Category: Geo Politics


The euro

January 17th, 2011 — 9:22am

from Scott Minerd of Guggenheim via ZeroHedge

‘Imagine You’re Irish’

To help explain why I believe a broader financial crisis is coming to Europe, let me start with a quick story. Imagine for a moment that you’re an Irish citizen. Needless to say, you have many concerns about your country’s economic situation. The unemployment rate is 13.7 percent and climbing, your economy continues to contract, your nation’s debt-to-GDP ratio is 97 percent and rising (up from 44 percent just two years ago), your national deficit has ballooned to a whopping 30 percent of GDP, your government is caught in a debt trap, and its borrowing costs have increased 75 percent year-to-date. If expressed in current market rates, the interest payments on your government’s debt obligations could easily account for 7 percent of GDP, or roughly one third of annual tax revenues. To put this into perspective, the situation facing the Irish government is akin to waking up everyday only to realize that one-third of your salary is gone before you even think about paying for the necessities of life.

Fiscally, everything is heading in the wrong direction in Ireland. However bad it may be, the country’s solvency is a secondary concern. If you’re an Irish citizen, the more pressing issue is what you’re going to do about your banking deposits. Your domestic Irish bank posted a 2.4 billion euro net operating loss in 2009 and is projected to nearly double its losses in 2010. The entire domestic Irish banking system has essentially failed, but the government wants you to believe that everything is fine. After all, the International Monetary Fund, the European Central Bank, and the European Union member countries have cobbled together an 85 billion-euro rescue package of which approximately 35 billion euros is set aside for the banking system.

In addition to the bailout, the Irish government has assured you that it will guarantee your deposits, therefore, there’s no need to worry.

Then you get a hold of the Central Bank of Ireland’s most recent Credit, Money, and Banking report (publicly available on the internet). You see that total deposits for Ireland’s dwindling base of domestic credit institutions were roughly 496 billion euros as of October 2010. Some quick math tells you that this is more than three times Ireland’s GDP, and 14 times the scope of the current banking system bailout package. You start to wonder, “If I try to get my money from the bank at the same time everyone else does, where is the government going to get the euros to pay everyone?” You can’t think of an answer. Then you start to feel silly. “Why am I even bothering with all this worry?” you ask yourself. “I’ll just go down to the bank and take my money out now before things get worse. I can give it to a multi-national bank and sleep better at night.”

It seems trite, but this little scenario is essentially what’s happening today. The Irish banking system is literally experiencing a run on its banks. According to the most recent banking update from the Central Bank of Ireland, total deposits in Irish banks declined more than 5 percent (28 billion euros) between August and October alone.

Comment » | Geo Politics, Macro Structure, The Euro

Euro death…

December 14th, 2010 — 4:12pm

In a research paper published today, the Centre for Economics and Business Research (CEBR) claims that keeping “the euro alive will require cuts in living standards greater than the UK faced in the Second World War” for weaker eurozone members.

“There is no modern history of falling living standards in peacetime on the scale necessary to keep the euro in its current form. This is why I think there is at best a one-in-five chance that the euro will survive as it is,” Douglas McWilliams, CEBR chief executive, said.

http://www.telegraph.co.uk/finance/economics/8197655/Euro-has-one-in-five-chance-of-survival-warns-CEBR.html

Comment » | Geo Politics, The Euro

Spain, the next domino.

November 29th, 2010 — 7:59am

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/8166198/Germany-faces-its-awful-choice-as-Spain-wobbles.html

Comment » | General, Geo Politics, The Euro

Circularity, and the futility of the EU bailouts.

November 29th, 2010 — 2:23am

Most EU sovereign debt is held by banks within the eurozone. The weaker states, (Greece, Ireland, Portugal, Spain and Italy) are increasingly unable to service their loans, which they have been doing by borrowing more in the open market when the loans roll over. Some have already ceased to be able to function, i.e. Greece, while Ireland is close. This is causing the banks holding these loans to have to consider the possibility of default. Weakness in the banking system would damage the economies of the eurozone countries, harming tax receipts and impacting the ability of the states to service their debt. Thus the prevention of damage to the banking system is the reason why the EU does not want to permit member states to default. So… they are funding a bail out fund to lend to the weakest countries that can’t borrow on the open market. This merely replaces the damage done by default with damage inflicted by other means.  The burden of this bailout fund is being borne by the healthier states, through increased borrowing and increased taxation. The increased borrowing increases the interest burden, and pushes indebtedness towards levels where the credit worthiness of the healthier borrowers becomes questionable. The increased taxation bears down on economic activity, all of which acts as a brake on economic activity. Damaged economies produce lower tax receipts so the health of the healthier nations deteriorates. The possibility of escape can only come from economic activity accelerating, and yet the policies being implemented are diminuishing the possibility of this occurring.

Thus taking on more debt and forcing the bail outs on the weak, such as has happened with Ireland, will not work. It is merely delaying the inevitable, and demonstrates the politicians’ fundamental failure to comprehend the situation. Added to this is the suspicion in which the politicians are held, since their routine deceit and contempt for their constituents, the sovereign peoples of europe whose interests they are meant to represent, will now fuel the fury they will face when the effects of their policies are felt in people’s real lives.

Comment » | Geo Politics

And, following on from the financial armageddon currently unfolding…

November 23rd, 2010 — 1:12pm

Red Alert:

North Korean Artillery Attack on a Southern Island November 23, 2010 North Korea and South Korea have reportedly traded artillery fire Nov. 23 across the disputed Northern Limit Line (NLL) in the Yellow Sea to the west of the peninsula. Though details are still sketchy and unconfirmed, South Korean news reports indicate that around 2:30 p.m. local time, North Korean artillery shells began landing in the waters around Yongpyeongdo, one of the South Korean-controlled islands just south of the NLL. North Korea has reportedly fired as many as 200 rounds, some of which struck the island, injuring at least 10 South Korean soldiers, damaging buildings, and setting fire to a mountainside. South Korea responded by firing some 80 shells of its own toward North Korea, dispatching F-16 fighter jets to the area, and raising the military alert to its highest level. South Korean President Lee Myung Bak has convened an emergency cabinet meeting, and Seoul is determining whether to evacuate South Koreans working at inter-Korean facilities in North Korea. The barrage from North Korea was continuing at 4 p.m. Military activity appears to be ongoing at this point, and the South Korean Joint Chiefs of Staff are meeting on the issue.

Comment » | Geo Politics

The Euro

November 17th, 2010 — 5:25pm

Ha ha. The recent rally appears to have fizzled, as the imminnent collapse of the Irish banking system threatens to bring down the entire euro project, and hopefully with it the “proto Fascist” EU,  as it was described by Ambrose Evans-Pritchard in a recent post in the London Telegraph. An Irish bailout would increase the pressure on Portugal, Spain and Italy in that order, with the final act potentially including France, as the entire European banking system collapses under the weight of this extreme indebtedness. As Evans-Pritchard writes “Like Alpinistas roped together, an ever-reduced core of solvent states are supposed to carry the weight on an ever-widening group of insolvent states dangling beneath them”.  An apt analogy. And while I’m quoting from another source I would add this, on the decision to discuss the imposition of haircuts and the subsequent backpeddling : “This is a breath-taking mixture of suicidal irresponsibility and farcical incoherence,” – Marco Annunziata from Unicredit.  This whole episode is symptomatic of the incompetence of the politicians and examples such as this are rarely laid so bare by the consequences being made apparent with such immediacy. The normal pattern is for their responsibility for the unintended consequences of their actions to be adeptly concealed with deceit. But I digress.

Further to our post of 1st November discussing the decision to impose haircuts on bond holders and by implication the higher interest rates across the eurozone that logically result from this, an act which by its very nature is inherently deflationary, we can now see that any euro rally that results from the shedding of the PIGS will occur from much lower levels. Hence the current weakness. Effectively, as long as the euro contains the dross of southern Europe it will never mimic the Deutschmark, as it was supposed to and as the Germans would have liked. Indeed their management of it as though it were, it could be argued, has contributed to its woes.

Anyway there is a degree of incomprehensibility to the gyrations caused by the politics. We’ll try in future to stick to technicals.

Comment » | EUR, Geo Politics

Bullish for the euro ?

November 1st, 2010 — 12:05pm

Last Friday’s EU “summit” saw the adoption of a change to the EU Constitution (aka the Lisbon Treaty) which gives the EU the right to impose restructuring on bond holders in the event that any nation comes to rely on the bail out fund. Given the short term expediency of the motive underlying the move, largely attributable to the threat to Merkel from the German Constitutional court in Karlsruhe, the fact that this has other ramifications cannot be considered surprising. Notably, the ECB’s Jean-Claude Trichet warned EU leaders on Thursday night that their actions were dangerous, and that they did not understand what they were unleashing.

He is reported to have pointed out, in quite blunt terms, that what this new scheme ensures is higher interest rates all across the Euro area. The assumptions of bond investors that the ECB would continue to bail out individual countries has finally been shown to have beeen completely unwise, but it was investment decisions based on this assumption that brought interest rates for the PIIGS close to German levels. By presuming no default risk on the part of PIIGS countries, interest rates were driven lower than they ever could have been had that been factored into the thinking of the market participants buying PIIGS debt. There is no rational justification for yields on Greek paper being as close as they were to yields offered by Germany.

The phrasing of the language being used by Axel Weber, head 0f the Bundesbank,  that “bond holders will have to be part of the solution, not part of the problem” can now be taken as a fairly clear indication that PIIGS bondholders will face being defaulted on with no expectation of an ECB bail-out,  and thus the bonds of the southern European economies will be priced accordingly. The relief this will create on the economies of those countries being called on to make the bailouts, i.e. the northern countries, will inevitably lead to a strengthening of the Euro. This will leave the PIIGS with the worst of both worlds; a currency whose exchange rate is far too high for their economies, and the loss of the low interest rate regime that formerly accompanied it. Just to be clear, the days of low interest rates for the PIIGS are gone for good.

There are a couple of points that will arise directly from this outturn of events. Projections made by various economists suggesting Greek debt rising to as high as 150% of GDP have been founded on assumptions of high growth and steady tax revenues. However, the Greek economy is still shrinking and tax revenues are still falling, thus these growth assumptions will prove to be wildly optimistic, and thus debt levels could rise above 200% of GDP within a very short space of time.

This then creates the scenario where purchasers of Greek debt will evaporate. Who will buy Greek debt if Greek debt levels are going to rise this high, especially in the absence of an ECB guarantee of Greek debt ? The measures announced have therefore thrown Greece into a debt trap. Greek debt levels are projected to rise too high for them ever to pay it off. Thus Trichet’s words will prove to be prescient. Effectively, German taxpayer refusal to fund Greece has led to Germany cutting Greece loose from the Euro area. In the absence of an ECB guarantee, Greek debt is now just as toxic for investors as if Greece were not in the Euro area, and therefore Euro membership now holds very few advantages for Greece.

With this unpalatable truth forced on them, the Greeks are now free to leave the euro and it will have no impact on their credit situation. The re-introduction of their own currency at a dramatically lower valuation will do wonders for Greek export prospects. Also, once Greece goes, pressure will mount on the other PIIGS countries as they will be faced by a similar dynamic.

How much of this news has been discounted by the rise from  the 6th June 1.1876 low ? Technically, the market remains in consolidation mode between the 1.3690 area and the recent high around 1.4150, but we continue to anticipate further gains above 1.42

Comment » | EUR, Geo Politics

The US is fucked

October 17th, 2010 — 5:10pm
This is from John Mauldin’s letter. Google him and sign up.

There’s trouble, my friends, and it is does indeed involve pool(s), but not in the pool hall. The real monster is hidden in those pools of subprime debt that have not gone away. When I first began writing and speaking about the coming subprime disaster, it was in late 2007 and early 2008. The subject was being dismissed in most polite circles. “The subprime problem,” testified Ben Bernanke, “will be contained.”

My early take? It would be a disaster for investors. I admit I did not see in January that it would bring down Lehman and trigger the worst banking crisis in 80 years, less than 18 months later. But it was clear that it would not be “contained.” We had no idea.

I also said that it was going to create a monster legal battle down the road that would take years to develop. Well, in the fullness of time, those years have come nigh upon us. Today we briefly look at the housing market, then the mortgage foreclosure debacle, and then we go into the real problem lurking in the background. It is The Subprime Debacle, Act 2. It is NOT the mortgage foreclosure issue, as serious as that is. I seriously doubt it will be contained, as well. Could the confluence of a bank credit crisis in the US and a sovereign debt banking crisis in Europe lead to another full-blown world banking crisis? The potential is there. This situation wants some serious attention.

This letter is going to print a little longer. But I think it is important that you get a handle on this issue.

Where is the Housing Recovery?

We are going to quickly review a few charts from Gary Shilling’s latest letter, where he review the housing market in depth. Bottom line, the housing market has not yet begun to recover, and it is not only going to take longer but the decline in prices may be greater than many have forecast. I wrote three years ago that it could be well into 2011 before we get to a “bottom.” That may have been optimistic, given what we will cover in this letter.

First, existing and new single-family home sales continue to slide, in the wake of the tax rebate that ended earlier this year. We have declined back to the down-sloping trend line. If you are a seller, this is not a pretty picture.

image001

The homebuilding industry, which was the source of so many jobs last decade (aka the good old days), is on its back. This country needs a healthy housing construction market to get back to lower unemployment, and until the overhang in the foreclosure market is cleared out, that is unlikely to happen.

image002

Lending is tighter, as is reasonable. Banks actually expect you to have the ability to pay back the mortgage you take out (solid FICO scores) and want reasonable down payments. Only 47% of applicants have the FICO score to get the best mortgage rates.

(Sidebar: Gary writes, “Furthermore, false appraisals rose 50% in 2009 from 2008. The tax credit for first-time homebuyers cost taxpayers about $15 billion, twice the official forecast, in part due to fraud. Over 19,000 tax filers claimed the credit but didn’t buy houses, while 74,000 who claimed $500 million in refunds already owned homes.” Where are the regulators?)

Shilling thinks prices are likely to fall another 20%. Given what I am writing about in the next section, that is a possibility. There is certainly no demand pressure to push up housing prices.

Finally, two charts on foreclosures. Residential mortgages in foreclosure are near all-time highs, close to 1 in 21 of all mortgages, up from 1 in 100 just four years ago. That’s got to be bad for your profit models.

image003

image004

Anyone who tells you the housing problem is “bottoming” either has an agenda or simply does not pay attention to the data. I really want to see housing bottom and then turn around and the home builders come back; the nation desperately needs the jobs. But my job is to be realistic. When we see 3-4 months of non-stimulus-induced housing sales growth, then we can start talking about bottoms.

But housing sales are not really the issue. Let’s look at the next leg of the problem.

The Foreclosure Mess

OK, in a serendipitous moment, Maine fishing buddy David Kotok sent me this email on the mortgage foreclosure crisis just as I was getting ready to write much the same thing. It is about the best thing I have read on the topic. Saves me some time and you get a better explanation. From Kotok:

“Dear Readers, this text came to me in an email from sources that are in the financial services business and with whom I have a personal relationship. The original text was laced with expletives and I would not use it in the form I received it. Therefore the text below has had some substantial editing in order to remove that language. The intentions of the writer are undisturbed. The writer shall remain anonymous. This text echoes some of the news items we have seen and heard today; however, it can serve as a plain language description of the present foreclosure-suspension mess. There is a lot here. It takes about ten minutes to read it. – David Kotok (www.cumber.com)

“Homeowners can only be foreclosed and evicted from their homes by the person or institution who actually has the loan paper…only the note-holder has legal standing to ask a court to foreclose and evict. Not the mortgage, the note, which is the actual IOU that people sign, promising to pay back the mortgage loan

“Before mortgage-backed securities, most mortgage loans were issued by the local savings & loan. So the note usually didn’t go anywhere: it stayed in the offices of the S&L down the street.

“But once mortgage loan securitization happened, things got sloppy…they got sloppy by the very nature of mortgage-backed securities.

“The whole purpose of MBSs was for different investors to have their different risk appetites satiated with different bonds. Some bond customers wanted super-safe bonds with low returns, some others wanted riskier bonds with correspondingly higher rates of return.

“Therefore, as everyone knows, the loans were ‘bundled’ into REMICs (Real-Estate Mortgage Investment Conduits, a special vehicle designed to hold the loans for tax purposes), and then “sliced & diced”…split up and put into tranches, according to their likelihood of default, their interest rates, and other characteristics.

“This slicing and dicing created ‘senior tranches,’ where the loans would likely be paid in full, if the past history of mortgage loan statistics was to be believed. And it also created ‘junior tranches,’ where the loans might well default, again according to past history and statistics. (A whole range of tranches was created, of course, but for the purposes of this discussion we can ignore all those countless other variations.)

“These various tranches were sold to different investors, according to their risk appetite. That’s why some of the MBS bonds were rated as safe as Treasury bonds, and others were rated by the ratings agencies as risky as junk bonds.

“But here’s the key issue: When an MBS was first created, all the mortgages were pristine…none had defaulted yet, because they were all brand-new loans. Statistically, some would default and some others would be paid back in full…but which ones specifically would default? No one knew, of course. If I toss a coin 1,000 times, statistically, 500 tosses the coin will land heads…but what will the result be of, say, the 723rd toss? No one knows.

“Same with mortgages.

“So in fact, it wasn’t that the riskier loans were in junior tranches and the safer ones were in senior tranches: rather, all the loans were in the REMIC, and if and when a mortgage in a given bundle of mortgages defaulted, the junior tranche holders would take the losses first, and the senior tranche holder last.

“But who were the owners of the junior-tranche bond and the senior-tranche bonds? Two different people. Therefore, the mortgage note was not actually signed over to the bond holder. In fact, it couldn’t be signed over. Because, again, since no one knew which mortgage would default first, it was impossible to assign a specific mortgage to a specific bond.

“Therefore, how to make sure the safe mortgage loan stayed with the safe MBS tranche, and the risky and/or defaulting mortgage went to the riskier tranche?

“Enter stage right the famed MERS…the Mortgage Electronic Registration System.

“MERS was the repository of these digitized mortgage notes that the banks originated from the actual mortgage loans signed by homebuyers. MERS was jointly owned by Fannie Mae and Freddie Mac (yes, those two again …I know, I know: like the chlamydia and the gonorrhea of the financial world…you cure ‘em, but they just keep coming back).

“The purpose of MERS was to help in the securitization process. Basically, MERS directed defaulting mortgages to the appropriate tranches of mortgage bonds. MERS was essentially where the digitized mortgage notes were sliced and diced and rearranged so as to create the mortgage-backed securities. Think of MERS as Dr. Frankenstein’s operating table, where the beast got put together.

“However, legally…and this is the important part…MERS didn’t hold any mortgage notes: the true owner of the mortgage notes should have been the REMICs.

“But the REMICs didn’t own the notes either, because of a fluke of the ratings agencies: the REMICs had to be “bankruptcy remote,” in order to get the precious ratings needed to peddle mortgage-backed Securities to institutional investors.

“So somewhere between the REMICs and MERS, the chain of title was broken.

“Now, what does ‘broken chain of title’ mean? Simple: when a homebuyer signs a mortgage, the key document is the note. As I said before, it’s the actual IOU. In order for the mortgage note to be sold or transferred to someone else (and therefore turned into a mortgage-backed security), this document has to be physically endorsed to the next person. All of these signatures on the note are called the ‘chain of title.’

“You can endorse the note as many times as you please…but you have to have a clear chain of title right on the actual note: I sold the note to Moe, who sold it to Larry, who sold it to Curly, and all our notarized signatures are actually, physically, on the note, one after the other.

“If for whatever reason any of these signatures is skipped, then the chain of title is said to be broken. Therefore, legally, the mortgage note is no longer valid. That is, the person who took out the mortgage loan to pay for the house no longer owes the loan, because he no longer knows whom to pay.

“To repeat: if the chain of title of the note is broken, then the borrower no longer owes any money on the loan.

“Read that last sentence again, please. Don’t worry, I’ll wait.

“You read it again? Good: Now you see the can of worms that’s opening up.

“The broken chain of title might not have been an issue if there hadn’t been an unusual number of foreclosures. Before the housing bubble collapse, the people who defaulted on their mortgages wouldn’t have bothered to check to see that the paperwork was in order.

“But as everyone knows, following the housing collapse of 2007-’10-and-counting, there has been a boatload of foreclosures…and foreclosures on a lot of people who weren’t sloppy bums who skipped out on their mortgage payments, but smart and cautious people who got squeezed by circumstances.

“These people started contesting their foreclosures and evictions, and so started looking into the chain-of-title issue, and that’s when the paperwork became important. So the chain of title became crucial and the botched paperwork became a nontrivial issue.

“Now, the banks had hired ‘foreclosure mills’…law firms that specialized in foreclosures…in order to handle the massive volume of foreclosures and evictions that occurred because of the housing crisis. The foreclosure mills, as one would expect, were the first to spot the broken chain of titles.

“Well, what do you know, it turns out that these foreclosure mills might have faked and falsified documentation, so as to fraudulently repair the chain-of-title issue, thereby ‘proving’ that the banks had judicial standing to foreclose on delinquent mortgages. These foreclosure mills might have even forged the loan note itself…

“Wait, why am I hedging? The foreclosure mills did actually, deliberately, and categorically fake and falsify documents, in order to expedite these foreclosures and evictions. Yves Smith at Naked Capitalism, who has been all over this story, put up a price list for this ‘service’ from a company called DocX…yes, a price list for forged documents. Talk about your one-stop shopping!

“So in other words, a massive fraud was carried out, with the inevitable innocent bystanders getting caught up in the fraud: the guy who got foreclosed and evicted from his home in Florida, even though he didn’t actually have a mortgage, and in fact owned his house free -and clear. The family that was foreclosed and evicted, even though they had a perfect mortgage payment record. Et cetera, depressing et cetera.

“Now, the reason this all came to light is not because too many people were getting screwed by the banks or the government or someone with some power saw what was going on and decided to put a stop to it…that would have been nice, to see a shining knight in armor, riding on a white horse.

“But that’s not how America works nowadays.

“No, alarm bells started going off when the title insurance companies started to refuse to insure the titles.

“In every sale, a title insurance company insures that the title is free -and clear …that the prospective buyer is in fact buying a properly vetted house, with its title issues all in order. Title insurance companies stopped providing their service because…of course…they didn’t want to expose themselves to the risk that the chain of title had been broken, and that the bank had illegally foreclosed on the previous owner.

“That’s when things started getting interesting: that’s when the attorneys general of various states started snooping around and making noises (elections are coming up, after all).

“The fact that Ally Financial (formerly GMAC), JP Morgan Chase, and now Bank of America have suspended foreclosures signals that this is a serious problem…obviously. Banks that size, with that much exposure to foreclosed properties, don’t suspend foreclosures just because they’re good corporate citizens who want to do the right thing, and who have all their paperwork in strict order…they’re halting their foreclosures for a reason.

“The move by the United States Congress last week, to sneak by the Interstate Recognition of Notarizations Act? That was all the banking lobby. They wanted to shove down that law, so that their foreclosure mills’ forged and fraudulent documents would not be scrutinized by out-of-state judges. (The spineless cowards in the Senate carried out their master’s will by a voice vote…so that there would be no registry of who had voted for it, and therefore no accountability.)

“And President Obama’s pocket veto of the measure? He had to veto it…if he’d signed it, there would have been political hell to pay, plus it would have been challenged almost immediately, and likely overturned as unconstitutional in short order. (But he didn’t have the gumption to come right out and veto it…he pocket vetoed it.)

“As soon as the White House announced the pocket veto…the very next day!…Bank of America halted all foreclosures, nationwide.

“Why do you think that happened? Because the banks are in trouble…again. Over the same thing as last time…the damned mortgage-backed securities!

“The reason the banks are in the tank again is, if they’ve been foreclosing on people they didn’t have the legal right to foreclose on, then those people have the right to get their houses back. And the people who bought those foreclosed houses from the bank might not actually own the houses they paid for.

“And it won’t matter if a particular case…or even most cases…were on the up -and up: It won’t matter if most of the foreclosures and evictions were truly due to the homeowner failing to pay his mortgage. The fraud committed by the foreclosure mills casts enough doubt that, now, all foreclosures come into question. Not only that, all mortgages come into question.

“People still haven’t figured out what all this means. But I’ll tell you: if enough mortgage-paying homeowners realize that they may be able to get out of their mortgage loans and keep their houses, scott-free? That’s basically a license to halt payments right now, thank you. That’s basically a license to tell the banks to take a hike.

“What are the banks going to do…try to foreclose and then evict you? Show me the paper, Mr. Banker, will be all you need to say.

“This is a major, major crisis. The Lehman bankruptcy could be a spring rain compared to this hurricane. And if this isn’t handled right…and handled right quick, in the next couple of weeks at the outside…this crisis could also spell the end of the mortgage business altogether. Of banking altogether. Hell, of civil society. What do you think happens in a country when the citizens realize they don’t need to pay their debts?”

Comment » | Geo Politics, US denouement, USD

BOJ Intervention

September 17th, 2010 — 1:45pm

Prior to the BOJ intervention earlier this week, there had been very little public discussion of the fact that China has been purchasing JGBs and that this had contributed to the appreciation in the value of the ¥en.  In June China purchased ¥457Bln worth of JGBs and in July purchased a further ¥583Bln worth.  Assessing the impact of this intervention purely in terms of the effect of the Yen’s appreciation against the US Dollar is to miss the point. The more interesting story is what is going on between China and Japan.

Superficially, likely motives for China’s JGB purchases include diversification out of the USD, since the majority of China’s accumulated surplus is recycled through the purchase of US Treasury debt. Naturally this exposes China to the inevitable depreciation in the value of the USD.  However this is a cycle that cannot continue and the policy makers in China have probably worked this out and are thus seeking to engineer an outcome more to their liking than the gradual devaluation of their USD reserves.

Added to this, the recent public exchange of views between China and the US as to who would come off worse in a trade war takes on a new light. One interpretation would be that  China has decided that the indebtedness of the American economy has now reached levels which point to its decreasing usefulness as a trading partner and thus wishes to end its reliance on the US as a target for its exports.

It must then turn to its Asian neighbours as trading partners.

Japan is the world’s second largest economy but has a debt to GDP ratio of 225%. It has so far managed through its own population purchasing JGBs, but is now facing an aging demographic and would be devastated by an inability to issue bonds at current 1% interest rates. Households have already stopped adding to their stock of JGBs, and the threat that rates in Japan will need to rise must now be looming large in the minds of Japanese policy makers. Should yields approach levels seen on European Government bond debt, i.e. 4%, rising debt service costs will threaten huge damage on the Japanese economy, threatening the Japanese state with bankruptcy. This threat would in turn open the floodgates of further QE. The yen would fall out of bed in a hyperinflationary blowoff.

Without doubt this would utterly derail the Chinese economy and threaten an unmanageable crisis on the Chinese, even possibly threatening the political status quo. The threat to China posed by the Japanese economic situation is thus so potentially grave that Japan’s problem is actually China’s problem also.

Thus the buying of JGBs by China could in fact be seen as the actions of a supporting partner, which are the result of an entirely aligned mutual self interest between the two nations.

Beijing would now be expected to react by tightening monetary policy via a rate hike. In August Chinese CPI jumped to 3.5%, indicating that they have to slow the economy. Tightening in this way would also be seen to be addressing the US political pressure on the Yuan exchange rate. It is clear now that the BOJ is willing to offset the impact on the strength of the Yen, and how they are going to do so.

As for the Fed, it is now operating with both hands tied behind its back evaluating whether to announce a baby-step QE2 at next week’s FOMC meeting, or at the November FOMC, which coincides with the Mid-Term Election Day.

As an aside, it should be noted that if a Japan meltdown is not prevented, the Japanese would also have to dump their holdings of US Treasuries, currently $750bn or 10pc of the entire stock of US Treasury debt, as well as selling Gilts and Belgian bonds, precipitating other government bond market funding crises and triggering an international bond rout spiking interest rates higher and sending stock markets into meltdown.

The interconnectedness of the whole system renders it non-linear and chaotic. I don’t see a happy ending.

this is what ¥2 trillion looks like

Comment » | Asia, General, Geo Politics

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