Wednesday, January 14, 2009

Thoughts on Europe

Well, Macro Man highlighted the issue of trade yesterday, but even he was surprised by the US trade number for November. The $40.4 billion deficit was much better than expected, and indeed the narrowest in nearly 5 years. While Macro Man had been troubled by the October report and its implication for his constructive dollar view, yesterday's data boosted his confidence in his economic analysis (though as observed yesterday, that does not necessarily translate into market success!)

What was particularly striking about yesterday's figures was the sharp decline in both imports and exports, providing further support for yesterday's theme. Macro Man received some pushback on his claim that the Baltic index represents true supply and demand for shipping (though why the unavailability of trade finance somehow doesn't count as a determinant of shipping demand eludes him), so he was curious to see an article in today's Torygraph suggesting that container rates on same routes have hit zero due to- you guessed it- falling demand.

Another source of curiosity yesterday came from a Market News story about tomorrow's ECB meeting. It must have been a slow day chez MNI, as they evidently had the luxury of time to ring around a few different ECB moles. The divisions within the ECB were pretty much laid out for all to see; one guy pretty much said "we're buggered", 50 bps is a done deal, and we'll push for more. Another was quoted as saying that the bottom may already be in and that they have to worry about eventual inflation.

Now Macro Man has had a go at the ECB before, and frankly been surprised at the amount of reader support for JCT and co. But frankly, he's left wondering if we will need to create a new species for the ECB; traditionally, central bankers are divided into "hawks" and "doves". Perhaps we'll need to include "frogs" on the in in Muppets. Where was this concern about the forward outlook in August, as oil was already on the way down? As things now stand, the ECB looks set to miss its inflation targt on the downside by as much as blew it on the topside. Good work, lads!
At the same time, there are more insidious structural headlines beginning to hit the tape. S&P, for all their many faults, have been conducting one of their periodic reviews of sovereign credit ratings over the past few days. Nations like the US and UK have had their ratings affirmed, while the PIGS are on negative watch (Ireland doesn't show in the chart below for some reason.)
Now, Macro Man isn't a Bernard Connolly type character who hates Europe for the sake of it. But he cannot help but wonder if the last year or so hasn't put a dent in the attraction of the euro as a store of value. After all, many FX reserve holders in Asia and the Middle East have belatedly come to realize that holding euros isn;t any good iff you need dollars to defend your currency. That in and of itself would argue for a higher dollar weight than a purely markowitz approach would dictate.

Moreover, insofar as the current crisis has been all about the small print, the Eurozone has small print in adbundance. Less than half of the countries in the Eurozone enjoy a AAA rating (though obviously a bigger percentage of Euroland GDP is AAA), and recent market developments have confirmed that EMU assets, including government bonds, are not, in fact, perfectly fungible. BTPs are not a government trade these days, they are a credit trade.

And while Ireland may not call in the IMF, a worst-case outcome for the economy and the banking system could raise serious questions about some countries' ability to pay their liabilities. Not exactly what you want to see in a reserve currency!

And try as he might, Macro Man cannot find the mechanism or gameplan within Europe should, say, Greece decide to withdraw from th single currency becuase they cannot afford their euro liabilities. The standard European respeonse seems to be "we don't need a plan because that cannot happen."

Funnily enough, that sounds an awful lot like S&P's comments on their subprime housing model should house prices decline in the recent Michael Lewis article (page 5, to be precise). And didn't that end well.....


PureGuesswork said...

There has always existed a built-in disadvantage for the euro as a reserve currency which your list of bond ratings for various EC countries highlights. If an Asian CB wants to hold euro reserves they have to hold govt notes. And the only govt notes they really want are bunds. And the bund market cannot compete with the US treasury market in liquidity.

dblwyo said...

MM, Gentlemen: have you seen this morning's Chinese trade figures as yet ? Just in case you needed another point of confirmation. BtW - you might also want to compare your trade chart to the equivalent YoY changes in GDP. Funny how much they look alike to my eye.

Here's the real question IMHO - now that we're all viciously re-coupled when do the respective BRICs cross their respective socionomic growth thresholds down and turn into nothing but straw ? That is when does social instability exponentiate ?

Manc Trader said...

MM you've definately been right about this theme.
On Greece a very valid point. I get very nervous when people insist something can't happen. The Euro's achilles heel has always been what would happen under a crisis when member countries' self preservation instincts take over.
On a can't happen theme I am also worried about Bernanke who does not seem to have an exit plan if things don't go as he expects.

As James Hamilton blogs above
"That sounds to me like an exit strategy for how to get out of this if everything works out just right and the problems all go away.

And what's the exit strategy if it doesn't work? I suppose more lending facilities."

Let's hope thing go right for Europe and Bernanke.

Ashish said...

Your trade contraction theme is the first sensible thing I have read this year (along with your non-predictions..)

Anonymous said...

MM, what do you make of the view that the EUR (currency) may strenghen simply on the basis that everyone apart from the ECB wants their ccy weaker (so it becomes the de-facto counter-cyclical currency)?

Macro Man said...

Pure, while it is true that there has always been a credit differentiation in Europe, it's also the case that until relatively recently, it didn't matter. The Bund/BTP spread was 30 bps this time last year (versus the current 143) and was 20 in mid-07. So when a lot of the FX rserves were accrued, BTPs kinda were quasi-fungible....and now they ain't.

dbl, insofar as the US consumer has generally been the straw that stirs the global economic drink, it is perhaps unsurprising at the correlation that as US domestic demand goes (and by extension, US GDP), so goes world trade.

Manc, agreed re Bernnake. His policy prescription may well be sub-optimal (then again, all possible solutions may be sub-optimal), but at least he has recognized the nature of the problem for the past year or so. The ECB, on the other hand....

Ashish, thanks.

Anon, that's been the major euro-bullish argument for the past couple of years. With the euro REER at mutli-decade highs recently, something tells me that there are some quarters of Europe where a weaker euro would be more than welcomed.

BoyPlunger said...

The other side of the coin re:baltics is that a collapse in world trading is setting up the stage for a supply shock later this year and next year both on oil and grains. The credit crunch together with the importers L/Cs ordeal must have left farmers high and dry and yields are probably already hurting (ie. Argentina in corn and soybeans).

Charles Butler said...


Complicating the eurozone matter is that the EU cannot come out and say it has a plan because of national political considerations. This is not to say that they don't actually have one, which is unlikely. But it certainly won't be hauled out until it's needed.

Recall that exactly the same things were said when bank liquidity was the issue.

Macro Man said...

CB, I think the decentralization of fiscal autonomy make a coordinated, consistent, and cohesive plan very, very difficult for Europe to achieve.

Mr.Sparkle said...

You're not the only one noticing the S&P activity in the PIGS. Across the Curve made mention of this as well.

Macro Man said...

And lo and behold, S&P cuts Greece's rating today.....

Charles Butler said...

There's no question about its difficulty, but I think that there is a fundamental desire to keep it working which will be strong enough to adapt as needed if the threat is that it fall apart. I also think it's far preferable to have larger, common issues looming overhead than to permit a slow disintegration through the application of beggar-thy-neighbour fixes to what are considered purely national problems, like unemployment and such. That is far more insidious.

In any event, we may be talking about the best bus route to take to the bridge we're going to live under.

t said...

OT - Fancy revisiting crack spreads?

Anonymous said...

Where's the Obama bounce gone? Agreed with CB that breakup is most unlikely, it still gets my goat that Italy & Greece were allowed to join and wouldn't be able to under current requirements. Having said that do not underestimate the intransigence of bureaucrats, I would not be surprised if no "plan" had been made.
After € broke through 1.32 (next support I see 1.3040) looks like we are off back to 1.25, I can only concede good call MM. Ta, JL

Anonymous said...

MM -- perhaps the grass always appears greener on the other side, but if you don't like JCT, we will happily send you Bernanke and Paulson for keeps (eg don't bother returning them).

I can't argue with your criticisms of JCT, but in comparison to the clown shop we have running the States, your criticisms are nit picking.

Maybe JCT should have lowered rates faster, maybe his concern for inflation (which was above targets for many years) will prove valid in the long run... At least JCT is staying consistent

Paulson/Bernanke, by contrast, have absolutely **NO PLAN**. They make stuff up as they go, change the rules whenever it suits them, and generally create uncertainty and chaos in a market already having an abundance of both.

They think there is nothing wrong with penalizing savers (of which the US has an extreme shortage).

But the worst part? They take their stolen property, and give it to companies that are proven FAILURES.

The ECB is trying (perhaps with varying success) to balance growth and inflation. Its only human that they won't do a perfect job.

The Fed/Treasury punish the prudent and reward the stupid -- which is not an honest mistake. Its the stupid looking out for their cronies

Bob said...

I just re-read that Lewis article, and was struck by the paragraphs in which Eisman's team are exploring the subprime financed neighborhoods - while the "royalty" of ratings agencies continued to assign AAA ratings from their air conditioned offices.

Has S&P/Moody's ever visited a western economy? Have they stepped outside their offices to the streets of NYC?

How big an actuarial deficit do western governments need to show in their old age social spending accounts in order to lose their AAA rating?

The U.S. is supposedly "the best" in this category, and its $42 trillion deficit is bigger than the GDP of the entire world (and roughly 3x US GDP). This "accounting" assumes the social security trust fund is anything other than a vacation savings account filled with IOUs to yourself.

Then you need to factor in a projected $1.2 trillion annual spending deficit.

Most European old age programs are in worse shape actuarially than the US. European governments are just starting to implement the crazy fiscal spending the US started on a year ago. And Germany -- widely viewed as the best credit in Europe -- just had a failed bond auction.

Not having enough income to support a mortgage loan didn't worry the ratings agencies one bit -- they gave subprimes a AAA rating anyways.

Being actuarily bankrupt, running perrenial deficits, and systematically attacking their own tax base is apparently no cause for concern?

Exactly what does a debtor need to do to lose their AAA rating?

Macro Man said...

Exactly what does a debtor need to do to lose their AAA rating?

Bob, I am guess that the answer to your question is something like "forget to pay your annual premium to the agency doing the rating"

Said with tongue only slightly in cheek...

bsanchez said...

"Macro Man cannot find the mechanism or gameplan within Europe should, say, Greece decide to withdraw from th single currency because they cannot afford their euro liabilities."

Wouldn't we just be talking about a pure and simple Argentina-style default? Rightly or wrongly the euro is popular in Southern Europe, and I think it would be (a lot) more palatable for politicians to default than withdraw from the euro.

The question is "will Greece get there before California"?

Gus said...

...PIGS and others will address the matter later in the year. They just need to "touch" the private savings in their respective countries (we're far from Argentina though we'll probably see some angry mob in the streets).

Anonymous said...

i was in the same camp, but now i think more likely germany will say aufwiedersehen when they tire paying for others. the pigs don't dare make the move. strength in numbers and all that.

Anonymous said...

Greece would never opt out of the euro. It enjoys low euro interest rates and can fund it's large foreign debt( both private and public) much cheaper than otherwise. The competitive advantage form a weaker exchange rate is not so important when there is not much of a manufacturing base left. Italy is a more likely candidate for opting out.

Greece's potential problem is if it cannot roll over it's maturing debt ie. default, unless there is a plan in place for such an occurence. Does anyone think there is no plan? I don't.

Macro Man said...

Let me make it clear.....the only countries that can voluntarily leave the euro are those at the very core, in my view. If, say, greece, were to leave, it would be because they could not uphold the fiscal standards for ongoing membership. And I would concur that there is NO plan for that eventuality, should it occur.

Anonymous said...

Greece leaving the eurozone under such circumstances would be a disaster for them, but would it be bad for the euro?

Christian said...

I think Macroman has been living in the UK for too long. It has distorted his good judgement with many things European. I have included a link to an excellent article from LBS Willem Buiter on the PIGS and the Euro. I hope it helps shed some lights as to why Greece opting out of the EMZ though many Britons are drooling over this possibility isn't really likely.

Anonymous said...

MM wrote: "If, say, greece, were to leave, it would be because they could not uphold the fiscal standards for ongoing membership."

Didn't ITL and GRD cheat to get in? (by which I mean that they've never upheld those standards.)

Also, do reserve managers really care about sovereign ratings? This is not a facetious remark, I'm genuinely curious.

Mr Risk said...

Here's the pessimist in me today talking...

S&P, Moody's, A&M Best, et. al. better be careful. It's one thing to cut Citigroup (however late in the cycle), but it's another thing to say, cut an entire country. An entire country with military, mobs and underworld villains.

I wouldn't want to be an employee traveling through Greece. Even though you are just the copy room guy, but somehow the whispers through the entire town suddenly make you the "guy" who spat on their country.

It never pays to be a bear. If you are, then keep it to yourself.

I jest, of course. But... politics is just a game. Money on the other hand is to "die for."

jonathan said...

Love your blog. Nice writing style.

Huge question: how much will demand fall? The ECB doesn't seem to think that's the real issue but the Fed does, perhaps because they have seen the latest lending, etc. numbers.

BTW, I see little good in Ireland's future. IMF may be a best case if trends continue.

With regard to the Euro, there's a general feeling the members are over-rated. There has been somewhat of a halo extending - mostly from Germany - but how much is that really worth? We may be finding out.