Thursday, November 10, 2011

Raising the dead and the Axis of Evil

OK, that's it. Calling on a European policy to appear in front of us as a divine saviour is turning out to be nigh on impossible. We have tried the Ouija board of Greek debt, then the talking in tongues of Greek politics, we have tried sticking needles in the French banks, and finally the market has resorted to sacrificing, on the Altar of Merkozy, the whole population of Italian debt. All of it - old and young, short and long in a conflagration that has resulted in much wailing and gnashing of teeth. The markets now look North for signs of the second coming of the Saviour who was seen to redeem the Irish and Portuguese. But silence... nothing... rien...Tumbleweed. Then a familiar noise... a bickering from Brussels and apology from the guy behind for breaking wind. But no saviour, no redeemer no bloody anything.

And you know whose fault it is? Not the Greeks for lying through their teeth over their off-balance-sheet-off-market-cross-currency-swaps, nor the Spanish for building too many holiday homes, nor the Portuguese for spending too much time playing golf, nor the Italians for being Italian, nor the Irish for dancing little property building jigs in leprechaun hats as the EU gold rained upon them, nor the French for believing that they are not in Club-Med. No... it's not them...

Its the Axis of Evil. And no, wrong again, TMM don't mean Iran, North Korea and the like. We mean the Bundesbank, the ECB and the German & Dutch governments. And it's time for action.

TMM reckon that one of two things is happening:

(a) The Axil of Evil are indeed clueless: staggeringly ignorant and blinded by anachronistic ideology, they are unaware of (or even exceptionally pleased with) the collateral damage they are causing, not just within Europe, but to the global economy and financial system. Yesterday's Italian bond market crash probably shocked them, but it's all these periphery guys' fault anyway, they can clear their own mess up.


b) Realpolitik dictates that Italy is held over a barrel in order for the Axis (led by Germany) to regain the power over the rest of Europe, lost circa 1944. This view follows the mid-1990s ERM crisis and the Bundesbank cutting off Italy up until contagion eventually spread to France, whereupon, Kohl called off the attack dogs.

TMM reckon that if it is the case that the Axis Powers are of view (a), then it should not be long until either they capitulate in the face of external political pressure or the stark fact that the Italian bond market (and soon the French bond market) have ceased to operate. This line of thought would be supported by German Wisemen calls for a joint and severally-guaranteed fund yesterday of around EUR 2.3trn. Of course, this comes with German fiscal control. It seems, as many have pointed out elsewhere, that Germany does not seem to recognise that creditors are just as "in it" as debtors are, and that it has benefited hugely from a weak currency, low bond yields and a captive export audience. It's time to get off the moral high ground.

Under (b), the Axis Powers have de facto taken control of the governments of the periphery, effectively dictating their fiscal policy. The precedent of the mid-1990s is certainly there, though TMM would highlight that this time it is not the Bundesbank that is the monetary anchor, it is the ECB, upon which, the Germans control two votes. It could certainly be out-voted: particularly if the contagion spreads to France in a disorderly manner (seem for the first time this morning). Thus, there are two outcomes from this viewpoint: (i) Italy passes the structural reforms and a technocrat government is in place early next week, followed by ECB buying, (ii) contagion spreads to France and the Axis powers back down, a la 1993/4.

The key question, of course, is what that particular trigger point of pain for France is. And to hazard a guess, TMM would guess is 10yr OAT/Bund at 200bps and/or widening bid-ask spreads and illiquidity in the French bond market. The latter, arguably, was seen this morning. Who will blink first?


German economic policy essentially consists of:

1) Tight fiscal policy to crush any signs of a recovery.

2) Tight monetary policy to crush any signs of recovery.

3) Tie yourself to some profligate countries so that you have a cheap exchange rate and can sell shedloads of exports.

4) When the countries you provided vendor finance to start having trouble paying you back insist that they follow 1) and 2).

5) Wonder why everyone hates you.

TMM's mate AH wryly observed: "It's a pulley system - you throw everyone over the cliff and let the rope take you higher. But eventually you reach the pulley."

Merkel's Lament:


Belektron said...

What if The Axis of Evil are not clueless but see a few years beyond the potential unleashing of ECB printing press. They see a Europe with national governments competing at which one has the highest deficit to please the voters. Debt/GDP ratio? No problem, ECB will buy our bonds as they did with PIIGS...

Bush saw the world in black&white. Please dont go that way :)

Polemic said...

Belektron..Do we put you down as an a) then?

Polemic said...

Unfortunately it IS becoming black and white as neutrality is not an option. To sadly quote Bush again, as far as the periphery are concerned the Axis are either "with them, or against them"

God forbid it goes one Bush stage further and the periphery rename their Hamburgers "Freedomers"

geokalp said...

why it can't be both happening?

taking de facto control covered with a strategic "road map"?

Charles said...

Regarding Germany's "wisemen", if it is this that you are talking about and one looks through it, it enters more within the b) category.

More intriguing is what is coming out of the CDU (and without doubt CSU and FDP will approve), I.e. allow countries who cannot or don't want to be part of the euro to leave.

That prepares the path for (c) : Germany is getting out.

It may be a good idea to fund BTP longs with borrowed euros...

Anonymous said...

Framany. You heard it here first. Big market. Security Council seat. Integrated hard and Club Med economies make competitive currency .

Belektron said...

Germany and the rest of the good guys (as I see them :)) have two alternatives that suck.
The ECB goes nuclear option would be a no brainer if there was a fiscal union. What the hell, UK, USA and JApan are doing it and getting away (so far).
Otherwise it is a German blank check to Frederico and Costa to party on with everyone else welcome to join the feast.
I grew up in Yugoslavia and that is history repeating itself today. We had earning and spending republics with spending republics having the central bank majority. It ended in hyperinflation, breakup, tears and blood. I dont envisage blood but all the rest is in the cards.

Anonymous said...

C says'
The crux of the problem was summed up best imo by someone who summarised that Germany wanted the other EU countries to be German. Isn't going to happen is it? Whatever partial fix they can put on it isn't a solution to what are cultural and ideological differences. I mean come on .I've done business in Greece,Italy and Germany for gods' sake and I'm here to tell you they might as well be different planets. Greeks are wonderfully entertaining ,but you couldn't pay me to try and do business with them. Italians are a strange mixture ,not quite the unreliability of the greek and nowhere near the reliability/predictability of the Germans/Dutch. Whoever thought this lot belonged together was clearly retarded.
The best as i see it that can be hoped for here is that people stop looking for a solution that is based upon Europe alone. Clearly the tipping point required for urgent action has not yet manifested otherwise that would have already happened. In terms of financial andpolitical/ideological
resources this is beyond Europes ability to fix. Indeed the differences between 2008/9 and now are stark. Faced with systemic now we have global major players all trying to theirown thing whereas what is called for is a global summit that brings them all into a cohesive approach to the twin issues of growth and debt.There is no major economy who doesn't have equity in this issue,who won't suffer IF they stand off as they have done. Even a kick the can fix on debt isn't the issue here ...after Greece there is Italy after Italy there and so forth...debt must be dealt with in tandem with growth/investment and structural reform of Western/European public sector commitments. If you think of it in these terms it's obvious that it extends well beyond what Europe can deal with on its' own.
On its' own we have the joke that passes for debt management and a Europe doing German fiscal discipline.That's simply incredibly stupid and that's what the markets been telling us all year,but where's the leadership that is listening ?.

Charles Butler said...

Hard to really back that up, C. If Germany wanted the rest to be like themselves they would have eased up on their domination of the ECB interest rate agenda back about 2004 - when the country with the housing bubble were turned down flat when they requested a bit of air conditioning from Frankfurt.

Anonymous said...

By way of reply I'd have to say one exception does not the general rule disprove. The German footprint for monetary and fiscal policy is allover this European issue regardless of the differences that I have mentioned that prohibit the success of same.

Anonymous said...

Euro is an absolute failure. The monetary union can only be saved by unlimited ECB guarantees and lowering of rates to 0 along with accepting higher inflation.

Guess what the chances of that happening are?

F*cking Germans again. Will the world never learn?

Leftback said...

Germany will fight ECB entry into a ZIRP/QE regime every inch of the way. But if a deep recession engulfs the Euro zone this winter, there may be no alternative.

An early breakout of the weakest members (Greece, Portugal, Italy?), and the reintroduction of native currencies, would be by far the most successful strategy, as those countries could become competitive again quite quickly, and the bond markets would recognize the renewed stability of France and Spain. The fact that we are talking about a buyers strike in French bonds shows how bad things have become.

Italy might have been retained in the core group if action had been taken sooner. But it is possibly already too late. Ireland, for now, has swallowed the austerity medicine so enthusiastically that they might just stay in the Euro.

There is growing talk of a fudge where countries take a "leave of absence" from the Euro with the option of returning at a later date after they get their house in order. Keep an eye on this one, politicians love "face-saving" solutions.

Secret--Sauce said...

Despite the efforts of Keynesians and politicians of nearly all stripes, cyclicity has not been eliminated from the market/economy.

This leads us to option c), namely, maybe it's just time again for Germany to thin out the European herd. Greek deadbeats won't pay up? Cry "Havoc" and let slip the dogs of war.

I have long agreed with the sentiment of letting the weakest members go, but that's just about everyone sans Germany & Finland. That France is driving this process as a "strong" member is more than a bit amusing.

Dee Dee Humberside said...

C is right

And I'd add, this is and remains - ever since the beginning of the subprime implosion - a global current account crisis.

Which is why, as TMM repeatedly points out, those who believe they have a god given right to a CA surplus are as much if not more, part of the problem than the deficit guys.

"Blank check to Frederico and Costa" is a nice enough soundbite, but I am afraid thinking along these lines IS actually what led us here.

You can say a lot of things about the Chinese, but at least behind their superficial barking at the US deficit tree, they do understand that funding that deficit *is* part of the deal. Germany? They'd like to have their cake and eat it too.

Dee Dee Humberside said...

Letting the weakest ones go sounds like a great idea, until you start trying to figure out how you'll sort out the ALM mess for all cross border businesses across the EU.

I guarantee this would go down the same way as the "maybe we should let LEH fail, I mean, Dick Fuld is such an asshole" idea.

Leftback said...

This has now reached the stage where it is FUBAR.

The Euro is going DOWN. Down if they do what now must be a massive QE, and down if they do nothing and the EZ economy grinds to a halt.

The US equity market cannot possibly rally when energy, materials, industrials and banks are all inversely leveraged to the dollar. Crude and gasoline is too high for US consumer and it has to fall before BB can even consider QE3.

Japan just might bumble along if the dollar rises so sharply that it becomes the safe haven ahead of the yen. Claims number today does seem to point to the fact that we are not struggling as badly as the rest of the world.

The stage is set for a decent move by Bucky. No fiscal stimulus possible b/c of DC gridlock. No monetary stimulus b/c BB cannot do QE until commodities fall.

I should add that once the deflationary rollover begins, BB is not going to piss around, he will have his finger on the QE3 trigger once crude dips firmly below $80 and the long bond is looking at 2 - 2.5%. Mortgage rates may eventually be in the 2s for the 30y and the 1s for the 15y in 2012.

LB finds himself on the road to Damascus today. Prepare for a modest deflationary episode. Since we are quoting GWB, "this sucker's going down".

Dee Dee Humberside said...

I am not an FX guy by any stretch of the imagination. But as much as I hear and understand the EM reserves diversification meme, I'm with LB, EURUSD has no business being at 1.35 with the way Eurobonds are pulling a textbook EM one.

Anonymous said...

C says'

You have pointed out the nature of symbiotic relationships.One which has worked and is still working after a fashion and the one which does not work because our German friends are simply pigheaded fuckwits who are excellent workers ,but should never be in charge of the big picture.That is what we call a backhanded compliment for the Germans.

Dee Dee Humberside said...

CfC - TMM and commenters may be well versed in Brit poetry, but if they had dusted off on their German classics, they wouldn't be surprised at all by this relapse of the deeply rooted Faustian ethos.

"Whoever strives in ceaseless toil, him we may grant redemption". They even make Tshirts about that one.

AG said...

The Euro-trap only works as long as they keep countries in the Euro. If Italy gets back to the Lira, their industrial, luxury and tech exports will thrash those of the Axis.

Anonymous said...

C says'
Dee although you were being a bit lighthearted you were nonetheless hitting on the core of the issue .German psychy is not remotely aligned to Southern Med Psychy ..their poetry ,their attitudes to 'work' and on and on...the gulf is huge.

On another point we've discussed before about markets looking abck at 2008 and reacting to it in expectancy of it happening again.Usually when we talk about this we do so looking at the Lehman defualt and aftermath and how people are trying to prepare for it etc etc and how that affects what they are doing now.
We've never really touched on another aspect of ot though have we.That is ,the global 'put' that occurred back then. A global cohesion that 'solved' the immediate concerns. I can't help thinking lately that there is a bid in thsi risk market that is looking back at that intervention and thinking Europes going to supply the same. You see how 2008 might actually be having more than the affect we initally touched on and of course my point is Europe and its' approach is not the approach we got in 2008 is it?

Secret--Sauce said...

Funny how my takeaway was a bit different:

"Approach the brink serenely and accept the risk of melting into nothingness"

Surely apropos for hedgies playing with OPM.

Leftback said...

A postscript to your hidden inflation post:

Thanksgiving Meal Jumps 13%

Lots of resizing tricks here too, and food inflation that hasn't yet been unwound after the QE2 spike. We need a firmer dollar over here.

Bucky and Betty for the winter?

Amplitudeinthehouse said...

You bet, watch Oil in regard of our little lady, then smash it!

Lemmiwinks said...

It's a pity you are turning paranoid and come up with conspiracy theories. Are you bitter with losses this week?
Smells like capitulation here.
EU countries are democracies and governments just chasing policies the voters want.

Donlast said...

Just don't believe Germany is lost without a "captive export market in Europe"...Germany has always been good industrially, always good at exporting. They went through many DM revaluations after WW2 and always emerged stronger than ever.

Then look at the UK. Went through devaluations and emerged a leader of what ? --- the exploitation of financial gimmickry. Intellectually fraudulent financial derivatives meant to control so-called risk management which merely obfuscate and delude. There is a golden rule in finance: keep it simple.

Anonymous said...

The Germans have many redeeming qualities ,but they are not superhuman.In the two major periods of outperformance Germany has had a hell of a lot help.
Post WW2 they were the global focus for investement to rebuild what had been destriyed and indeed become a bulwark between the West and the ermging Soviet threat...major bucks were thrown at them and they got a nice new shiny car of an economy to drive to market in.
Post the wall dropping ..they again got tied froma position of competitive advantage to a currency that reflected the overall competitive weakness of their European partners ...big big legup.
Don't misunderstand me the Germans know how to get on and get up when they have an opportunity.I simply point out they have a great deal of help in creating said opportunities.
Indeed f.. it ..will someone come and bomb the crap of the UK tomorrow because the persuasive argument goes that that is what it will take to mobilise us.Oh sorry I think 3 terms of labour govt have done just that.Thanks Gordon!

Charles Butler said...

What it's all reduced itself to...

Between advice from the staff medic, outbreaks of dancercise and the usual overdose of celebrity gossip and reports from the trials of serial axe murderers, today's (Friday) TVE mid-morning fare slipped in a panel of journalistic eminencias furrowed-browedly going on about 'two speed Europe', 'risk premia' and the like.

Spanish grandmothers will be short Telefónica en masse come Monday.

Leftback said...

Two-speed Europe and reintroduced Deutsche Mark are all the rage suddenly on the telly.

Meanwhile it's Whack-A-Mole* time in the bond markets. Down goes Italy, up pops Spain and France!

European Bond Whack-A-Mole

* Popular fairground game in the US involving a rubber mallet. The carnie usually wins.

Leftback said...

Equity silly-buggers rally in progress while the US bond markets are closed. Another great day to take off some risk. EURUSD has a date with 1.20.

Charles Butler said...

Indeed, LB. The DM entertainment is making its second appearance in about a year. As to its credibility, we doubt that anyone of consequence has failed to note that the German share of intra- + extra-EU trade relative to other members has tracked flat since, oh, about 2006.

theta said...

Excellent post.
I think it's mostly (a) rather than (b), i.e. clueless rather than realpolitik.
Btw, do people who suggest any current EZ member leaving (be it one of the weakest or one of the strongest members) and the euro staying intact really believe that this will solve the problem? The fundamental issue of the EZ being a non optimal currency area remains even if you have a union of only Germany and Finland, let alone adding France to the mix. Same if Germany leaves and you have the Club Med staying. Whatever combination you choose (and no matter how much you depreciate the currency as a result (if Germany leaves for example) the issue of a dysfunctional monetary union in the absence of a fiscal union remains.
In the end I do believe that the fiscal union will come, one way or another, instead of a breakup, but maybe I'm too much of an optimist. We'll see.