Thursday, 2 August 2012

Euro Area – More Wrangling, All Eyes on Draghi and the Roving Crisis Ambassador

The Upcomming ECB Decision: Most observers are united in their view that it now 'all comes down to Mr. Draghi' and the extent to which he manages to meet expectations on Thursday. We will of course comment once we have seen the press conference and digested the details, but in the meantime it is noteworthy that German resistance against a banking license for the ESM has hardened in recent days.
However, there is no word from Mrs. Merkel or Mr. Schäuble on the topic so far, although vice chancellor Philip Rösler insisted that they are 'all agreed' that it would be the wrong thing to do:

“Some euro zone governments say the fund, the European Stability Mechanism (ESM), should receive a banking licence from the European Central Bank that would allow it to buy virtually unlimited amounts of debt, thus pushing down yields for heavily indebted countries such as Spain and Italy.
"The chancellor (Angela Merkel), the finance minister (Wolfgang Schaeuble) and I are all agreed that … a banking licence for the European Stability Mechanism cannot be the path we take," Roesler told reporters. "We do not want to take the path to an inflation union but … to a stability union," he said.
Roesler, leader of the pro-business Free Democrats, junior partner in Merkel's centre-right coalition, also said he expected the European Central Bank to remain focused on its core task of maintaining price stability in the euro zone.”

(emphasis added)
Other than Rösler,  CSU leader Horst Seehofer voiced his displeasure with the reanimation of the banking license debate. While this resistance within Mrs. Merkel's coalition is not insignificant, it should be noted that the people doing the grumbling are not the ones ultimately taking the decisions. Seehofer's threat to leave the coalition in the event of Germany dispensing more aid than hitherto is probably mainly political bluster aimed at his domestic audience in Bavaria. Then again, he is also pursuing a suit in the constitutional court that seeks to overturn Germany's famed 'Finanzausgleich' – the shifting of funds from richer to poorer 'Länder' (roughly equivalent to the states in the US). Bavaria, Seehofer's home base, is the biggest donor in this scheme. So he doesn't even want to be in a fiscal union with his fellow Germans anymore. This is fairly typical for a darkening social mood – suddenly it's all 'us against them'.
Der Spiegel meanwhile has published a well-worded analysis that comes out against the banking license 'bazooka' idea as well. This is noteworthy because the magazine is often slightly left-leaning in its editorial outlook. When it comes to monetary and fiscal matters it is fairly easy to get most Germans to agree though, regardless of their political affiliations.
With the BuBa also remaining opposed to more sovereign bond buying by the ECB, we tend to go with the expectation that Draghi will pull some of the other rabbits from his hat which we briefly discussed yesterday. If this indeed includes a decision that the NCB's making up the euro-system can buy up private assets with money from thin air, then the euro area will have 'QE' anyway. Only, it won't involve direct fiscal financing via the printing press (governments still stand to profit though,  from higher tax revenues down the road and the fact that inflationary policy will tend to devalue their existing debt).
We will know more later today.
Regarding the BuBa's resistance to bond buying, the Telegraph's Ambrose Evans-Pritchard reports:

“Bundesbank chief Jens Weidmann shows no sign of relenting, warning today that the ECB must not “overstep its mandate” or stray into fiscal rescues. He issued a blunt reminder that the German central bank is master of the euro project, and not “just one” bank among others. “We are the biggest and most important central bank in the euro system,” he told the Bundesbank journal.
While the Bundesbank does not command an ECB majority – and has been outvoted in the past – Mr Draghi must move with extreme care. Two German members of the ECB have already resigned in protest over bond purchases, seen as debt pooling by the back door. EU officials fear that Mr Weidmann may leave as well if pushed too far, risking a political storm in Germany.”

(emphasis added)
We strongly doubt that the ECB is prepared to do anything that has not the reluctant placet of the BuBa. Mario Draghi almost certainly will be eager to present a united front.

Roving Crisis Ambassador

Mario Monti has taken it upon himself to act as the mediator between the 'Club Med' and the Northern half of the euro area. He is about to arrive in Finland to preach the need for more solidarity (the Fins meanwhile were astonished to find out that the SNB is now busy buying Finnish shares because it doesn't know anymore what to do with all those euros it has bought).
Monti is widely seen as the man best suited for this job, given his past incarnation as a eurocrat.
He now wants to get everyone to 'back Mario Draghi' in the endeavor to 'do whatever it takes' to save the euro:

Italy’s Prime Minister Mario Monti is pressing his European counterparts to sign on to collective action to fight the financial crisis, trying to bridge a north- south divide in the euro area for help to lower borrowing costs.
Monti, who is due in Helsinki today for talks with Finnish Prime Minister Jyrki Katainen, is seeking to capitalize on a pledge by European Central Bank chief Mario Draghi to do whatever it takes to defend the euro. Bundesbank President Jens Weidmann said the ECB shouldn’t exceed its inflation-fighting mandate, according to an article published on the German central bank’s website today.
“The question is whether the Germans and the Finns have the stomach for a much looser ECB policy that is more suited to the south, and so far we haven’t seen much appetite for that,” Jonathan Tepper, a partner at London-based investment research firm Variant Perception, said by phone. “Neither seems to want to budge.”

The basic problem remains always the same – and this applies to the ESM banking license idea just as much as it applies to other types of interventions in sovereign bond markets in the euro area: how does one get governments to institute painful, but urgently necessary reforms, if market pressure is somehow taken away? We already know from experience that this doesn't work. On the other hand, market pressure could become so overwhelming that the euro area simply breaks up. The situation reminds one of the Uroboros, i.e. it remains a 'catch 22'.

Uroboros – the snake that eats its own tail

The above quoted Telegraph article also relates that pressure is mounting on Spain to accept a full-scale bailout. This seems to run counter to Spanish pride and tradition, and we doubt it is somethingany Spanish government could accept. However, if Spain wants EFSF intervention in its bond market, it will have to bow to the demand to 'cede its fiscal sovereignty' as Evans-Pritchard puts it. Apparently the bearer of this demand is also Mario Monti:

“Mr Monti will swoop into Madrid today after garnering support in a whirlwind tour of European capitals for a “grand plan” to shore up the euro. The mission is designed to cajole Spanish premier Mariano Rajoy into requesting help from the euro zone’s bail-out fund (EFSF), the last missing piece of a complex twin-trigger plan to buy Spanish and Italian bonds
Mr Monti was coy about details, saying he was working on “various combinations”, but diplomats say the key thrust is an EFSF “soft rescue” for Spain. This would allow the fund to buy Spanish bonds at auctions on the primary market, giving political cover for the ECB to intervene with real muscle in the secondary markets. The sequencing is crucial. Only the EFSF can impose the tough conditions needed to satisfy Germany, the Netherlands, and Finland. The snag is that Spain would first have to sign a memorandum ceding fiscal sovereignty.
Mr Rajoy’s team is digging in its heels. Deputy premier Soraya Saenz de Santamaria repeated this week that “there is not going to be a rescue”. A volte-face would be devastating for Mr Rajoy and risk a political crisis at a time when Madrid is locked in conflict with Spanish regions.”

Meanwhile, the recent sharp decline in Spain's bond yields has halted at an approximate level of support and a little of the drop has been reversed. No doubt this is a result of growing uncertainties as to what the ECB can actually 'deliver' in the wake of Draghi's full-throated announcement last week.

Spain's 10 year government bond yield – rising again a little bit after the big pullback last week – click chart for better resolution.

Similarly, sovereign CDS spreads and CDS on the senior debt of banks have come down across the euro area in anticipation of ECB intervention, but the action seems to have gone into 'pause mode' on Wednesday:

5 year CDS on Portugal, Italy, Greece and Spain – only small movements ahead of the ECB - click chart for better resolution.

Our proprietary unweighted index of 5 year CDS on the senior debt of eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito) – (white line) compared to 5 year CDS on the senior debt of Goldman Sachs (orange), Morgan Stanley  (red), Citigroup (green) and Credit Suisse (yellow) – all lower lately as well - click chart for better resolution.

A weekly candlestick chart of Spain's 10 year yield shows that the medium and long term uptrend remains intact and that a bullish inverted hammer may have formed now - click chart for better resolution.

Addendum: How the State's Minions Spend Their Time
The US military industrial complex is without a doubt the greatest racket in the history of the world. This became clear when Donald Rumsfeld relayed on September 10, 2001 that the Pentagon had 'lost track' of $2.3 trillion in spending. This was extremely unfortunate timing, as the WTC attack happened one day later and it was all forgotten thereafter. However, given that this was the number estimated over ten years ago, we can imagine that it has become a lot bigger since then. Here is a video of Rumsfeld's admission including a few comments by people who tried – in vain – to track some of the missing funds down.

$2.3 trillion of funds have gone 'missing' at the Pentagon as of 2001.

So given that keeping this racket going appears an extreme luxury in times of soaring budget deficits and hard-pressed tax payers, are the boys charged with defending the country at least on the job? It seems actually that some of them have taken a leaf from the habits of their colleagues at the SEC.They're surfing internet porn sites:

The Pentagon’s Missile Defense Agency warned its employees and contractors last week to stop using their government computers to surf the Internet for porn sites, according to the agency’s executive director.
In a one-page memo, MDA Executive Director John James Jr. wrote that in recent months government employees and contractors were detected “engaging in inappropriate use of the MDA network.”

Admittedly, sitting around in a missile silo in the middle of nowhere is probably boring as hell. And yet, they get paid for being bored out of their skull, don't they? Babysitting nukes seems to be something that requires a certain modicum of responsibility.

Addendum 2: Some Interesting Links – The 'Music Men', The Anti-Rothbard Cult, Treasury Inadvertently Calls A Bond Top?

Below are links to  few other interesting articles we have come across. One is a critical discussion of central bank intervention in the WSJ entitled 'The Music Men'. Here is a brief excerpt that gets the flavor across:

“Central bankers are today's music men, the maestros we desperately want to believe can rescue the world economy by playing one more monetary tune. Buy more bonds and lift the stock market! cry the boys at Pimco and Goldman. Pay less for bank reserves! shout the Princeton professors. Promise to keep rates at near-zero until 2015—or 2016 or 2017—beg the politicians.
And so Mario Draghi and Ben Bernanke will try to sell us 76 more trombones. Sooner or later we'll discover that their money illusion can't save an economy from its more fundamental problems, and that they may even be interfering with the faster growth they want.”

Included is a chart that shows the 'diminishing returns' from central bank intervention in the US:

Via the WSJ: the diminishing returns of monetary policy interventions – click chart for better resolution.

Of course this should surprise exactly no-one.
At Lew Rockwell's site there is an audio file of a recent presentation delivered by Thomas Woods entitled the 'Anti-Rothbard Cult', in which Woods recounts Murray Rothbard's great achievements, as well as his personal interactions with Rothbard and what he learned from them. Woods rightly bemoans that there is a tendency today to diss or simply ignore Rothbard even among libertarians, something he ascribes mainly to envy.  This presentation is well worth listening to.
Lastly, a friend pointed out to us that the US treasury reportedly plans to issue floating rate bonds from next year. That this happens with yields near an all time record low may well be a sign that the top of the bull market in treasury debt is not too far off.

Charts by: Bloomberg, Bigcharts, WSJ


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