Spain is Greece… Only Bigger and Worse
Submitted by Phoenix Capital Research on 09/16/2012 20:42 -0400
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As I’ve outlined in earlier articles, Spain will be the straw that breaks the EU’s back. The country’s private Debt to GDP is above 300%. Spanish banks are loaded with toxic debts courtesy of a housing bubble that makes the US’s look like a small bump in comparison. And the Spanish government is bankrupt as well.
Indeed, in the last month alone we’ve seen:
- Spain’s banking system saw a bank run to the tune of €70 billion in August. The market cap for all of Spain’s banks is just €114 billion. So Spanish banks need to raise at least €20+ billion or so per month in the coming months to stay afloat. This is without depositors pulling additional funds in September onwards. That’s really bad news.
- Spain’s now nationalized Bankia just took another €5.4 billion from Spain’s in-country rescue fund. This indicates that once nationalized, problem banks DO NOT cease to be problems.
- The region of Andalusia is requesting a bailout from the Spanish Federal Government. This comes on the heels of bailout requests from the regions of Valencia, Murcia and Catalonia (none of which want any “conditions” on the funds).
- Spain has set aside €18 billion to bailout its regions. The current bailout requests already amount to €10.8 billion. That’s just from this year alone.
If you need more info on Spain, the bullet items from them that you need to know are that:
- A huge portion of Spain’s banking system (representing over 50% of mortgage loans AND deposits) was totally unregulated up until just a few years ago.
- Spanish banks were drawing €337 billion from the ECB on a monthly basis to fund their liquidity needs.
- Every political figure and bank in Spain is HIGHLY incentivized to lie about the true nature of the Spanish banking system (a private text message from the Prime Minister claimed the REAL capital needs were closer to €500 billion… which is assuming he knows what he’s talking about/ the banks were honest with him… which I HIGHLY doubt).
Indeed, the markets are beginning to figure out the Spain is DONE regardless of what the ECB does. The truth is that Spain is in as bad a shape as Greece if not worse. Expect things to get very, very ugly soon.
The reason is two fold:
- Spanish banks need to roll over (meaning renew terms on) more than 20% of their bonds this year.
- Spanish sovereign bonds are collateral for hundreds of billions of Euros’ worth of trades.
With Spanish banks already under severe funding stress (again, they drew €337 billion from the ECB before the new OMT program… and depositors took €70 billion out of the system last month), they’re in no position to start paying out higher interest payments to bondholders.
And with investors realizing that Spain’s banks are all lying about the state of their balance sheets (remember, Bankia was talking about paying a dividendjust one month before it collapsed and revised its €41 million 2011 profit to a €3.3 billion LOSS), we’re going to be seeing plenty of bank failures this year.
Remember, Spain’s initial request was for the EU to bail out its banks NOT the country itself. However, with some six Spanish regions (probably more) looking for bailouts Spain is now facing both a sovereign debt AND a banking crisis.
The timing of this issue will be difficult due to the ECB’s intervention, but at the end of the day, the math doesn’t add up. Spain has big problems and when the market figures out that the ECB cannot solve them… it’s going to be a very difficult time in Europe.
Much has been written over the course of the last few days/weeks about what Bernanke could do, has done, and the efficacy of said actions. Inflation, unintended ‘energy’ consequences, debasement, financial repression, scarcity transmission mechanisms all come to mind but realistically they are all just symptoms of what is really going on. As the following chart from Barclays shows, the real effect of LSAPs is to suppress the signaling effect of macro data from the real economy. During periods of extreme monetary policy, the stock market’s beta to macro-economic data surprises is dampened massively – and hence the forced mal-investment and mis-allocation of funds occurs. However, given the now open-ended nature of QE3, this may change with the ‘good news/bad news’ logic leading to a stronger market (higher beta) response (since all bad news is automatically attenuated by QEternity and thus all the good news is out there).
An important driver of this attenuated market response to economic news was the sense that important elements of the monetary policy framework were ‘in play’, and that policy was likely to respond if the economy weakened sufficiently, but not otherwise. In this context, bad economic news may not seem so horrible, if it is perceived to raise the probability of a market-friendly monetary policy response. In the run-up to June 2011, the question facing investors was whether the Fed would allow QE2 to end in June, in accord with the Fed’s stated intention. More recently, the question has been whether the Fed would put a more aggressive policy in place. But the ‘good news/bad news’ logic was much the same.
It seems to us that this logic will not, however, remain operative in the months to come, since the policy frameworks recently announced by both the Fed and the ECB have no stated end date on which markets can focus (as did QE2), and are not likely to be materially adjusted in response to economic data for some months to come. Economic news may have been a ‘good news/bad news’ story in the recent past. But now that the monetary policy responses to economic weakness are in place, markets have had the good news.
In the future, bad economic data will be, well, just bad, and good news will be unambiguously positive. This should lead to a stronger market response to economic data in the weeks and months to come.
QE3. No QE3. The markets have been injected with this hopium for months and have been let down on every occasion except for this last one. The Fed’s issuance of this last round of quantitative easing has rendered future doses of this drug ineffective.
It was explicitly stated that the Fed would issue QE as needed in unlimited amounts until the market is able to create enough jobs to stimulate dramatic growth. This means that there will not likely be any future spikes in the market as a result of another QE announcement…the market no longer questions whether or not more drugs will come, now they expect them.
The Fed had been using “QE hype” to rally the markets. Every time we were on the verge of a collapse another QE announcement would be made bringing us a few feet back from the fiscal cliff. But that tactic wont work anymore…
The Fed’s actions are fiscally irresponsible and the U.S. will quickly suffer the consequences of this poor decision. If the economic change needed to return to growth is structural then a monetary fix, or QE, isn’t the remedy.
The U.S. Dollar is on the decline against other major currencies, and investors are losing confidence in the Fed’s ability to manage the ensuing risk of another recession. Question that remains, what happens when the QE drug gets taken away?
It’s time to hedge; if the value of the U.S. dollar collapses how will you respond? Diversification is key. Learn to manage your risk by looking a head; join the Forward Thinking waiting list now.
Your currency analyst,
Central bankers will get a lot less bang for their buck, pound, euro and yen as they struggle to stimulate flagging economies, trading strategies in the $4 trillion a day foreign-exchange market suggest.
The UBS AG V24 Carry Index, which measures returns from borrowing in lower-rate currencies to buy higher-yielding ones for so-called carry trades, has fallen 2.8 percent from a four- month high on Aug. 9. Bloomberg Correlation-Weighted Indexes show that the worst-performing major currency in the past month was the Australian dollar, typically a beneficiary when investors are bullish on the economy because the nation has the highest interest rates among developed economies.
From the $2.3 trillion pumped into the U.S. by the Fed since 2008 to record-low interest rates in the euro zone, U.K. and Japan, nothing has prevented the world’s economy from slowing this year. Foreign-exchange traders are signaling they expect little improvement any time soon, and that’s a change from the past. After Chairman Ben S. Bernanke flagged $600 billion of quantitative easing, or QE, in August 2010, the carry trade gained 3.1 percent in 30 days.
“I can’t be optimistic that investor sentiment will improve rapidly and the world’s economy will pick up,” Yoshisada Ishide, who oversees $14 billion as the manager of the biggest mutual fund focused on Australian dollar-denominated debt at Daiwa SB Investments Ltd. in Tokyo, said in a phone interview on Sept. 7.
That outlook echoes Yale University professor Stephen Roach and Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co. They say central bank money printing is losing its effectiveness in spurring growth.
“I’ve been negative about the U.S. ever since the Fed went to their unconventional monetary policy,” Roach, the former non-executive chairman for Morgan Stanley in Asia, said in a Bloomberg Television interview on Sept. 6.
“Our credit-based financial system is burdened by excessive fat and interest rates that are too low,” Gross, who oversees Pimco’s $270 billion Total Return Fund, wrote in the monthlycommentary posted on Pimco’s website Sept. 5.
Falling demand for commodity imports in China sent the Australian dollar down 3.6 percent over the past month, the biggest drop among the 10 developed-nation currencies tracked by the Bloomberg indexes. That contributed to a 9 percent decline since August 2011 for carry trades funded by the dollar and invested in the so-called Aussie, South African rand, Brazilian real and Mexican peso.
Carry trades had returned almost 80 percent from March 2009 through July last year as investors took advantage of lower borrowing costs in developed markets to buy assets in emerging and resource-producing nations. Benchmark interest rates in the Group of 10 will average about 0.53 percent this year, compared with 6.39 percent for Brazil, Russia, India and China, according to data compiled by Bloomberg.
The dollar sank 1 percent last week according to the Bloomberg index, after the U.S. Labor Department said the economy added 96,000 jobs in August, below the 130,000 median estimate of 92 economists surveyed by Bloomberg. The dollar advanced 0.2 percent to $1.2793 per euro as of 8:40 a.m. in Tokyo. It was little changed at 78.23 yen.
Concerns that growth will continue to deteriorate gives the Fed room to signal a third round of bond purchases as early as this week. A gauge of indicators used to measure expectations for Fed stimulus rose to 99 percent in August, the highest ever, according to Citigroup Inc.
Policy makers began injecting money into their economies after the collapse of Lehman Brothers Holdings Inc. four years ago this week sparked the biggest financial crisis since the Great Depression.
After the Fed’s first round of quantitative easing, the Bank of England announced 75 billion pounds ($120 billion) of asset purchases in March 2009, and the European Central Bankprovided 442 billion euros ($566 billion) in one-year loans to the region’s lenders in its Long Term Refinancing Operation, or LTRO, three months later. The Bank of Japan said in October 2010 it would buy 5 trillion yen ($64 billion) of government and corporate debt.
The unprecedented actions came with interest rates already at or about record lows. The Fed cut its overnight bank lending rate to between zero and 0.25 percent in December 2008 and has indicated it may keep it there through 2014. The ECB has reduced borrowing costs to 0.75 percent and the BOE to 0.5 percent. The BOJ lowered its target rate to about zero from 0.5 percent.
Fed stimulus has typically debased the currency. IntercontinentalExchange Inc.’s Dollar Index (DXY) tracking the greenback against six U.S. trading partners, dropped 13 percent between the Fed’s announcement of $2.3 trillion in easing in November 2008 through the end of the bond buying in June 2011.
That might not happen this time. While the index fell 2.4 percent in the last month to 80.25, it’s still within 5 percent of a two-year high of 84.10 reached on July 24. Bloomberg Correlation-Weighted Indexes show New Zealand’s currency weakened 2.3 percent in the past month, the biggest decline after the so-called Aussie dollar.
The political backlash over QE has been fierce. Republicans called for an audit of the Fed in their 2012 platform adopted in Tampa, Florida, on Aug. 28. Senator Bob Corker of Tennessee said in a press release Sept. 6 that an “unhealthy obsession” with monetary policy is distracting the public from the need for fiscal reform. The Fed’s balance sheet has swelled by almost threefold since the collapse of Lehman to $2.81 trillion.
“We’re seeing clearer signs of diminishing returns from success of quantitative easing programs,” Robert Rennie, chief currency strategist at Sydney-based Westpac Banking Corp., Australia’s second-largest lender, said in a telephone interview on Sept. 5.
Carry trades may benefit from a resolution for Europe’s debt turmoil. Prospects for a cure rose when ECB President Mario Draghi announced on Sept. 6 an unlimited bond-buying program to damp yields in the euro area and fight speculation that Greece might leave the 17-nation currency union. Purchases will be sterilized, meaning the money supply won’t grow.
Global stocks and riskier currencies rallied. The 17-nation euro strengthened 1.9 percent last week to $1.2816, the highest closing level since May 21, while the Australian dollar added 0.6 percent to $1.0385. The MSCI World Index (MXWO) jumped 2.6 percent in the five days through Sept. 7 to a five-month high.
“We’re pretty bearish on the dollar,” Mary Nicola, a New York-based currency strategist at BNP Paribas SA, France’s largest bank, said Sept. 5 in a telephone interview. “We see weakness against the commodity currencies.”
BNP estimates the Dollar Index may fall to 76.4 by the end of June, the lowest projection among 10 analysts in a Bloomberg survey. The median of their forecasts signal the gauge will advance to 82.4.
Signs that China is losing steam may dent economies such as Australia that depend on the world’s second-largest economy to buy their commodities.
Manufacturing contracted in China at the fastest pace in August since March 2009, according to the purchasing managers’ index released by HSBC Holdings Plc and Markit Economics on Sept. 3.
Even a calming of currency price swings that normally would benefit the carry trade is having little effect. The JPMorgan G7 Volatility Index fell to 8.03 percent on Sept. 7, the lowest since October 2007, and down from its record 26.55 percent in October 2008. A smaller number means the potential profit from carry trades is more predictable, boosting the allure of the strategy.
“Volatility is low simply because people are staying on the sidelines, awaiting the next storm,” Masashi Murata, a currency strategist in Tokyo at Brown Brothers Harriman & Co., said in a telephone interview on Sept. 6. “Conditions for carry trades aren’t being met.”
The U.S. may tip into recession next year if lawmakers can’t break an impasse over the federal budget, according to report from the nonpartisan Congressional Budget Office. Economic output would shrink next year by 0.5 percent, and joblessness would climb to about 9 percent, unless $600 billion in scheduled tax increases and spending cuts are halted, the CBO said Aug. 22.
“What the record shows is we’ve had the weakest recovery on record, we have anunemployment rate above 8 percent, and the U.S. consumer is basically dead in the water,” Yale’s Roach said on Bloomberg Television’s “First Up” with Susan Li.
The rest of the developed world isn’t much better off. The euro-zone and U.K. economies contracted 0.5 percent in the second quarter from a year earlier. Japan is struggling to overcome more than a decade of deflation and the effects of last year’s record earthquake.
New regulations requiring banks to hold more capital and increased saving by households has prevented record low interest rates from sparking the recovery central bankers anticipated, Gross wrote in the monthly commentary posted on Pimco’s website Sept. 5.
“Returns from both stocks and bonds will be stunted,” Gross said. “Central banks are agog in disbelief that the endless stream of QEs and LTROs have not produced the desired result.”
Ever since investors started panicking about a Chinese hard landing, analysts started warning about troubles in Australia, which supplies so many natural resources to China.
In April, Societe Generale’s Dylan Grice summed up concerns about Australia’s economy when he wrote that Australia is “a credit bubble built on a commodity market built on an even bigger Chinese credit bubble.”
And added, “Australia looks like leveraged leverage, a CDO squared.”
Then in August, BHP Billiton the world’s largest miner reported a 35 percent drop in second half profit, kicking off a storm about the Australian mining bust. Here’s what’s gone wrong in Australia:
- Australia has been riding a mining boom that has helped it avoid a recession for 21 straight years.
- But commodity markets are known for their boom-bust patterns and with a slowdown in China, curbs on the Chinese property sector, and a slowdown in the global economy, demand for crucial Australian exports like coal and iron ore are waning.
- The massive investment in mining for coal has overlooked the shale gas boom in the U.S., according to Grice. While, Bank of America’s Bin Gao and Ethan Mou write that the increase in U.S. exports of coal to China have eaten into Australia’s share of the Chinese coal market.
- Australia has a property bubble with Sydney, Melbourne, Adelaide, Brisbane, and Perth being some of the world’s most expensive cities, according to SocGen’s Albert Edwards.
- The Aussie dollar continues to be stronger than the U.S. dollar despite the softening in commodity prices.
- Australian stock price moves are closely correlated with China. Given the dismal performance of Chinese equities the Australian stocks are overpriced according to SocGen’s proprietary model. SocGen’s analysts write, “The strength of Australia is particularly hard to explain, given the recent weakness in figures like the housing data.”
- Australia’s resource minister Martin Ferguson recently said (via The Telegraph): “You’ve got to understand, the resources boom is over. We’ve done well – A$270 billion in investment – the envy of the world. …It has got tougher in the last six to 12 months. Look at Europe, the state of the European and global economy. Think about the difficulties in China. The commodity price boom is over and anyone with half a brain knows that.”
- Last week, Deutsche Bank’s Adam Boyton and Phil Odonaghoe warned of the end of the investment boom and a 2013 recession in Australia. “It does seem to us that there is some complacency surrounding the prospect of a sizeable decline in the terms of trade – and some over-confidence that the investment pipeline is ‘locked in’. While there may be reasons as to why this time is different …history would counsel some caution on the investment outlook. Indeed, an average response to a circa 15% decline in the terms of trade would see business investment falling in year over year terms by early 2013.”
4 Things Everyone Gets Wrong About The Australian Commodity Bust
Much has been written about the commodity bust in Australia. But that debate has reiterated “important misconceptions” according to Morgan Stanley analysts Gerard Minack and Katie Hill.
Minack and Hill write that most focus on Australian GDP growth, commodity prices, and the Chinese economy, and miss the real issues at hand.
They identify four things about the Australian commodity boom-bust debate that really annoy them:
Watching levels instead of growth rate
Minack and Hill believe commenters shouldn’t watch levels i.e. commodity prices or terms of trade (the value of exports relative to imports). They should instead focus on changes in real national income growth. For instance, the drop in costs of Chinese iron ore imports commodity prices will impact real national income, but terms of trade will still be high.
Watching real GDP instead of real income
Real GDP growth wasn’t crucial to Australia’s commodity boom because the GDP growth was driven by higher commodity prices, rather than an increase in production.
Moreover, real GDP isn’t a good measure of real income when the terms of trade (the ratio of export to import prices) change, because mere price changes don’t impact real GDP (what a country produces).
A rise in terms of trade does however increase real income. Currently, Minack tells Business Insider, the commodity boom has caused a gap between real income and GDP, by adding 17 percent to real income. Focusing on GDP alone ignores the fact that in the event of commodity bust this real income will decline.
“This boom is different”
Talk that this boom is different is nonsense. This is because commodity busts aren’t caused by a decline in demand, rather, they’re caused by expanding supply. Australia according to Minack and Hill is in a supply-expanding boom.
“There is no bubble”
Mining is a bubble that could pose a threat to the Australian economy in the next two – three years. “The increase in commodity prices has far outstripped house price increases over a similar period. The income effect of the commodity boom has been more direct and powerful than the wealth effects of rising house prices”