morph366

The Euro in 2012: expect more testing times

2012-01-02T10:47:00.000-08:00

The following comes from an article published here as well as on this site in February 2011 and seems just as relevant today as then

If E-bonds are a non-starter, and if the Germans are only committed to a pro-rated liability for anything that can go wrong within the Eurozone states, is it right for the CRAs to continue to rate the securities issued by any new facility as AAA? While Moody’s and S&P analysts may possibly ponder that question, the capital markets may well be moving towards another test of the issue. But again, there is a danger in thinking that they are only testing the size of the facility… more seriously they may be ultimately testing the nature of the legal guarantee behind the facility.

2 and 20 anyone?

2012-01-02T10:22:00.000-08:00

Can the technocrats save the euro?

2012-01-02T07:40:00.000-08:00

Downward adjustment to the external value of a currency has traditionally been one important policy tool which can benefit an economy which is uncompetitive and in need of a stimulus from increased exports. In addition, there should eventually be enhanced capital inflows following such an adjustment, as the risk to foreign capital investors is reduced as the exchange rate corrects to more long term sustainable levels.

The troubled economies of the Eurozone have the problem that they effectively are imprisoned within a foreign currency - the euro - since its external value is not something that can be managed down by for example the Greek, Spanish, Portuguese or Italian governments.

The problem is compounded because, even if deemed appropriate by the EZ as a whole, an adjustment down of the euro by as much as 30% - which many feel is required in order to be of benefit to the peripherals, just doesn't look feasible in a weak global economy with signs of protectionist rhetoric already, and which is likely to become even more prevalent in a year with many key elections.

There would be an extremely high hurdle to overcome for a policy initiative which might hypothetically be adopted by the ECB to engineer a gradual decline of the euro towards parity with (say) the US dollar, which is what a 30% decline would amount to.

In essence the major hurdle is that the Federal Reserve, the PBOC, other Asian central banks and even the central banks within Europe that are not part of the Eurosystem, would not condone it. Simply stated they do not want high quality goods from Germany and other efficient EZ economies becoming even more attractive as they become cheaper under such an ECB competitive devaluation initiative. This would, in the context of election flavored rhetoric, pose even more "unfair" competition for home-grown wares in global markets.

Despite the likelihood of strong tail winds behind it from FX speculators, a concerted effort to reduce the value of the euro against the other major currencies would face strong head winds from those other central banks that are focused on enhancing (or at least preserving) their own "competitiveness".

The growing realization that there may be no possibility of a gradual and technocratically "managed" solution to the current vicious circle of more austerity/ weaker economic performance/growing public deficits for the EZ peripherals, could well result in one or more of them seeing the benefit of taking a similar route to the one that Iceland has taken. The problem is, of course, that the consequences for the global banking system of a possible euro collapse would be of a completely different order of magnitude to that resulting from the collapse of the Icelandic krona.

One can only wonder at how little time and attention must have been invested in risk modelling by the architects of the Maastricht treaty and the EMU project.

Surely the pundits can't be wrong over Meredith Whitney bashing, can they?

2012-01-02T06:05:00.000-08:00

This chart can be found at M3 Financial Sense which is one of the most stimulating TA flavored blog sites that I look at.

The Supreme Currency 1999-2012

2011-12-31T09:55:00.000-08:00

Notice how the Fiat, Citroen and car with the Spanish flag behind the limousine, are having to be pushed along.

By Patrick Blower in The Daily Telegraph, December 31, 2011

Sovereign debt in 2011

2011-12-30T08:27:00.000-08:00

Excluding the usual suspects at the bottom of the table, sovereign debt outperformed, by a considerable margin, most global equity indices.

Eurosystem balance sheet heading to Euro 3 trillions

2011-12-29T09:37:00.000-08:00

Long and low and the outlook for bond price volatility

2011-12-28T08:12:00.000-08:00

When thinking about bond price volatility it might be useful to have the image of a crocodile in mind. Modified duration (MD) - where the maths is not that challenging but need not detain us here - is a measure of the approximate sensitivity of the price of a bond to a given change in interest rates - say one percent.

The highest MD is to be found with low coupon bonds with a long time left to redemption, and a mnemonic for the notion of long and low that I have found useful is the image of the crocodile.

With the yield on 10 year UST's below 2% and 30 year UST's below 3% as we close out 2011 those portfolio managers that are stuffed to the gills with the aforementioned paper had better be hoping that interest rates continue to decline since they will be getting the best bang for their bucks if rates are going down. But then again one of the last places to be should interest rates begin to climb will be in high MD bonds.

Just to elucidate further, high duration and high beta are often considered together from the perspective of asset allocation. Just as high beta small cap equities are not a good place to be during a significant stock market correction, long and low UST's might just bite the hand that's feeding them when (eventually) rates start moving higher.

How to get a job at Royal Bank of Scotland

2011-12-24T02:48:00.000-08:00

Young Paddy bought a donkey from a farmer for £100. The farmer agreed to deliver the donkey the next day.

The next day he drove up and said, 'Sorry son, but I have some bad news. The donkey's died.'

Paddy replied, 'Well then just give me my money back.'

The farmer said, 'Can't do that. I've already spent it.'

Paddy said, 'OK, then, just bring me the dead donkey.'

The farmer asked, 'What are you going to do with him?'

Paddy said, 'I'm going to raffle him off.'

The farmer said, 'You can't raffle a dead donkey!'

Paddy said, 'Sure I can. Watch me. I just won't tell anybody he's dead.'

A month later, the farmer met up with Paddy and asked, ' What happened with that dead donkey?'

Paddy said, 'I raffled him off. I sold 500 tickets at £2 each and made a profit of £898'
The farmer said, 'Didn't anyone complain?'

Paddy said, 'Just the guy who won. So I gave him his £2 back.'

Paddy now works for the Royal Bank of Scotland.

Ultra high incomes: agency/principal neglect

2011-12-23T08:30:00.000-08:00

Martin Wolf wrote an interesting piece in the FT on the growing gap between those with median incomes in both the US and UK and the super wealthy. One of the most perceptive remarks he makes is as follows:

People will disagree over why rising inequality matters and what should be done about it. I suggest it matters most, at least in the high-income countries because it both undermines hopes for any reasonable degree of equality of opportunity and cements the inequalities in power that have, in turn, allowed the preservation of a wide range of privileges, particularly in taxation.

These outcomes should matter even to those who have no concern for equality of outcome. I would add that some – perhaps a great deal – of the ultra-high incomes at the top are almost certainly the fruit of rent extraction facilitated by a breakdown in the control exercised by principals – outside investors – over their agents – corporate executives and financiers. Huge rewards then are both unjust and inefficient.

EFSF chief sounds confident about sufficient funding...doesn't he?

2011-12-17T08:41:00.000-08:00

Al Jazeera has a substantial and candid interview with Klaus Regling, the EFSF chief, which is well worth watching. I came away with the sense that, although he stated early in the interview that the facility has more than enough firepower to handle potential crises from Italy and Spain, as the questioner kept probing about the possibility of downgrades from the CRA's for the major guarantors of the EFSF, his confidence in the adequacy of the facility's funding became much less reassuring (even to himself).

Also worth referencing back to this piece here from July.

Should we be more or less comfortable that the stability facility is up to the task now? See what you think after watching Mr. Regling.

New fiscal pact for EZ

2011-12-11T05:47:00.000-08:00

Will those states within the EZ that exceed the new limits on budget deficit to GDP (apparently set at 0.5% but who knows) be able to borrow the money from Germany (or the ECB) to pay the fines?

The EMU monetary convergence myth exploded

2011-12-10T08:30:00.000-08:00

The chart below reveals more clearly than endless obtuse verbiage what is going wrong for those EZ states that are committed to using a "foreign" currency i.e. the euro.

Good news for those who like Swiss francs...there are now a lot more of them!

2011-12-10T08:07:00.000-08:00

The only major country within Europe which is neither a member of the EU or the EEA is the euro's biggest supporter.

Source The Swiss National Bank

"It means what I choose it to mean"

2011-12-10T05:42:00.000-08:00

'You don't know what you're talking about!' cried Humpty Dumpty. 'How many days are there in a year?'
'Three hundred and sixty-five,' said Alice.
'And how many birthdays have you?'
'One.'
'And if you take one from three hundred and sixty-five what remains?'
'Three hundred and sixty-four, of course.'
Humpty Dumpty looked doubtful. 'I'd rather see that done on paper,' he said.
Alice couldn't help smiling as she took out her memorandum book, and worked the sum for him:
365
1
----
364
----
Humpty Dumpty took the book and looked at it carefully. 'That seems to be done right —' he began.
'You're holding it upside down!' Alice interrupted.
'To be sure I was!' Humpty Dumpty said gaily as she turned it round for him. 'I thought it looked a little queer. As I was saying, that seems to be done right — though I haven't time to look it over thoroughly just now — and that shows that there are three hundred and sixty-four days when you might get un-birthday presents —'
'Certainly,' said Alice.
'And only one for birthday presents, you know. There's glory for you!'
'I don't know what you mean by "glory",' Alice said.
Humpty Dumpty smiled contemptuously. 'Of course you don't — till I tell you. I meant "there's a nice knock-down argument for you!"'
'But "glory" doesn't mean "a nice knock-down argument",' Alice objected.
'When I use a word,' Humpty Dumpty said, in rather a scornful tone, 'it means just what I choose it to mean — neither more nor less.'
'The question is,' said Alice, 'whether you can make words mean so many different things.'

EFSF structure: actual and simplified

2011-11-13T10:15:00.000-08:00

Hours required by US workers to buy the S&P 500

2011-11-13T05:29:00.000-08:00

Brain Dead

2011-11-13T03:06:00.000-08:00

ATTORNEY: Doctor, before you performed the autopsy, did you check for a pulse?

WITNESS: No.

ATTORNEY: Did you check for blood pressure?

WITNESS: No.

ATTORNEY: Did you check for breathing?

WITNESS: No..

ATTORNEY: So, then it is possible that the patient was alive when you began the autopsy?

WITNESS: No.

ATTORNEY: How can you be so sure, Doctor?

WITNESS: Because his brain was sitting on my desk in a jar.

ATTORNEY: I see, but could the patient have still been alive, nevertheless?

WITNESS: Yes, it is possible that he could have been alive and practicing law.

S&P 500 down 30% in real terms since 2000

2011-10-09T03:38:00.000-07:00

Eurozone Bonds perhaps, but with one less AAA guarantor?

2011-08-06T10:53:00.000-07:00

Here is a slightly modified extract from an article which appeared here in February entitled Macro Eurozone Risk: We're all in this together aren't we?

Some have suggested that the best way around the difficulties of designing a new architecture for the EFSF or its successor would be to grant the ECB the power to issue new E-bonds, but this may have the unintended consequence of highlighting the legal flaw that the current guarantees for the EFSF are several but not joint. It would also certainly require major EU treaty changes and plebiscites in many states with highly uncertain outcomes, not something favored by those anxious to solve the current Italian debt crisis in a hurry.

Interestingly one of the main critics of E- bonds is the current ECB president as this article makes clear.

BRUSSELS (MNI) - The European Central Bank maintains its position that eurobonds with a "joint and several" guarantee would not be appropriate given the present circumstances in the European economies, ECB president Jean-Claude Trichet said.

"In the ECB, as you know, we are not in favour of European bonds in which the European countries would be joint and several. We don't consider it is something that would be appropriate in the present circumstances," Trichet told the European Parliament's Economic and Monetary Affairs Committee.

Just to be totally clear and unambiguous on the matter – never something that a central banker should really do – the following direct quotations from M. Trichet are also on the record of the European Parliament:

1."We are not ourselves in favour of issuing securities, treasuries that will be joint and several," Trichet told the European Parliament.

2. "We consider it is good that each particular state, each particular treasury has its own refinancing and has its own way of being on the market."

If E-bonds are a non-starter, and if the Germans are only committed to a pro-rated liability for anything that can go wrong within the EZ states, is it right for the CRA’s to continue to rate the securities issued by any new facility as AAA? While Moody’s and S&P analysts may possibly ponder that question, the capital markets are moving towards yet another test of the issue. But again there is a danger in thinking that they are only testing the size of the facility… more seriously they are testing the nature of the legal guarantee behind the facility, or any EZ facility.

The ultimate test for any structure that the EZ might try to devise as a way of containing the threat of further contagion hinges on how the federalists can counter the strong conviction within the Bundesbank and parts of the German government that it would be prudent to step away from the forces of encroaching fiscal unification, fiscal transfers and complete financial integration of the EZ, which would result in Germany effectively providing a safety net under the whole EZ project.

The easiest way out of this impasse would seem to be for Germany to cap its obligations and future contributions to the ECB capital structure rather than leaving the bank with an open cheque as it is committed to at present, and to seek an exit from the EFSF artifice sooner rather than later.

If Germany did exit the Eurozone experiment it would reduce the number of EZ states to sixteen and the number of AAA guarantors to four. Of the other twelve "guarantor" states many, it could be argued, are either basket cases or candidates themselves for financial rescue. So exactly how the EFSF architecture - notwithstanding the over-collateralization and credit enhancement features - is supposed to provide comfort to investors in EFSF paper is left to the reader's imagination.

What is clear is that without Germany the EFSF is a paper tiger, and that brings us back, in circular fashion, exactly to the reason why it is too onerous for Germany to continue the charade that "We're all in this together aren't we ( as long as it's all pro rata )?"

Signs that are becoming part of life in Tokyo

2011-07-31T03:25:00.000-07:00

Italy's regions are microcosm of the European Union

2011-07-23T02:31:00.000-07:00

Merkel/Sarkozy lost in an Escher like maze with no exit

2011-07-21T01:42:00.001-07:00

The onslaught of headlines in this morning's media (July 21st) exclaiming that we have reached the day of reckoning for the Euro project etc. etc. suggests a rather apt metaphor which sums up the bind that EZ leaders find themselves in.

According to reports on talks that took place for most of the preceding day Angela Merkel and Nicholas Sarkozy would appear to be completely and frustratingly lost in an Escher like maze, where even trying to get back to the entry point (rediscovering EMU structural flaws at its inception) is not only historically impossible but also topographically impossible

This only goes to highlight the hubris and financial engineering mistakes made by those who conceived the idea of a single currency club and were then very lax about handing out membership cards.

To extend the metaphor even further it is as if they are literally imprisoned in a construct similar to those M C Escher drawings where, quite simply you cannot get there from here.

Larger Private Sector not good for GDP growth

2011-07-20T07:53:00.000-07:00

Chart: Penile Length Leads to Little Economic Growth

The following article is provided without comment.

DINO GRANDONI JUL 18, 2011
The opening question to most undergraduate macroeconomics courses usually is, "Why are some countries rich and others poor?" The lecturer will then probably dive into all of the usual suspects behind economic growth--natural resources, technological innovation, savings rate--without mention of perhaps the most primal of measurements: penis size.

That's right, penis size. In a study published today, the University of Helsinki's Tatu Westling points out a surprising strong correlation between a country's GDP growth rate and average penile length. As the chart above shows, countries that averaged smaller penis sizes grew at a faster rate than their larger counterparts between 1960 and 1985. Every centimeter increase in penis size accounted for a 5 to 7 percent reduction in economic growth. The study also showed that overall GDP was at its highest in countries with average-sized penises with GDP falling at the extremes of penis length.

As Westling explains in his paper, previous studies "concentrate on economic, social and political factors, these and many related treatments largely abstain from biological and/or sexual considerations. The aim of this paper is to fi ll this scholarly gap with the male organ." Interesting choice of words (the study is full of them, as you'll see below), but why should this particular, um, unit have any explanatory power? Penis size and economic growth might be related through some intermediary variable like gender equality, political stability, or population growth, Westling writes, but he seems to prefer an admittedly more Freudian explanation that goes like this: Penile length and income are both factors that contribute to an individual's level of self-esteem, and if a person has more of the former, he'll need less of the latter. Or, to put it in layman's terms, some fast-growing countries may be compensating for something. Not a particularly poor argument until you realize, as Westling acknowledges, that half the world's population don't have penises.

As Westling told the GlobalPost, he was only half-serious about the study until he saw such a strong statistical correlation. "But seriousness," he says, "does not imply that I believe in causality at this point." That seriousness doesn't always quite come through given the way some things are worded in the study. Here are some choice quotes; sometimes it's not entirely clear if the double entendres are intentional.

Taken at face value the findings suggest that the `male organ hypothesis' put forward here is quite penetrating an argument. Yet for the best of author's knowledge, male organ has not been touched in the growth literature before.

...the `small male organ' countries would gain more utility by expanding their economy than the `large male organ' countries. Actually the latter populations would simply exploit their nature-given, non-disposable groin-area endowments.
And finally...
It clearly seems that the `private sector' deserves more credit for economic development than is typically acknowledged.
Zing!

At critical times markets need disambiguation

2011-07-17T08:33:00.000-07:00

Much of the time, during non-critical phases, capital markets will embrace the ambiguities being promulgated (spun) by central bankers, policy makers, and analysts, and this provides the basic disagreements about price and value amongst traders and investors which promotes liquidity. There is no urgent demand for transparency or unequivocal clarification of systemic information. Risk appetites and complacency levels are relatively high.

But from time to time, when a disruptive event occurs or when markets have moved into a critical phase -as they are now with regard to the Eurozone crisis specifically, and to some extent with the US debt ceiling "crisis" (or melodrama) - market participants will immediately press for disambiguation on as many fronts as possible. Risk aversion moves to center stage, non-equivocation is demanded, and the fractiousness which enables liquidity, is replaced by a coherent viewpoint which results in markets becoming lopsided with a subsequent (and sudden) drop in liquidity.

The longer the demand for disambiguation goes accompanied by a failure by policy makers to be decisive and provide unambiguous answers, the greater the risk of systemic accidents and a complete collapse in liquidity. When markets reach such critical stages - and we could be getting quite close to one in the mid summer of 2011 - the more likely it will be that there are no private bids only private sellers that ultimately will be seeking out public sector bids (i.e. bailouts).