, the dollar's new uptrend has not been sufficiently powerful or reliable to force many of the carry traders to flee their dollar-fueled risk trades. With stocks still hitting new highs and most commodities having briefly re-strengthened, I suspect that the majority of traders who have used borrowed dollars to place their bets have been little worried, given the still-bullish outlooks for emerging markets, commodities and the rest even if they were taking a modest "haircut" on their dollar positions. But now the big picture might be changing in their minds.
China— as I have often argued, most notably back in a key commentary in the November issue— has an interest in seeing commodity prices come down, and the U.S. dollar go up. The economic news in the U.S. continues to be uninspiring at best. Especially if the dollar re-confirms its cyclical bullish trend by moving above 78.5, the pain might finally become too great for carry traders to maintain their positions; and the domino effect of the carry trade's unwinding I've warned about might finally come about.
So— more than anything— I'm watching the Dollar Index right now. Its success (or lack thereof) in breaking higher will determine where we go from here.
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ECB Prepares Legal Ground For Euro Rupture As Greek Crisis Escalates
Fears Of A Euro Break-Up Have Reached The Point Where The European Central Bank Feels Compelled To Issue A Legal Analysis Of What Would Happen If A Country Tried To Leave Monetary Union.
By Ambrose Evans-Pritchard | 17 January 2010
The economic struggle facing Greece caused riots in December 2008. "Recent developments have, perhaps, increased the risk of secession (however modestly), as well as the urgency of addressing it as a possible scenario," said the document, entitled Withdrawal And Expulsion From The EU And EMU: some reflections. The author makes a string of vaulting, Jesuitical, and mischievous claims, as EU lawyers often do.
Half a century of ever-closer union has created a "new legal order" that transcends a "largely obsolete concept of sovereignty" and imposes a "permanent limitation" on the states' rights. Those who suspect that European Court has the power pretensions of the Medieval Papacy will find plenty to validate their fears in this astonishing text. Crucially, he argues that eurozone exit entails expulsion from the European Union as well. All EU members must take part in EMU (except Britain and Denmark, with opt-outs).
This is a warning shot for Greece, Portugal, Ireland and Spain. If they fail to marshal public support for draconian austerity, they risk being cast into Icelandic oblivion. Or for Greece, back into the clammy embrace of Asia Minor.
ECB chief Jean-Claude Trichet upped the ante, warning that the bank would not bend its collateral rules to support Greek debt. "No state can expect any special treatment," he said. He might as well daub a death's cross on the door of Greece's debt management office.
This euro-brinkmanship must be unnerving for the Hellenic Socialists (PASOK). Last week's €1.6bn (£1.4bn) auction of Greek debt did not go well. The interest rate on six-month notes rose to 1.38%, compared to 0.59% a month ago. The yield on 10-year bonds has touched 6%, the spreads ballooning to 270 basis points above German Bunds.
Greece cannot afford such a premium for long. The country must raise €54bn this year— front-loaded in the first half. Unless the spreads fall sharply, the deficit cannot be cut from 12.7% of GDP to 3% of GDP within three years. As Moody's put it, Greece (and Portugal) faces the risk of "slow death" from rising interest costs.
Stephen Jen from BlueGold Capital said the design flaws of monetary union are becoming clearer. "I don't believe Euroland will break up: too much political capital has been spent in the past half century for Euroland to allow an outright breakage. However, severe 'stress-fractures' are quite likely in the years ahead."
As Portugal, Italy, Ireland, Greece, and Spain (aka, the 'PIIGS') slide into deflation, their "real" interest rates will rise even higher. "It is tantamount to hiking rates in the already weak PIIGS," he said. This is the crux. ECB policy will become "pro-cyclical", too tight for the South, too loose for the North.
The City view is that the North-South split may cause trouble, but that there will always be a bail-out to prevent a domino effect. "If a rescue turns out to be necessary, a rescue will be mounted," said Marco Annunziata from Unicredit. It comes down to a bet that Berlin will do for Club Med what it did for East Germany: subsidise forever. It is a judgement on whether EMU is the binding coin of sacred solidarity, or just a fixed exchange rate system like others before it.
Politics will decide, and in Greece it is already proving messy as teams of "inspectors" ruffle feathers. The Orthodox LAOS party is not happy that an EU crew dared to demand an accounting from the colonels. "The Ministry of Defence is sacrosanct," it said.
Greece alone in Western Europe treats the military budget as a state secret. Rating agencies guess it is a ruinous 5% of GDP. Does the country really need 1,700 battle tanks, 420 combat jets, and eight submarines? To fight NATO ally Turkey? Merely to pose the question is to enter dangerous waters.
Who knows what the IMF surveillance team made of their mission in Athens. The Fund's formula for boom-bust countries that squander their competitiveness is to retrench AND devalue. But devaluation is ruled out. Greece must take the pain, without the cure.
The policy is conceptually foolish and arguably cynical. It is to bleed a society in order to uphold the ideology of the European Project. Greece's national debt will be 120% of GDP this year. S&P says it will reach 138% by 2012. A fiscal squeeze— without any offsetting monetary or exchange stimulus— will cause tax revenues to collapse. Debt will rise higher on a shrinking economic base.
Even if Greece can cut wages without setting off mass protest, it lacks the open economy and export sector that may yet save Ireland in similar circumstances. Greece is caught in a textbook deflation trap. Labour minister Andreas Loverdos says unemployment would reach a million this year— or 22%, equal to 30m in the US. He broadcast the fact with a hint of menace, as if he wanted Europe to squirm. Two can play brinkmanship.
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Greece, Ireland May Leave Euro
By Dan Weil | 11 December 2009
The economic crises in Greece and Ireland may necessitate financial bailouts or even an exit from the euro for these countries, according to Standard Bank analyst Steve Barrow. "Countries like Ireland and Greece may not be able to grow out of the current crisis," Barrow, head of G-10 currency strategy for the bank, told Bloomberg. "With interest-rate cuts, exchange-rate depreciation and significant fiscal support all off limits for these countries, bailouts or even pullouts from EMU (European Monetary Union) may happen [in 2010]."
EMU rules limit member countries' interest rate moves, currency moves and budget deficits. Ireland and Greece have suffered more from the financial crisis than their neighbors. Ireland's real estate market collapsed, and its banking system is in tatters after taking on too much risk.
The Irish government estimates that its economy will shrink 7.5 percent this year and 1.25 percent next year. As for Greece, Fitch Ratings cut its credit rating recently, and Standard & Poor indicated it may soon follow. Greece is struggling with a massive debt burden. The economy contracted 1.7 percent in the third quarter from a year earlier, and the budget deficit totals 12.7 percent of GDP.
While the government has plans to cut the gap, many analysts are skeptical. "The likely rise in public debt to more than 120 percent of GDP next year and further to 125 percent in 2011 would leave the public finances highly exposed to shocks," Fitch analysts wrote in a report. Standard Bank's Barrow told Bloomberg that the inability to make fiscal transfers within the 16-nation Euro region may do in the currency system.
He said the two countries' woes will continue to drive the premiums of their bond yields over German bond yields higher. "That can, in many ways, be a more destructive line of attack for the market than currency pressure," Barrow says. Irish and Greek officials deny they will leave the euro.
"This suggestion is an example of completely uninformed comment," the Irish finance ministry said in a statement. "As the Minister for Finance stated nine months ago, it is akin to stating that Texas will leave the dollar". Greek Prime Minister George Papandreou told reporters, "There is no possibility of a default for Greece."
Hedge fund legend George Soros said the same thing in an interview with Sky Television. But many experts remain concerned. "The Greek problem will be an acid test for the currency union," a senior German government official told German magazine Der Spiegel.
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Société Générale Tells Clients How To Prepare For Potential 'Global Collapse'
Société Générale Has Advised Clients To Be Ready For A Possible "Global Economic Collapse" Over The Next Two Years, Mapping A Strategy Of Defensive Investments To Avoid Wealth Destruction.
By Ambrose Evans-Pritchard | 18 November 2009
| Explosion of debt: Japan's public debt could reach as much as 270% of GDP in the next two years. |
In a report entitled "Worst-case debt scenario", the bank's asset team said state rescue packages over the last year have merely transferred private liabilities onto sagging sovereign shoulders, creating a fresh set of problems. Overall debt is still far too high in almost all rich economies as a share of GDP (350% in the US), whether public or private. It must be reduced by the hard slog of "deleveraging", for years.
"As yet, nobody can say with any certainty whether we have in fact escaped the prospect of a global economic collapse," said the 68-page report, headed by asset chief Daniel Fermon. But it is an exploration of the dangers, not a forecast. Under the French bank's "Bear Case" scenario (the gloomiest of three possible outcomes), the dollar would slide further and global equities would retest the March lows. Property prices would tumble again. Oil would fall back to $50 in 2010.
Governments have already shot their fiscal bolts. Even without fresh spending, public debt would explode within two years to 105% of GDP in the UK, 125% in the US and the eurozone, and 270% in Japan. Worldwide state debt would reach $45 trillion, up two-and-a-half times in a decade.
| (UK figures look low because debt started from a low base. Mr Ferman said the UK would converge with Europe at 130% of GDP by 2015 under the bear case.) |
The underlying debt burden is greater than it was after the Second World War, when nominal levels looked similar. Ageing populations will make it harder to erode debt through growth. "High public debt looks entirely unsustainable in the long run. We have almost reached a point of no return for government debt," it said.
Inflating debt away might be seen by some governments as a lesser of evils. If so, gold would go "up, and up, and up" as the only safe haven from fiat paper money. Private debt is also crippling. Even if the US savings rate stabilises at 7%, and all of it is used to pay down debt, it will still take nine years for households to reduce debt/income ratios to the safe levels of the 1980s.
The bank said the current crisis displays "compelling similarities" with Japan during its 'Lost Decade' (or two), with a big difference: Japan was able to stay afloat by exporting into a robust global economy and by letting the yen fall. It is not possible for half the world to pursue this strategy at the same time. SocGen advises bears to sell the dollar and to "short" cyclical equities such as technology, auto, and travel to avoid being caught in the "inherent deflationary spiral".
Emerging markets would not be spared. Paradoxically, they are more leveraged to the US growth than Wall Street itself. Farm commodities would hold up well, led by sugar.
Mr Fermon said junk bonds would lose 31% of their value in 2010 alone. However, sovereign bonds would "generate turbo-charged returns" mimicking the secular slide in yields seen in Japan as the slump ground on. At one point Japan's 10-year yield dropped to 0.40%. The Fed would hold down yields by purchasing more bonds. The European Central Bank would do less, for political reasons.
SocGen's case for buying sovereign bonds is controversial. A number of funds doubt whether the Japan scenario will be repeated, not least because Tokyo itself may be on the cusp of a debt compound crisis. Mr Fermon said his report had electrified clients on both sides of the Atlantic. "Everybody wants to know what the impact will be. A lot of hedge funds and bankers are worried," he said.
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