"Camel cigarette advertisement at Times Square, New York City"
Ilargi: Well, the coups have been successful: Greece changed Papa's, and Italy's going to get its Full Monti. If the financial world can't get the votes, it simply chases away chosen leaders and appoints its own guys in their place. Woe the people of Athens and Rome. Who still have no clue, if one can go by the support both non-elected leaders of only-in-name democracies have received at home. Don't say you weren’t warned.
Italy sold €3 billion in 5-year bonds at 6.29% today, and that is a victory how again? Italy can't afford to pay almost 5 times as much interest as Holland or Germany do, not for long. The EFSF, according to the Telegraph, even had to buy its own debt in its first ever issue. The fund has denied the report, but who do you believe, them or your lying eyes?
Everyone and their pet parrot are by now clamoring for the ECB to step in and buy everything under the sun, but that horse is already dead tired. The ECB itself doesn't want to be lender of last resort, Germany doesn't want it to be, and it also happens to be plain illegal to let it, under EU law and probably under that of some of its members as well.
European Council president van Rompuy is said to be working on treaty changes that should make it all possible, but I can guarantee you that one or more member countries will insist on at least a referendum on such issues. And Europe doesn't have the time for that, let alone the gusto.
So what to do? It's really very simple. It may lead to economic pain and political chaos, but other than that, it's not that hard at all.
Europe needs to grow a pair. It needs to refuse to bail out financial institutions that can no longer stand on their own two feet without bail outs to prop them up. It then needs to demand full discovery of any and all assets in the bank vaults. It can offer temporary support to those banks that remain viable as going concerns once all their paper has been marked to market, insure any and all deposits from citizens and businesses, and subsequently close the doors on those banks that are going concerns no more.
Washington and Wall Street will shout fire, murder and brimstone, but you know what? Let them take care of their own for once. The notion that -future- European taxpayer revenue must be put at risk to save Wall Street banks needs to be put out by the curb. It doesn't work, not for the European taxpayer.
Both Wall Street and European banks that hold too much American and European private debt, sovereign debt and/or derivatives, need to be purged from the system. Europe can make a start, and if America knows what's good for it, it will follow suit. If not, tough luck.
It's high time to come clean, to stop the incessant lying. To stop pretending things are a bit hard right now, but otherwise just fine. They're not. Extend and pretend works only so long. Then it snaps back in your face with a vengeance. That's why the bond markets are so successful in bringing down Italy and Greece. Not because the ECB doesn't step in, since that would only serve to cover up reality for a little bit longer, but because they've both lied for so long about their real predicaments.
No, just stop lying. The consequences and challenges will be formidable, but they’ll be that anyway. You can't cover up the debt and the losses forever. And the chances of growing your economies out of the cesspit are zero, if not below.
One thing no more lying will achieve is this: it will re-establish confidence in the markets -or what'll be left of them-. And isn't that what you guys always say you want to accomplish? Well, I can assure you, it's the only way to do it: cut the fairy tales. Take a breath of fresh air and get to work. Do something real and rewarding for a change, and for a living.
Oh, and one other thing that must stop something urgent: stop talking about economic growth. There ain't none, and we need to wonder hard and loud why we still and always unquestioningly assume and accept that we need it. No, the Greek economy will not grow its way out of its misery. Neither will Italy's, or France's or America's. There's too much debt to grow out of.
But perhaps this is hard to fathom without resorting to more philosophical questions. For those of you who've never read or heard Professor Albert Bartlett's work on exponential growth (since that is what we're talking bout), get moving. Bartlett is a physicist. That means he's an actual scientist, and capable of understanding the inevitable endgame of exponential growth. People like Papademos and Monti, as well as just about any political and economic leader on the planet, don't understand the science involved. Either that or they’re willfully blind to it.
And there's another layer to the question, one that goes beyond the easy to understand impossibility of endless and eternal growth. That is, when we look around our respective places on the planet, why do we think we need to grow more? Why do we feel we haven't grown enough? And perhaps more quintessential: what is it that we want to grow into? At what point, if we do want more growth, will it be enough for us? Have we even thought about that?
We are fed the constant growth story because it is indeed a necessity in our present system. When all money issued carries interest i.e. is issued as debt, you will need to grow your GDP at least as much a that interest rate to play even. Just as easy to understand as the exponential growth conundrum. Or so you would think.
But that doesn't mean that you can always keep issuing enough money to meet your interest payment requirements. Not when a huge part of it is issued as for instance mortgage loans, but very few people buy homes. Not when money is created when banks issue fresh credit to industries, but industries find no market for their products and instead contract.
In other words: if we don't grow, we will shrink. And that, we are told, is the very definition of armageddon. But why couldn't we shrink a little and still be comfortable? In theory we could perhaps, but first of all the human mind isn't made for shrinkage, and second the money we create as credit is virtual, and can disappear as fast as it was created, and into the same nothingness.
If we would for instance consciously choose to shrink by 5%, we'd run a very real risk that we would cause 50% of the money to vanish. The system based on credit will have the tendency to go down like so many dominoes. It has very little resilience and is thus enormously fragile, something we don't pay attention to when we have growth, and are therefore not prepared for when we no longer do.
These days we can find a lot of 2012 growth predictions in the media. Just about every single one contains a revision to the downside. 0.5%, 1%, that's all that's left. And that's not enough to pay the interest. It's always instructive to look at the terminology used in the news. Economic growth will be reported as meager vs healthy, robust vs lagging, weak vs strong.
More is always better. A 1% growth number for a modern western economy just doesn't cut it. Even though it's just as much of an exponential growth number as any other. And exponential growth inevitably leads to disaster. Still, the system's proponents seem to think there's such a thing as too little exponentiality.
Now, of course I recognize that more philosophical musings such as these are easily discarded. You can't change the system overnight, I hear you say. It worked well for a long time. We are much better off than we were before. Than our parents and grand parents were.
That last one is a bit of a stretch. In her lectures, TAE's Nicole "Stoneleigh" Foss puts the highest point of our wealth as a society (EU and US) at 1982 at the latest. As in for instance: what percentage of your income, wealth, went to pay for education, health care, then as opposed to now? It's probably a few years earlier still: mid-70's. When the world started processing Nixon's decision to take the US off the gold standard (which I don't want to discuss here).
After that, and we're talking some 35 years ago, more than a generation, the money as debt system really took off. It took a while for the psychopaths among us to realize the possibilities, but it's 2011 now and boy, have they ever realized it. And so have we, of course. Jay Hanson once wrote something like (I paraphrase) : "Democracy only works until voters realize they can vote themselves an ever larger piece of the pie".
It's 2011, and Greece and Italy have just put their fate and faith in the hands of non-democratically appointed leaders. Over the past 35 years, they may have gotten a bit richer, but those days are gone, and are the Greeks and Italians today really happier than the preceding generation?
But, yes, the system worked for a while, even if not really for a long time. And yes, you can't change the system overnight.
I guess what irks me most when I read all the "return to growth" stories, whether they address the US or Greece or any other nation, is that it's such a one-dimensional notion. I never see anyone asking questions about the core issue. And most of all, I never see a politician or economist addressing the question of what would happen to us, and what we should do, if we can not return to growth.
Surely we can all agree that political decisions and measures would in all likelihood be very different if we, if even hypothetically, considered a no-growth scenario. For now, it's treated as a doomsday tale, to the extent that anyone gives it any thought at all.
And that at a time when I am personally simply not able to see any way at all to get our societies back to what is considered "healthy" economic growth. Certainly not if we all keep lying, and accepting lies, about where we are. Shed daylight on the paperwork and let's look it over. If it all turns out to be relatively benign, all the better. But if it doesn't, at least we’ll know what to prepare for and work on.
The fact that 800 pounds a day of funny accounting is used to cover up losses all over the place is probably a good indicator of our reality. Which means we'd better start talking about what to do when growth is no longer a viable option. And get rid of this quasi-religious clinging to it as something some immovable deity handed to us atop a removed mountaintop.
Because that's it, in the end, isn't it: the growth religion makes us destroy not only our economies, but the very world we live in. And that is embarrassing, if nothing else. For onr thing, how does that define as growth? It makes us look just about infinitely stupid. Luckily for us, we can do something about it: start thinking about and discussing why we want growth; if we need it, why we want it.
Stop your leaders from lying, and stop lying to yourselves. At the very least, you’ll feel less embarrassed. And ask yourself: what do you want to grow into? What's missing?
Merkel: Europe in toughest hour since World War II
by Noah Barkin and Stephen Brown - Reuters
Chancellor Angela Merkel said on Monday that Europe must move step-by-step towards political union, calling the euro zone debt crisis the continent's "toughest hour since World War Two".
In a one-hour address to thousands of delegates from her Christian Democrats (CDU), Merkel offered no new ideas for resolving the crisis that has forced bailouts of Greece, Ireland and Portugal, and has stirred worries about the survival of the 17-state currency zone.
But she made clear that Germany will have to make more sacrifices. "The challenge of our generation is to finish what we started in Europe, and that is to bring about, step by step, a political union," Merkel told the party congress in the east German city of Leipzig. "Europe is in one of its toughest, perhaps the toughest hour since World War Two," she said.
The two-day party meeting was supposed to focus on education policy but was dominated from the outset by the euro zone's debt crisis, which showed no signs of abating despite the naming of new technocrat governments in Greece and Italy.
Merkel, who came to power in 2005, does not face an election until 2013, but knows she could easily become another victim of euro turmoil unless she plays her cards right. The CDU is the party of Helmut Kohl, who led Germany into the euro.
Nearly 13 years on, many German conservatives are uneasy with taxpayer-funded bailouts of weak euro states, deeply resent fiscal backsliding in countries such as Greece and worry the crisis may compromise the independence of the European Central Bank. Some in the party believe the whole project was a mistake which must now be undone.
But Merkel argued that Germany had a responsibility towards its partners and was vulnerable itself if other euro zone states were dragged into the crisis, reminding the party that 60 percent of German exports go to the European Union . "Irish problems are Slovak problems, Greek problems are Dutch problems, and Spanish problems are our problem," Merkel said. "Our responsibility does not end at our borders."
At the same time she made clear there are red lines Germany was not prepared to cross, rejecting joint euro zone bonds and other quick fixes which Germany believes would discourage euro states from running responsible fiscal policies.
"Tough Road Ahead"
"The hard part is that this crisis was not created overnight, it is the result of decades of mistakes, and we can't solve it in one fell swoop. We have a long, tough road ahead of us," she said.
Merkel was walking a fine line at the party congress in Leipzig which ran under the banner "For Europe - For Germany".
The main resolution from the CDU leadership sent two seemingly contradictory messages: that Germany has benefitted hugely from the euro, must gird for more burdens to save it and be ready to give up sovereignty to Brussels, and that member states that violate European fiscal rules must be dealt with harshly, and may even leave the bloc.
It is not only her euro policy which has sparked dissension in CDU ranks. After the Fukushima disaster in Japan earlier this year, Merkel abruptly abandoned the party's long-standing support for nuclear power, enraging the CDU's business wing. Last month she made another surprising about-face, backing the introduction of a nationwide minimum wage, a policy she had publicly opposed for years.
Both reversals are part of a deliberate strategy by Merkel to co-opt the positions of rival parties, as she did on evironmental and family policy in her first term, and increase her coalition options for 2013, when partnerships with the Social Democrats (SPD) or Greens may be her only hope of retaining power.
Since becoming chancellor six years ago, she has overseen a dramatic transformation of the CDU that has made it nearly unrecognisable from the free-market, business-friendly party that gathered in the same city of Leipzig back in 2003.
Back then Merkel was often likened to Britain's hard-charging reformist Prime Minister Margaret Thatcher, a comparison no one makes anymore after her sharp turn left. But if the euro zone crisis blows up before the next German vote, forcing one or more countries out of the bloc and hammering the region's economy, then even the most canny political maneouvres and reinventions probably will not save her.
Merkel Says EU Must Forge Closer Union to Sway Bondholders
by Tony Czuczka and Brian Parkin - Bloomberg
German Chancellor Angela Merkel said it’s time to embrace a "political union" in Europe to send a message to bondholders that euro-area leaders are serious about ending the sovereign debt crisis.
Speaking on the eve of her Christian Democratic Union party’s annual congress in the eastern German city of Leipzig, Merkel said that she wants to preserve the euro with all current 17 members. "But that requires a fundamental change in our whole policy," she said.
"I believe this is important for those who buy government bonds: that we make it clear that we want more Europe step by step, that is that the European Union, and the euro area in particular, grows together," Merkel said in an interview with ZDF television late yesterday. "Otherwise people won’t believe that we can really get a handle on the problems."
Merkel will address her party at about 11 a.m. today after weeks of crisis fighting during which she raised the prospect of ejecting Greece from the euro and joined with French President Nicolas Sarkozy to call on Italy to hold to its budget pledges. After leadership changes in Italy and Greece, the chancellor is turning her attention to shaping the euro and EU’s future.
"Big political changes are now sweeping through the euro zone, putting -- at least for now -- the many skeptical political observers to shame," said Erik Nielsen, chief global economist at UniCredit SpA in London. In Italy, Greece and Spain, which holds elections on Nov. 20, "people want ‘more Europe,’ not less."
Asian stocks rose the most in a week as Italy and Greece recommitted to the reform path. The MSCI Asia Pacific Index climbed 1.3 percent as of 2:57 p.m. in Tokyo, after losing 2.4 percent last week. The euro rose for a second day and was at $1.3755 as of 7:01 a.m. in London from $1.3750 in New York on Nov. 11. It reached a one-month low of $1.3484 on Nov. 10.
In her interview, Merkel said that the next step to bolster investor confidence means what was begun by the euro’s founders must be completed with "a fiscal union, and then turn it step by step into a political union." "That is the lesson of the crisis and this will still require a lot of effort," she said.
Euro leaders are due to meet in Brussels on Dec. 9, when they have asked EU President Herman van Rompuy to present them with a report on a "timeframe for the further strengthening of the euro zone" that should include "the question of possible treaty changes," the German Finance Ministry said Nov. 9.
"Merkel wants far more centralized euro fiscal oversight so that something like Greece can never happen again," Jan Techau, director of the Brussels-based European center of the Carnegie Endowment for International Peace, said by phone. That means euro governments will have to cede some sovereignty over budgets, he said. "There seems to be some kind of deal between Merkel and Sarkozy on this."
Michael Meister, the CDU’s parliamentary finance spokesman, raised the prospect of joint euro-area bonds following on. "An integrated fiscal policy" in the euro region would mean "we can discuss the question of joint liability," he said in an interview on Nov. 10. "The sequence of events is important."
The euro crisis now entering its third year is the main theme occupying Germany’s ruling party as more than 1,000 delegates gather in Leipzig. The convention’s main motion is on the euro.
Euro members that get financial support must reduce debt and strengthen their economies, according to the draft text of the motion to be debated today. "Some countries will achieve this quickly, while others will need our solidarity and our encouragement for years," it says.
The chancellor addresses the convention with domestic public opinion going her way. Merkel’s handling of the debt crisis is backed by 56 percent of Germans, up from 45 percent in early October, according to an FG Wahlen poll for ZDF television published Nov. 11. Merkel’s overall approval rating also rose. The Nov. 8-10 poll of 1,278 people has a margin of error of as much as 3 percentage points.
Merkel will use her speech to issue a "warning" that it’s necessary to do everything to move toward a "stability union," the CDU’s Meister said. "We mustn’t just draft rules, we need to patrol them and enforce them," he said. "We need more discipline." Merkel will deliver that message "loud and clear."
Eurozone bail-out fund has to resort to buying its own debt
by Harry Wilson and Kamal Ahmed - Telegraph
Europe's €1 trillion (£854bn) rescue fund has been forced to buy its own debt as outside investors become increasingly concerned about the worsening eurozone sovereign debt crisis.
The European Financial Stability Facility (EFSF) last week announced it had successfully sold a €3bn 10-year bond in support of Ireland. However, The Sunday Telegraph can reveal that target was only met after the EFSF resorted to buying up several hundred million euros worth of the bonds.
Sources said the EFSF had spent more than € 100m buying up its own bonds to help it achieve its funding target after the banks leading the deal were only able to find about €2.7bn of outside demand for the debt.
The revelation will be seen as a major failure and a worrying sign of future buyers strike after EFSF officials and their bankers had spent recent weeks travelling the world attempting to persuade key investors, including China's national wealth fund and Japanese government funds, to buy its bonds.
Chinese and Japanese money was crucial to last year's first bond sales by the EFSF, but they have since been dismayed by the eurozone's failure to resolve the worsening debt crisis and alarmed at how fund has morphed from being a rescue facility for European banks into a potentially €1 trillion leveraged first-loss insurer for eurozone governments.
Other European Union funds are also understood to have supported the EFSF's bond sale. The failure of the EFSF will increase pressure on the European Central Bank to effectively become the lender of last resort for the eurozone, a move it has strongly resisted.
At a private breakfast organised by PI Capital last week, Mark Hoban, the Treasury minister, said: "What it doesn't do is provide the next stage of the solution, which is how do you stop this from happening again?" he said.
The move, by the European Investment Bank, will cause more disquiet among non-eurozone EU members who have become concerned about their growing exposure to the cost of rescuing the currency bloc.
EFSF Denies It Is An Illegal Pyramid Scheme
by Tyler Durden - ZeroHedge
If there is one thing one can say about the insolvent European continent is that despite everything, it is a bastion of truth, and a knight of see-thru disclosure.
After all, who can forget such brutally honest statements as "Greece will not default", or the follow ups: "Ireland is not Greece", "Portugal is not Ireland", "Spain is not Portugal", "Italy is fine", "Italy has turned down money from the IMF", "The IMF has never offered any money to Italy", and then the old standbys, "the ECB will not be a lender of last resort", "the EFSF will use 4-5x leverage", wait, make that "the EFSF will use 3-4x leverage", and last but not least, "Europe is not America" and "it is all the fault of evil CDS speculators."
Well we have one more to add to the list: "the EFSF is not an illegal ponzi scheme" - because after the mindboggling report in the Telegraph yesterday that the EFSF has bought hundreds of millions of its own bonds, exposing the scam in the heart of the Eurozone for anyone to see, the European rescuer of last resort (at least until the ECB comes out monetizing and Eurobonds are issued)has no choice but to join in the parade of truths and as Reuters reports "said on Sunday that it did not buy its own bonds last week, denying a British newspaper report that it spent more than 100 million euros ($137 million) to cover a shortfall of demand.
"The EFSF did not buy its own bonds and the book was 3 billion euros," an EFSF spokesman said, referring to the 3 billion euros raised in last Monday's 10-year bond issue."
We are certain that in order to dispel rumors about its fraud-i-ness, the EFSF will promptly submit a full breakdown of the entities that received bond allocations (we know that Japan is good for €300 million, that China is good for €0.0, and that as Merkel said one week ago, "hardly any countries in G20 have said they will participate in the EFSF."
So, because we believe everything that comes out of Europe, we are patiently waiting to see just who it was that bought EFSF bonds when nobody else did. And yet what is most troubling to us, is that it took the world 5 minutes to completely agree that the EFSF is a ponzi scheme, with nobody doubting this supposedly "refuted" disclosure for even a second. Perhaps that tells you more about the current state of Europe than anything else...
These bailouts aren't democracy. What's worse, they aren't even a rescue
by Heather Stewart - Observer
The idea that Italy's and Greece's new technocratic governments will be apolitical is nonsense. And it's becoming clear that, in Athens, austerity is already turning a crisis into a disaster
Investors are breathing a sigh of relief after a tumultuous week, with at least a semblance of stability restored to Italy and Greece. But the past seven days have also flipped the euro to reveal a new face – and it wasn't a pretty one. The deeply undemocratic nature of the euro project had already been laid bare in Cannes by the European elite's outraged response to George Papandreou's announcement that he would hold a referendum on the latest "rescue" package for his country.
Papandreou may have had his own tactical reasons for demanding a vote. But given that the bailout package involves further hardship for an already restless populace, it didn't seem unreasonable that, in order to avoid the nation becoming ungovernable, he felt the need to ask for a fresh mandate.
Last week, it was Italy's turn to face intense pressure from financial markets – and, in turn, from its eurozone partners. As Berlusconi showed few signs of carrying out his promise to resign, France began openly calling for regime change in Rome. Now, there's no doubt that Silvio Berlusconi is both odious and ineffectual; but for Italy's neighbours to be demanding the departure of its democratically elected leader was hardly a shining moment for European democracy.
Of course, the fig leaf is that Berlusconi's Yale-trained successor, Mario Monti, will lead a "technocratic" government that will implement drastic spending cuts and necessary structural reforms to nurse the economy back to health. Exactly the same story is being told about ex-central banker Lucas Papademos in Greece. But there are two major flaws in this argument.
First, there's no such thing as a harmless, neutral technocrat; and second, the plan they are toting won't work. The recipe of privatisation, deregulation and welfare cuts that is being presented as the only solution to Italy's woes is a deeply contentious one.
Decisions on how the professions should be regulated, how easy it should be to fire staff, and how much of the national infrastructure should be owned by the state, for example, will be fiercely contested, and have profound implications for the distribution of resources in society. Sir Mervyn King may be a fine monetary policymaker, but would you want him in charge of deciding how many Sure Start centres should be shut? He would say it wasn't the kind of decision he should make.
As Peter Chowla of the Bretton Woods Project, which monitors the work of the IMF, says: "You need an understanding of what these crises mean for different segments of the population."
Older British politicians remember the humiliation of having to answer to the IMF for the Treasury's spending plans after the UK's 1976 bailout. But the austerity-plus-reform package imposed on the bailed-out eurozone members reaches far deeper into national life.
In case there was any doubt that Italy faces joining Greece, Portugal and Ireland as closely monitored protectorates of Brussels, economic and monetary affairs commissioner Olli Rehn wrote to the Italian finance minister last week, demanding details about each one of the 39 reform measures Italy has promised to take.
And it won't have gone unnoticed among the eurozone's poor relations that Germany and France haven't themselves always embraced the reforms they are now recommending. In a paper for the pro-Europe Centre for European Reform last week, Simon Tilford and Philip Whyte said: "The punishing (and self-defeating) economic adjustments imposed on debtor countries contrasts with the self-righteous complacency shown in the creditor countries."
The second problem with "technocratic government" as detailed in an excellent new report by economists from Research on Money and Finance, austerity has been comprehensively proven to fail. Greece has offered up the scalps of 30,000 civil servants, raised taxes, cut public sector salaries and put a cornucopia of state assets up for sale.
The result? A cumulative 10% decline in output through 2010 and 2011, and an unemployment rate of 18.4%. Greece's debt-to-GDP ratio has actually risen, not fallen, since the "rescue" package was implemented, and forecasts from the commission show debt hitting a Japanese-style 198% of GDP by 2013. On its own terms, the programme has been self-defeating.
Ireland is often touted as the success story among the bailed-out euro states, but critics point out that much of its growth has resulted from profits made by multinationals that base their headquarters in Ireland to take advantage of its rock-bottom corporation tax rate, but create few jobs. The Dublin government is predicting that unemployment will still be 11.6% by 2015.
As Stephen King at HSBC puts it: "Far from putting a firewall around Greece, the eurozone has instead ended up with a 'scorched earth' policy where contagion is threatening not just the periphery but the core too."
Italy is now being prescribed more of the same medicine, but with all of its euro partners tightening their belts at the same time, the end result is likely to be a long period of stagnation, high unemployment and political and social conflict over the painful reforms demanded, in what Brian Reading at Lombard Street Research refers to as "Merkozy's pound of flesh".
He rightly insists that restoring growth must come before reforms: "growth eases the passage of structural reforms that bring future benefits. Immediate and brutal retrenchment is medieval bloodletting in hope of a miraculous cure."
Barring such a miracle – or a large-scale intervention by the ECB, which still looks a long way off – there are two paths facing Italy and Greece. They could accept their penance, and effectively become protectorates of Berlin and Brussels.
Or they could seize the opportunity already hinted at by hardline northern Europeans and start to plan for a new economic life outside the single currency. It would be a painful and messy business, involving debt default and capital controls, but at least the inevitable devaluation would hold out some plausible hope of growth.
The single currency began with lofty aims of cementing political unity and building a powerful economic bloc. But far from the hoped-for convergence, the ensuing two decades have exacerbated the competitiveness gap between the wealthy core and the struggling periphery, while reckless cut-price lending by the under-regulated banks helped to paper over the cracks. The tragedy now is that living in an economy strangled by remote-control austerity might cause a resurgence of nationalism.
The great euro Putsch rolls on as two democracies fall
by Ambrose Evans-Pritchard - Telegraph
Europe’s scorched-earth policies have begun in earnest. The inherent flaws of monetary union have created a crisis of such gravity that EU leaders now feel authorized to topple two elected governments.
As I long feared, the flood of cheap credit into Southern Europe and the slow death of Club Med industry by currency asphyxiation have together created such a dangerous situation for world finance that informed opinion is willing to turn a blind eye to EU sovereign trespass. Some even applaud.
The Greeks were ordered to drop their referendum on measures that reduce their country to a sort of Manchukuo, with EU commissars "on the ground", installed in each ministry, drawing up lists of state assets to be liquidated to pay foreign creditors.
Europe had the monetary and fiscal means to contain the EMU debt crisis long enough for Greeks to give or withhold their crucial assent to this ultimatum in December. It chose - under German-Dutch pressure - not deploy those means. Instead it forced Greece to capitulate by cutting off an agreed loan payment.
In Italy, the European Central Bank has engineered the downfall of Silvio Berlusconi by playing the bond markets, switching purchases on and off to enforce compliance with its written dictates ("La Lettera"), and ultimately allowing 10-year yields to spike to 7.45pc to drive him out. Europe’s president Herman Van Rompuy swooped in to Rome to clinch the Putsch. "Italy needs reforms not elections," he said.
We are not that far from use of EU judicial coercion, and then EU police power, and ultimately EU "border troops" - for those old enough to remember Soviet methods of fraternal assistance. Chancellor Angela Merkel tells us that peace in Europe can no longer be taken for granted, and she is right. Her own Gothic actions and her inflexible imposition of 1930s Gold Standard contraction and debt-deflation on Southern Europe is itself preparing the ground for Europe’s civil war (hopefully pacific), a rebellion by the South against the North.
Italy’s youth are turning. Watch the footage of students chanting "democracy" and brandishing their "95 Theses" of Wittenberg revolt as poet Van Rompuy tried to speak in Fiesole. "No to Austerity," starts the Luther List: "Troika out of Greece", "IMF and ECB out of Italy, Ireland, and Portugal", it goes on. "The EU has become ever less accountable to the people of Europe. The undemocratic structures have infiltrated the very structures of the Union," they said.
Behold "the EU’s furious reaction to the Greek government’s effort to seek popular consent over the financial stranglehold imposed on the country. No longer are expressions of popular consent simply ignored, it is now impermissible to consult citizens."
Let us agree that Greece’s Lucas Papademos and Italy’s Mario Monti are excellent men (Mr Monti has been picked for the task by President Giorgio Napolitano, himself a former Stalinist who later switched his loyalties to the sublime Project). But the two good men also represent the EU enforcement machine. Papademos was ECB vice-president. Monti was an EU commissioner for ten years.
Professor Monti enjoys great goodwill in Rome but it is far from clear that he can put together a durable government able to implement Project demands. Antonio di Pietro’s Party of Values has spurned a technocratic regime that lacks democratic legitimacy, saying Italy is "under EU tutelage". La Lega Nord’s Umberto Bossi has denounced the stitch-up.
"The game is getting dangerous," said Il Sole. Some suspect that the Berlusconi camp would not do too badly in snap elections, if allowed, campaigning against the "hated euro and EU bosses". Is that why Brussels is now so afraid of Italy’s voters?
If Mr Monti relies on the Left, how can he comply with EU orders to break the power of the trade unions and impose "Anglo-Saxon" wage-bargaining? A large bloc in parliament will die in a ditch to defend Article 18 of the labour code. Labour minister Maurizio Sacconi warned last week that careless handling of this issue threatens to unleash another round of terrorism in Italy. It is only nine years since Marco Biagi was assassinated by the Red Brigades for threatening the sacred cows of the Sindicati.
No doubt Italy needs a blast of Thatcherism. The country has fallen down the World Bank rankings in ease of doing business from 74 (2009), to 76 (2010), to 80 (2011). Its average economic growth rate has been 0.6pc over the last decade. Productivity and per capita income have declined, and this before the demographic crunch hits with a vengeance.
The old age dependency ratio will reach 59pc by mid-century, compared to 56pc for Germany, 45pc for France, and 38pc for the UK, according to Commission data). But those of us who wrote years ago that Italy’s sclerosis and inflation proclivities were going to cause a train-wreck within the rigours of EMU were told by Europe’s authorities to curb our insolence.
In 2009 the European Commission praised Italy’s "spectacular job creation" and its "greater resilience to external shocks". In 2008 it said Italy was making "good progress" on the Lisbon reform agenda. In 2007 it said Italy’s debt sustainability risk was "broadly in line" with France and Germany.
Italy’s four sets of pension reforms were held out as a shinging example. Finance minister Giulio Tremonti was feted in Brussels, lauded for his iron discipline and primary budget surplus.
And now these same EU bodies tell us that Italy’s failure to grasp the nettle of reform and tackle its debts is so egregious that Europe must step in to overthrow an elected government.
Let us end this EU lie - propagated by Berlin’s uber-bully Wolfgang Schauble - that Italy is suddenly guilty of economic crimes and debt debauchery. What has changed is the industrial recession in Italy that began over the late summer and the likelihood of full-blown depression next year. As you can see from this chart below, all three monetary aggregates in Italy have been collapsing for months, a lead indicator of Hell to come.
The ECB could have prevented this monetary implosion in Italy. Instead it tightened further, without a squeak of protest from the governor of the Banca d‘Italia, then Mario Draghi.
Europe’s own policies of synchronized fiscal and monetary contraction are surely to blame for this sudden lurch downwards in Italy’s prospects.
We all agree that Italy’s economic model is unfit for the 21st Century, but it was also unfit for EMU. The Schumpeterian shock was needed before Italy locked its self into the D-Mark forever.
It is too late now for Italy to claw back 40pc in lost labour competitiveness against Germany within the constraints of monetary union. Any attempt to do so by grinding debt deflation will prove self-defeating for a country with a public debt stock of 120pc of GDP.
Such a policy - already tested to destruction in Greece - will itself cause Italy’s debt dynamics to spiral out of control. There is no possible way at this late stage to reconcile Italy’s needs for massive devaluation with Germany’s hard-money doctrines. One or the other must give.
Germany Resists Austerity in Budget
by William Boston, Andreas Kissler And Matthias Rieker - Wall Street Journal
As Germany puts the final touches on its 2012 budget, it is becoming increasingly clear that Europe's largest economy is a glaring exception at a time when a worsening debt crisis is forcing other major capitals to pull their belts ever tighter.
Berlin is enjoying its lowest unemployment in decades and the government is still finding money to spend on infrastructure and income tax cuts and to preserve German influence in the French-German aerospace group European Aeronautic Defence & Space Co. by buying shares in the company.
But in France, Europe's second-largest economy, the government has presented two austerity budgets as it tries to preserve its triple-A credit rating. Greece's government has been forced to slash public-sector wages and shut down vital public services, even closing some hospitals. And Italy, one of the world's biggest economies and a member of the Group of Seven leading industrialized nations, is being monitored by the International Monetary Fund.
Of course, Germany can't escape the global economic slowdown. Growth in German gross domestic product is expected to grind nearly to a halt, falling to just 0.8% next year after about 2.9% this year, the European Commission forecast this week. Yet even as growth slows, Germany remains on track to balance its budget by 2016 and even has money to spend.
"We now have stronger tax revenues, rising wages and our companies are more competitive. That is why we can consider doing these things now," said Peter Altmaier, chief parliamentary whip for Chancellor Angela Merkel's Christian Democrats.
The German parliament put the final touches on the 2012 budget on Friday. Bolstered by strong tax revenues, the final deficit this year will fall to €22 billion from a projected €48 billion. Parliament also cut the forecast budget deficit for 2012 to €26.1 billion from an original forecast of €27.2 billion. Federal spending is expected to be unchanged at about €306 billion.
Germany's robust job market—unemployment is 7%—is creating a windfall in employment taxes. As a result, federal tax revenue is expected to be €2.7 billion higher next year than previously forecast, at about €250 billion.
The government is also taking steps to bolster its finances. The new budget earmarks about €5 billion in revenue from privatizations, which could include shares held in telecommunications giant Deutsche Telekom AG and the postal agency Deutsche Post AG. And the government will continue to cut public-service employees, reducing the number of government workers by 1,300 to 254,200.
One area of public service won't suffer, however. The finance ministry will see its staff increase "as a result of increasing tasks involved in stabilizing the euro," the budget committee said.
Despite its fiscal health, Germany isn't planning significant new spending on major projects, but it does have leeway on spending. The government announced Friday, for example, that it would earmark €1 billion (about $1.36 billion) in the 2012 budget to purchase a 7.5% stake in EADS in order to preserve Germany's influence on the board. The stake is now held by Daimler AG, which wants to sell the shares.
Germany has also found €1 billion for repairs to the national railway system and highways. And in an apparent political trade-off, the government is considering creating a special €1 billion fund to help communities hit by the closure of military bases, a move to buy political support from the states and local communities for a controversial plan to streamline the German military.
In a nod to families, the government is also considering a new €100-a-month subsidy for parents who send their children to private nannies or day care rather than state-sponsored day-care centers.
And to thank German citizens for the burdens they have shouldered during the euro-zone debt crisis, leaders of Ms. Merkel's center-right ruling coalition last week agreed to restructure income tax rules in a way that would result in an effective tax cut of about €6 billion in 2013, just in time to give a boost to Ms. Merkel's re-election campaign that same year.
In the face of growing public outrage over the rise of a new class of working poor in Germany, Ms. Merkel has done an about-face on the issue of minimum wages. Germany has no statutory minimum wage like the U.S. or many European countries. Instead, unions and employers work out minimum pay on a sector-by-sector basis.
But there are still many low-paying workers such as florists, hairdressers and sanitation workers, who earn such low wages that they often have to supplement their income with social-welfare payments. In some parts of the country full-time florists and gardeners earn as little as €2.75 an hour.
In the past, Ms. Merkel has opposed a minimum wage. Now, she is considering establishing a commission of unions and employers who would be charged with establishing minimum wage levels for those industries that don't have them now.
The issue won't cost the government a single euro, but Ms. Merkel's switch here shows that she believes Germany's economy is strong enough to force small companies to pay employees a liveable wage. The move has drawn opposition within her Christian Democrat party, but is supported by a large majority of German voters.
As much as national budgets are created to pay a country's bills, budgets are also intensely political affairs. And while the rest of Europe groans under the weight of the debt crisis, Ms. Merkel is using the 2012 budget to demonstrate to her voters that even in the midst of the worst global economy in decades most German citizens have never had it so good.
Berlin Prepares for Possible Greek Exit from Euro Zone
The German government has been simulating a range of scenarios to prepare for a possible exit of Greece from the euro zone. Under a worst-worst-case scenario, the country could descend into a vicious circle of misery that could last decades.
The German government is preparing for Greece's possible exit from the euro zone in the event that the country's new government decides not to continue with the previously agreed austerity programs. Experts at the German Finance Ministry have been simulating a variety of scenarios based on different assumptions, SPIEGEL has learned.
A so-called baseline scenario is based on the expectation that the situation does not get too bad. Under this scenario, Greece's exit from the monetary union could even contribute to the strengthening of the euro zone in the long term, following an initial period of turbulence. The thinking goes that the currency union could be more stable without its weakest member.
Admittedly, peripheral euro-zone members like Spain and Italy would still face challenges, but the assumption is that they would be better able to tackle their problems without the additional burden of the Greek crisis. According to the assessment of German government experts, these countries may currently be struggling to get access to money, but unlike Greece they are not close to insolvency.
Under the Finance Ministry experts' worst-case scenario, developments in the euro zone would be less favorable. In this case, Italy and Spain would find themselves in the crosshairs of the global financial markets, and their borrowing costs would rise.
In this simulation, the European backstop fund, the European Financial Stability Facility (EFSF) would be forced to supply those countries with fresh money. For this to succeed, the experts argue, the EFSF should be expanded as quickly as possible so that it has an effective lending capacity of €1 trillion ($1.4 trillion).
In addition, the government experts also looked at a so-called worst-worst-case scenario. In this model, Greece's new currency would dramatically devalue against the euro. That would have the positive effect of making the country's exports cheaper, but the negative effects would outweigh the benefits. The country's national debt would rise despite a haircut, because Greece's debts would still be denominated in euros.
The country's credit rating would be immediately downgraded again, and Greek companies would struggle to get access to money because the country's banks would also be cut off from international capital markets.
Many firms would go bankrupt because their debts would also be denominated in euros, with the result that many more workers would lose their jobs. Domestic consumption would collapse, aggravating the downturn. The country could take decades to free itself from this vicious circle, and other nations might also be drawn into the vortex. The German government experts do not, however, consider this scenario to be the most likely one.
Down with the Eurozone
by Nouriel Roubini - Project Syndicate
The eurozone crisis seems to be reaching its climax, with Greece on the verge of default and an inglorious exit from the monetary union, and now Italy on the verge of losing market access. But the eurozone's problems are much deeper. They are structural, and they severely affect at least four other economies: Ireland, Portugal, Cyprus, and Spain.
For the last decade, the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) were the eurozone's consumers of first and last resort, spending more than their income and running ever-larger current-account deficits. Meanwhile, the eurozone core (Germany, the Netherlands, Austria, and France) comprised the producers of first and last resort, spending below their incomes and running ever-larger current-account surpluses.
These external imbalances were also driven by the euro’s strength since 2002, and by the divergence in real exchange rates and competitiveness within the eurozone. Unit labor costs fell in Germany and other parts of the core (as wage growth lagged that of productivity), leading to a real depreciation and rising current-account surpluses, while the reverse occurred in the PIIGS (and Cyprus), leading to real appreciation and widening current-account deficits.
In Ireland and Spain, private savings collapsed, and a housing bubble fueled excessive consumption, while in Greece, Portugal, Cyprus, and Italy, it was excessive fiscal deficits that exacerbated external imbalances.
The resulting build-up of private and public debt in over-spending countries became unmanageable when housing bubbles burst (Ireland and Spain) and current-account deficits, fiscal gaps, or both became unsustainable throughout the eurozone's periphery. Moreover, the peripheral countries’ large current-account deficits, fueled as they were by excessive consumption, were accompanied by economic stagnation and loss of competitiveness.
So, now what?
Symmetrical reflation is the best option for restoring growth and competitiveness on the eurozone's periphery while undertaking necessary austerity measures and structural reforms. This implies significant easing of monetary policy by the European Central Bank; provision of unlimited lender-of-last-resort support to illiquid but potentially solvent economies; a sharp depreciation of the euro, which would turn current-account deficits into surpluses; and fiscal stimulus in the core if the periphery is forced into austerity.
Unfortunately, Germany and the ECB oppose this option, owing to the prospect of a temporary dose of modestly higher inflation in the core relative to the periphery.
The bitter medicine that Germany and the ECB want to impose on the periphery – the second option – is recessionary deflation: fiscal austerity, structural reforms to boost productivity growth and reduce unit labor costs, and real depreciation via price adjustment, as opposed to nominal exchange-rate adjustment.
The problems with this option are many. Fiscal austerity, while necessary, means a deeper recession in the short term. Even structural reform reduces output in the short run, because it requires firing workers, shutting down money-losing firms, and gradually reallocating labor and capital to emerging new industries.
So, to prevent a spiral of ever-deepening recession, the periphery needs real depreciation to improve its external deficit. But even if prices and wages were to fall by 30% over the next few years (which would most likely be socially and politically unsustainable), the real value of debt would increase sharply, worsening the insolvency of governments and private debtors.
In short, the eurozone's periphery is now subject to the paradox of thrift: increasing savings too much, too fast leads to renewed recession and makes debts even more unsustainable. And that paradox is now affecting even the core.
If the peripheral countries remain mired in a deflationary trap of high debt, falling output, weak competitiveness, and structural external deficits, eventually they will be tempted by a third option: default and exit from the eurozone. This would enable them to revive economic growth and competitiveness through a depreciation of new national currencies.
Of course, such a disorderly eurozone break-up would be as severe a shock as the collapse of Lehman Brothers in 2008, if not worse. Avoiding it would compel the eurozone's core economies to embrace the fourth and final option: bribing the periphery to remain in a low-growth uncompetitive state. This would require accepting massive losses on public and private debt, as well as enormous transfer payments that boost the periphery’s income while its output stagnates.
Italy has done something similar for decades, with its northern regions subsidizing the poorer Mezzogiorno. But such permanent fiscal transfers are politically impossible in the eurozone, where Germans are Germans and Greeks are Greeks.
That also means that Germany and the ECB have less power than they seem to believe. Unless they abandon asymmetric adjustment (recessionary deflation), which concentrates all of the pain in the periphery, in favor of a more symmetrical approach (austerity and structural reforms on the periphery, combined with eurozone-wide reflation), the monetary union's slow-developing train wreck will accelerate as peripheral countries default and exit.
The recent chaos in Greece and Italy may be the first step in this process. Clearly, the eurozone’s muddle-through approach no longer works. Unless the eurozone moves toward greater economic, fiscal, and political integration (on a path consistent with short-term restoration of growth, competitiveness, and debt sustainability, which are needed to resolve unsustainable debt and reduce chronic fiscal and external deficits), recessionary deflation will certainly lead to a disorderly break-up.
With Italy too big to fail, too big to save, and now at the point of no return, the endgame for the eurozone has begun. Sequential, coercive restructurings of debt will come first, and then exits from the monetary union that will eventually lead to the eurozone’s disintegration.
Greece and Italy Seek a Solution From Technocrats
by Rachel Donadio - New York Times
Under the white-hot pressure of the bond markets and the glare of European leaders, both Greece and Italy snapped into action on Thursday, looking to technocratic leaders to pull them back from the brink of chaos.
Greece named Lucas Papademos, a former vice president of the European Central Bank, interim prime minister of a unity government charged with preventing the country from default. In Italy, momentum was building behind Mario Monti, a former European commissioner, to replace the once-invincible Prime Minister Silvio Berlusconi as early as Monday.
The question now, in both Italy and Greece, is whether the technocrats can succeed where elected leaders failed — whether pressure from the European Union backed by the whip of the financial markets will be enough to dislodge the entrenched cultures of political patronage that experts largely blame for the slow growth and financial crises that plague both countries.
Some said there was cause for optimism. "First, the mere fact that they have been asked in such difficult circumstances means that they have a mandate," said Iain Begg, an expert on the European monetary union at the London School of Economics. "Granted, it’s not a democratic one, but it flows from disaffection with the bickering political class."
The conventional wisdom from European Union leaders in Brussels has been that greater political consensus in Greece and a change of leadership in Italy could help restore market confidence in the euro. But with investors increasingly viewing European sovereign debt as a toxic asset, it seems doubtful that the markets will truly calm down until both Italy and Greece do more than apply fiscal bandages and until the European Union can put more firepower in its bailout mechanisms.
On the surface, Greece and Italy seem remarkably alike. Both countries have entrenched patronage networks that predate the European Union by centuries and suffocating regulations and work rules. And both Mr. Papademos, 64, and Mr. Monti, 68, the president of Bocconi University in Milan, have close ties to European Union officials, who are taking a strong hand in managing the affairs of both countries because the fate of the euro hangs in the balance.
Both face daunting changes. In Italy, a new government will be asked to carry out labor and tax reforms and other growth-enhancing measures. It will also have to write a new electoral law.
In Greece, the government must push through unpopular wage cuts and public sector layoffs in exchange for more foreign aid, and then try to make more structural changes during its brief mandate than the country has introduced in 30 years.
But the similarities end there. Greece is effectively bankrupt and needs a steady hand to guide it. Prime Minister George A. Papandreou ran out of political capital trying to impose austerity on a restive country. Some have criticized him for failing to carry out reforms fast enough, while no party alone has wanted to bear the political cost of stepping into his shoes.
Mr. Papademos must also negotiate with the European Union and banks on the terms of a delicate voluntary write-down of Greek private debt so as to avoid a default — amid a deep recession, a credit crunch and a climate of growing social unrest.
In Italy, where the economic fundaments are far stronger than those of Greece, there is a new wind of optimism mixed with trepidation this week, as the debt crisis led to the abrupt end of the Berlusconi era.
"It’s a historic moment," said Roberto Napoletano, the editor in chief of the business daily Il Sole 24 Ore, which has been running campaigns to alert Italians that their savings and businesses are at risk without credible leadership. "Italy has to act, but it can do it."
Indeed, Italy pulled back from the brink on Thursday as investors gained confidence that Mr. Berlusconi would be gone by Monday, replaced by Mr. Monti, an economist with an international reputation. That impression was underscored by the sight of Mr. Monti arriving at the Quirinal Palace on Thursday, where he met for two hours with Italy’s president, Giorgio Napolitano, who is responsible for picking a new head of government. Mr. Berlusconi himself sent Mr. Monti a telegram wishing him "fruitful work in the interests of the country," the news agency ANSA reported.
In contrast to Greece, which resents outside interference, Italy has often looked to technocratic leaders backed by outside powers in moments of political transition. It did so in the early 1990s, after the collapse of the postwar political order, and again in the mid-1990s, when a unity government pushed through changes that helped Italy into the euro.
Today, many in the governing class see a technocrat backed by the European Union as the only force strong enough to dislodge an entrenched culture of political patronage that has grown worse under Mr. Berlusconi, despite the fact that he was elected three times on a reform platform.
"We have lost a capital of confidence," Mr. Napoletano said, adding that it was time for the country to "invest politically in a government of people who have the capacity to do what for 20 years no one has done in Italy."
By that, he said, he meant making the structural changes that economists say Italy needs to quicken growth and stay competitive, including making its labor market more flexible, creating a more efficient tax code and tax collection system, and cutting red tape. Since it was re-elected in 2008, the Berlusconi government has done virtually none of those things.
While Italy is highly indebted and suffering anemic growth — projected at only 0.1 percent in 2012 and 0.7 percent in 2013, according to the European Commission — it has considerable assets. It has a high domestic savings rate and a manageable budget deficit, and the northern industrial region is considered among the wealthiest areas of Europe.
But no one doubts the need for shaking things up. Asked this week why there was no figure like Margaret Thatcher in Italy, Mario Baldassarri, the chairman of the Senate Finance Committee, singled out the political class, saying, "Because in Italy there are 3,000 or 4,000 people who count on waste and theft of public spending and now they are more powerful than 60 million people."
But there were signs on Thursday that the status quo was giving way. The breakthrough came when a bloc in Mr. Berlusconi’s People of Liberties party appeared ready to support a government led by a nonpolitician, which would require a majority in Parliament. That goal seemed to be within reach, since the main opposition Democratic Party has already said it would back such a government, as would several crucial centrist groupings.
There is much work to do. "I’m afraid the costs of disassembling a system of privileges and advantages, not just of the political class but also many people is hard," said Beppe Severgnini, a columnist for Corriere della Sera and the author of "Mamma Mia!" a new book about Mr. Berlusconi. "The E.U. is only a babysitter," he added, "it’s not a magician."
Greece is a far different, and far more challenging, situation. Greeks have greater antagonism toward the European Union, and, to date, greater antagonism to structural changes. Although the urgency of the debt crisis may yet change the picture, past efforts at unity governments have been unsuccessful in a volatile society still scarred by a civil war between right and left in the late 1940s and a military dictatorship from 1967 to 1974.
Some see the incoming prime minister, Mr. Papademos, as too beholden to the foreign lenders who helped bring Greece to its knees. Others say that as a technocrat, he will be less corrupt than the political class and may actually effect change.
The fear among members of the Greek political class is that if Mr. Papademos fails, they will take the blame, and if he succeeds — by laying off tens of thousands of public workers, cutting pensions and privatizing state properties — they will lose their power.
There is also skepticism about the extent of Mr. Papademos’s powers in the face of the country’s ills. "If unemployment is 20 percent at the end of the year, no politician, no political system, no technocrat can sustain such a mess, such a social burden," said Stelios Kouloglou, the director of an independent news Web site, tvsx.gr, in Athens. "That’s the problem."
Fitch Cuts Hungary’s Outlook
by Veronika Gulyas - Wall Street Journal
Hungary on Friday evening saw Fitch Ratings, the last ratings firm that still had a positive outlook on the country, turn gloomy and cut its forecast to negative, just like Standard & Poor’s and Moody’s.
Hungary already feared a downgrade of its sovereign-debt rating to junk category by the latter two agencies, so the Friday-night blow came from the blind side. Fitch Ratings, unlike the other two, hasn’t sent its team to Hungary to assess the situation over the past few weeks, making the decision all the more unexpected.
Fitch said a worse-than-anticipated economic slowdown, evidence of private-sector capital outflows or problems in the banking sector, a rise in the risk premium or fiscal financing pressure could lead to a downgrade on Hungary’s credit, adding to material weakening in the government’s commitment to fiscal consolidation.
Hungary’s economic growth has indeed slowed significantly, with analysts forecasting growth of only around 1.5% this year, and even less next year—if we don’t count those who foresee recession in 2012. Hungary, a small and open economy, suffers from slowing euro-zone economic growth, stagnating household consumption, as well as heavy taxes and government austerity measures.
The cabinet, which has pledged to keep to strict deficit targets of below 3% of GDP this year and next, is trying to manage the squeeze. But at times it has applied unorthodox measures such as extraordinary "crisis" taxes in certain sectors, or special mortgage-repayment options for households with foreign-currency home loans.
The government was quick to say it disagrees with Fitch’s outlook change late Friday, saying it’s committed to cutting public debt further to 73% of GDP by the end of this year, versus Fitch’s forecast of 76% of GDP. The economy ministry also said it will take all measures to reach the 2.5% of GDP budget-deficit target next year.
The ministry said it expects Fitch will revise its "overtly pessimistic" view on Hungary at the beginning of 2012 when the final data on the government’s foreign currency mortgage scheme, and the final budget figures are published.
Chinese ratings agency threatens US with new debt downgrade
by Peter Beaumont - Guardian
The head of China's biggest ratings agency, Dagong Global Credit Rating, is warning that it may downgrade the US's sovereign debt rating again because of Washington's failure to tackle the federal budget deficit. The remarks by Dagong's chairman, Guan Jianzhong, to be broadcast in an interview with al-Jazeera on Saturday morning, come at the end of another week of deep turmoil for the world economy.
Dagong, which has maintained a pessimistic outlook on US fiscal policy, has been leading the charge to downgrade US debt over the last 12 months, lowering the US rating from AA to A+ a year ago. In August it downgraded US debt again, to A. Days later, Standard & Poor's followed in its wake, becoming the first western agency to downgrade US debt after the threat of a default was narrowly avoided following weeks of political squabbling in Washington over whether President Obama should be allowed to raise the US debt ceiling.
Guan's intervention comes as another embarrassing political standoff over budget policy looms in Washington. The cross-party "supercommittee" given the job of finding ways to cut the budget deficit is reportedly deadlocked, with Republicans refusing to countenance the tax rises being suggested by Democrats. The committee is due to report by 23 November, but there are fears they could fail to reach agreement, prompting a new crisis.
Founded in 1994 by the Chinese government and the People's Bank of China, Dagong is the only credit ratings agency in China that grades foreign sovereign debt and bonds. In an interview with Talk to Al-Jazeera, Guan agrees that it is almost inevitable that his agency will cut America's debt rating once again, arguing that the only solution open to the US economy is further quantitative easing.
"The measures available to them [the US] cannot be effective so they have another way out which is to depreciate the US dollar, to print more money," he says. "And that will also make it a lot worse, this has affected their credit and it is negatively affecting their credit prospects – so that their overall ability to pay back their debt will continue to go down. Asked directly if he believed another ratings cut was inevitable, Guan replies: "I think so."
He goes on to say: "We are continuing to monitor this closely. First of all we need to look at this year's economic growth and then predict next year's trends. If in the year 2012 the overall projections are not very good, meaning that the sources of payment – and liabilities – are bad and cannot be changed, or change for the worse, then we will lower the rating once again. Any further downgrading of the US credit rating, while making more US borrowing more expensive, would also be a matter of concern to Beijing.
China is the largest foreign buyer of US government debt – accounting for around third of all foreign-held US securities – despite the fact it has gradually reduced its holdings since the S&P downgrade and has also lost heavily on its large holdings of US currency.
Since the summer – and the debt-ceiling crisis – China has become ever more vocal about what it describes as the US "addiction" to debt, warning in August that more "devastating credit rating cuts" and global economic turmoil were around the corner unless Washington learned to live within its means.
The Xinhua news agency issued a commentary that cautioned: "The US government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone."
Bank of England to downgrade UK growth forecast
by Angela Monaghan and Kamal Ahmed - Telegraph
The Bank of England is set to give a gloomy update on the state of the British economy, sharply downgrading growth forecasts and issuing a stark warning on the eurozone debt crisis.
The Bank is expected to cut its 2011 and 2012 growth forecast to about 1pc from its August forecast of about 2pc when it publishes its latest quarterly Inflation Report on Wednesday. Sir Mervyn King, the Bank’s Governor, is likely to emphasise there are serious downside risks to the UK growth outlook because of the threat posed by the eurozone’s continued problems.
On the domestic front, the manufacturing PMI survey showed the sector unexpectedly shrank in October, boding ill for the economy in the fourth quarter. A squeeze on household incomes caused by low wage growth, high inflation and rising unemployment, as well as fiscal austerity, is also expected to weigh on consumer spending.
A spokesman for the Treasury said yesterday: "The National Institute of Economic and Social Research last week stated that the UK economy continues to grow. But what is clear is that the UK is not immune from the problems faced by its trading partners, including in the eurozone.
"The Government is doing all it can to protect the UK economy and make sure that it remains a relative safe haven in the face of international instability and uncertainty, whilst also putting in place the longer-term conditions needed for strong and sustainable growth."
Whitehall sources have revealed that there is increasing frustration within David Cameron’s inner circle over the lack of substance in the Government’s growth plan, which is due to be announced alongside the Chancellor’s Autumn Statement on November 29. "Every time we try and put something in, the Liberal Democrats say that we should take it out," one source said.
One particular area of tension is employment law, where the Conservatives would like to see changes to the present system which is seen as being weighted in favour of the employee. The Prime Minister wants to make it easier to sack under-performing staff and ensure that people who take unsuccessful employment tribunals against their employers have to pay at least part of the costs. "It is not as if Nick Clegg is coming up with a load of ideas of his own," said one official of the tensions within the Coalition.
The Bank of England is also expected to say that inflation will fall sharply in 2012, as temporary factors, including January’s VAT rise, fall out of annual comparisons. Data published by the Office for National Statistics on Tuesday is expected to show inflation eased slightly to 5.1pc in October. Lower petrol and food prices and lower shop price inflation are expected to offset price rises among some utility companies.
Bond market vigilantes turn on Italy
by Tom Stevenson - Telegraph
I remember a former editor of this newspaper instructing the City desk in 2006 to get up to speed on collateralised debt obligations (CDOs). Most of the people in the room at the time had not even heard of these. Even less did they have any idea what they were or how toxic they would turn out to be. We soon found out, however, as the unfolding financial crisis forced us to get to grips with the language of derivatives.
Today, it's bonds you need to understand. The global bond market is worth $100 trillion (£62 trillion). That's around twice the size of the world's equity markets and a number so large it is scarcely comprehensible.
Last week, the bond market's so-called vigilantes turned their fire on Italy and, as with Greece before it, they quickly drove the cost of borrowing for its government to unsustainable levels. Yet again, the bond market forced politicians to think the unthinkable, casually stepping over every line they attempted to draw in the sand.
I think the markets are about to step over another critical line, forcing a rethink of the idea that the European Central Bank (ECB) is not the eurozone's lender of last resort. Until last week, it could plausibly pretend it was not, but the storm has blown across the Ionian Sea to a country that is peripheral only in terms of its geography.
That has changed everything. Accounting for more than a sixth of European GDP and fully a quarter of the eurozone's outstanding government bonds, Italy is beyond the reach of any institution with less than the ECB's unlimited firepower in the sovereign bond market.
It is widely held that there are only two possibilities for Europe now. Either Germany gets over its historically understandable fear of inflation and frees the ECB to underpin the price, and so drive down the yield, of Italian bonds, or the single currency is dead.
Forget the constitutional constraint on the ECB bailing out individual countries; only the really big bazooka of open-ended quantitative easing can hold the eurozone together now. The fundamental problem in Europe today is actually not one of liquidity, it is one of growth and a chronic lack of competitiveness.
Measures which obsess over austerity and fail to kick-start the region's sclerotic economy are doomed to failure because you cannot deflate your way to sustainable growth. Europe is already heading into recession, which can only make the fiscal outlook worse.
The big question is what it will take for Germany and the ECB to accept that the only way to make monetary union work is to move towards fiscal and political union backed by a real central bank.
What will trigger the hard-liners' capitulation, I think, is when the crisis ships up on Germany's borders, threatening catastrophic bond market losses on the banks and insurers that control the country's vast savings.
What does this mean for investors? Certainly, it means more volatility in the short term, although a quicker than expected move towards quantitative easing (QE) could create a painful spike for anyone sitting on the sidelines. That said, capital preservation will be key and that means paying less attention to what a company does than how well financed it is.
Fortunately, many companies are in much better shape than their governments, and that is not always reflected in the prices of either their shares or bonds. Default rates could be lower than the market implies, which might make some high-yield bonds attractive. Meanwhile, the dividends on blue-chip shares provide good support.
Investors must also pay attention to where a company's customers are. Weaker global growth could help governments in countries like China and Brazil step back from monetary tightening as inflation dips again.
The long-term growth in consumption in those markets, which has been an unfashionable story this year, could gain momentum if risk assets come back into favour. Finally, investors must begin to think seriously about the likelihood of inflation in developed markets becoming entrenched further down the track if and when there is more QE on both sides of the Atlantic. Time to extend that bond market education to index-linkers, I think.
EU turmoil revives calls for referendum
by Bruno Waterfield - Telegraph
David Cameron is to face renewed pressure to call a referendum after senior European Commission officials said the overhaul of the eurozone would trigger a national poll in Ireland.
European leaders will redraft key treaties to ensure that beleaguered economies cannot borrow or spend too much in future as a condition of receiving billions of euros in rescue packages.
However, the treaty changes will involve a transfer of sovereignty, triggering an Irish referendum. The Irish vote, to be proposed at a European Union summit next month, will increase demands in Britain for a popular vote on Europe, setting off calls for referendums across Europe in countries such as Holland, Finland and France.
The Government fears the pace of developments in Europe, including the imposition of "technocrat governments" in Greece and Italy, combined with a German demand for treaty change, will make a campaign for an EU referendum unstoppable. Ministers have stopped saying that they plan to use treaty change to take powers back from the EU. This follows private warnings from Germany that it is not willing to trade eurozone "fiscal union" for British opt-outs.
Bill Cash, chairman of the Commons scrutiny committee, said last night he was concerned that the emergence of French plans for a twin-track Europe, regular eurozone summits and German domination of EU decision-making amounted to a serious change in Britain's place in Europe.
"Despite all the talk about it being a limited treaty change this is real fundamental change," he said. "Germany is pushing with determination to have a Europe made in its own image. The changes are a fundamental change in the relationship between Britain and Europe. A referendum is absolutely demanded."
Douglas Carswell, the Tory MP for Clacton, said the pace of change, with France and Germany raising the idea of expelling Greece from the eurozone last week, "shows that the Westminster tribe and the mandarins are completely out of their depth". He has called on the Prime Minister to spell out the British strategy in Europe and to reshuffle the team of negotiators involved in EU treaty talks.
"Unless we are to be overwhelmed, we need a strategy," he said. "Cameron must fire our useless dealmakers and put any new deal to the people."
On Wednesday, Nick Clegg, the Deputy Prime Minister, talked with EU officials in Brussels to see if treaty change and calls for popular votes could be averted. He warned Herman Van Rompuy, the European Council president, that his plan to present a report on "limited treaty change" to an EU summit in December would open a "Pandora 's box" across Europe.
"It is not just a British thing," he said. Similar fears would be expressed by politicians in Austria, Finland, Ireland or even France, "where they have had pretty unhappy experiences with referendums on Europe in the past".
Catherine Day, the secretary-general of the European Commission, said treaty change proposals to remove sovereignty over national budgets for euro members will need to be passed by a popular vote in Ireland.
The proposed changes would amount to a "big transfer of sovereignty", said an unnamed commission official, working for the EU-IMF "troika" running Ireland, Greece and Portugal. "Personally, I would not support something like this if it did not have democratic sanction," he told the Irish Times.
Ms Day, an Irish national and the most senior official in the commission, has conceded that a vote in Ireland would be necessary under the country's constitution.
Irish voters have twice rejected European treaty changes in referendums but on both occasion they were passed after the EU demanded second votes. Last week, the Irish government warned that it would have "great difficulty" passing a new treaty at a time when Ireland was undergoing a deeply unpopular EU-IMF austerity programme.
David Rosenberg: We Are In Year 4 Of A 7-10 Year Depression
by Cullen Roche - Pragmatic Capitalism
David Rosenberg of Gluskin Sheff joined Consuelo Mack on Wealth Track this weekend to discuss his outlook for the economy.
Rosenberg isn’t just bearish. He say the US economy is in a modern day depression similar to what Japan has suffered from for the last 20 years. He bases this view on the idea that de-leveraging tends to coincide during a prolonged period of economic weakness that is not merely consistent with recession.
Rosenberg says we’re just 4 years into a depression that will likely last 7-10 years. He says the economy is likely to begin contracting again in 2012 and that the employment situation is going to deteriorate further. He calls the MF Global bankruptcy the Bear Stearns of 2011.
Contrary to common misconception, Rosenberg is not bearish on everything. After being a long-time US Treasury bull, Rosenberg is sounding a bit less bullish on government bears. He says the love affair is over. He now prefers corporates and income at a reasonable price.
BofA Says Regulators May Limit Transfer of Merrill Derivatives
by Hugh Son - Bloomberg
Bank of America Corp. may be prevented by regulators from shifting derivatives contracts into the books of a deposit-taking unit, potentially forcing the lender to hand over more collateral to counterparties.
The lender has designated the retail-deposit unit, Bank of America NA, as the new counterparty on some Merrill Lynch contracts after the company's credit ratings were cut in September, it said last week in a filing. The Federal Reserve and Federal Deposit Insurance Corp. have disagreed over the moves, and they are now discussing whether to allow future transfers, according to people with knowledge of the matter.
"Our ability to substitute or make changes to these agreements to meet counterparties' requests may be subject to certain limitations, including counterparty willingness, regulatory limitations on naming Bank of America NA as the new counterparty, and the type or amount of collateral required," the lender wrote in the quarterly regulatory filing.
At stake for Bank of America is the power to curb billions of dollars in collateral payments to counterparties that could be required after a credit-rating downgrade. The company, which has lost more than half its market value this year amid rising expenses from soured mortgages, is vulnerable to further rating cuts, the bank said in the Nov. 3 regulatory filing.
Limits on moving contracts from Merrill Lynch to the deposit unit could "adversely affect" results of operations, the Charlotte, North Carolina-based bank said in the filing. The transfers lower collateral obligations because the retail unit still has a higher rating than the Merrill Lynch subsidiary after the Sept. 21 downgrades from Moody's Investors Service.
"It's a game of 'move the risk,'" said Mark Williams, a former Federal Reserve examiner who lectures on financial-risk management at Boston University. "It makes sense for Bank of America, but the broader implication is that it makes the retail operations potentially riskier. If there is another downgrade, you have the possibility of falling off a credit cliff."
The Fed has signaled that it favors moving the derivatives to give relief to the bank holding company, people familiar with its position said Oct. 18. The FDIC, which would have to pay depositors in a failure, objected, the people said.
The other two major ratings firms, Standard & Poor's and Fitch Ratings, are re-evaluating Bank of America and may also cut its credit grades, the lender said in the quarterly filing. The full scope of damage from a credit-rating downgrade is "inherently uncertain" because it depends upon the behavior of counterparties and customers, the bank said.
Derivatives are financial instruments used to hedge risks or for speculation. They're derived from stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in the weather or interest rates. The contracts often require counterparties to post collateral in amounts that can increase if their creditworthiness deteriorates.
Bank of America's holding company -- the parent of both the retail bank and the Merrill Lynch securities unit -- held almost $75 trillion of the contracts at the end of June, according to data compiled by the Comptroller of the Currency. About $53 trillion, or 71 percent, were within Bank of America NA, according to the data, which represent the notional values of the trades. The company is the second-largest U.S. lender by assets.
In August, the bank said a two-level downgrade by all ratings companies would require it to post $3.3 billion in additional collateral and termination payments, based on agreements as of June 30. As of Sept. 30, the bank could have been required by counterparties to produce $4.9 billion beyond what it had already posted, according to last week's filing. Of that, $3.2 billion resulted from the Moody's downgrade.
Bank of America also said the impact of further downgrades would be more severe than in previous projections. A two-level cut could have amounted to $6.6 billion in collateral demands as of Sept. 30, it said. The firm held cash and securities collateral of $93 billion as of Sept. 30, and had posted $87.8 billion, about 30 percent more than the end of 2010.
Bank of America's rating is now four grades below the one Moody's assigned to JPMorgan Chase & Co., which became the biggest U.S. bank by assets this year, and a level below the rating given to Citigroup Inc., the No. 3 lender. JPMorgan's deposit-taking entity, JPMorgan Chase Bank NA, contained 99 percent of the New York-based firm's $79 trillion of notional derivatives, according to the OCC.
'Not FDIC Insured'
Andrew Gray, a spokesman for the FDIC, declined to comment today on Bank of America's filing. The Fed [was closed Friday] for the Veteran's Day holiday, and Barbara Hagenbaugh, a spokeswoman, didn't respond to messages seeking comment. "These derivative trades are not FDIC insured," said Jerry Dubrowski, a Bank of America spokesman. "Other financial institutions hold higher derivative balances in their banking entities."
Bank of America Chief Financial Officer Bruce R. Thompson discussed the transfers on a conference call with analysts last month after Bloomberg News reported that federal regulators were at odds over the movements.
"We had worked very hard over the course of the last nine months to be prepared to the extent that we did receive a downgrade, and feel very good about the way that we've minimized the potential impact," he said on the Oct. 18 call. The moves are part of "the normal course of dealings that we've had with counterparties since Merrill Lynch and BofA came together."
Geithner tells Europe to "move quickly" as instability hurts US and Asia
by Josephine Moulds - Telegraph
Europe must "move quickly" to control its spreading debt crisis, because the volatility it is causing is the "central challenge" to global growth, US Treasury Secretary Timothy Geithner said.
Speaking at the Asia Pacific Economic Cooperation (APEC) summit in Hawaii this weekend, Mr Geithner said: "We are all directly affected by the crisis in Europe, but the economies gathered here are in a better position than most to take steps to strengthen growth in the face of these pressures from Europe."
Mr Geithner added that the basic framework for the European recovery was good."But we need to see it put in place with the speed that markets require and with the force that restores confidence," he said. "They’re moving ahead. We just need to see them move a little more quickly and with a little more force behind it."
Despite being thousands of miles away, Europe has been the main preoccupation at the meeting of Pacific Rim leaders in Honolulu. At the annual summit, hosted this year by US President Barack Obama,Mr Obama had hoped to focus on a free-trade pact for the region, but debates were often hijacked by concerns about Europe.
The 21 countries that make up APEC promised no direct measures to help European countries, although they recognised the threat the European crisis posed to global growth. Singapore’s Prime Minister Lee Hsien Loong, said: "We are preoccupied, and I think for the time being rightly so, with problems off-stage, elsewhere, with Italy and Europe."
There was a general feeling that Europe had to sort out issues internally before other countries would be willing to step in with financial help. Zhu Min, deputy managing director of the IMF, said: "That the European crisis is a global crisis that needs global cooperation and a global solution has become ever clearer. But before that, the Europeans have to make efforts to provide a clear picture and provide a solution and put their hands on their own issues."
This sentiment was echoed by the business community. Dennis Nally, chairman of PwC, said: "First of all, I think Europe has got to help itself. "Some of the difficult decisions that have to be made in Europe have to get made. And quite frankly the longer it goes on with those decisions not getting made, I think it’s going to raise serious questions about the economic recovery."
Above all, the leaders who were gathered in Honolulu sounded frustrated with the pace of implementing measures to deal with the crisis. Philippines finance minister Cesar Pursima said: "It is not being dealt with forcefully."
However the politicians and business leaders at APEC had not written Europe off entirely. Donald Tsang, chief executive of the Hong Kong Special Administrative Region of China, said he still hoped the euro could become a reserve currency to ease reliance on the dollar, although he accepted that it could not perform that task at the moment. In the long haul, he said the Chinese renminbi would be the third reserve currency.
Europe Disaster Headed to U.S.
by Niall Ferguson - Newsweek
Can America withstand the death spiral of debt?
As an author who has just published a book on the crisis of Western civilization, I couldn’t really have asked for more: simultaneous crises in Athens and Rome, the cradles of the West’s law, languages, politics, and philosophy.
Yet most Americans are baffled by the ongoing economic pandemonium in the European Union. For them, places like Greece and Italy are primarily tourist destinations they’ll visit at most once. The finer points of Mediterranean politics leave them cold, except insofar as they’re funny. After all, who could resist the opera-buffa character of Silvio "Bunga-Bunga" Berlusconi?
But only a few weirdos really feel their pulses quicken when they hear news like: the new Greek prime minister is a former central banker called Papademos! Ever tried to explain to a New Yorker the finer points of Slovakian coalition politics? I have. He almost needed an adrenaline shot to come out of the coma.
So why should Americans care about any of this? The first reason is that, with American consumers still in the doldrums of deleveraging, the United States badly needs buoyant exports if its economy is to grow at anything other than a miserably low rate. And despite all the hype about trade with the Chinese, U.S. exports to the European Union are nearly three times larger than to China.
Until March, it seemed as if exports to Europe were on an upward trajectory. But the euro-zone crisis has stopped that. Governments that ran up excessive debts have seen their borrowing costs explode. Unable to devalue their currencies, they’ve been forced to adopt austerity measures—cutting spending or hiking taxes—in a vain effort to reduce their deficits. The result has been Depression economics: shrinking economies and unemployment rates approaching 20 percent.
As a result, according to the new president of the European Central Bank, Mario Draghi, a "double dip" recession in Europe is now all but inevitable. And that’s lousy news for U.S. exporters targeting the EU market.
But there’s more. Europe’s problem is not just that governments are overborrowed. There are an unknown number of European banks that are effectively insolvent if their holdings of government bonds are "marked to market"—in other words, valued at their current rock-bottom market prices. In our interconnected financial world, it would be very odd indeed if no U.S. institutions were affected by this.
Just as European institutions once loaded up on assets backed with subprime U.S. mortgages, so most big U.S. banks have at least some exposure to euro-zone bonds or banks. One institution—MF Global, run by former Goldman Sachs CEO Jon Corzine—just blew up because of its highly levered euro bets. Others are biting their fingernails because it is suddenly far from clear that the credit-default swaps they have bought as insurance against, say, a Greek default are worth the paper they are written on.
But the third reason Americans should care about Europe is more important even than the risk of a renewed financial crisis. It is the danger that what is happening in Europe today could ultimately happen here. Just a few months ago, almost nobody was worried about Italy’s vast debt, which amounts to 121 percent of GDP. Then suddenly panic set in, and Italy’s borrowing costs exploded from 3.5 percent to 7.5 percent.
Today the U.S. gross federal debt stands at around 100 percent of GDP. Four years ago it was 62 percent. By 2016 the International Monetary Fund forecasts it will be 115 percent.
Economists who should know better insist that this is not a problem because, unlike Italy, the United States can print its own money at will. All that means is that the U.S. reserves the right to inflate or depreciate away its debt. If I were a foreign investor—and half the debt in public hands is held by foreigners—I would not find that terribly reassuring. At some point I might demand some compensation for that risk in the form of ... higher rates.
Athens, Rome, Washington ... The shortest route from imperial capital to tourist destination is precisely this death spiral of debt.
Pressure on the ECB grows as Mario Monti rides to rescue
by Ambrose Evans-Pritchard - Telegraph
The European Central Bank (ECB) is under intense pressure to step up purchases of Italian bonds after premier Silvio Berlusconi finally relinquished power in Rome, clearing the way for former EU commissioner Mario Monti to form an emergency government of technocrats.
The "halo effect" of Mr Monti helped bring Italian bond yields back from the brink of a catastrophic spiral on Friday but the gains are likely to be tested again as the new team faces the stark reality of Italy's fractured politics.
"The ECB must make it clear that it will not allow Italy's bond yields to rise above 5pc, however much it costs," said Thomas Mayer, chief economist at Deutsche Bank. He described the current policy of half-hearted bond purchases as "a recipe for failure", signalling to markets that the ECB is not willing to see the job through with overwhelming force.
Britain's Business Secretary, Vince Cable, echoed the calls for bolder action, blaming the ECB's passive stand for the dramatic escalation of the crisis last week that pushed Italy's €1.8 trillion to brink of meltdown and spread contagion to France. "The central bank has to have unlimited powers to intervene to support economies, and indeed banks, to prevent collapse," he told the BBC.
"It's very clear that in addition to the disciplines that the southern Europeans are going to have to adopt, the Germans are going to have to play their role in supporting the eurozone. That's either directly or through the central bank, making absolutely sure that the big countries that are subject to speculative attack are properly supported with adequate liquidity."
The EU's €440bn rescue fund (EFSF) is supposed to take the baton from the ECB so it can step back, but the fund is not yet ready and is itself struggling to raise money at a viable cost.
The replacement of Mr Berlusconi with a credible leader committed to the deep reforms demanded by the EU makes it much easier for the ECB to justify help for Italy, but it is far from clear that the bank is willing to give Mr Monti a "dowry" of lower borrowing costs to lighten his task.
Jens Weidmann, head of Germany's Bundesbank and a pivotal ECB governor, has further dug in his heels against any extension of bond purchases. "We have a mandate and we have to stick to our mandate. Fixing an interest rate for a country is certainly not compatible with our mandate," he said over the weekend.
"The eurosystem must not be a lender of last resort for sovereigns because this would violate Article 123 of the EU treaty. I cannot see how you can ensure the stability of a monetary union by violating its legal provisions."
Investors are betting on a torrid relief rally across global asset markets this week on hopes that new leaders in Italy and Greece will at least break weeks of deadlock, but it is already clear that politics will remain messy.
Mr Berlusconi warned that his People of Liberty Party intends to exercise a de facto veto in Italy's Senate, maintaining its grip on power behind the scenes. "We are ready to pull the plug," Mr Berlusconi allegedly told supporters. He aims to block any form a wealth tax or bank account levy.
Mr Monti faces a difficult task, forced to work with shifting alliances and bitterly opposed parties on one issue at a time. "We won't give you a blank cheque," said Umberto Bossi from the Northern League.
Whose Economy Has It Worst?
by Ian Bremmer and Nouriel Roubini - Wall Street Journal
With Europe, China and the U.S. in crisis, the real question is which of them will stumble first
It's no wonder that global markets are so jittery. The world's three largest economies can't continue along their current paths, and everybody knows it. Investors watch nervously for signs that China is headed toward a hard landing, that America will sink back into recession, and that the euro zone will simply implode.
In all three cases, kicking the can down the road has staved off disaster so far, but the cans are getting bigger and heavier. Which economy will be the first to stumble on its problems?
In Europe, the tough decisions have been put off because the principal players don't agree on how or why the trouble began. Germany and the other better-off countries blame the profligacy of Greece, Portugal and Italy and fear that an early bailout would relieve pressure on them to mend their ways. For their part, the debtor nations believe that the entire euro zone is out of balance and that more prosperous countries like Germany should export less and consume more to set things right.
Other Europeans say that a shared currency cannot survive indefinitely when monetary policy is centrally managed but each government decides how much to tax and spend. Still others warn that access to market capital requires a form of collective insurance, preferably in the form of a euro bond. Not surprisingly, Germany resists this solution because it implies a gradual transfer of wealth from the core economies to the periphery, a "transfer union" from rich to poorer states.
Yet another European view holds that the austerity plans now envisioned by Germany and the European Central Bank are worse than the disease. The Continent needs growth, not just reform and belt-tightening, they argue, and only a surge of stimulus across the entire euro area can achieve it.
The 17 countries and four European institutions now entangled in the euro zone crisis will continue trying to muddle through, but their dawdling can't be sustained. Markets are already losing confidence in piecemeal reform. Doubts about Italy, an economy too big to bail, will only add to the volatility.
Europe will be the first to drop out of the game of kick the can: Expect a disorderly debt default in Greece, more trouble for European banks and a sharp recession across the continent.
In China, the need for economic reform also has become obvious. It has been four years since Premier Wen Jiabao first warned that the country's economic model is "unstable, unbalanced, uncoordinated and ultimately unsustainable" and three years since the financial crisis made clear that China's growth remains dangerously dependent on exports to Europe, America and Japan.
To ensure long-term economic expansion (and political stability), Beijing must figure out a way to encourage Chinese consumers to buy more of the products that local manufacturers make. This will demand a massive transfer of wealth from the state and China's state-owned companies to Chinese households.
But Beijing is moving in the opposite direction. The leadership responded to Western market turmoil not by boosting consumption but by increasing state and private spending on fixed investment, which now accounts for nearly half of China's growth. The result has been an explosion in residential and commercial real estate, more state spending on infrastructure and more cheap loans from state-owned banks to state-owned enterprises.
Indeed, a key obstacle to reform is that China remains so heavily invested in its state-managed model of capitalism. Of the 42 Chinese companies listed in the 2010 edition of the Fortune 500, 39 were state-owned enterprises, and three quarters of China's 100 largest publicly traded companies are government controlled. Party officials with a stake in the success of state-owned enterprises have amassed considerable power within the leadership, and they ferociously resist efforts to transfer away their wealth to private enterprises and ordinary citizens.
China has the cash and foreign reserves to postpone a crisis. But growth is slowing, financial stresses are rising, and there is good reason to fear that China's days of can-kicking are numbered as well.
Which leaves the U.S. No one can restore confidence in America's long-term fiscal health without a credible plan to cut spending on entitlements and defense while raising revenues, which are now at a 60-year low as a share of GDP. But don't expect any immediate solutions from Washington. The campaign season will only exacerbate petty partisanship and political gridlock, which means that the structural problems of the U.S. economy are likely to persist.
But the longer-term future appears much brighter for the U.S. than for either Europe or China. America is still the leader in the kind of cutting-edge technology that expands a nation's long-term economic potential, from renewable energy and medical devices to nanotechnology and cloud computing. Over time, these advantages will yield more robust economic growth.
The U.S. also has a demographic advantage. In Europe, declining birthrates and rising sentiment against immigration point toward a population that will shrink by as much as 100 million people by 2050. In China, thanks in part to its one-child policy, the working population has already begun to contract. By 2030, nearly 250 million Chinese will have passed the age of 65, and providing them with pensions and health care will be very costly.
Despite debate over illegal immigration, the U.S. population will likely rise from 310 million to about 420 million by midcentury. Between 2000 and 2050, according to Mark Schill of Praxis Strategy Group, the U.S. workforce is expected to grow by 37%. China's will shrink by 10%. Europe's will contract by 21%.
Finally, despite the rising exasperation of the American public, the U.S. is significantly more likely than Europe or China to quit kicking the can down the road. Nothing much will change during the election year, but 2013 offers a chance for real fiscal reform.
Next November, Republicans are likely to win both houses of Congress. If a Republican is elected president, the GOP will face enormous public pressure to deliver on its reform promises. Even if President Obama is re-elected, the outlook for a grand bargain is bright. He would be free of the most immediate demands of electoral politics, and like other second-term presidents, he could begin to consider his legacy.
Make no mistake: The challenges that the U.S. faces are formidable, and persistent political gridlock could delay badly needed fiscal and structural reforms. But everything is relative, and the best can to be kicking down the road just now is undoubtedly the one made in America.
Subtle Details Loom Large in Italian growth Plan
by Christopher Emsden - Wall Street Journal
The Italian government's plan to boost growth includes headline-grabbing measures such as raising the retirement age and tweaking the country's inflexible labor laws, but the more pertinent points of the package European officials are expecting of Italy are far less sexy.
They involve shaking up local authorities' control over public-service contracts, the liberalization of professions such as in the law and architecture and a plan to privatize public real estate in a way that could relieve pressure on the country's banks. The growth initiatives come at a time of sharp fiscal austerity in the euro zone's third-largest economy, which the European Commission warned would grow just 0.1% next year.
Inserted as an amendment to the 2012 budget bill, which Parliament is expected to approve this weekend, the growth measures respond to demands from the European Union and the European Central Bank, key counterparts if Italy is to obtain needed relief on its sovereign borrowing costs. EU authorities have given guarded approval of the plans as a first step toward boosting Italy's growth potential, saying the key thing is they are implemented.
As for the ECB, which is coming under increasing pressure from the international community to backstop the single currency, the expected arrival of Mario Monti as prime minister is likely to offer an initial guarantee of real change. The initiatives to boost jobs and investment include payroll holidays for youth apprenticeship programs and tax credits for highway building.
All those measures carry a fiscal cost at a time when Italy's sharply slowing growth means the government may have to push through further budget squeezes to comply with the EU's stringent debt rules. Yet many of Italy's problems aren't linked to cash restraints. For example, economists at BNP Paribas say Italy's infrastructure investments are roughly the same as those in other EU countries, but the return is less because initial budgets are typically exceeded by 40% and the projects completed 20% late.
Measures that don't raise costs are likely to prove to be the most important of the new proposed measures. One example: The budget amendment abolishes mandatory fees for lawyers, architects and other professionals. It also allows them to set up their services on an incorporated basis. That measure is aimed at tackling the guild-like structures that limit access to jobs.
"Italy no longer needs to have a legal entity governing all ski instructors," Economy Minister Giulio Tremonti recently said. Mr. Tremonti is a member of the ski-instructor guild.
If passed, the budget would also give incentives to local authorities to privatize public-service companies in areas like sanitation and transportation and encourage those companies to broaden their geographic scope. The bill also gives the Italian Economy Ministry the right to accept government bonds instead of cash as payment for state real-estate assets.
That innovation, people in the government and financial industry say, provides Italian banks an opportunity to decrease their holdings of Italian government bonds known as Buoni del Tesoro Poliennali, or BTP, without having to accept losses due to their current market prices.
Such transactions would allow banks to improve the quality of the assets on their balance sheets and potentially lower their need to raise fresh capital under new European rules, while also giving the banks a new asset they could collateralize and use to refinance at the ECB. Net proceeds from such sales will be used to reduce Italy's public debt, and bonds used instead of cash would simply be retired.
The current plan is likely to be followed in coming months with further measures, most notably in the delicate area of employment law, where virtually guaranteed lifetime contracts keep productivity gains low and youth unemployment high.
David Cameron hit by double whammy on growth and jobs
by Patrick Hennessy, Kamal Ahmed and Angela Monaghan - Telegraph
Britain is on course for a double economic blow this week, with the Bank of England set to downgrade its growth forecast and youth unemployment likely to hit one million for the first time.
The news, coupled with the crisis gripping the eurozone, is likely to hand David Cameron one of his worst weeks since the Coalition was formed in May 2010. The Prime Minister and George Osborne, the Chancellor, are preparing a fightback this weekend.
Their efforts, however, are being hampered by a series of stand-offs with Nick Clegg, the Deputy Prime Minister, and his Liberal Democrat party. "It’s not that there is a row over the growth strategy, it’s that there isn’t really a strategy yet. Every time we try to put something in, the Liberal Democrats say that we should take it out," a senior Whitehall source told The Sunday Telegraph.
The Italian parliament yesterday voted through an austerity package, paving the way for prime minister Silvio Berlusconi to resign. The eurozone countries hope this will reassure the bond markets, which had pushed the country’s borrowing costs to crisis point.
As British ministers prepared for a grim week, it emerged that:
- The Bank of England is preparing to cut its forecast of growth in 2011 from close to two per cent to as low as one per cent on Tuesday. It is also preparing to reduce its 2012 forecast of just over two per cent, again to about one per cent. The Bank is likely also to warn that a failure to resolve the crisis affecting the eurozone may make things much worse in Britain because of its reliance on trade with the rest of Europe.
- The number of people aged between 16 and 24 out of work is set to break the one million barrier on Wednesday for the first time since figures began to be calculated almost 20 years ago.
- Ministers kept up a series of warnings of the dire effects of the eurozone crisis. William Hague, the Foreign Secretary, said: "The jobs and the life savings of tens of millions of people in Europe may be at stake." Mark Hoban, the Treasury minister responsible for planning Britain’s detailed response to the crisis, admitted to business leaders at a private breakfast: "The instability in the euro area does have a chilling effect on the UK economy."
- Coalition tensions were blamed for a lack of progress over drawing up a growth strategy to be unveiled in Mr Osborne’s Autumn Statement on November 29. A meeting last week did not come to any firm decisions because of lack of "substantive" policies to announce, the senior source said.
It is the latest example of tensions between the Coalition partners that have recently flared up in other policy areas as well as the economy, including human rights, NHS reform and tax.
Mr Clegg is understood to have blocked suggestions in a report into deregulation by Adrian Beecroft, a venture capitalist, which would have allowed employers to sack poorly performing staff without fear of unfair dismissal cases.
Ministers are preparing a fightback over youth unemployment with an emphasis on apprenticeships and a planned expansion of a flagship scheme that allows young unemployed people to do eight weeks of work experience without losing benefits.
However, a report by the Institute for Public Policy Research (IPPR) will this week suggest that apprenticeships are failing. The report, seen by The Sunday Telegraph, says employers are using Government cash meant for apprenticeships to subsidise training for older workers instead. According to the IPPR, 40 per cent of new apprenticeships went to over-25s last year.
Labour has accused Mr Cameron of dodging criticism over his record. A short parliamentary break means there will be no Prime Minister’s Questions on Wednesday when the figures are released. The Prime Minister is expected to tour European capitals this week to put more pressure on EU leaders to find a solution to the eurozone crisis.
Mr Hoban sent out a warning to France, Germany and others among the 17 eurozone nations not to vote in the EU’s Council of Ministers – the main decision-making body – as a caucus, effectively seizing control of key areas of policy-making vital to Britain’s interests, including over the City of London.
At the private breakfast, organised by PI Capital, he said: "The challenge is, as we work on the institutional arrangements, to be very clear those matters which are the preserve of the 17 'ins’, and those matters which should be the preserve of all 27 member states. "We’ve made it very clear that things like the single market, competition policy, financial services, should be dealt with by all 27 and not by a caucus of 17."
Will the ECB and Mario Draghi save Europe?
by Angela Monaghan and Philip Aldrick - Telegraph
Less than two weeks into his new role as President of the European Central Bank, Mario Draghi is already facing an even bigger job: saviour of Europe.
As eurozone leaders have tried but failed miserably to convince markets that they have either the will or the way to solve the region's sovereign debt crisis, a growing number of world leaders and economists are calling on the ECB to step in and fight the raging fire.
They argue that as the region lurches from one crisis to another, with Italy its latest focus, the ECB is the region's best chance of drawing a line under this terrible chapter by agreeing to act as lender of last resort to its governments through the large-scale purchase of sovereign bonds.
Yet Mr Draghi is strongly opposed to the suggestion. He insists that such a move would compromise the central bank's independence and amount to a bail-out for individual countries which is not the role of the ECB. Instead, he and his fellow policymakers would like to continue to focus on the ECB's remit of targeting below 2pc inflation.
But as days and weeks pass without a resolution of the crisis - which is plaguing the region, weighing down on the global economy and threatening to bring down the European Monetary Union - it may now be the only credible option.
The problem is not going to go away. Among major European economies, a total of €1.1 trillion of debt will mature in 2012. Question marks over Italy's ability to honour its debts pushed the Italian government's borrowing above 7pc this week, an unsustainable level which forced fellow eurozone countries including Greece and Ireland to be bailed out. So who is going to come to the rescue?
"This really is Europe's Lehman's moment and it is make or break," according to Danny Gabay, a former Bank of England economist and director at Fathom Consulting.
Although the Italian parliament yesterday voted through austerity measures, political uncertainty and huge debt burdens have not been wiped away,
Some believe that Italy is already past the point of no return. When the government's borrowing costs soared past 7pc, the country put itself in the bail-out club as fears about its ability to fund itself coalesced and branded it with a stigma that cannot be erased. The lesson from Greece, Ireland Portugal is that there is unlikely to be any escape.
For some economists, though, it's not all over for Italy. For a start, the country is not insolvent. According to the Italian Treasury, the book value of its assets is €1.8 trillion (£1.53 trillion) – barely less than its €1.9 trillion of debt. Of that, €45bn is tied up in listed companies such as oil group ENI and the utility Enel, €400bn in real estate and €140bn of gold in today's prices.
The country has assets to sell. On top of that is the €8.5 trillion of net wealth held by Italy's households, which could also be crow-barred into supporting the economy.
On the other hand, there are its financing requirements. Next year, €220bn of debt matures and the IMF calculates the country will need another €150bn to finance its borrowing costs. Half the maturing debt is owned by domestic investors, so ought to be rolled over – leaving roughly €250bn of refinancing. It is that debt hurdle that has spooked the markets.
However, Raj Badiani, IHS Global Insight senior economist, believes Italy "can endure several quarters of expensive debt auctions" assuming its borrowing costs stay below 7pc. Last week, it raised €5bn one-year money at 6pc.
Time is of the essence. According to Fabio Fois, economist at Barclays Capital, if Italy can use the time to demonstrate it is committed to reform, it can restore confidence and get its borrowing costs back down to levels that will allow the economy to outgrow its debt burden.
The point about the value of the state's assets and the vast wealth held by its people is that Italy does have options, unlike Greece. Asset sales and wealth taxes can be used to cut the Italian debt pile. Structural reforms to make the economy more competitive can stimulate growth, from the moribund sub-1% average of the past 10 years. That will be the challenge for Mario Monti, the new Italian prime minister, and his fellow technocrats.
In some ways, Italy is in pretty good shape. If you exclude the debt servicing costs, the government will take more in taxes this year than it spends, according to the IMF. Its primary surplus will be 0.5pc – better than Germany's, which is the only other major western economy to boast of a primary surplus. After paying the bill on its debts, though, the surplus turns into a 4pc deficit.
The catch is that, because its credibility is now in tatters, it will be left to the ECB to spend heavily to keep Italy's borrowing costs below 7pc.
Italy is deemed too big to fail, but yet it is also too big to bailout. It is not a peripheral eurozone country like Greece, it is the world's eighth largest economy. The European Financial Stability Facility (EFSF) and the International Monetary Fund do not possess the firepower which is likely to be required, and the markets know it.
"Policymakers could try to soldier on and pretend that Italy's size does not matter but, in all likelihood, they will have to try to find some sort of nuclear button to turn back the markets," says Steven Barrow, currency strategist at Standard Bank.
A growing number of economists expect the ECB to cut interest rates to 0.5pc from the current 1.25pc level early next year, but a bond purchasing programme would amount to a "nuclear" option, bringing down borrowing costs, increasing the money supply, and causing the euro to fall in value over time, thus improving the competitiveness of eurozone countries. "This could certainly work to end the crisis – if the ECB promised to buy unlimited amounts of debt from the outset," he said.
The EFSF has been unable to convince investors not to sell off sovereign debt – illustrated by a bond auction this week in which the rescue fund was forced to buy its own bonds due to lack of outside demand. But the ECB could succeed where the EFSF failed, possessing the ability to print an unlimited amount of new money. According to Peter Vanden Houte, chief eurozone economist at ING, markets will now only be reassured by a saviour with "very deep pockets".
The chief hurdle is the ECB itself, and its unwillingness to dig into those pockets. Mr Draghi's message was reiterated this week by Juergen Stark, a fellow ECB policymaker. "We are not the lender of last resort [to governments] and I do not advise European governments to ask the ECB to become a lender of last resort.
"From my personal perspective, and I think I speak on behalf of my colleagues on the Governing Council, we will not ask and we will refuse to have an extension of the mandate for the ECB to become lender of last resort to governments."
The ECB has already engaged in bond purchases on a relatively modest scale, but has so far stopped short of quantitative easing – the creation of new money to fund purchases. "Larger purchases would be seen as an unacceptable step into fiscal policy that would pose a serious threat to the Bank's independence," says Jennifer McKeown, senior European economist at Capital Economics.
The ECB's seemingly inflexible approach should be considered in the context of Germany's own fiscal and monetary history, after it was modelled closely on the German Bundesbank,
The Bundesbank was itself established as an independent central bank in the post-war era, committed to monetary discipline. Scarred by the hyper-inflation of the past, German policymakers are vehemently opposed to quantitative easing. Such a move by the ECB would only encourage countries to be ill-disciplined, thus storing up problems for the future. Those countries should not be given the easy way out.
Open Europe, a think tank, agrees on the latter point. Its economic analyst, Raoul Ruparel, said: "This money would be provided to states such as Italy and Spain without conditions, meaning the pressure to enact necessary economic and institutional reforms would be removed. It is vital that these countries enact such reforms if they have any hope if becoming competitive again and maintaining a sustainable debt load. Therefore, such a move by the ECB could end up being counterproductive."
German policymakers find it impossible to accept that a central bank should buy sovereign bonds on such a huge scale, even if the purchases would be made on the secondary market and not directly from governments. In German minds, it would amount to monetising the deficit, and go against the Maastricht Treaty, if not in letter then in spirit.
Other world leaders do not agree, and want to see decisive action from the ECB. David Cameron said there were now "real question marks" over whether eurozone countries could deal with their debts, and called on the "institutions of the eurozone" to act. US President Barack Obama and Russian Prime Minister Vladimir Putin have also called on the ECB to do more.
Peter Vanden Houte of ING believes the ECB is its own worst enemy, exacerbating the Italian bond sell off by refusing to act. Ultimately the ECB may consider a large-scale bond purchasing programme the lesser of two evils, with a collapse of the eurozone almost inconceivable.
"I can't imagine that if they were faced with a major financial collapse or the necessity of printing money [the ECB] wouldn't print money," said Jerry Webman, chief economist at OppenheimerFunds Inc. If the ECB does not act, Mr Draghi may find the eurozone's blood on his hands.
Italian Debt Threatens Europe's Savers
by Hester Plumridge - Wall Street Journal
Italy could deal insurers a lethal blow. Europe's insurers own an estimated €300 billion (about $408 billion) of Italian sovereign debt—equivalent to a large chunk of their €450 billion shareholders' equity, notes JP Morgan. While banks' exposure has been much debated, an Italian default or euro exit could devastate insurers' capital and in turn Europe's savings.
Insurers' holdings make up a sizeable chunk of Italy's €1.6 trillion government debt. Some insurers have cut exposure—Zurich Financial Services sold around €2.3 billion in the last quarter—but many are reluctant to crystallize big losses when they hold assets to maturity and a default is still an outside scenario. Finding enough long-dated assets to replace them and back their huge liabilities is tricky.
Italian insurers—among the sector's largest holders of the debt—are already suffering from low domestic bond prices and falling equity markets. Fondiaria SAI declared a €250 million asset write-down last month. An Italian default could be a potentially fatal blow. Trieste-based Assicurazioni Generali's gross exposure to Italian government bonds is more than double its shareholders' equity. Losses on bank debt and equity holdings would likely amplify the problem.
Foreign insurers, too, have sizeable Italian debt holdings and could face big hits to their capital. German-based Allianz, one of Italy's largest insurers, has a €26 billion gross exposure. If Italy were to leave the euro, domestic insurers might at least be able to re-denominate their policies into the new currency, but foreign players could face an additional currency risk. Much of their holdings back policies in other countries, meaning the assets would devalue but not the liabilities.
Shares in Europe's insurers have fallen between 5% and 10% in the past two weeks, but the sector still trades at or just below book value. It's difficult to price in an Italian default or euro break-up, which might prove an unmanageable capital event for many. Ultimately, politicians and regulators may find a solution that shields the industry.
But the effects would still likely be felt by savers. Policyholders in many life insurance products bear 80%-90% of any losses on insurers' investments unless minimum return guarantees are breached. If a country leaves the euro, devaluation and inflation could destroy much of the value of its domestic savings, with or without crushing its insurers.
Europe's Shrinking Core
by Richard Barley - Wall Street Journal
The core of the euro zone ain't what it used to be—at least so far as the bond markets are concerned.
The debt crisis has eaten its way through the periphery via Greece, Ireland, Portugal, Spain and Italy. Now, the gap between French and German government-bond yields is widening. That spells trouble for France—and the euro zone.
Franco-German spreads are at levels not seen since the early 1990s. French 10-year bonds yielded 1.71 percentage points more than similar German bonds at one point on Thursday, before the gap shrank somewhat to end Friday at 1.48 points.
French yields have moved in the opposite direction to Germany on three days this past week. On Thursday, they rose 0.25 percentage point when German yields rose just 0.05 point. France is no longer being treated as a safe haven. On "risk-off" days, France loses out, while on "risk-on" days, it gains—but not enough to reverse the widening trend.
There are two factors at play. France itself looks vulnerable, although it has hastened to implement policy aimed at protecting its credit rating. Its economy is slowing. It has the highest debt of triple-A euro-zone nations, at 87% of gross domestic product. France has to do more fiscal work to balance the books than Italy, RBS points out. To restore debt to 60% of GDP in 2030 requires fiscal tightening of 6.3% of GDP by 2020 in France versus 3.1% for Italy, according to the IMF. In addition, French bank exposures to Southern European debt are large.
The second factor is the euro, which facilitates rapid cross-border investment—and disinvestment—flows. The pool of safety for investors is shrinking. In 2007, seven of the euro zone's major bond issuers were triple-A, accounting for 73.7% of the currency bloc's GDP. Five of them remain triple-A, but in investors' eyes, only Germany, Finland and the Netherlands are safe havens now, accounting for just 35.6% of GDP. France is triple-A in name only, as is Austria, where concerns about Eastern European exposure have driven yield spreads wider.
The risk is that the widening yield gap begins to influence France's approach to the crisis. That poses a threat to the political alliance between France and Germany that has been at the heart of the European project, making the crisis harder to resolve. Economically, it poses the threat of a further pullback from cross-border lending, damaging growth.
The bond market, in effect, is breaking up the euro. France can no longer be assured of being in the core club.
Bond Market Rates Portugal CCC as Downgrades Loom
by John Detrixhe - Bloomberg
The bond market rates Portugal's creditworthiness at least six steps lower than either Moody's Investors Service or Standard & Poor's, suggesting lower ratings may be on the horizon for Europe's most indebted nations.
Investors charge Portugal the same for money as a borrower with a CCC ranking, according to data from Moody's Analytics. That's six levels worse than the Ba2 assigned by the credit- rating division of New York-based Moody's Corp.'s and eight levels below Standard & Poor's and Fitch Ratings' BBB- grades.
The discrepancy signals more gloom for Portugal, which saw its benchmark debt yield reach a record 13.44 percent this year and was forced to follow Greece and Ireland in seeking outside help to service its debt obligations. The rate on the Iberian nation's 10-year bond was 11.43 percent at 9:32 a.m. in New York. Sovereign downgrades can lead to cuts in the ratings of nations' banks, sparking higher borrowing costs and forcing them to provide more collateral to counterparties.
"Certainly you can see more downgrades" on the way, said Noel Hebert, a credit strategist at Mitsubishi UFJ Securities USA Inc. in New York. "Financial systems are dependent on accessing capital. If you can't access capital because investors believe the quality of the collateral is overstated, then it can cause a domino reaction."
Portugal, Cyprus, Italy, Spain, and Belgium have outlooks that are negative, on review for downgrade or are have a negative rating watch by the three biggest credit ranking firms, according to data compiled by Bloomberg.
Between 2007 and 2009, Moody's downgraded 56 percent of borrowers whose bond-implied rankings were six or more steps lower than those assigned by the rating company, according to a September report by Moody's Analytics.
Portugal, Italy, Spain, Slovenia, Belgium and Cyprus have the biggest rating discrepancies among the 17 euro nations, according to Moody's Analytics data as of Nov. 9. The debt has grades by Fitch, S&P and Moody's that are at least six steps out of line with their bond-yield derived rankings.
A Bank of Italy study this month showed Portugal is the most vulnerable of seven of the biggest euro-bloc members to a budget crisis. It registers 0.61 according to a central bank gauge where a reading of more than 0.51 signals "the possibility of a budget crisis" based on "budget and macro- financial variables."
That compares with 0.6 for Greece, 0.41 for Italy and 0.52 for Spain. Germany's score is 0.18. Higher yields may affect banks' ability to raise cash through financial transactions in which they use those securities as collateral.
"It's a vicious feedback loop," said Kathleen Gaffney, a money manager at Boston-based Loomis Sayles & Co., which oversees $157 billion. "The market is being very anticipatory. The longer politicians wait to provide clarity with regards to a resolution, the quicker the market is to assume that they're not able to get it done."
About 60 percent of Greek, Irish and Portuguese banks were downgraded after their host countries' ratings were cut, Alberto Gallo, head of European credit strategy at Edinburgh-based Royal Bank of Scotland Group Plc, said Nov. 9 in a conference call. The rate in Italy is about 20 percent, supporting the view its "banking system is more solid," he said.
Downgraded banks "would have a little more difficult time borrowing, presumably, if they wanted to issue any debt or commercial paper," Paul Kasriel, chief economist at Northern Trust Corp., said in a telephone interview from Miami. "A counterparty would reduce its line of credit if not eliminate it if there's a downgrade."
The ratings of Banco Santander SA, Banco Bilbao Vizcaya Argentaria SA and CaixaBank SA were reduced by Moody's on Oct. 19, a day after the company lowered Spain's ranking two levels to A1, the third cut in 13 months. Fitch downgraded Spanish banks on Oct. 11 after it reduced Spain's sovereign debt to AA- from AA+ on Oct. 7.
UniCredit SpA, Italy's biggest bank, said a downgrade of the company's credit worthiness is among factors that could spark a "liquidity crisis," according to an August filing. The bank is rated A2 by Moody's and A by S&P with a negative outlook by both, Bloomberg data show.
LCH Clearnet SA, Europe's largest clearing house, increased the deposit it demands for trading Italy's securities amid deepening concern the government of Prime Minister Silvio Berlusconi will struggle to enact austerity measures to reduce borrowing costs in Europe's second-most indebted nation.
Italian government debt plunged on Nov. 9, sending the yield on two-year notes to more than the seven percent for the first time since before the euro was introduced in 1999. Greece, Ireland and Portugal sought outside aid after their bonds exceeded that level.
Italy's Senate will vote on debt-reduction measures today in an attempt to shore up investor confidence and pave the way for a new government that may be led by former European Union Competition Commissioner Mario Monti. The rate on Italian two-year notes was at 5.97 percent today, while 10-year yields were at 6.66 percent.
"The pressure's on Italy," Axel Merk, chief investment officer at Merk Investments LLC in Palo Alto, California, said in an interview with Lisa Murphy on Bloomberg Television's "Street Smart." "If they're able to show the market that there is leadership and there is confidence, then things can improve dramatically. It's in the hands of Italian politicians, if they can put politics aside and realize how serious the situation is."
'Out of Line'
While Moody's market-implied gauge, launched in 2002, tends to lead changes in Moody's Investors Service grades, its rankings are more volatile and match the traditional ratings about a quarter of the time, the analytics division said in a September report.
"Agency ratings tend to trend toward the market trading level," David Munves, a divisional managing director at Moody's Analytics said Nov. 9 in a telephone interview. "There have certainly been times when the market has been out of line."
Borrowing by Italian lenders from the ECB more than doubled to 85 billion euros between June and August. Greek and Irish banks each took about 100 billion euros from the ECB in August. Irish lenders also got 56 billion euros from their domestic central bank. Portuguese banks borrowed about 46 billion euros from the ECB, while Spanish banks took 52 billion euros in July.
"We're nearing some turning points that could result in adverse feedback loops," Gallo of RBS said Nov. 8 in a telephone interview. "Indicators of bank funding stress are rising across Europe, and there is not enough of a firewall set up as the backstop."
Bundesbank warns against intervention
by Ralph Atkins and Martin Sandbu - FT
The president of Germany’s powerful Bundesbank has firmly rebuffed international demands for decisive intervention in the bond markets by the European Central Bank to combat the eurozone debt crisis, warning that such steps would add to instability by violating European law.
Bundesbank president Jens Weidmann told the Financial Times that only politicians could resolve the crisis, and he rejected the idea of using the ECB as "lender of last resort" to governments.
He also criticised actions taken by eurozone governments as "inconsistent", and warned that their plans to involve private sector banks in rescue plans for Greece could add to the eurozone’s woes. Such private sector involvement, he said, could undermine market confidence in the eurozone’s crisis-fighting tools such as the rescue fund, the European financial stability facility.
The forthright comments by Mr Weidmann, who is one of the most influential voices on the 23-strong ECB governing council, come at a decisive moment for Europe’s 13-year-old monetary union, which in recent days has seen Italy’s borrowing costs soaring dangerously and the prime ministers of both Italy and Greece resigning.
To prevent the crisis erupting into a global economic shock, the ECB has been urged to intervene directly by economists and politicians around the world, including at the weekend by Russia’s Vladimir Putin.
Mr Weidmann highlighted the stance being taken by the Bundesbank by arguing governments, not central banks, were mainly responsible for ensuring financial stability. Mario Draghi, the ECB’s new president, has said it is not the ECB’s job to act as lender of last resort, but Mr Weidmann went further, saying such a step would breach Europe’s ban on "monetary financing" – central bank funding of governments.
"I cannot see how you can ensure the stability of a monetary union by violating its legal provisions," Mr Weidmann argued. "I don’t see how you can build trust in a system that violates laws."
Mr Weidmann said current Italian interest rates levels were "not such a big issue" in the short run. "What we are facing in Italy is an acute confidence crisis, and only the Italian government can resolve that crisis."
Since May last year, the ECB has been buying eurozone government bonds – a move opposed by the Bundesbank – but sees its role as limited and aimed only at ensuring functioning markets.
Mr Weidmann worried that repeated changes in eurozone plans for dealing with the crisis had simply undermined financial markets’ confidence. He also explained why he, along with other members of the ECB’s governing council, had expressed concern about Berlin-led attempts to secure a contribution from banks towards Greece’s bail-out costs – the so-called "private sector involvement".
"PSI might appear an easy way out of self-inflicted problems. If this is the case, you achieve the opposite of what you wanted to achieve. You will have more contagion instead of containment of the crisis because it’s seen as a potential model for other countries."
Mr Weidmann offered no clues on whether the ECB might cut interest rates further at its December meeting from the current 1.25 per cent. But he stopped short of reiterating past Bundesbank opposition to the ECB’s main interest rate falling below 1 per cent. "I won’t speculate about the future actions ... and limits to future action."
Fears rise over banks’ capital tinkering
by Brooke Masters, Patrick Jenkins iand Miles Johnson - FT
Concern is growing that banks in Europe and elsewhere are moving to meet new tougher capital requirements by tinkering with their internal models to make their holdings appear less risky.
Under the global Basel III rules, which will be phased in between now and 2019, banks have to hold top quality capital equal to 7 per cent of their assets, adjusted for risk. The biggest banks will also be hit with an additional surcharge of up to 2.5 per cent. Banks in the European Union will also have to hit a temporary 9 per cent ratio next year after discounting their risky sovereign debt holdings.
All of these requirements are aimed at making banks more resilient by forcing them to have more capital to absorb unexpected losses. But banks, faced with volatile markets and low share prices, are reluctant to issue equity right now.
So many of them are instead trying to reach the required ratios by reducing the denominator, through what they call "risk-weighted asset optimisation". In some cases, that means selling or running down risky assets, but in others, it means changing the way risk weights are calculated to cut the amount of capital that will be required.
Regulators, who must approve bank models, are alive to the problem and the European Banking Authority’s board has essentially set a floor on how low the risk weights can go when it comes to calculating the EU’s 9 per cent target. "The language of RWA optimisation is basically regulatory arbitrage," said one senior EU regulator.
But that hasn’t stopped many banks from doing their best to boost their ratios. A recent Morgan Stanley analysis of Lloyds Banking Group found the bank sharply reduced the risk weighting of its overseas retail mortgage portfolio in 2010, leading to a £16bn fall in risk-weighted assets.
Lloyds’ optimisation programme is understood to include selling and running off assets and also getting the agreement of the UK regulator to change risk weights on various loans so less capital needs to be placed against them.
UK bankers said that the Financial Services Authority was tougher about model changes than continental regulators. "This is a long, rigorous process that is particularly time consuming," one said.
Santander has said that it is currently in the process of "optimising" its risk-weighted assets even as Alfredo Sáenz, its chief executive, hit out at "fudges outside of Spain". Spain’s largest bank said it is focusing on the risk weighting of certain kinds of loans, such as unused lines of credit and loan commitments, as well as shrinking its balance sheet by writing off non-performing loans.
Germany’s Commerzbank reported in its third-quarter results that it is getting new models approved in the wake its merger with Dresdner and should see benefits in its risk-weighted asset totals.
Some of the optimisation is encouraged by the regulators. Banks effectively get an risk-weighted asset break when they switch from the old Basel I rules – which apply standardised risk weights to loans based on their category – to the "internal ratings based" system that is the basis for Basel II and III.
Under the internal ratings system, banks come up with models that predict the probability a particular loan will default and the likely loss if that occurs. The numbers are then plugged into a formula that assigns a risk weight. In general, using internal ratings produces somewhat lower risk weights – and therefore requires less capital – than the standardised approach because regulators want banks to build good models and improve risk management.
BBVA, Spain’s second-largest bank by assets, has been slowly switching to the internal ratings system since 2008 and last year got approval from the Bank of Spain for more models.
For now, the regulator has established an risk-weighted asset floor equal to the standardised approach, but the bank said it would expect that this floor could be removed in the coming months, which would lead to a drop in its overall risk-weighted assets. "What BBVA is doing is catching up with practices that are common elsewhere in Europe," the bank said.
But there is a second kind of optimisation that regulators are more concerned about. When banks create models, regulators then back-test them and will only approve those that produce probabilities of default and predicted losses that are higher than real-life experience.
But the current recession has produced lower loan default rates than past downturns – partly because interest rates are low – so many bank models are currently producing results that are significantly more conservative than real life.
That creates room for banks to tweak their models, and some are doing so in a deliberate effort to cut their capital needs, industry participants say. As a curb on the tinkering, the European Banking Authority board has turned to a sometimes neglected rule that no bank’s risk-weighted assets can drop below 80 per cent of where they would be under the Basel I standardised approach. "The EBA board of supervisors has agreed to apply the ... floors in a consistent and conservative manner across all the banks in the sample," it said.
Supervisors in the UK and elsewhere also said they will be looking carefully at bank plans to reach their new capital requirements and intend to come down hard to anything they see as cheating.
Europe’s Woes Pose New Peril to Recovery in the U.S.
by Annie Lowrey - New York Times
For the second time in two years, European debt troubles threaten to slow the momentum of the fragile recovery in the United States.
Although American financial institutions have taken steps to protect themselves from Europe’s long-simmering problems, the likely slowdown in Europe could damage consumer and business confidence in America and strengthen the dollar, making United States exports less competitive.
"Financial contagion can lead to the very rapid global spread of recession," said Chris Varvares, senior managing director for Macroeconomic Advisers, a forecasting company. "If trouble intensifies and spills over to equities and other U.S. risk assets, we could see a soft patch."
Economists say Europe’s troubles would need to worsen significantly before putting the United States economy, which has been strengthening lately, at risk of a new recession. The European Union and United States economies are the two biggest in the world and their financial institutions are deeply intertwined. They have the single largest bilateral trade relationship, together accounting for nearly a third of global trade flows.
On Thursday, the European Commission announced that it foresaw little or no growth in the European Union in the fourth quarter of the year, and a slight 0.1 percent contraction for the euro zone, the 17 countries using the euro currency. It forecast a scant 0.5 percent annual growth in 2012 for the union and warned that the Continent might be slipping into a "deep and prolonged" recession. As recently as this spring, the commission forecast that Europe would grow 1.75 percent for 2012.
Speaking on Thursday at the Asia-Pacific Economic Cooperation summit meeting in Hawaii, the Treasury secretary, Timothy F. Geithner, said: "The crisis in Europe remains the central challenge to global growth. It is crucial that Europe move quickly to put in place a strong plan to restore financial stability." He added, "We are all directly affected by the crisis in Europe."
United States financial institutions have tried to inoculate themselves by drastically cutting risk to the euro zone debt markets, partly in response to urging from policy makers.
For instance, prime money-market funds — a common and higher-yielding alternative to bank deposits, and the site of a freeze in the financial markets in October 2008 — have reduced their exposure to euro zone banks by more than half since May, according to a JPMorgan analysis released this week. "Most prime fund managers are allowing existing euro zone exposures to run off," the analysts wrote.
But these measures may not be enough in the event of a bank failure or bond market panic, which could have broad and unpredictable effects on global markets. "I don’t think we’d be able to escape the consequences of a blow-up in Europe," Ben S. Bernanke, the chairman of the Federal Reserve, said Thursday in Texas while answering questions after a speech.
Even with the recent moves, the United States financial system still has billions at risk to European institutions. In an extensive report to lawmakers in September, the Congressional Research Service estimated that the exposure of banks to Greece, Ireland, Italy, Portugal, and Spain — some of the most heavily indebted euro zone economies — amounted to $641 billion. It added, "a collapse of a major European bank could produce similar problems in U.S. institutions."
It further estimated American banks’ exposure to German and French banks at in "excess of" $1.2 trillion, equivalent to about 10 percent of total commercial banking assets in the United States. Similarly, the Bank for International Settlements reports that at midyear banks in the United States had $757 billion in derivatives contracts and $650 billion in credit commitments from European banks.
"Europe is very clearly in a Bear Stearns environment," said Stephen Wood, chief market strategist at Russell Investments, referring to the investment bank that collapsed in early 2008 without setting off broader financial panic.
"The question is: ‘Do they get to a Lehman environment?’ They’re not there yet, but the dark clouds are beginning to gather. Right now, we’re seeing the U.S. dollar and U.S. markets benefiting, relatively, as safe havens," Mr. Wood said. "But that wild card, that sword of Damocles, is going to be what the capital market implications are if there is a major credit event in Europe."
Because Europe’s troubles have been developing for more than two years, financial firms have had more time to prepare than they did for the 2008 crisis, when the collapse of Lehman Brothers almost caused credit markets to freeze. This preparation could prevent a repeat of the 2008 global crisis, even if the European troubles deepen.
Still, the woes in the euro zone will probably weigh on the broader American economy, economists say. Consumer confidence has nearly returned to its lows during the worst of the recession and financial crisis, in late 2008 and early 2009.
"If stock prices start falling, consumers are likely to cut back on spending, which would be sufficient to grind the recovery to a halt," said Ryan Sweet, a senior economist at Moody’s Analytics. "And business confidence is very fragile. Any weight on confidence could hurt hiring and lift the unemployment rate."
Europe’s troubles, including the possibility that the euro zone could break up, has caused the dollar to rally against the euro, which makes American exports more costly. On Wednesday, the euro hit a one-month low against the dollar before recovering slightly by the end of the week.
For the euro, "the downside risk is considerable and the current level doesn’t do a great job of exhibiting the extent of risk there," says Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington. "I’d argue there’s a lot more risk" that dollar-denominated goods will become relatively expensive.
In an interview Thursday with Reuters, John E. Bryson, the commerce secretary, said, "We’ve had such strong exports to Europe and now, with the European financial crisis, those will come down, appear to be coming down."
In the last few weeks, several companies with major European operations have lowered earnings forecasts because of the tumult. In a research note this week, Tobias Levkovich, Citigroup’s chief equity strategist, called some falling early sales indicators a "worrisome sign" for companies with significant business in Europe.
Such companies include General Electric and McDonald’s. The most at-risk sectors included auto components and automobile companies, which generate nearly 30 percent of their sales in Europe, as well as food and tobacco firms. General Motors said Wednesday that it expected to go into the red in the region this year. Daniel F. Akerson, the chief executive of G.M., blamed the European "morass" for a lowered outlook.
In light of the risk the European crisis poses to the United States, policy makers have urged Europe to deal with the issues immediately. Mr. Geithner said Thursday that European leaders had developed a "good framework" for dealing with the crisis late last month. "But we need to see it put in place with the speed that markets require and with the force that restores confidence," he said.
Let pensions fund homes for first time buyers, says Britain's CBI
by Graham Ruddick - Telegraph
Potential first-time buyers should be allowed to use their pension savings to buy homes, according to a new report on how the boost the housing market.
The number of property sales in the UK has crashed since the recession despite 5m people "languishing on waiting lists", the CBI claims today in its Unfreezing the Housing Market study. John Cridland, CBI director-general, said the fall in sales has accounted for a third of the 6pc drop in UK GDP during the recession. Boosting housing sales could be "a major game-changer for growth", he added.
Allowing young people access to their pension pot for mortgage deposits, which would help their chances of getting a mortgage, would drive this boost. The CBI also said a so-called "Mortgage Indemnity Guarantee" insurance scheme, which has been discussed by banks and housebuilders, would provide banks with more confidence to offer higher loan-to-value mortgages to first-time buyers. This would protect lenders from the risk of a default on mortgage payments through an industry and lender-backed insurance fund.
Mr Cridland added: "While we would not want to see a return to overly-risky lending practices and unsustainable personal debt levels, it is important that we get credit flowing to those who need it most." The CBI said housebuilding, which is at the lowest peacetime level for 90 years, also needed to be increased. It called on the Government to address "structural housing market failures" and allow offices to be turned into homes without planning permission.
Pension fund investment sought by UK ministers to stimulate economy
by Allegra Stratton - Guardian
Up to £50 billion could be put in to projects to improve Britain's housing, power stations, super-fast broadband and roads
Ministers are finalising a radical plan to boost investment in UK infrastructure and stimulate the economy, with proposals to pool the vast assets held in British pension funds and use them to back an ambitious programme of road and house building. Pension and insurance funds are to be encouraged to invest up to £50bn in improving infrastructure, including private and social housing, power stations, super-fast broadband and motorway toll roads.
Government sources want UK pension funds to ape the financial activities of Canadian pension funds, which last November invested in the UK Channel tunnel rail link. Though pushed out by the Liberal Democrats on Sunday, the plan appears to have the support of ministers and officials across the coalition as they try to galvanise the economy without breaking the strict rules on public spending set out in the government's deficit reduction plan. This would see them accused by the opposition of resorting to a "plan B".
It is understood the government will create a "pension infrastructure fund" as part of the growth review, due for publication on 29 November. The situation is becoming increasingly critical as the Bank of England prepares to cut its growth forecasts for 2011 and 2012, revising down the forecasts for this year from the 1.5% predicted in August to just 1%. Ministers believe that as the pension funds could receive a share of the eventual revenue raised by the infrastructure building – via energy bills, tolls or rents – the plan is financially attractive.
Variants of this type of intervention have been championed by Oliver Letwin, the prime minister's chief policy adviser, and the idea was last included in a pamphlet by the business secretary Vince Cable for the thinktank Centre Forum in September, but Treasury officials suggested it be left out.
Since then, the idea has been taken up by both the Treasury and the Department for Business, of which Cable is head. A Tory source confirmed the idea was being actively pursued by the coalition, with the focus on how pension funds could be co-ordinated to enable them to act together. The new plan comes after battles between the Lib Dems and Conservatives over policy suggestions by the venture capitalist Adrian Beecroft.
Some Tories are keen to adopt suggestions by Beecroft, who was commissioned by the prime minister's head of strategy, Steve Hilton, including the ending of unfair dismissal claims. It is thought that Lib Dem leader Nick Clegg is resisting the compromise solution currently on the table that unfair dismissal be ended for young workers. The move could make employers more inclined to hire young people – on the basis that they were no longer scared of being locked into employment contracts they feared they might not be able to afford in months to come.
Clegg was due to make a speech on youth unemployment on Monday, but this has now been delayed because of the eurozone crisis, officials said. However policy debates on what Clegg's speech should include are continuing.
There is mild irritation within the government over Lib Dem tactics, with Tory sources blaming Lib Dems for a story which emerged last week suggesting the chancellor was now taking on Hilton over Beecroft's suggestions. It remains unresolved whether the funds contributing to the new pension infrastructure fund will take their own risk on the investment, with the prospect of good returns on their money, or whether the government will underwrite their investment.
If the latter, the government will be adding liabilities to the public books, and it is thought this could be done off the balance sheet. A decision to do that, however, would expose the government to accusations that it is repeating the tactics of the Blair-Brown years when, through public-private initiatives, the costs of improving state infrastructure were also left off the UK's balance sheet.
This comes alongside an expected major push on credit easing – where the Treasury buys company debt – which is also expected to be off balance sheet. A Treasury source fuelled this expectation, telling the Sunday Times: "We will not be changing the government's capital spending envelope and we will not be issuing new bonds to fund this." He said the mechanism would not affect the UK's balance sheet.
The government has already made clear it will push infrastructure spending in a bid to jumpstart the economy. In a speech earlier this year, Clegg spoke of the need to ensure infrastructure projects in receipt of money from Whitehall would actually take place, deploying the chief secretary to the Treasury, Danny Alexander, to ensure that the 40 projects that have been approved are completed.
In their conference speeches, both Alexander and the chancellor, George Osborne, announced that money clawed back from departmental underspend would go into infrastructure projects. The government put £500m into a "growing places fund" for infrastructure projects. The new £50bn pot marks a significant amplification of this strategy.
British pension funds will be encouraged to behave as their counterparts in Canada do. The Ontario teachers' and municipal workers' pension funds last year invested in Britain's Channel tunnel link, winning the contract to run the service for 30 years. Such funds find lengthy contracts financially desirable.
Cable told the Sunday Times: "We know there is a large amount of institutional investment in pension funds and insurance companies looking for a safe return. At the moment, it is extraordinary that foreign institutions will invest in British infrastructure but British companies won't.
"What we have to do is create a framework regulation so that private investors will have the confidence to invest in big projects and help get the British economy moving again." In his pamphlet, Cable called for a new programme of road building to be made a financially attractive proposition by allowing the contractor to bring in payment through road tolls.
Road building is also favoured by the Treasury because it increases the prospect, through the fuel duty paid by motorists, of increasing revenue further down the line. One possible new toll road is the A14 around Cambridge, which is in a heavily congested area and of critical importance to the economy because it brings lorries into the country from the port of Felixstowe in Suffolk.