Credit Writedowns

Michael Pettis had a very good post out yesterday that focused on the sectoral balances within and across eurozone countries which I recommend. His point is that excess German savings driven by wage suppression was behind macro imbalances and not thrift. I want to expand upon this theme. My prediction here is that rebalancing away from excess German savings will not occur on nearly a large of scale to matter.

One of the reasons that it is been so hard for a lot of analysts, even trained economists, to understand the imbalances that were at the root of the current crisis is that we too easily confuse national savings with household savings. By coincidence there was recently a very interesting debate on the subject involving several economists, and it is pretty clear from the debate that even accounting identities can lead to confusion.

Earlier today I wrote a post on the free blog site about blaming Germany for the problems in the euro zone. I ended up defending the German political response and blaming the euro. Let me just add a bit of colour to that here.

Last year, we saw a sea change in official German policy regarding the euro crisis and inflation. The German government came out in favour of accepting higher inflation domestically in Germany as a sacrifice for eurozone wage and price adjustments to help alleviate crisis. The question is whether this matters. I believe it does, but only in part.

These are the words of European Commission President José Manuel Barroso in a recent interview with Die Welt, a German newspaper. Rather than translate this article in full, I want to put it in context given Barroso’s outburst about austerity hitting its social and political limit in response to journalist Matina Stevis. As I indicated at the time, Barroso was not denouncing austerity, as was assumed in the media. Barroso was calling for backloaded austerity instead of the front-loaded variety. And the Die Welt interview makes this clear.

I have been trying to break up the links posts because I have so many. So I have been writing brief theme posts to go with the links as I used to do when I had more time. I want to make this one short here and I have two topics to highlight. The first topic is Italy and its [...]

A recent FT article points out that the electoral campaign positioning has already started. And it has the Social Democrats in bed with the Green Party to an unusual degree. The way the Greens and the SPD are talking makes me believe it would be difficult to form a Grand Coalition between Angela Merkel’s Christian Union parties (CDU/CSU) and the SPD, if it were to come to this. On EU policy, this matters.

I am not going to say a whole lot here in this post because I have been writing non-stop about Europe of late. I just want to share the European links with you. I think what the links show is that the European paradigm is in transition from front-loaded austerity to back-loaded austerity. This is something I have remarked on at length in the past. What I would like to know is what impact this move is going to have on bond and stock prices.

The overarching theme here is that the economy of Europe is in tatters and this is causing a re-think of the policy course. In my view, the political space for the re-think is limited and will ultimately entail some tacked on growth policies and relaxed deficit target timetables. The prevailing economic paradigm will remain the same, fiscal consolidation to prevent sovereign default. As fiscal consolidation is a deflationary policy, I expect European growth to be weak. On the bank and sovereign debt front, some leeway is available but crisis is never far away. However, fiscal consolidation is negative for periphery corporate bonds in particular as I will detail below.

Here is the video of an interview I did with Max Keiser on the situation in Europe. A lot of our discussion revolves around why the Germans actually do want a cohesive Europe but feel compelled to pursue the present policy path. We also discuss the advancing plan bail-in plans in Europe and the advent of wealth taxes as a talking point in the crisis.

I caught this FT graphic via David Wessel yesterday. It shows you that while the labour force in the Euro Zone as a whole generally continues to grow, the labour force in Germany has shrunk. During the euro era, Germany’s labour force between 15 and 64 has shrunk by 2% while the euro zone whole has increased by 7%.

I have been saying for some time now that Germany is concerned about its own public finances. So it is good to see that Angela Merkel is now confirming this. According to the Telegraph, Merkel believes that Germany simply doesn’t have the economic strength to launch a stimulus package to counteract the austerity now ongoing elsewhere in the periphery. This is significant because it drives not just the adjustment process in Europe but also the perceived need for bail-ins and private sector involvement.