The role of government bonds as an asset class is changing

Mar 21st 2015

NEGATIVE bond yields are a very modern phenomenon. The idea that rational investors would sign up to lose money in nominal terms would have seemed laughable 30 years ago. Now it looks as if European investors are embracing Islamic finance, which eschews interest altogether.

It is possible to explain negative yields in terms of deflationary fears or risk aversion. But Jérôme Teiletche of Unigestion, a Swiss fund-management group, says that such yields are fundamentally changing the risk-reward profile of government bonds and thus the role that bonds should play in investors’ portfolios.

Many natural phenomena, such as people’s heights, conform to what is known as the normal distribution or the “bell curve”. If the average male height is 178cm, say, the number of men who are shorter or taller will decline the further you get from that mark. The normal distribution is easy to model: 95% of the data will be within two standard deviations of the mean. It is thus common to use the normal distribution when analysing the financial markets—when calculating, for example, the “value at risk” of a portfolio.

But financial markets tend to have “fat tails”—more extreme outcomes, in the form of bubbles and crashes, than the normal distribution would suggest. The 23% fall in the Dow Jones Industrial Average on October 19th 1987 is an obvious example. Markets tend to rise more slowly than they fall. They may take months to advance by 15-20% but can drop that far in a week or even a day. In statistical jargon, this is known as “negative skew”.

Strategies with negative skew have been described as “picking up nickels in front of steamrollers”.

An investor may make a series of small gains, only to be wiped out by a sudden, large loss. An example would be offering insurance (selling put options) against a sharp plunge in the stockmarket.

Most of the time, the market will not fall, and the seller will pocket the premium. But at times like October 1987, the bill will come due.

Another asset class with negative skew is high-yield, or junk, bonds. At best, investors will be repaid at par on maturity; at worst, the company defaults and investors get back pennies on the dollar.

In contrast, government bonds have typically been used as “shock absorbers” within portfolios.

When equities or commodities are plunging, government bonds tend to do very well. Even when bonds do badly, the pain is not that great. Since 1925 the biggest annual loss in real terms (including the income from interest payments) in the Barclays US bond index was 15.5% in 2009. In contrast, the biggest real loss in equities was 38.9% in 1930; and there were seven other instances of a real annual loss of more than 20%.

When yields are zero or negative, government bonds clearly do not give investors an income.

The problem is that they may not function as shock absorbers either. It is hard to say precisely how far yields can fall: until recently, many people may have felt that zero was a firm limit.

Even if slightly negative yields are palatable, however, it seems inconceivable that investors would accept an annual loss of 5%, say.

Since prices move in the opposite direction to yields, it is thus difficult to imagine investors buying bonds at current yields making much of a capital gain. It is easy, though, to imagine them making a big loss. If inflation returns, nominal yields would rise sharply and prices would plummet. Government bond returns seem likely to have a negative skew.

As evidence, Mr Teiletche points to Japanese government bonds, which have had very low yields since the turn of the century. Japanese bonds have not been very volatile but they have had a negative skew. In this respect, they resemble equities and high-yield bonds (see chart).

If government bonds in the rest of the developed world start to behave like Japan’s, then some investors may doubt whether they are worth holding at all. They will simply offer reward-free risk.

Low yields may still last for a while, even so. Many investors—pension funds, insurance companies—are forced holders of government bonds for accounting or regulatory reasons.

Central banks also tend to hold other countries’ government bonds as a key component of their reserves. And of course, the European Central Bank and the Bank of Japan are committed to buying tens of billions of government bonds each month. But in doing so, Mr Teiletche implies, they are fundamentally altering the nature of the bond market—perhaps for ever.

Gold Moving Up, But Watch Out For Whipsaw

by: Ben Lockhart

  • The low I expected at $1140 has now played out and we should be targeting at least $1200 in the short term.
  • Fed induced market volatility in February and March shows that we should remain alert to the potential for whipsaw.
  • Gold movement up or down as we move into early April should set up a profitable swing trade in the opposite direction into the summer months.
I have to admit that going into the Federal Reserve announcement on Wednesday I was feeling a little bearish on gold (NYSEARCA:GLD) and the gold miners (apologies to those following along in the comments section), but my fears were unjustified and the forecast in last week's article was pretty much on point.

If you remember, I was looking for gold to put in a low at an ideal price level of $1140, before starting a fed induced rally that should take us up to at least $1200 and possibly a good deal higher. On Wednesday we bottomed at $1141 and started a rally that took us up as high as $1188 before closing the week at $1182. So are we now in the throes of a rally up to test the January 2015 highs? Possibly, but bulls need to be careful this week as I feel there is potential for whipsaw in the gold price.

What's Up With The Fed?

In the February meeting and subsequent press conference, Janet Yellen indicated that the Federal Reserve is open to raising the base rate as soon as June 2015. Global markets went haywire, with stocks bond and commodities all declining pretty hard on the day. The only real winner was the US Dollar which broke out to new highs on the news, and pressured the gold price into a pretty sizeable drop.

This time around we had the reverse, whereby Aunty Janet soothed and caressed the Wall Street faithful by saying that the decision to raise the benchmark rate is 'data dependent' and just because they can raise the rate in June, doesn't mean they actually will decide to take that action. Everything rallied, with stocks, bonds and precious metals putting in decent gains. The US Dollar fell hard on the day, with the euro appreciating 3% against it within a few short hours.

So what's up with that? Is there indecision within the ranks? Can they just not make up their minds?

In my opinion the answer to that is a resounding no - the Fed are unanimously desperate to raise rates but were pressured into a more dovish announcement by various foreign central banks (and one particularly influential monetary maven) who are fully aware that a rate hike will hurt their own economies. At a press conference in India just a few days prior to the Fed meeting, IMF Chief Christine Lagarde said the following:
The danger is that vulnerabilities that build up during a period of very accommodative monetary policy can unwind suddenly when such policy is reversed, creating substantial market volatility.. We already got a taste of it during the taper tantrum ... I am afraid this may not be a one-off episode. This is so, because the timing of interest rate lift-off and the pace of subsequent rate increases can still surprise markets.
The Fed want to raise rates. They are painted into a corner and should a financial crisis unfold in the near term they would be unable to take any real action to restore confidence to the markets. Despite the massive cash injections via their QE programs inflation is still anemic at best, and although QE is not seen as an outright failure, it is certainly not lauded as a runaway success. Markets are all about confidence - the confidence you need to put your hard-earned money at risk - and with rates at current low levels, and QE not really having the effect intended, they need to restock the medicine bag should markets need a shot in the arm.

Emerging market economies do not want the Fed to raise rates. Many have issued bonds denominated in US Dollars and are already suffering in light of dollar strength which makes repayments more costly. We saw what happened when the Fed hinted at a rate hike - bonds dropped hard while the US Dollar soared higher - and we can expect the same thing to happen when they finally do take action.

Christine Lagarde is essentially warning these markets that they need to prepare for volatility ahead, and at the same time lobbying the Fed not to take action too soon.

Given the market reaction to the possibility of a US rate increase we have seen in February and March, it is fair to assume that this is a hot topic and is likely to result in some market gyration as and when it is being discussed. When asked on Friday about the possibility of a correction in markets, former Dallas Fed President Richard W. Fischer said:
Are we vulnerable in my personal opinion to a significant equity market correction? I do believe we are, and the reason for that is people have gotten lazy. They've depended totally on the Fed… 
Yes, we have… conditioned the markets.
This coming week we have a number of Fed board members attending public functions and some making public speeches, with Janet Yellen speaking in San Francisco on March 27th. Market participants therefore need to stay flexible and alert for whipsaw in gold and other markets, as one wrong word is likely to result in a big move. The merest hint of the Fed 'no longer having our back' could send markets into a temporary tailspin.

Data Points

Has the US Dollar Topped?

I have been asked this question quite a bit recently, and I have read many articles this weekend that point to a coming correction in the dollar, some even suggesting that we have just put in a major high. Those with that opinion are likely to be correct - but only for about 3 weeks! I keep saying it but it's worth repeating: The US Dollar is going much higher, and much quicker than you expect.

When I wrote my fist article for Seeking Alpha in mid-December last year The US Dollar index (DXY) had a value of 87.50 and there were calls for a correction even then, with many writers/analysts stating that the move was 'parabolic'. It is has since appreciated by close to 15%, and we are only now approaching what may be a temporary stopping point at 103.

The chart I included last week is still very much applicable, but this week I have zoomed in a little to the daily timeframe. We can see that the pullback this week found support at the 23.6% fib retracement level of the previous wave, and has since bounced a little.

(click to enlarge)

There is a chance that we have already made the low before resuming our ascent to 103, but I can't rule out the chance of a move that retests this low and possibly drops further to the 38.2% retracement at 94.29 before heading higher.

Once we do hit 103, and assuming that we don't just blast through it, major support for the rise to date comes in at 91.59 and would be a great price to enter long with a stop just below. I will be adding to my long positions at that point if we get there, but with a move this bullish don't be surprised if we hold support higher towards that 94/95 region - traders will be looking to buy dips.

Commitment of Traders Report

The latest COT figures are below:


Last week I noted that the Large and Small Speculator categories were piling on the short contracts at what could be precisely the wrong time, and with the rally from $1141 now having taken place you can see exactly why.

The report comes out each Friday but includes data up to and including the preceding Tuesday, so this week's report gives you the number of contracts bought and sold between March 10th & 17th. The highest gold price for the week (actually on the 10th) was roughly $1170, so each and every short contract detailed in this report was purchased at a price lower than the price gold trades at today.

You can imagine the scramble to sell these contracts as gold moved up from $1141, and of course it is possible that they were all sold without incurring a loss, but I would imagine next week's report won't show that to be true, and some of these contracts will remain on their books and underwater.

The Commercials added 25,000+ long contracts during the period, and even if these were all purchased at the highest gold price in the week (very doubtful), they are all nicely in profit and looking good for gains ahead. You have to hand it to the Commercials - they are almost Zen-like in their trading; always one step ahead.

Overall the report is bullish for gold, but just bear in mind that we have the potential for whipsaw this week and next, and we may see changes now that the rally has blasted off and the Commercials can take profits.


As of March 15th detailed in his supply and demand report, Keith Weiner of Monetary Metals indicates that backwardation (scarcity of physical metal for sale and/or greater demand for physical metal than current supply allows) remains in place for the April contract and has increased from last week. The June contract is also close to going negative, meaning that there should be a bid underneath the gold price as no shortage of buyers wait in the wings to make purchases.

The data is a week old, but the important point is to note that backwardation has increased since the last report was given. With the pop in the gold price this week it will be interesting to see if any great changes appear when figures are next detailed - should it remain in place or increase I would view this as very bullish for gold prices over the next few weeks.

Gold Miners

The gold mining majors (NYSEARCA:GDX) and the juniors (NYSEARCA:GDXJ) all performed well this week given the rise in the gold price. I have included a chart for the majors below:

(click to enlarge)

As we can see, we held the December 2014 low and have started to move higher, but we are now approaching a possible area of resistance and you should be on the lookout for a pullback from this zone. There is a gap in the price at 19.50-20, and declining trend line resistance stands at just over 20.

I have detailed the options on the chart via red and blue markings. The red count says we fill the gap, but fail to take out the trend-line resistance and create what would be a head and shoulders technical pattern which if it triggers targets new lows. The blue count says we are now in a C wave higher, and if we break strongly through the declining trend line we should be targeting 24.

The junior miners have exactly the same pattern and options at present, with the gap and trend line resistance coming in at broadly the 25 level, and a target of 29-32 should this level be broken to the upside.

Gold Chart

A look at the chart tells us that the pop I expected is now playing out, and our first target is the $1200-1220 price zone:

(click to enlarge)

The count lines up well with how I see the gold miners progressing also, with the $1200-1220 zone representing the gaps at 20 for GDX and 25 for GDXJ. Our first test is now coming, and I expect that we will see at least a pullback from this area.

The pullback (or lack of one) will determine whether or not we are in our C wave higher. A corrective decline would indicate we are heading to test the January highs and perhaps exceed them ($1345?); an impulsive move lower from this price zone would mean we are more than likely on our way to new lows and targeting $1086 at a minimum.

Cycles indicate that a turning point for gold is close (April 6th +/- 3 days), but this can be a high or a low. If we were to blast higher over the next 2 weeks in our C wave we should be setting up a very tasty short into the summer. If we decline to new lows over the next couple of weeks, we are likely setting up a decent long entry.

A lot will be decided in the next month, so it would pay traders to say alert and not to marry positioning. As usual I will update thoughts in the comments section and I wish everyone good luck for the coming week!

The New Order Emerges

By: Alasdair Macleod

Friday, March 20, 2015

China and Russia have taken the lead in establishing the Asian Infrastructure Investment Bank (AIIB), seen as a rival organisation to the World Bank and the Asian Development Bank, which are dominated by the United States with Europe and Japan. These banks do business at the behest of the old Bretton Woods[1] order. The AIIB will dance to China and Russia's tune instead.
The geopolitical importance was immediately evident from the US's negative reaction to the UK's announcement this week that it would join the AIIB. And very shortly afterwards France, Germany and Italy also defied the US and announced they might join. In the Pacific region, one of America's closest allies, Australia, says she is considering joining too along with New Zealand.

The list of US allies seeking to join is growing. From a geopolitical point of view China and Russia have completely outmanoeuvred the US, splitting both NATO and America's Pacific alliances right down the middle.
This is much more important than political commentators generally realise. We must appreciate that anything China does is planned well in advance. Here is the relevant sequence of events:
  • In 2002 China and Russia formally adopted the founding charter for the Shanghai Cooperation Organisation, an economic bloc that today contains about 35% of the world's population, which will become more than 50% when India, Pakistan, Iran, Afghanistan and Mongolia join, which is their stated intention. Russia has the resources and China the manufacturing power to develop the largest internal market ever seen.
  • In October 2013 George Osborne was effectively summoned to Beijing because China wanted London to be the base to develop renminbi-denominated financial instruments. London has served China well, with the UK Government even issuing the first renminbi-denominated foreign (to China) government bond. The renminbi is now on the way to being a fully-fledged international currency.
  • The establishment of an infrastructure bank, the AIIB, will ensure the lead funding is available for the rapid development of road, rail, electric and electronic communications throughout the SCO, ensuring equally rapid economic development of the whole of the Asian continent. It could amount to the equivalent of several trillion dollars over time.
The countries that are applying to join the AIIB realise that they have to be members to access what will eventually become the largest single market in the world. America is being frozen out, the consequence of her belligerence over Ukraine and the exercise of her hegemonic power through the dollar. America's allies in South East Asia are going with or will go with the new AIIB, and in Europe commercial interests are driving America's NATO partners away from her, turning the Ukraine from a common cause into a festering liability.

The more one thinks about it, the creation of the AIIB is a masterstroke of tactical genius. The outstanding issue now is China and Russia will need to come up with a credible plan to make their currencies a slam-dunk replacement for the dollar. We know that gold may be involved because the SCO members have been accumulating bullion; but before we get there China must manage a deliberate deflation of her credit bubble, which will be a delicate and dangerous task.

Unlike the welfare-driven economies in the west, China has sufficient political authority and internal control to survive a rapid deflation of bank credit. When this inevitably happens the economic consequences for the west will be very serious. Japan and the Eurozone are already facing economic dislocation, and despite over-optimistic employment numbers, the US economy is faltering as well. The last thing America and the dollar needs is a deflationary shock from China.

The silver lining for us all is a peace dividend: it is becoming less likely that America will persist with a call to arms, because support from her allies is melting away leaving her on her own.

10:55 am ET Mar 19, 2015

The Fed Turns Gloomier on the Supply Side       

By Greg Ip.

Fed Chairwoman Janet Yellen on Wednesday.
Getty Images

The Fed has revised down its growth outlook so often that it seems hardly noteworthy it did so again Wednesday.

Yet the downgrade is telling in a little-noticed way: the Fed is getting gloomier about the supply side of the economy, and that’s one reason why interest rates may be low for longer.

All the monetary stimulus the Fed has thrown at the economy since 2009 has been aimed at reviving demand so that unemployed people and unused capital can be put back to work, restoring U.S. output to its much higher, theoretical “potential” level.

Yet in recent years, the Fed has had to acknowledge the economy’s potential level is less than previously thought. On Wednesday, it did so again.

There are several bits of evidence for this.

The first is the downgrades to the near term growth outlook. GDP is expected to grow 2.5% this year (that’s the midpoint of officials’ fourth quarter to fourth quarter projection), down from 2.8% in December, and 3.2% the prior December. While that reflects the weak character of first quarter data, it’s telling that the Fed does not expect the weakness to be recouped later in the year, as would happen if weather were the culprit.

They also downgraded next year’s forecast to 2.5% from 2.75% in December and 2.9% the prior December. Growth in 2017 is now seen as just 2.2%, compared with 2.4% last December.
Is this because the Fed thinks demand will be weaker, for example, because of the stronger dollar? No: the second bit of evidence is that the Fed also sees unemployment lower over the next three years than it did in December. The difference is trivial–just a tenth of a percentage point–but part of a yearslong pattern.

According to a very old rule of thumb called Okun’s law, unemployment falls when an economy grows faster than its potential rate of growth, and it rises when it grows more slowly.

The fact Fed officials have had to keep revising down both growth and unemployment means they are also, implicitly, marking down potential growth.

True, they left their long-term outlook for economic growth unchanged at from 2% to 2.3%.

There are two possible reasons for that. One is that Fed officials think much of the human and physical capital the economy had before the recession is now obsolete. However, the rate at which the economy acquires new human and physical capital in the future is untouched, so long-run growth is the same. The second possibility is they haven’t got around to downgrading their long-run growth forecast yet. Given the dismal performance of productivity lately, they may have to.

(The Fed did lower its estimates of the natural rate of unemployment, below which inflation takes off, to between 5% and 5.2%, from a range of 5.2% to 5.5%. This, however, simply reflects the fact that wages have been slow to pick up. It doesn’t alter the fact that the labor force–both the employed and unemployed–remains strangely small, and is expanding quite slowly.)

The third bit of evidence of their diminished optimism about supply is the lower view of the long-term federal funds rate. It was 4% a year ago, and then lowered to 3.75% in June. This month, it dropped again, with the majority of officials picking either 3.5% or 3.75%.

The long-run interest rate is the rate that balances investment with saving and keeps the economy growing just fast enough to keep unemployment at a minimum without fueling inflation. If the rate drops, that implies there is less investment competing for savings, and the economy’s potential growth rate is lower.

This is one of the symptoms of “secular stagnation,” the phenomenon that Larry Summers has publicized for well over a year. Mr. Summers blames secular stagnation on a shortfall of demand, which holds down inflation, interest rates and growth. But his main exhibit–low interest rates–could be due to weak supply. If businesses and households are pessimistic about technology, productivity and incomes, they will borrow and invest less and save more.

This may help explain why Fed officials lowered the path of interest rates over the next three years so much. It is in great part due to the lower inflation and weaker growth officials now see, both in the U.S. and abroad. But it may also reflect a view that interest rates don’t have to be as high as they were when potential growth was higher.

The strong dollar

Mismatch point

The rise of the dollar will punish borrowers in emerging markets

Mar 21st 2015

IN THE three months following the collapse of Lehman Brothers, as the world economy crumbled and investors scrambled for shelter, the dollar rose by 5% against a basket of other widely used currencies. In the past three months it has jumped by 11%; over the past year, by 22%—its fastest ascent in decades. The dollar is not yet in uncharted waters: one euro was worth one dollar in the early 2000s, for example. Its rise will help exporters in less vibrant parts of the world, notably Europe. But moves of this magnitude usually catch someone out, and the likeliest candidates this time are in emerging markets.

The principal reasons for the greenback’s rapid strengthening are simple to grasp. With Europe and Japan stuck in the doldrums, and China and other emerging markets slowing, America’s economy looks relatively strong. The IMF expects it to grow by 3.6% this year. The Federal Reserve has already begun to tighten monetary policy, by stopping its programme of asset purchases, and is now preparing the ground to go further. This week the Fed altered the wording it uses to describe its plans, giving itself room to raise interest rates later this year—the first rise since 2006. With American monetary policy tightening, and other central banks still loosening, investors can make higher returns from dollar-denominated assets. In capital floods, and up the dollar goes.

The mechanics of dollar strength may be simple, the effects anything but. American firms that sell abroad are hit: around a quarter of the profits of firms in the S&P 500 are earned in foreign currencies. The greenback’s ascent also mutes inflation, complicating the Fed’s judgment about when to raise rates.

But the chance of a shock is highest outside America. Companies around the world, and especially in emerging markets, have been bingeing on dollar-denominated debt, seduced by the lower interest rates on offer compared with local-currency debt. The stock of dollar debts owed by non-financial borrowers outside America has grown by 50% since the financial crisis, according to the Bank for International Settlements. It now stands at $9 trillion. Emerging markets account for half of that amount, up from a third before the crisis. In China alone, dollar-denominated loans have vaulted from around $200 billion in 2008 to more than $1 trillion now.

As the dollar rises, this debt becomes more expensive to service in local currency. And as the Fed starts to tighten, the interest rates charged on dollar debts—whether in bond markets or via banks—will rise in tandem. As a result, borrowers are at risk of a double whammy: a strengthening dollar and a rising cost of borrowing and refinancing. That does not necessarily portend a wave of bankruptcies. But it does mean another drag on growth at a time when swathes of the emerging world are already struggling. Brazil and Russia are heading for deep recessions; China’s property market, for years the economy’s biggest engine of growth, is slowing. Outside the BRICS, in the last quarter of 2014 emerging markets made their smallest contribution to global growth for more than five years.
Tantrum 2.0
Optimists make several soothing arguments. First, plenty of corporate borrowers have income as well as liabilities in dollars, meaning that currency mismatches are not a concern. But many of the firms that do have matched debts and revenues are oil or mining firms, which have seen their income in dollars plunge because of falling commodity prices. And that still leaves lots of other firms which are exposed to currency moves. A quarter of China’s corporate debts are dollar-denominated; only 9% of companies’ earnings are. That the yuan has barely depreciated against the dollar, and that China shows little inclination to let it do so, is a comfort. But the peg is not guaranteed to hold; if corporate borrowers have not bothered to hedge, they will be hard hit.

The second argument is that, as much as borrowers in emerging markets may come under pressure to service their debts, emerging-market exporters will benefit from a falling currency.

Unfortunately, things are not so neat. Although most emerging-market firms that borrow in foreign currency do so in dollars, exporters may trade not with America, but with other countries whose currencies are also depreciating against the dollar. Thus the strengthening dollar can add to emerging economies’ debt burden without helping their exports.

The third source of reassurance is that emerging markets have ample foreign-exchange reserves, which they can use to prop up firms, as Russia and Brazil have done. But countries like South Africa and Turkey have less firepower, and large short-term government debts that will gobble up dollars.

Emerging markets have been put under pressure by the Fed before—most recently in 2013, when the announcement that it would start tapering the pace of its quantitative-easing programme caused money to stampede for safety. If the system could weather that storm, optimists say, it can survive this. But firms have continued to load up on dollar-denominated debt since the “taper tantrum”. And emerging markets are weaker now than they were. The surge of the greenback is one more worry in a world already drowning in them.

Heard on the Street

ECB Faces Tough Task to Revive Securitization

Central bank’s asset-backed securities purchases have proved underwhelming so far

By Richard Barley

March 20, 2015 8:41 a.m. ET

The European Central Bank’s new headquarters in Frankfurt. The ECB started buying asset-backed securities late last year. Photo: European Pressphoto Agency

The European Central Bank’s power to steer markets is undeniable—just look at the euro or eurozone-government-bond yields. But it is finding it trickier to get a grip on purchases of asset-backed securities. The ECB’s efforts to revitalize Europe’s securitization market are falling short of its rhetoric.

The ECB started buying asset-backed securities—which bundle together pools of underlying loans—in late November. But as of March 13, it had bought just €3.8 billion ($4.1 billion) of these securities. By contrast, the ECB bought €9.8 billion of government and public-sector bonds in the first three days of its expanded asset-purchase program. Purchases of securitizations were never going to be the driving force behind expanding the ECB balance sheet, of course, but the result is still disappointing.

Both internal and external factors are at play here. First, the purchase program itself is somewhat cumbersome. The ECB makes use of four external asset managers to suggest potential purchases. But the due diligence required and the time taken for the ECB to decide on whether to buy a security means that actual purchases are a slow process. The system might yet be streamlined. At some point national central banks will take over the purchases, but it hasn’t yet been decided when that will happen.

Second, there has been relatively little new issuance of securitizations, which might provide better opportunities for purchases. One concern is that the massive provision of liquidity by the ECB through other channels, such as long-term loans, means that banks have no incentive to turn to securitization, as funding is plentiful and cheap. In the first two months of the year, securitizations placed with investors totaled €7.6 billion, according to Barclays, the slowest start to a year since 2009.

Third, the regulatory treatment of asset-backed securities is in flux and is still deterring both issuers and investors. A key attraction of securitization for issuers is the ability to transfer risk to investors, freeing up capital, but regulation has made this difficult. This isn't the ECB’s fault but does emphasize that the central bank cannot do everything on its own—as it has made clear on monetary policy more generally.

Part of the problem may be that the ECB’s asset-backed securities program has to serve two ends. It is part of monetary-policy operations, but has an aim beyond that to develop a durable market that could help fund Europe’s small businesses better in future. That creates conflicts: a program to get the market back on its feet might work much better if it was aimed at helping banks transfer risk by buying lower-rated slices of securitizations; as a monetary policy operation the ECB is focused on low-credit risk securities.

The hope remains that a brighter eurozone outlook, greater borrowing and lending and regulatory compromise could yet lift issuance of asset-backed securities. But for now, the market appears beyond the reach of even the long arm of the ECB.

Germany, Greece and history

Pointing fingers

With the euro zone on the brink again, neither childish squabbles nor historical arguments are helpful to Germany or Greece

Mar 21st 2015

THE level of debate between Germany and Greece, protagonists in a drama that could make or break the euro zone, could hardly be called edifying. Take, for example, the YouTube video from 2013 which shows Yanis Varoufakis, then a left-leaning economics professor, arguing that Greece should simply default on its debts and “stick the finger to Germany”, and making an appropriate hand gesture for emphasis. When Mr Varoufakis, now Greece’s finance minister, was confronted with the clip on March 15th during a talk show on German television, he claimed the footage was doctored.

The ensuing “Fingergate” lasted days, as the German media proved that the video was genuine, albeit taken out of context. Germany’s pundits spluttered with rage: the Greeks were mendacious as well as impertinent.

This week marked a nadir in relations between Greece and its largest creditor. The tone has been deteriorating ever since January when Alexis Tsipras, leader of the far-left Syriza party, took over as Greek prime minister. It is clear that Wolfgang Schäuble, Germany’s finance minister, and Mr Varoufakis no longer trust each other as partners in negotiations to extend Greece’s bail-out. When Mr Schäuble called his counterpart “foolishly naive”, Greece’s ambassador in Berlin filed a diplomatic protest.   

Greece’s defence minister has threatened to let masses of Syrian refugees, possibly including terrorists, pass through to Germany. Europe has only itself to blame if that happens, he said. The Greek justice minister suggested that, as part of his country’s ongoing claims against its old oppressor, he might even seize the Athens property of the Goethe Institute, Germany’s cultural agency.

Arguments over a tactless hand gesture might be called a childish spat. But historically based threats to seize German assets carry a heavier payload because they recall some dark spectres that have never ceased to haunt both countries. Between 1941 and 1944 the Nazis occupied Greece with a brutality exceeded only in Slavic countries. Greece has never formally dropped claims on Germany which date from that time. Now, in the midst of a debate about recently incurred Greek debts, the government in Athens suddenly wants Germany to settle some much older obligations, both financial and moral, as well.

Germans don’t like being reminded of the past by others, because they have their own very formal rituals of recollection. Remembering and drawing lessons from the past is baked into the German approach to politics, psychologically and even physically. When legislators walk to debates in Berlin’s Reichstag building, they see walls covered in Cyrillic graffiti. These were scribbled by Red Army soldiers after they stormed to victory in 1945, and meticulously preserved as silent exhortations to responsible governance. Germany’s politicians generally go out of their way to be sensitive to countries which the Nazis invaded or occupied.

Had it not been for Russia’s aggression in Ukraine, Angela Merkel, the German chancellor, would now be preparing to attend the 70th-anniversary celebrations of the Soviet Union’s victory over Germany on May 9th. As it is, she will instead go to Moscow the following day, May 10th, to visit the grave of an unknown soldier. Meanwhile, the need for unequivocal contrition over the Holocaust is the main reason why Mrs Merkel still calls her country Israel’s strongest ally in Europe.

But for all Germany’s impressive atonement and sensitivity, there are limits. This becomes clear when one looks in detail at the cluster of historical issues that have been raised by Greece, and how they have been handled. The Greek demands can be broken into three categories. First, there are general reparations which Germany was expected to pay to the governments of countries that were the victims of its aggression. Second, there are moral or legal debts Germany may owe to individual victims. And third, there is the specific matter of a loan that Greece was forced to extend to Germany during the occupation; it was used to finance the war in Africa.

At a big London conference in 1953, Germany’s creditor countries, including Greece, forgave much of West Germany’s foreign debt, thus helping to make possible its “economic miracle”. But reparations were deferred to a future peace treaty. That treaty was, in effect, signed in 1990, when the two Germanies and the four victors (America, Britain, France and the Soviet Union) accepted reunification. Helmut Kohl, the chancellor, and Hans-Dietrich Genscher, the foreign minister, deliberately avoided calling this “2+4 agreement” a peace accord. This helped deflect suggestions that the matter of reparations should have been dealt with explicitly at the same time. But it was widely assumed that the issue had simply expired.

Greece did not speak up at the time. But it later argued that a treaty to which it was not a signatory could not have wiped out its claims. As Greeks sometimes put it, they were told before 1990 that it was too early to deal with the issue of reparations. Then they were told it was too late. This month Mr Tsipras declared in parliament that Germany had used “tricks” to get out of reparations. This view was firmly rejected in Berlin. Germany considers this case “closed, legally and politically”, as Mrs Merkel’s spokesman repeated this week.

Germany takes a similar view about its possible debts to individual victims and their families. West Germany made many payments of atonement in the post-war years, totalling €71 billion ($75 billion), according to government data. As part of a 1960 agreement with west European countries, it paid DM115m (or €57.5m) to Greek victims of Nazi crimes, which amounts to €2.50 “for each day at Auschwitz,” says Eberhard Rondholz, a historian. To victims and their descendants that seems laughable. Starting in 1997 victims of one German massacre, in the village of Distomo in 1944, sued Germany privately.

In 2012, however, the International Court of Justice in The Hague sided with Germany, invoking the notion that governments have immunity from lawsuits by individuals in foreign courts. Germany was not the only country relieved by that decision; the world is full of governments that have done wrong to foreigners in the past.

The forced loan by Greece to Germany in 1942 is different. It amounted to 476m Reichsmarks or, according to Greek estimates, €11 billion today. (That is about 17% of the €65 billion that Greece today owes Germany as part of its bail-out.) In the 1960s Ludwig Erhard, the then chancellor, said that Germany would repay the loan once it reunified. He may have assumed this would never happen.

There are many in Germany who are open to repaying the forced loan. “When if not now?” asks Mr Rondholz. To avoid setting precedents Germany could put the money into a trust or foundation, he adds. Several politicians from the centre-left Social Democrats and Greens are also calling for repayment, in keeping with Germany’s post-war tradition of assuming responsibility and showing goodwill.

Other Germans see the timing of renewed Greek impatience to talk about the war as suspicious. Since roughly 2000, German identity has shifted, says Hans Kundnani, author of a new book, “The Paradox of German Power”. Germans no longer see themselves only as perpetrators but also as victims of the war, as heirs not only of Auschwitz but also of Dresden, a city incinerated by British bombs.

In today’s narrative, reasonable or not, the Germans see themselves as victims in the euro crisis. They think they are being asked to pay for the errors of others, who are using the past as a “pretext for extortion, a way to get German money”, Mr Kundnani thinks. Indeed Bild, the largest German tabloid, has described the talk of reparations as “blackmail”.

This worsening climate inevitably affects the tone of debate about the future of the euro zone.

According to a new poll, 82% of Germans doubt that Greece will carry through the reforms it has promised, and 52% want it to exit from the single currency. In a sign of her concern, Mrs Merkel has invited Mr Tsipras to Berlin on March 23rd. It will take all her vaunted skill to save Europe from an unintended disaster.

Journal Reports: Health Care

Should All Adults Take a Daily Aspirin?

Jack Cuzick says it’s clear that aspirin can reduce cancer risk; Lianne Marks warns of dangerous side effects

March 22, 2015 11:00 p.m. ET 

Photo: Corbis

The medical guidelines surrounding aspirin therapy can be confusing.

Most doctors agree that an aspirin a day is a good idea for people who already have had a heart attack or stroke, but opinions differ on who, if anyone, should take aspirin to prevent a problem from happening in the first place, a use known as primary prevention.

The controversy centers on the painkiller’s blood-thinning properties: While studies have shown that aspirin offers protective benefits against cardiovascular disease and certain cancers, they also have shown that aspirin use can cause bleeding in the stomach and brain.

The question is, do the benefits outweigh the risks for generally healthy people?

The Food and Drug Administration doesn’t think so. Some researchers, however, believe the tide will turn in aspirin’s favor once the growing body of cancer evidence is fully evaluated.

Jack Cuzick, director of the Wolfson Institute of Preventive Medicine at Queen Mary University of London, argues in favor of general aspirin use, saying the benefit far outweighs the risks; Lianne Marks, assistant dean for educational development and regional chairwoman for internal medicine at Texas A&M Health Science Center College of Medicine, believes the risks are just too great.
YES: The Evidence Is Clear It Reduces Deaths From Cancer
By Jack Cuzick 
If you are a middle-aged adult at low risk for bleeding, there is a simple, low-cost way to reduce your chances of dying from cancer and to a lesser extent heart disease: Take a daily baby aspirin.

A group of international experts reached that conclusion after conducting a formal benefit/harm analysis on aspirin use in the general population. Our study, published in the Annals of Oncology, found that overall for both men and women aged 50 to 65 the benefits of 10 years of low-dose aspirin outweigh the risks of gastrointestinal bleeding and other complications by a large margin.

Specifically, we estimated that daily aspirin could prevent 4% of all deaths in the next 20 years, mostly due to reduced cancer mortality. In terms of cancer prevention, that is exceeded only by avoiding tobacco use and is comparable to reducing obesity but much easier to achieve. Eight deaths from cancer and heart disease would be prevented for every death from gastrointestinal bleeding or stroke. Those are pretty good odds!

Cancer fighter

Many clinical trials have shown a clear reduction in colorectal cancer from aspirin use, and long-term follow-up of those studies suggests aspirin offers protection against other types of cancers, too.

Aspirin seems to have the biggest effect on colorectal, esophageal and stomach cancers, where reductions in excess of 30% were seen both for the development of new cancers and deaths. Smaller but fairly consistent benefits have been reported for lung, prostate and breast cancer, with both incidence and mortality reduced between 10% and 15%. Over 150 observational studies have also confirmed these findings.

Why has it taken so long for aspirin’s anticancer benefits to be discovered? The benefits don’t occur right away, so early follow-up of the clinical trials failed to observe them. It is now clear that at least five years of aspirin use is needed for aspirin’s anticancer properties to kick in, and that the benefits are sustained for many years after aspirin use has stopped. How long this carry-over effect lasts needs to be studied further to determine when to stop aspirin, since the bleeding side effects become more serious after age 70.

Aspirin use isn’t without potential side effects, and those who oppose its routine use may cite studies showing higher-than-acceptable rates of bleeding complications to bolster their case.

We consider such studies to be outliers. We found serious complications to be rare, with one extra major bleeding event requiring hospitalization occurring for every 300 individuals who take aspirin for 10 years. Aspirin also can increase the incidence of hemorrhagic strokes due to bleeding in the brain, but these events are even more rare and are balanced by a similar reduction in the more common occlusive strokes associated with blood clotting. Still, because hemorrhagic strokes are more often fatal, the small number of people with higher bleeding risks (mostly those with diabetes or hypertension, or who take blood thinners) shouldn’t use aspirin without consulting a doctor.

Changing the equation

When aspirin is evaluated solely in the context of cardiovascular disease, its protective effects are less pronounced, which is why major health organizations don’t recommend it for primary prevention. But the growing body of cancer data tips the benefit-risk calculation strongly in aspirin’s favor, and I expect those recommendations to change once that evidence is fully evaluated.

Many things still need to be discovered to refine our use of aspirin for cancer prevention, but that shouldn’t deter people from making use of the clear information we have now.

Dr. Cuzick is director of the Wolfson Institute of Preventive Medicine at Queen Mary University of London. Email him at reports@wsj.com.

Europe squeezes more reforms from Greece as Merkel steps into bail-out talks

Ceditors show no sign of alleviating pressure on cash-stricken government after late-night talks in Brussels

By Mehreen Khan

12:30PM GMT 20 Mar 2015


Chancellor Merkel said she trusts Greece will come good on its promises 
Greece's hard-Left government was told to redouble its reform efforts and begin rebuilding the trust of its eurozone partners after a marathon four-hour meeting of European leaders yesterday.
With time running out on agreeing the details of a new bail-out deal, Athens was urged to speed up its commitment to raising revenues and overhauling its economy by the leaders of France and Germany.
"We have to take that at face value and say we trust that this will happen,” said Angela Merkel, referring to the Athens' promises to meet their bail-out conditions. “And then we will see what comes."
In a welcome sign for Greece, the country's interminable debt talks are now taking place at the highest level of European diplomacy.
Previously, Greece was left to negotiate with the lower tier of European finance ministers. But relations with the Eurogroup deteriorated earlier this week after the group's chief suggested Athens may need to resort to capital controls.
Greek Prime Minister Alexis Tsipras said he was more optimistic of drawing up a satistfactory reform list after the summit.

“There was confirmation of the will of all sides to work so as to restore the financing ability of the Greek economy as soon as possible,” said Mr Tsipras.

A four-month continuation of the country's bail-out was agreed in principle last month. But the €7.2bn has yet to be released to the cash-strapped government which is struggling to stay solvent this month. Greece is due to repay its last tranche of IMF loans due for March later today.

The debt-stand-off has seen Greece's 10-year bonds spike above 12pc, the highest level since June 2013.

In a statement released in the early hours of Friday morning, the EU said the Greek government had "ownership" of its reforms and would present them to creditors in the coming days.

"In the spirit of mutual trust, we are all committed to speed up the work and conclude it as fast as possible."

A release of funds could be agreed for as early as April 8 should the anti-austerity government satisfy the Brussels Group with its reforms list by the end of next week.

Speaking ahead of the European Council summit, Ireland's premier Enda Kenny condemned Athens's threats to unleash a wave of jihadists into Europe as "unacceptable."

He said it the anti-austerity government had to "face up to their responsibilities."

"The [Greek] prime minister has asked for time and space and he has been given that to come forward with sustainable and workable proposals," said Mr Kenny.

Athens has been involved in a series of unsavoury episodes with its largest debtor country in recent weeks.

Finance Minister Yanis Varoufakis has been embroiled in a controversy over sticking his middle finger to Berlin, while demands for Second World War reparations have angered Germany.

Writing on his website, the "rock star" academic turned politician dimissed the episode as a "kerfuffle" and urged and end to the "toxic blame game" that has taken hold in the debt negotiations.

"Beyond current tensions, our joint task is to re-design Europe so that Germans and Greeks, along with all Europeans, can re-imagine our monetary union as a realm of shared prosperity," wrote Mr Varoufakis.

'The U.S. Is Broke'

by: Shareholders Unite            

  • From time to time, we hear deeply serious economists expound that the US is broke.
  • Invariably, this involves discounting future entitlement obligations to present day dollars, which usually deliver intimidatingly large sums scaring the uninitiated.
  • The curious thing is, if the US is broke, somebody should tell US bond market investors, as rates should rise dramatically if the 'broke' analysis is right.
  • A less dramatic look at the issues shows that the markets have it right. The US is far from broke.
According to Laurence Kotlikoff, the US is broke. To be more precise, it's broke today! While stuff like this has moved down a little on the current wall of worries (it used to be much more popular) it still gets remarkable traction. Kotlikoff really should know better. Here he is:
"Our country is broke. It's not broke in 75 years or 50 years or 25 years or 10 years. It's broke today," he told the Senate Budget Committee. "Indeed, it may well be in worse fiscal shape than any developed country, including Greece."
Worse than any developed country? Worse than Greece? How's that? Well, here is his explanation of sorts:
"Instead, the federal debt and its annual change, the deficit, are purely linguistic constructs that reflect how members of Congress choose to label government receipts and payments." For example, that figure omits the almost $750 billion the government is collecting this year in Social Security payroll taxes from workers and the future Social Security transfer payments these FICA contributions secure, he explains. "Were we to go back in time and re-label all past Social Security taxes as borrowing, official federal debt held by the public would not be $13 trillion, but $38 trillion, which is 211 percent of U.S. GDP." In reality we're facing a fiscal gap of $210 trillion, Kotlikoff proclaimed. That's 16 times larger than official U.S. debt.
We'll get to the social security nonsense in a moment. First, a couple of other things one has to realize.
It seems that "broke" is also a linguistic construct, because Kotlikoff argues that the US is broke today. This is remarkable. Somebody tell the investors in US debt! They are still willing to lend the US at record low interest rates, so there really must be some mass psychosis going on in the bond US markets, which is one of the most liquid markets in the world.
It is even more remarkable because many of the people who argue this sort of stuff (the US is broke) also often have great faith in the wisdom of markets. The markets give this nonsense a thorough thumbs down, and rightly so.
Unlike Greece, the US can issue its own currency, so it can basically always pay for its obligations.
Yes, under some conditions, this could lead to inflation taking off, but to get there things have to get pretty dire.
Today we see Japan monetizing its debt in a pretty dramatic fashion in order to create at least a modicum of inflation, so far with fairly limited success, that should tell you how difficult this actually is. We're not in Venezuela or Argentina, let alone in Weimar or Zimbabwe.
Also, you have to remember that countries are not households. We are the owners of much of the outstanding US debt, foreigners hold roughly $5B of the $17B outstanding debt (but we also hold foreign assets...). So the future generations, which we're supposed to burden with all that debt also inherit most of the bonds issued in relation to it.
Social security
One of the 'owners' of US debt is actually the social security trust fund (or better, funds as there are two). These funds put the excess of payroll taxes it receives in the trust fund in order to meet future obligations. Until 2009, payroll tax receipts exceeded current social security payments, so the trust fund increased. This is no longer the case.
Under present projections the Old Age and Survivors Fund runs out in 2033 and the smaller Disability Insurance Trust Fund could run out much sooner, by next year. The latter should be manageable, as the figures involved are small:
In December 2014, nearly 11 million people received Disability Insurance from Social Security, with an average benefit of roughly $1,000 per month. While the Old-Age and Survivors Insurance Trust Fund, the portion of Social Security that most people think of as their retirement benefits, is not set to run out of money in the trust until 2033, the Disability Insurance Trust will run out in 2016 if nothing is changed. This shortfall would result in a nearly 20% cut to benefits, reducing those $1,000 checks down to $800 a month.
That's a shortfall of 20% of 12 times $11B or $26.4B a year, which is just 0.15% of GDP, no reason to worry. Given that we also know that the number of pensioners will increase we can safely conclude that the problems are with the pension trust fund, not the disability fund.
Remember, what is lacking is the difference between the trust fund and the payout. That is, present contributions from the payroll tax (plus interest income on the fund itself) are not enough to cover pensions, which is why the trust fund is slowly depleting, expected to run out of money.
The corollary of that is that payroll taxes are covering most of the pensions, but not all of them.
So when the trust fund runs out, they'll have to cover all of the pensions. Instead of discounting all future payments back from infinity into today's dollars (the preferred method for those that want to scare the living daylights out of you), let's simply look at what kind of percentages of GDP it takes:
There are several rather noteworthy (and dare we say, reassuring) conclusions to draw from this graph:
  • Note the rather unprecedented decline in discretionary public spending after 2009, the state has been shrinking, not expanding.
  • As far as the automatic programs are concerned, the medical programs are increasing more (which is not surprising, given increased life expectancy, introduction of new expensive medicines and treatments, and difficulty to increase productivity in the medical sector). And the good news here is that the cost curves have started to bend, at least partly because of Obamacare, despite all the histeria.
  • The biggest factor in the debt projections is actually the projected rise in interest rates on the debt. It's also the most uncertain factor.
  • Pensions are expected to reach roughly 6% of GDP by 2039, and you can see in the graph that there really isn't a steep increase, it's roughly 5% of GDP now.
Does this sound like a crisis (let alone a US bankruptcy) to you? Hardly. Since the payroll tax is covering almost, but not quite all of pensions today, and pensions are likely to increase by 1% of GDP over the next 25(!) years, payroll tax needs to find an additional 1-2% of GDP over the next 25 years.

This is certainly not negligible (1% of GDP is $170B), but the time frame is very large, so it can be done very gradually. In fact, lifting the payroll tax from 6.2% to 7.6% (a 1.4% increase, double that for self-employed as they also pay the employer part) would eliminate the deficit and maintain the trust fund.

It's hardly bankruptcy...

And there is quite a bit that can be done to make this more palatable, like lifting the payroll ceiling (that is, taxing higher incomes), increasing the retirement age and/or means-testing benefits, etc.

In a way, the outcome is totally unsurprising. The US is a country with a fairly low tax pressure and good demographics, the combination of which should make any pension problem rather manageable. The US isn't Japan, which has a more serious problem with its declining population and steeply increasing dependency rates.

And the funny thing is, what do the scaremongers usually want to do with respect to this non-existing social security problem? Cut pensions! So we have to cut pensions now in order to avoid having to cut pensions in a couple of decades (even if there are other options available, like increasing pension age, etc.)? It doesn't really make sense.