Thursday, December 29, 2011

December 29 2011: Trends 2012: The End of the Euro, The End of the Investor

G. G. Bain Fire 1916
"W.T. Grant department store fire at New York's Sixth Avenue and 18th Street in April 1916"

Ilargi: Oh, sure, don't get me wrong, there may still be a Euro a year from now. And there’ll certainly be some investors left.

But the Euro, if it manages to survive, will have to do so in what can only be characterized as a radically different form and shape. At the same time, small mom and pop stock investors will be few and far between; there's no money in the "traditional" stock markets, as they've found out - once more - in 2011. Many will also need what money they still have in stocks to pay down various kinds of other obligations.

As for the stock markets, I found it greatly ironic that on December 23, the S&P 500 was up for the year. Yesterdays markets plunge did away with that irony, but given the psychological importance, I wouldn't be surprised if, in the slim trading volume between Christmas and New Year's, one party or another will make sure the number comes in positive anyway.

What strikes me in all this is the disparity between the S&P and financial stocks. It’s unreal. If mom and pop hold bank stocks, they're not very likely to have turned a profit. If pension funds are anything to go by (they lost big time this year), mom and pop had lean turkey at their holiday family parties.

Here's a little overview of the year-to-date performance of some of the major global banking stocks on December 29, 2011, before the opening bell:

  • BofA: -60.38%
  • Citi: -44.76%
  • Goldman Sachs: -46.41%
  • JPMorgan: -23.03%
  • Morgan Stanley: -45.24%
  • RBS: -50%
  • Barclays: -34.32%
  • Lloyds: -63.02%
  • UBS: -29.33%
  • Deutsche Bank: -28,55%
  • Crédit Agricole: -56.04%
  • BNP Paribas: -37.67%
  • Société Générale: -59.57%

These are just some of the Too Big To Fail institutions. And while your governments have enough faith in them - or so they want you to believe - to prop them up with trillions of dollars of your money, investors are fleeing them, even if they can expect them to be propped up further.

That doesn't just say something about confidence in the individual banks, it shouts loud and clear from the rooftops on confidence in the banking system as a whole, and indeed on governments' ability to continue bailing them out. In other words: bailouts don’t build confidence, they are taken as a sign that trouble's on the way.

Mom and pop will finally clue in to this in 2012, and get -their money- out of harm's way. Well, either that or lose it. Their money, that is. Perhaps their minds too. And their homes. Their jobs.

Of the banks above, the European ones are in even deeper doodoo than their US counterparts. Gordon T. Long, in a report called Collateral Contagion, lifts a hitherto little known part of the veil:

There are approximately $55 trillion of banking assets in the EU. This compares to only $13 trillion in the US. Bank assets in the EU are 4 times as large as in the US.

In the US, debt held by the bank is smaller because retail deposits are a primary source of funds. EU banks use wholesale lending and, as a consequence, the debt held by banks is close to 80% versus less than 20% by US banks.

Wholesale bank lending in the EU approximates $30 trillion versus only $3 trillion in the US, a 10 X differential.

Wholesale lending is fundamentally borrowing from money market funds and other very short term, unsecured instruments. The banks borrow short and lend long. It all works until short term money gets scarce or expensive.

Both have occurred in the EU and this recently placed Dexia into bankruptcy, forcing it to be taken over by the Belgian and French governments. The unsecured bond market fundamentally closed in the EU in Q3 2011, as fears mounted that an EU solution was not forthcoming.

Assuming $30 trillion of loans is spread over three years, EU banks have a requirement for $800 billion a month of rollover financing for wholesale lending outstanding.

Ilargi: If those numbers don't render you speechless, please read them again. $800 billion a month of rollover financing, every single month for three years.

The ECB recently passed out €489 billion in three-year loans at 1%. Nobody was impressed for more than a few hours. Gordon T. Long's report reveals at least a part of the reason why. Moreover, the ECB is now accepting the proverbial toilet paper as collateral for the loans, but guess what, banks are running out of toilet paper! David Enrich and Sara Schaefer Muñoz touch on the same topic for the Wall Street Journal:

Europe's Banks Face Pressure on Collateral
Even after the European Central Bank doled out nearly half a trillion euros of loans to cash-strapped banks last week, fears about potential financial problems are still stalking the sector. One big reason: concerns about collateral.

The only way European banks can now convince anyone—institutional investors, fellow banks or the ECB—to lend them money is if they pledge high-quality assets as collateral.

Now some regulators and bankers are becoming nervous that some lenders' supplies of such assets, which include European government bonds and investment-grade non-government debt, are running low.

If banks exhaust their stockpiles of assets that are eligible to serve as collateral, they could encounter liquidity problems. That is what happened this past fall to Franco-Belgian lender Dexia SA, which ran out of money and required a government bailout.

"Over time it is certainly a risk," said Graham Neilson, chief investment strategist for Cairn Capital Ltd. in London. "If banks don't have assets good enough to pledge as collateral, they will not be able to tap as much liquidity...and this could be the end-game path for a weaker bank."

Ilargi: The market for unsecured bonds issued by banks is dead. And they no longer have any collateral left to issue secured bonds. So what will they do?

Saw this Guardian headline yesterday: Liquidity crunch fears stalk markets. I’d say that should have read Solvency crunch fears stalk markets. The ECB has taken care of short term liquidity. But to no avail.

Collateral equals solvency. The ECB loans equal liquidity. And liquidity means nothing if you're insolvent. Inevitably, banks will start to fall by the wayside. Even some of the Too-Big-To-Fail ones.

As will countries. There is no chance - well, I’ll give you 1% or 2% - that Greece will still be part of an unchanged Eurozone a year from now. Chances for Portugal, Ireland, Italy and Spain may be a bit higher, but certainly not by much. France will face huge market pressure. And presidential elections.

The road going forward has become completely unpredictable. For you and me, and also for our "leaders". They don’t like that, even less than we do. That's why we saw this report from Philip Aldrick in the Telegraph a few days ago:

UK treasury plans for euro failure
The Government is considering plans to restrict the flow of money in and out of Britain to protect the economy in the event of a full-blown euro break-up.[..]

Officials fear that if one member state left the euro, investors in both that country and other vulnerable eurozone nations would transfer their funds to safe havens abroad. [..]

Under European Union rules, capital controls can only be used in an emergency to impose "quantitative restrictions" on inflows, [..]

Capital controls form just one part of a broader response to a euro break-up, however. Borders are expected to be closed and the Foreign Office is preparing to evacuate thousands of British expatriates and holidaymakers from stricken countries.

The Ministry of Defence has been consulted about organising a mass evacuation if Britons are trapped in countries which close their borders, prevent bank withdrawals and ground flights.

Every government, in Europe and in the US, is busy working on contingency plans, just like this one, over the holidays. Bank holidays are considered, capital controls, travel restrictions.

In order to keep the basics of their economies going in case of financial disaster, governments will need to make sure they have the means to cover basic necessities. In a world where most of the energy and food is imported, that is a herculean task.

Who's going to issue the letters of credit that make imports possible? And what will they be covered with? Will Saudi Arabia, Russia, China and the US still accept euros when the defection of Greece and/or others makes the future of the Eurozone and the entire EU highly uncertain? No, they will probably want guarantees in US dollars.

As we speak, the euro is getting hammered, as is sterling, as is gold. Or are they? Or is it perhaps that the USD is rocking, in anticipation of near-future demand?

The risks for Europe come from all sides now, and at some point, which I think could be very close, one of these risks will not be -fully- covered. Because of the close interconnectedness between EU countries, as well as that between European and global financial institutions, one single domino may set in play a chain of events that will be beyond governments' control.

And, as I said, they don't like that. They may opt to pre-empt any such possible events. In the Eurozone alone, we're looking at 17 different governments who may decide to do so, in whatever way. Leave the Eurozone, leave the EU, stall decision making, refuse to pay debt. 17 different governments, many of whom will change during the course of the year, have multiple options that would derail the entire EU project as it was intended to be.

While sovereign and private debt is certain to keep on rising, and willingness to lend in order to stave off defaults is disappearing.

No, I don't know what the euro will look like next Christmas, but it won't be what it looks like today. It could be the return of the drachma and lira, or the return of the mark and guilder, or all of the above. But not a 17 countries' Eurozone.

Nontas Stylianidis, AFP, Getty Images Burning Greek 2011
"Bringing Greece's economy back under control has led to many protests, none more dramatic than when Apostolos Polyzonis set himself alight outside a bank branch in Thessaloniki, Greece, on Sept. 16. He survived his serious burns."

A bit more Europe. I’m spending some time in Holland, and wrote down the following over Christmas:

Holland has already officially confirmed it is in recession. And this at a point in time when its gigantic housing bubble hasn't even started popping yet. With mortgage debt at anywhere between €650 billion (official government number) and €1 trillion (Ernst & Young, unconfirmed by me) for its 16.7 million citizens, and taking into account that only an estimated 50% of Dutch are homeowners to begin with, it should be obvious that a "mere" 10% or 20% drop in prices would be devastating.

If 9 million (well over that 50%) Dutch men, women and children bear that €650 billion debt, each and everyone of them carries over €72,000. A typical family of 4 is then €288,000 ($375,000) in debt. On average! The huge popularity of interest-only mortgages has undoubtedly contributed strongly to this debt proliferation. And most will still feel fine, because the inevitable fall in prices hasn't materialized yet. And, admittedly, there are substantial savings.

Any drop in prices beyond 20% would mean unmitigated disaster. A huge part of private savings would be wiped out, and the banks that hold the mortgages would be pushed further into their already bankrupt status. Given the near inevitability of one or more countries leaving the Eurozone, even after trillions of euros were spent to prevent just this from happening, it's hard to see what the government could do to stave off widespread financial mayhem.

That same government did launch one idea last week: it seeks to force the country's "home-building corporations", a left-over from post-WWII state building projects aimed at offering affordable rental homes to everyone, to sell 75% of their rental homes to present occupants (at "reasonable" prices...). That’s a lot more potential debt slaves in one fell swoop. Whether or not a government, any government, should aim for just that is quite another matter.

This is one of Europe's richest countries. Or so everyone seems to think. Europe is rotten at the core too, not just the periphery.

S&P 500 Falling Below 600? This Will Even Make The Bears Shudder
by Tomi Kilgore - Wall Street Journal

United-ICAP senior technical analyst Walter Zimmerman says the S&P 500 could rally a little further into January before beginning a "traumatic decline" for the rest of 2012, dragged down by weakness in Europe.

How traumatic? You might want to sit down for this one.

He thinks the index will reach its 2012 peak in the 1293-1311 zone, then start a "sharp and sustained drop" until December. His downside target is around 579.57.

579.57! The index would have to wipe out the March 2009 lows and fall by more than 50% current levels to reach that target. And the last time the S&P 500 traded below 600 was in the mid 1990s, when the Backstreet Boys burst on the scene and bell-bottom jeans were making a comeback.

Zimmerman’s reasoning is Europe is in an even worse shape now than it was at the beginning of the year. "If the history of debt tells us anything it is that one cannot solve a debt crisis by lending more money to the bankrupt and the insolvent," Zimmerman says.

He expects 2012's price action will mirror what the S&P 500 did from its Oct 2007 peak until it bottomed in March 2009.

"The technical patterns suggest that 2012 will be a terrible year for holding stocks. Even if by some miracle the euro zone hangs together, it is already falling into a deep and enduring recession," says Zimmerman. "We expect this recession will drag down both the USA and China."

The S&P 500 was recently up 0.2% at 1268.

Europe's Banks Face Pressure on Collateral
by David Enrich and Sara Schaefer Muñoz - Wall Street Journal

Even after the European Central Bank doled out nearly half a trillion euros of loans to cash-strapped banks last week, fears about potential financial problems are still stalking the sector. One big reason: concerns about collateral.

The only way European banks can now convince anyone—institutional investors, fellow banks or the ECB—to lend them money is if they pledge high-quality assets as collateral.

Now some regulators and bankers are becoming nervous that some lenders' supplies of such assets, which include European government bonds and investment-grade non-government debt, are running low.

If banks exhaust their stockpiles of assets that are eligible to serve as collateral, they could encounter liquidity problems. That is what happened this past fall to Franco-Belgian lender Dexia SA, which ran out of money and required a government bailout.

"Over time it is certainly a risk," said Graham Neilson, chief investment strategist for Cairn Capital Ltd. in London. "If banks don't have assets good enough to pledge as collateral, they will not be able to tap as much liquidity...and this could be the end-game path for a weaker bank."

The ECB earlier this month moved to address the collateral shortages; Mario Draghi, the central bank's new president, announced it would accept a wider range of assets as collateral for ECB loans, which have become a primary source of funding for many European banks.

The looser rules, which will allow some corporate bonds to be used, kick in early next year, in time for banks to pledge the assets in exchange for three-year loans that the ECB will offer on Feb. 29.

Some bank executives, regulatory officials and other experts are optimistic that will largely solve the problem. "The ECB is being much more generous. We think there's enough [collateral] to exceed European banks' funding needs for the next year," said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group.

In one sign that the ECB move has eased market strains, even if only modestly, Italian borrowing costs dropped sharply Wednesday as the country successfully auctioned more than €10 billion, or $13 billion, of short-term debt. Average yields on six-month bills were 3.251%, half that of an auction a month ago and even below those in October, although yields on 10-year benchmark bonds remained just below 7%.

Other market watchers, however, remain concerned. In addition to fears that the banks might simply run out of eligible collateral, some bankers and regulators worry that the banks' growing reliance on "secured lending" will make it harder for the industry to return to its past practice of funding itself by issuing unsecured bonds. That could result in a permanent funding scarcity.

It is tough to tell how big a problem this is. European banks generally don't disclose how many assets they have on their balance sheets that would be eligible as collateral, either to pledge with the ECB or to package into "covered bonds," which are secured by mortgages or, in some cases, municipal loans that remain parked on the banks' balance sheets.

The Bank of England is among those ringing alarm bells. Officials are worried that the growing reliance on secured lending like covered bonds has left increasing portions of bank assets "encumbered," or otherwise committed. That means they wouldn't be available to unsecured creditors if the bank collapsed.

Officials also are nervous that some banks, particularly smaller ones, could exhaust their supplies of collateral that can be used for covered bonds or with the ECB, according to people familiar with the matter.

The U.K.'s Financial Services Authority recently conducted a confidential survey of British banks to gauge the degree to which their assets are encumbered. The Bank of England is in the early stages of reviewing the data and hasn't yet reached any firm conclusions, said the people familiar with the matter.

Since this summer, it has been difficult for banks to issue unsecured bonds, because investors view European banks as risky investments. In the second half of 2011, European banks issued a total of about $80 billion of senior unsecured bonds, according to data provider Dealogic. That compares to $240 billion in the same period last year and $257 billion in 2009.

Banks have had to turn to other sources for funding. Banks in Spain, Italy and France, among others, have borrowed hundreds of billions of euros from the ECB on a short-term basis, posting items including government bonds—often from financially weak countries such as Greece and Ireland that helped precipitate the crisis—as collateral.

For longer-term financing, banks have been issuing covered bonds. European banks have issued about $334 billion of these bonds this year, up 8% from last year and 24% from 2009, according to Dealogic.

UK treasury plans for euro failure
by Philip Aldrick - Telegraph

The Government is considering plans to restrict the flow of money in and out of Britain to protect the economy in the event of a full-blown euro break-up.

The Treasury is working on contingency plans for the disintegration of the single currency that include capital controls. The preparations are being made only for a worst-case scenario and would run alongside similar limited capital controls across Europe, imposed to reduce the economic fall-out of a break-up and to ease the transition to new currencies.

Officials fear that if one member state left the euro, investors in both that country and other vulnerable eurozone nations would transfer their funds to safe havens abroad. Capital flight from weak euro nations to countries such as the UK would drive up sterling, dealing a devastating blow to the Government’s plans to rebalance the economy towards exports.

Earlier this year, Switzerland was forced to peg its currency to the euro to protect the economy after a massive appreciation in the Swiss franc due to spiralling fears over Europe.

The plans emerged as Spain’s new finance minister Luis de Guindos warned the country’s economy was set for negative growth in the last quarter. Speaking yesterday he warned the next two months "are not going to be easy".

Britain’s response to the possible break up of the euro would reflect measures taken by Argentina when it dropped the dollar peg in 2002, according to sources. In addition to the risk of an appreciating currency, dealing with potential UK corporate exposures to the euro poses a considerable challenge for the Treasury.

Britain’s top four banks have about £170bn of exposure to the troubled periphery of Greece, Ireland, Italy, Portugal and Spain through loans to companies, households, rival banks and holdings of sovereign debt. For Barclays and Royal Bank of Scotland, the loans equate to more than their entire equity capital buffer.

Under European Union rules, capital controls can only be used in an emergency to impose "quantitative restrictions" on inflows, which would require agreement of the majority of EU members. Controls can only be put in place for six months, at which point an application would have to be made to renew them.

Capital controls form just one part of a broader response to a euro break-up, however. Borders are expected to be closed and the Foreign Office is preparing to evacuate thousands of British expatriates and holidaymakers from stricken countries.

The Ministry of Defence has been consulted about organising a mass evacuation if Britons are trapped in countries which close their borders, prevent bank withdrawals and ground flights.

Treasury officials would not comment on the specifics of any plans but said the Government always had contingency plans that cover a full range of eventualities.

A break up of the euro would have a devastating impact on the UK. HSBC economists have warned that it could trigger a global depression and forecasters at the Centre for Economic & Business Research reckon it would knock about a percentage point off UK growth – plunging the country into a full-blown recession in 2012.

The scale of economic problems alongside the existing debt burden would leave the Government with little in its armoury to combat the collapse, making capital controls one of the few viable options.

There is a glimmer of good news for the global economy with upbeat figures expected today from the US. Reports from America suggested US consumer confidence figures out today could rise to a five month high as house prices stabilise.

Why ECB's LTRO Won't Stop Collateral Contagion
by Tyler Durden - ZeroHedge

How long can the European media keep the EU credit implosion a secret? The disgraced former IMF Director, Demonic Strauss Kahn said on Tuesday December 12th, 2011 that No 'Firewall' Exists and Europe Has 'Only Weeks' [28].  Of course within minutes of this Financial Times news release which detailed his vent on EU leadership and the perilous situation in Europe, the article disappeared.

The details of the European liquidity crisis are generally reported, but for some reason no media source wants to pull the pieces together so everyone can see the magnitude and futility of the crisis. A growing Collateral Contagion is being shrouded in the apparent belief that the solution to the European Financial and Banking crisis is a grand change in Treaty governance. 

Obviously the European Central Bank (ECB) was well aware of the reality, when it was forced to deploy a historic and unprecedented LTRO (Long Term Purchase Operations) on Wednesday December 21, 2011.  560 banks desperately and immediately grabbed what they could, to the tune of €489B.

The LTRO bought the EU private banks some time. It did nothing to solve the EU Sovereign Debt Crisis. After less than one week, the cash held at the ECB surged [29]€133B to a new record €347B. Since the net LTRO [30] was only €210B, it tells you that the EU banks not only have a cash problem, but more specifically, as ECB President Mario Draghi says [29] : "hoarding at the ECB signals that the problem afflicting the Eurozone is not so much about the amount of liquidity but that this liquidity is not circulating around the region's banks".

I would argue that the problem short term is a shortage of real collateral and that US dollar cash, versus 'encumbered' cash flow, is now king. It is clear that the rampant advancing Collateral Contagion will quickly eat this futile attempt like ravenous wolves.  A well circulated Tweet [31] from PIMCO bond king Bill Gross said it all: " What does LTRO stand for? 1- A shell game; 2-Cash for trash; 3 Three-card Monti; or 4. All of the above."

Here is the stark reality of what forced the ECB to offer unprecedented three year loans at absurd rates and most alarmingly, the acceptance of collateral that no other financial institutions will accept. The ECB has sacrificed its balance sheet in yet another EU "kick at the can".


1.     COLLATERAL CONTAGION: There is a cascading Collateral Contagion crisis in which secured lending, based on sound assets, has replaced unsecured lending based on future expected cash flows.

2.     WHOLESALE LENDING: Wholesale bank lending, which is a unique cornerstone of European banking, has completely frozen since the failure of Dexia and US Money Market Funds will no longer risk short term capital having learned their lesson in 2008.

3.     BANK RUNS: Bank Runs are quietly and insidiously occurring throughout the peripheral EU countries as corporate and private depositors seek safe havens for their cash holdings.

4.     SHADOW BANKING SYSTEM: The European Shadow Banking System off balance sheet and unreported leverage structures, such as SIV (Structured Investment Vehicles) is collapsing due to non performing loans which must finally be rolled nearly 3 years since the financial crisis began.

5.     GLOBAL INVESTORS PULLING SOVEREIGN EU INVESTMENTS: Net outflows from the euro-zone’s financial account reached €32.1 billion in October alone, on an unadjusted basis. The drop reflects the sale by foreign investors of €53.3 billion in euro-zone debt instruments and €6.6 billion in equities.

6.     INTERBANK LENDING: Prior to LTRO, overnight interbank lending was impaired as LIBOR, LIBOR-OIS and TED spread yields were going almost straight up on a percentage change basis.

7.     INVERTED YIELD CURVES: Prior to LTRO, yield curves in the EU peripheral countries were either inverted or nearing inversion prior to LTRO.

8.     US DOLLAR SWAPS: A shortage of US dollar denominated loans forced the US federal Reserve and other global central banks to intervene and offer what is turning out to be unlimited US dollar SWAPs for minimal interest rates and unprecedented, extended durations, not previously considered.

9.     SOVEREIGN BOND MARKET: The EU Sovereign Bond Market is being avoided by almost all Global financial institutions. The only participant are Central Banks desperate to buy more time until confidence is restored.

10.  GERMAN BUND SCARE: You cannot have a currency without a risk free bond. The German Bund had become a proxy for this, but recently even the Bund has come under pressure as selling escalated in a flight from Europe.

11.  YEN CARRY TRADE: The YEN Carry Trade which has been a major financing source for the EU, even prior to its inception, is being forced to unwind due to a significantly weakening Euro and the threat of a serious drop.

12.  BASEL BOX: The Tier 1 Core Capital requirements have forced many banks to actually shrink lending to meet requirements. A significant withdrawal from lending in Central and Eastern Europe and many Emerging countries is now clearly seen as a direct result.

13.  CREDIT DOWNGRADE ONSLAUGHT: S&P placed the long-term sovereign-debt ratings of 15 euro-zone nations, including struggling Italy and Spain, on negative watch. That typically means there is at least a 50% chance of a downgrade within 90 days. France is likely to soon lose its coveted AAA rating, which will impact the European Financial Stability Fund (EFSF) borrowing costs.

The list is even longer, but it will need to suffice for this shorter article.

The above issues suggest, minimally, an immediate  €4-8 Trillion EU problem.

The EU has no ability to solve this problem short of simply printing Euros, which unlike the US Federal Reserve, Bank of England and Bank of Japan, the ECB presently (I stress presently) refuses to do.

Let's briefly discuss a few of these so we can appreciate the seriousness of the EU problem and what lays behind a first half 2011 surge of $107 TRILLION in derivative SWAPS.


The rest of the interesting and unusually complete article can be found here:

Article Collateral Contagion [32]

The euro area risks 'hyperdeflation' and, ultimately, demise

The European Central Bank must intervene in the government bond market to prevent a default by solvent states such as Spain

Confidence is crucial in economic and financial affairs. Once it is lost, it can be very difficult to rebuild. Confidence in the euro zone is draining away and matters have gone so far that it is not at all certain that any set of measures will stop the slide.

How much of the inaction and delay is brinkmanship by some creditor countries to ensure debtor countries impose reforms they need remains to be seen. But the price of brinkmanship is paid in confidence and credibility.

The most recent decision of the European Central Bank to further erode its own credibility came last Friday when it signalled that its interventions in the sovereign bond market would be limited to €20 billion a week. It is hard to imagine a worse decision. Self- declared ceilings on purchases guarantee the ineffectiveness of intervention.

That was all too plain to see this week. On Tuesday the Spanish treasury was obliged to offer interest rates of 5.1 per cent on bonds maturing in just three months. That was more than double the rate (of 2.3 per cent) it offered on the same securities just one month ago. This can only be explained by a massive panic premium. Spanish government debt is lower than Germany’s and the effectiveness of that country’s political system is closer to Germany than Greece.

On Wednesday, the outright failure of Germany – of all countries – to sell all the bonds it had put up for auction gave a further sign of just how fragile the situation has become.

Without the biggest change of policy tack yet, Italy and Spain are unlikely to be able to raise money at any price within months, if not weeks. Such a scenario would leave these countries unable to pay maturing debt. Without an emergency bailout, a second and third euro zone sovereign default would take place. In the short term, the ECB is the only institution with the wherewithal to prevent the situation reaching that point.

If evidence of the power of open-ended central bank commitments is needed, Europeans have only to look inwards to see it. Switzerland, surrounded by euro zone states, is a perceived safe haven. It experienced very sharp exchange rate appreciation during the summer and into the autumn as a result of capital fleeing the euro and flooding into the Swiss franc. The soaring franc threatened to price the Alpine economy’s exports out of international markets.

When the Swiss National Bank (SNB) responded, it came out with all guns blazing. The response was almost instantly effective, bringing down the value of the franc and anchoring it at or close to the level it had targeted against the euro.

The SNB was successful because it has an unlimited supply of Swiss francs to sell. Once it signalled that it would exercise this option as aggressively as was necessary in order to prevent its currency rising above a named threshold, the euro, franc exchange rates stabilised. And the lesson: market participants know they cannot win against a central bank with unlimited firepower.

For those wondering why the Irish Central Bank was not able to prevent the Irish pound suffering devaluations in the past, it should be recalled that to support a weakening currency you need to buy your own currency. That requires foreign currency. Because central banks have a finite supply of foreign currency, their reserves will be depleted sooner or later if the markets push them far enough. But markets cannot defeat a bank selling the currency it prints for itself.

The ECB must intervene now in the government bond market with the same determination that its Swiss counterpart has done in the foreign exchange market.

This, of course, does not mean there is a free lunch available. It is intuitive to anyone that, for one branch of government to lend to another, is not a costless means of solving the underlying problem of public overindebtedness. But that is not the purpose.

The purpose of intervention now is to eradicate the panic premium that could push a government as solvent as that of Spain’s into default within weeks.

What are the objections to taking such a course of action? First, if the ECB bails out bad governments, it provides an incentive to all to govern badly. This is moral hazard. But the ECB put moral hazard to one side after the collapse of Lehman Brothers in order to save the financial system. It must do so again to prevent sovereign default. It could be added that the departure of George Papandreou and Silvio Berlusconi goes a distance to addressing the moral hazard problem anyway.

Another argument against the ECB buying up large amounts of government debt is that it will cause inflation. But a central bank can "sterilise" its bond purchases by conducting counterveiling operations so that the money supply is not affected. That is exactly what the ECB has done. I cannot see any reason why there should be a limit to the amounts it can sterlise.

And even if some or all of the purchases were not sterilised, there is little reason to fear inflation running out of control in the prevailing economic climate. Just look at Britain and the United States. In both countries unsterlised central bank interventions have been conducted in the form of quantitative easing (QE). But even with these large unsterilised interventions, inflation in both economies is only slightly ahead of the rate in the euro zone.

There is plenty of scope for the ECB to follow the lead of other central banks without any danger of inflation, never mind hyperinflation, a spectre raised by the ECB’s ultra-orthodox Jürgen Stark in Dublin on Monday. It is true that if unsterilised central bank intervention is done to excess and for too long it will certainly destroy a currency, as periods of hyperinflation in Weimar Germany and today’s Zimbabwe have shown. But Europe is light years from that point.

Yet another concern that has been raised about purchasing government bonds is the risk of losses for the ECB if the bonds it is exposed to are written down.

Treaty law appears to rule out the bank printing money to give to governments to pay off their debts (known as monetisation). If that is so, the question becomes how big a loss could the Frankfurt bank take before becoming insolvent itself?

Opinions differ on how much capital the ECB and the wider euro system of national central banks has. But the choice facing the bank is between risking some of its independence (by seeking recapitalisation if it does burn through all its capital) and putting its own existence at risk.

Europe is now very close to a default on Italian or Spanish debt. That would, in turn, trigger a collapse across other asset classes. It is hard to see where this would end until all the dominoes had fallen.

Therefore, the imminent risk Europe faces is – to coin a phrase – hyperdeflation in asset prices, not hyperinflation in consumer prices. Everything possible must be done to prevent hyperdeflation. If the ECB does not act to prevent that, it will surely bring about its own demise.

Italy 10-Year Borrowing Costs Stay Near Record At Sale
by Valentina Za - Reuters

Italy's borrowing costs fell from recent record highs at a bond auction on Thursday but cautious investors still demanded a near 7 percent yield to buy 10-year debt, a level seen unsustainable over time for the euro zone's third-largest economy.

Traders said the European Central Bank stepped in after the auction to buy Italian bonds on the open market as investors worry about the country's ability to sell enough long-term debt ahead of large redemptions early next year. The ECB's injection of nearly half a trillion euros of cheap funding for banks and a new Italian budget package this month have eased pressure on short-term debt, but longer-dated bonds still pose a challenge.

Italy raised 7 billion euros of debt in thin holiday markets, just above the mid-point of its target range. It sold the top planned amount of its 10-year benchmark bond but the yield was 6.98 percent, not far from a euro lifetime record of 7.56 percent a month ago.

The yield on the three-year BTP bond fell more markedly to 5.62 percent from a euro era record of 7.89 percent at an end-November auction. At the time, in a sign of acute market worries about Italy's ability to repay, the three-year yield was higher than the one on the longer maturity.

"Today's decline in the auction yield by 'just' about 60 basis points versus end-November in such a high-yield territory underscores that the genuine pressure on Italy is still tremendous, despite bold ECB actions that have given (short-term debt) a big boost," said David Schnautz, a rate strategist at Commerzbank in London.

The fall in the three-year yield came after Italian six-month borrowing costs halved at an auction on Wednesday. These were the first Italian debt sales since the ECB flooded euro zone banks with three-year funds and the Rome government overcame internal opposition to a radical pension reform as part of Italy's third budget package since the summer.

This week's auctions will settle in January and help towards the Treasury's challenging gross funding target of around 450 billion euros has for next year. In a push to keep investors buying Italian debt, a new technocrat government in Rome is planning to tackle Italy's chronic low-growth problems.

But markets look with concern at some 91 billion euros of Italian bonds coming due between January and April. "Given the scale of its funding requirements, there are still big concerns about Italy's ability to get through 2012," said Nicholas Spiro of Spiro Sovereign Strategy. "Next quarter is going to be all about Italy."

While Italy can count on strong domestic support such as from retail investors at its short-term debt sales, its longer-dated bonds are more reliant on foreign buyers, giving a clearer picture of the market attitude towards the country's debt. The ECB intervened after the sale as Italian 10-year yields remained locked above 7 percent on the secondary market.

The euro crisis deepens
by Aditya Chakrabortty - Guardian

Every week brought more dire forecasts in the battle to save Europe's economic club. But 2012 will be its worst year yet

Europe's leaders have spent most of the euro crisis denying there's a euro crisis. A "specific Greek problem", that they'd give you. Irish and Portuguese aberrations. As for the Spanish, that really was hard manchego. Wherever disaster struck over the past two years it was always the member's fault, never the club's.

The denialism ended this summer, as the financial bushfire moved to Italy and even began to menace Belgium and France. Sequestered in their conference rooms in northern Europe, policy-makers found it easy to wave away catastrophe in the distant, poorer periphery – but far harder when the second and third-largest economies in the entire bloc were under threat.

If the rhetoric and the not-so-faint snobbery have vanished, to be replaced by panic about "a last wakeup call" and "a crucial crossroads", the actual policy-making is as clueless as ever. At the last major summit, the one where David Cameron pressed the eject button, little was agreed apart from a restatement of Maastricht rules on budget deficits.

Markets got excited about the promise of a $200bn loan to the IMF; until it transpired that the figure had been plucked out of thin air and no one knew where it would come from.

The eurocrats can impose austerity, and bring in Goldman Sachs employees such as Mario Monti to run newly impoverished economies; but anything that might actually break the fire still eludes them.

In the meantime, the crisis has just kept growing. In February 2010, Greece needed to raise just €53bn for the entire year; now euro leaders are looking for a trillion euros and counting.

Compare and contrast: in his memoirs, Alistair Darling recounts that it took ministers and officials 10 days and one curry-fuelled all-nighter in autumn 2008 to hammer out the complex and costly combination of ready cash, loans and guarantees that saved the British banking system.

Over in the EU, on the other hand, finance ministers have met formally 10 times this year alone, their heads of state a further 10. They have agreed four "comprehensive packages", each more comprehensive than the last, yet none has created any sense that the continent is fortified against the battering it is about to get.

Because it is almost certain that 2012 is going to be the worst year yet for the eurozone. Easily the worst financially, terrible economically and increasingly grim politically.

A good rule of thumb in this crisis is that when a European state pays more to borrow than an ordinary taxpayer shells out for a bank loan, the government eventually has to call in the rescue brigade.

For much of November, Italy was borrowing at a rate of 7% – and probably the only thing that has kept interest rates from going higher still is that the European Central Bank (ECB) has been buying Rome's IOUs.

In other words, the markets trust the Italian state – with its own tax-raising powers – less than it does a couple in Kettering who'd quite like a new kitchen. Which, given that Italy plans to roll over more than €360bn (£310bn) of debt next year, is hardly sustainable for the new prime minister Mario Monti.

Indeed, on 1 February, Rome will have to either repay or renew €28bn of loans. Even now, no one has the faintest idea how it will do that.

Over the next couple of months, Italy's crisis can go one of three ways: either the ECB keeps on buying its bonds, with the blessing of northern-European voters and markets; or ECB head Mario Draghi pledges to fund financially distressed eurozone governments; or Rome gives in and calls for a bail-out.

If the last even looks likely, financiers will almost certainly panic that Italy is about to default on its debt. With about a third of the country's bonds held abroad, this could wreak chaos in world markets – including in Britain, which is by far the biggest foreign owner of BTPs. That's the sort of event Barack Obama has in mind when he remarks that Europe's crisis is "scaring the world".

Rome's not the only government whose finances are in jeopardy; Madrid is in the same boat, while Brussels and Paris have also seen a surge in loan rates. Less often talked about is that many of Europe's banks, even well-known French names, are unable to borrow unless from the ECB.

"You have European banks nowadays claiming they're not European at all because they're worried the very word will scare away investors," says Grant Lewis, head of research at Daiwa Europe. That credit crunch cannot carry on for much longer without causing either a full-scale banking crisis or throttling economic growth.

Not that there's much growth to be had, because the prescription of austerity for sick economies simply makes them sicker. By the IMF's own projections, 2012 will be Greece's fifth straight year in recession, which by now should really be termed a depression.

The Germans and their allies may have demanded sharp spending cuts in southern Europe, but it leaves them struggling to export. Couple that with the credit freeze and the eurozone looks set for another recession.

"If the euro fails then Europe fails," Angela Merkel has said. But is this version of continental union worth saving? Northern European governments frozen before an existential threat. Southern European regimes forcefed a diet of IMF-style austerity. And hardly any institutions to bolster or stand behind its currency.

When people think about the euro they often think about expensive buildings in Brussels or Strasbourg. But the 17-state eurozone has no international bank regulator, no common treasury and hardly any budget.

All it has is a central bank and big capital markets. Businesses and financiers can move easily, but for workers the euro is a battering ram against their standards of living.

Playing out in western Europe right now is the kind of race to the bottom people normally associate with Latin America. That's already happened to German workers, whose wages (after inflation) fell 4% in the 2000s. And now it's happening in Greece and Spain and Portugal too – only there the deflation is even more toxic because it's been imposed by northern Europe.

Meanwhile in Germany they're wondering why they should pay for the continent's economic car-crashes.

No wonder opinion polls across the continent show anti-euro sentiment is rising. No wonder too that financiers are no longer idly speculating about a breakup of the single currency, but are now modelling its likely impact.

And not just in eurosceptic London either. Lewis chaired a conference in Asia a few months ago with an audience of about 100 fund managers and big investors. They were asked to vote on whether the euro club would look the same in three years' time as now. Less than half the crowd thought it would.

After the turbulence of 2011, could the euro crisis get worse? Oh yes, it could – and it will. I'll bet you a thousand drachmas.

Euro Outlook 2012 – Do or Die?
by Boris Schlossberg - GFT

Until recently, the notion of EUR/USD fracture was inconceivable to most market analysts who assumed that the breakup of the world's largest integrated economic bloc was simply too complex and too destructive to consider seriously.

However, the events of 2011, which saw the sovereign debt crisis spread from the periphery to the very core of Europe, radically changed market perception as the idea of the euro break up suddenly became a very real possibility. Interbank FX dealing platforms even went so far as to run tests on the old regional currency units, such as the drachma and the lira, to be prepared just in case of such eventuality.

Therefore, the upcoming year shapes up as a do-or-die year for the EUR/USD. The question on most traders' minds isn't whether the single currency pair will rise or fall, but whether it will actually survive the year intact.

Market analysts are almost universal in their agreement that, in order for EUR/USD to remain a viable currency, the region will need to move towards much closer fiscal integration, but it remains to be seen whether EZ officials will be ready to make the necessary political adjustments to create a more unified European structure that can respond to the market challenges ahead.

Turmoil in the Credit Markets Engulfs All
In 2011, the Eurozone credit problems (which started with Greece the year prior) blew up into a full-scale crisis as one member after another came under the assault of bond market vigilantes. By the end of the year, it appeared that no country was safe as panic spread from the Southern periphery all the way to the Northern core.

Although Greece was "patient zero" in this particular pandemic, in many ways, it was an outlier in the Eurozone. Unlike other European economies, Greece was clearly insolvent as its debt-to-GDP ratio rose above 150% while its revenue-raising ability was severely hampered by an inefficient and corrupt taxation system.

The country needed immediate debt restructuring and capital infusion in order to revive the economy. Yet due to political considerations, theEurozone officials delayed any action and then imposed draconian terms on any bailout funds, insuring that the country devolved into a near economic depression.

The net result is that Greece is now effectively a ward of the Eurozone, but worse, the delays and political wrangling that surrounded the whole bailout process destroyed investor confidence and emboldened the shorts to go after other weak European credits, exacerbating the crisis exponentially.

Viva Italia?
By the end of 2011, the credit crisis in Europe engulfed not only Greece, Portugal, Ireland, and Spain, but jumped directly to Italy - the region's third-largest economy and the world's fourth-biggest issuer of sovereign bonds.

The turmoil in the Italian credit markets ended the career of Silvio Berlusconi whose anarchic-governing style dominated Italian politics for more than 19 years. In his stead, Mario Monti, a well-respected technocrat, became the prime minister.

The markets welcomed the change, but the damage had been done. By the end of 2011, Italy was paying more than 7.5% on its 10-year bonds versus 4.5% just a year earlier.

Most analysts agree that this near doubling of debt costs is absolutely unsustainable. In 2012, Italy faces a roll of nearly 300 billion euros in its sovereign debt obligations. Most of these transactions are frontloaded to the first half of the year, making the financing even more challenging.

Ironically enough, Italy is one of the few G-10 countries that runs a primary budget surplus, meaning that, absent interest payments, the country takes in more revenue than it spends. Yet, despite these impressive internals, Italy also carries a Herculean-debt burden of more than 120% of GDP, which is why the country is so vulnerable to a credit attack by the shorts.

Italy simply cannot service debt at 7.5% with headline inflation at 3% or lower and GDP growth not expected to exceed 1%. The burden of carrying such high, real-interest rates is simply too onerous for the country to bear and many analysts fear that Italy will not be able to survive such harsh financing conditions if it's forced to deal with the problem unilaterally.

Half Measures But No Solutions
As the Eurozone credit crisis deepened, most market analysts have come to the conclusion that the region must implement a much more unified fiscal policy if the euro is to survive. Ultimately, that will mean some sort of a federal budget, a pan-European taxing authority, and a rationalization of pension benefits across the union.

Such complete integration will require a massive cultural and political change from the region's 300 million plus citizens and is unlikely to occur quickly. In the meantime, the Eurozone will have to move towards issuing Eurobonds to address the concerns of the capital markets.

Only by federalizing credit risk across all of its member nations will the Eurozone be able to lower the cost of financing for its peripheral economies to a sustainable level.

A recent European Commission study on the subject of Eurobonds offered three possible scenarios on how Europe could issue debt. The first and the most radical option would be to replace all of the national credit issuance by bonds backed by the whole EU.

This course of action would create a huge capital market that could compete on equal terms with U.S. Treasuries, but it would also mandate extensive changes in the EU treaty and would require Europeans to give up much of their national sovereignty.

A more moderate approach would be for euro area countries to issue "stability bonds," which would only be partially guaranteed and would be subject to caps on volume. Such a solution could provide some relief to beleaguered Club Med economies, but it may not be enough to stabilize the markets.

Finally, a third way would allow EU countries to issue a limited amount of "blue bonds," which would enjoy the collective backing of all of the members, and thereafter issue "red bonds," which would be backed solely by the issuing sovereign.

For the time being, European fiscal officials have been highly reluctant to adopt any of these proposals as Germans are loathe to dilute their balance sheet while periphery members are reluctant to cede authority over budget matters to some supra-national entity.

The only policy response has come from monetary authorities and it has been limited at best. Because the ECB is legally prevented from buying member bonds on the primary markets, the central bank has been woefully ineffective at controlling the interest spikes suffered by Spain, Italy, Portugal, and other member nations.

Instead, the ECB has tried to support the secondary market, but even there, its participation has been limited at best. The ECB has contained its purchases to no more than 20 billion euros per week, sterilizing the trades for minimum impact. Little wonder then that its activities have been woefully ineffective.

In a perfect world, the Eurozone would quickly move to a Eurobond solution, allowing member nations to mutualize the credit risk across the whole region. Such a structure would put an end to the endless game of hunting the next weakest credit, but it is unlikely to become policy anytime soon due to fierce resistance from Northern Europe.

Instead, policymakers are trying to use a multifaceted approach that includes more aggressive intervention from the ECB, a mild leveraging of the EFSF, and the prospect of using the Fed along with 17 central banks from Europe.

Together, they would create a lending consortium that would provide a "triple-digit billion" loan to the IMF. This would be used to create a special fund that would help finance troubled credits in the Eurozone region.

It appears that authorities on both sides of the Atlantic are coming to the conclusion that the central-banks-to-IMF scheme is the most expeditious policy response to the sovereign debt problem.

It neatly sidesteps many political barriers by providing much needed capital without obtaining legislative approval. Yet, the jury is still out on whether this course of action will actually pacify the credit markets and create a viable firewall around the biggest EU sovereigns.

Teetering on the Verge of Recession
Meanwhile, as Eurozone officials struggle with the burgeoning debt crisis, the turmoil in the markets is clearly expanding into the real economy. The region's basic measurements of economic activity have all turned sharply lower.

Both PMI Services and Manufacturing surveys have dipped below the 50 boom/busts line for the past three months in a row, indicating that the region as whole will likely contract in Q4 of this year.

The ECB has acknowledged the rapid deceleration in activity and the new ECB president, Mario Draghi, surprised many market observers with a rate cut of 25bp at the October meeting and added another 25bp cut in December.

The drop in the benchmark rates has had no meaningful impact on stimulating lending and instead, it simply served to partially offset the major contraction of credit conditions caused by the volatility in the sovereign debt markets.

Going forward, it is almost certain that the ECB will need to cut rates further as it tries to counterbalance the draconian austerity measures demanded by the market.

The irony of the situation is that, even if the Eurozone officials are able to weather the storm in the capital markets, the massive budget cuts required to bring the balance sheets to order will likely result in a severe recession in the Eurozone as government demand is removed from the economy.

2012 may well be the moment of truth for the Eurozone as the region struggles to resolve the issues of sovereignty and currency. There is little doubt that the single currency project has been a massive economic success for the region, eliminating many former barriers to trade while making commerce much more efficient and friction free.

The euro has made the Eurozone not only an economic powerhouse, but a political force to be reckoned with as Europeans compete on an equal footing with Asians and North Americans on the global economic stage. The testament to the strength of the idea lies in the price of the euro itself.

Despite all of the problems, the euro trades at 130% of the greenback as the Eurozone remains the largest economy in the world. The key to maintaining that status will mean that member nations will have to sacrifice political sovereignty in return for economic prosperity.

If they are finally willing to make that adjustment, the euro will survive and may once again prosper. If not, 2012 may well become the year that the single currency experiment in Europe comes to a chaotic end.

European markets await more turbulence in 2012
by Ben Perry - Agence France Presse

European stocks and the euro will face fresh turbulence in 2012 after a year in which equity markets slumped and the single currency lost ground against the dollar mainly due to the eurozone crisis.

Europe's main stock markets have tumbled between 6.5 and 25 percent since the start of 2011, as traders looked past positive economic data and earnings, while the euro has fallen 2.5 percent versus the dollar in volatile trading.

Yields on eurozone sovereign debt meanwhile rocketed in late 2011 as investors demanded top returns for lending money to the bloc's indebted countries such as Greece and Italy. "Attempting to forecast where the dollar, euro, gold, oil or any western stock market might end next year is no less a mugs game than it was this time last year," said Howard Wheeldon, a senior strategist at BGC Partners.

"Who could have imagined that by the eleventh month of the year we would have been talking about not only the collapse of the eurozone but also a possible breakdown of the European Union? "Who would have thought that in such a short space of time the economies of Europe would have effectively ground to a halt and that the outlook for resumption of growth would be virtually nonexistent?" he questioned.

The eurozone debt crisis dominated market sentiment in 2011 and is widely expected to be the main focus in 2012, at least in the early part of the year, overshadowing geopolitical strains and the race for the White House. The euro ended the year by briefly diving under $1.30 and hitting the lowest point since the start of 2011. By Friday, it had recovered slightly to trade at $1.3076.

The single currency meanwhile plunged to a 10-year low point against the yen in September as investors reacted to mounting economic uncertainty and tumbling equities in Europe and the United States. "2012 is likely to be dominated by the quest for safe havens on the foreign exchange markets, as risks are omnipresent," said Commerzbank analyst Ulrich Leuchtmann.

"The eurozone debt crisis is threatening to escalate or at least to become a permanent institution connected to a high level of anxiety. Globally economies are either sliding into recession or have to expect falling growth levels. "In view of all these dangers the US dollar might turn out to be the real winner," he added. Other traditional safe havens include the yen and gold.

Although the euro is set to end the year lower against the greenback, at the start of May it struck a 16-month high of $1.4940 owing to weak US economic data and as investors welcomed a bailout of indebted eurozone member Portugal.

In recent months the euro and European stock markets have headed south as countries struggle to get to grips with the escalating debt crisis. "For 2012, the eurozone crisis is likely to remain a key issue," said Neil MacKinnon, an economist at Russian financial group VTB Capital. "Greece is likely to default and other countries, including Italy, would require debt restructuring."

Among Europe's main stock markets, Milan has been the biggest faller in 2011, losing 25 percent since the start of the year, as investors worried about a possible bailout of Italy, the eurozone's third biggest economy.

London's benchmark FTSE 100 index has shed 6.5 percent to around 5,500 points, with non-eurozone member Britain shielded to an extent from the bloc's crisis, even though the bloc remains its main trading partner. Frankfurt has slumped 15 percent, Paris 18 percent and Madrid 13 percent.

"Rather than providing a FTSE 100 prediction for end-2012, we are recommending the 'bottom-up' approach for investors," said Richard Hunter, head of equities at Hargreaves Lansdown stockbrokers.

"There remains ongoing uncertainty around the eurozone situation. The likelihood of a peripheral country stepping outside of the euro increases as the situation wears on. On the economic front, the possibility of a recession in the area seems more likely than less to happen."

Dollar and yen higher in 2011 flight to safety
by Garry White - Telegraph

The dollar reasserted itself as the global reserve currency of choice in 2011, despite concerns about US debt.

Worries over borrowing in recent years have seen the dollar weakening, despite successive Treasury Secretaries repeating their mantra that the country has a "strong dollar policy".

However, as a lack of safe-haven alternatives and a liquidation of risky assets unfolded, the US currency rallied sharply in the last few months of the year. The dollar index, which tracks the greenback against a basket of currencies, jumped by about 9pc from its lows earlier in the year.

Worries over eurozone sovereign debt prompted the dollar gains, as did the removal of the Swiss franc as an alternative safe haven currency in September. The Swiss central bank intervened to dampen the currency's appreciation as the exchange rate hit an export-damaging level.

The Swiss National Bank (SNB) set a minimum exchange rate of 1.20 francs to the euro, arguing the current value of the franc was a threat to the economy. To achieve this, the bank said it would buy foreign currency in "unlimited" quantities.

In December, speculation mounted that the Swiss would move to weaken its currency further, as data showed that orders at Swiss industrial companies had fallen by about 5pc. However, the SNB did not make such a move. It does, however, remain a possibility for 2012.

A couple of weeks ago, UBS said that the SNB's intervention meant that the Swiss franc could no longer be regarded as a safe haven. "As we enter 2012, neither gold nor the Swiss franc retains a safe haven status," Alexander Friedman, Zurich-based chief investment officer at UBS Wealth Management, said.

At the start of 2011 UBS said investors considered gold, the franc, the US dollar, US Treasuries and Japanese government bonds as safe havens. Gold, which many believe is an alternative currency, spike to all time highs during August, hitting $1,923 an ounce, but retrenched sharply over the next few months.

The recent flight to safety means that Japanese yen is likely to be the best performing currency of the year in 2011 - for a second year in a row. The Japanese central bank was also forced to intervene this year, selling yen to protect its exporters. At the end of October, the bank sold $100bn (£64bn) worth of yen. However, dollar strength at the end of the year meant that the Japanese currency weakened against the dollar. As we enter 2012, City strategist expects the dollar and yen to continue to strengthen.

US pressure on China to drop its policy that caps the strength of the yuan continued. The policy makes the country's exports more competitive over the world, but makes imports more expensive - a fact which has accelerated the shift of manufacturing jobs to the east from the west. The country dropped the yuan's fixed peg against the dollar in 2010 but still intervenes to control its value.

Other countries that have had to manage soaring currencies have been the commodity producing nations. Canada, Australia, Russia, Brazil and South Africa have benefited from strong export demand for natural resources. However, this has led to rising costs for major international companies in these countries – with miners being especially hard hit by the money-market moves.

The Australian dollar hit another all-time high against the pound in July, but the Canadian dollar did not match its record high set in 2012 - but it came close. The pound was weak against the euro, as were all major crosses, in the first half of the year, but the single currency has been weakening against all major crosses as the Sovereign debt crisis unfolds. The pound also weakened against the dollar in the second half.

Will German Growth Stall in 2012?
by Katrin Elger, Dietmar Hawranek, Martin Hesse and Christian Reiermann - Spiegel

The global economy is at risk from all sides, with the European debt crisis, a weak US economy and a slowdown in China. But most German companies are still doing well, and executives are optimistic about 2012. Experts wonder, however, how long the export-driven German economy will be able to elude the gathering storm.

Ever since she became the managing director of the International Monetary Fund (IMF) last July, Christine Lagarde, 55, has been lamenting the state of the world economy.

The Frenchwoman recently said that the outlook for the global economy was "quite gloomy" and that if the international community failed to act decisively to halt the downward trend it could lead to a great depression such as the one in the early 1930s. "There is no economy in the world … that will be immune to the crisis," she said.

That is true. Nevertheless, there are countries that are doing better than others despite all the current global difficulties -- and this includes Germany, the core of the ailing euro zone, which Lagarde has pointed to as the cause of the current problems.

Most leading indicators and economic statistics in Germany point toward an improvement for the coming year. Wages and salaries are expected to rise in 2012, as is the number of jobs. Exports are predicted to continue to grow along with domestic demand.

There's a growing sense of optimism among German companies and consumers. The Ifo index, which measures German business sentiment, has been rising again for the past two months and the GfK consumer confidence index also rose in December. It looks as if the Germans are ignoring all the dire predictions.

Astonishingly Resilient
Over the past year, the German economy has already shown itself to be astonishingly resilient amid the global economic turmoil sparked by the euro crisis, the sluggish recovery in America and a weakening of economic growth in China. Germany's gross domestic product (GDP) rose this year by approximately 3 percent, much more than in neighboring countries and in the US and, more importantly, far more than in the crisis-stricken peripheral countries of the euro zone.

In fact it's been a record-breaking year for the German economy. This year, German companies exported goods worth over €1 trillion ($1.3 trillion) -- the highest figure ever. The number of people in work has also risen to 41.6 million, more than ever before.

Germany's economic success does not make the country more popular among its neighbors, though. After all, this is the same country that has been blocking all proposals to use the European Central Bank (ECB) to provide more generous financing for embattled euro-zone countries. Some European countries appear to be secretly hoping that Germany, Europe's economic paragon, will also soon feel the brunt of the crisis.

In effect, the question is how long the export-driven German economy can elude the downward economic spiral that has affected many regions of the world. The economy is shifting down a gear around the globe, not just in the US and China, but also in the debt-ridden euro-zone members, which are the main customers for German companies. Austerity programs in these countries are curbing growth.

Still Doing Comparatively Well
The Germans are not immune to this development either. Economic research institutes and bank economists are revising their forecasts downwards from week to week. Nevertheless, the German economy is still expected to grow over the coming year, albeit at a slower rate. The most recent forecasts range from 0.3 to 0.6 percent.

But even if growth will be modest, Germany is still doing rather well compared to the rest of Europe. Other European countries, such as France, are on the verge of a recession -- and the southern euro-zone crisis states are already seeing their economies shrink.

Germany is primarily able to defy the downward trend thanks to its dynamic flagship industries. For instance the electrical and electronics industry is anticipating continued brisk business in 2012. The German Electrical and Electronic Manufacturers' Association (ZVEI) expects growth of 5 percent and sales amounting to €190 billion. "We've just completed an outstanding fiscal year and we're about to begin a record year," says ZVEI head Klaus Mittelbach.

The mechanical engineering sector is also brimming with self-confidence. Hans-Jochen Beilke, chairman of the board of Ebm-Papst Group, which manufactures electric motors and fans, is extremely satisfied. His employees in the southern German town of Mulfingen make components such as fans for energy-saving refrigerators and blowers for silent kitchen exhaust hoods, and his company's products are found everywhere from Rome to Beijing. "Things went extremely well last year," says Beilke, "and we're also optimistic for 2012."

The German Engineering Federation (VDMA) is forecasting 4 percent growth for its members. "There's currently an upbeat mood in the mechanical and plant engineering sector," says the organization's chief economist, Ralph Wiechers, "even though there are clear signs of decreasing demand." This year the sector reported a 14 percent increase in production.

The forecast for 2012 is significantly lower, but that's "no sign of a crisis," says Wiechers. "Following the sharp drop in production a few years ago, many manufacturers were recovering from low levels. They had a lot of catching up to do," argues Wiechers. "The sector normally doesn't experience such extreme fluctuations."

Ready for a Crisis
German car manufacturers BMW, Daimler and Audi even had to shorten the usual break in production during the Christmas season because they have so many orders to fill. Their plants are operating at capacity.

But that's just the current situation. "We don't know exactly what lies in store for us in 2012," says BMW CEO Norbert Reithofer, who has warned his supervisory board that sales may drop in the near future. At their last meeting of the year, he presented three scenarios: What will happen if BMW's sales drop by 60,000 or 100,000 or even 200,000 vehicles in 2012? The answer: not much.

Such a crisis would not be a crisis for BMW. The Munich-based carmaker could easily absorb a possible decrease in sales. Thanks to numerous extra shifts, many workers have accumulated overtime hours in their so-called working-time accounts (an instrument used by some German companies to give themselves flexibility during economic slowdowns).

If production has to be reduced, the workforce can simply take some time off. BMW has significantly more equity and liquidity than it did in 2008, when sales plummeted in the wake of the Lehman Brothers bankruptcy. "We're prepared," says Reithofer.

Reithofer's counterparts Dieter Zetsche at Daimler and Martin Winterkorn at Volkswagen also don't see any serious threats looming on the horizon for their companies. The automotive bosses assume that sales will decline in Europe. But the three German manufacturers hope that they can largely offset this with rising sales volumes in the US, China, India, Russia and Brazil. "There is no reason to assume there will be a crisis scenario," says Daimler boss Zetsche.

Small and medium-sized companies, the backbone of the German economy, are also entering the new year with confidence. According to a report on a survey conducted by the German Chambers of Industry and Commerce (DIHK), "small and medium-sized businesses continue to rate the economic situation as exceptionally good."

Companies say that their order books are well filled and most German firms are satisfied with their workload. The results also showed that 44 percent rated their economic situation as "good," while only 9 percent felt it was "poor." According to the study, "the tumultuous developments on the stock exchanges and the sovereign debt crisis are not reflected in the economic reality of large segments of the small and medium-sized business sector."

Furthermore, 23 percent of the small and medium-sized companies surveyed expect business to be even better in 2012 than this year, and only 16 percent anticipate poorer results. Their willingness to invest also matched up with these findings: Some 26 percent of small and medium-sized businesses intend to invest more next year, while 16 percent plan to invest less. The general positive mood is also apparent on the job front. Small and medium-sized firms intend to create some 200,000 new jobs next year.

Competitive Firms
The strong competitiveness of German companies is behind this positive situation -- and that's unlikely to change in the near future. Although wage agreements are higher than in previous years, they're not so high that they rob German companies of their competitiveness.

On the contrary: Collective bargaining agreements are currently having a beneficial effect. Since employees are now earning more money, they make more purchases. What's more, approximately half a million new jobs were created in 2011. Both factors combine to boost consumption which, together with investments by companies, will also bolster growth in the coming year.

Unemployment in Germany is expected to continue to decline by over 100,000 to some 2.8 million. This is due to new jobs and demographic change. More older individuals are retiring than are being replaced by young people entering the workforce. The greatest concern facing small and medium-sized businesses is not problems like the faltering global economy, but rather the growing shortage of skilled workers.

Germany's fellow members in the euro club can only dream of such problems. The crisis-ridden states of Ireland, Portugal, Greece and Spain are stuck in a slump. Austerity measures imposed by the European Commission and the IMF are strangling economic activities in these countries. Growth is not expected here until 2013, at the earliest.

Italy and France, the two largest economies after Germany in the euro zone, are also facing a possible downturn. Economists predict that France's economic output will shrink in the final quarter of 2011 and the first quarter of 2012. This would fulfill the classic definition of a recession.

Growing Fears of a Credit Crunch
The gains made by Germany are not enough to balance out the losses made by the other members of the monetary union. Germany's Ifo institute is predicting an overall decline of 0.2 percent in the total GDP of the euro zone.

Banks play a key role in determining whether Europe slides into recession -- and how severe such a recession would be. Due to the sovereign debt crisis, the business world is now afraid of the prospect of a second Lehman effect: In the fall of 2008, Europe's economy went into a state of shock within weeks after the collapse of the Lehman Brothers investment bank. The banks didn't lend each other money anymore, and companies' flow of credit threatened to dry up.

Now this fear is returning. The crisis of confidence in the banking sector is scarily reminiscent of the conditions that led to the Lehman bankruptcy, as the ECB warns in its latest financial stability report. "We're afraid of a credit crunch," says the head of the Central Bank of Luxembourg, Yves Mersch. Meanwhile, the head of the European Banking Authority (EBA), Andrea Enria, says that he's afraid that the financial institutions, which have been sharply criticized for years for their risky investments, could now become risk averse.

The fact of the matter is that Enria's EBA may have actually exacerbated the situation. Acting on behalf of the EU, it told the banks that they needed larger capital buffers to be prepared for possible defaults on European sovereign bonds. Banks have two ways of achieving higher core capital ratios: They can either acquire additional capital -- or reduce the scope of their business to minimize their capital reserve requirements.

Since investors are reluctant to inject fresh money into financial institutions, many banks are choosing the second option. Germany's Commerzbank alone has announced that it intends to reduce its risk-weighted assets by €30 billion. In some EU countries, like the UK, Ireland and Spain, banks have already started cutting back on their loans, according to the ECB.

No Lack of Credit
Germany's central bank, the Bundesbank, noticed back in the third quarter that banks had tightened their conditions for granting loans. But does this mean that the country is already facing a credit crunch?

"No," says Lutz Goebel, president of an association of family-owned businesses in Germany. "As I see it, there's currently no financing shortfall for most companies in Germany." When German companies need loans, then this is primarily at locations where they are rapidly growing, such as in emerging markets in Asia where, according to German bankers, there is no lack of credit.

It's a very different story, though, in Europe's crisis-stricken countries, where banks are having increasing problems borrowing the money that they need for their ongoing activities. European banks have €200 billion of debt maturing in the first quarter of 2012 alone.

This prompted the central banks of the leading industrialized nations to flood the markets with money in late November, and in December the ECB again eased the conditions under which banks can borrow money. "We are doing our best to avoid a credit crunch," said ECB President Mario Draghi.

Cash injections on an unprecedented scale have boosted growth in the US, where the central bank, the Federal Reserve, has been pursuing a zero interest rate policy for years. The flood of money is enticing Americans to spend more again. Private consumption plays a much greater role in the US than in Europe. Over 70 percent of America's economic output is based on domestic consumption.

In November the US unemployment rate dropped below 9 percent for the first time since March 2009. Nevertheless, growth remains slow and, at slightly more than 2 percent, will hardly be enough to rapidly reduce the country's jobless rate in the new year. More importantly, it won't be sufficient to pull the global economy out of its slump.

Worst-Case Scenario
Two years ago, it was China's huge demand that kept the world's economy from crashing. Now, the land of seemingly endless growth is showing signs of fatigue. Over the last few months, industrial production has slowed and exports have weakened. Sales of Chinese commodities are a far cry from what they were just a few years ago, and the slump is affecting everything from electronics manufactured in Shenzhen to machinery made in Shanghai.

The Chinese government is trying to counter this development, but its options are limited. The central bank recently relaxed its monetary policy -- and fueled yet another threat to economic stability. There's already a real-estate bubble in China. If it bursts, this would significantly slow the country's economic growth.

There have always been risks and dangers to the world economy looming everywhere, but the combination of the euro crisis and flagging growth in Asia makes it difficult for economists to predict future developments. In their scenarios they still only concede a slight possibility that the European monetary union could collapse, but if the euro actually does implode in 2012, all their predictions will be obsolete.

Executives at a German carmaker have already examined what would happen if the heavily indebted so-called PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) were to leave the monetary union. According to their calculations, the economies in these countries would shrink by 6 percent, while the economies of the countries that retained the euro would contract by 4 percent. The managers agreed that this scenario would be a disaster -- and not just for the automotive industry.

ECB overnight deposits reach record
by William Launder - MarketWatch

Use of the European Central Bank's overnight deposit facility reached a new, all-time high Monday, as euro-zone banks increasingly turned to the ECB as a safe-haven for extra funds.

Banks deposited €411.813 billion overnight Monday, up from €346.994 billion deposited overnight Thursday ahead of the Christmas holiday, ECB data showed Tuesday.
Monday night's deposit figure surpasses the previous all-time high record of €384.3 billion reached in June 2010.

The high level reflects ongoing distrust in inter-bank lending markets, where banks prefer using the low-risk ECB facility for excess funds rather than lending them to other banks. The high deposit level also suggests markets aren't fully convinced that the ECB's massive long-term loan allotment last week is enough to fortify the currency bloc's banking sector.

The central bank extended nearly half a trillion euros in long-term loans to euro-zone banks last week, hoping to ease fears of a new credit crunch as banks struggle to borrow from markets.

The ECB further said banks borrowed EUR6.131 billion from the ECB's overnight lending facility, compared to EUR6.341 billion borrowed Thursday. When markets are functioning properly, banks only use the facility to the tune of a few hundred million euros overnight.

ECB Reaches €211 Billion Target At Weekly Drain Operation
by William Launder, Dow Jones Newswires

The European Central Bank drained the full volume of its government bond purchases from the euro zone's banking system as planned Tuesday, removing EUR211 billion in liquidity from the market.

The target amount equals the total volume of purchases under the ECB's program for buying euro-zone government bonds on the secondary market. The data indicate that the ECB is still able to mitigate the inflationary impact of its bond purchases, despite acute tensions in euro-zone financial markets and a sizeable increase in the bond buying program since August.

The ECB said it received a total of 95 bids, accepting 63.12% of bids at a marginal rate set at 0.89%. The central bank is typically able to drain all of the funds targeted at the routine, weekly operation. Last month, it missed its weekly target for the first time since the central bank relaunched its bond buying program in August, as banks concerned about the debt and banking crisis hoarded liquidity.

Banks still continue to park record high levels of funds in the ECB's overnight deposit facility, using the central bank as a safe-haven for funds rather than lend them out to banks they perceive as increasingly risky because of their exposure to sovereign debt and counter party risk.

2012: Stocks up 10% — or Doomsday scenario?
by Paul B. Farrell - MarketWatch

10 triggers threaten capitalism as 'Super-Rich Gap' rivals 1929’s

"Strategists predict a glowing 2012: Stocks forecast to finish the year up more than 10%." Yes, USA Today reports that the strategists are high on holiday cheer.

But is "America’s Financial Doomsday" a more likely headline for 2012, as international bank analyst Martin Weiss predicts? Here’s what he sees in the near future: "An historic world-changing event is about to crush the U.S. economy and stock market."

"Crush"? Is that word too strong? No. Even the International Monetary Fund’s chief, Christine Lagarde, echoes the warning: "The world economy is in a dangerous situation."

Weiss Ratings was the first to downgrade U.S. debt — before the ratings agencies. Weiss has 500,000 readers because he’s been making solid market predictions for 40 years: The 1980s S&L crisis, the dot-com crash in the ’90s, the 2008 credit meltdown and now the new European bank crisis.

So listen closely (and protect your portfolio): The next crisis, according to Weiss, "will destroy the incomes, savings, investments and retirements of millions of Americans."

Yes, destroy.

"It will plunge vast numbers of families into the nightmare of poverty … hunger … and homelessness. Only a minority of investors will survive intact."

Get it? A new and "crushing" global meltdown. Destroying trillions. Most will lose. Only a few will "survive intact." Are you a gambler? Bad odds. On an inflation-adjusted basis, Wall Street has lost trillions of your retirement money since 2000. Are you going to keep betting your future on winning 10%, hoping USA Today’s short-term thinking "strategists" are guessing right?

Or will a "historic world-changing event" crush the American economy, markets … and your retirement? Ask yourself, is gambling on making 10% too risky in 2012? Before you place any bets at the Wall Street casino tables, mull over these 10 "macrotriggers," any one of which could ignite the global "doomsday scenario" that Weiss is predicting.

Trigger 1: Doomsday’s mutant democracy.
"Occupy Wall Street" and the tea party agree: Democracy is dead. "All men are created equal" is now a political fiction. The public has no voice in a nation where wealth buys votes, a naive public is easily manipulated, and elected officials have a price. Capitalism won the battle for the soul of capitalism.

Vanguard’s Jack Bogle warned us: The "invisible hand" no longer serves the public welfare. Today, an insatiably greedy class of "Super-Rich," the 1%, steers America from the shadows, obsessed with restoring the unregulated free-market ideology that loved gambling in the speculative $600 trillion global derivatives that triggered the 2008 meltdown.

Trigger 2: Doomsday’s class warfare.
After our bankrupt Wall Street banks were bailed out in 2008, it became painfully obvious that Bogle’s "mutant capitalism" was self-destructing, killing democracy. Today nobody trusts Washington. Wealth rules government. Polls show the public now believes that no matter who’s elected in 2012, our descent into disaster can’t stop.

Sen. Bernie Sanders of Vermont said it best: "There is a war going on in this country … the war waged by the wealthiest people in America on the disappearing and shrinking middle class of our country. The nation’s billionaires are on the warpath. They want more, more, more. Their greed has no end, and they are apparently unconcerned for the future of this country if it gets in the way of their accumulation of power and wealth."

Trigger 3: Doomsday’s legal conspiracy. In the past generation Adam Smith’s invisible hand" was replaced by an open conspiracy among Wall Street, corporate CEOs, politicians and Forbes 400 billionaires operating with arrogance and absolute power, corrupting America’s soul. This conspiracy has no moral compass yet, ironically, is legal.

Yes, "legal," thanks to the Supreme Court. Wealth buys favorable laws, making even the most unethical, selfish, corrupt behavior "legal" by fiat: All the rewards of capitalism for a Super-Rich 1%, while the liabilities are dumped on the 99%.

Trigger 4: Doomsday’s political anarchy.
Forget buzzwords like "socialism," "oligopoly," "plutocracy," even "republic." Washington is now a pure anarchy with 261,000 high-priced lobbyists fighting for the best budget deals for their clients’ interests, not the public interest.

Our Super-Rich anarchists know the only votes that count are in Congress, where lobbyists are brokering special interests, fighting for a slice of a $1.7 trillion federal budget pie, for special regulations, for tax loopholes, exemptions, loans, earmarks, access to policy makers, agency appointments, defense contracts — you name it.

Trigger 5: Doomsday’s growth economics.
The principle of "growth or die," once a given in economics and politics, is being challenged by new "growth and die" research yet relentlessly subverted by a numbers racket used by traditional economists to hide their manipulation of government, consumer and financial data to deceive investors, consumers, voters, the public.

Most economists work for the "establishment": banks, politicians, CEOs, biased think tanks or the Fed. And all economists have political agendas. They’re more like speech writers, hyping short-term policy agendas, while dismissing long-term consequences. For example, global population will increase from 7 billion to 10 billion by 2050, yet old-school economics pretends natural resources are infinite.

Trigger 6: Doomsday’s neurosciences.
Back in 2002 behavioral science offered investors a level playing field: Psychologist Daniel Kahneman won the Nobel Prize in Economics, exploding Wall Street’s myth of the "rational investor." The behavioral scientists promised to help investors understand our brains and make better decisions: Trust us, and you’ll be "less irrational"; control your brain, and be a successful investor. Wrong. Just the opposite. Why? Your brain is irrational. Always will be. You cannot win: Wall Street quants are light-years ahead of your amateur "brain rewiring." They know you’re vulnerable, easy to manipulate. They hire the top global neuroscientists for their casinos. The house always wins.

Trigger 7: Doomsday’s casino technologies.
Sophisticated new technologies, mathematical algorithms and neuroscience all guarantee Wall Street insiders’ huge margins in gambling at the global derivative casinos, by leveraging fees, commissions and deposits from Main Street’s "dumb money."

Today Wall Street is even more obsessed, grabbing for high-risk profits in the dangerous "new normal" of high volatility, increasing risks, lower returns. Sadly, average investors are no match for Wall Street’s "high-frequency traders," who easily win by huge margins at this rigged game. Still, naïve investors keep betting, despite studies warning that the more you trade the less you earn.

Trigger 8: Doomsday’s global warfare. The Pentagon math is simple: By 2020 "warfare will define human life," while global population is on its way toward its explosion from 7 billion to 10 billion. Commercial, political and ideological forces drive globalization, all competing for scarce resources. This is "the mother of all national security issues," warns the Pentagon.

Unrest will "create massive droughts, turning farmland into dust bowls and forests to ashes. Rather than causing gradual, centuries-spanning change, they may be pushing the climate to a tipping point. By 2020 there is little doubt that something drastic is happening.

As the planet’s carrying capacity shrinks an ancient pattern re-emerges: the eruption of desperate, all-out wars over food, water and energy supplies and warfare defining human life."

Trigger 9: Doomsday’s cycles of history.
Bubble-and-bust financial cycles have been well-documented for eight centuries. Yet humans seem never to learn the lessons of history. Euphoria blinds us in boom times. Risk is denied. Bubbles blow. Meltdowns happen. We deceive ourselves: "This time is different!" Wrong.

In "Colossus: The Rise and Fall of the American Empire," financial historian Niall Ferguson warns: "Collapse may come much more suddenly than many historians imagine. Fiscal deficits and military overstretch [suggest] that the United States may be the next empire on the precipice. Many nations in history, at the very peak of their power, affluence and glory, see leaders arise, run amok with imperial visions and sabotage themselves, their people and their nation."

Trigger 10: Doomsday’s retirement investing.
You need a survival strategy. Barton Biggs, the former Morgan Stanley guru and now a hedge-fund manager, warns "Super-Rich" investors: Learn survival skills. In his "Wealth, War and Wisdom," he foresees "the possibility of a breakdown of the civilized infrastructure" — a doomsday scenario. "Think Swiss Family Robinson," he advises.

"[Y]our safe haven must be self-sufficient, capable of growing food, well-stocked with seed, fertilizer, canned food, wine, medicine, clothes. And be ready to fire a few rounds over the approaching brigands’ heads, to persuade them there are easier farms to pillage." But that won’t work for the other 99%, the Main Street investors. Studies now show most don’t have enough saved for retirement today, let alone survival in a 2020 jungle.

Has America already passed the point of no-return? Can we change course?

We must see a paradigm shift in how our leaders think, says Jared Diamond, in "Collapse: How Societies Choose to Fail or Succeed." America needs leaders with "the courage to practice long-term thinking, and make bold, courageous, anticipatory decisions at a time when problems have become perceptible, but before they reach crisis proportions."
And that will never happen, says Jeremy Grantham, whose firm manages $100 billion: "It’s more or less guaranteed that every time we get an outlying, obscure event that has never happened before in history," our leaders in Washington, Wall Street and corporate CEOs "are always going to miss it." Always. Remember the 2008 meltdown? And if today’s banal political discourse about the 2012 presidential election is any indication, our leaders are guaranteed to miss the next one, too.

Bottom line: Underneath America’s endless political drama lie deep wounds that are widening the gap between the "Super-Rich" and the other 99% of America, a wealth gap that’s as wide today as before the 1929 crash.

Now, as then, we know the "Super-Rich" don’t really care about the needs of the rest of America. The greed of the "Super-Rich" is insatiable. For them, more is never enough.

So without a fundamental shift in the brains of our leaders’ thinking, the 2020 timetable projected in the work of the Pentagon, Ferguson, Grantham and others will mark the final countdown, the inevitable ignition of "Doomsday Capitalism."

New Greek Government Runs Out of Steam
by Ferry Batzoglou - Spiegel

Six weeks after forming a transitional government to overcome its crisis, Greece is still failing to deliver its promised reforms. The cabinet of Prime Minister Lucas Papademos is deeply divided and has lost the public's confidence. Even the most urgent measures have ground to a halt.

The president of Greece's SEV business federation, Dimitris Daskalopoulos, recently invited journalists to his imposing neoclassical headquarters in Athens. He straightened his tie, leaned forward and with a grim expression spoke into half a dozen microphones arrayed in front of him. "Now the issue is simply whether we remain in Europe or not. The governing parties have an obligation to work together honestly to finally banish the nightmare of a return to the drachma. If this government doesn't get it right, Greece will go hungry."

His dramatic appeal was ignored, once again. The Socialist PASOK party, the conservative-liberal New Democracy party and the far-right LAOS party formed a transitional government six weeks ago under non-partisan former central banker Lucas Papademos. They vowed to avert a looming state bankruptcy. But they remain as divided as ever.

Instead of getting down to business, they are absorbed in policy wrangling that seems absurdly trivial given the scale of the tasks they face. At a cabinet meeting last Thursday, Finance Minister Evangelos Venizelos and Transport Minister Makis Voridis of LAOS fell out over a draft law to accelerate amicable divorces. Marriage, Voridis argued, was "a central component of our value system" -- therefore LAOS could not agree to the law. Papademos remained silent.

This isn't the first time the LAOS minister has blocked a decision. Recently he resisted the complete liberalization of the issue of taxi licenses, and publicly threatened to resign.

'The Negotiations Have Run into Major Difficulties'
To its credit, the Papademos government mastered two important challenges early on: it secured the payout of the sixth international loan tranche of more than €8 billion ($10.45 billion) from the €110 billion European Union and International Monetary Fund bailout package agreed in May 2010. And the parliament has passed the state budget for 2012.

But since then, Athens has failed to deliver on the binding reforms and spending cuts it had pledged in return for the cash. The top priority is the exchange of Greek government debt agreed at the EU summit on Oct 27. Under the deal, private creditors will voluntarily write down 50 percent of their loans.

But under the terms of the summit agreement, the Greek government must reach an agreement with creditors before the end of 2011 so that the bonds can be swapped for new securities at the start of 2012. It is clear that Greece won't make that deadline. "The negotiations have run into major difficulties, we are working day and night to find a solution," Venizelos admitted.

The sticking points appear to be the levels of interest rates that Greece will have to pay for new bonds and the size of the voluntary debt cut. Even if an agreement is reached, there is doubt about whether all private creditors will stick to it. Spanish hedge fund Vega, for example, has already pulled out of the talks and threatened legal action if the losses amount to more than 50 percent. If the debt swap fails, the entire 2012 budget will be null and void because it depends on drastically reduced interest payments on Greece's government debt.

Reforms Have Ground to a Halt
The October EU summit also promised Greece an urgently needed further megaloan totalling €130 billion -- but only if the country meets strict conditions that amount to political dynamite. The reforms undertaken so far in return for the 2010 aid package were so unpopular that the country is at the breaking point. Indeed, further pain will be unavoidable. Despite all the cuts this year, the government has to close an additional budget hole of €3.3 billion due to the unexpectedly severe recession.

The extent to which Greece's reform drive has slowed under Papademos can be seen in many areas:
  • The privatization program has completely ground to a halt. The plan was to sell off €50 billion of government-owned assets by 2015, but so far only €1.7 billion has been raised. Why? Because the government first wanted to implement the debt swap.
  • Labor markets have yet to be freed up and deregulated.
  • The program of public sector layoffs is a fiasco. Instead of the planned 30,000 job cuts, only around 1,000 workers have been transferred to a so-called labor reserve by the end of 2011.
  • The merging or winding down of public authorities is proceeding at a snail's pace.
  • The modernization of the civil serice and of the inefficient health service is plagued by delays.
  • The planned third round of pension cuts has come to a stop. Additional pensions are to be cut by between 15 and 40 percent -- but the New Democracy party in particular is blocking the process.

On Friday, Papademos, who is virtually a lame duck prime minster, met the party leaders to sound out what can still be done before the next general election -- and when it is to be held. Feb. 19 has so far been scheduled as the date for the election.

It's not suprising that New Democracy leader Antonis Samaras in particular wants to stick to that date, given a recent opinion poll that puts his party at 30.5 percent, 12.5 points ahead of PASOK. But after a PASOK party meeting on Tuesday, Finance Minister Venizelos stated through a spokesman that the "elections will take place after Easter at the end of April," which would give the transitional government more time to implement the tax, pension and justice reforms that have been demanded by the EU and IMF in exchange for bailouts.

Lawmaker Gets €1 Mln Lottery Win
The transitional government started out with a lot of goodwill from the Greek public, but it has lost that trust in record time. When it was formed, some 48 percent of Greeks said they had confidence in the government -- but only 26 percent still do today. And the proportion of Greeks who distrust Papademos has surged to 65 percent from 38 percent. Almost four out of five Greeks now think their country is heading in the wrong direction.

Public sentiment is unlikely to be improved by the publication of the private assets of the country's 572 leading politicians. It's no surprise that party leaders and members of government are well-off -- all lawmakers have had to disclose their finances for years.

But attention has focused on 11 politicians whose 2009 asset statements reveal that they withdrew substantial sums from their accounts, and who are refusing to say where the money went.

Meanwhile, one LAOS member of parliament, psychiatrist Vaitsis Apostolatos, can claim to be Greece's luckiest politician. Suddenly he had €1 million in his bank account, which he said had come from a lottery win.

Despite the gloomy outlook for 2012, there are still some politicians who are determined to cheer the nation up with a touch of Christmas humor. Gerassimos Giakoumatos, a doctor and a conservative member of parliament, wished all Greeks a "Happy New Year with good health and above all luck." After all, the passengers on board the Titanic had all been healthy, he said. "They just weren't lucky."

Angela Merkel's economic adviser Weder di Mauro refuses to rule out eurozone break-up
by Andrew Trotman - Telegraph

One of German Chancellor Angela's Merkel's economic advisers, Beatrice Weder di Mauro, has refused to rule out a break-up of the eurozone, in an interview published on Thursday. Beatrice Weder di Mauro warned that unless the financial crisis is intercepted quickly, it can lead to a recession in Germany

Ms Weder di Mauro, a member of the German Council of Economic Experts, said that while the collapse of the single currency would be "bad for everyone involved", it cannot "be completely excluded".

When asked about a potential split, the 36-year-old Swiss economist told Germany's "That would be bad for everyone involved - but not completely excluded. The policy has been trying for almost two years to contain the crisis and to draw firewalls. However, these walls are not rich yet."

She also warned that unless the financial crisis is intercepted quickly, it could lead to a recession in Germany, with the economy contracting 0.5pc, and leading to an increase in unemployment.

"[We need to] get the crisis under control quickly now," Ms Weder di Mauro said. "Then the German economy in 2012 is expected to grow by around 0.4pc. But [if] the crisis should lead to zero growth in world trade, a contraction of the economy by 0.5pc is possible. Then, jobs [would be] in jeopardy."

The comments are likely to add further pressure on Ms Merkel, who has repeatedly refused to entertain thoughts of an EU collapse, even stating last month that "it's never going to happen".

However, Ms Weder di Mauro blamed politicians for the two-and-a-half year eurozone debt crisis. "The crisis was initially underestimated [by politicians] and too little was done. Now they sometimes cannot act as fast as they want. This is a problem, because the markets are nervous and impatient," she said.

"Some countries have taken part and individuals over the years [have] too much debt. The banking crisis has also driven the national debt. Now the fear is great that they cannot repay the debt.

"We need a triad: over-indebted eurozone nations must submit to a long-term insolvency rule. The others must undertake to reduce debt and stabilize the government budgets. With a debt settlement pact, the debt ratios may fall below 60pc over 20 years. This requires that the short-term interest rates are pushed through [with] mutual guarantees to a realistic level.

"If we succeed with a debt settlement pact, to stick together to stabilize the euro, no significant losses are expected. Failing that, consequences and costs are incalculable."

China Debts Dwarf Official Data With Too-Big-to-Finish Alarm
by Michael Forsythe and Henry Sanderson - Bloomberg

A copy of Manhattan, complete with Rockefeller and Lincoln centers and what passes for the Hudson River, is under construction an hour’s train ride from Beijing. And like New York City in the 1970s, it may need a bailout.

Debt accumulated by companies financing local governments such as Tianjin, home to the New York lookalike project, is rising, a survey of Chinese-language bond prospectuses issued this year indicates. It also suggests the total owed by all such entities likely dwarfs the count by China’s national auditor and figures disclosed by banks.

Bloomberg News tallied the debt disclosed by all 231 local government financing companies that sold bonds, notes or commercial paper through Dec. 10 this year. The total amounted to 3.96 trillion yuan ($622 billion), mostly in bank loans, more than the current size of the European bailout fund.

There are 6,576 of such entities across China, according to a June count by the National Audit Office, which put their total debt at 4.97 trillion yuan. That means the 231 borrowers studied by Bloomberg have alone amassed more than three-quarters of the overall debt.

The fact so few of the companies have accumulated that much debt suggests a bigger problem, says Fraser Howie, the Singapore-based managing director of CLSA Asia-Pacific Markets who has written two books on China’s financial system.

"You should be more worried than you think," he said of Bloomberg’s findings. "Certainly more worried than the banks will tell you. "You know how this story ends -- badly," he said.

Repayment Doubts
The findings suggest China is failing to curb borrowing that one central bank official has said will slow growth in the world’s second-largest economy if not controlled. With prices dropping in China’s real estate market, economists warn that local authorities won’t be able to repay their debt because of poor cash flow and falling revenue from land sales they rely on for much of their income.

Provinces and cities are going deeper into the red to finish projects, from the Manhattan on the east coast, to highways in northwestern Gansu and a stadium fronted by Olympic rings in Hunan, central China. Many were started as part of China’s stimulus program to beat the 2009 world recession. The financing companies accounted for almost half of the 10.7 trillion yuan in all local government debt tallied by the official audit.

The 231 borrowers whose public filings were reviewed by Bloomberg raised a combined 354.1 billion yuan by selling securities this year. They have credit lines from banks of at least 2.3 trillion yuan that have yet to be drawn down, the documents show.

Rising Lending
Bank lending continues to rise, Bloomberg found, even after China’s banking regulator repeatedly warned banks to control risks associated with it and speed up repayment.
Forty-seven of the 56 local financing companies that issued prospectuses from Oct. 1 through Dec. 10 said their debt load had increased this year. The combined debt of those issuers rose 10 percent from the end of 2010.

What’s more, adding up lending by bank also raises the question as to whether China’s lenders are understating their exposure to local government debt. Only 113 of the local government borrowers disclosed such a breakdown; and yet this small group appears to account for an outsized portion of what the banks have said is their overall lending.

Data Disparities
For example, China Construction Bank Corp. (939), the world’s second-biggest bank by market value, has lending to those 113 local government borrowers of 250 billion yuan. That’s 43 percent of the 580 billion yuan the bank said it had extended in loans to all such borrowers at the end of June. The bank has untapped lines of credit to the vehicles of a further 341 billion yuan.

Disparities like this suggest lenders may have bigger risks than they’ve disclosed publicly, says Charlene Chu, a banking analyst at Fitch Ratings Ltd. in Beijing. China Construction Bank said it stood by its total for loans to local governments and that cash flow from them was "good." Nonperforming loans to such companies amounted to 6.5 billion yuan, or 1.11 percent of the total, and the lender had set aside provisions of more than three times that, it added in an e-mailed response to questions.

The prospectuses offer a rare window into borrowing by the local government financing vehicles. The issuers disclose total debt and often details of their loans and lines of credit from banks and trust companies. The data are not consistent, with some reporting total debt as of the end of 2009 and some as recently as Sept. 30 this year.

'Too Big to Complete'
Local authorities, who shoulder most of the infrastructure spending in China, have to keep borrowing to complete projects so they can generate cash flow needed to start paying debt back, said Vincent Chan, head of China research at Credit Suisse Group AG (CSGN) in Hong Kong.

Yao Wei, an economist at Societe Generale (GLE) SA in Hong Kong, says another 7 trillion yuan of debt will be needed to finish projects in the government’s five-year plan through 2015. "At some point the central government will realize this is too big to complete," said Yao. Banks will need to be recapitalized as bad loan rates rise, she said. At least 1.4 trillion yuan of soured debt was taken off banks’ books after China’s last lending crisis which began in 1998.

Senior Chinese banking officials themselves have been raising alarm bells. Xie Duo, director general of financial markets at the People’s Bank of China, told a Nov. 23 Beijing conference that local governments depend too heavily on bank borrowing and failure to solve the problem will hurt economic growth. China’s banking regulator in November asked lenders to control the risks associated with the vehicles and said that slumping land sales mean some projects may run out of funding.

Loans Invested
Loans to local government companies aren’t a problem because the projects will generate returns, even if not immediately, said Huang Jifa, deputy general manager for investment banking at Industrial & Commercial Bank of China (601398) Ltd., the country’s biggest lender.

"The money that Chinese local governments have borrowed is not like the money people borrowed in Europe or Greece," Huang said in a Nov. 24 interview. "The Chinese government’s borrowed money is all invested. Many projects will have returns."

The bank says it had extended 931 billion yuan of such loans as of June 30. Outstanding local government financing vehicle-loans at the end of the third quarter declined from the first half, an ICBC spokesman said. He wouldn’t comment further.

Construction Boom
A building boom by thousands of local governments became the backbone of the country’s stimulus program started in November 2008 -- on borrowed money. The financing companies were created starting in the 1990s and enabled provinces, cities, counties and townships to bypass rules barring most of them from directly selling bonds.

Projects undertaken include a stadium, which resembles Beijing’s iconic Bird’s Nest Olympic venue, in Jinan, the capital of eastern China’s Shandong province; and a superhighway in the country’s second-poorest province of Yunnan that stretches into the foothills of the Himalayas, where there are no cities of more than 1 million people.

In Tianjin, about 160 kilometers (99 miles) southeast of Beijing, a sea of hundreds of construction cranes stretches along both sides of the river at an oxbow that gives the Yujiapu financial district its Manhattan-like shape, testimony to the scale of China’s ambitions. Downriver are the ruins of centuries-old forts stormed by British and French troops during the Second Opium War in 1860.

Thousands Evicted
To build Yujiapu, Tianjin officials are piling onto borrowing that is already at least almost half a trillion yuan - -equivalent to half the annual per capita income of the city’s 13 million people. More than 5,000 people were moved out of the area starting in 2008 to make way for the project, among the millions nationwide evicted from homes to make way for China’s urbanization projects.

The planned 15.2 million square meters (164 million square feet) of office space by 2020 in Yujiapu and across the Hai River in Xiangluo Wan, or Conch Bay, is more than one-third of the 450 million square feet in Manhattan.

One of the companies building Yujiapu -- Tianjin Binhai New Area Construction & Investment Group Co. -- sold 10 billion yuan in bonds in November. It earmarked 1 billion yuan from the sale to fund the construction of the district’s transport hub, which includes a high-speed rail line that will cut the time to Beijing to 45 minutes. In the first half of the year its debt, mostly from banks, rose 11.9 percent from the end of 2010 to 71 billion yuan, according to the prospectus.

More Loans Needed
More borrowing is needed, Tianjin Vice Mayor Cui Jindu said Sept. 16. New loans to the city’s financing vehicles may slump by as much as 140 billion yuan in 2011 from last year’s level as lenders curb risks and boost support to small and medium-sized businesses, he said.

"If the banks don’t give us any new loans, there will be problems," Cui said, saying some projects in the city may not get completed. Tianjin had "no problem" repaying loans this year, having to that date paid off 33 billion yuan of the 39.5 billion yuan in principal due this year, he said. Another 60 billion yuan is due in 2012, Cui added.

Some 14 of 122 planned buildings are under construction in Yujiapu, as are all 48 skyscrapers in Conch Bay, said Xu Fei, vice-chairwoman of the office of the Tianjin Binhai New Area CBD Commission, as she stood in front of a brightly lit model of the future city.

Rockefeller Center
They include a 588 meter-high tower, taller than the 541 meter-high 1 World Trade Center currently under construction in the real Manhattan, being built with the help of the Rockefeller family’s Rose Rock Group. Steven Rockefeller Jr. attended a Dec. 16 groundbreaking event for the project, which includes the skyscraper inspired by the Rockefeller Center in New York, Zhao Jia, an outside spokeswoman for Rose Rock, said. The Lincoln Center is advising on the construction of a performing arts center.

Yujiapu’s resemblance to the Big Apple extends to its rising debt that analysts like Howie say is unsustainable. New York was near bankruptcy in 1975 after a succession of overspending administrations, before then-President Gerald Ford agreed to lend it $2.3 billion.

"In many of these projects, like the mini-Manhattan, it’s never going to make money," Howie said. "Maybe the government can write a check from somewhere else. But that means education gets affected, health gets affected. There’s a cost somewhere else, because they’re wasting all these resources."

Bond Sale
Tianjin Infrastructure Construction and Investment Group Co., another state-owned builder working on Yujiapu, is the most heavily indebted local government financing vehicle in China to disclose its finances in bond prospectuses this year with 291 billion yuan in debt. It sold 3 billion yuan of bonds in April.

An official with Tianjin’s foreign affairs office said no one was available to answer questions about whether the city’s financing vehicles had sufficient cash flow to service their debts.

The true level of local government debt nationwide is hard to ascertain because the borrowing vehicles are mostly opaque. There’s even disagreement over how many exist. The People’s Bank of China, the country’s central bank, said in a June 1 report there were more than 10,000. In a separate study, China’s banking regulator tallied 9,828 as of the end of Nov. 2010, according to an unpublished report cited by the 21st Century Business Herald in March.

'Lending Binge'
"It’s very likely that senior government leaders have no way of knowing which numbers provide the best picture of the evolving lending binge China’s banks seem to be on," said Carl Walter, who retired as chief operating officer in China for JPMorgan Chase & Co. (JPM) earlier this year and is co-author with Howie of "Red Capitalism," an analysis of China’s banking system.

The audit office said in an e-mailed response to questions that it counted debt that local governments have responsibility to repay, that they have guaranteed, or other debts that they may be liable for. People’s Bank of China didn’t answer faxed questions. An official with the China Banking Regulatory Commission said to use the audit office’s figures.

The number of loans going bad will rise because of the borrowers’ poor cash flow, according to a November report from London-based HSBC Plc. Around 68 percent of 184 local financing companies that have sold bonds analyzed by HSBC had a return on capital lower than 5 percent, the benchmark lending rate last year, compared with 37 percent for all 499 corporate issuers it studied, the report said.

Loan Mismatch
"One of the problems with the local government financing vehicle loans issued in 2009 was there was a mismatch between the duration of the assets and the duration of the liabilities," said Michael Werner, a banking analyst at Sanford C. Bernstein & Co. in Hong Kong. "If you’re building a railroad or a highway, it takes several years and you’re not going to get direct revenues."

Take Gansu Provincial Highway Aviation Tourism Investment Group Co. The company builds roads across the arid province, including a 3.4 billion-yuan, 235-kilomter stretch of high-speed expressway along the ancient Silk Road to Jiayuguan, at the westernmost pass of the Great Wall of China.

Its total debt surged 29 percent in the first nine months to 15 percent of the province’s gross domestic product last year. The company’s entire 2010 operational cash flow was 3.04 billion yuan, while it had 55.9 billion yuan in bank borrowing reported at the end of September. The revenue wouldn’t cover interest payments at China’s standard lending rate of 6.56 percent, let alone paying down principal.

Interest Rolled Over
Fortunately for Gansu Highway, it doesn’t have to. Almost half of its outstanding loan principal and interest due this year -- 24.1 billion yuan -- is being rolled over into its outstanding bank debt, and the company plans to repeat that exercise every year until at least 2019 when it is forecast to owe lenders 148.9 billion yuan, according to a chart in the prospectus it issued for a 2 billion-yuan bond sale last month.

Gansu Highway’s situation encapsulates the problem of local government borrowers, which often have minimal or no plans to repay debt aside from borrowing more money, says Fitch’s Chu.

"In the past, Chinese banks could carry borrowers like this indefinitely," she said. "But today they don’t have the large cash reserves they used to to do this. I don’t see how all of this doesn’t turn into a major problem at some point."

Lei Wanming, the deputy Communist Party secretary for the Lanzhou-based company, said Gansu Highway had no problem covering interest and principal payments.
"You can’t look at look at Gansu roads just from an economic perspective," he said, citing the benefits they will bring to poorer regions and its role in helping to eventually connect China and Europe with high-speed expressways.

Municipal Bond Trial
China’s government has taken steps in the past four months to help local governments as their debt comes due. It has urged them to sell assets and allowed a pilot program for cities including Shanghai and Shenzhen to issue bonds directly for the first time under Communist rule, reducing their borrowing costs.

Standard & Poor’s upgraded Bank of China Ltd. (3988) and China Construction Bank on Nov. 30, saying there was a "very high" likelihood of lenders getting government help in the event of financial distress. The new ratings are higher than most of their largest U.S. rivals including Bank of America Corp. and Goldman Sachs Group Inc.

Slumping Bank Shares
Even so, shares in the four biggest commercial banks in China -- China Construction, ICBC, Bank of China and Agricultural Bank of China Ltd. (601288) -- have tumbled an average 23 percent this year in Hong Kong. The banks have loans to the 113 local government borrowers that disclosed such information of 832 billion yuan, Bloomberg found.

That’s almost one third of the combined 2.57 trillion yuan in loans extended to all such financing vehicles that they declared as of June 30. The banks had another 1.19 trillion yuan in unused lines of credit to those companies.

Bank of China President Xiao Gang, speaking at the Asia Pacific Economic Cooperation summit on Nov. 12 in Honolulu, said that most of his bank’s lines of credit to local government financing vehicles were conditional, and only a minority of them were irrevocable. Agricultural Bank said in an e-mailed response to questions that its loans were mainly to cash-producing infrastructure and qualified port and highway companies.

Property Price Risk
Local governments’ reliance on land sales for revenue means a drop in property prices may expose weaknesses in the borrowing, Huang of ICBC said. "The real problem is the real estate market cannot fall, the price can’t go down," he said. "If the property market really falls, the local government financing vehicle problems will really come out. Not only will they have problems, but the banks will have problems."

There are signs the market is already declining, with residential property prices falling in November from the previous month in 49 cities of the 70 measured, the worst performance this year. The cities of Guangzhou in the south and Wuhan in central China canceled land sales in the last three months.

Tianjin, which isn’t among the cities piloting municipal bonds, was reliant on land sales for 41 percent of its income in 2009, according to China Index Academy, a Beijing real-estate research firm.

That doesn’t bother Xu Hongzhi, the chief accountant for Tianjin Binhai Construction, which is building Yujiapu’s transport hub. He said that the company can pay its debts because the area’s economy is growing at 10 percent a year.

"There is no risk," he said.