"Max Wiehle, son of the founder of the long-defunct Fairfax County, Va., hamlet of Wiehle Station, was a Washington, D.C., businessman who owned Potomac Sales, a car dealership”
Ilargi: The August 15 trading day closed to headlines such as this:
"[US] stocks jumped, posting the third consecutive gain and the best 3-day rally since March 2009...".
Sounds good, doesn't it? But perhaps a wee bit of perspective is in order. Financials were up yesterday, but here's what they look like over the medium term:
- Bank of America:
+7.93% Aug 15, but -22.4% in past month, -34.95% in past 3 months
+4.76% Aug 15, but -18.53% in past month, -24.71% in past 3 months
- Morgan Stanley:
+6.10% Aug 15, but -15.03% in past month, -25.74% in past 3 months
- Goldman Sachs:
+2.28% Aug 15, but -8.28% in past month, -15.79% in past 3 months
- Société Générale:
+2.06% Aug 15, but -28.53% in past month, -41.23% in past 3 months
Reality is not quite the same, in other words, as the headlines. The "best 3-day rally since March 2009" leaves a lot to be desired. In fact, the chances that these stocks will ever recover are very slim, and even if they do, it won't be for long.
The financial institutions are being slowly overwhelmed by their debts, despite all the bailouts thrown at them, both in the past 3 years and going forward.
Today may be a crucial day in the markets, though chances are that you'll have a hard time noticing as much when all's said and done. The language of politics and diplomacy will take care of that. Still, no matter how carefully it'll all be put into words, something's on the verge of breaking.
There will be a meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy. The issue at hand is, as it always is these days, how to save the euro, the eurozone, and the economies of the peripheral countries, a list that keeps growing slowly but surely.
The one item that spokesmen trip over themselves to declare will not be on the agenda is the only one that counts. Therefore, it will be on the agenda. Eurobonds.
In order to save Italy and Spain from being downgraded by the ratings agencies and attacked by the bond markets, Europe needs to come up with a huge pile of money. It's really as simple as that. But Europe either doesn't have that kind of money or is not willing to spend it, depending on your point of view. The difference between financial capital and political capital; the chasm may not be that wide.
The "official tools" such as the European Financial Stability Facility, and the European Stability Mechanism it is set to give birth to, are woefully inadequate.
The total size of Italy and Spain's bond markets is €2.1 trillion ($3 trillion), while PIIGS bonds due in the next 2 years add up to €795 billion ($1.145 trillion).
The EFSF and ESM can't prop up all of this. Not even close. The European Central Bank has started buying some of the bonds, but long before it could swallow them in sufficient numbers, it would be in need of a bailout itself. And that's how we inevitably get to Eurobonds.
If the Eurozone would start issuing bonds guaranteed by all its members, the hope is that they would be rated as high as German bonds (Bunds) today, AAA, and carry similar interest rates. Italy and Spain (as well as Ireland, Portugal, Greece etc.) could then borrow on international markets much cheaper than they can presently.
But this will never happen, as I've argued many times before, for instance in Europe throws in the towel. The premise of that article, that the ECB had irrevocably signaled its fatal lack of firing power, was doubted by many, and perhaps still is. Today's developments will show why it is correct nevertheless. Perhaps not instantly, but since there is just one possible outcome, this is an easy call.
First, there is fast growing opposition in Germany against the Eurobonds plan, not in the least because it is widely deemed unconstitutional (in both German and EU constitutions). Opposition is equally fierce in Holland. A poll yesterday by YouGov and Bloomberg showed 75% of Germans disapprove of their government's actions during the eurozone debt crisis, with 59% saying no further bailouts should be given, even if they were essential to keep the eurozone intact.
Second, reports came out just this morning that indicate that the German and Dutch economies have stopped growing almost entirely. Both show a Q2 2011 growth rate of 0.1% (statistical error territory). If anything, this is bound to increase opposition to the Eurobonds issue. Not that more opposition were needed or would make a difference anymore. No EU treaty ever provided for Germany saving Italy, or the other way around, for that matter. No such thing was ever a realistic option.
Merkel and Sarkozy may come out of their meeting later today with some sort of plan, veiled in carefully crafted language, that aims at raising the ceiling(s) for one or more of the financial instruments that are presently available in the Eurozone. And the ECB may keep buying PIIGS bonds for a while longer. But none of it will change the real problem in any way or shape that matters.
What I said on August 5 in Europe throws in the towel will become accepted reality in a manner of weeks. Europe will -have to- admit that it can't save a country the size of Italy, at least not one with debts the size of Italy's.
What happens after that is, for now, anybody's guess. We can be sure that there are contingency plans being set up, and likely even discussed at today's meeting, but it doesn't look at all like Berlin and Paris have any more grip on the issues than anyone else has.
Germany and Holland may decide to leave the EU, but that would leave France in a type of isolation that Sarkozy deems unacceptable. Greece, Ireland and Portugal could be thrown out, but that wouldn't solve the Italian and Spanish problems. They could aim for a two-tier Euro system, with "northern" euros more highly valued than "southern" ones, but that would still leave France very unhappily hanging by its fingernails.
Perhaps it's reasonable, then, to expect the financial markets to have the final word. They can start, or rather resume, doing so today. If and when it becomes clear that Europe's support of Italy and Spain is hollow at best and non-existent at the core, their borrowing rates can rise once again, along with those of the rest of the PIIGS and perhaps soon France. What is to save the likes of Société Générale (huge Italy exposure, world's no. 1 equity derivatives book) when that happens is also anybody's guess.
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The Bigger Picture: Primer Guide Update
Germany's Angela Merkel faces eurobond mutiny
by Ambrose Evans-Pritchard - Telegraph
German Chancellor Angela Merkel's coalition partners are threatening a withdrawal from government if she agrees to eurobonds or any form of fiscal union to prop up southern Europe.
The simmering revolt in the Bundestag makes it almost impossible for Mrs Merkel to offer real concessions at Tuesday's emergency summit with French president Nicolas Sarkozy. "We are categorical that the FDP-group will not vote for eurobonds. Everybody must understand that there is no working majority for this," said Frank Schäffler, the finance spokesman for the Free Democrats (FDP).
Oliver Luksic, the FDP's Saarland chief, told Bild Zeitung the survival of Germany's coalition was now rests on the handling of this issue. "Eurobonds are a sweet poison that leads to more debt, rather than less. Should the government endorse a common European bond and with it take the final step towards a long-term debt union, the FDP should seriously ask whether the coalition has any future."
Alexander Dobrindt, general-secretary of Bavaria's Social Christians (CSU) and a key Merkel ally, said his party has issued a "crystal clear 'No' to eurobonds". Chancellor Merkel also faces mutinous grumbling among her own Christian Democrats (CDU), though the party's policy elite is willing to consider partial eurobonds up to the Maastricht limit of 60pc of GDP but only under stringent conditions.
It is clear the German public is in no mood for any such formula. A YouGov poll shows 59pc of Germans oppose all further bail-outs. The majority want to see Greece expelled from the euro and 44pc want Germany to withdraw from EMU. "Given the rising euroscepticism in the population, it is too politically dangerous to toy with the explosive subject of eurobonds," said Hamburger Abendblatt.
Otmar Issing, the European Central Bank's former chief economist, told German TV a move to eurobonds would impoverish Germany and subvert the Bundestag. "That would be catastrophic. I cannot understand how any German politician agree to this," he said.
Germany's constitutional court has yet to rule on the legality of EMU's bail-out machinery and is likely to pay close attention to his warnings that the drift of EU policy is to concentrate budgetary powers in the hands of EU officials outside democratic control.
Professor Wilhelm Hankel from Frankfurt University said a eurobond is camouflage for fiscal union. "That is forbidden under EU law and the German constitution. Everybody in parliament realises we are very near to the Rubicon and that if they say yes to eurobonds they cannot stop the march to a transfer union."
Mrs Merkel's spokesman played down hopes of a breakthrough at Tuesday's meeting, denying reports that eurobonds are on the agenda. The meeting will focus on tougher rules for delinquents.
Wolfgang Schäuble, Germany's finance minister, is sticking to the script that the EU's accord in July provides all the tools needed to tackle the crisis. "I'm ruling out eurobonds for as long as member states pursue their own financial policies and we need differing interest rates as a way to provide incentives and sanctions, in order to enforce fiscal solidity. Without this solidity, the foundations for a common currency don't exist," he told Der Spiegel.
However, events are moving at lightning speed and markets fear the €440bn bail-out fund (EFSF) is too small to cope with dual strains in Italy and Spain. The crisis has now escalated to a new and dangerous level as concerns over a global double-dip recession put the spotlight on the debt dynamics of France. The French economy stood still in the second quarter and EFSF costs may see the country to lose its AAA rating.
The ECB is holding the breach for now. It bought a €22bn of eurozone bonds last week, a high figure given the low liquidity in August. The purchases have cut yields on 10-year Spanish and Italian bonds by 120 basis points to about 5pc. Investors know yields also fell hard when the ECB first bought Greek, Irish, and Portuguese bonds, only to climb back up within weeks.
Marcel Alexandrivich from Jefferies said the moment of danger will come when the ECB is seen to hit its limits. "The ECB can act as a buyer-of-last resort for a while but if it has to purchase bonds at €20bn to €30bn a week there will come a point it will say enough is enough, we can't take this on our books any longer."
It is unclear where that point lies. The ECB intends to hand the baton to the EFSF once its new powers are ratified by all parliaments, but EFSF's remaining firepower will be less €300bn. Carl Weinberg from High Frequency Economics said this constraint will force the ECB to desist sooner rather than later. "If so, yields on Italian and Spanish bonds will jump in a heartbeat," he told Bloomberg.
Concerns Mount in Germany Over ECB Bond Buys
by Peter Müller, Christoph Pauly, Christian Reiermann, Michael Sauga and Hans-Jürgen Schlamp - Spiegel
The euro drama is escalating in Berlin. In order to save the common currency, the European Central Bank is now purchasing large volumes of Italian government bonds. German central bankers and politicians in Chancellor Merkel's government oppose the move, which they see as a dangerous threat to the ECB's independence.
The timing was very cunning. It was 7:50 p.m. on Sunday, Aug. 7, when Germany's Federal Press Office released a joint statement by Chancellor Angela Merkel and French President Nicolas Sarkozy. Though hedged in diplomatic terms, the Continent's two most powerful political leaders were demanding that the Frankfurt-based European Central Bank (ECB) take an active role in helping Spain and Italy weather the euro crisis. Either the bank supplied money, they said, or the euro was finished.
It wasn't long before the wire agencies transmitted the first news alerts. It was a carefully planned chain of events -- and an insidious one, too. Indeed, Merkel and Sarkozy knew only too well that, at that very moment, the ECB's governing council was holding a conference call to discuss the next steps. The council's 23 members had been arguing for almost two hours over whether the ECB should buy up Spanish and Italian sovereign bonds to prop up their value.
It took the central bankers almost two more hours to cobble together a majority to support the plan. The toughest resistance came from Jens Weidmann, the president of the Bundesbank, Germany's central bank. He stubbornly opposed the decision till the bitter end -- but all was in vain. The next day, the ECB launched the greatest purchasing of government debt in its history. The move shakes the already fragile foundations of the monetary union. But it's not just the stability of the euro that's at stake; it's also the credibility of the very institution charged with preserving its value.
When the ECB was founded 13 years ago, it was meant to be a European version of Germany's Bundesbank and the heir to its steadfast principles: The sole duty of central bankers is to maintain price stability while remaining politically independent. And their supreme task is to deny the government access to the money printers. Indeed, things at Europe's central bank were supposed to go just like they did under Karl Otto Pöhl and Helmut Schlesinger, the legendary pair of Bundesbank presidents who served between 1980 and 1993 and primarily solidified their reputations by being able to say "no" at the crucial moment.
'Europe's Biggest Bad Bank'
But, under the pressure of the euro crisis, Europe's central bankers have assumed duties listed nowhere in their statutes. For example, the ECB is drafting austerity programs for heavily indebted countries, including Greece, Ireland and Italy, bailing out major banks and propping up the value of the sovereign bonds of five euro-zone countries.
Critics have come to ridicule the ECB as "Europe's biggest bad bank," and the reputation of ECB President Jean-Claude Trichet has also suffered. Indeed, even some of Trichet's close companions believe he has become all too eager to bend to political will. For example, in a guest contribution published in London's Financial Times on Aug. 8, former ECB chief economist Otmar Issing criticized the bank for considering an amendment to its "no bail-out" clause. Doing so, he wrote, would be "a move on a slippery road to a regime of fiscal indiscipline drowning hitherto solid countries in the morass of over-indebtedness."
Indeed, the common currency that was supposed to unite the Continent is now threatening to split it apart. And one of the deepest fissures runs straight through the ECB itself. Trichet and his colleagues from heavily indebted countries in southern Europe favor a massive effort to purchase sovereign state bonds. But the head of the Bundesbank and his colleagues from the EU's "net payer" countries, such as Luxembourg and the Netherlands, believe that would be a major mistake because they fear it would only trigger inflation.
Almost two years after Greece's government acknowledged that the country was much more indebted than previously known, the currency crisis has reached a whole new stage. Until now, euro-zone governments have been trying to protect the common currency by piling more and more money into bailout funds. But that's not enough for investors anymore. Now they're demanding that the net-payer states offer practically unlimited guarantees for almost every conceivable amount, even when it comes to seriously indebted countries, such as Spain and Italy.
Germany's Tough Choices
"Germany is in the driver's seat," says George Soros, the major investor and hedge fund manager based in New York. As he sees it, Germany's government is facing a difficult decision: Either it accepts that the ECB will provide long-term assistance as a financer of state debt, or it clears the way for the introduction of so-called "euro bonds," ones common to all euro-zone member states. In effect, the latter option would mean that Germany would automatically be jointly liable for any loans taken out by fellow euro-zone countries, such as Italy or Greece.
German Finance Minister Wolfgang Schäuble opposes this second option and believes that economic assistance should only be given out under strict conditions. "We're not going to bail out countries at any price," Schäuble told SPIEGEL in an interview published this week. Although he left open the question of potential consequences, there's no denying they would be significant: Greece would go bankrupt and possibly abandon the monetary union. The whole euro zone could break up.
Indeed, with ECB President Trichet saying this "is the worst crisis since the second world war," it's hardly surprising that the government coalition in Berlin -- made up of Merkel's center-right Christian Democratic Union (CDU), its Bavarian sister party, the Christian Social Union (CSU) and the business-friendly Free Democratic Party (FDP) -- is getting increasingly nervous. Senior party officials are worried they might not secure majorities in the upcoming votes on the euro bailout package in the Bundestag, Germany's federal parliament.
What's more, they're afraid that Trichet's controversial bond plan might spark opposition within their own ranks. "It would be a serious matter if we reached the point where Germany was outvoted on the ECB's governing council by the debtor countries," says Alexander Dobrindt, the CSU's general secretary. "The ECB needs to regain its political independence as quickly as possible and only make decisions based on stability principles."
Such displeasure is understandable given the considerable political pressure the ECB has been facing in making its decisions. For example, when the risk premiums on Italian government bonds rose to all-time highs in early August, the ECB initially bought up Irish and Portuguese bonds, just as it had already done a number of times before.
'We Cannot Give Way to Panic'
When it became clear that the measures were having little effect, Trichet summoned the other members of the ECB's executive board and the central bankers of euro-zone countries on Aug. 7 to join an evening conference call to debate how Spain and Italy should be helped.
Trichet sensed he would have a hard time making his case. To soften up his colleagues, he wrote a harshly worded letter to the Italian government relaying his conditions for granting support. Together with Mario Draghi, the president of Italy's central bank and his designated successor at the helm of the ECB, Trichet called on the Italian government to implement far-reaching reforms to the labor market, pensions and the deficit-ridden public health-care system. He also urged Rome to privatize state assets. Likewise, he stressed that Italy had to balance its budget by 2013, a year ahead of schedule.
Although Rome promptly signaled it would agree to such terms, Trichet still knew that the ECB's governing council would be deeply divided. Indeed, the cleft had already become apparent the previous Thursday. Bundesbank chief Weidmann had led the group arguing against anything involving the buying of government bonds. Doing so, he reasoned, would be tantamount to dissolving the border between monetary and fiscal policies. Following in the footsteps of his predecessor, Axel Weber, Weidmann urged his colleagues to keep the greatest distance possible between the central bank and the finances of individual states.
Actions Upsetting to Merkel
Weidmann's actions were deeply upsetting to Chancellor Merkel. Just a few months earlier, Weidmann had been serving as one of her economic advisers. She had called him right before the conference call on Sunday evening urging him to relent. Shortly thereafter, the members of the ECB's executive board hustled into Trichet's office to use his secure telephone line. On the call were the other 17 members of the ECB's governing council all across Europe, some of whom had been forced to cut their vacations short. In dramatic terms, Trichet pleaded with his colleagues to act. If they didn't, he warned, Italy, the world's third-largest bond market, would implode -- and no one could predict how this would affect the euro and the global economy.
Nevertheless, Weidmann, ECB Chief Economist Jürgen Stark and the representatives from Luxembourg and the Netherlands held their ground. They argued that the ECB's sole mandate was to safeguard the stability of the euro's value and that it wasn't its job to prop up heavily indebted countries or even to protect the capital markets from themselves.
The debate focused on key issues of financial and monetary policy. For the Bundesbank, it had always been taboo to finance the state by purchasing its sovereign bonds. Behind this belief was the terrifying example of its predecessor, the Reichsbank, which had printed money with abandon in the 1920s in order to support the budget of the Weimar Republic. The result was a hyperinflation that has become deeply entrenched in the collective memory of Germans.
Indeed, Axel Weber, Weidmann's predecessor, was so opposed to the idea of purchasing sovereign bonds that he prematurely retired from his position as Bundesbank president and withdrew his name as a candidate to succeed Trichet as head of the ECB. As he saw it, the fact that ECB higher-ups had even discussed breaking this still-unbroken taboo in May 2010 in response to the crisis in Greece was an unforgivable error.
'A Clear Violation of the Treaty'
This led Weber to write an impassioned e-mail on May 7, 2010 to his colleagues on the ECB's governing council. Though the contents of the letter had not been made public before, last week's developments make it particularly relevant to the current situation.
"We must not panic" he warned them. Although he believed the ECB had to respond to the crisis by making an unlimited amount of liquidity available, he vehemently argued against purchasing sovereign bonds. Doing so would be "a clear violation of the treaty" that had served as the basis for establishing the bank. He also wrote that the ECB was standing at a crossroads and that the governing council had to "resist government pressure." The risk of damaging the ECB's reputation, he argued, by far outweighs any short-term gains that might be made by buying sovereign bonds. "Let us not disappoint our people" Weber warned -- and he announced that he would go public with his opposition.
Despite the passionate appeal, Weber was only able to convince four other colleagues on the ECB governing council to join him in voting against the plan to buy up sovereign bonds. The vast majority of its members bought the argument of Trichet, who already at that point viewed the world as teetering at the edge of the abyss.
Within a few months, the ECB purchased almost €80 billion ($115 billion) in government bonds from Greece, Portugal and Ireland, which everyone was eager to unload. Together, the national central banks that are part of the euro system and shareholders in the ECB, including the Bundesbank, have been forced to make billions in writedowns.
Even with such bad experiences behind them, on Aug. 7, the majority of members on the ECB's governing council voted to support Trichet's new proposal. Weidmann and his three confederates were outvoted.
This was a bitter outcome for the Bundesbank. As a result of this decision, already last week it was forced to buy up massive amounts of Italian and Spanish sovereign bonds. This results from the fact that, within the context of the euro system, the ECB also uses the Bundesbank as a vehicle to make billions in such purchases. As one Bundesbank official put it, doing so "goes against our genes."
The ECB's Sweet Poison
Those in the Trichet camp, on the other hand, view the ECB as the last functioning institution in Europe. ECB experts argued that this is why the bank was forced to take action after interest rates on Italian bonds rose to dangerously high levels in recent weeks. In their view, failing to act threatened to dry up lending to companies and private clients.
The ECB was happy when the interest rate on Italian bonds dropped from 6 percent to 5 percent in the wake of its actions. But even if that sounds like success, Trichet knows that his strategy won't work in the long term. If, as in the case of Greece, the markets have made up their mind that a country will never pay back its debts because it is bankrupt, then there is also little the ECB can do. In fact, the central bank would be constantly pumping more money into the markets without really helping the country.
Even worse, such actions could also get politicians in the entire euro zone quickly used to the ECB's sweet poison. After all, it's much easier to fall back on ECB money than to get parliament to agree to tax increases. This has led former Bundesbank officials, including Weber, to accuse the ECB's measures of only delaying the inevitable introduction of the kind of radical reforms necessary in countries like Italy.
More than anything, buying up sovereign bonds is damaging the reputation of the ECB itself. If the ECB adds huge amounts of questionable sovereign bonds to its portfolio and that country one day becomes insolvent, it could result in considerable losses. In that case, it would be forced to write down parts of its assets and beg euro-zone governments for fresh capital. Doing so would risk damaging the central bank's reputation and independence, and the ECB could be tempted to start up the money-printing presses purely out of its own self-interest.
The ECB's questionable decision has also alienated members of the governing parties in Berlin. So far, members of parliment with the CDU/CSU and FDP have reverently accepted ECB decisions related to bailing out the euro, including the first and second bailout packages for Greece, the establishment of temporary and permanent euro-bailout funds -- the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM), respectively -- and the aid programs for banks.
Opposition Grows in Berlin
Indeed, the coalition government has already made more than €140 billion available for efforts to bail out the euro. Given this generosity, politicians in the coalition parties are alarmed that the ECB's governing council has apparently now decided to routinely act against the reservations of its German members.
"The ECB cannot become an institution that can compensate for the failures of the budgets of individuals states, such as Italy, over the long term," says Volker Bouffier, governor of the western state of Hesse, where the ECB is based. "That doesn't correspond with its mandate, and that takes the pressure off the affected countries to put their budgets in order by themselves."
Stanislaw Tillich, the governor of the eastern state of Saxony, holds a similar view and believes the ECB program has to "remain an exception." To do otherwise would "only prove correct the people who were afraid at the time of the euro's introduction that the ECB would be less diligent in safeguarding monetary stability than the German Bundesbank."
Even Rainer Brüderle, the senior FDP official who recently stepped down as economics minister to become his party's parliamentary floor leader, views the ECB's policy of buying sovereign bonds to prop up troubled nations "with very mixed feelings." Things cannot be allowed "to go on like this forever," he says.
Still, the greatest resentment can be found within the ranks of the CSU. Many of its members share the fears of Thomas Silberhorn, a party expert on European affairs, who says that the ECB's "institutional independence … is gone." As he sees it, by introducing these measures, the ECB has overstepped its competencies in terms of monetary policy, and made a "shambles" of the foundations of the EU treaties.
Even Erwin Huber, former head of the CSU and finance minister of the state of Bavaria, believes the ECB's reputation has been damaged. "The Bundesbank would never have financed state debt at the expense of the currency's value," he says. "That is a serious violation of the entire euro blueprint."
By breaking this taboo, the ECB has bred mistrust in the most recent bailout measures and is giving fresh impetus to the euroskeptics within the coalition parties. About a dozen members of parliament from the FDP are considered to be euroskeptics, and more and more members of the CDU/CSU are calling for an emergency gathering to discuss the debt crisis.
To respond to this growing resentment, coalition leaders in Berlin have started making futile attempts at appeasement. CDU higher-ups hope to calm the base in coming weeks at so-called regional conferences. Economic Minister and FDP chairman Philipp Rösler has announced plans to set up a stability council at the EU level -- though the announcement took even Finance Minister Schäuble by surprise.
'A Country Like Italy Can't Be Saved'
Even the bailout experts in Merkel's Chancellery are trying to allay worries among it supporters by noting that the ECB is only temporarily supposed to purchase sovereign bonds, until late September. On July 21, the heads of state and government of the euro-zone member states decided that the EFSF euro bailout fund would take over such responsibilities at that time.
But, until then, the ECB will be obliged to prop up the euro's value. The only problem with that is that everyone wants to get rid of the risky sovereign bonds from Spain and Italy, but hardly anybody wants to buy them. In other words, the ECB will be bleeding money for weeks.
Experts even fear the ECB might buy several hundred billion euros in Italian and Spanish bonds. If it took a similar proportion of bonds from those countries as it previously did from Greece, Ireland and Portugal, it would have to pay €300 billion.
A Risk of Inflation
In theory, the ECB can afford such sums, since it will be the one printing the money. And that's what makes this kind of intervention so attractive to many. As they see it, the ECB has unlimited firepower at its disposal to deter the markets from continuing to speculate against Spain and Italy.
In doing so, however, the ECB runs the risk of triggering inflation. What's more, there's some doubt as to whether the EFSF will be able to take responsibility from the ECB for purchasing sovereign bonds in September, as planned, because only limited means are at its disposal. At the moment, the amount of loans the EFSF can issue is capped at €440 billion. But a major portion of that has already been earmarked to help Greece, Portugal and Ireland. As a result, the bailout fund won't be able to afford to keep up for long the constant pace of purchasing that the markets have grown used to.
Given these circumstances, many political players believe an increase in the funds at the EFSF's disposal will be inevitable in order to impress the markets. This group includes European Commission President José Manuel Barroso, but even the French government has shown some sympathy for the idea. Backers of the Barroso plan argue that this use of means will boost credibility. But the Germans don't agree. In their view, each time the EFSF's resources are increased, it sends a fresh invitation to the markets to test new boundaries.
Experts surrounding Finance Minister Schäuble suspect it would be almost impossible to win this kind of race with the markets, at least when it comes to Italy. As they see it, if the financial markets fail to recover their faith in Italy's government, even those in Berlin who favor a bailout would have nowhere else to turn. As one official put it: "A country like Italy can't be saved."
German Economy Almost Stalled in Q2
by Jana Randow - Bloomberg
The German economy, Europe’s largest, almost stalled in the second quarter as the region’s sovereign debt crisis weighed on confidence.
Gross domestic product, adjusted for seasonal effects, rose 0.1 percent from the first quarter, when it jumped a revised 1.3 percent, the Federal Statistics Office in Wiesbaden said today. Economists had forecast growth of 0.5 percent, according to the median of 33 estimates in a Bloomberg News survey. From a year earlier, GDP increased 2.8 percent.
Germany has been powering euro-area growth as the debt crisis curbs spending across the region. The worse-than-expected GDP data add to signs the region is flirting with a renewed economic slump. France’s recovery unexpectedly ground to a halt in the second quarter, Italian and Spanish expansion remained sluggish and Greece’s economy contracted.
“Euro-zone growth will be very, very sluggish for the rest of the year,” said Aline Schuiling, senior economist at ABN Amro Bank NV in Amsterdam. “If the global economy is cooling, we’ll also see it in Germany.”
Euro-area economic growth probably slowed to 0.3 percent in the second quarter from 0.8 percent in the first, a Bloomberg survey shows. The European Union’s statistics office in Luxembourg will release that report at 11 a.m. today.
France said last week its economy stagnated in the three months through June, while reports on Aug. 5 showed Italy’s GDP rose 0.3 percent and Spain’s increased 0.2 percent. The German statistics office revised first-quarter growth down from the initially reported 1.5 percent.
Quantitative easing 'is good for the rich, bad for the poor'
by Heather Stewart - Observer
As the Bank of England prepares to vote on quantitative easing, a report argues the extra cash 'exacerbates already extreme income inequality'
Quantitative easing (QE) – the Bank of England's recession-busting policy of buying up billions of pounds of bonds – may have contributed to social unrest by exacerbating inequality, according to one City economist.
As the Bank of England considers unleashing a fresh round of QE, Dhaval Joshi, of BCA Research, argues the approach of creating electronic money pushes up share prices and profits without feeding through to wages. "The evidence suggests that QE cash ends up overwhelmingly in profits, thereby exacerbating already extreme income inequality and the consequent social tensions that arise from it," Joshi says in a new report.
He points out that real wages – adjusted for inflation – have fallen in both the US and UK, where QE has been a key tool for boosting growth. In Germany, meanwhile, where there has been no quantitative easing, real wages have risen.
As the Bank waded into the financial markets to spend its £200bn of newly created money, mostly on government bonds, the price of many assets, including shares and commodities such as oil, was driven up.
That helped to boost companies' revenues, but Joshi argues that with the labour market remaining weak, employees have had little hope of bidding up their wages. "The shocking thing is, two years into an ostensible recovery, [UK] workers are actually earning less than at the depth of the recession. Real wages and salaries have fallen by £4bn. Profits are up by £11bn. The spoils of the recovery have been shared in the most unequal of ways."
Joshi adds that this also helps to explain why sales of high-end luxury goods have continued to soar, while many consumers have been forced to tighten their belts. "High-income earners are more exposed to profits as owners of businesses or shareholders. Low-income earners are dependent on wages," he says.
Joshi's contribution is the latest salvo in a furious row among economists about the effectiveness of QE. Some, including Danny Gabay of consultancy Fathom, have argued that the electronically created money would have been better invested in housing, instead of disappearing into the crisis-hit banking sector.
Adam Posen, the US economist on the Bank's monetary policy committee, has repeatedly voted for a new round of QE, urging his colleagues to agree to spend another £50bn. This month's meeting of the MPC will reveal whether any other members joined him in voting for what the Americans are calling "QEII".
Paul Krugman: Fake Alien Invasion Would End Economic Slump
Paul Krugman is so frustrated by the lack of support for another round of stimulus spending that he's now calling for a fake alien invasion of the United States to spur a World War II-style defense buildup. Krugman was a guest on CNN's "Fareed Zakaria GPS" on Sunday.
Speaking with Zakaria and Harvard economist Ken Rogoff, he made the same case he has been making for years--that deficits are not the top economic concern of the day. Krugman noted that the effort of World War II helped end the Great Depression, and joked that something similar was needed today.
"If we discovered that, you know, space aliens were planning to attack and we needed a massive buildup to counter the space alien threat and really inflation and budget deficits took secondary place to that, this slump would be over in 18 months," he said. "And then if we discovered, oops, we made a mistake, there aren't any aliens, we'd be better--"
"We need Orson Welles, is what you're saying," Rogoff cut in.
"There was a 'Twilight Zone' episode like this in which scientists fake an alien threat in order to achieve world peace," Krugman said. "Well, this time, we don't need it, we need it in order to get some fiscal stimulus."
We've been warned: the system is ready to blow
by Larry Elliott - Guardian
Only a new way of managing the global economy can prevent more mayhem in the markets and on the streets
For the past two centuries and more, life in Britain has been governed by a simple concept: tomorrow will be better than today. Black August has given us a glimpse of a dystopia, one in which the financial markets buckle and the cities burn. Like Scrooge, we have been shown what might be to come unless we change our ways.
There were glimmers of hope amid last week's despair. Neighbourhoods rallied round in the face of the looting. The Muslim community in Birmingham showed incredible dignity after three young men were mown down by a car and killed during the riots. It was chastening to see consumerism laid bare. We have seen the future and we know it sucks. All of which is cause for cautious optimism – provided the right lessons are drawn.
Lesson number one is that the financial and social causes are linked. Lesson number two is that what links the City banker and the looter is the lack of restraint, the absence of boundaries to bad behaviour. Lesson number three is that we ignore this at our peril.
To understand the mess we are in, it's important to know how we got here. Today marks the 40th anniversary of Richard Nixon's announcement that America was suspending the convertibility of the dollar into gold at $35 an ounce.
Speculative attacks on the dollar had begun in the late 1960s as concerns mounted over America's rising trade deficit and the cost of the Vietnam war. Other countries were increasingly reluctant to take dollars in payment and demanded gold instead. Nixon called time on the Bretton Woods system of fixed but adjustable exchange rates, under which countries could use capital controls in order to stimulate their economies without fear of a run on their currency.
It was also an era in which protectionist measures were used quite liberally: Nixon announced on 15 August 1971 that he was imposing a 10% tax on all imports into the US. Four decades on, it is hard not to feel nostalgia for the Bretton Woods system. Imperfect though it was, it acted as an anchor for the global economy for more than a quarter of a century, and allowed individual countries to pursue full employment policies. It was a period devoid of systemic financial crises.
There have been big structural changes in the way the global economy has been managed since 1971, none of them especially beneficial. The fixed exchange rate system has been replaced by a hybrid system in which some currencies are pegged and others float. The currencies in the eurozone, for example, are fixed against each other, but the euro floats against the dollar, the pound and the Swiss franc.
The Hong Kong dollar is tied to the US dollar, while Beijing has operated a system under which the yuan is allowed to appreciate against the greenback but at a rate much slower than economic fundamentals would suggest.
The system is an utter mess, particularly since almost every country in the world is now seeking to manipulate its currency downwards in order to make exports cheaper and imports dearer. This is clearly not possible. Sir Mervyn King noted last week that the solution to the crisis involved China and Germany reflating their economies so that debtor nations like the US and Britain could export more.
Progress on that front has been painfully slow, and will remain so while the global currency system remains so dysfunctional. The solution is either a fully floating system under which countries stop manipulating their currencies or an attempt to recreate a new fixed exchange rate system using a basket of world currencies as its anchor.
The break-up of the Bretton Woods system paved the way for the liberalisation of financial markets. This began in the 1970s and picked up speed in the 1980s. Exchange controls were lifted and formal restrictions on credit abandoned. Policymakers were left with only one blunt instrument to control the availability of credit: interest rates.
For a while in the late 1980s, the easy availability of money provided the illusion of wealth but there was a shift from a debt-averse world where financial crises were virtually unknown to a debt-sodden world constantly teetering on the brink of banking armageddon.
Currency markets lost their anchor in 1971 when the US suspended dollar convertibility. Over the years, financial markets have lost their moral anchor, engaging not just in reckless but fraudulent behaviour. According to the US economist James Galbraith, increased complexity was the cover for blatant and widespread wrongdoing.
Looking back at the sub-prime mortgage scandal, in which millions of Americans were mis-sold home loans, Galbraith says there has been a complete breakdown in trust that is impairing the hopes of economic recovery.
"There was a private vocabulary, well-known in the industry, covering these loans and related financial products: liars' loans, Ninja loans (the borrowers had no income, no job or assets), neutron loans (loans that would explode, destroying the people but leaving the buildings intact), toxic waste (the residue of the securitisation process). I suggest that this tells you that those who sold these products knew or suspected that their line of work was not 100% honest. Think of the restaurant where the staff refers to the food as scum, sludge and sewage."
Finally, there has been a big change in the way that the spoils of economic success have been divvied up. Back when Nixon was berating the speculators attacking the dollar peg, there was an implicit social contract under which the individual was guaranteed a job and a decent wage that rose as the economy grew. The fruits of growth were shared with employers, and taxes were recycled into schools, health care and pensions. In return, individuals obeyed the law and encouraged their children to do the same. The assumption was that each generation would have a better life than the last.
This implicit social contract has broken down. Growth is less rapid than it was 40 years ago, and the gains have disproportionately gone to companies and the very rich. In the UK, the professional middle classes, particularly in the southeast, are doing fine, but below them in the income scale are people who have become more dependent on debt as their real incomes have stagnated. Next are the people on minimum wage jobs, which have to be topped up by tax credits so they can make ends meet. At the very bottom of the pile are those who are without work, many of them second and third generation unemployed.
A crisis that has been four decades in the making will not be solved overnight. It will be difficult to recast the global monetary system to ensure that the next few years see gradual recovery rather than depression. Wall Street and the City will resist all attempts at clipping their wings. There is strong ideological resistance to the policies that make decent wages in a full employment economy feasible: capital controls, allowing strong trade unions, wage subsidies, and protectionism.
But this is a fork in the road. History suggests there is no iron law of progress and there have been periods when things have got worse not better. Together, the global imbalances, the manic-depressive behaviour of stock markets, the venality of the financial sector, the growing gulf between rich and poor, the high levels of unemployment, the naked consumerism and the riots are telling us something.
This is a system in deep trouble and it is waiting to blow.
Markets Gird for Fresh Drama
by E.S. Browning - Wall Street Journal
As stock markets prepared to open Monday after one of the most volatile weeks in history, some world leaders Sunday warned about the worrisome health of the global economy.
"We are entering a new danger zone," World Bank President Robert Zoellick said Sunday during a visit to Australia, adding that world leaders need to take strong action "both short- and long-term to restore confidence." Singapore Prime Minister Lee Hsien Loong said that another global recession could arise given economic uncertainties in the U.S. and Europe, which could drag down Asian powerhouses such as China and India.
The Dow Jones Industrial Average swung last week between huge gains and losses amid doubts about the strength of the U.S. economy and Europe's deepening debt crisis. In Asian trading midday Monday, shares were broadly higher on the back of Wall Street's gains Friday, with benchmark indexes in Hong Kong, Australia and Taiwan around 2% higher. Tokyo was up 1% amid better-than-expected gross domestic product figures.
Although the week in the U.S. ended on a high note—the Dow rose a combined 5.1% on Thursday and Friday—many market analysts say the big swings, and particularly the big dips, are a sign that financial markets are far from stabilizing three years after the financial crisis.
These market analysts say stocks may be in for more volatility, in part because political leaders have been unable solve core issues afflicting many developed nations, such as huge debt burdens and stagnating economies.
In the coming week, French President Nicolas Sarkozy and German Chancellor Angela Merkel are scheduled to meet to discuss Europe's problems, and investors will get reports on manufacturing activity, the housing market, jobless claims and European growth. All of this could affect market confidence.
Some analysts are comparing the current market situation to the long-running market troubles of the 1930s and 1970s, when it took well over a decade for world economies and markets to recover and return to normal. Not everyone shares this view, but these skeptical analysts are warning clients to be prepared for more market trouble.
Whether stocks will continue to recover in the short run or resume their declines is much in debate. Some analysts sent out reports over the weekend reassuring clients that the past week's moves were a classic sign of a bottom. Others argued that it is too soon to predict how world events will affect stock performance.
The optimists point out that corporate profits have been exceptionally strong in recent quarters and that stocks look inexpensive as long as corporate earnings continue their strong gains. Skeptics contend that it will become hard for companies to repeat their strong profit gains, which could pose a problem for future stock growth.
Over the past nine trading days, five have been up and four have been down. Money managers say that has rattled client confidence. Jack Ablin says he gets lots of client calls on big down days—lately almost every other day. "It is certainly creating a higher level of anxiety," says Mr. Ablin, chief investment officer at Harris Private Bank in Chicago. To protect his clients' assets, he says, he has moved to reduce his firm's exposure to risky market sectors.
The anxiety may not be over soon. "It is going to be volatile because the overall economic environment is going to be volatile," says investment strategist Russ Koesterich at money-management firm BlackRock Inc.
Skeptics say that market behavior in the 2000s is looking similar in some ways to what investors faced in the 1970s, when inflation stifled stock growth for more than a decade, and in the 1930s, when an economic depression led to long-running market trouble.
The current period of stock weakness began in 2000 with the bursting of the technology-stock bubble, they say, and continued with the popping of the real-estate and mortgage bubbles in 2006 and 2007. "This current environment is similar, from a market standpoint, to the late '70s and even the late '30s," says Tim Hayes, chief investment strategist at Ned Davis Research in Venice, Fla. Market turmoil tends to keep recurring during these periods, he says, because "you have to go through this very long healing process, this process of restoring confidence."
Just like today, markets in the 1930s and 1970s were paying the price for the market bubbles and financial speculation that had come during boom times, and also were dealing with troubled world economies. It took years in each case to restore economic fundamentals and investor confidence.
A symptom of the current malaise is that, in the wake of bear markets from 2000 to 2002 and from 2007 to 2009, many individuals have been putting less money into stock mutual funds. Net dollar flows into U.S. stock mutual funds peaked in 2000 and have been lackluster since, according to the Investment Company Institute, a mutual-fund trade group.
Early this year, investors put money into U.S. stock funds, but lately have been taking money out, with billions of dollars moving out of such funds in each of the last five weeks. A net total of $10.4 billion came out of such funds in the week ended Aug. 3, the trade group reported, following $8 billion in withdrawals the previous week.
In periods such as the one that began in 2000, says Mr. Hayes of Ned Davis Research, "confidence never really comes back because of all the lingering worries. At the first signs of a double dip or some kind of recession, it gets the market moving in a negative way." Ultimately, those bearish eras end and strong market performance returns. Stocks returned to sustained gains from 1942 to 1966 and from 1982 to 2000.
Not all analysts agree with this kind of historical analysis. Some think stock movements are random events driven by economic events that can't be predicted. But those who endorse this way of looking at historic events call these longer-term periods of strength and weakness "secular" bull and bear markets. That distinguishes them from shorter-term "cyclical" bull and bear markets.
Cyclical bull and bear markets are simply moves of 20% or more, up or down. A secular bull or bear market includes several of these individual bull and bear markets, making these secular trends last roughly 12 to 18 years.
A secular bear market looks like a long sideways period. Stocks move violently up and down. Cyclical bull markets occur in this environment, but they tend to be weak. They can be followed by long, strong bear markets such as the one from 2007-09, which wipe out all or much of the previous bull market's gains. In this kind of long-term period, investor hopes are repeatedly raised and dashed.
Eventually, a secular bear market will give way to a period of sustained strength. But with debt and economic-growth problems afflicting both the U.S. and Europe, few economists expect the current market troubles to resolve themselves easily. "We are working through the speculative excesses of the last couple of bubbles" and the process isn't yet over, says Ben Inker, director of asset allocation at money-management group GMO LLC in Boston.
Markets enter 'new danger zone'
by Jonathan Sibun - Telegraph
Investors worldwide have lost confidence in economic leadership, driving financial markets into a "new danger zone", the head of the World Bank has warned ahead of a crucial meeting that could shape the future of the eurozone.
In a clear shot across the bows of leaders in Europe and the US, Robert Zoellick said the events of recent weeks had led "many market participants to lose confidence in economic leadership of some of the key countries".
Speaking at a dinner in Sydney, Australia, he added: "I think those events, combined with some of the other fragilities in the nature of recovery, have pushed us into a new danger zone. I don't say those words lightly ... so that policymakers recognise and take it seriously for what it is." Mr Zoellick said that a trend of acting on issues "a day late" had led to a situation where worry "has accumulated and so we're moving from drama to trauma for a lot of the eurozone countries."
The stark warning comes as French leader Nicolas Sarkozy and German chancellor Angela Merkel are set to hold a crunch meeting tomorrow. Mr Sarkozy, who saw French banks and the country's national debt come under attack last week amid speculation about the state's financial health, is expected to press the case for the eurozone to issue bonds backed by all 17 member nations. The idea has thus far been rejected by German leaders.
However, Germany newspaper Welt am Sonntag yesterday reported a possible thawing of opposition to the plan. The newspaper claimed the German government was no longer ruling out using the bonds as a last resort to protect against a break-up of the eurozone. Mrs Merkel and Mr Sarkozy are keen to find a permanent solution to Europe's sovereign debt crisis, which has already claimed Greece, Ireland and Portugal.
A spokesman for the German Finance Ministry declined to comment on the report but any optimism was tempered by an interview given by finance minister Wolfgang Schaeuble earlier in the day. He reportedly told Der Spiegel magazine: "There is no collectivisation of debt or unlimited support."
Hopes of a compromise could buoy European markets this morning after one of the most volatile weeks in recent memory left traders shell-shocked at the close of play last Friday. Markets should also take confidence in Italy's decision late on Friday to push through a €45.5bn (£39.8bn) programme of austerity measures, although optimism will be tempered after the country's biggest union threatened a general strike in opposition.
The CGIL labour union criticised the package of spending cuts and tax rises, hastily passed in response to demands by the European Central Bank, claiming it will strangle Italy's moribund economy. The CGIL said a strike was the only way to "change the inequity of this package".
Giulio Tremonti, Italy's finance minister, defended the programme, putting some of the blame on European neighbours. "We wouldn't have gotten here if we had had euro bonds," he said, calling for greater fiscal consolidation across Europe. Herman Van Rompuy, the EU president, said the austerity measures were "crucially important not only for Italy but for the eurozone as a whole". He added: "I fully support and welcome the timely and rigorous financial measures."
George Soros, the US investor, told Der Spiegel that the only solution for Europe might be for Greece and Portugal to quit the European Union. "The EU and the euro would survive it," he was reported to have said. Proof that Greece's austerity drive was having some success surfaced as it emerged that tax fraud tip-offs rose fourfold in Greece last year. The country's financial crimes squad received 18,500 tip-offs of financial impropriety against 4,500 in 2009.
Washington sets out to slay America's debt monster
by Richard Blackden - Telegraph
A week after its historic downgrade by Standard and Poor's, investors have been piling their money into US bonds.
'It's a fantastic auction," exclaimed Bill O'Donnell from his desk on Royal Bank of Scotland's vast trading floor in Stamford, Connecticut. It was early Wednesday afternoon and there was nothing fantastic about the state of the stock markets, with the Dow Jones Industrial Average down about 200 points as rumours swirled about the health of French banks. O'Donnell, one of RBS's chief fixed-income strategists, was instead talking about the US government's first sale of 10-year bonds since it dramatically lost its AAA credit rating five days before.
The pressure that had built as salespeople took orders from customers for a slug of the $24bn (£15bn) of debt was dissipating. And, among the hundreds of headlines scrolling at high-speed down the banks of Bloomberg terminals that pepper the 90,000 sq ft trading floor, you only needed to look at a handful to see the auction's success.
The US Treasury had managed to borrow money for 10 years by offering buyers a yield of 2.14pc, the lowest on record. The bid to cover ratio, a measure of demand used in the bond markets, was stronger than the average for the past 10 sales.
The much-anticipated auction had been given a helping hand from the Federal Reserve the day before, when the central bank promised to keep interest rates at record low levels until at least 2013 in its latest effort to shore up the economy. "There's currently a desperate need for yield," said O'Donnell. "The Fed has pushed short-term interest rates so low that people will be forced to take on more risk."
The five trading days that followed America's historic downgrade saw the US Treasury barely break a financial sweat in selling a total of $72bn in bonds. The last week has also underlined the advantages that the US has over other countries, including Britain, that are faced with large deficits.
Alongside gold, the Swiss franc and the Japanese yen, the $9trillion US Treasury market remained the safe-haven of choice for global investors seeking refuge from the turmoil. "The market is transparent and very liquid," said Rich Tang, who is head of fixed-income sales in the US at RBS, one of the 20 banks on Wall Street that help sell the government's debt. "You can do a $1bn ten-year bond trade and you're not going to leave a footprint."
But the extra cards that America still has in its deck, including the dollar's status as the world's reserve currency, are beginning to cause concern of their own. Will they be used by Washington to put off the country's day of reckoning with its $14trillion debt pile?
The Congressional Budget Office, an independent arm of government, has in its bleakest scenario forecast that the ratio of debt compared to the size of the economy will reach 190pc by 2035 if nothing changes. Even its more optimistic projection puts the ratio at 90pc by 2021 without a combination of reductions to key pension programmes such as Social Security and healthcare ones like Medicare, as well as tax increases. It's averaged just under 40pc for the last 40 years or so.
"Our form of government works best under pressure," said Bill Frenzel, the chief Republican member of the House of Representatives Budget Committee during the 1980s. "In my judgement S&P had to make the first step and I think it's a necessary first step."
Financial markets have spent the last year twitching, and often doing considerably more, in reaction to the successive efforts of European leaders to solve the region's debt crisis. But with last week's downgrade, and a Presidential election fast-approaching in which the deficit will be a central issue, it's politicians on Capitol Hill who will have to get used to more intense scrutiny from the world's financial capitals over the next 12 months. "The centre of finance is now in Washington DC," said Tang of RBS. "You have monetary and fiscal policy driving markets and I don't see that going away any time soon."
With the world's biggest economy averaging growth of just 0.8pc during the first half of the year, America has this month become the latest country to have to walk the tightrope between introducing a measure of fiscal austerity and ensuring the economy doesn't slide into another recession.
It wasn't in the script at the start of the year written by either The White House or the Fed, which had both forecast the recovery would be much stronger by now. It's why the focus of some in Washington and on Wall Street is turning to Britain, where the Coalition Government has embarked on a £110bn plan to eliminate the structural deficit by 2015.
"Britain has a plan," says Al Simpson. "We just need to give the world a plan." There aren't many people who have spent more time thinking about America's public debt than Simpson, a former Republican Senator from Wyoming. He was the co-chairman of the National Commission on Fiscal Reform and Responsibility, which last December presented President Barack Obama with a 60-page plan to begin to balance the country's books.
"We both know we're in the same boat," Simpson says of Britain and the US. The usual conversational icebreakers may not have been needed when he spoke to the Chancellor George Osborne for the first time earlier this year.
Whatever the Chancellor told Simpson, Britain's example so far offers one clear lesson for the US, according to Michael Saunders, the chief UK and European economist for Citigroup in London. "Announce early a credible fiscal plan that cuts the deficit over a long period," says Saunders. "By detailed, I mean what does it mean for the police? What does it mean for other budgets? It shows you're serious."
This month's bitter wrangling over raising the country's $14.3trillion debt ceiling suggests the lesson has yet to be absorbed. The deal that eventually saw the borrowing limited lifted at the eleventh hour agreed about $900bn of spending reductions and created a bipartisan Congressional committee to find another $1.5trillion of cuts over the next decade.
Voters were left underwhelmed, according to a poll this week in the Washington Post, with almost 75pc of people no longer believing that politicians are capable of addressing the country's economic challenges, including a budget deficit that's forecast to reach an annual record of $1.4trillion this financial year.
But the depth of the division between Republicans and Democrats over spending and taxes also alarmed investors. "Most US investors were surprised by the degree of divergence in ideological views and by the inability to come to some middle ground over cuts for the next 10 years," says Saumil Parikh, a fund manager at Pacific Investment Management Co (PIMCO), which runs the world's biggest bond fund.
And attention is already turning to the 12-person panel, known as the Joint Select Committee on Deficit Reduction, whose final three members were named last Thursday. Should they fail to find common ground on reducing the deficit by November 23, then automatic spending cuts of $1.2trillion will be triggered. "We'll be looking for a move away from something intransigent to a more balanced approach," explains PIMCO's Parikh. "It will be watched very, very closely."
The expectation is that, shaken by the recent turmoil in the stock markets and the downgrade, the panel will manage to cut the deficit by $1.5trillion over the next decade. But the early signs aren't immediately encouraging. Nancy Pelosi, the chief Democrat in the House of Representatives, made her three appointments to the panel last week, arguing that it must also deliver ways of creating new jobs. The six Republicans on it are likely to balk at any such suggestion unless growth slows much more rapidly over the next three months.
As the Obama administration and the Fed again struggle to reignite the recovery, a minority in Washington and on Wall Street remain hopeful that the committee will be galvanised to beat expectations. This would involve agreeing to reduce the deficit by at least $4trillion over the next decade, and confronting the politically explosive issues of spending on healthcare and raising taxes. Tax revenues as a share of gross domestic product (GDP) fell from their historic average of about 18pc to 15pc in 2009, and the CBO expects them to stay at those levels this year. Spending on healthcare, meanwhile, has soared from 4.8pc of GDP in 1960 to 16.5pc in 2009.
And Simpson, the former Senator from Wyoming, argues that what financial markets, as well as the American public, want in different ways is some clarity and detail on reducing the deficit over a 10-year horizon. "All you need is a plan. You don't need to give the baby teeth straight away," he says. Our report "didn't do BS and didn't do mush, and they're (the public) very appreciative of it," he says.
But with an election just over a year away, the betting remains that politicians will push back the tough decisions until 2013. "I think that's an enormous misjudgement," says Frenzel, who believes the economy is in need now of the clarity a long-term agreement could bring.
The advantages that the US has as a borrower won't melt away in the space of a year. But if the country's politicians fail to rise to the national debt challenge sometime over the next 18 months, then it may be the last time the government can hold a fantastic bond auction in the week after a downgrade.
Eurobonds not on agenda at Paris summit
Eurobonds will not be a subject for discussion at tomorrow's summit meeting in Paris between German Chancellor Angela Merkel and French President Nicolas Sarkozy, a government spokesman in Berlin said today. 'Eurobonds will play no role in the talks,' Steffen Seibert told a regular news conference.
Sarkozy is due to host his counterpart Chancellor Angela Merkel in Paris as he struggles to chip away at German resistance to increased European financial governance. Between them, Merkel and Sarkozy lead the 17-nation euro zone's biggest economies, and markets will be watching anxiously to see whether they can boost lender confidence amid an unprecedented sovereign debt crisis.
Last week, European stock markets saw their worst losses since 2008, amid rumours that France might lose its Triple A credit rating, but Berlin remains opposed to deep reforms of the European financial system. Sarkozy has been pushing for governments to turn the debt crisis into an opportunity to forge a more centralised system of controls across the zone, better able in Paris' eyes to protect against future meltdowns.
But Merkel - and German voters - oppose any change that might create what they have dubbed a 'transfer union', in which Germany's powerful export-led economy effectively underwrites its underperforming euro zone partners. Such a system would make it easier for struggling members like Greece or Portugal to finance their massive public deficits, but would also inevitably transfer some of the cost of servicing these debts to German taxpayers.
Until last week, France was seen as among the better performing euro zone economies, even if still lagging behind its German neighbour - but rumours, angrily denied, about the health of its banks rocked the market. Sarkozy was forced to abandon his summer holiday at a Riviera villa and fly back to Paris to propose tougher austerity measures, while Merkel remained calmly in Italy.
French officials say he still intends to press for an 'acceleration' of reforms to Europe's financial institutions and hopes he and Merkel will agree 'common positions on the reform of the governance of the euro zone'. He will also push for a quicker application of decisions made last month, when European leaders found another €159 billion for Greece and broadened the scope of their rescue fund to allow it to buy government bonds.
But, over the weekend, German officials were quick to head off any talk of broader reform - rejecting both the idea of issuing joint eurobonds or of further expanding the €440 billion European Stability Fund.
Merkel and Sarkozy are to meet in Paris in the afternoon, then hold a press conference before sharing a working dinner. Afterwards, they will make recommendations to European Union President Herman Van Rompuy. Sarkozy will meet his own cabinet on Wednesday and next week, on August 24, he is due to unveil a new round of severe austerity measures designed to bring France's budget deficit down to less than 3% of its GDP by 2013.
German ministers repeat Eurobond opposition
Two leading German ministers reiterated their opposition to issuing jointly guaranteed European sovereign bonds as a means to end the crippling debt crisis. Finance Minister Wolfgang Schaeuble told German news magazine Der Spiegel that eurobonds are out of the question as long as the currency zone's 17 nations still run their own fiscal policy, and that different interest rates for euro zone nations were needed to provide 'incentives and the possibility of sanctions to enforce solid financial policy.'
Schaeuble acknowledged that the EU must, and will, beef up its response to the crisis to assist the heavily indebted nations, but that 'there won't be a collectivisation of debt or unlimited assistance.' Chancellor Angela Merkel has long ruled out eurobonds, and Economy Minister Philipp Roesler joined the chorus today, describing jointly guaranteed debt as 'the wrong way' out of the crisis.
'Eurobonds would mean that everybody shares the same interest burden which would be a punishment for financially sound nations,' he was quoted as saying. 'We cannot want this for Germany and for all other good states,' he added. Eurobonds would be a major step toward the bloc's economic integration, and are billed by supporters as an overnight solution to the crisis. Italy, Belgium and Luxembourg are among the nations calling for eurobonds.
Merkel's spokesman Steffen Seibert said that Merkel and Sarkozy will discuss strengthening financial and economic cooperation and governance across the euro zone. 'This is one of the lessons from the euro crisis, we need a stronger economic cooperation across the euro zone,' he added, declining to specify which concrete proposals will be discussed at the meeting.
The principle behind eurobonds is that European countries would guarantee each other's debts, so that investors would see the bonds as super-safe and loan at low interest rates. The hope is that lower borrowing costs would prevent any more financial bailouts. But Germany as the most creditworthy European country fears it would face higher borrowing costs and more risks if it had to borrow jointly with financially shaky nations.
Eurobonds could drive down the borrowing costs for troubled euro zone countries immediately, but Germany maintains that cheap credit without a powerful European institution overseeing the member states' budget and fiscal policy cannot be a solution.
Europe Pressures Merkel to Accept Euro Bonds
Angela Merkel has been steadfastly opposed to euro bonds so far, but Germany's Nein no longer seems set in stone. French President Nicolas Sarkozy may have changed his mind too after the market turmoil last week. However, euro bonds present a serious domestic political risk for Merkel.
The introduction of euro bonds, government debt issued by the entire euro zone, may be the only remaining way to solve the euro debt crisis, say some government leaders and economists, and Chancellor Angela Merkel could come under pressure from French President Nicolas Sarkozy to drop her categoric opposition to them at the special meeting planned by the two in Paris on Tuesday. Over the weekend, Italian Finance Minister Giulio Tremonti called for the introduction of such bonds, saying, "We wouldn't be where we are now if we had had euro bonds."
The chairman of the euro group of euro-zone finance ministers, Jean-Claude Juncker of Luxembourg, and the EU Economic and Monetary Affairs Commissioner, Olli Rehn, have long proposed euro bonds, arguing that they would restore stability by stopping speculative attacks on the debt of individual euro member states. But they would also increase Germany's borrowing costs, because the interest rates on such debt would be higher than on German sovereign bonds. Estimates for the annual rise in German interest payments vary widely, from €10 billion ($14.3 billion) to just under €50 billion ($72 billion).
'No Unlimited Support'
In an interview with SPIEGEL published on Monday, German Finance Minister Wolfgang Schäuble signalled he would remain firm. "The following remains true: There is no collectivization of debt, and there is no unlimited support," he said. Asked if he was opposed to euro bonds, he said: "I'm ruling out euro bonds for as long as member states pursue their own financial policies and we need differing interest rates (on sovereign debt) as a way to provide incentives and the possibility of sanctions, in order to enforce fiscal solidity. Without this solidity, the foundations for a common currency don't exist."
The pro-business Free Democratic Party (FDP), junior partner to Merkel's Christian Democrats, has ruled out the creation of euro bonds. Their leader, Economy Minister Philipp Rösler, reiterated his opposition to them in an interview in the Die Welt newspaper on Monday, saying they "lead to equal interest rates in the whole euro zone and thereby undermine the incentives for a solid budget and economic policy in the member states."
Is German Resistance Waning?
At present, the euro zone has no common fiscal policy. Every government issues its own bonds. Euro bonds would broaden part of public debt issuance to the entire euro zone. The interest rates on these bonds would be the same for all countries, and the crisis-hit nations would be able to obtain finance at far lower rates. Germany's borrowing costs, by contrast, would rise. In economic terms, euro bonds would herald the launch of a transfer union , a long term shift of resources from the bloc's richer countries to the poorer ones.
Transfer union is a dirty word in the center-right coalition. Members of Merkel's government have consistently promised that German taxpayers won't be left to foot the bill for the euro crisis. If Merkel were to sign up to euro bonds it would endanger her parliamentary majority.
Members of parliament from the coalition parties are already unhappy with reforms to the EU's bailout fund , which will be put to the vote in the German parliament after the summer recess. Horst Seehofer, the head of the Christian Social Union, the Bavarian sister party to Merkel's CDU, has said his party won't agree to a transfer union. "We as the CSU won't support it," he said. But the most recent escalation of the crisis could lead previous opponents of euro bonds to change their minds. Last week the French debt market came under pressure following rumors that France may lose its top AAA rating.
The German Sunday newspaper Welt am Sonntag reported that resistance to euro bonds was starting to crumble in Berlin. It cited unnamed government officials as saying steps towards a transfer union were no longer being categorically ruled out. The strategy employed so far -- launching massive new bailout packages -- was hitting its limits, officials said, according to the paper.
Germany's opposition Social Democrats and Greens have both said they would support the introduction of euro bonds provided that certain conditions were attached to them, including a tighter control of nations' fiscal policies. Green Party leader Cem Özdemir said the volume of euro bonds should be limited to 60 percent of a nation's gross domestic product.
Euro Bonds Could Cost Germany €47 Billion - Per Year
Economists are divided about the likely impact of a euro bonds. Kai Carstensen of the Ifo institute, a respected economic think tank, calculated that Germany would face a 2.3 percentage point rise in its interest rates on government debt -- meaning annual costs increase of around €47 billion.
Investor George Soros said in an interview with SPIEGEL published on Monday that for the euro zone to work, member states need to be able to refinance a large part of their debt at equal interest rates. "You need to establish fiscal rules that will ensure the solvency of every member," said Soros. "This should make the euro bond acceptable to German voters. Europe needs a fiscal authority that has not only financial but also political legitimacy."
At the same time, Soros added, high-debt countries may have to leave the euro zone. "Europe, the euro and the financial system could survive Greece leaving. It could survive Portugal leaving. And the remainder would be stronger and more easily managed," he said.
Germany and France rule out eurobonds
by Peggy Hollinger, Chris Bryant and Quentin Peel - FT
Germany and France are ruling out common eurozone bonds to solve the bloc’s current debt crisis, in spite of renewed pressure ahead of a meeting of chancellor Angela Merkel and president Nicholas Sarkozy on Tuesday.
Wolfgang Schäuble, German finance minister, made clear in an interview with Der Spiegel, that Berlin remains opposed to such a policy. “I rule out eurobonds for as long as member states conduct their own financial policies and we need different rates of interest in order that there are possible incentives and sanctions to enforce fiscal solidity,” he said.
Senior French officials also played down speculation that any firm announcement on jointly issued bonds would be issued after meetings when Ms Merkel comes to Paris on Tuesday. “Eurobonds would require a much more determined integration of budgetary policy,” one said. “We do not have that today. It could be a long-term project, but you cannot have eurobonds and at the same time national economic and budgetary policies.”
The comments come after Giulio Tremonti, Italy’s finance minister, this weekend described jointly issued bonds that would lower some struggling states’ borrowing costs as a “master solution” to the eurozone debt crisis, George Osborne, the UK finance minister, on Thursday said the idea now required “serious consideration”, while billionaire investor George Soros warned on Friday that the euro “could implode” if eurozone leaders failed to accept the principle of mutualising debt.
Yet Ms Merkel and Mr Sarkozy are on Tuesday expected to reiterate the need for greater fiscal and economic co-operation before any European bond can be considered. Nonetheless they hope to reassure markets by flagging a common determination to implement the measures agreed at the last Eurozone summit on July 21 where members agreed a new round of emergency crisis measures.
As a first step, Paris is hoping to make real progress on proposals to improve the governance of the eurozone. One official said the idea would be to push forward economic and fiscal integration, but also to improve the “institutional architecture that allows us to take decisions.”
For President Sarkozy, still deeply unpopular in the polls and facing a difficult re-election campaign next year, it will be important to come out of Tuesday’s meeting with concrete progress. Mr Sarkozy has already sought to reassure markets – and his German partners – on France’s determination to get public spending under control after last week demanding that his government come up with new deficit reduction measures by this week.
There was speculation at the weekend that Ms Merkel and Mr Sarkozy could even announce some new measures for further fiscal co-operation between their two countries. But officials close to the German chancellor caution against expecting any major initiative from the talks. They insist that the meeting will focus on proposals for long-term reforms of eurozone governance, and not on short-term measures to calm the markets.
“We have promised to table proposals for long-term improvements in governance in October,” a senior official said. Ms Merkel’s difficulty is that there is already strong resistance in Germany to July’s new eurozone crisis measures. A vote on the package is due to be held in the German parliament on September 23.
However this weekend even that timetable was coming under threat. Norbert Lammert, Bundestag president, warned yesterday that it was “scarcely possible” for the parliament to decide on the eurozone crisis measures by then. It was up to the Bundestag to decide its own schedule, he said, and the government could agree nothing without it.
German government no longer rules out euro bonds: report
by Erik Kirschbaum - Reuters
The German government no longer rules out agreeing to the issuance of euro zone bonds as a measure of last resort to save the single currency, conservative newspaper Welt am Sonntag reported on Sunday.
Even though Finance Minister Wolfgang Schaeuble and Economy Minister Philipp Roesler again spoke out against euro zone bonds and debt collectivization, Welt am Sonntag reported the German government is nevertheless considering that and other measures. "Preserving the euro zone with all its members has absolute top priority for us," according to a government source quoted in the newspaper under the headline: "Government no longer excludes European transfer union and joint euro bonds as last resort."
The newspaper, traditionally close to Chancellor Angela Merkel's Christian Democrats (CDU), indirectly quoted the source adding: "In case of emergency, one would thus even be prepared to accept the introduction of a 'transfer union' and at the end of the day even joint euro zone bonds. "Without these euro bonds, it might no longer be possible to save the euro zone," the newspaper continued, further quoting the source indirectly. "The path we've taken so far with multi-billion rescue packages for financially struggling states is beginning to reach its limits."
A government spokesman in Berlin declined to comment on the report in Welt am Sonntag but instead pointed to the Schaeuble interview in Der Spiegel news magazine published on Sunday. Schaeuble said Germany remains against any collectivization of euro zone governments' debt and creating common euro bonds is impossible while countries run separate economic policy.
"It still stands: there will be no collectivization of debt and there will be no unlimited support," he said. "There are certain support mechanisms that we are developing further -- with strict conditions." "The member states that need our solidarity must reduce their deficits and reform their economies -- with at times very tough measures," he said.
Der Spiegel said Schaeuble also ruled out the issuance of eurobonds unless certain hurdles are removed. "I rule out Eurobonds for as long as member states conduct their own financial policies and we need differing interest rates so that there are possibilities of incentives and sanctions to force fiscal solidity," he said. "Without that kind of solidity, there is no foundation for a joint currency," Schaeuble added.
Economy Minister Roesler also spoke out against euro zone bonds in an interview in Handelsblatt newspaper on Monday: "I consider euro bonds to be the wrong approach in a Europe in which every member state should take responsibility for itself."
Pressure is nevertheless growing on euro zone leaders to take a more radical approach to the euro zone's debt crisis ahead of a potentially vital meeting of German Chancellor Angela Merkel and French President Nicolas Sarkozy next week.
Italian Economy Minister Giulio Tremonti renewed his call for a collective euro zone bond on Saturday. Tremonti returned to proposals for jointly issued bonds that would effectively make individual governments' debt a common burden, saying they were the "master solution" to the euro zone debt crisis. "We would not have arrived where we are if we had had the euro bond," he said on Saturday.
The comments underline the sharp divisions hampering efforts to coordinate a response to the euro zone debt crisis, which escalated dramatically last month as markets turned their fire on Italy, one of the bloc's most heavily indebted countries. What is at stake was highlighted by a new poll for the Bild am Sonntag newspaper on Saturday which showed 31 percent of Germans believe the euro will be gone by 2021.
The idea of euro bonds was also dismissed by Deutsche Bank chief economist Thomas Mayer. He told Deutschlandfunk radio that and raising the European Financial Stability Fund (EFSF) could lead to the end of the European Monetary Union (EMU). "I believe such considerations would be poison pills for the EMU," Mayer said. "It would violate a fundamental democratic principle if the EFSF were boosted to several trillion euros or euro zone bonds were introduced."
He added: "If at the end of the day German, Dutch and Finnish taxpayers are going to be held responsible for decisions made in other parliaments as a result of raising the size of the EFSF or introducing euro bonds, that will lead to a political collapse of the EMU. That is not an option."
ECB buys €22 billion in eurozone bonds
by Ralph Atkins and Richard Milne - FT
The European Central Bank spent €22bn on government bonds last week - more than ever before – as it sought to prevent the eurozone debt crisis escalating out of control.
The larger-than-expected display of fire-power highlighted the scale of the task the euro’s monetary guardian faces in keeping official borrowing costs under control for Italy and Spain. It also added to the risks the ECB is carrying onto its balance sheet – and of fresh splits on its 23-strong governing council.
The buying caused Italian and Spanish yields to plummet with their benchmark borrowing costs on 10-year bonds falling from above 6 per cent to 5 per cent on Monday. The buying came just in time for analysts and investors, with many worrying that Rome’s and Madrid’s borrowing costs were on the verge of becoming unsustainable.
The ECB’s governing council had given the go-ahead to resume bond buying on August 4. At the start of last week Jean-Claude Trichet, president, announced it would “actively implement” its bond purchasing programme, which had been dormant since March – a clear sign that it would be expanded beyond previous purchases of Greek, Irish and Portuguese bonds.
The ECB gives no details of its bond buying but traders reported the central bank reporting Spanish and Italian debt throughout the week and in many different bond maturities. The ECB’s move followed pledges by Rome and Madrid of fiscal austerity measures and other steps to boost their economies’ longer-term growth prospects.
The ECB’s re-entry into bond markets marked a dramatic escalation compared with its past activity. The previous largest weekly amount spent was in the first seven days after the programme was launched in May 2010, when it spent €16.5bn.
Writing before the figures were disclosed, Gary Jenkins of Evolution Securities said: “Anything under the €10bn mark is likely to disappoint and question the ECB’s commitment; more than €15bn could be seen as the ECB applying a shock-and-awe tactic and give a further boost to the market.”
The €22bn total covered purchases made since the governing council meeting and up to the middle of last week. It brings the total amount of eurozone government bonds on the ECB’s books to €96bn. The ECB will this week seek to reabsorb the equivalent amount of liquidity from the eurozone financial system in an attempt to “sterilise” any inflation impact.
Some analysts have worried that because of the size of Italy’s and Spain’s bond markets – a collective €2,100bn in size – the ECB could have difficulties in sterilising all its purchases if it has to carry on buying on such a large scale.
The ECB governing council decision for August was opposed by at least three members. The size of last week’s purchases will probably lead to at least some urging that the programme is reduced as soon as possible. However analysts believe the ECB may have to maintain large-scale intervention until eurozone governments have secured national approval for the European Union’s bail-out fund to take over the ECB’s actions.
'You Need This Dirty Word, Euro Bonds'
by Gregor Peter Schmitz And Thomas Schulz - Spiegel
In a SPIEGEL interview, billionaire investor George Soros criticizes Germany's lack of leadership in the euro zone, arguing that Berlin must dictate to Europe the solution to the currency crisis. He also argues in favor of the creation of euro bonds as a way out of the turbulence.
SPIEGEL: Mr. Soros, we currently see a global banking crisis, a currency crisis and a sovereign debt crisis. Has the financial dilemma become too big to handle? How can politicians on both sides of the Atlantic be expected to solve such a multitude of crises?
Soros: The politicians have not really tried to fix any crisis; they have so far only tried to buy time. But sometimes time is actually working against you if you refuse to face the relevant issues and explain to the public what is at stake.
SPIEGEL: Are you talking about the Germans? Many experts think Chancellor Angela Merkel has been particularly hesitant to address the euro crisis.
Soros: Yes. The future of the euro depends on Germany. This is the point I really want to bring home. Germany is in the driver's seat because it is the largest country in Europe with the best credit rating and a chronic surplus. In a crisis, it is always the creditor that calls the shots. Sure, this is not a position Germany or Chancellor Merkel ever desired and they are understandably reluctant to embrace it. But the fact is: The Germans are now in the position of dictating to Europe what the solution to the euro crisis is.
SPIEGEL: Why should Berlin embrace that idea?
Soros: There is simply no alternative. If the euro were to break up, it would cause a banking crisis that would be totally outside the control of the financial authorities. So it would push not only Germany, not only Europe, but the whole world into conditions very reminiscent of the Great Depression in the 1930s, which was also caused by a banking crisis that was out of control.
SPIEGEL: What, then, needs to be done to fight this crisis?
Soros: I think there is only one choice. It is not a question of whether Europe needs a common currency. The euro exists, and if it broke apart all hell would break loose. Germany has to make it work. To make it work, you have got to allow the members of the euro zone to be able to refinance the bulk of their debt on reasonable terms. So you need this dirty word, the "euro bonds". But when you study what it involves to have euro bonds, you really have a problem because each European country remains in control of its own fiscal policy, and you have to rely on the country to meet its financial obligations.
SPIEGEL: Germans hate the euro bonds idea. They fear that under this scenario they will ultimately need to bail out everyone, even large nations like Italy.
Soros: That is why you need to establish fiscal rules that will ensure the solvency of every member. This should make the euro bond acceptable to German voters. Europe needs a fiscal authority that has not only financial but also political legitimacy. The difficulty is agreeing on the rules. Unfortunately, Germans have some funny ideas. They want the rest of Europe to follow their example. But what works for Germany can't work for the rest of Europe: No country can run a chronic surplus without others running deficits. Germany must propose rules that other countries can also follow. These rules must allow for a gradual reduction in indebtedness. They must also allow countries with high unemployment, like Spain, to continue running cyclical budget deficits until they recover.
SPIEGEL: More and more economists, especially in Germany, would like to see Greece leave the European Union. Do you consider that to be a viable option?
Soros: I think that the Greek problem has been sufficiently mishandled by the European authorities that this may well be the best solution. Europe, the euro and the financial system could survive Greece leaving. It could survive Portugal leaving. And the remainder would be stronger and more easily managed. But the financial authorities have to arrange for an orderly exit in order for the European banking system to survive it. That will cost money because the European banking system including the European Central Bank has to be indemnified for its losses. Depositors in Greek banks have also got to be protected. Otherwise depositors in Irish or Italian banks would not feel safe.
SPIEGEL: Is the current crisis even worse than the one in 2008?
Soros: This crisis is still the continuation of the same crisis. In 2008, the financial system collapsed and it had to be put on artificial life support. The authorities managed to save the system. But the imbalances that caused the crisis have not been removed.
SPIEGEL: What do you mean?
Soros: The method the authorities chose, rightly, three years ago was to substitute the credit of the state for the credit in the financial system that collapsed. After the failure of Lehman Brothers, the European financial ministers issued a declaration that no other systemically important financial institutions would be allowed to fail. That was the artificial life support; it was exactly the right decision. But then Chancellor Merkel stated that such support would only be granted by each EU member state individually, and not by the European Union.
SPIEGEL: That undermined the concept of a strong European response to the crisis. Has that been the biggest mistake so far?
Soros: That Merkel statement was the origin of the euro crisis. It shattered the vision that the EU will protect the euro in a joint effort.
SPIEGEL: Where will the current crisis stop? Even France now seems to be threatened by a financial meltdown.
Soros: Of course it is spreading. Markets fear uncertainty. Germany has to realize that it has no alternative but to defend the euro. The longer it takes, the higher the price Germany will have to pay.
SPIEGEL: You have been very critical of how the crisis has been handled by governments. Many European citizens, however, blame speculators like you for their attempts to bring down the euro. Huge hedge funds like yours have waged massive bets against the European currency over the past year. And in recent days, several European countries have even imposed temporary bans on short selling, bets on falling share prices.
Soros: You are confusing markets and speculators. At the moment, the biggest speculators are the central banks because they are the most important buyers and sellers of currencies. Hedge funds have definitely been supplanted by central banks. Markets expect the authorities to produce a financial system that actually holds together. If there is any hole in that system, speculators will rush through that hole.
SPIEGEL: That sounds very noble. But in reality, speculation makes any crisis worse. Look at the credit default swaps (CDS) market where speculators can bet on a further decline of currencies and economies. How can that be helpful?
Soros: Of course, speculation will always make a crisis worse. If there is a weak point, it will expose it. And you are right, the CDS market is a very dangerous instrument and I think it should not be allowed. I am one of the very few people who argue that the CDS is a dangerous instrument because it is so lop-sided in favor of a negative outcome.
SPIEGEL: Do you think the European Central Bank is part of the solution or part of the problem, when it comes to the dealing with the euro crisis?
Soros: It is part of the solution, but which part? Any central bank should only be in charge of liquidity. Solvency is a matter for the treasury. But because there is no European treasury, the ECB was pushed into that arena. To keep the financial system alive they overstepped their limits, as the former German Bundesbank president Axel Weber pointed out, by discounting the government bonds of a country that was clearly bankrupt.
SPIEGEL: You are referring to the purchase of Greek bonds. Now the European Central Bank even started buying Spanish and Italian bonds. It is not even clear, however, if it is legally allowed to do so.
Soros: Yes, but there is a well established conviction that the central banks always do what is necessary to keep the system going and then afterwards you then take care of the legal aspects. In a crisis, you simply do not have time to think about such concerns for too long.
SPIEGEL: The United States is drowning in even more debt than Europeans. Its economic recovery has been painful. Are we going to see a double-dip recession in the US?
Soros: The indebtedness of the US is not all that high, but if a double-dip recession was in doubt a few weeks ago, it is less in doubt now, because financial markets have a very safe way of predicting the future. They cause it. And the markets have decided that America is going to see a recession, particularly after the recent downgrade of the US by the rating agency Standard & Poor's.
SPIEGEL: President Barack Obama has been fiercely criticized for his handling of the economy. You were one of his biggest supporters in 2008. Are you happy with his economic policy?
Soros: No, of course not. But the reality is that we have had 25 years of excesses building up in America -- a combustible mix of too much credit and too much leverage. You need a long time to reverse that.
SPIEGEL: Obama tried to stimulate growth with a gigantic stimulus program which increased the national debt further. Was that a mistake?
Soros: Obama embraced the ideas of John Maynard Keyes. Basically, the analysis of Keynes is still very relevant -- with one big difference between now and the 1930s. In the 1930s, the states, the governments had practically no debt and could, therefore, run deficits. Nowadays, all governments are heavily indebted, and that is a big change.
SPIEGEL: If Keynes were still alive, would he adjust his theory?
Soros: Definitely. He would say that governments can still benefit from running fiscal deficits, but the new debt has to be invested in a way that will pay for itself. So the money spent would have to increase productivity.
SPIEGEL: The $800 billion stimulus program launched by Obama did not live up to that?
Soros: Obama's stimulus program was not big enough and it was not directed at improving the infrastructure or human capital. So it was not productive enough.
SPIEGEL: And any further stimulus is now basically a non-starter, because the conservative majority in Congress is hell-bent on preventing it.
Soros: That is what is pushing the world towards another recession, into a double-dip.
SPIEGEL: The Republicans are doing that?
Soros: Yes, but Obama is also at fault. He yielded the agenda to the Republicans. He is talking their language. The president would have to show leadership to counter the Republican wave, and so far he has not done so.
SPIEGEL: Do you think the US deserved the recent downgrade by Standard & Poor's?
Soros: Probably not. This decision was the attempt by the rating agencies to reinvent themselves as anticipating rather than responding to changes that have occurred. So they are really basing that downgrade on that expectation that the political process will not provide the solution. Judging such political developments is a very new role for the rating agencies, though.
SPIEGEL: As an investor, do you listen to the rating agencies?
Soros: Well, I do not, but many other investors do.
SPIEGEL: The credit rating agencies are accused of exascerbating the crisis. Do you think the role of the rating agencies in the financial system needs to be scaled back?
Soros: I do not have an answer to that.
SPIEGEL: There are no alternatives.
Soros: Frankly. It is an unsolved problem in my mind
SPIEGEL: As an investor, would you still bet on the euro?
Soros: I certainly would not short the euro because China has an interest in having an alternative to the dollar. You can count on China to back the efforts of the European authorities to maintain the euro.
SPIEGEL: Is that the reason why the euro is still so strong compared to the dollar?
Soros: Yes. There is a mysterious buyer that keeps propping up the euro.
SPIEGEL: And it is not you.
Soros: It is not me (laughs).
SPIEGEL: In the end, will China be the only winner in this crisis?
Soros: China, of course, has been the great winner of globalization, and if globalization collapses, the Chinese will also be among the losers. So they have a strong interest in preserving the current global system. However, in some ways, they have been just as reluctant to accept it as the Germans. Germans have been hesitant to accept responsibility for Europe, and the Chinese have been hesitant to accept responsibility for the world. But they are both being pushed into it.
Spain branded the eurozone's big weak link as 'the indignant' take to the streets
by Sarah Rainey - FT
They call themselves "the indignant". Armed with sleeping bags and week old clothes stuffed into rucksacks, around 500 people stand shoulder-to-shoulder in Madrid's central square.
As darkness falls, and the last few tourists flock to their hotels, the nightly vigil begins. Some hoist placards. Others gather outside the gates of the Ministry of the Interior, chanting in unison: "It's not the crisis, it's the system" and "End the cuts". Many of them have been here since May 15, when they joined the nationwide protests against government austerity measures and Spain's chronic unemployment.
But this is not just Spain's disaffected youth. Among the crowds are parents, pensioners, teachers and civil servants, all angry and frustrated as their nation – once a European heavyweight – teeters on the brink of a crisis. As the rest of Europe suffers amid soaring sovereign debt, the protesters reiterate their demands for jobs, secure housing and increased hospital funding.
This is no longer a peaceful protest. Last week, riots broke out in Madrid's Plaza de Cibeles, leaving at least 20 young people and seven policemen injured. Police estimate that up to 100,000 people have taken part in protests so far, with countless strikes, clashes and arrests across Spain. There is increasing speculation that the protests may turn violent on Tuesday as participants react badly to the cost of the proposed €60m (£37m) visit by the Pope.
Despite efforts by Jose Luis Rodriguez Zapatero, Spain's Prime Minister, to quell the movement, the ranks of the "indignant" are growing. Early elections have been called and opposition parties are strengthening as the turbulent economy continues to fuel popular unrest. But what does this domestic turmoil mean for Spain in its European context? The markets remain volatile as Zapatero's government struggles to restore investor confidence and stave off financial crisis. Is this once-stable nation becoming the weakest link in the eurozone?
"Spain is the reality everyone is ignoring," warned Nouriel Roubini, the bearish US economics professor, addressing a recent conference in Madrid. Looking at Spain's faltering domestic economy, traders might be advised to heed his words.
With government debt at 64.5pc of gross domestic product (GDP), the nation has only shown halting and at times regressive recovery after the economic crisis burst the property bubble that had previously propped up the Spanish boom. The latest figures from the Bank of Spain place second-half growth at a cautious 0.8pc – dampened by a sluggish first half and the threat of tensions over its neighbours' sovereign debts.
In a bid to reduce the deficit and fortify banks' balance sheets, PSOE, Zapatero's ruling party, introduced a raft of austerity measures in 2010. The programme includes spending cuts, raising the retirement age, liberalising the labour market and selling off state assets. But the result is far from the increased fiscal liquidity the embattled leader was hoping for. Figures from Spain's National Statistics Institute show that industrial production fell 2.7pc in June, while the number of bankruptcies increased 16.5pc in the second quarter against the same period last year.
Unemployment remains the thorn in Zapatero's side, however, with more than a fifth (20.9pc) of the working-age population out of work, according to government data. Carina O'Reilly, senior European analyst at IHS Jane's, says the unemployment problem has been "building for a while", soaring to around 43pc among the under-30s. "When the crisis hit Spain, unemployment rates were – even then – very high, and it's been rising steadily since 2007," she adds. Much to the despair of the "indignants", this puts career opportunities in Spain below the rest of Europe, Egypt, Lebanon and Tunisia.
The spillover from Spain's domestic woes has already been felt in Europe. The benchmark Ibex 35 index fell to its lowest level – 7966 – on August 4 from a high of 11113 earlier in the year.
Moody's downgraded Spain's credit rating to Aa2 back in March, warning that the economy was "subdued", and late on Thursday night short-selling in Spanish banking stocks was banned by the European Securities and Markets Authority. Earlier that day, Standard & Poor's cut the credit rating of Telefonica, the Iberian telecommunications giant and a major economic driver, from A- to BBB+ after its net profit slumped 27pc.
In the Spanish bond market, 10-year government bond yields reached 14-year highs of 6.29pc in July, soaring dangerously close to the 7pc level that saw Greece and Portugal bailed out in the last 18 months. Even the reactivation of the European Central Bank's bond-buying programme has left shaken investors hesitating to venture into the rollercoaster Spanish market. Last week, bond yields dropped back below 5pc, but analysts are warning traders to remain cautious.
Louise Taggart, European analyst at AKE consultancy in London, says the ECB's intervention gave Zapatero's government "breathing space", but is unlikely to signal the end of economic volatility in Spain. "At the minute, unemployment is the major issue, and if the protesters involved in the 'indignant' movement aren't seeing any improvement in the situation, then there's no reason for them to get off the streets," she adds. "But I'd be surprised if the civil unrest impacted on the markets unless it got worse."
Jan Randolph, director of sovereign risk at IHS Global Insight, sees little difference between Spain and Greece and Portugal where civil unrest in response to austerity measures saw both countries seek European Union bail-out funds. "The battle for the euro will be won or lost on the southern flank for sure," he warns. "My bottom line is that Italy and Spain are solvent but if markets push new borrowing costs at the margin up to 6-7pc, and this permeates the rest of their debt mountains over time, then this could make them insolvent."
Mr Randolph was one of the first to blacklist Spain as the "big weak link" in the eurozone, and says the "indignant" movement has already proven a "major political constraint on more aggressive structural reform in Spain". He adds: "Whether social cohesion holds together under such pressures is still an open question."
The economic outlook on the Iberian Peninsula is not all doom and gloom, however. A handful of companies in the Ibex 35 continue to post positive reports, buoyed by dominant positions in niche markets. Amadeus, the airline bookings company, grew first-half profits by more than 12pc to €263.7m, while Madrid-based insurer Mapfre climbed 13.5pc to €322m in the first quarter. A report published by Deutsche Bank in July revealed latent optimism towards Spain's stock market, with hotel chains – particularly Melia International – profiting from a booming tourist trade.
Back in Madrid's main square, Spain's "indignants" will not be moved. Angered by job losses, hospital closures and 150,000 annual housing repossessions, they have planned a raft of protests this month, culminating in the nationwide "Real Democracy Now" strike on October 15. With one eye on the elections, brought forward to November after mounting pressure on Zapatero to resign, opposition leader Mariano Rajoy is wooing potential participants with promises of tax cuts and sturdy growth.
But the protesters may take more convincing. "We won't leave until they promise us jobs," says Silvia Inez, a former secretary who has been unemployed since last year. Isabel Gimenez, a university professor in Madrid, adds: "The 'indignant' movement has been highly positive ... it has served to revitalise Spanish society."
With widespread support, robust motives and no jobs to go home to, the "indignant" movement shows no signs of abating. And as Spanish markets and bond yields rollercoaster, investors' confidence in domestic recovery continues to plunge. Within a debt-ridden eurozone, Spain is clearly not the only cause for concern. But while everyone looks the other way, it could well be the next domino to fall.
Italy’s austerity package branded unfair
by Giulia Segreti - FT
Italy’s austerity package, passed by an emergency cabinet meeting on Friday, is facing growing criticism at home, even as it is welcomed by European Union officials.
Herman Van Rompuy, president of the European Council, said after a conversation with Silvio Berlusconi on Saturday that he fully supported and welcomed the “timely and rigorous financial measures”. “I underlined that these approved measures are crucially important not only for Italy but for the eurozone as a whole,” he said.
But critics say the €45.5bn package of spending cuts and tax increases over the next two years, which aim to balance the budget by 2013, will strangle Italy’s stagnant economy. Opposition parties, unions and industry representatives also say the measures unfairly target public sector employees, pensioners and mid-income workers, leaving the wealthy almost unscathed.
The critics, including nine members of Mr Berlusconi’s own coalition, say the measures will hit the middle class but fail to tackle Italy’s big tax evasion problem. “Nobody seems to be happy, except for Mr Berlusconi, who does not lose a moment to celebrate the action of his centre-right government,”said Rosy Bindi, president of the opposition Democratic Party.
Her party is threatening a “war of amendments” in parliament to press for additional measures, including the sale of state-owned property and the allocation of funds to the impoverished south.
It is also calling for stronger measures against tax evasion. Although the government has claimed this as a priority and launched an advertising campaign last week to shame tax evaders, measures to tackle the problem are expected to bring no more than €1bn into the state coffers in the next year.
Susanna Camusso, leader of the CGIL trade union, told La Repubblica newspaper that a strike was the only way to “change the inequity of this package”, in particular, the reform of the labour market and pension system. Union officials would meet on August 23 to set a strike date, she said, and invited other unions to join.
Giulio Tremonti, finance minister defended the package on Saturday, congratulating the ruling coalition for working through the summer recess and approving the decree within a week. “I have done everything with conscience and for the good of the country”, said Mr Tremonti. “We are convinced that the liberalisation, streamlining of the labour market can have a significant impact on GDP,” he said, adding:“For the meantime we do not expect revisions to our growth estimates.”
While there is a political consensus on the need to cut Italy’s debt, there is also growing concern about the slow pace of Italy’s recovery. The economy grew 0.3 per cent in the second quarter of the year. The government’s most recent forecasts for 2011 in April predicted a 1.1 per cent growth rate, while Confindustria predicts 0.9 per cent, one of the lowest growth rates in the eurozone.
Fears about the lack of economic momentum have caused the Milan stock market to lose almost a quarter of its value in the last month. Market reaction to the austerity package will not become clear until Tuesday, when the bourse reopens after a public holiday. The procedure to convert the decree into law will start in the Senate on August 22 and a final vote is expected by September 5.
Dutch Say Better to Remove Greece From Euro Than Extend Loans
by Maud van Gaal - Bloomberg
A majority of Dutch respondents to a poll published today said it would be better to remove countries including Greece from the euro zone, rather than continuing to support them. This view was supported by 54 percent of people surveyed in a poll by researchers Maurice de Hond and No Ties BV, published on their website. As many as 60 percent of the participants said the Netherlands “should stop lending money to other euro zone countries now.”
Lawmakers responsible for finance are cutting their vacations short to question Prime Minister Mark Rutte and Finance Minister Jan Kees de Jager on the size of the Dutch contribution to a second Greek bailout package on Aug. 16.
The European Union and International Monetary Fund on July 21 agreed to a 159 billion-euro ($227 billion) package that includes 50 billion euros from bondholders. Rutte created confusion by telling reporters after the meeting the total amount was 109 billion euros, including the private sector contribution. He said last week he plans to apologize to parliament for the confusion he created, without withdrawing his calculations, which he said related to Greece’s funding needs until 2014 instead of 2020.
Lawmakers may ask for a second, plenary, meeting on Aug. 17 to vote on motions submitted by them in which they request the government to take certain actions, or to express discontent. The government formally doesn’t have to ask parliament for approval for the new support package for Greece, or an amendment to the European Financial Stability Facility framework agreement, De Jager said in a letter dated Aug. 8, adding he will discuss the matters with them anyway.
ECB is euroland's last hope as bail-out machinery fails to resolve crisis
by Ambrose Evans-Pritchard - Telegraph
The leaders of Germany and France have three bad choices as they decide whether to save EMU this week, or pretend to do so.
They can agree to fiscal fusion and an EMU debt union, entailing treaty changes and a constitutional revolution. This implies the emasculation of Europe's historic nation states. They can tear up the mandate of European Central Bank and order Frankfurt to go nuclear with €2 trillion of `unsterilized' bond purchases until the M3 money supply in Italy, Spain, Portugal, Ireland, and Greece stops contracting at depression rates and starts to grow again at recovery speed (5pc). This might destabilize Germany.
Or they can try to muddle through with their usual mix of half-measures and bluster. This will lead to a rapid disintegration of monetary union and a banking collapse. It risks a repeat of 1931 if executed badly, as it most likely would be.
They have days or weeks to make up their minds, not months. The EFSF rescue fund was never more than a stop-gap device to avoid grappling with the core issue: the economic chasm between North and South. It has failed. Insistence that it could handle a dual crisis in Spain in Italy was a bluff, and last week that bluff was called when France too was sucked into the maelstrom.
Escalating bail-out costs are eroding French debt dynamics. "Bad" is contaminating "good". The EFSF has itself become a source of contagion and this would turn yet more virulent if the fund were quadrupled to €2 trillion as some suggest. "The larger the EFSF, the faster the dominos fall," says Daniel Gross from the Centre for European Policy Studies (CEPS).
"Only Germany can reverse the dynamic of European disintegration," writes George Soros in the Handelsblatt. "Germany and the other AAA states must agree to some sort of Eurobond regime. Otherwise the euro will implode."
Mr Soros knows that the trigger for the denouement of the pre-euro ERM in 1992 was a quote from a Bundesbanker in the same Handelsblatt hinting that sterling and the lira were overvalued. That was all it took. The Tory government that had tied Britain's fate to an over-heating Germany was destroyed.
Once again we are all reading the German press, and what we see is subversive commentary once again from Frankfurt, and bail-out fatigue and simmering anger among Bavaria's Social Christians, Free Democrats (FDP), and Angela Merkel's own Christian Democrats in Berlin. If Germany is about to immolate itself for the sake of EMU, this is not obvious in the Bundestag.
What German politicians want is yet more Club Med austerity, even though Euroland growth has wilted. The demands have become ideological, going beyond any coherent therapeutic dose. The effect of such fiscal tightening at this stage is to repeat the error of the 1930s Gold Standard when the burden of adjustment fell on weaker states, pushing them into a downward spiral that eventually engulfed everybody.
Fiscal cuts make little sense for Italy, where the output gap is 3.1pc. "Increasing potential growth should be the main policy goal. Fiscal tightening could further depress aggregate demand" said the IMF in its Article IV report.
Italy does not have a debt problem as such. Its budget is in primary surplus this year. Total debt – the relevant gauge -- is under 250pc of GDP: similar to France, and lower than Holland, Spain, Britain, the US, or Japan. Italy is one of the few EU states to have sorted out its pension liabilities, by linking payouts to life expectancy
What Italy has is a growth problem, rooted in currency misalignment. Having lost over 40pc in unit labour cost competitiveness against Germany since EMU, it is trapped in slump. Per capital income has contracted for a decade.
So why is Europe forcing Italy to tighten drastically and run an even bigger primary surplus within two years, and doing so just as the world flirts with a double-dip downturn? Why too is the ECB's Jean-Claude Trichet acting as the enforcer? His leaked letter to Italian premier Silvio Berlusconi is a diktat, a long list of measures imposed as a condition for the ECB's action to shore up the Italian bond market.
Mr Berlusconi has capitulated, with a "bleeding heart". He is slashing payments to regional authorities, though he has resisted wage cuts. "They made us look like an occupied government," he said. Northern League leader Umberto Bossi accused the ECB of "trying to blow up the Italian government."
Mr Trichet is moving into dangerous waters dictating budgets to sovereign parliaments. It matters enormously whether citizens have political "ownership" over austerity, or whether it is imposed by outside forces. His former colleague Otmar Issing fears that Europe is becoming a deformed union where officials run roughshod over nations and fiscal power lies beyond democratic control. Such encroachments have "brought war" in the past, he said.
The bank should correct its own errors first. It was ECB tightening that choked Europe's recovery. "Eurozone monetary weakness has been the key driver of the recent deterioration in global economic and financial conditions," said Simon Ward from Henderson Global Investors.
Real M1 desposits are not only collapsing across southern Europe, they have turned negative in the North as well. This signals big trouble. „It was astonishing that the ECB, which trumpets adherence to monetary analysis, chose to rein back its longer-term repo lending in late 2010 and raise interest rates in April and July. This was a repeat of its error of 2008," he said.
Mr Ward said the ECB should stop choosing which nations to rescue through "quasi-fiscal transfers" and stick to neutral central banking. It should launch quantitative easing for the whole of EMU. "At this point the Eurozone needs a massive infusion of liquidity," said Dr Gross from CEPS. Otherwise there will be a "break-down of the interbank market that would throw the economy into an immediate recession as after the Lehman bankruptcy".
HSBC's chief economist Stephen King said the ECB must print money a l'outrance in "exactly the same" way as the Fed. "At the heart of the problem is the ECB's unwillingness to be seen 'monetizing' government debt. Yet if the alternative to QE is the collapse of the euro or a descent into depression, then massive expansion of the ECB's balance sheet seems a small price to pay."
Such views are rarer in Germany but at last making themselves heard. Kantoos Economics said the ECB has been "extremely tight" and lost sight of its essential purpose. "It is therefore an important cause of the current mess." "European policy makers and central bankers are wrecking one of the most fascinating projects in human history, the unity and friendship among the countries of Europe. This is beyond depressing," he said.
The path of least resistance for Angela Merkel and Nicolas Sarkozy on Tuesday is surely to force the ECB to change course, by treaty power if necessary. Or kiss goodbye to the Kanzleramt, the Elysee, and monetary union.
Lord Myners calls for inquiry on 'black box' trading
by James Quinn and Harry Wilson - Telegraph
Lord Myners has called on the Government to launch a focused inquiry into so-called "black box" computerised trading in the wake of extreme volatility in the UK's biggest companies.
The former City minister said that high-frequency trading also known as black box trading had been a "contributing factor" in the harsh swings which have led to more than £300bn being wiped off the value of British shares since the beginning of July. He wants both the Treasury and the Financial Services Authority (FSA), the City regulator, to investigate thoroughly the phenomenon and the impact it has.
High-frequency trading (HFT), which accounts for as much as 50pc of trading in London, has been blamed for exacerbating intra-day swings and putting ordinary investors at a disadvantage due to the speed with which such trades are placed in the market.
Lord Myners, the former fund manager, also called for European banks, which have been at the centre of the storm, to be more honest to investors and increase levels of disclosure of the sovereign debt they are holding. His calls on disclosure were echoed by Georges Pauget, an adviser to the French government, who said banks must be more open with investors if they are to end the market fears that have led their share prices to collapse in recent weeks. The comments from the two men come after a wild week in global stock markets.
The nadir came last Wednesday, when investors moved strongly against Societe Generale, France's largest bank, forcing its shares down as much as 20pc. As a result, European regulators chose to ban shorting on banks in France and three other countries.
But Lord Myners said that rather than shorting – which he said was not a contributing factor in falling bank shares – there was a "greater need to address" such trading methods. "High-frequency trading appears so detached from the true function of capital markets, but is potentially fraught with hazard. It definitely deserves more attention than either the FSA or the Treasury has given it."
Lord Myners has tabled a series of questions in the House of Lords on the subject. Lord Sassoon, commercial secretary to the Treasury, said last week in a written answer that the Government's two-year study into the "Future of Computer Trading in Financial Markets", would not report until autumn 2012.
Andy Haldane, the Bank of England's executive director for financial stability, last month warned now may be the time to set a "speed limit" on market trades to tackle the dangers posed by so-called "flash trading" by high-speed computers.
Larry Tabb, founder of financial market research house Tabb Group, said although HFT was not directly to blame, it was indirectly to blame for removing large swathes of liquidity from the market, meaning that when sizeable sell orders are made, prices drop further than they might have done.
Lord Myners' calls for wider disclosure were echoed by Mr Pauget, the former chief executive of Credit Agricole, who said banks should move quickly to give better disclosure of their funding positions to reassure the markets they are well-financed.
"They have to provide more information. Banks have to give more information on liquidity," said Mr Pauget. He went on to say there was a growing need for all banks to give more details of their net stable funding ratios, which show the proportion of a bank's assets that are financed with longer-maturity debt.
His comments come amid concern that the UK's largest banks are on a collision course with the FSA over the need for more detailed disclosure of the amount and type of sovereign debt each is holding.
The Swiss enter Alice in Wonderland territory
by Gillian Tett - FT
Last week, something astonishing happened in Switzerland. In the London interbank offered rate market – where traders bet on future rates – implied Swiss interest rates plunged into negative territory.
Yes, you read that right: if you want to lend Swiss francs or make a deposit in the next year, you must pay for that privilege, or so the Libor market implies. The normal assumptions of finance have been turned upside down; call it Alice in Wonderland economics.
Nor is this the first time. In the 1970s the Swiss National Bank imposed negative interest rates on foreign accounts to deter inflows; and in 2008 some short-term Swiss market rates briefly turned negative. That also happened in Japan in the late 1990s. Recently, amid financial panic, some dollar short-term rates have touched negative territory.
What makes the Swiss situation so remarkable, however, is that it affects not just ultra-short rates. On Friday, futures markets predicted negative rates until 2013 (and minus 8 basis points next summer). This is unprecedented. Thus investors should watch closely to see what happens next, After all, it is a sign of how distorted the global financial system has become amid eurozone and US turmoil – and the pressure this is creating in currency markets.
Last week’s swing, for example, was sparked by the rise of the Swiss franc. In the decade before 2008, the franc traded in a relatively narrow band. However, since then, it has strengthened 40 per cent on a trade-weighted basis, as panicked investors seeking havens away from dollars or euros have purchased the currency.
Last year, the SNB tried to slow this trend with large-scale unilateral intervention. But after a brief hiatus, the franc rose further, creating SFr10bn ($14bn) of losses for the central bank this year alone, and prompting some politicians to demand the resignation of Philipp Hildebrand, its governor. This summer’s chaos in the eurozone and dollar markets has strengthened the franc again. Indeed, last week Goldman Sachs described it as “the most overvalued currency” in modern history, 71 per cent stronger than fundamentals justified.
Unsurprisingly, the SNB warns that overvaluation threatens to create a recession and deflation. It is also causing losses for millions of east European homeowners with mortgages in francs, and (less visibly) for European banks holding franc-linked derivatives contracts.
Thus the SNB faces pressure to act. But last year’s experience has left it wary of intervention. So on August 3 it launched a desperate experiment: in 10 short days, it raised liquidity from SFr30bn to SFr120bn (an injection into the financial system worth a stunning 20 per cent of gross domestic product), and conducted currency swaps. The hope is that this shock therapy will push markets rates into such negative territory that foreigners will not want to hold francs.
Will it work? Opinions are divided. The good(ish) news is that the franc did weaken late last week. The bad news is that money markets also started to gum up, partly because no one knows what negative rates will do to the financial system. They might, for example, force banks to impose negative rates on Swiss savers. “Even sophisticated investors [are] inquiring about the possibility of bank runs should people decide that holding cash in bank accounts [is pointless],” says Beat Steigenthaler of Swiss bank UBS. This “nonsensical” idea reflects the “rather chaotic turn the money markets have taken”, he says.
Meanwhile, some doubt that even this shock treatment will stop people buying francs; they want the SNB to reimpose the 1970s controls. “The Swiss authorities do not seem to have woken up to the fact that the only way to control this [currency swing] is to introduce negative interest rates for large foreign deposits,” says Christopher Wood, analyst at CLSA in Hong Kong.
Do not bet on this happening soon, however. SNB officials insist (probably correctly) that imposing capital controls would undermine Switzerland’s status as a financial centre. They also doubt the 1970s measures even worked. And there is a third important point: though data are patchy, it seems (unlike the 1970s) that flows in global derivatives markets, not bank accounts, are driving the franc higher. Thus, imposing negative rates on bank accounts by fiat may not work as well as lowering market Libor rates through indirect means.
Nevertheless, if global financial turmoil continues, pressure on the SNB will rise. If so, its next step will probably be further currency intervention, despite last year’s unhappy experience (not to mention the risk of sparking a currency war). The SNB’s only comfort is that domestic politicians are no longer calling for Mr Hildebrand’s head; it is now clear to all that Switzerland – like much of the west – is sailing into uncharted policy waters. The wild experiments could soon grow wilder still.
Unless, of course, eurozone and US governments can solve their own problems. And cuckoo clocks might fly.
Nouriel Roubini: Karl Marx Was Right
In a clip from a longer interview with WSJ's Simon Constable, Dr Nouriel Roubini claims Karl Marx was right about capitalism self-destructing. While the U.S. is not there yet, he believes there is considerable danger facing the United States.
Nouriel Roubini: Invest in Cash
In a clip from a longer interview with WSJ's Simon Constable, Nouriel Roubini explains his investment strategy: invest in cash. "Better to be safe than sorry," he says.
London House Prices Plunge on Financial Turmoil
by Scott Hamilton - Bloomberg
London home sellers lowered asking prices by the most in a year in August as demand in Britain’s most expensive property market was hit by turmoil in financial markets, Rightmove Plc said.
Asking prices in the capital dropped 3.4 percent from the previous month, when they decreased 1.4 percent, the U.K.’s biggest property website said in an e-mailed report today. Nationally, values fell 2.1 percent, a second consecutive monthly decline and the largest since December. “Prices often fall back at this time of year, but the renewed turmoil in global financial markets may be starting to hit home with London buyers who have thus far been insulated from the worst of the downturn,” Rightmove said.
While values are being supported by a lack of property supply and record low interest rates, waning consumer confidence and the potential impact on bank lending from an escalation of Europe’s debt crisis may undermine activity further, Rightmove said. U.K. business confidence fell last month and the recovery in the labor market will slow, separate reports published today showed.
National asking prices were down 0.3 percent in August from a year earlier to an average 231,543 pounds ($377,000), Rightmove said. That’s the first annual decline since September 2009. In London, prices were up 3.2 percent to 418,008 pounds.
U.K. stocks have plunged this month, with the FTSE 100 Index falling 9 percent amid a global selloff sparked by concern that Europe won’t be able to contain its debt crisis. Europe’s Stoxx 600 has fallen 11 percent.
Rightmove said the impact of the financial turmoil across the U.K. is “likely to be limited because prices are already bumping along the bottom.” In London, prices probably won’t continue to fall at the same rate as in August as the market “is seen internationally as a safe haven in times of financial upheaval,” it said.
Eight out of 10 regions in England and Wales tracked by Rightmove showed monthly declines in August, led by London and a 2.6 percent drop in southeast England. In the U.K. capital, all 32 boroughs saw prices fall. The Kensington and Chelsea district and Westminster both had a 2.9 percent decrease.
“With both buyers and sellers staying away from the market unless they are strongly motivated to move, we expect prices to stabilize with continuing subdued transaction volumes,” said Miles Shipside, commercial director of Rightmove, referring to the London market. “It remains to be seen whether the latest round of global financial jitters will affect the London market over the next few months.”
For the reports, Rightmove measured 102,031 prices for homes put on sale on its website between July 10 and Aug. 6. That accounts for about 90 percent of the market, it said.
U.K. business confidence weakened in July, BDO LLP said in a separate report, with firms seeing “little economic growth” over the next six months. Companies’ inflation expectations rose to the highest in almost three years.
An index of sentiment fell to 95.1 last month from 95.6 in June, while a gauge of estimated business output for the next three months fell to 95 in July from 96.3. A reading above 95 signifies expansion. A measure of factory production for the next quarter signaled contraction.
The Chartered Institute of Personnel and Development and KPMG LLP said the U.K. jobs recovery may “slow sharply” this quarter, citing a survey of more than 1,000 employers. An index measuring the difference between the proportion of employers that intend to hire and those that plan to reduce their workforce fell to minus 1 in the third quarter from 3 in the second quarter.
The recovery “continues to falter,” said BDO partner Peter Hemington. “The rapid decline of the manufacturing sector, championed as the key to a rebalancing of the U.K. economy, is alarming. And the services sector is showing little sign of picking up the slack.”
Rail fare rises of 13% 'may break government', campaigners warn
by Dan Milmo and Heather Stewart - Guardian
Passenger groups, environmental lobbyists and unions predict average fares will rise four times faster than wages in 2012
Hitting rail commuters with a swath of double-digit rail fare increases will carry "economic and political consequences" for the government, campaigners have warned on the eve of inflation figures that will mean some tickets rise by 13%.
Millions of rail passengers will get an indication of the fare increases due in January when the inflation rate that sets annual price rises is published on Tuesday. Under the government's austerity drive, from next year season tickets will rise by the rate of retail price index inflation plus 3% until 2014, with room for a further 5% increase on some services. With the RPI due to hit 5% next week, commuters face a 13% increase on certain routes – to the dismay of passenger groups, environmental lobbyists and trade unions.
"It will be a straw that breaks the camel's back," said Stephen Joseph, chief executive of the Campaign for Better Transport (CBT), which has warned that average fares will rise four times faster than wages in January. "There are both economic and political consequences for this. For some people in the London labour market and some cities outside of London, this will be a big chunk of money.
"If you look at places where there is a large number of rail commuters, there is a significant number of marginal seats. Those are precisely the places that will be affected by eye-watering rail fare rises."
The Department for Transport has confirmed that it will retain the so-called flex system, which allows rail companies to average out fare increases across a basket of tickets instead of applying uniform price increases. Under this framework, a further 5% can be added to the RPI + 3% hike on certain fares, provided that the total increase within that batch of fares is in line with the official limit. This means that an annual season ticket from Bournemouth to London, currently £5,424, could rise by £705 to £6,129. Increases could be even higher on fares that are not capped, such as advanced purchase fares.
Train operators, who levy the fare increases and are often a lightning rod for passenger ire over ticket prices, will pass on the increased revenue to the government and are keen to emphasise that they are only following DfT policy.
"Increasing the money raised from fares will mean that taxpayers contribute less to the running of the railways, whilst ensuring that vital investment can continue," said David Mapp, commercial director at the Association of Train Operating Companies. The government spends around £4.6bn a year on the railways with the farepayer contributing £6.2bn, a gap the DfT wants to widen after setting a target to reduce industry costs by a further £1bn by the end of the decade.
Theresa Villiers, the rail minister, ruled out scrapping the flex system, which had been dropped in the final year of the Labour government. "The scale of the deficit means that the government has had to take some very difficult decisions on future rail fares, but the long-term solution is to get the cost of running the railways down. That way we can get a better deal for passengers and taxpayers. We are determined to do this and if we succeed, we hope to see the end of above-inflation rises in regulated fares," she said.
Nonetheless, a concerted campaign against the rises has already begun. The environmental group Climate Rush will join the CBT, unions and the shadow spokeswoman for transport,
Maria Eagle, at Waterloo station, in London, tomorrow to protest against the increases. According to the CBT, train fares will rise by an average of 8% – four times more than the average wage rise. Eagle said: "For many, the cost of getting to work is now the biggest single item in the monthly budget, bigger even than rent or mortgage payments. These fare rises are the direct consequence of the decision to cut too far and too fast, meaning commuters are having to pay more to plug the hole in the transport budget."
Despite warnings that inflation-busting hikes will dent demand for rail travel, journeys on the network rose by 6.9% last year to 1.32bn. Inflation fell modestly in June, to 5% on the RPI measure, as hard-pressed retailers slashed the price of electronics goods such as televisions. City analysts expect a similar reading for July, with average earnings growing at less than half that pace, many households are already enduring a painful squeeze on their living standards.
High oil prices, January's increase in VAT and the weakness of the pound, which pushes up the cost of imports, have all boosted prices. CPI inflation, the measure targeted by the Bank of England, is expected to be above 4%, for most of this year. Sir Mervyn King will be forced to write to George Osborne this week to explain why inflation remains more than half a percentage point above the government's 2% target.
Japanese Rating Firm Warns of Sovereign Downgrade
by Natasha Brereton-Fukui - Wall Street Journal
One of Japan's two major credit-rating companies could cut its top-notch rating on Japan within months, unless it sees a surprising commitment from the government to fiscal retrenchment in the budget for next fiscal year, according to analysts at the firm, Rating & Investment Information.
It has been nearly 13 years since Moody's Investors Service became the first of the international rating firms to retract its perfect rating on Japan's debt. But a downgrade by a Japanese rating firm could jolt domestic investors, who hold around 95% of government bonds. Japan's other major rater, Japan Credit Rating Agency, still ranks Japanese government debt at triple-A.
There is at least a 50% probability that R&I will downgrade its assessment of government debt, having kept the rating on negative outlook since March 2001, said Kenji Sekiguchi, primary analyst for Japan sovereign ratings, in a recent interview. He said R&I could take action as soon as the outlines of the budget become clear, with early spending indications expected from government ministries in September. While any rating cut would be preceded by a downgrade monitor warning, that can last as little as a week.
"The path we have to follow to maintain a triple-A rating is really, really narrow," Mr. Sekiguchi said, adding Prime Minister Naoto Kan's successor, still undetermined, would likely face fierce opposition. "Thereby, I think the commitment I would like to see in the budget isn't likely to come about," he added.
Until now, R&I has taken the view that Japan's public debt—which at double its annual economic output is the highest ratio in the industrialized world—was compensated for by its strong political and social stability, economic fundamentals, availability of financing, and policy management. But the latter has been getting weaker with every change of prime minister, said Masatoshi Taniguchi, deputy head of R&I's credit ratings division in charge of international issuers.
R&I will be "keenly paying attention" to September's spending estimates. "Based on it, we will decide whether we can sustain our triple-A rating or we will decide to downgrade," he said. Having stepped up its warnings this year, R&I gave Japan the benefit of the doubt after March's devastating earthquake, in the hope that lawmakers might pull together to tackle the country's fiscal woes. But what followed has been a "big disappointment," Mr. Sekiguchi said.
"What we've seen for these past few months is just political games," he said, adding that what the rating firm really needs to see is the "will" of politicians to tackle Japan's debts. "What we have right now is an even harder situation for fiscal management and for the economy itself. Given this, I think what we would like to see is more commitment and a firmer stance toward fiscal consolidation," Mr. Sekiguchi said.
Japan faces "huge" accumulated risks, and simply meeting the basic spending ceiling of Y71 trillion ($925.8 billion) and new government bond issuance of Y44 trillion is "not enough." "What we would like to see is more surprise—some measures showing commitment that even surprises us," Mr. Sekiguchi said.
Wall Street's volatility compounds states' pension fears
by Michael Gormley - AP
Wall Street's volatility has hit state pension funds just as they were beginning to recover from the recession, turning what was merely a troubled forecast into a potentially stormy future for taxpayers who are on the hook for billions in unfunded liabilities for government retirees.
As for the millions of government clerks, engineers, janitors, teachers and firefighters in the retirement systems, they are protected by law or, as in New York, by the state constitution, to be backed up by tax dollars if necessary. Their benefits remain safe for life in guaranteed "defined benefit" pension plans that are disappearing in the private sector, where most employees are left to fend for themselves with 401(k) plans that they mostly or entirely fund themselves.
California's main public-employee pension fund, the nation's largest, has lost at least $18 billion off its stock portfolio since July 1, about 7.5 percent of its $237.5 billion total asset value on June 30. Florida's pension fund has lost about $9 billion since June 30, a decline of 7 percent for a fund valued at $119.4 billion on Thursday, while the Virginia Retirement System shrank from $54.5 billion on June 30 to about $51 billion by week's end, a decline of 6.4 percent, said its director, Robert P. Schultze.
New York's state comptroller will not say how much the state pension fund has lost during the latest Wall Street roller coaster, but the fund was 5 percent below its pre-recession value before the recent losses and remained nearly $8 billion below its pre-recession value. And Kentucky, which has more than $20 billion in unfunded pension liabilities, has seen the value of its public pension fund decline $1.7 billion — or 15 percent — since July 1, falling to a total value of $9.7 billion.
Nationwide, states have a combined $689.5 billion in unfunded pension liabilities and $418 billion in government retiree health care obligations, according to data collected earlier this year by The Associated Press. Those benefits are protected by state law or, as in New York, by the constitution. Pension fund managers say there is no risk current government retirees will miss a monthly check and that they are remaining calm and taking the long view in their investments. Some say the market plunge is even providing a great opportunity to buy stocks at fire-sale prices.
Kentucky Retirement Systems Chief Investor T.J. Carlson said his fund has not made significant changes to its investments in response to the market turmoil. "We haven't changed our long-term strategy in any way," he said.
Critics of the defined benefit plans, which guarantee pensions for life to public employees and are rarely found any longer in the private sector, say the recent stock market plunge underscores the need for fundamental changes. The amount state and local governments are being forced to funnel into pension payments is rising as retirees live longer and elected officials have awarded more generous pension benefits in recent years, taking taxpayer money away from core public services.
At the same, pension funds promise returns on investments — 7 percent to 8 percent or more a year — that many critics say are unrealistic in the future. E.J. McMahon, a senior fellow at the conservative Manhattan Institute for Policy Research, said the asset levels of virtually all public pension funds are below 2007 levels despite the recovery of the market in 2009 and 2010. "They still think there is a 'long-term norm,'" he said of fund managers. "The events of the last two months are a reminder of how wrong that might be."
As recently as last month, California's two public pension funds reported investment gains of more than 20 percent for the fiscal year ended June 30, largely driven by rising stock values. The increase came as both funds — one for teachers, the other for state and local government workers — were clawing their way back from losses in 2008 and 2009 that cost them up to one-third of their asset value.
The recent losses are stoking fears again that taxpayers will have to bail them out at the expense of other programs that already have been subject to deep budget cuts. The state already faces an estimated $75 billion in unfunded public pension liabilities. "The stock market volatility just shows that the public budget should not be subject to the Dow Jones Industrial Average," said Dan Pellissier, president of California Pension Reform, a group that is preparing a ballot initiative to limit the amounts governments can spend for future pensions.
Pellissier himself will qualify for a $5,000-a-month state pension when he turns 55 in five years after working in state government for two decades. Despite his own government pension, Pellissier said public employees should bear the investment risk for retirement benefits just as private-sector employees do through 401(k) plans.
New York state Comptroller Thomas DiNapoli said public pension funds work well. New York has reduced pension benefits in the past year for newly hired workers and lowered its performance outlook to 7.5 percent, while most states remain at 8 percent. "This is a fund that has worked and been able to pay out benefits for 90 years," he said. Managers also note the "funding ratio," which is the percentage of the fund needed to pay out all its obligations, is more than 80 percent in many states, which pension managers say is positive.
As an example of pension funds adapting to meet changing conditions, the $51 billion Pennsylvania Public School Employees' Retirement System increased its cash allocation to 8 percent after the 2008 market crash so it could pay benefits without having to sell assets. It has lost as much as 3 percent in value since July 1.
After a strong showing last year in a rebounding market, many state pension fund managers are confident they will ride out the latest gut-churning gyrations on Wall Street. nWhile Virginia's fund has an unfunded liability of $17.6 billion, it diversified after the stock market losses in 2008 and 2009, allowing it to better weather stock market swings. New Jersey's pension portfolio is more diverse than ever and includes real estate, hedge funds and private equity investments.
"It's a hedge against the kind of market conditions we've seen over the past two weeks," state Treasury spokesman Andy Pratt said. "We have significant protection against the ups and downs of the stock market we're seeing now." He said returns for the last fiscal year were between 17.5 percent and 18.5 percent, the best year since 1998.
In Massachusetts, investments are being diversified and loopholes to accrue pension benefits are being closed. The state also added 15 years to its deadline for fully funding the retirement system, pushing it to 2040. Julie Graham-Price, spokeswoman for Ohio's Public Employees Retirement System, said the fund's bond holdings gained this week even as stock values sunk, evidence of a balanced portfolio.
"We have no idea yet what July and August will look like except to say it's not good when the market is volatile and has dropped like it has," said David Urbanek, spokesman for the Illinois Teachers Retirement System. "It's a cyclical thing. We will ride it out, just as we have overcome numerous other downturns over the last 72 years."
Even with the steady-as-she-goes response from pension fund managers, critics of the system say taxpayers should be nervous about their future liabilities to government retirees, said Jim Waters, vice president of the Bluegrass Institute, a nonpartisan group that has pressed for a defined contribution system for government employees in Kentucky.
"Without pension reform, Kentucky could be headed for bankruptcy and the inability to provide necessary services for its neediest citizens," he said. "Kentucky's been in a hole for a while now, but continues to dig ... There's no way we can rely solely on the stock market or even individual contributions alone to close the liability gap."