August 8, 2013 4:53 pm

 
Why the eurozone will come apart sooner or later
 
The single currency has failed to become the harmonising force that it was supposed to be
 
Flags of the EU member states fly in front of the European Parliament in Brussels


Imagine a corner shop that is not doing well. At best it cannot provide its owner with a minimum standard of living. At worst it cannot even cover its costs and is kept going by loans and donations from relations, friends and well-wishers. One of these was even heard to remark that he would do what was necessary to keep the shop going, and added: “Believe me, it will be enough”.

All analogies are imperfect but this one is quite near the mark for the eurozone’s uncompetitive members. Since the euro was inaugurated in 1999, German unit labour costs have risen by less than a cumulative 13 per cent.
 
During this time, Greek, Spanish and Portuguese labour costs have risen by 20 to 30 per cent, and Italian ones by even more. It is hardly surprising that Germany has a current account surplus of 6 per cent of gross domestic product, while Greece, Italy, Portugal and Spain have a bare balance.
 
Estimates need to be taken with a very large pinch of salt but their general message is all too plausible. No so-called banking union or fiscal harmonisation will suffice while these imbalances remain.
 
The economic theorysuch as there wasbehind the creation of the euro was that the single currency itself, and the supposed impossibility of devaluation by members, would act as a harmonising force. But this has not happened and present relationships have become unsustainable.

Herbert Stein, an economist active in Washington towards the end of the last century, said that if a policy or situation was unsustainable, it would not be sustained. But he did not indicate how long it would take for such situations to unravel.

Meanwhile, it is in the interests of the eurocrats to make the problems seem as complicated as possible so that only a small number of so-called financial experts can even discuss them; and we have had one financial package after another and one guarantee after another to keep the structure going. But loans and guarantees do not make the unsustainable sustainable. There is only a limited number of ways that the situation could develop.

First, austerity” in the peripheral countries could succeed. By this, I mean the demand squeeze imposed on them results in a fall in costs and prices, relative to their eurozone neighbours, leading to greater competitiveness, an eventual recovery in living standards and a sharp drop in unemployment.
 
A variant of this would be an improvement in non-price competitiveness: more imaginative Aegean tourist trips or more attractive hotels in the Algarve. The key question is how many years – or decades – the correction would take.
 
Second, the peripherals could continue to stagnate. Unemployment is now 22 per cent in Greece, 24 per cent in Spain, 18 per cent in Portugal, 15 per cent in Ireland and 10 per cent in Italy. (By comparison, it is 8 per cent in the US and the UK). I am afraid a variant would be for their situation to grow still worse; and emigration beckons.

The third option is unlikely, but included for completeness. Germany and other northern euro members could pursue moreexpansionary” (read inflationary) policies, thus reducing the agony of the south. Alternatively it could continue to subsidise the peripherals indefinitely.

The fourth option is for one or more of the peripherals to leave the eurozone. All hell would then break loose, not only among the departing but also in the remaining euro countries, where banks have large and potentially depreciating euro assets on their books. But eventually the ex-euro members would pick up the pieces and emerge with more tolerable performance, as occurred with Argentina when it severed a supposedly unbreakable link with the US dollar. Some economists would like to approach matters the other way round and would prefer Germany and its neighbours to take the initiative and appreciate out of the euro; but this will not happen irrespective of the results of he forthcoming German elections.

Of course, one can imagine any number of permutations and compromises among the above four conjectures, but the possibilities are limited. If I had to bet (which I don’t), my money would be on number 4. But I would not bet at all on when it will occur. The Holy Roman Empire – which was proverbially neither holy nor Roman nor an empire – was founded by Charlemagne in 800 and lasted until it was dissolved by Napoleon in 1806. The German Confederation was inaugurated after the Napoleonic wars and had no real powers over member states. It was reinforced by a customs union (Zollverein) in 1834 and the whole rickety structure lasted until it was dissolved into the German Reich by Bismarck in 1871.

History may have since sped up, but we do not know by how much, and the timescale of euro disintegration is anyone’s guess. There is a limit to how much forward guidance one can give.

 
Copyright The Financial Times Limited 2013


Europe’s bail-out programmes

What Angela isn’t saying

Euro-zone rescues have left sovereign debt too high to be sustainable

Aug 10th 2013
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AN ORCHESTRATED hush has descended over the euro area as Angela Merkel, the German chancellor who conducts its troubled band of 17 states, campaigns for a third term in the election on September 22nd. The calm also stems from signs that the euro-zone economy may gradually be emerging from recession. But discord will reappear after the poll as it becomes clear that Europe’s bail-out programmes won’t be unwound harmoniously and that more big bills are on their way.

Of the first three rescued euro-zone countriesGreece in the spring of 2010, Ireland at the end of that year and Portugal in mid-2011—only one should be able to leave its bail-out programme as planned. Helped by its resilient economy, Ireland, whose rescue amounted to €67.5 billion ($90 billion), looks set to bow out at the end of this year. In practice, however, it will be only a partial departure.


Ireland will then rely on private markets to meet its financing needs rather than on official loans. It will no longer have to comply with harsh fiscal and economic conditions set and monitored by the European authorities and the IMF. But although Ireland has made some successful forays into the capital markets this year it is rightly nervous about standing alone again. This year’s budget deficit remains high, at 7.5% of GDP.

Government debt, swollen by a massive injection of public money into Ireland’s banks, has reached 125% of GDP (see chart). The actual burden is higher because a big chunk of GDP comprises lightly-taxed profits made by foreign multinationals; debt as a share of GNP, the part of GDP that goes to Irish residents and the main tax base, is over 150%.

Conscious of its vulnerability, Ireland wants its borrowing to be shielded from bond vigilantes by the European Central Bank (ECB) through its pledge to make potentially unlimited purchases of debt in secondary markets. But the country will be eligible only if it signs up for a precautionary programme with the euro zone’s rescue fund, which will provide a credit line. Although the conditions for this will be lighter than those for a full bail-out, Ireland will still have to be monitored. Moreover, the ECB has said that the IMF should be involved. In short, Ireland will exit from one bail-out programme and enter another.

The Irish departure is supposed to pave the way for Portugal’s exit in mid-2014, again three years after it received a rescue, in its case of €78 billion. But this prospect is now in doubt as a wrenching recession has undermined support for the government led by Pedro Passos Coelho. Although Portugal managed to raise some funds from the markets earlier this year, it has since suffered an acute political crisis, which has weakened its capacity to tackle a budget deficit of 5.5% of GDP this year.

Weighed down by debt, Portugal’s medium-term growth prospects are poor. Public debt has reached 127% of GDP, and the potential burden is higher. The government has big contingent liabilities, arising from guarantees, public-private partnerships and publicly owned firms. These could turn into actual debt: the IMF estimates they could add a further 15% of GDP to the burden, taking the ratio above 140%. Whereas Irish ten-year bond yields are below 4%, Portuguese yields are above 6.5%too high for so indebted a country. Markets are signalling disbelief that Portugal will avoid some form of second bail-out.

That was the fate of Greece last year, following its original rescue in May 2010. Altogether its two bail-outs have provided €246 billion of rescue financing, bigger than Greek GDP. And yet even more is now necessary: the IMF says that a hole of €4.4 billion will open up in late 2014.

Since it can lend only if financing is secure a year ahead, the IMF wants reassurance from the Eurogroup of finance ministers that they will plug the gap. Beyond lies another hole in 2015, of €6.5 billion.


The fundamental problem is that Greek debt is still far too high. Public debt will peak at more than 175% of GDP at the end of this year. The hope is that economic recovery from 2014 together with continuing fiscal stringency will put it on a downward path. But Greece will need more debt relief if it is to hit a target of 124% by 2020. Since Greek debt is now overwhelmingly in official hands and the IMF insists on its loans being repaid, that relief will have to come from the rest of the euro zone. The IMF says that the Eurogroup must provide debt relief worth 4% of GDP (around €7 billion) in 2014-15. And it will have to come up with even more to reach another target, for debt to drop below 110% by 2022.

Beating targets for privatisation revenues would help, but Greece has a terrible record of undershooting them: the goal for this year will be missed by €1 billion. The main answer will have to be debt forgiveness. Europe has already eased debt burdens on bailed-out economies by lowering interest rates on its loans and extending maturities. Greece is getting even more help, receiving for example central-bank profits from buying its bonds. But it is still not enough. That awkward truth, already apparent before the German election, will become manifest after it.


August 8, 2013 5:13 pm

 
Wanted: writer to help Fed share its feelings
 
The role of America’s central bank has become largely literary
 
 
I have a modest proposal for Barack Obama. I think that the president should consider writers as well as economists as he looks for the next chairman of the Federal Reserve.
 
I say this with all due respect for the reputed frontrunners, economists Janet Yellen and Lawrence Summers. Their CVs have a lot more lines on them tan mine does.
 
I just fear that people of this sort were meant for a time that has come and gone – by which I mean the era when central bankers actually moved interest rates up and down.

Economists were handy in those circumstances because they had facility with figures needed to quickly calculate the precise level of the overnight lending rate – to the very basis point – that would yield full employment, low inflation, harmony and understanding.

But the Fed no longer aims so high. The central bank lowered the overnight rate to nearly zero close to a half decade agoin 2008 (you could look it up) – and it is still waiting for the desired results. The Age of Aquarius hasn’t been quite what it was cracked up to be, in case you haven’t noticed.
 
The big drama at the Fed these days involves the question of when it might start to taper not end or reverse, mind you, just taper – its latest round of bond-buying or quantitative easing, known as QE3, which was undertaken to hold down longer-term interest rates for mortgages and that sort of thing.

The Fed’s role in this context has become largely literary. It doesn’t change rates. It issues statements about its feelings – which are then parsed by the financial community, as if they were passages of the Bible, for signs of policy shifts to come.

We all hope this state of affairs will pass and economic conditions will return to the old normal. But a wish won’t make it so. There’s a very real possibility that the next Fed chairman will do nothing more than produce text, and that suggests Mr Obama should at least consider a professional writer for the post.

An illustration by Banx about the Vatican bank


Now, I know what many of you are thinking and I would say for the record that I’m not interested in the job. You’re looking at one reporter who can resist the lure of public serviceat least for now (the midterm elections could change things, given my enduring commitment to working families with children in New York’s Fourth Congressional District, where I grew up and was taught in the public schools).

Besides, there’s a world of better choices. Mr Obama will obviously select a US citizen to head the central bank, but if we let our imaginations drift across the literary landscape, we would find scribblers in all corners of the globe who could help the Fed better describe the current economic environment.

Near the top of any list would be Salman Rushdie. There’s a man who wouldn’t go weak-kneed at the sight of bond market vigilantes; after all, he has taken on the real-life Revolutionary Guard. I also suspect he would be better equipped than most economists to handle the public relations side of central banking. The key, of course, is to be interesting without being understandable, and anyone who has tried to read The Satanic Verses knows Mr Rushdie’s skills in this regard. This guy would be like Alan Greenspan on steroids.

Another possibility would be someone along the lines of the unforgettable Milan Kundera. His skill set is exactly what the Fed needs to carry out its basic mission in these tentative times – to change its language on the economy. Mr Kundera originally wrote in his native Czech and then switched to French. Think of what it would be like if the Fed could move between the two tongues to suit the situation. The level of nuance would be off the charts; CNBC’s Rick Santelli, for once, would be rendered speechless.

Back in the USA, Mr Obama might consider the poet who appeared at his second swearing-in ceremony, Richard Blanco. Indeed, the piece Mr Blanco read – a survey of a day in the life of the USreminded me in its rigour of the Beige Book, the Fed’s regular summary of economic conditions in its various districts.

The difference was that Mr Blanco put flesh on the data points, and I can’t see how it would hurt the Fed’s next leaderwhoever it is and whatever his or her academic training – to do something similar.

Even when monetary policy is on hold, the Fed chairman still speaks to a people in motion. Days give way to nights, as Mr Blanco said, leaving all of us/facing the stars/hope – a new constellation/waiting for us to map it,/waiting for us to name ittogether”.


 
Copyright The Financial Times Limited 2013

sábado, agosto 10, 2013

CARRY ON TRADING / THE ECONOMIST


Buttonwood

Carry on trading

Why nominal interest-rate differentials are important to currency markets

Aug 10th 2013


AROUND $5 trillion is traded on the foreign-exchange markets every single day, according to a recent survey sponsored by the world’s big central banks. That compares with global trade in goods and services of $18.3 trillion a year, or about $50 billion a day.

In other words, the currency markets are not solely devoted to helping German carmakers turn their export earnings back into euros. Even if you exclude deals made between banks, financial institutions account for a much larger chunk of foreign-exchange transactions than other businesses. Shifting capital around the world moves currencies more tan shifting goods does.

What inspires investors to favour one currency over another? Perhaps the most consistent factor over the past 20 years has been the “carry trade”. This involves a trader borrowing in a country with low interest rates and investing the proceeds of the loan in a country with higher rates, and pocketing the difference.

In theory, it seems odd that the carry trade works. The most likely reason for one country to have higher nominal interest rates than another is because it has persistently higher inflation. Over time you would expect to see currency depreciation in the high-inflation nation because its exports will gradually become less competitive.

In the forward markets, which set prices for specified future dates, this rule is rigidly observed. When one country has a higher interest rate than another, its currency will trade at a discount to that of the other nation in the forward market. That discount will exactly offset the rate differential. So if euro-zone interest rates were two percentage points higher tan those in America, the euro will trade at a 2% discount to the dollar in the 12-month forward market. If it did not do so, traders would be able to make a risk-free profit.

The forward market is a naiveforecast” of future currency movements. But an analysis by Record Currency Management of 33 years of data on five big currencies shows that the currency in the country with the higher interest rate outperforms the forward exchange rate slightly more often than not. This translates into a small monthly gain for investors.

Why is this the case? Neil Record, the founder of the currency-management firm, finds that, with the exception of America (which has the privilege of issuing the world’s reserve currency), countries with persistent current-account deficits tend to have higher real interest rates than surplus countries. In other words, countries with an addiction to imports have to pay a risk premium to investors to hold their currency.



But the carry trade is based on exploiting the difference between nominal, not real, interest rates. Figures from the Royal Bank of Canada (RBC) show a strategy of being long the currency with the highest yields (ie, betting on a price increase) and short the currency with the lowest yields. The most profitable approach over the past 20 years has been to focus on nominal rates (see chart).

One explanation is that nominal rates are a lot easier to target than real ones. Some governments issue inflation-linked bonds, which pay real rates, but these securities are not that liquid. For other bonds the true real rate can only be known in retrospect.

Elsa Lignos, a currency strategist at RBC, calculated the returns investors would have received had they possessed foresight of the rate differentials between currencies. Even on this basis, knowledge of nominal-rate changes was more important than shifts in real rates.

One reason might be that currencies move in line with relative inflation rates (a theory called purchasing power parity, or PPP) only over the very long run. In the short term they can depart a long way from PPP levels. Currency traders are more concerned about the next few weeks than about long-term exchange-rate movements.

If one country has an extremely high inflation rate relative to the rest of the world, its currency will depreciate very rapidly (Zimbabwe is an obvious recent example of the effect of hyperinflation). But the differences between inflation rates across the developed world are very small and so will not have much of an impact on a country’s competitiveness.

Traders who look at differentials between nominal rates know exactly what they are getting and do not have to worry about such complexities as whether different countries are using compatible inflation measures. The carry trade may be simple, but it works.


Putin Laughs At Saudi Offer To Betray Syria In Exchange For "Huge" Arms Deal

by Tyler Durden

08/08/2013 11:20 -0400

 
One of the more surprising news to hit the tape yesterday was that Saudi Arabia, exasperated and desperate by Russia's relentless support of the Syrian regime and refusal to abandon the Syrian army thus facilitating the Qatari plan to pass its natgas pipeline to Europe under Syria, had quietly approached Putin with a proposal for a huge arms deal and a pledge to boost Russian influence in the Arab world if only Putin would abandon Syria's Assad. It will hardly come as a surprise to anyone that in the aftermath of yesterday's dilettante mistake by Obama which alienated Putin from the western world (and its subservient states such as Saudi Arabia of course), has just said no. It will certainly come as no surprise because as we explained previously, the biggest loser from Russia abandoning Syria (something we predicted would never happen) would be none other than Russia's most important company - Gazprom - which would lose its energy grip over Europe as Qatar replaced it as a nat gas vendor. What is shocking in all of this is that Saudi Arabia was so stupid and/or naive to believe that Putin would voluntarily cede geopolitical control over the insolvent Eurozone, where he has more influence according to some than even the ECB, or Bernanke. Especially in the Winter.
 
From AFP:

On July 31, President Vladimir Putin, a strong backer of Syrian leader Bashar al-Assad, met Saudi Arabia's influential intelligence chief Prince Bandar bin Sultan, after which both Moscow and Riyadh kept a lid on the substance of the talks.
 
"Every two years, Bandar bin Sultan meets his Russian counterparts, but this time, he wanted to meet the head of state," said a European diplomat who shuttles between Beirut and Damascus.
 
"During the meeting at the Kremlin, the Saudi official explained to his interlocutor that Riyadh is ready to help Moscow play a bigger role in the Middle East at a time when the United States is disengaging from the region."
 
Bandar proposed that Saudi Arabia buy $15 billion (11 billion euros) of weapons from Russia and invest "considerably in the country," the source said.
 .
This is where it gets funny:

The Saudi prince also reassured Putin that "whatever regime comes after" Assad, it will be "completely" in the Saudis' hands and will not sign any agreement allowing any Gulf country to transport its gas across Syria to Europe and compete with Russian gas exports, the diplomat said.

Right. Of course, if Saudi is found to have lied about this tiny factoid, it will be none other than the US who would step in and defend its brand new "allies" in the Syrian government.

In 2009, Assad refused to sign an agreement with Qatar for an overland pipeline running from the Gulf to Europe via Syria to protect the interests of its Russian ally, which is Europe's top supplied of natural gas.
 
An Arab diplomat with contacts in Moscow said: "President Putin listened politely to his interlocutor and let him know that his country would not change its strategy."
 
"Bandar bin Sultan then let the Russians know that the only option left in Syria was military and that they should forget about Geneva because the opposition would not attend."
 
Russia and the United States have been trying for months to organise an international peace conference between Assad's regime and the opposition to take place in Geneva, but so far to no avail.
 
Asked about the Putin-Bandar meeting, a Syrian politician said: "As was the case before with Qatar and Lavrov (in talks), Saudi Arabia thinks that politics is a simple matter of buying people or countries. It doesn't understand that Russia is a major power and that this is not how it draws up policy."
 
"Syria and Russia have had close ties for over half a century in all fields and it's not Saudi rials that will change this fact," he added.
 
The meeting between Bandar and Putin came amid tension between Moscow and Riyadh over the conflict in Syria, as Russia has accused the Saudis of "financing and arming terrorists and extremist groups" in the war which has killed more than 100,000 people since March 2011.
 
While there was no official reaction to the meeting, Russian experts also said Putin had apparently turned down the Saudi offer.
 
According to military expert Alexander Goltz from online opposition newspaper Ejednevny, "such an agreement seems extremely improbable."

Of course it is, because as JPM and Goldman are to the US government, so Gazprom is to Russia.

What is most interesting here is that Russia is now actively stretching its wings against not only the US but its chief foreign allies abroad. Which only means that a confrontation with Israel, directly over Iran or otherwise, is only a matter of time.