Last week, the high yield market seized up, in part due to jitters surrounding a high profile freeze of funds at the Third Avenue Focus Credit fund. The big problem for Third Avenue was energy high yield credit and the contagion from that sector into other credits. This latest event bears some similarities to the fund freeze at three funds at BNP Paribas in August 2007. And I think it makes sense to think of energy high yield as the equivalent in this credit cycle of residential MBS in the last cycle. So I want to put what’s happening in a broader context and make some conclusions about what it says about the credit cycle.
Success of the German-inspired solution for the latest Greek crisis is far from assured. If it fails, the Eurozone may be changed forever. This column argues that the failure would lead to an outcome that has been favoured for decades by Germany’s Finance Minister, Wolfgang Schäuble. Perhaps the package the Eurozone agreed is just a backdoor way of getting to the ‘variable geometry’ and monetary unification for the core that the Maastricht criteria had failed to achieve.
Over the past couple of years, there has been a decent amount of chatter about the Fed’s not being able to ‘reload’ in order to have enough tools to deal effectively with the next cyclical trough. And while the fear of running out of runway during the next downturn should not effect present policy, it likely is as it is a background consideration for the Fed as it thinks about liftoff. Below, I want to talk about this reload process. But I also want to move forward to the end of the cycle and give some thought to what happens to monetary policy when the cycle turns down with rates pinned near zero percent. I believe unconventional policy actions like quantitative easing – potentially including short-term municipal debt – will be used.
In the 2008-9 crisis, Latvia suffered more than any other country despite its extensive bank reforms after the 1995 crisis. Yet only one of its banks failed (Parex): the rest were bailed out by their foreign owners. So the question is, if Latvia’s banks were actually in better shape than those in other countries, why did Latvia suffer the worst recession in the world? To be continued……
The title of this post is what the Fed wants us to believe. It wants us to believe that it is prepared to raise interest rates this year but that it will increase them slowly by assessing the data, hiking once and re-assessing, and then hiking again if the data warrant doing so. I believe the Fed. The Fed wants to raise interest rates and it will raise interest rates if the data are sufficiently robust to do so. The questions then become what are those data, how robust do they have to be and what are the trigger points for hiking further down the line. And beyond these questions, we need to ask what is the reaction from markets and the real economy. I think Japan’s experience is a good cautionary guide here.
Recently I told a few friends how frustrating the events unfolding in Greece are. It’s clear to most that the delays to a full restructuring in Greece reduces the net present value available to creditors. Yet, for political reasons, delay seems to be the only way forward. Meanwhile we have to watch as the spectacle unfolds with increasing acrimony that makes clear how the euro has become a source of division rather than unity.
As Greece staggers under the weight of a depression exceeding that of the 1930s in the US, it appears difficult to see a way forward from what is becoming increasingly a Ponzi financed, extend and pretend, “bailout” scheme. In fact, there are much more creative and effective ways to solve some of the macrofinancial dilemmas that Greece is facing, and without Greece having to exit the euro. But these solutions challenge many existing economic paradigms, including the concept of “money” itself.
The euro crisis is a crisis of Europe, not of European countries. It is not a conflict between Germany and Spain (and I use these two countries to represent every European country on one side or the other of the boom) about who should be deemed irresponsible, and so should absorb the enormous costs of nearly a decade of mismanagement. There was plenty of irresponsible behavior in every country, and it is absurd to think that if German and Spanish banks were pouring nearly unlimited amounts of money into countries at extremely low or even negative real interest rates, especially once these initial inflows had set off stock market and real estate booms, that there was any chance that these countries would not respond in the way every country in history, including Germany in the 1870s and in the 1920s, had responded under similar conditions.
The European situation is still flirting with recession, if we look at the latest PMI data. I think the drop in oil prices will give the Europeans an unmitigated boost but the longer-term situation is still dire given the policy framework in place. In the US, on the other hand, the economy is doing well and will continue to do well despite the problems in the shale community. These problems are becoming more severe, however, and that means we cannot rule out a crisis down the line. But right now, everyone seems to be talking about crisis in Russia and making parallels to 1998. I think these fears are unwarranted and will explain below.
The German economic miracle is coming unstuck. And while a German recession this year would merely be a technical recession, it would highlight the underlying flaw in German economic policy, both domestically and for the eurozone as a whole. The German paradigm is predicated on fiscal probity, wage restraint and growth via trade. As such it is at once predicated on weakness in both public sector and private sector domestic consumption and on export competitiveness due in part to lower cost. This policy worked for Germany in isolation in the previous decade. But it means a perpetual domestic consumer weakness and a dependence on foreign demand. For the eurozone as a whole, the German model will be catastrophic.
Last Thursday, we ran a unique half-hour segment on gold, gold investing and the gold standard over at Boom Bust. The panel was made up of four investors: Marshall Auerback, Rick Rule, Cullen Roche and Peter Schiff. I moderated the panel with regular Boom Bust host Erin Ade. I really enjoyed this format and think we could or should have run the segment for a full hour because there was a lot more ground to cover.
Take a look.
“I am determined that the American dollar must never again be a hostage in the hands of international speculators”
Below is the video of Richard Nixon closing the gold window exactly 43 years ago today. Hat tip to Raja Korman