Think Grand Canyon

By: Doug Noland | Fri, Aug 3, 2012
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Things get wackier by the week. My proposition has been that once a Credit crisis comes to afflict the "core" (gravitating from the "periphery") the deleterious consequences tend to be irreversible. As such, with Spain now engulfed in full-fledged financial, economic, political and social crisis, the overall European debt crisis has turned interminable. Of course, desperate politicians and central bankers promise to do whatever it takes to finally resolve the crisis. "Pointless to short the euro," Mr. Draghi warned yesterday. Their determination is surely intensified by the fact that they are fighting for the very survival of euro monetary integration.

Policymakers and market participants alike appreciate what's at stake. With global risk markets these days enveloped in an extraordinary "risk on, risk off" speculative melee, the historic battle to "save" the euro has come to dictate global trading dynamics. The European crisis is taking an increasing toll on the global economy, though the incredible measures to combat the bursting of the European Credit Bubble fuel an escalating speculative Bubble throughout global risk markets.

Why does "core" affliction prove such a momentous crisis development? Importantly, the associated costs become enormous and, by definition, the number of parties with the wherewithal to finance a core country bailout turns quite limited. While large, initial Greek bailouts costs were manageable when spread across euro zone partners and a robust ECB. The ultimate costs of bailing out Spain's banks, regional governments and the sovereign will be many hundreds of billions. And with "robust" a thing of the past, there are scant few places to spread huge prospective bailout expenses. Italy is on the ropes and France is increasingly vulnerable. It is today essentially left to the Germans and the ECB to shoulder the burden of bailout responsibility. And only a small and increasingly isolated minority has an issue with gambling German Creditworthiness and ECB credibility.

It's been my thesis that there would come a time when the Germans would begin to reevaluate. There are the age old economic issues of "solvency vs. illiquidity" to contend with - along with that fateful "throwing good money after bad" predicament. There is the issue of sacrificing one's Creditworthiness for the profligacy and misdeeds of others. These issues can be downplayed or completely disregarded - they're just not going away. At the end of the day, I don't expect the German people will be willing to shoulder the financial burdens of Spain and Italy. The Germans won't bury themselves and won't be blackmailed. And I don't expect the Bundesbank to completely turn over the keys to the European Central Bank printing press and vault to the MIT trained Italian economist Mario Draghi. There are very deep philosophical differences. Think Grand Canyon.

The markets' Thursday-to-Friday depressive-manic response to Mr. Draghi was something to behold (being kind here). Reasons behind the about face were not immediately obvious. The Financial Times' sanguine view didn't hurt: "Far from moderating his forceful London remarks, Mr Draghi made clear that the ECB is ready to act to stop the disintegration of eurozone financial markets. In a significant step for the ECB's interpretation of its own role, he left no doubt that the central bank considers it 'squarely' within its mandate to counteract 'convertibility risk' - the market effect produced by doubts that the euro will survive intact. Mr Draghi, in combative mood, declared that the euro is here to stay: it is 'pointless' to bet against it - a big statement."

The FT editorial made its own big statement: "Investors... should not underestimate the adroitness of Mr. Draghi's political manoeuvre." Candidly, I missed it when watching Mr. Draghi's press conference; few were thinking impressively adroit on Thursday. After the previous week's bluster, Mr. Draghi simply didn't have the goods. Moreover, he seemed content to dig a deeper hole for himself. Indeed, one was left assuming that his latest big bazooka idea wasn't about to pass muster with an increasingly alarmed Bundesbank. But that was Thursday thinking.

Capturing the much-improved Friday market mood - and the markets' imagination - was a big statement from an ECB policymaker: "There are 23 members in the council and if there will be a vote then everyone's vote has the same weight in the sense that some questions are solved by a majority." Rather bold for a new member of the ECB's rate setting committee from the Bank of Estonia to claim his bank's vote is as powerful as that from the esteemed Bundesbank.

Especially by week's end, markets were happy to disregard what I believe were telling comments from prominent Bundesbank officials - current and former. Mr. Otmar Issing penned a brilliant op-ed for Monday's Financial Times, "Europe's Political Union is Worthy of Satire." This was followed by "the Bundesbank celebrates its 55th birthday on 1 August and continues to stand for an exceptionally strong orientation to stability," with the Bundesbank's website highlighting an insightful interview with current Bundesbank President Jens Weidmann and former (1991-1993) head Helmut Schlesinger. Considering the backdrop, I thought it was worthy of major excerpts.

Mr. Weidmann: "...Despite all our various qualifications and tasks, within the Bank, there is a shared vision and a clear commitment to monetary stability. This is unique for such an institution and has also made the Bank an attractive option for people applying to work for us. The public good of maintaining price stability and thus contributing to the common good is a major incentive for many."

Mr Weidmann, how did you yourself see the Bundesbank, say, while you were at university?

Mr. Weidmann: "In 1987 I was studying in France. The Banque de France was not yet independent at the time. That is when I first clearly saw the differences in outlook concerning the role of, and oversight over, the central bank. I myself had pretty much 'inhaled' the Bundesbank's role; my French student friends, however, could not possibly imagine a government institution performing a key sovereign task and still being outside parliamentary control. Two very different world views were colliding. They have continued to do so in all political debates - essentially, up to the present day."

Where can you identify this?

Mr. Weidmann: "I recently gave an interview to the French daily newspaper 'Le Monde'. Many readers responded to the substantive positioning, some positively, some negatively. However, some responded along the lines of 'Why is he meddling in the political debate? He's only a central bank governor, a 'civil servant' who actually shouldn't be saying anything on the matter."

In 1990, the Bundesbank wrote that the participants in economic and monetary union would be inextricably linked to one another 'come what may' and that such a union would be an 'irrevocable joint and several community which, in the light of past experience, requires a more far-reaching association, in the form of a comprehensive political union, if it is to remain durable'.

Mr. Weidmann: "The assessment at that time merely reflected the Bank's long-held position. As early as 1963, President Karl Blessing had stated that the introduction of monetary union should be conditional on political union. The Bank's stance has not only been consistent over time but has, in fact, taken on even greater relevance in a dramatic way owing to the recent crisis in the euro area."

Political union did not feature in the Maastricht Treaty at the end of 1991. How did the Central Bank Council react to this?

Mr. Schlesinger: "When I took office as President of the Deutsche Bundesbank in the summer of 1991, Chancellor Helmut Kohl was still in favour of political union. However, the decision to implement monetary union by no later than 1999 was taken just four months later. This was a clear defeat for us. There is no other way of putting it. We had assumed that the Treaty would be concluded with a definition of the entry criteria, but without a fixed date being set."

Mr. Weidmann: "It is interesting that we are having a similar discussion now in connection with the banking union. Here, too, some quarters are evidently seeking a far-reaching joint solution, but without imposing stricter rules on the other policy areas that are also affected. A genuine European banking supervision can indeed form a major component of closer integration within monetary union. However, such an institutional reorganisation of banking supervision also has to be integrated - into a comprehensive reform of the supervisory regulatory framework and of the respective national scope for economic and fiscal policy. Otherwise, too great a burden will be placed on banking supervision."

What is crucial for political union is the willingness to hand over national sovereignty. Does such a willingness actually exist within the EU?

Mr. Schlesinger: "This question always takes me back to the start of European unification. At that time, the main objective was quite a different one - namely, to ensure that there would never again be a war in Europe. The plan for a common European army was ultimately blocked by France, even though the loss of sovereignty involved would have been easy to implement. It is actually hard to envisage how a loss of monetary sovereignty could be achieved in the absence of a unified state."

Mr. Weidmann: "Seeing how reluctant some countries are to relinquish their fiscal policy autonomy - even in return for financial assistance - it is hard to imagine political union being achieved in the foreseeable future."

Mr Schlesinger, should the Bundesbank have fought more strongly against monetary union without a political counterweight in the 1990s?

Mr. Schlesinger: "All of our demands were fulfilled. But I think we all underestimated just how wide the gulf is in the mindset not only of the political class but also in terms of public opinion in the individual countries concerning the objectives of fiscal policy. I would like to refer you to a chapter by Rudolf Richter in the publication marking the 50th anniversary of the Deutsche Mark... He writes that the culture of stability in Germany has been able to develop only because it has had the full backing of the general public. If you look at the Maastricht Treaty, the relevant criteria are there. But you won't find any reference to the member states having to have the same culture of stability.

Mr. Weidmann: "Political efforts to use the central bank for policy purposes exist in all countries. However, the public's stance on this is probably the crucial factor."

Is there a lack of political will?

Mr. Weidmann: "The founding fathers of the EU treaties evidently took a skeptical view of the political will, and it is precisely for this reason that they made the central bank independent in order to protect it from a lack of or a conflict of political will. But the central bank must use and maintain this protection. Furthermore, it should be aware that this independence also requires it to respect and not overstep its own mandate. Mr. Schlesinger's examples show that what is politically desirable and what is economically prudent have often not matched up. Whether we're talking about interest rates or some sort of non-standard measures, in the end it always comes down to the central bank being instrumentalised for fiscal policy objectives. However, policymakers thereby overestimate the central bank's possibilities and expect too much of it by assuming that it can be used not only for price stability, but also for promoting growth, reducing unemployment and stabilising the banking system. This pattern occurs again and again; this time it is perhaps even more pronounced than in the past because there is increased doubt among the general public about policymakers' ability to act, and the central bank is seen as the sole institution that is capable of doing something. In this respect, the central bank is perhaps under even more pressure than in the past - even though you, Mr. Schlesinger, are better able to judge this as you have witnessed all of these periods. Furthermore, in Europe we are faced with some quite different ways of looking at the central bank's role - not only in politics, but also in the media and on the part of the general public. If a central bank also has to work against public opinion, things get difficult."

Today it is even harder for the Bundesbank to assert its influence as it is just one of 17 central banks in the Eurosystem. What impact does this have on your work?

Mr. Weidmann: "Even though what you say is correct in terms of shares of voting rights, I certainly would not say that we are 'just' one of 17 central banks. We are the largest and most important central bank in the Eurosystem and we have a greater say than many other central banks in the Eurosystem. This means that we have a different role. We are the central bank that is most active in the public debate on the future of monetary union. This is also how some of my colleagues expect it to be."

It is often said that Germany has benefitted from monetary union and it therefore has a duty to help.

Mr. Weidmann: "I think that argument is incorrect. First, counting up the for and against of who has benefited to what extent from monetary union is not helpful. A stable single currency benefits all member states - some perhaps more than others, but that, too, can change over time. After all, Germany was certainly not considered to be a winner during the first few years of monetary union. Second, when monetary union was established, we agreed on a legal framework which has to be respected: a single monetary policy ensures price stability and each member state is responsible for its own fiscal policy. This is precisely what is expressed in the 'no bail-out' clause. And third: Germany is already providing large-scale assistance for the peripheral countries, not least as an anchor of stability and as a guarantor of the rescue packages."

Mr Weidmann, in your opinion, what are the biggest challenges that the Bundesbank is facing now and in the coming years?

Mr. Weidmann: "The crisis requires all our energies. We shall continue to use all of our resources at all levels to stand up for the positions we believe in and to ensure that the monetary union remains a stability union..."

Especially these days, I have little company when it comes to extolling the virtues of the Bundesbank or German economic thinking more generally. For me, it's an issue of principle. Over the past 22 years I have come to deeply respect the German (including "Austrian") view of economics, money and Credit, and monetary management. I'm partial to a sound analytical framework, discipline and the so-called "orientation of stability." Back in 2004, in a CBB titled "Issing vs. Greenspan," I highlighted a WSJ op-ed by then ECB Chief Economist Otmar Issing, with his prescient warning against central banks ignoring Bubbles:

From Issing's article, aptly titled "Money and Credit": "Huge swings in asset valuations can imply significant misallocations of resources in the economy and furthermore create problems for monetary policy. Not every strong decline in asset prices causes deflation, but all major deflations in the world were related to a sudden, continuing and substantial fall in values of assets. The consequences for banks, companies and households can be tremendous... Prevention is the best way to minimize costs for society from a longer-term perspective. ...it should not be overlooked that most exceptional increases in prices for stocks and real estate in history were accompanied by strong expansions of money and/or credit."

This has been a multi-year battle for what constitutes sound analysis and economic doctrine. Mr. Issing and the Bundesbank know they have won the debate on Bubbles, money, Credit and monetary policymaking. There is reason to believe they view U.S. monetary and fiscal policymaking as an ongoing disaster. And it is ironic that markets today celebrate Mr. Draghi's desperate move to adopt Fed-like quantitative easing. As Mr. Issing wrote this week in the FT, "Juvenal would have said: Difficile est satiram non scribere (It is difficult not to write a satire)."

I suspect the Bundesbank has commenced preparation for a difficult confrontation. I am less clear on the stance of what appears an increasingly divided Merkel government, although a decisive shift in German public sentiment has seemingly begun. According to recent polling (YouGov), only 33% of respondents now support Ms. Merkel's handling of the euro zone crisis, down sharply over recent weeks. And, for the first time, a majority (51%) of Germans now believe they would be better off without the euro (Merkel was said to be "profoundly disturbed"). The vast majority of Germans want Greece out of the euro, and fewer each week would be content subsidizing profligate Spain and Italy. If either the Bundesbank or the Federal Constitutional Court of Germany should in coming weeks draw a harder line, they might just enjoy an outpouring of support from the German people - if not global risk markets.

 


For the Week:

The S&P500 increased 0.4% (up 10.6% y-t-d), and the Dow added 0.2% (up 7.2%). The Morgan Stanley Cyclicals were little changed (up 4.7%), while the Transports dipped 0.8% (up 1.3%). The Morgan Stanley Consumer index declined 0.8% (up 6.4%), and the Utilities lost 0.7% (up 4.4%). The Banks were about unchanged (up 17.0%), while the Broker/Dealers (with Knight Capital) were slammed for 6.2% (down 5.8%). The S&P 400 Mid-Caps dipped 0.5% (up 7.5%), and the small cap Russell 2000 fell 0.9% (up 6.4%). The Nasdaq100 was up 1.1% (up 17.5%), and the Morgan Stanley High Tech index rose 0.8% (up 12.0%). The Semiconductors jumped 1.5% (up 7.0%). The InteractiveWeek Internet index slipped 0.4% (up 8.3%). The Biotechs fell 5.6% (up 31.0%). With bullion down $19, the HUI gold index declined 1.1% (down 18.3%).

One-month Treasury bill rates ended the week at 2 bps and three-month bills closed at 8 bps. Two-year government yields were unchanged at 0.24%. Five-year T-note yields ended the week one basis point higher at 0.67%. Ten-year yields added 2 bps to 1.56%. Long bond yields increased 2 bps to 2.64%. Benchmark Fannie MBS yields increased 2 bps to 2.36%. The spread between benchmark MBS and 10-year Treasury yields was unchanged at 80 bps. The implied yield on December 2013 eurodollar futures declined one basis point to 0.475%. The two-year dollar swap spread was little changed at 21 bps. The 10-year dollar swap spread rose 3 to 15 bps. Corporate bond spreads were volatile before ending somewhat narrower. An index of investment grade bond risk declined one to 104 bps. An index of junk bond risk fell 7 to 557 bps.

Debt issuance was decent, especially for junk. Investment grade issuers included Citigroup $3.75bn, Texas Instrument $1.5bn, Campbell Soup $1.25bn, Ford Motor Credit $750 million, Unilever $1.0bn, Northern Trust $500 million, Estee Lauder $500 million, Praxiar $500 million, PPG Industries $400 million, Private Export Funding $400 million, Ventas Realty $275 million, and NYU Hospitals $250 million.

Junk bond funds saw inflows slow to $401 million (from Lipper). Junk Issuers included CIT $3.0bn, First Data $1.3bn, Level 3 $750 million, Steel Dynamics $750 million, Ashland $500 million, Jabil Circuit $500 million, Host Hotels & Resources $450 million, Entertainment Properties $350 million, Boyd $350 million, Crescent Resources $350 million, and Trac Intermodal $300 million.

I saw no convertible debt issued.

International dollar bond issuers included VTB BAnk $2.0bn, Teck Resources $1.75bn, Itau Unibanco $1.4bn, America Movil $2.75bn, Trans-Canada Pipeline $500 million, and Interamerican Development Bank $500 million.

Spain's 10-year yields ended an extraordinary week up 11 bps to 6.77% (up 173bps y-t-d). Italian 10-yr yields rose 9 bps to 6.01% (down 102bps). German bund yields increased 2 bps to 1.42% (down 41bps), and French yields fell 11 bps to 2.10% (down 104bps). The French to German 10-year bond spread narrowed 9 to 68 bps. Ten-year Portuguese yields dropped 32 bps to 10.57% (down 220bps). The new Greek 10-year note yield sank 131 bps to 24.53%. U.K. 10-year gilt yields added 2 bps to 1.56% (down 42bps). Irish yields declined 5 bps to 5.83% (down 243bps).

The German DAX equities index rallied 2.6% (up 16.4% y-t-d). Spain's IBEX 35 equities index ended a wild week 2.1% higher (down 21.1%), and Italy's FTSE MIB jumped 3.9% (down 6.4%). Japanese 10-year "JGB" yields declined one basis point to 0.73% (down 25bps). Japan's Nikkei slipped 0.1% (up 1.2%). Emerging markets were mostly higher. Brazil's Bovespa equities index gained 1.2% (up 0.9%), while Mexico's Bolsa fell 1.2% (up 10.6%). South Korea's Kospi index gained 1.1% (up 1.3%). India's Sensex equities index rallied 2.1% (up 11.3%). China's Shanghai Exchange increased 0.2% (down 3.0%).

Freddie Mac 30-year fixed mortgage rates rose 6 bps to 3.55% (down 94bps y-o-y). Fifteen-year fixed rates increased 3 bps to 2.83% (down 71bps). One-year ARMs were down one basis point to 2.70% (down 32bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 3 bps to 4.18% (down 84bps).

Federal Reserve Credit declined $10.9bn to $2.833 TN. Fed Credit was down $16.2bn from a year ago, or 0.6%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 8/1) increased $8.0bn to a record $3.527 TN. "Custody holdings" were up $107bn y-t-d and $63bn year-over-year, or 1.8%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg - were up $433bn y-o-y, or 4.3% to a record $10.529 TN. Over two years, reserves were $2.046 TN higher, for 24% growth.

M2 (narrow) "money" supply declined $5.5bn to $10.030 TN. "Narrow money" has expanded 7.1% annualized year-to-date and was up 7.8% from a year ago. For the week, Currency increased $0.9bn. Demand and Checkable Deposits declined $0.4bn, and Savings Deposits dipped $2.3bn. Small Denominated Deposits declined $2.4bn. Retail Money Funds fell $1.2bn.

Total Money Fund assets declined $4.0bn to $2.551 TN. Money Fund assets were down $144bn y-t-d and $17bn over the past year, or 0.7%.

Total Commercial Paper outstanding jumped $31.7bn to $1.034 TN. CP was up $75bn y-t-d, while having declined $141bn from a year ago, or down 12.0%.

Global Credit Watch:

August 3 - Bloomberg (Mark Gilbert and Emma Charlton): "The European Central Bank is edging toward a bond-buying program that investors say could end up printing money, echoing efforts by the Federal Reserve and other central banks to fix a credit crisis nearing its sixth year. ECB President Mario Draghi... left open the question on whether the bank would neutralize future bond purchases, a step it has taken with all of its interventions to date. He also said the size of the new program would be 'adequate to reach its objective' of curbing Italian and Spanish borrowing costs, a contrast with the 'limited' scope of the previous approach. 'You shouldn't assume that we will not sterilize or sterilize,' he told reporters... 'Bit by bit over the past two years, the ECB and all of the euro-region governments have been capitulating,' said Neil Williams, chief economist at Hermes Fund Management... 'I sense from Draghi's comments he is inching toward QE and now trying to get other ECB members to sign that off. It seems to me inevitable.'"

July 31 - Bloomberg (Rainer Buergin): "Chancellor Angela Merkel's coalition rejected granting the permanent euro rescue fund access to European Central Bank liquidity via a banking license... The rules of the European Stability Mechanism don't foresee a license to allow refinancing at the ECB, the Berlin-based ministry said... France and Italy are building support for a previously floated plan to allow the permanent backstop to wield unlimited firepower courtesy of the ECB, Germany's Sueddeutsche Zeitung newspaper reported..."

August 2 - Bloomberg (Sharon Smyth): "The total value of homes in Spain fell by around 360 billion euros ($442bn) from 2008 to 2010... The total value of existing homes in Spain reached 5.6 trillion euros in 2008 and declined 6.8% to 4.9 trillion euros over the next two years as prices dropped 9.2%..."

July 31 - Reuters: (Paul Day and Nigel Davies): "Capital flight from Spain gathered pace in May and the central government deficit rose further above target in June, taking the country two steps closer to the full-scale bailout it is desperate to avoid. Outflows rose to 41.3 billion euros ($50.6bn)... In all, 163 billion euros - or around 16% of economic output - left Spain between January and May, with domestic banks sending money abroad, foreign lenders pulling out cash and mostly non-resident investors dumping domestic assets. Over the last 11 months, funds equivalent to 26% of GDP exited the country, Tuesday's data from the Bank of Spain showed."

July 31 - Bloomberg (Esteban Duarte and Angeline Benoit): "Spain's rescue of Catalonia and Valencia risks diverting the taxes those regions need to pay their debts, disadvantaging holders of more than $150 billion of regional debt. Spain collects income, sales, gasoline, tobacco and alcohol taxes on behalf of its regional governments, excluding the Basque country and Navarra. More than half of the 65.9 billion euros ($81bn) gathered in the first six months of the year was then assigned to local states... The government is doubling loans to 17 semi-autonomous regions to as much as 41 billion euros after the local authorities lost access to capital markets to meet debt redemptions, pay suppliers and finance their deficits... 'The potential subordination is an element, which is implicit in the way the rescue mechanism has been designed,' said Fernando Mayorga, an analyst at Fitch Ratings in Barcelona."

July 31 - Bloomberg (Angeline Benoit): "Budget Minister Cristobal Montoro will urge Spain's regions today to deepen budget cuts as support to prevent their defaulting has worsened the central government's finances. Representatives of Spain's 17 semi-autonomous regional governments are scheduled to convene in Madrid... Montoro... said the central government's budget deficit widened in the first half to about 4% from 3.41% in January through May. Prime Minister Mariano Rajoy has asked the regions to implement most of Spain's planned budget-deficit reduction this year after they overshot last year's target by more than 100%."

August 2 - Bloomberg (Annette Weisbach): "German savings banks warned the European Central Bank against damaging the 'stability culture' of the euro by sticking to low interest-rate policies and flooding the markets with liquidity. 'The current ECB policy of keeping interest rates at a record low, buying more sovereign debt and flooding the markets with liquidity reduces the value of savings and, with that, people's provisions for old age throughout Europe,' Georg Fahrenschon, the president of the Berlin-based DSGV banking group, said... 'The ECB is on the verge of moving further away from the stability culture of the Bundesbank.' While non-standard measures are needed to fight the debt crisis, pumping increasing amounts of liquidity doesn't tackle overindebtedness, which is the root cause of the crisis, Fahrenschon said. 'The ECB shouldn't forget that fighting fire with fire leaves a lot of scorched earth behind,' he said."

August 2 - Bloomberg (Andrew Frye and Kasper Viita): "Italy risks a public backlash that could lead to an anti-euro government in the region's third-biggest economy should European policy makers fail to bring down borrowing costs, said Prime Minister Mario Monti... 'If the spread in Italy remains at this level for some time, then you're going to see a non-EU oriented, non-euro oriented, non-fiscal discipline oriented government in Italy,' Monti said..."

Germany Watch:

August 3 - Bloomberg (Rainer Buergin): "Members of German Chancellor Angela Merkel's coalition parties signaled they won't stand in the way of European Central Bank chief Mario Draghi's plan to buy government bonds... Norbert Barthle, CDU budget spokesman, said that German lawmakers will have veto rights over bond purchases by the euro- area's rescue funds, which would operate in tandem with the ECB under Draghi's proposal... With Merkel on vacation for another week and parliament in summer recess, there was no official government reaction to Draghi's announcement... Economy Minister Philipp Roesler, whose Free Democratic Party is Merkel's junior coalition partner and has been skeptical of bailouts, said the ECB should 'focus on its core mandate' of safeguarding monetary stability... Alexander Dobrindt, general secretary of the third coalition party, Bavaria's Christian Social Union, called for a reform of ECB voting rules to give Germany a veto right in the Governing Council... Handelsblatt, in a front-page article, focused on the 'isolation' of Bundesbank President Jens Weidmann, whom Draghi signaled was the only Governing Council member to oppose the bond-buying plan."

August 3 - Bloomberg (Brian Parkin): "Germany's financial liabilities toward the European Stability Mechanism, the euro-area's permanent bailout fund, can't surpass a fixed ceiling, Deputy Finance Minister Steffen Kampeter told Frankfurter Allgemeine Zeitung in a response to critics. Some economists have interpreted the ESM contract as foisting unlimited liabilities on Germany under certain scenarios, Kampeter said... No ESM clauses can force Germany to raise its input to the ESM above the agreed amount of 190 billion euros ($232bn), in line with the country's economic weighting in the euro area, Kampeter said."

August 3 - Bloomberg (Zeke Turner): "The plot of Ayn Rand's controversial 1957 novel 'Atlas Shrugged' couldn't be more relevant to Germany as the European financial crisis unfolds -- or so contends a young Munich executive, Kai John, who has published a new translation of the libertarian classic. In the novel, the brightest and most productive citizens (i.e. the Germans) deeply resent having to support the weaker members of society and rebel, leaving society in tatters, a fate that could befall the Continent if Angela Merkel and the German parliament refuse to bolster the European Union's straggling economies... A series of bailouts has left John, 36, a vice president at a multinational financial services company, feeling like Rand's hero, John Galt: 'The time is here to make Germans aware that collectivism has its limits.'"

Global Bubble Watch:

August 2 - Reuters: "China's central bank on... pledged to guarantee steady expansion in money supply and credit to cushion the world's second-largest economy against stiff global headwinds. Chinese leaders... pledged to step up policy fine-tuning in the second half of 2012 to bolster an economy that saw its slowest pace of growth in more than three years in the second quarter. 'China will use multiple monetary policy tools to guide stable and appropriate growth in credit and money supply and maintain the reasonable scale of social financing aggregate,' the People's Bank of China said..."

August 1 - Bloomberg (Sarika Gangar): "Corporate bond sales globally reached $293.5 billion last month for the busiest July on record as yields on investment-grade debt tumbled, falling below 3%... for the first time. Offerings by companies from the U.S. to Europe and Asia surpassed the previous record of $286.4 billion set in July 2009..."

August 3 - Bloomberg (Lisa Abramowicz): "Investors are stockpiling corporate debt rather than trading as banks retreat from bond brokering, with daily trading volumes in the U.S. slumping to the slowest July in four years even as offerings reached a record. Volumes averaged $9.97 billion last month, 8% below July 2011 and the lowest for the period since two months before Lehman Brothers Holdings Inc.'s failure ignited the credit crisis... Investment-grade sales rose 58% from the same month last year to $80.5 billion..."

August 2 - Bloomberg (Patricia Kuo): "Companies are borrowing the most in the loan market since 2008 to finance acquisitions worldwide, betting that they can quickly replace the debt with permanent financing as yields on corporate bonds fall to records. Anheuser-Busch InBev NV... obtained $14 billion in credit to buy Mexico's Grupo Modelo SAB... pushing loans for mergers to $221 billion this year, up 34% from the same period of 2011 and the most since $276 billion four years ago..."

August 1 - New York Times (Landon Thomas Jr.): "A hedge fund titan has decided to return a large sum of money to investors, a revealing illustration of how dried-up markets, vicious volatility and a paralysis of ideas all borne of the crisis in Europe have been particularly hard on the traders who swing for the fences on currencies, stocks and bonds all over the world. Louis M. Bacon, who together with Paul Tudor Jones and George Soros has come to define this style of high-stakes macro investing for more than 20 years, said in a letter to his investors... that he would be giving back $2 billion, about one quarter of the size his benchmark Moore Global Investment fund... As a big macro trader, Mr. Bacon has investments all over the world. But, with markets having become so tightly correlated -- veering up and down in line with what central bankers and European politicians are doing, or not doing for that matter -- true diversification has become harder than ever... 'Investing becomes primarily about who will be in the door first and out the door last... Everyone is forced to become a macro investor or trader... The political involvement is so extreme -- we have not seen this since the post-war era... And what they are doing is trying to thwart natural market outcomes. It is amazing how important the decision-making of one person, Angela Merkel, has become to world markets.'"

August 2 - Bloomberg (Katherine Burton): "Louis Bacon's decision to return $2 billion to investors highlights the difficulties the biggest macro hedge funds are having this year as government intervention and declining trading volumes limit managers' ability to make large bets. Bacon told clients... he's giving back about 25% of the money in his main hedge fund after returning just 1.6% this year through July. Ray Dalio, who runs Bridgewater Associates LP, lost 2% in his $54 billion macro fund through July 20... Alan Howard, who runs Brevan Howard Asset Management LLP, lost 1.3% in his Master Fund in the same period... Macro funds trade in global equity, bond, currency and commodities markets. They lost an average of 1.3% in the first six months of the year... Caxton Associates LP... lost 2.8% through July 17..."

Currency Watch:

August 3 - Bloomberg: "China's central bank and foreign- exchange regulator played down risks of an exodus of funds after reporting a record capital-account deficit last quarter... SAFE figures this week showed a $71.4 billion capital-account gap, the widest in quarterly data going back to 1998. Additional outflows of money may further weaken a yuan that has dropped more than 1% against the dollar since March as China's economic growth slowed to a three-year low. With a second-quarter current-account surplus of $59.7 billion, the balance of payments was negative for the first time since 1998..."

The U.S. dollar index slipped 0.4% to 82.635 (up 2.7% y-t-d). For the week on the upside, the Swedish krona increased 2.4%, the New Zealand dollar 1.1%, the Norwegian krone 1.1%, the Australian dollar 0.8%, the Mexican peso 0.8%, the euro 0.5%, the Danish krone 0.5%, the Singapore dollar 0.4%, the Taiwanese dollar 0.3%, the South Korean won 0.3%, the Canadian dollar 0.2% and the South African rand 0.1%. On the downside, the British pound declined 0.7% and the Brazilian real 0.3%.

Commodities Watch:

August 1 - Bloomberg (Rudy Ruitenberg): "Italy may have lost a third of its corn crop, the European Union's third-biggest, and half of its soybean harvest because of drought and record heat, farm- industry organization Confagricoltura wrote."

The CRB index added 0.4% this week (down 1.5% y-t-d). The Goldman Sachs Commodities Index rose 0.9% (up 0.4%). Spot Gold declined 1.2% to $1,603 (up 2.5%). Silver gained 1.1% to $27.80 (down 0.4%). September Crude rose $1.27 to $91.40 (down 8%). August Gasoline increased 1.5% (up 10%), while September Natural Gas fell 4.6% (down 4%). September Copper fell 1.7% (down 2%). September Wheat declined 0.8% (up 37%), while September Corn gained 1.4% (up 25%).

China Watch:

August 1 - Bloomberg (Kyoungwha Kim and David Yong): "Chinese banks are selling the most bonds on record this year as policy makers urge them to lend more freely in support of state projects needed to steer the world's second-largest economy out of a six-quarter slowdown. Lenders issued 1.32 trillion yuan ($206bn) of bonds in the first half... The total is 36% higher than in the preceding six months and 16% more than a year earlier."

July 31 - Bloomberg (Justin Doom): "Suntech Power Holdings Co., the Chinese solar-panel producer that said yesterday it may have been defrauded by an affiliate, will need government intervention to avoid bankruptcy, an analyst said. Suntech has about $541 million in debt due in March that it may struggle to repay, Aaron Chew, an analyst at Maxim Group LLC in New York, said..."

July 31 - Bloomberg (Christopher Martin, Bradley Olson and Joshua Gallu): "Suntech Power Holdings Co.'s admission that it may have failed to verify the existence of German bonds it accepted as loan collateral adds to growing concerns about Chinese business practices that are sparking a wave of lawsuits and regulatory probes. It's the third time in a week that internal controls at Chinese companies have been found lacking."

August 1 - Bloomberg: "China's manufacturing teetered on the edge of contraction in July and South Korea's exports and inflation declined, indicating that stimulus efforts have yet to bear fruit. The Purchasing Managers' Index in China unexpectedly fell to 50.1 in July, the weakest in eight months... South Korea's exports slid by more than double the amount forecast by analysts..."

July 31 - Financial Times (Patti Waldmeir): "Chinese steelmakers saw their profits plunge by 96% in the first half compared to a year ago, a Chinese official said...as the economic slowdown turned the industry into a 'disaster zone'. Zhu Jimin, chairman of the China Iron and Steel Association (CISA), said in a speech posted on the association's website that the aggregate profit of the nation's steelmakers fell to Rmb2.39bn (£376m) in the first half year due to falling demand and rising costs... The China Securities Journal, an official newspaper, described the steel industry as the "main disaster zone" in the current downturn..."

India Watch:

August 1 - Bloomberg (Rajesh Kumar Singh and Rakteem Katakey): "India's worst-ever power crisis is the legacy of 60 years of missed investment targets and on current projections fixing the nation's electricity supply is still decades away. The network in Asia's third-largest economy loses 27% of the power it carries through dissipation from wires and theft, while peak supply falls short of demand by an average of 9%... A blackout yesterday across the north and east of the country, the second in two days, left more than 640 million people without electricity."

August 1 - Bloomberg (Kasia Klimasinska): "India's cash-starved electric utilities, unwilling to buy power, are exceeding their allotments from the nation's grid, which helped trigger the world's biggest blackout, India's chief electric regulator said. The 'financial position is not really sound, so they don't have enough money to buy electricity,' Pramod Deo, chairman of India's Central Electricity Regulatory Commission, said... 'So first thing is that you withdraw and hope that nothing will happen.'"

July 31 - Bloomberg (Anoop Agrawal and Jeanette Rodrigues): "India's companies cut rupee bond sales by 50% in July to a nine-month low as the fastest inflation among the largest emerging-market economies drove yield premiums to the widest in three years."

European Economy Watch:

July 31 - Bloomberg (Jeff Black and Brian Parkin): "German unemployment climbed for a fourth straight month in July as the sovereign debt crisis prompted companies to delay hiring... The adjusted jobless rate held at 6.8%."

August 1 - Bloomberg (Patrick Henry): "Belgium's economy contracted the most in more than three years in the second quarter, adding to signs that the sovereign debt crisis is pushing the 17-nation euro area into a recession. Gross domestic product in Belgium, the sixth-largest economy in the single-currency area, fell 0.6% from the first quarter, when it rose a revised 0.2%..."

Latin America Watch:

July 30 - Bloomberg (Blake Schmidt): "Sales of Brazilian bonds backed by real estate are falling the most on record as a faltering economy and mounting consumer defaults spark a slowdown in mortgage lending. Offerings of the securities sank 49% to 3.3 billion reais ($1.6bn) in the first half of 2012 compared with the year-ago period..."

Global Economy Watch:

July 30 - Bloomberg (Anchalee Worrachate): "The falling cost of protecting against inflation in the German bond market portends a deeper slowdown in Europe's largest economy, signalling the effects of the continent's debt crisis are edging closer to the core. The two-year breakeven rate, a gauge of inflation expectations, dropped to minus 0.45 percentage point for Germany... 'Germany is most probably heading for a recession,' said Humayun Shahryar, chief executive officer of Auvest Capital Management... 'We are going through a debt crisis in Europe, and massive global economic slowdown. I'm not sure how Germany will be able to escape that.'"

U.S. Bubble Economy Watch:

August 3 - Bloomberg (Alan Bjerga): "U.S. farmland values rose 11% to a record this year as crop and livestock prices surged and export demand remained high, the Department of Agriculture said... The sample was taken before the worst drought since the 1950s spread through the Corn Belt and Great Plains, which may make investors shy away in the short term, said Brent Gloy, an agricultural economist at Purdue University... From an economic viewpoint, 'one year shouldn't have a big impact,' Gloy said... 'From a psychological impact, people won't be as aggressive buying land in places that didn't have a crop.'"

August 2 - Reuters: "California's projected revenue related to Facebook Inc's initial public offering faces a bumpy ride as the company's share price hit fresh lows, a state analyst said... Facebook's IPO in May and related stock transactions were projected to generate about $1.9 billion for California's coffers. That projection, however, assumed the California-based company's stock would be fetching $35 a share in November. 'The bottom line is that the lower the stock price is the lower (state) revenue is,' said Jason Sisney, deputy legislative analyst."

August 3 - Bloomberg (Nina Mehta and Whitney Kisling): "Knight Capital Group Inc., stung by a software malfunction that triggered a $440 million trading loss, survived another day as it secured a funding lifeline and more customers resumed routing orders to the market maker. The firm told brokers it has money for today after it received short-term financing..."

Fiscal Watch:

July 31 - Bloomberg (Bernard Kohn): "The U.S. Postal Service affirmed it won't make a required $5.5 billion payment due tomorrow to the U.S. Treasury for future retirees' health care, an obligation the agency said must end for it to become financially viable... The Postal Service, which has more employees than any U.S.- based publicly traded company other than Wal-Mart Stores Inc., lost $3.2 billion in the quarter ended March 31. It has said it expects to temporarily run out of cash in October unless Congress alters or ends the retiree health-care obligation and lets it make other changes that include ending Saturday mail delivery."

July 31 - Bloomberg (Alan Bjerga): "This year's once-in-a-generation U.S. drought may prompt record insurance payouts and still leave some farmers with serious losses as indemnities rival those of a 1988 drought and a 1993 flood... Farmers who have already signed contracts to sell corn, soybeans or wheat may have to repay buyers with their insurance money after their crops fail, Tom Zacharias, the president of National Crop Insurance Services, said..."

California Watch:

August 1 - Bloomberg (Alison Vekshin, James Nash and Rodney Yap): "Stockton, California, Police Chief Tom Morris was supposed to bring stability to law enforcement when he was appointed to the job four years ago. He lasted eight months and left the now-bankrupt city at age 52 with an annual pension that pays more than $204,000 -- the third of four chiefs who stayed in the position for less than three years and retired with an average of 92% of their final salaries... The pensions are the consequence of decisions made when stock markets were soaring, technology money flooded the state, and retirement funds were running surpluses. 'We didn't have very many people looking out for the taxpayers when these deals were negotiated,' San Jose Mayor Chuck Reed, 63, said... San Jose, the state's third-largest city, approved a ballot measure in June to contain annual retirement costs that soared to $245 million from $73 million in the past decade."

August 2 - Bloomberg (Steven Church, Dawn McCarty and Michael Bathon): "San Bernardino, California, filed for municipal bankruptcy after disclosing a $46 million shortfall in the city's budget, the third California city to seek court protection from creditors since June 28. California cities from the Mexican border to San Francisco Bay are confronting rising pension costs as they contend with growing unemployment and declining property- and sales-tax revenue. The costs stem from decisions made when stock markets were soaring and retirement funds were running surpluses."

August 1 - Bloomberg (Steven Church): "Stockton, the bankrupt California city, is trying to force bond insurer Assured Guaranty Corp. to accept $100 million in losses instead of seeking more concessions from labor unions, the company said... In a statement today, Assured said that its claims should be treated the same as those of other creditors, including any filed by employees."

July 31 - Bloomberg (Dan Levy): "San Francisco office-building sales may exceed $5.3 billion this year, the most since the market peaked in 2007, amid a technology-fueled rent surge that shows no signs of slowing."

Muni Watch:

July 31 - Bloomberg (Gillian White): "California municipal funds are garnering the most demand since 2007, helping fuel the biggest rally in the state's debt since May and allaying concern that bankruptcies would curb the appetite of individual investors. With local yields close to the lowest since the 1960s, investors seeking tax-free income are willing to take the added risk of debt from Standard & Poor's lowest-rated U.S. state. Bond funds focusing on California issuers have added assets for 18 straight weeks, the longest streak since 2007, according to Lipper..."

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
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