Return of the euro crisis
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After the sugar rush
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Spanish bond yields have risen as the effect of cheap ECB cash wears off
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Apr 14th 2012                   


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THE high is over. The European Central Bank’s two long-term refinancing operations (LTROs) in December and February saw commercial banks borrow over €1 trillion ($1.3 trillion) of three-year money at the ECB’s main interest rate, which it had cut to 1%. Ostensibly a scheme to keep euro-area banks afloat, the LTROs also boosted flagging public-debt markets in the zone’s southern periphery, as banks used some of the cash to buy high-yielding bonds. That effect has faded.
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Spain’s ten-year government-bond yield has been rising since the second tranche of three-year ECB cash was doled out. This week it reached almost 6%, the highest level since November (see chart 1). The U-turn owes a lot to the shifting dynamics of the euro-zone bond markets, which have also affected Italy. Missteps by Spain’s new government have not helped. Beneath all this lie deeper fears about Spain’s injured banks, the stringency of the government’s fiscal plans, and the impact of both on an already weak economy.



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Start with the bond-market dynamics. With tacit support from regulators, the stock of government bonds held by Spanish and Italian banks rose by €122 billion between November and February. Prices surged and yields fell. Hedge funds which had sold borrowed bonds in the hope that prices would fall were forced to buy them back. The rally lured others in.



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This virtuous cycle turned vicious in early March. Some investors say the buying petered out once yields fell below 5%, when the bonds might no longer be considered cheap. But the conclusion of the second and last LTRO may have been the main trigger. Banks which bought periphery bonds have used up their ammunition. “The minute the ECB saysno more,’ the bank bidder is lost,” says a hedge-fund manager. Since there are few committed buyers of bonds beyond such banks, the smart money bet that yields would rise again.


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Brokers are less willing to take bonds off sellers’ hands in the hope that buyers eventually turn up, says Andrew Balls of PIMCO, a fund manager. In thinly traded markets, bond prices can suddenly shoot up if only a few investors take fright and start selling.



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The clumsy handling of Spain’s 2012 budget may have persuaded some to sell. The newish Spanish government delayed it until after local elections in March; it also announced that its deficit target would be 5.8% of GDP, not the 4.4% agreed with European leaders (the compromise was a goal of 5.3%). The budget minister, Cristóbal Montoro, and the economy minister, Luis de Guindos, “contradict each other all the time”, complains a Spanish economist.



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Yet Spain has deeper problems than muddled messages. The 2011 budget deficit was 8.5% of GDP, not the goal of 6%, in large part because of overspending by Spain’s autonomous regions. The economy is in recession—industry shrank by 5.1% in the year to February according to figures released on April 11th. Attempts to cut the deficit by 3.2% of GDP in a year will make things worse. Reforms to the jobs market, making it cheaper to fire workers and easier to set pay locally, will benefit Spain’s economy in time but not now.



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Anxiety about Spain’s banks worsens the outlook further. A messy end to Spain’s long construction and mortgage boom means a lot of bank loans have already turned sour. More are likely to. Property prices have not yet fallen as far as in Ireland, the euro zone’s other housing black spot. Investors fear that the state will be called on to recapitalise Spain’s banks.
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To complicate matters, much of Spain’s huge private debt is owed indirectly to foreigners via its banks. Spain’s net investment deficit—the sums owed to foreigners by firms, householders and the government, less the foreign assets they own—comes to 93% of GDP, the cumulation of a long series of current-account deficits. The increasing home bias of euro-zone investors makes it harder for countries with foreign debts to roll them over. Greece and Portugal have similar foreign debts but have higher borrowing costs (see chart 2).



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Spain and Italy could not live with today’s borrowing costs for long unless the outlook for their economies were to improve dramatically. So they may have to look to outside help. But it would be hard for the ECB to sanction another LTRO so soon, reckons Laurence Boone of Bank of America.




The ECB could restart direct bond purchases: Benoît Cœuré, a member of the bank’s six-strong executive board, suggested on April 11th that it might, which helped push Spain’s bond yields down a bit. But that would make existing investors worry more about subordination to the ECB in the event of a restructuring. In any case Mario Draghi, the bank’s president, has recently said high yields are the bond markets’ way of asking governments to implement promised reforms.



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Spain could volunteer for the kind of support programme that Greece, Portugal and Ireland have signed up to. But Italy is scarcely in any less trouble and the euro zone’s meagre rescue fund could not stretch to a bail-out of both countries for long. A more likely outcome is that Spain is eventually forced to draw on the shared rescue fund to recapitalise its banks, which might in turn take pressure off its sovereign-borrowing costs. Meanwhile, some have turned to the next trouble spot. “France is our cheapest and biggest short,” says one hedge-fund manager.



April 15, 2012 9:14 pm

Spain has accepted mission impossible


Are the markets panicking because Spain may fail to hit its deficit targets, or are they panicking at the thought that Spain may succeed? That, to me at least, is the key question facing eurozone policy makers. The ultimate outcome of the eurozone crisis will depend to a large extent on how that question is answered.



News coverage seems to suggest that the markets are panicking about the deficits themselves. I think this is wrong. The investors I know are worried that austerity may destroy the Spanish economy, and that it will drive Spain either out of the euro or into the arms of the European Stability Mechanism.

 

The orthodox view, held in Berlin, Brussels and in most national capitals (including, unfortunately, Madrid), is that you can never have too much austerity. Credibility is what matters. When you miss the target, you must overcompensate to hit it next time. The target is the goal – the only goal.




This view does not square with the experience of the eurozone crisis, notably in Greece. It does not square with what we know from economic theory, or from economic history. And it does not square with the simple though unscientific observation that the periodic episodes of market panic about Spain have always tended to follow an austerity announcement. One such episode came with the discussion that led to the recently introduced draft budget, which included a deficit correction of 3.2 per cent of gross domestic product for 2012.


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When Mariano Rajoy, Spain’s prime minister, began to outline the deficit cuts for 2013 last week, the markets panicked again and drove Spanish 10-year yields back to 6 per cent. The targeted fiscal adjustment amounts to 5.5 per cent of GDP over a period of two years. It is one of the biggest fiscal adjustments ever attempted by a large industrial country. It is perfectly rational for investors to be scared.



European policy makers have a tendency to treat fiscal policy as a simple accounting exercise, omitting any dynamic effects. The Spanish economist Luis Garicano made a calculation, as reported in El País, in which the reduction in the deficit from 8.5 per cent of GDP to 5.3 per cent would require not a €32bn deficit reduction programme (which is what a correction of 3.2 per cent would nominally imply for a country with a GPD of roughly €1tn), but one of between €53bn and €64bn. So to achieve a fiscal correction of 3.2 per cent, you must plan for one almost twice as large.



Spain’s effort at deficit reduction is not just bad economics, it is physically impossible, so something else will have to give. Either Spain will miss the target, or the Spanish government will have to fire so many nurses and teachers that the result will be a political insurrection.



The wider eurozone crisis was caused by financial flows from banks in the core countries, which financed bubbles in the periphery, except in Greece. Spain may also have a dysfunctional labour market and fixing it may still be highly desirable. If this is a good moment to do it politically, then so be it. But we should not fall for the illusion that structural reforms are going to make a big difference. Austerity and reform are not the magic combination policy makers believe them to be.



Fixing the Spanish crisis will have to start with the banks – and this is a task the private sector is not willing, and the government not able, to perform. The only halfway benign solution I can see would involve a European rescue programme for Spain that focuses specifically on the recapitalisation and downsizing of the financial sector. Spain would also need to undershoot the eurozone’s average inflation rate over many years to redress some of the lost price competitiveness. At the same time, the country needs to go easy on austerity.



That combination of policies might just work, though it would still be difficult. What is not going to work is a combination of deflation, austerity and private sector deleveraging, all at the same time, for a decade.



But it will be tried – of that there can be little doubt. The EU will resist an ESM programme for as long as possible. The eurozone finance ministers fear that any such programme might reopen the debate about the size of the ESM, a debate they want to avoid at all costs. But as the recession gets worse, and Spanish unemployment rises towards 30 per cent, the pressure for Spain to turn to the ESM will grow. It will happen eventually. And even when that happens, it will not end the crisis in Spain. For that a eurozone-wide bank resolution system would also be necessary.



I can see only two outcomes for Spain. The crisis will end either in a catastrophic Spanish withdrawal from the eurozone, or in a variant of a fiscal union that includes a joint eurozone backstop to the financial sector. If the Spanish government pursues the strategy it has announced to the bitter end, the first outcome will become vastly more probable.


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Copyright The Financial Times Limited 2012.


Up and Down Wall Street

SATURDAY, APRIL 14, 2012

A Golden Opportunity

  By ALAN ABELSON





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Some savvy investment pros are bullish on gold, and even more so on gold-mining stocks.


The sound has diminished but the fury, we're delighted to report, hasn't. For a few moments there, when it became obvious that Mitt Romney would be duly anointed the Republican candidate for president, we feared that the curtain had come down on the most entertaining clown show since George McGovern ran for president.






But thanks to Newt Gingrich and Rick Santorum, we haven't yet been deprived of our full quota of tickles and chuckles and our hopes are high there are still encores aplenty in store before these worthies develop laryngitis.


.You may well wonder, as we have, whatever happened to Ron Paul? Surely, you remember him -- he's the one whose son is a senator. There have been sightings, but alas nothing confirmed. Our own guess is that he's sequestered in some distant hideaway, conserving his strength for another run at the big prize in 2016.



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Rick Santorum confessed that he ran out of dough or sleeveless sweaters, we can't quite remember which, so he had to "suspend" his campaign. "Suspend" is Washingtonspeak for "quit," which every candidate for dogcatcher on down vows never to do.



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Newt's campaign cupboard apparently is also empty but, true warrior that he is, it sure hasn't stopped him from mouthing off and, in any case, it's not clear whether he's still in or out. He says he hasn't the faintest interest in taking the No. 2 spot on the ticket. One reason might be that nobody's offered it.



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Newt blamed Fox News, which like Barron's is owned by News Corp., for his terminally limp showing in the race for the GOP nomination. Ah, come on, Newt, give credit where credit is due: What turned voters off was little old you. Our advice, which for reasons beyond our ken you haven't solicited and for which we won't charge you, is next time smile more and yak less. Or at least yak less.



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Mitt Romney's triumph shows that flip-flopping is no deterrent to winning the nomination for president, especially when it's accompanied by more bucks than most contenders ever dream of, much less have. Mitt seemingly lacks the common touch, possibly because he's injured his fingers trying to count his money.


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We can only conjecture that he has learned something from the trials and tribulations of campaigning. Most important among the lessons he likely has taken to heart is never, never drive to Canada carrying a dog caged on the roof of you car. It's one heck of a job cleaning up the mess if a pooch, as in this case, can't find a loo.




That Mitt seems a lock to get the nomination he so arduously pursued no doubt comes as a relief to many citizens who found the bitter bickering that marked the campaign exchanges offensive or boring or both. To those benighted souls, we say savor the intermezzo. If you thought the preliminaries were ugly, just wait 'til you catch the main event. Man, that shapes up as really, really ugly.



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ALL THAT'S GOLD DOESN'T GLISTEN. That melancholy assay applies in particular to the shares of companies that mine the precious stuff. While bullion has taken its lumps this year, it's still up something like 18% over the past 12 months. In sorry contrast, the mining shares, which had a relatively brief but brisk upswing, have been marked down sharply, and investors' seemingly only interest in the group is to sell whatever stray nuggets they still happen to possess.


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Which to us spells opportunity. More to the point, it does also to a couple of savvy investment pros -- Alan Newman, who puts out the unfailingly valuable market commentary Crosscurrents, and Darren Pollock, a seasoned, risk-conscious portfolio manager and principal of Cheviot Value Management, which calls Santa Monica, Calif., home. Both Alan and Darren evince a healthy skepticism of whatever the conventional Street wisdom of the moment happens to be, and sedulously avoid the usual sell-side platitudes. Neither is overly thrilled by the outlook for the economy.



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Alan points out that gold stocks have languished or worse for months, even as equities as a whole staged an impressive rally. But he's convinced that the next move for gold shares will be sharply higher. He's strongly cautions, however, against rushing out to scoop up the mining issues until the market overall suffers a meaningful correction, which he sees as very much in the cards.



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Not the least of Alan's bona fides is that he started pounding the table for gold as a super long-term investment back in September 2001, in the wake of the bursting of the dot-com bubble, and since then, bullion has risen a cool 347%. He exhibits the typical technician's affinity for charts and ratios, and on this score, he finds that the fact that the stock market, as measured by the Dow, is trading at a ratio of eight times gold vastly underestimates the potential for gold. He confidently expects that ratio to shrink in the fullness of time to 5-to-1.


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The catalyst for such a sharp decline, he asserts, is the near-universal debasement of currencies around the globe, an inexorable and extended process destined to continue "until paper assets once again can prove their worth." That desideratum, in turn, will be achieved only with a great unwinding of the debt cycle, stretching out over many years.


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To illustrate the extremely bullish implications for gold if he's right, the inexorable contraction of the Dow/gold ratio to 5-to-1 would mean $3,000-an-ounce gold, with the Dow at 15,000; $2,400 an ounce with the Dow at 12,000, and $2,000 an ounce with the Dow at 10,000.

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Again, let us make clear that Alan doesn't expect this to happen overnight, but rather to stretch out for a bunch of years. And, in any event, he firmly believes that any would-be buyers of the gold stocks rather than bullion itself would do well to delay taking the leap, and until the "significant correction" he foresees for equities generally runs its course.


.He ends his little seminar on gold by pronouncing its less-than-exhilarating recent action "an ideal consolidation." Fear has shaken out the weak holders (something, we might interject here, we've been prattling on about for quite a spell), and doubt pervades. Meanwhile, he contends "the fundamentals argue that each dollar printed ensures an increase in value for each ounce of gold."


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In his astute view, the battle-scarred market vet Darren Pollock also cites the wave of liquidity unleashed by nervous governments as a compelling cause for investor concern, and a big long-term plus for gold. The stock market, he posits, has been ignoring the "longer-term requirements and ramifications of deleveraging economies," which manifests itself in the recent lessening enthusiasm for the metal and especially gold shares.



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He points out, however, that one group of investors, namely the central banks, "are keenly aware of a time-tested cause and effect: the more debt monetization, the greater the likelihood of lower currency value and higher inflation." The central banks are worried stiff, Darren says, about shielding their own assets from devaluation, and, accordingly, abandoned a long-term inclination to sell off their stockpiles of gold—and are now busily accumulating it.


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Out in front of this noteworthy about-face, he reports, are the creditor nations -- China, India, Brazil, Russia and South Korea. Darren calculates that, were these countries to invest "even a paltry 15% of their foreign reserves" in gold, they would have to buy all new production of the metal for the next four years. And, he anticipates, if anything, they'll step up their demand for bullion, kiting its price in the process.


America’s presidential election

Game on

The campaign looks likely to sharpen America’s divisions

Apr 14th 2012                    




AMERICA’S primary elections are not yet formally over, but with the exit of Rick Santorum it is at last plain that Mitt Romney will be the Republicans’ nominee. After the bruising primaries, Mr Romney starts from behind. Barack Obama leads in the head-to-head polls. But there are still seven months to election day, and Mr Romney has a fair chance of victory in November. Less than half of America’s voters approve of the way Mr Obama is doing his job. Six out of ten think the country is on the “wrong track”. The recovery is still weak and 12.7m Americans are unemployed. America added only 120,000 jobs in March, below expectations and fewer than in previous months.




This fight is going to be nastier than the one in 2008. By instinct Mr Romney is a moderate, but the primaries tugged him sharply right, forcing him to boast that he was “severely conservative” by embracing policies, including deep cuts in social spending, that even the famous flip-flopper will now find it difficult to drop. After the primaries, candidates pivot towards the centre. But Mr Romney knows that to turn out a conservative base that does not love him he must mobilise their hatred of Mr Obama. In the meantime Mr Obama appears to believe that he cannot afford to present himself once more as a healer who will soar above party divisions. He is running a more partisan campaign this time round. An already polarised America therefore faces a deeply polarising elections.

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The second time, it’s harder


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In 2008 Mr Obama promised audacity, hope and “change we can believe in”. His appeal sprang from who he was: a fresh young senator offering a new direction after the clapped-out administration of George Bush and a safer pair of hands than the 72-year-old John McCain. But incumbents cannot run on promise alone. This time he will be judged less on who he is and more on what he has done.


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Considering the circumstances, he has not done badly. He can justly claim to have prevented a great recession from turning into a great depression. He rescued Detroit’s carmakers and finished the job of stabilising the banks. Mr Romney says he made a bad situation worse, but if Mr Obama had not used billions of borrowed dollars to stimulate the sagging economy, even more Americans would be out of work today. By battering al-Qaeda and killing Osama bin Laden, he has disproved the notion that Democrats are soft on national security.


.Still, “it could have been worse” has never been an inspiring re-election slogan. The recovery is still so tepid that Mr Obama cannot risk running on his record alone. He has therefore to cast the election as a choice, not a referendum on his performance.


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That requires him to make the choice as stark as possible. For months he has portrayed the Republicans as ruthless asset-strippers who care nothing about the middle class so long as they can promote the interests of the super-rich. How lucky for Mr Obama that the super-rich Mr Romney made his fortune in the cut-throat business of private equity.



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This is the electoral logic behind the speech last week in which Mr Obama claimed that the Republicans had embraced a form of “thinly veiled social Darwinism” that would deprive needy children of healthy food, slash cancer research, close down national parks and eliminate air-traffic control in swathes of the country. It sounds scary, and it contains more than a grain of truth—but in fact the Republicans have proposed none of these specific cuts. Mr Obama’s dystopian predictions are based on his own extrapolations from the broad spending cuts proposed by the Republicans in Congress.



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Mr Romney’s retort is that the president is attacking policies nobody is proposing, “setting up straw men to distract from his record”. Coming from the Republicans, this is rich. They have attacked a straw man since the day Mr Obama was inaugurated. They labelled his conventional Keynesian response to a deep recessionsocialist”. They called Obamacare unAmerican, even though this market-based scheme to extend health cover to 30m uninsured Americans is almost identical to the one Mr Romney adopted as governor of Massachusetts.


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Mr Romney also accuses Mr Obama of drowning the American dream in a sea of red ink. But on this issue there is plenty of blame to go round. Although Mr Obama has yet to come up with a serious plan to tame entitlements, he did try last summer to negotiate a “grand bargain” on the deficit. And when that failed, Congress voted for an automatic deficit-reducing spending cut (the “sequester”) of $1.2 trillion over the next decade that is supposed to kick in at the end of this year.


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Elections that offer clear choices can be good things. Isn’t that politics as usual? But American voters are in danger of being forced to choose in November between a Republican Party that is allergic to needed tax rises and a Democratic Party that lacks the courage to make the spending cuts required for America to live within its means. The prospect is for a shouting match that pushes the parties ever further apart and threatens to make the whole system of government seize up.



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This is not politics as usual


.Indeed, the system is already dangerously close to seizing up. The present Congress is the most polarised of modern times. The Republican landslide in the 2010 mid-terms swept a new breed of conservative zealot into office, destroying the middle ground and making legislating next to impossible. The Supreme Court is polarised, too—so much so that it might strike down Obamacare, the president’s flagship achievement, on the deciding vote of a single judge.



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In short, America is in dire need of the sort of comity Mr Obama promised in 2008. We are not red states and blue states, he said then, we are the United States. What a pity that he is changing tack this time, bashing the rich via gimmicks such as the “Buffett rule” (which is supposed to make millionaires like Mr Romney pay at least the same tax rate as their secretaries) and galvanising his base by brushing aside even the sensible part of the Republican argument that something radical must be done to curb entitlement spending. He may feel he has no choice. But it is a miserable portent for the future.