Credit Writedowns

As a Canadian, perhaps I should feel a surge of patriotic pride now that Mark Carney has been designated the new head of the Bank of England – quite a step up for the current governor of the Bank of Canada.  There is no question that Mr. Carney is a market-savvy guy (he did, after all, work for the vampire [...]

By Marshall Auerback The real weak link now in the Eurozone is Spain, where the data is a disaster. It is Greece writ large. And this is before Madrid, under Prime Minister Mariano Rajoy, has submitted to a new ECB program of agreed austerity in exchange for the ECB backstopping the nation’s bonds via a renewed Securities Market Program (SMP). One [...]

By Marshall Auerback Germany’s Constitutional Court gave a green light on Wednesday for the country to ratify Europe’s new bailout fund, boosting hopes that the single currency bloc is finally putting in place the tools to resolve its three-year old debt crisis. In an eagerly anticipated ruling that has had investors on tenterhooks for months, the court in the southern city [...]

By Marshall Auerback There appears to be an emerging consensus that the euro will survive, especially now that Mario Draghi has apparently grasped the nettle and persuaded his colleagues that the ECB is prepared to initiate unlimited purchases of national government bonds in order to underwrite their solvency.  Of course, as usual with the ECB, there’s a sting in the tail, [...]

Just when you think that things can get no worse in Spain, they do.

The eurozone’s architects failed to follow through with the logic of a political union. Nobody cares about “trade imbalances” in the Canadian confederation. And nobody would care if Alberta, for example, were to run perpetual trade surpluses with the other 9 provinces. Fiscal transfers from the strong to the weak are part of the Canadian bargain in a full national union. Had Europe adopted a similar federal structure, the Greek and Spanish issues would be moot. As it stands, however, the architects of the euro have created a doomsday machine and a gift for speculative capital.

Spain has become the new Greece. Actually, in many respects Spain is now worse than Greece. The Spanish unemployment rate is already so high and unlike Athens, Madrid has made no headway in reducing its public debt levels (whereas the Greeks are close to running a primary fiscal surplus at which point they could leave and turn the problem back on to Brussels). Moreover, Spain has a huge private debt burden that is twice that of Greece.

Marshall Auerback suggests the Troika’s goal in the Greek deal is to make the deal so miserable for the Greek people that the Spanish, Portuguese, Irish and Italians don’t even begin to think of trying to get a similar haircut on their debt.

The decision for Europe’s bosses is this: they must ultimately confront the consequences of their policy choices. They can destroy the eurozone by continuing with the same failed mix of policies or by salvaging it by adding what has been missing from the outset: a mechanism for shifting surpluses to the deficit regions in the form of productive investments (as opposed to handouts or loans).

I have been making a big deal about strength in the household series of employment and the trend in IUCs. These are statistical series that do not get revised out of recognition. They often tell the tale at turning points. Given that past household survey employment and IUC trends have persisted, the current bond market rally will be even more insane and the stock market will probably continue to work higher, even though the favorable seasonable window has closed. I expect the recent trend of large outflows from stocks to bonds over the last year (and last five years) to be reversed in 2012. Not only are interest rates at generational lows but many high-quality companies are yielding (at 2.5% or even better) well above the yield on the 10-year U.S. note.

Despite the ongoing hawkish rhetoric from the ECB, there are signs that they are getting it: The LTRO can’t work, as you’re essentially just swapping one liability for another one (albeit more long term in duration, therefore making it better for the banks). But note the way the ECB balance sheet is expanding: The consolidated assets of the European system of Central Banks is now 4.4 billion euros or $5.7 billion. In effect, the consolidated ESCB balance sheet is almost two times that of the Fed and its increase over the last 6 months is almost equal to the entire increase in the Fed’s balance sheet over the last several years. Bottom line: the system of European Central Banks (ESCB) has been engaged in massive QE and much more is in the pipeline. With such massive injections of “liquidity” into the European banks, a European Lehman type failure with Lehman’s systemic consequences becomes ever less likely.

As for Italy itself, the country runs a primary fiscal surplus. As George Soros has noted: “Italy is indebted, but it isn’t insolvent.” Its fiscal deficit to GDP ratio is 60% of the OECD average. It is less than the euro area average. Its ratio of non-financial private debt to GDP is very low relative to other OECD economies.

It is not at all like Greece. It has a vibrant tradeable goods sector. It sells things the rest of the world wants. You introduce austerity at this juncture, and you will cause even slower economic growth, higher public debt, thereby creating the very type of Greek style national insolvency crisis that Europe is ostensibly seeking to avoid. And then it will move to France, and ultimately to Germany itself. No passenger is safe when the Titanic hits the iceberg.