Kiron Sarkar
November 27, 2011
Hi there,
Weekend reports from German newspapers and the WSJ, suggest that France
and Germany are to propose a fast track mechanism which, if
implemented, would put in place a tougher and integrated fiscal policy
for all 17 Euro Zone members - a new "Euro Stability Treaty" (haven't we
heard that before), to become effective by the beginning of 2012 - wow a
speedy Merkozy - does that imply that they are getting worried?
sounds like it, does it not.
Essentially, Euro Zone countries would by pass the EU (as the EU would
take too long) and, essentially, enter into bilateral agreements with
each other (as per the Schengen agreement, which scrapped passport
controls within Euro Zone countries that signed up to it) to effect
these new policies. The EU treaty allows for "enhanced cooperation",
once at least 9 of the 17 Euro Zone countries agree - also means that it
circumvents the need for all 27 EU member states to approve the changes
ie the avoids problems with the UK, in the main, I suspect. By the way,
how many bilateral treaties would that involve (answers
please) - and yet its considered faster, than through the EU !!!!!!!
As an aside, the Schengen treaty is in disarray at present, as a number
of signatories to that agreement have decided to take matters into their
own hands - not a great precedent, I would have thought - I'm sure you
wont hear that from the Euro Zone/EU.
These agreements, when entered into, would enable the Euro Zone to agree
to fiscal measures, which would be much tougher than currently is the
case and will be subject to verification centrally, by the EU -
presumably with enforcement provisions and penalties for non compliance
- basically goodbye Greece at the very least, if implemented - no great
loss, I must admit.
Apparently, details of this new plan will be revealed, prior to the 9th
December EU Summit. There are extremely serious issues about democratic
accountability, the impact on non Euro Zone members, Ireland's
corporation tax rate etc, etc, but hey when has the EU ever been a
democratic organisation - its very structure, whereby non elected
commissioners create laws, which are applicable to all 27 countries, is
existing proof of that. Further evidence is the appointment of
Technocrats in Greece and Italy - OK, the alternatives were awful, but
you can hardly describe their appointment as democratic - though
heralded by the Euro Zone as great news.
Furthermore, the (so called) non political ECB is rumoured to have
caused the exit of Berlusconi, by not buying Italian bonds, resulting in
yields soaring.
There is a thin line, but the EU crosses it many many times for my
comfort. These are a number of the very many reasons I have been and
remain staunchly opposed to the EU, which I still believe should have
remained just a free trade zone.
I cant help thinking that this new French/German plan stems from the
realisation, by Germany, that, inter alia:
Germany is not immune from market forces - the recent failed Bund
auction (by the way the 6th to date, as my friend Marc Chandler from
Brown Brothers Harriman points out to me - by the way his and his teams
reports, for mainly forex participants, are excellent - a must read);
Germany is losing support from its allies Austria, Finland and
Holland, who are getting mighty nervous as to Germany's hard ball
tactics to date, particularly as they (and their banks, in particular)
are being affected, to say the least;
German banks are really feeling the pinch - very serious indeed, as
most of them are grossly under capitalised.
I know, I keep banging on about the above issues, but, for a variety of
reasons, I am now convinced as to the merit of the above 3 points.
The further downgrade of Portugal and, more importantly, Belgium, the
home of the EU, are facts that Germany cannot ignore - basically the
economic news is one way and that's southwards and, alarmingly,
expanding to well within core Europe. The easier way to look at it is to
follow those who have not been downgraded - a much fewer number.
Prospective bond yields of the PIIGS - well think of a number (and
probably double it), if this continues. Interestingly, Belgium having
been deadlocked politically for over 1 year, suddenly produced a budget
once they were downgraded - pure coincidence - I think not.
Indeed, they may even form a Government - poor Belgium's - they were
over the moon when free from politicians, as my Belgium friend Renaat
tells me.
Furthermore and amusingly Germany, Holland and Finland have called for
greater IMF involvement - lost faith in the EU - thought so.
Personally, I remain of the view that the IMF has to be involved - Euro
Zone institutions are not credible - one of the most serious market
negatives around. The IMF has hinted at short term financing schemes,
based on lending a multiple of recipients original capital subscriptions
- likely to be implemented. Will provide some breathing space.
The myth (until recently) was that Germany was immune from the financial
turmoil. Germany (and much more importantly, the markets) are beginning
to understand that that is not the case. Indeed, the market smells blood
and we all know what happens next. For example, a further rise in Bund
yields (if, for example, investors believe that the threat to Germany
from a disorderly break up of the Euro Zone and/or the likelihood that
Germany will have to take on additional financial burdens, with the
consequential severe adverse financial implications - which, in my
opinion, is obviously the case) will place additional pressure on the
country and on bund yields.
Lets, for the sake of an example, consider a German bank - D Bank.
It's sitting on a lot of Sovereign debt, most of which underwater, with
the exception of German Bunds, UK Gilts and US Treasuries (and is highly
leveraged and, in addition, knows that regulators are going to impose
rules which will force it to raise capital shortly). OK, they will
reduce their foreign exposure and repatriate funds, fiddle risk weighted
assets etc, etc - happening at present. Indeed, most analysts believe
that Euro repatriation is one of the major reasons why the Euro has not
tanked even more. By the way, reduced/a cut back in lending is very bad
news for (capital hungry) EM's - the FT reported that European banks
accounted for 21% of Asian/S E Asian loans. Basically, it means that EM
interest rates in Asia/S E Asia will rise. US and Japanese banks may
fill in part of the gap, but they will demand higher rates and lend only
to the biggest companies, as will local banks.
However, lets return to D Bank and their holdings of Sovereign bonds
- ignoring D Bank's holding of UK Gilts/US Treasuries for the purpose
of this exercise. The European Banking Authority ("EBA"), I understand,
has expressed a view, that unrealised gains on banks bond portfolios
cannot be recognised (possibly will be changed to partial
recognition) in assessing, in effect, capital adequacy, though losses
must be fully accounted for. However, the EBA are using 30th Sept prices
for the relevant banks bond portfolios ie before the recent turmoil -
will they ever stop trying to fiddle the books.
These rules are still to be finalised, but banks have to achieve a core
Tier 1 capital ratio of 9.0% by June 2012, I believe. Well, I, for one,
would not be surprised if Bank D realises its gains, by selling its
Bunds, thereby improving its ratios. Investors are increasingly
concerned as to the state of the entire Euro Zone, including Germany,
and German bund yields are not generous.
Furthermore, the Euro is weakening. If Bund yields rise further, so will
investor concern, resulting in, guess what, more selling of Bunds. The
question is who are the buyers - any volunteers?
Ignoring the Sovereign debt financing requirements, European banks have
and will have problems arranging medium term debt financing. As a
result, I am certain that the ECB will provide medium term (2 year
certainly and there has even been talk of 3 year) facilities - no great
surprise - well leaked. However, for once, would it not be better for
the ECB/EU/ECB to operate via formal press announcements, rather than
the nudge, nudge, wink, wink policy they currently maintain.
Whoops. The above is far too far fetched you say. Well, over 1 year ago,
people told me that my sceptical views on the fiscal position of Spain,
in particular, and indeed, France were far fetched - case semi proven, I
believe.
Germany's financial position is not wunderbar - sorry, probably buggered
up the spelling. It does have great businesses model, fabulous companies
etc, etc, but the global slowdown will impact its export driven economy,
which represents approximately 50% of its economy. To date, domestic
demand has held up, but the Germans are notorious for pulling back on
spending in times of stress and strain and sure seems like S&S to me
right now. Personally, I will not be surprised if Germany suffers a
technical recession next year. Current
2012 GDP forecasts, which are declining and getting ever closer to zero,
makes such a possibility likely.
Recent comments by Dutch, Finnish and even Austrians, confirm my view
that they are getting mighty nervous. In addition, previous supporters
of Germany are becoming more and more cautious and possibly even
critical of the German position. OK, not a problem if it came from the
Greeks - indeed, quite the reverse - but from the Dutch..........
Germany has been pushed into the headlights, internationally - not
something it is accustomed to. The international community is watching
every move. Sure Germany can ignore criticism (possibly longer than
most), but not for too long. Criticism sticks and if the proverbial pooh
hits the ever faster spinning fan, it will stick even more and on a far
wider group - not a pleasant prospect for German politicians/officials.
A number of my German readers tell me I am wrong. However, reading
between the lines, their main argument is that they (German's) consider
that sticking to their kind of stability/hair shirt policies, even in
tough times, is paramount, whatever the consequences. They clearly know
their German countrymen, far, far better than I - but, whilst clearly
true in the past, I would say maybe not this time around. I remain a
firm believer that, in today's global economy, market forces will
override national policies/dogma, particularly when a country is not as
strong as may have been thought. If I'm wrong, don't bother to read
further, but.........
It's time to speculate.
First Germany needs treaty changes - mainly to convince its population
that it will not pay out endlessly and, in addition, that the lazy, good
for nothing, useless etc, etc, Southern Europeans, in the main (though I
suspect they also view the French with deep suspicion) must be brought
to heel. However, Germans, I believe, understand that the Euro has
benefited them enormously. They have seen, only too recently, what
happened to the Swissy and what the Swiss authorities had to do.
Whilst Germans may yearn for their beloved DM, I think that most
rational German's understand it would be the kiss of death for their
export driven GDP model - the Government certainly does.
Martin Wolf of the FT wrote a fantastic piece on this subject recently
- he set out how Germany has benefited enormously from the Euro and why,
in his (and I totally agree), a return to the DM is impossible, unless
there is a catastrophic collapse of the Euro - even in this case, I
think dreams of the DM are just that - nostalgia.
Germany is beginning to understand that it must act and act fast - hence
the proposals to fast track fiscal measures, as described above.
Whilst German's are becoming more market aware, though they still view
markets as irrational and an Anglo Saxon plot to destroy their
meticulously planned, process driven, ordered state. Numerous stories
abound where Mrs Merkel asks her aides to explain the markets to her -
silence follows !!!!!. In any event, clearly impossible. If any of us
understood markets, we would all be on a beach somewhere doing far more
interesting things. However, she is a scientist (a physicist, I
believe) who really needs to understand and be fully briefed - she
always masters her brief I understand - other politicians should take
note - you will be amazed how much of the time they do not read their
briefs and make policy "on the hoof". How markets work and operate -
that is going to be an interesting brief and personally, I'm glad I'm
not trying to write it. Anyway, good luck Mrs M - having said that I
will probably find out that she will be teaching all of us soon - well I
certainly need to be educated, according to many of you out there.
Assuming, tougher fiscal measures are, indeed, fast tracked, the next
step involves Mrs Merkel trying to become Machiavelli - though
personally, I would stick to Italian blood, rather than E German - they
have far far more experience and practice. Her coalition partners are
convinced that she is just pushing through the (fast track fiscal
measures described above, for example) treaty changes to placate the
public and, in the end will give in, to ECB bond buying/QE/Euro bonds
- they are right to, because, I suspect that's exactly her plan, to be
accomplished sooner rather than later. OK, so my German readers now know
I'm nuts. In addition, what you say, the ECB is independent and indeed,
has proven to be staunchly independent. Come now. Politicians can CHANGE
THE ECB MANDATE - an old trick, but the old ones remain the best. Before
I get numerous emails, I am perfectly aware of Mrs Merkel's recent
comments re non interference with the ECB - convinces me even more of my
view.
A number of commentators point to the German Constitution/Constitutional
Court. A friend of mine sent me a report on this issue - must read it
again, but , if i recall, it suggests some flexibility. However, a
German referendum is certainly a possibility in due course, as are
Parliamentary votes/referendum in other Euro Zone countries. Will the
German's vote in favour of stricter and enforecable fiscal measures -
off course they will. They are unlikely to be told of the subsequent
plan though - maybe this is just unwarranted speculation on my part.
Will other countries, well what other choice have they. Are they
deliverable - ah, well that's the question.
The continued uncertainty will weigh on markets - personally, hands up,
I have been far too early, though I remain of my view that you will have
ECB bond buying/QE by the ECB (probably, post the enactment of the
above fiscal measures) and indeed (I am now of the opinion, even sooner
rather than later thereafter) Euro Bonds. I accept that I'm fast
becoming a minority of 1 (if I'm not there already), but I really cant
see any other way, except for a break up of the Euro Zone and I suspect
that option remains verboten - German is not my strong point as you will
notice - I trust it does not extend to my views of the German
people/policy. However, even Germany wants the Euro Zone to survive.
Finally, the increasingly obvious conclusion that the EFSF is a "dead
duck", is doing the rounds in the Euro Zone - the Dutch Finance Minister
recently stated that if the EFSF was a non starter, other means (read
ECB bond buying/QE) should be considered. I generally follow the Dutch,
who I consider one of the most (only?) sensible countries in the Euro
Zone.
Before I finish off on the Euro Zone, markets on Friday rallied (a
bit) on speculation that banks would not have to take further hits on
their holdings of Sovereign bonds. What nationalise private sector
losses again. Surely Ireland showed exactly why that is clinically
insane - even before one addresses the moral hazard issues involved.
Everyone is focusing on the Euro Zone right now.
However, interesting developments in China, the remaining Bric's and the
US and UK.
I remain bearish (and increasingly so, if that is possible) on China,
even though I suspect that the authorities will loosen monetary policy
- some smaller banks have had their RRR loosened - I would expect that
RRR's for the larger banks will be relaxed as well. Economic data is
trending one way and that's southwards. It is assumed that the Chinese
Communist Party will want a smooth transition to the new regime next
year. However, housing bubbles abound (personally, even the authorities
know it, I believe), social tensions rise (increasing riots), local
authority finances are a complete mess (they rely on property sales,
which have collapsed both in terms of price and volume), talk about
major financial difficulties for all (other than politically connected)
companies, slower exports (certainly to the fast slowing Europe -
China's main trading partner), over reliance on fixed asset investment
for growth, not enough pick up in domestic consumer demand, forecasts
for a zero trade surplus, some say a deficit, within 2 years, bust
banks, etc, etc. The list is endless and I have bored you with it for a
very long time. However, the situation is deteriorating, in my humble
opinion.
However, the key issue once again - capital flight from China is ever
increasing and at a much faster rate - generally, pretty good evidence
of serious prospective problems. I'm fast coming to the view that the
Yuan may actually be overvalued.
Russia, well Putin is acknowledged by boos nowadays - the deal with
Medvedev (where they switch jobs) is not popular. It's all because of
plots by foreigners Putin says - come on, not that old line. Whilst
Putin is expected to win the forthcoming Presidential elections in 2012,
polls suggest his majority and that of his party, will be reduced
significantly. Oil has to remain at near US$100 to support the bribes
(oops sorry - the forward thinking socially beneficial, brilliantly
executed...........someone might be reading this, poor person). Evidence
of capital flight (increasing) is even acknowledged by the authorities.
India, well I'm here at present and my well informed friends are nervous
- when they get nervous, watch out. One issue, India, like China, is not
allowing utilities to pass on much higher coal prices in electricity
prices - to help control inflation. The problem is that the utilities
are reducing production - there have been even more power cuts than
normal. The new plan is to stop coal suppliers from raising prices -
yeah, we all know what happens next. The Indian Rupee
- well, its performing badly - is it the worst performing in the region
- I must check. On the political front, India cancelled a scheduled
meeting with China on discussions involving border disputes
- the Dalai Lama is cited as the reason - however, not good news.
Brazil. Andy Lees of UBS reports that bad loans re Brazilian banks are
rising fast - well what a surprise, when credit card debt costs 250%+
per annum and people buy on credit - indeed, they are encouraged to -
retailers make more money on the financing, rather than the profit on
the sale of the particular item. Recent policy confirms that the
Government is deeply worried. Personally, I believe the current
situation is a hangover from Lula's expansionist policies. Anyway, a
very good friend of mine like the statistic's in Brazil, though his
stats lie on Copacabana beach - I would also be impressed. (By the way,
is this the time to remind you that Santander has a major banking
operation in Brazil. Another issue, Santander, recently put the squeeze
on some of their debt holders - generally considered a no no as you wont
have buyers of your debt the next time round. Could it be that they need
capital - off course it is).
The bottom line is, once again, EM's are NOT DECOUPLED. Thanks Mr
O'Neill, but no thanks.
On the other hand, US data continues to be positive - yeah, I know GDP
was revised lower, but inventories were a main reason - suggests to me
that it will correct in future months. On the downside, the ending of
accelerated tax allowances, Bush tax cuts and possibly even payroll
taxes, will act as a drag next year. However, the biggest issue is the
political logjam - if it was not for the Euro Zone news, it would be
headline news I guess.
The UK, well, I'm sorry to say that the economic data continues to
weaken - a 2012 recession is a near certainty.
The Middle East is being ignored - dangerous. My friend Robert Hardy
produced, amongst other articles, yet another excellent report on
Syria/Iran in his GEOSTRAT publication - GEOSTRAT IS a must, must, must
read.
Gosh, I need a stiff drink after the above - I suspect you do to.
Best
Kiron
|