Interesting fall-out from the dogfight among Britain's Conservatives

The British conservative party is tearing itself apart over the EU referendum in June. The internecine fighting has reached new highs over the recent days and some quite interesting bits of information are contained in the intense exchanges.

Work and Pensions Secretary Iain Duncan Smith resigned last Friday over a particular line item contained in the budget just presented by Chancellor George Osborne, some cuts in spending for handicapped.

Duncan Smith is also known as a passionate proponent of Britain's exit from the EU, the Brexit, and obviously he is free to campaign for his views from outside the cabinet. The British press has over the weekend been full of all kinds of guesswork about his reasons to resign.

The most interesting in this exchange is in fact Duncan Smith's resignation letter, which contained the following statement:

"I am unable to watch passively while certain policies are enacted in order to meet the fiscal self imposed restraints that I believe are more and more perceived as distinctly political rather than in the national economic interest".

Please read this again. One of the uncompromising conservative politicians in the UK states that the economic policies are subject to "fiscal self-imposed restraints".

He is talking about the balance budget target zealously pursued by Osborne in close cooperation with Prime Minister Cameron.

In a few words Duncan Smith revealed what has been clear to economists for a long time: Pursuing a balanced budget at all times is simply a question of ideology rather than the "national economic interest".

In the days after the presentation of the budget, there was a discussion about what would happen if the optimistic growth projections behind the budget did not materialise.

Osbornes view was that it would then be hard to balance the budget, unless further public sector cutbacks were introduced.

So there it is: The British economic policy is driven by the same ideology as the fiscal policy in Germany - and which Germany does everything to stamp upon the rest of the Eurozone.

So at least it has become clear that there are no real economic arguments for the wish to leave the EU.

Former PM Sir John Major is trying to make the opposite point: that there are significant economic reasons for Britain to stay. Britain can not expect that EU should be rushing to give Britain a privileged status, as Britain needs the EU more than the EU needs Britain. Major is afraid the Britain will find herself “sleepwalking into antagonisms it cannot repair”.

I notice use of the word "sleepwalking". Major basically tells his party to wake up and try understand what is at stake.

I am afraid that given the intensity and the personal focus of the exchanges inside the conservative party, his words are likely not to be heard. A good personal jibe is easier to sell to the press than a long historic argument about the role of the EU.

Fed: everything normal, so go back to work

Writing about Federal Reserve's monetary policy is rarely exciting, same goes for reading comments about it.

I am sorely tempted to share my opinions about the Republican primaries instead. But since the situation on that front develops every day, I better hold back until things get more stable. There is one connection though.

The Republican party has since Obama's election set new standards in obstruction of the legislative process. It has had some bizarre side effects, such as "Government Shutdown" on a number of occasions.

The legislative gridlock has had one positive effect: any tendency on either side of the political spectrum to introduce "austerity" has been mostly curbed. The effect has been that the US as almost the only country has seen the public sector deficit develop according to the textbooks. As the crisis hit, government finances went deeply into red, providing stimulus to the economy. This stimulus has automatically been reduced as the economy recovered. No German-style destabilising "stability policy" here.

It does not mean that all is good, nor that I find political gridlock as a way to obtain an economic-political target is an idea to imitate.

Together with the timely (albeit rather distasteful) help to the banks, it does mean that the US today is in a better place than most of the other larger economies in the Western world. There has been a long period of economic growth, jobs that disappeared during the crisis are roughly re-created. Growth has been more subdued than seen in the years until 2007, but there has also been a significant improvement of the debt situation of the households, meaning that their savings have increased. That leads to slower growth in the short term.

Of course there are still a multitude of problems stemming from the fact that decisions on the fiscal policy are simply not taken. Still, the US economy is in a better state than the European economies.

Hence it is no surprise that Fed in general are upbeat: the US growth has survived a visible strengthening of the dollar and a slowdown in China. So there is only one way of interpreting Feds inactivity: the Open Market Committee simply finds that they are on the right path and are waiting for inflation to begin crawling up towards the 2 per cent target. And obviously, Fed finds itself on tract for further interest hikes during the year.

Whether it is 2, 3, or 4 hikes is not that important. Important is what Fed's analysis shows about the US economic growth. FOMC was not in doubt. We are on the right track and further rate hikes will follow as prices begin to crawl upwards.

What the markets should be spooked about is the capacity limit. Inflationary pressures begin to build as a shortage of certain kinds of labour begins to build. Inflation could also begin to increase if US companies hit their production limits. The fact is that nobody knows where the inflationary limits are. We just know that an awful lot of productive capacity has been dismantled after 8 years of crisis.

So no, further interest rate hikes are not taken off the agenda going forwards.

ECB's Bazooka?

This time ECB delivered what the market expected in terms of easing. By some standards ECB even over-delivered by increasing the monthly bond purchases from 60bn € to 80bn € and by increasing the Targeted Long-Term Refinancing Operations or TLTRO for short. The lead interest rate was lowered to 0.4%

After an initial bout of optimism, the stock markets had second thoughts: By delivering that much, has ECB run out of ammunition for the "bazooka". Stock markets reversed sharply. The Euro also reversed parts of its initial loss.

Reactions from the stock market are largely irrelevant in this context, since they are mostly driven by day to day sentiment anyway. I also have some trouble believing the wisdom of stock market traders when it comes to assessing the effects of monetary policy in the medium and long term. I mean, stock market traders do not usually work on that kind of time horizon, right?

ECB's initative certainly created some angry comments, mainly from Germany, where "flooding" the banks with money is seen as a bad thing. For many German observers, the problem lies mainly in the clash between a macroeconomic reality and the deeply ingrained culture of saving among ordinary Germans. Obviously, negative interest rates removes the most important incentive for saving. And that is considered a very bad thing.

Germany has had a fantastic run of economic success. It has been built on strong exports of high quality industrial products. Germany has through its success in engineering been able to be competitive beyond expectations for decades, and even lived through the 55 years after the end of WWII with a steadily appreciating currency because of strong productivity gains.

Apart from strong productivity, this success was made possible by German savers, who provided the means for the investments necessary. In Germany it is still considered a virtue for households to save.

And of course the anger at ECB is because German newspapers and a great many politicians mistake household economics for macroeconomics. There is even a name for this misunderstanding. It is called the "thrift's paradox". If we all save, we will all get poorer.

Europe does not need any more savings. We need consumption and, in particular, investments to pull us out of the quagmire. The problem is that somehow the glut of savings does not translate into finance for consumption or investment.

The problem is that the intermediary, namely the banks, are badly out of order. Too many banks in Europe are still carrying too many dud loans on the balance sheets. So they remain unwilling or unable to boost their balance sheets with new lending.

And that is the rub. The TLTRO offers cheap liquidity to banks, and is targeting banks which have grown their balance recently. But the previous LTRO programmes have not been strong in inceasing bank lending, So I do not see why it should work this time. It seems that it is not the price of central bank money that stops the banks from lending. Instead it is their bad loans.

Since 2008 I have consistently claimed that in order to get out of the crisis we need to fix the banks and to increase public spending primarily on long-term infrastructure projects.

Markets fear that ECB is running out of ammo. Markets may be right. Markets, however, forget that it is not the responsibility of central banks to push the economy. Politicians must create  fiscal policies that will resolve this crisis. And the Germans have long time ago won a complete victory in pressurising other EU countries to not do what is needed. ECB is put in an uncomfortable position because of a wrong fiscal policy.

When it comes to fixing the banks, this is not the time to be moralists. The Euro-TARP is still needed after 8 years of crisis.

Think about this one: what happens to  banks all over Europe as long as they are afraid of charging clients negative interest rates? Well, they lose money on simple deposits. Certainly, it does not provide an incentive to lend.

Follow-up on Italian banks

In a letter to Financial Times on 23 February, the Director-General of the Italian Treasury provides some info directly related to my previous post.

Vinzenco la Via writes that:

"Between the beginning of 2015 and the beginning of 2016, the Italian government introduced radical changes in the banking sector (...) The new system will exploit economies of scale, allow better use and allocation of skills, and permit better market access, while improving the management of non-performing loans.

Vinzenco, I love what you write.

My only question is: Why did it take you so long??? Where were you between 2008 and 2015?

I know. You were fighting the deeply entrenched interests in the financial sector which had put personal interests ahead of the common good. And various governments had been unwilling or unable to make a serious push to force the banks in this direction.

Has anybody got the guts to make an analysis of the costs to the society of not acting with far more resolve? I'm just asking..

Now I am curious about what happens in the French banking sector. Not to mention in what remains of the partially reformed savings bank sector in Spain.

Euro-Tarp? Maybe... look at Italy

In the dying days of the Bush administration, then Secretary of the Treasury Hank Paulson introduced a US 1tn program called  the Troubled Asset Relief Program, or TARP for short. Translated into plain words, it was an offer to the banks that the Federal Government would buy the worst stinking pieces of bad loans the banks carried on their balances. And it was clear that not too many questions would be asked.

It was a variation of one of the elements in the famous rescue of the Nordic banking sector in the 1990's. At that time, banks signed up to be rescued, the insolvent ones were taken over by the Finance Ministries, who then combed through the bank balances, hunting for the worst stinking pieces of bad loans. The bad loans were then folded into a company which was floated on the market with a time limited loss guarantee from the government.

In the Nordics, shareholders lost their investments and boards and management lost their jobs. In the US the management largely kept their jobs while the shareholders saw their holdings diluted severely.

However, in both cases, the action contributed to "clean out" the bank balances, meaning that the banks relatively quickly could get back to the core business of a bank: to receive deposits and lend money.

Not so in Europe. 8 years after the onset of the crisis, and two "asset quality reviews" later we are stuck in a situation large European banks are sitting with unrealised losses, which - if they were realised - would lead to the demise of the banks in question. I - and several others with me - have a sneaking suspicion that this state of things holds back European bank lending in a significant way.

Last week, the ECB gave a startling confirmation of the gravity of the situation.

Since 2015, the ECB has tried its own version of quantitative easing or QE. This of course refers to the programs whereby central banks in the US, UK, Japan and Canada have purchased enormous amounts of their own government bonds in the market. Some covered bonds, such as mortgage backed bonds have also been purchased. All in the purpose of forcing down interest rates, particularly in the longer maturities.

ECB faces a particular problem in implementing a QE, since its statutes prevents it from financing the individual governments by buying their government bonds. A compromise was found, whereby government bonds were eligible if bought in proportion with the shareholdings in ECB of the individual countries.

It would of course mean that ECB was forced to buy mostly German Bunds - even if it is a relatively small bond market. There are tons of e.g. Italian bonds on the market, but ECB cannot buy that many of those. Then there is some agency debt out there, but having to buy 60bn EUR worth of bonds each month seems to be a problem.

So ECB has had a brainwave: Let us buy some of the worst stinking pieces of bad loans the banks have been carrying on their balances. In casu the Italian banks, who suddenly admit to have a small sum of 225 bn EUR of bad debts they would really, really like somebody else to buy from them.

Which is possible for ECB if the Italian government is guaranteeing the debt. Once that obstacle is cleared away, we can start guessing which other banks are sitting on a mountain of bad debts.

In other words, the ECB QE program is now morphing into a Euro-Tarp. I am sure that the Germans are shaking their heads or even worse. I do not really care. The TARP program gave the US banks a headstart to recover even if bank regulators had to hold their noses while buying the bad debt.

Here in Europe we have had a very peculiar attitude. We want to punish the banks for doing a dirty on us all, so we want them to recover without any help. But we do not want to punish them so badly that the boards and bank managements were actually kicked out. So the "Swedish solution" was also excluded.

The result has been that it has taken waaay too long time for credit growth to return to Europe. It has held back consumption and investment. When we will be writing the story of the financial crisis in Europe, the lack of dealing properly with the banks will stand out as a monumental error.

So monumental that it will almost be on a par with the German insistence on draconian savings programs to curb government debt creation in an environment of weak consumer demands.

Cameron's nightmare - and EU's

So the UK got a watered-down set of modifications to the various EU agreements, delivered with sufficient gravitas that Cameron could declare victory and go home and call the promised referendum to take place on 23 June.

Anybody just vaguely familiar with EU's workings knew already that nothing substantial could be negotiated in a few months. Substantial changes require changes to the treaties, and with 28 member states it will take at least 5 years to change as much as a comma.

But now the referendum has been called - with potential disastrous consequences for EU, Europe and not the least, for the EU.

EU created peace
It is worthwhile to remember the historical roots of the EU. Since Germany created itself as a national state under the stewardship of Bismarck, the country always had the uncomfortable geopolitical situation of having strong and often bellicose neighbours to the east and to the west: Russia and France. Bismarck saw this clearly and built a national strategy on the necessity to be able to fight a two-front war. This national strategy touched upon education, infrastructure, industrial production and defense. The strategy required speed, mobility and technological and tactical advantages. It is probably not wrong to claim that Germany's situation today is a direct consequence of the geopolitical situation and of Bismarck's response.

After Germany had tried to "solve" the geopolitical dilemma twice, each time ending in defeat, the US influence over Europe led to a major geopolitical change. By putting Germany under the US nuclear umbrella and by uniting Germany and her erstwhile enemy France in a close political and economic cooperation, Germany could finally forget the need to fight two enemies at once. The existence of the EU changed important geopolitical parameters.

EU is in other words the political and economic "leg" of the post-WWII re-organisation of the European map. Together with NATO, EU has been spectacularly effective. So much so that people today forget how efficient the combo has been in preventing war in Europe. The 70 years of peace in Europe since 1945 has been one of the longest and most prosperous periods in the continent's war-torn history.

The Britons have always had an ambivalent relationship to EU: why participate in the club of losers (of WWII) when we were one of the victors? For centuries Britain managed to survive nicely by playing the other European nations against each other and profiting from her naval superiority.

And now?

Fast forward to today. Many brits appear to have forgotten entirely that they do not any longer dominate the seas. They do not any longer have colonies. And more seriously: The Americans do not any longer consider the "Special Relationship" between USA and Great Britain as particularly special. President Obama even told the Brits directly that Great Britain would be more useful to the USA inside the EU than out.

Europe has also lost in importance on a global scale. The larger powers do not any longer focus on the Europe. Instead it is China's growth, Russia's possible reemergence as a major player and the continued global dogfight over access to oil and minerals that dominate. Britain may have been good at manipulating the other European nations into wars for 400 years. That ability is just much less marketable today.

Zbigniew Brzezinsky, a former national security adviser to US president Carter put it brutally: Great Britain is not a geostrategic player… Its ambivalence regarding European unification and its waning special relationship with America have made Great Britain increasingly irrelevant (The Grand Chessboard: American Primacy and Its Geostrategic Imperatives (1998)).

A tactical error
In 2013 Prime minister Cameron feared a major incursion on traditional Tory ground by the UK Independence Party. In order to placate the notoriously loud Euro-sceptical wing of his party and in order to convince euro-sceptical voters of his own credentials in this department, he promised a referendum on "in or out", in case he was re-elected as PM.

At that time, not much looked as if it would ever happen. The Tories were lagging Labour in the opinion polls, UKIP seemed to be a threat, and the Lib Dems still had some credibility and were not at all foreign to threaten Cameron to switch sides if needed.

And then things began to pear-shaped. First there was the 2014 Scottish referendum on independence. Scotland was deeper divided than expected and the outcome too close for comfort (55% voted to stay in the UK, 45% against). The next act was the 2015 general elections. The Conservatives had nearly no representation north of the border. So Scottish voters who wanted to vent their frustration hit Labour hard. The party was viped out in Scotland and that alone was enough that an expected national majority evaporated. UKIP did worse than expected because of a very weak party organisation, and the Lib Dems were hit badly by the law saying that the junior partner in a coalition partner most often suffer badly at the next elections (ask FDP in Germany).

Suddenly Cameron had a majority in Parliament - and had given a promise to the right wing of his party to make a decisive referendum after a round of negotiations with the EU. He had solidly painted himself into a corner with no way out. Except of course by resigning, which is not on the cards for now.

Refugees
The European refugee crisis has changed the dynamics in Europe as well as in the UK. By many voters not steeped in history, "migrants" of any colour and shape are seen as the result of Europe's open borders and flagrant disrespect for national values. Europe has certainly not handled the refugee crisis in a reassuring way, and it has given wind in the sails to illiberal nationalist parties across the continent.

Also in the UK, this particular political mood has gained strongly despite the weakness of UKIP. It is visible in the fact that Cameron's negotiation strategy has been to gain concessions on "migrants" even if the people in question are far from being refugees. Most often they are quite skilled labourers who quickly find jobs, particularly in the UK construction sector.

So the refugee crisis has in Cameron's strategy morphed into a general "bash the migrants" policy - which obviously annoys the eastern European EU members.

How bad could it end?
We may be heading towards one of those rare moments in history where one man's actions actually matter.  Cameron's wrong reading of the situation inside his own party in 2013 could now lead to the following scenario:

Were UK to leave the EU, Cameron will be toast having campaigned for UK to remain in the EU and will have to resign. His own party, the Conservatives, will suffer a deep division that will take decades to heal.

Both the EU and the UK ends up weaker and destabilised.

Egged on by national conservative movements, more countries will ask for substantial opt-outs, in particular in the fields of EU law and integration. Scotland will request independence from the UK as the Scots are firmly in favour of a continued EU membership.

The EU may end up being split and the UK may be torn apart. That could be the parting shot for independence movements elsewhere, in Catalonia, in Belgium and who knows, in Wales?

Cameron may still go down in history as the man who made the worst tactical gamble possible and refused to see the implications of it until it was too late.

And over in Moscow, Putin and his inner circle will be all smiles.

Same old, same old

Famously, the rapper Eminem declared "I'm back" on one of his albums and reviewers noted with some surprise: Has he been gone at all?

I have not been away, I have been working my blog under the name "Connecting the dots" and it is likely to reappear soon under that name soon. But until that is in place, I will publish my opinions here.

When I review what I wrote in 2012, it is surprising to see how little has changed:

QE is still in place, except that ECB has now replaced FED as the driver. Economic growth is still way weaker than politicians hope, and the reasons are the same: consumers are still saving too much and the European banks still carry too many bad loans on the balance in order for them to lend freely.

Japan remains an unmitigated disaster. Seen from the helicopter it is incredible that anybody is still surprised to see that a country with a rapidly shrinking population is experiencing negative growth.

The German establishment is still fighting against a reasonable European monetary policy, based on a mixture of angst and a rigid belief that rest of Europe must become like Germany in order for healthy economic growth to return to the continent.

Egged on by the Tea Party, US Republicans have taken further steps away from economic sanity - one would have sworn that it was impossible. The only good thing is that the political paralysis has created a situation where the economy has been able to recover healthily, undisturbed by ideological incursions.

A couple of things are new, though. Some countries have negative interest rates, Denmark, Sweden, Germany, Switzerland. Oil has fallen to comfortable levels. Russia is trying to reestablish Soviet era glory on the backdrop of an impending economic disaster.

And then over to a subject as relevant today as in 2012: The European monetary policy and in particularly the impact of the debt crisis on certain South European countries. Italy is of course the 800 pound gorilla in the room with a government debt in excess of 130 per cent of GDP and more than 2,000 bn EUR.

Add that Italian banks still drag a ton of bad debts along. 8 years after the onset of the financial crisis, many banks in Europe's south (broadly defined) have still not managed to write off the bad loans and move on.

Italy, German wise men and haircuts

I found this article and it is interesting reading. Apparently the German Council of Economic Advisors now recommend that before the institutions of the Eurozone will help a country with a bail-out, the holders of the country's debt will have to take a "haircut", i.e. a programmed loss of a certain percentage of the bonds. Rumours are that Finance Minister Schäuble is backing the proposal.

This breaks with a tradition that has survived even the Greek debt crisis: Eurozone countries holding debt of another Eurozone country will not suffer losses on that debt. Private debt holders, however, can lose money, as they did in the case of Greece.

By now gingerly suggesting that other countries must suffer a loss before help can be granted to a country in need, Germany will make sure that they will not be the only ones to insist on budget discipline. They simply obtain that everybody else will also stand to lose money. The effect is of course to avoid that Germany is the only villain to insist on budgetary discipline.

If the proposal is accepted by the other Eurozone countries, Germany will not be alone in resisting "frivolous" proposals from left-wing or populistic new governments in e.g. Portugal, Spain or, oh horror, Italy.

The Germans are understandably tired of being portrayed as latter day nazis imposing iron discipline on freedom-loving countries with young and dynamic governments, as it happened in Greece. The German proposal would remove the focus from Germany as the sole source of budgetary rectitude. Everybody else would have an incentive to put pressure on countries who habour pipe dreams of breaking with austerity demanded by the Eurozone.

It is intelligent, at least seen from a German point of view. To me it again looks as if Germany in its rigid adherence to the belief that every Eurozone country should become a mini-Germany continues to impose rules that simply imposes more instability in the name of stability.

The proposal will give other governments an incentive to put pressure on "irresponsible" governments. It will also give all investors a motive to sell government debt in the affected countries as soon as the word "bail-out" is mentioned.

Ideology continues to stand in the way of ending the economic crisis. Ideology prevents an economic policy that will support economic growth in Europe. Wonder if anybody has calculated the price Europe has paid as a result of a sluggish recovery over the past years.
  

Bank downgrade - yawn. Europe downhill. Spain

Banks downgrade
Moody’s has been doing a hatchet job on banks across Europe recently and yesterday saw Moody’s downgrade 15 large international banks. For some reason it came as a shock to many. I do not really get the point. The markets have known for years that something was wrong in the banking sector. The banks are forced to increase their capital base, reducing their profitability. Households are deleveraging, reducing income for the banks. So why is it a surprise that banks are a worse business now than before? The chart below compares global banks (blue line) to global equities (red line). Banks have underperformed the market badly – the market participants have been voting with their feet for years.

Europe
The “Flash” PMI for the Eurozone and for some of the larger countries were released yesterday. It was very bad reading, as the European contraction continues. The German index showed an accelerating contraction. German export orders continue to fall rapidly. The only question one can ask is how long it is allowed to continue. I wrote on Thursday that domestic and international pressure on Merkel to change her economic policies were mounting. Yesterday’s data release just confirms that economic policies in Europe must change and the sooner the better. IMF Chief Lagarde seized the opportunity to tell the German government that joint debt would be a very useful element in solving the crisis. I remain optimist that they will. Germany will find it in her own interest to adjust. The only question is when.


For a comparison, look at Industrial Production in USA (red line) and in the Euro-zone (blue line). Europe’s output has been falling whereas the US output has been increasing. The difference? The degree of austerity.

Spain
Two international consultancies had been asked to conduct an independent review of the capital injection needed to salvage the Spanish banks. They ended up with a maximum of 62bn EUR. Just some months ago the Spanish government believed that 25bn would be enough. Or at least that is what they said. Two weeks ago the same government asked for 100bn in help from the Euro-zone.


I think the 62bn is good news, on the condition that the two consultancies have built in enough buffers in to compensate for the continued recession in Spain that will increase the credit losses. At this moment it is not important if the necessary capital is 62bn or 100bn. We just need to get to a point where the markets finally begin to believe that the number is final. 

Finally, a move to rescue banks

Spain asked for a bailout from the EU and the other EU countries appear to have accepted it. It is not a general bailout as known from Greece, Portugal and Ireland, but limited to assistance in recapitalising the ailing savings banks. Apart from my firmly held conviction that the method chosen is the most expensive for everybody, it was positive that something happened.  Even if the details will take some weeks to hammer out, I think it is important to understand that this step is more momentous than the three previous bailouts. Finally the EU is moving to resolve the situation with Europe’s sick banks.

Importantly, the oversight with the package appears not to go to EU and IMF, but only to the EU and it is not a general control of the country’s spending, but only a control of the banking sector. It may be an important pointer that we are moving towards a “banking union” with a joint euro-zone banking regulator.

It ought also by now be clear that the crisis is not only about public sector debt. The four countries that had seen the strongest increase in private sector debt in 2000/2007 are also those where the banking sector is in deepest problems. UK, Spain, Ireland are involved in major rescue actions for their banking sector and the economies are suffering from protracted recessions or zero growth.

The fourth, Denmark, has escaped a deeper economic crisis because of a very efficient mortgage financing system, and relatively healthy public finances. But the economic growth is anaemic, the banking sector is still in deep trouble, and more than a quarter of the country’s banks have closed. The largest bank, Danske Bank, only survived through generous government loans.

Greece is in deep trouble because of public over spending to the tune of 15 per cent of GDP. Portugal needed its bailout because of a sclerotic economy and its government is fighting to rush economic reforms which should have been implemented 10/15 years ago.

So the lesson is that 1) bailouts are different from case to case, 2) it is good that EU is finally getting some focus on the banks and 3) private sector indebtedness is at least as important in the current economic crisis as the public sector debt. 

Portugal obtained EU’s accept to spend some 6.6 bn EUR out of its emergency facility to recapitalise the country’s four largest banks. Good news for two reasons: another banking rescue as in Spain, and it appears that the costs can be covered without increasing the emergency facility. It is a sign that Portugal’s economy is moving the right way. 

I still do not exclude that the best solution would be to keep the emergency facility in place until 2014 instead of 2013. We will see.

The German opposition may have some luck flexing its muscle (it controls the Bundesrat and could delay all legislation) and appears to have forced Chancellor Merkel to accept some kind of growth initiative for Germany. That is absolutely fine, it is completely in line with the fact that general elections will take place next year, but it is not enough. We still need more pressure on the government to accept something like the "redemption fund" that would change investors' perceptions of European government debt.

Five steps to European Happiness

Well, not quite. But the events in Spain, Portugal, and Germany are small steps in the right direction. All of them fall within the five requirements I listed back in December 2011. Here is the link to my blog post from back then.

Bank rescue. Chicken

Bank rescue
Today is the day where the EU should present its blueprint for salvaging the EU banks. In principle it is simple. We need an EU banking regulator, a deposit guarantee, and a big bag of money. But then the problems begin. Which authority should be given to the EU banking regulator? Who should be covered by the guarantee? And who is to pay? Enough open questions to ensure that it will take quite a while to make the scheme work.


There is one big issue that deserves some attention. EU has had as a principle to “protect smaller shareholders” who are supposedly “innocent” as regards the banks’ reckless lending practices. This principle stands in the way of something very important, the ability of the state/regulator/government to take full control over an insolvent bank.


Only by taking full control it becomes obvious to start the necessary process: to sell the non-performing assets, while the now government-owned banks can continue the activities that are absolutely indispensable in the society, namely payments and lending. 


It would then become possible to obtain an honest estimate of the losses. Eventually, it will lead to much smaller costs for the tax payers.


The key is of course that it is possible to temporarily suspend normal reserve requirements, because there is a deposit guarantee in place. As long as such a guarantee is in place, a nationalised bank can in principle operate without a capital base. 


It obviously requires that all shareholders must be wiped out. On this point I am more adamant that the EU Commission. It is normal capitalist logic that one can lose money through bad investments. There are no “innocent” investors. Protecting small investors should not stand in the way of providing a much larger public good: a restored and restructured banking sector.


Chicken
The venerable game of Chicken is played in a variety of ways. One is when two young men on motorbikes race towards each other on the white line. He who first veers away from the line is Chicken. If both stay the course, there is no Chicken. Only two dead bikers.


Germany’s Finance Minister Schäuble has given an interview in Handelsblatt. Under the heading “No easy way out for Europe”, Schäuble says “If government debts are made collective, and it leads to lower bond yields in the debtor countries, it would reduce the pressure to solve the problems”. Written in black on white: Germany resists an EU solution because it would remove the pressure on the debtor countries.


Apart from the fact that Mr S forgets that Spain’s government debt is lower than that of Germany, he says in plain words that Germany is playing Chicken with the rest of Europe.


Could that end up as badly as Motorbike Chicken? I am not alone in fearing just that. Germany’s former Foreign Minister Joschka Fischer has written an analysis of the European problem. He ends it with the following warning: “Germany destroyed itself – and the European order – twice in the twentieth century... It would be both tragic and ironic if a restored Germany, by peaceful means and with the best of intentions, brought about the ruin of the European order a third time.”


It cannot be stated any clearer than this.

Whoops! Helicopter. Euro.

Whoops!

The drama of the Spanish banking sector is getting worse. The government has asked the (savings) bank sector to increase loss provisions from 54 bn EUR to 166 bn EUR to cover potential losses on loans to construction companies and developers: It would not be that bad, if it also covered potential losses from loans given to property buyers. Some estimate that making reasonable provisions for such loans would mean that the banks would have to make provisions of 270 bn EUR. That would effectively kill the sector.

Spain is rapidly approaching an Irish situation, with one important difference: the Spanish government has not been silly enough to guarantee anything. The problem is quickly beginning to look like a situation where it will be impossible for the government to bail out the banks by injecting capital. I am afraid that at some point in time it will be impossible for the government not to explore the “Swedish model”, of nationalisation without any compensation to shareholders, flotation of huge chunks of bad loans, and a later re-privatisation of healthy banks.

The good news is that EU is now clear in offering Spain an extension of the time limit to reduce government deficit to below 3% of GDP. In return Spain has to accept an “audit” of the plan to rescue the banking sector. I am not entirely sure that such a plan really exists.

Spain is a living testament to the complete misunderstanding that this crisis is about government debt. It is not it is about total leverage of the economy, public AND private. Spain and Ireland (and Denmark) had healthy government finances but a hugely leveraged private household sector as the crisis began. Healthy government finances proved to be no help.

More Whoops!

JP Morgan-Chase admitted to have lost some loose change, USD 2bn and counting, on their Prop Trade activities, i.e. speculation for the bank’s own books. Of course that old devil, mark-to-market, was to blame (together with poor risk management and failing organisational oversight). If only JPM had been allowed to book the positions at prices that suited the bank better insted of being mercilessly forced to book the positions at market prices, things would not have run out of hand.

To me it sounds as if the arrogance of the pre-2007 period is coming back with a vengeance. As they say in French “Chasser le naturel, il revient au gallop”.

The good news is that such a loss is a major setback for Wall Street’s lobbying activities, aimed at weakening the legislative efforts to curb Prop Trade, the so-called Volcker rule.

Helicopter Ben gets company

Fed Chief Ben Bernanke got the nickname early in his career because he advocated QE programmes to stave off financial crises. Now Citi’s chief economist Willem Buiter joins Ben in the helicopter. Buiter recommends even more radical easing of the monetary policy than seen so far. Buiter is not just any bank economist. He was a highly respected academic economist and a member of Bank of Englands Monetary Policy Council before taking the jump to the big paycheque in Citi. It is just six weeks ago that Buiter claimed that Spain was heading for a debt restructuring. The reason: the government is not strong enough to recapitalise the savings bank system.

Now Buiter sees that the monetary initiatives by the world’s central banks are becoming increasingly ineffective when combined with a banking system in full deleveraging mode. Add the death-by-austerity fiscal policies in Europe. Buiter suggests Central Banks to lend money directly to the private sector, circumventing the banking system.

And some good news

The Euro has been weakening recently (no, it is not really the dollar that has gained, if you measure on a trade-weighted basis), and the usual chorus of anti-EU megaphones have trumpeted that as a sign of the Euro-zone’s imminent collapse.

For those who remember my writings last year in the autumn, I am strongly in favour of a weaker currency. I am even in favour of parity with the USD. It should not happen too quickly and disorderly, though. But for sure it would help on Europe’s economic situation. As long as Europeans still find it cheap to shop in the US, there is something wrong with the terms of trade.

Overstepping the limits. Banks. US economy.

Overstepping limits

German member of ECB’s management Jörg Asmussen gave an interview in Handelsblatt that almost – almost - gave me sympathy for outgoing French President Sarkozy. Sarko once famously hissed at former ECB chief Trichet that as an unelected civil servant, Trichet’s role was not to decide on politics. That should be left to politicians.

Mr Asmussen, who is a career civil servant, clearly oversteps all limits for public statements from the ECB. He lectures Greece – where no government is formed. He lectures incoming French president Hollande. He gives rather precise policy designs – namely that the deadly austerity policy must be continued at any price. His only admission is that the austerity drive may be “complemented” with a growth initative. Mr Asmussen repeats the views of Bundesbank, and acts like a mouthpipe of the most conservative politicians in Germany. This is not the way for a high ranking member of the ECB to gain friends. Such a rant from Asmussen would have served him a stinging rebuke if there had not been a power vacuum in France and Greece.

Spain dodges an important decision

The Spanish government has apparently decided to yet again recapitalise a local savings bank, Bankia, created by merging 7 smaller regional lenders. The top management, including highly respected former central bank chief Rato, has resigned. The problem with giving the banks more money instead of nationalising them is that it does not solve the issue of the bad assets, in this case loans to real estate development. In the USA, the government gave money to the banks (without demanding a management change) and lifted a huge amount of bad debts off their balance sheets.

The bad news is that according to all statistics, Spanish property prices have nowhere fallen enough. More bad loans will arrive.

The Spanish banking crisis will not be solved until the government decides how to handle the bad debt. I still believe there is a simple solution: Package it and sell it in the markets. It may mean that the banks are insolvent. Some of them should then be allowed to fold.

Denmark enforces tougher rules on bad bank loans

The Danish banking sector – which started the banking crisis as one of Europe’s most fragmented – is reeling under new, tougher rules for loan provisions. After three years where dozens of local banks have gone belly up, the Danish regulator’s no nonsense approach is likely to force more bank closings. Prospective loan provisions are likely to exceed all market expectations and may push some more of the weaker banks into insolvency. Last year, tighter practices led to the first senior debt loan losses in Europe and it shut many Danish banks out of the interbank market.

It is ironical that the country which arguably is further ahead in the cleaning up of its bank sector is being punished by the financial markets. It compounds the problems of getting the economy going again. It proves the old adage: it is better to fail conventionally than to excel alone. It is better to pretend the problem of bad loans does not exist than to get it out in the open.

US need more QE??

A number of pundits are trying to change the tone of the economic debate in the US. Some disappointing economic data have created renewed doubts about the future growth. It is interesting to see the difference between perception and reality. The reality is that the US economy is chugging along with virtually all of the economic indicators pointing to continued growth. It is particularly good news that small and medium sized companies are getting more optimistic.

However, the perception is that data are disappointing. You cannot be disappointed if you did not have expectations. And we have seen everybody (and his dog) revising forecasts upwards in the past three months as the US economy recovered from a mini-slowdown in Q3 of last year. Now the growth is stabilising – and we get disappointing news in comparison to the new, more optimistic expectations. Following the time honoured practice of economists and other pundits, it could lead to 2-3 months of disappointment. Even if there really isn’t anything to be disappointed about.

European elections

The elections in Europe largely had the outcomes expected last week. However, it did not come as any great relief to the markets. What was two days ago a potential political uncertainty is now a confirmed political uncertainty. This adds to the uncertainty created by the horrible data indicated by the “Flash PMI” numbers last week. It is interesting that the uncertainty only affects the stock markets and the Euro. All other kinds of risk assets are holding up nicely. It rhymes with our perception that this is a completely normal rotation between the asset classes, driven by a readjustment of growth expectations. It is confirmed by our proprietary risk indicators, which remain low. This is not a repeat performance of the 2011 market collapse.

France

Hollande won the French election and will now have to face the reality. That reality is a country with high unemployment, slow growth, slow productivity growth, and a twin deficit as both government and external balances are in minus. He will not be able to fix any of that with the economic program presented during the election campaign. Rumours are also that he will face a wave of redundancies from large French companies – companies that Sarkozy allegedly leaned upon to make them postpone firings until after the elections. His first foray into the international scene will be a visit to Berlin, where he will be reminded that agreements are there to be respected.

However, the EU commissioner for economic affairs, Olli Rehn, has already indicated that the pact could be interpreted in a more flexible way – which probably means that the budget targets will stand but that the deadline for their implementation. German Finance Minister Schäuble has spoken of Hollande’s need to “save face”.

What the practical outcome will be is still uncertain. My guess is that some kind of growth initiative plus a de facto (even if not official) delay in the deadlines for cutting the budgets.

Greece

The preliminary results of the general elections pointed to a hung parliament, where the parties behind the debt restructuring agreement command exactly half of the seats in the new parliament. A motley crew of parties opposing the agreement form the other half. For the financial markets the issue will be whether this will now lead to an actual default on the reduced government debt. It is too close to call, by my impression is that a weak coalition will be formed between parties in favour of staying inside the EU, and – by extension – to respecting the agreements. It may then survive a few months.

Germany

Local elections in the German state of Schleswig-Holstein gave an important pointer to the mood among Germans voters. Chancellor Merkel’s party experienced a slight loss, The main opposition SPD gained and most of the votes came from the minority partner in the current government, the liberal FDP. Merkel’s coalition is somewhat weakened, but mainly because of the plight of the coalition partner. So far it has no practical implications for her government.

What it means

All of this will probably keep the stock markets on their toes in the short term. There appears to be two main strands of thinking out there, and the market movements can be interpreted as result of the mood prevailing at any given mood. There are those who (still) believe that it is possible to cut one’s way to growth, and those who believe that excessive cutbacks will kill growth.

So far, the latter camp has been right. While nobody contests the necessity to increase budget discipline, it is obvious that Europe’s growth is tanking because of public sector cutbacks. And a lack of funding to small and medium-sized companies. We expect that the stock markets will remain jittery in the days to come and that EUR will continue to weaken. 

A possible change to Europe's austerity

The French presidential elections on Sunday will be followed by elections to the parliament in June. So if all the opinion polls are right, France will have a new president and a new majority within a few weeks.

For Europe this could have a significant effect. Francois Hollande, who appears to become France’s next president has been very clear that he wants changes to the current “Fiscal Compact”, the code name for Europe’s German-inspired austerity programs, by which all Euro-zone member state must have cut their budget deficits to 3 per cent of GDP by 2013.

Data released this week point to a sharp downturn in the economic activity in Southern Europe and in France. Economic activity is also stalling outside the Euro-zone and unfortunately there is no other explanation than government cutbacks. All of this will eventually hit Germany, whose growth is strongly dependent on the growth in the export markets. With the rest of Europe slowing, Germany’s economy is bound to follow.

All over Europe voters are throwing out politicians who have been managing the crisis and are now connected with the austerity programs. The “hard core” of the Fiscal Compact is crumbling. The Dutch government has resigned as the far-right PVV refused to support domestic budget reductions. In Finland, the True Finns party has adopted a similar position.

This creates an interesting situation. Will Hollande cave in, faced with Merkel and Schäuble, and give up on his election rhetorics? Or will Merkel and Schäuble realise that keeping Europe on track will require that France is fully on board and that this can only be obtained by relaxing the economic policy? Most pundits expect the first.

My guess is that Germany will “cave in”.

In practical terms it could imply that the 3% budget targets will be postponed by a year or two. All kinds of EU funds will be used to provide assistance in long term financing to southern Europe. It will reach from Infrastructure funding to long term financing. Portugal and Ireland will probably be able to negotiate a 1-year extension of their bail-out loans.

All of this will happen in the face of determined resistance from the Bundesbank.

Does it sound too good to be true? Well, maybe. But Germany is not controlled by a strict economic philosophy alone. There is a political dimension to it as well, and Chancellor Merkel is a politician with strong instincts.

Having failed to explain to German voters what the packages to Greece, Portugal, and Ireland were all about, Merkel is now facing German voters fed up with “paying for Europe”. Local elections in the coming days will give an important indication of the strength of the dissatisfaction. If the results are a strong showing for the Social Democrats, Merkel will be weakened politically and will need to adopt her policies well in advance of the next national elections to be held in 2013.

The only way of getting out of that situation is to make sure that growth will resume soon. So far Germany’s leading politicians and Bundesbank have acted as if Germany alone was immune to the crisis. That perception has allowed them to treat lack of growth in the other European countries with something akin to disdain.

A combination of a crumbling Eurozone “hard core”, a sharp drop in exports and political resistance from German voters could change Merkel’s mind.

On top of that, remember that for the longer term political prospects in Europe, Germany cannot afford to alienate France. Germany needs Europe as much as Europe needs Germany.

If I am not right in assuming that growth will be back on Europe's political agenda, things could get worse than they are now. I hope I am right.

Hollande. S&P. Spain. US GDP.

Expecting Hollande

The expectation of Francois Hollande winning the French Presidency has triggered some shuffling of feet in Berlin, Frankfurt, and Bruxelles. In Berlin, Chancellor Merkel tries to make sure that Hollande will feel welcome when he arrives for the first of his foreign visits, probably already on the day after the election. On the other hand she is also clear that the Fiscal Pact is not up for renegotiation. However, she subtly changed her language about the necessity of balancing the budget. Now it is needed “over time”.

Francois Hollande on his part said that when he arrives in Berlin, the French people will have given him a clear mandate for renegotiation.

Not particularly surprising, Bundesbank believes that the “fiscal consolidation” should continue. Even if the negative growth makes it increasingly difficult for many countries to actually consolidate.

And perhaps the best news is that the Eurocrats in Bruxelles are discretely pointing out that there is enough legal leeway in the Pact to actually relax it quite a bit. “The pact is not stupid”, as an anonymous source have succinctly put it. Changes must be approved by a majority. Germany holds no veto in this matter.  

Spanish Downgrade

S&P Downgraded Spanish government debt by two notches from A to Bb. Yawn. The press has ignored it. The downgrade happens after everybody has found out there is something wrong in Spain.

Spain takes the bull by the horns

Sorry, could not let that one pass! The Spanish economy minister has announced that the Governent will force a sale of real estate assets from the crisis Cajas. He expects foreign real estate funds to bid for the property. It confirms my impression that Spain are more hands on handling their banking crisis than many other countries. Unfortunately, forcing a firebrand sale of assets will likely leave a colossal hole in the balance sheets of the local savings banks, that the government will then have to fill. It would be better first to nationalise the banks.

US GDP

Stronger than expected labour market data, an increase in Consumer Spending and better data from the US housing market has made most US economists upgrade their expectation for today’s release of US GDP data. They now expect an annualised growth rate of between 2.5 and 3.0 per cent.

Adam Posen, an American member of the Bank of England Monetary Policy Board, has explained why things are better in the US: There is no austerity programs, and companies are not as dependent on banks for financing as in Europe. European small and medium-sized companies depend critically on bank loans they cannot get. No further explanations are necessary.

Austerity backlash on its way

How stupid are the markets?

Faced with a growing unease over the effects of the austerity programmes, German Chancellor Merkel and her spokespersons are making it clear – this lady is not for turning. The message from Berlin is that there is no alternative to the “balanced budget”  fiscal pact, and that “Europe’s Credibility” is identical to the ability of respecting budget discipline.

No, Europe’s credibility (or rather, that of the Euro-zone) depends on the ability to find a cure for the current predicament that does not kill the patient. Continuing with cutbacks in an economy with negative growth is suicidal.

To the best of my knowledge, suicides committed to prove credibility has never led to anything but a passing admiration and a shaking of the head. Too bad, so sad.

Anyway, The Dutch government collapsed on the issue. If Hollande wins the French elections, the “core” of the “Team Austerity” has shrunk to one member, Germany. With upcoming local elections in Germany we will see how strong that core really is.

As for the alternatives, are there really any? Of course, it is just a question of not putting on the ideological sunglasses on. Germany could add to domestic demand. France could unleash an economic revolution by privatising the state-controlled behemoths that increasingly hampers French competitiveness. Spain could (temporarily) nationalise the Cajas and move on, in particular with reforming the dysfunctional labour markets. All of Europe could postpone the insane idea of forcing the banks to deleverage amid the economic crisis. And so on.

British recession

The UK GDP numbers for Q1 have just been released and they showed a second consecutive quarter of negative growth. Construction fells sharply, and there is no growth in the biggest sector. The service sector. Consumers are squeezed by higher oil prices, government cutbacks, slow income growth. Oh, and then there is the problem of having too large debts related to buying property.

All of this is not surprising. A possible cause for concern is that UK exports are not doing any better after a long period of  a weakened currency. Maybe because things are not looking too good in the export markets, either.

Where did the money go?

ECB President Chairman Draghi gave a testimony to the Economic and Monetary Affairs Committee of the European Parliament. Draghi clearly asked the politicians to put growth back on the agenda. And he revealed a concern (which I share): The huge loans granted to the banks are not flowing into the economy in the form of loans to businesses and consumers. Draghi is optimistic that it will happen with time.

The question is: how long time does Draghi expect this will take?

On a lighter note

FT today carries this little story about Italian Banking. Enjoy. Or cry.

Hollande. Europe's growth is slowing.

France

French presidential contender Francois Hollande of the Socialist Party came out with most votes in the first round of the French presidential elections. He will now face incumbent president Sarkozy in the second round in two week’s time. Opinion polls have persistently shown that Holland would win the second round hands down. Assuming that he wins, there will probably also be snap parliament elections.

Markets are now nervous that a new French government will challenge the German-imposed austerity programmes. Hollande has been clear that he wants to renegotiate the basis for the euro-zone “fiscal compact”. I have previously been quite convinced that faced with German determination, Hollande would back down quickly. But it seems that one of the austerity stalwarts, the Netherlands are also beginning to have second thoughts about the austerity programme

Netherlands

Growth has slowed markedly in the Netherlands in the first months of the year. It has now led to the Anti-Immigration party PVV to refuse supporting the EUR 16bn cutbacks, required for the country to meet the demands of the Fiscal Pact. Party Chairman Geert Wilders demand new parliamentary elections, in order “to allow the voters to decide” on the “Brussels diktat”. The open question is whether the other political parties can find an agreement to force through further savings as the economy is slowing.

Spain

Bank of Spain released its quarterly survey this morning and it is not uplifting. Economic growth in Q1 is falling, demand as well as supply is contracting. Employment is falling at a rate of 4% per year. BoE points out that private sector demand is weak and the decline in house prices has accelerated to a rate of more than 7% per year. So far, exports have been a growth driver. That has also stopped, but is more than balanced by a strong fall in imports. Add the significant budget cutbacks. Ugly!

PMI

This morning’s “Flash” PMI for the Eurozone and for Germany were not good news. Essentially, they point to a stronger rate of decline in Europe now at the start of the second quarter. I am certainly uncomfortable with this, as it demonstrates what has been visible in the Euro-zone monetary data, that bank lending is not reflecting a recovery.

I need some time to think this one over. My expectation has been that Germany would do nicely, and that the rest of Europe would be past the maximum downdraft forced by the austerity programmes. With Germany as the motor, I had expected Europe’s recession to end now. I may have been mistaken on two elements: Germany’s growth is still more driven by exports than by domestic demand – which means that the economic activity in the other European countries affect key export sectors. And the austerity programmes in Italy, France, UK, Spain and elsewhere may have more power in pulling down the economies than expected.

If this is the case, we will see Europe – including the UK - tanking under the weight of its own mistakes (the accelerated austerity programmes) while the US will do relatively fine because of the absence of austerity programmes for now.

If France and the Netherlands join Italy in a criticism of Germany regarding the austerity programmes, we are entering a phase of new political dynamics. The austerity programme may come under heavy fire, eagerly helped by the London-based financial press who will find it a brilliant opportunity to counter the increasing German influence on the continent. We may be looking at a renewed round of crisis meetings.

It will only confirm my opinion that the German zero-deficit ideology was destabilising for the economic growth. I will be happy if the rest of Europe comes to its senses and oppose Germany’s wrong designs. I am not sure I will be happy about the way it happens. It could be messy.

Spain. IMF.

Mr Market has got something right

You will not often catch me saying something positive about the large majority of financial market participants. In the past couple of days, I have found several pieces that have left me thinking whether the markets are actually getting something right.

In Spain, all signs point to disaster. The story is well-known by now. A host of weakly banks have fuelled a housing boom. The growth falls, property prices begin to fall, banks end up in deep trouble, and that accelerates the economic downturn. Government finances deteriorate sharply. Add Spain’s notoriously ineffective labour market.

In Berlin, Paris, and Bruxelles, politicians are still shocked that Greece was “forced” into a de facto bankruptcy. The response is that the market “attacks” are best countered by draconian austerity measures.

The markets now appear a good deal more sophisticated than that. Bond markets are not afraid of government deficits as such. Bond markets are afraid of losing money. That leads to the critical point: Markets are not afraid of the Spanish budget deficit, but they rightfully fear that a German-style austerity policy will make things worse and lead to a “death spiral”, which eventually increases the default risk.

So far it appears that this analysis is better than the one made by the European politicians: in order to meet the EU demands to the budget deficit in 2013, the Spanish government introduces policies making it close to impossible to reach the goal.

Suddenly I find myself siding with the bond markets. Weird feeling, indeed.

IMF

Has adjusted its growth forecast for the EU-zone upwards. From -0.5% to -0.3% in 2012. Wow, let’s have a party! This is entirely for public consumption. No economist worth his salt believes that forecasts can be made that precise (and in 98% of the cases they are wrong anyway).

The most important is that IMF strongly pushes the European politicians to make it their “overarching priority” to prevent a renewed escalation of the debt and growth crisis. IMF also tells Europe to get more busy in resolving the problems in the banking sector. IMF identifies two major obstacles to a resumption of normal growth in the Western economies, fiscal consolidation and bank deleveraging. I totally agree.

In the cases of USA, UK, Spain, and Denmark another factor is at play, a heavy increase in household debt related to property investment, all happening while property prices were booming. That complicates the situation in those four countries. In the US there is no political consensus to fight the budget deficit and hence no austerity. In Denmark the government debt is sufficiently low that dramatic action can be postponed. But have a look at UK and Spain.

EBF. Spain. Seasonality

EBF

There is now less than three months until the European banks have to meet EBA’s strict demands for a Tier 1 Capital of 9 per cent. I have repeatedly been highly critical of the decision to force the banks into a rapid deleveraging at a point in time when the European economies are being hit left right and centre by austerity programs. Not surprisingly Christian Clausen, President of the European Banking Federation (EBF) is also highly critical. In his criticism, he adds a couple of points that are worth noting.

His first point is that the new standards are often so weakly formulated that the banks tend to be more careful, rather than aggressive, when implementing the standards. Another point is that in order to meet new demands for net stable funding, the interbank market need to provide funding to the tune of 1.9 tn EUR, which is frankly impossible.

While I agree with some of Clausen’s views, it is worth remembering that the banks themselves created the mess that politicians are now trying to get them out of. Shame that the same politicians managed to make a mess out of the rescue mission.

Spain

I continue to be surprised about the lack of precision in the financial press when it comes to “bailouts”. Reading the most recent batch of comments about Spain’s economic problems, the reader would be excused for believing that Spain faced bankruptcy. It could also seem that the European bailout funds are not sufficiently large as their total volume more or less corresponds to Spain’s government debt. It is nonsense.

Greece got a debt restructuring. It means that a large proportion of the country’s government bonds were declared null and void, and new ones with a lower nominal value were issued instead.

Portugal and Ireland got what is now popularly referred to as a “bailout”. It is a credit line, established for a limited period in time, allowing the countries to cover their financing needs from other EU countries. Such credit facilities allow the countries to bypass the market, and the idea is to reduce the financing costs temporarily while the countries try to get their economic house in order,

Such a credit facility is not related to the overall outstanding debt, but to the financing and refinancing needs for the term of the facility. If it is e.g. a three year period, it is assumed that 10-year bonds will be dealt with on market terms later.  

Spain may opt for such a facility if the short term yields continue to climb. But it has nothing to do with 10-year bond yield climbing past 7 per cent, as the press has had it.

In order for a country’s debt/GDP ratio not to increase, the average yield on the outstanding debt cannot exceed the nominal growth of the GDP. That is exactly the purpose of “bail-out packages”, and explains why the interest paid on the credits are lower than market rates.

Seasonality

The most recent job numbers from the US came out a bit worse than expected after a number of months with better than expected numbers. While being highly interesting from a political point of view, the data are probably simply a result of the milder than normal winter in the US.

Job data are always seasonally corrected, as everybody knows that bad winter weather leads to short term layoffs. When the winter is milder than expected, fewer people are laid off. Seasonal correction mechanisms are based on several years of data and adds some jobs. The result is an overshoot. Unless you are familiar with this mechanism, you will have a tendency to adjust your forecasts upwards.

But around March, the effect of the warm winter disappears out of the statistics as the seasonal correction does not add those extra jobs in the spring. So suddenly your fresh optimistic forecasts collide with the seasonal correction mechanism. And the data disappoint. Interesting to see if we are in for more disappointments.