Posts Tagged ‘Euro’

Political analysis required for investment decisions

Sunday, May 20th, 2012

We haven’t been writing for quite a long while and our dear readers may wonder why. One of the reasons is because today, economic and investment outcomes are increasingly being determined by politics instead of economics. Since we are no political analyst, we have very little to say. Back in 2006, when we first started this blog, we brought our readers through with great expositions on economic theory, particularly from the Austrian School of economic thought. Back then, economic analysis was the key to foresight. Today, the environment is different?there is a rising trend of government interventions, which results in more unintended consequences, which in turn led to more interventions. As Marc Faber said, having brilliant economic and financial analysis is not enough nowadays; we also need to enlist the help of political analysts in order to anticipate the next move by politicians.

As we all know, after months of calm in the financial markets, fear and panic are returning again, thanks to political upheavals in Europe. In this video, Stratfor made a very good point regarding the solution to this problem:

So, when ANZ’s CEO reckons that a euro-zone breakup is likely, he is in effect making a political judgment, which isn’t what bank executives are supposed to do in the first place. But we live in interesting times anyway, so this is hardly unreasonable. So, what will be the economic outcome for us in Australia should that happen? We don?t know but one thing we are sure: the euro-zone breakup is the most anticipated crisis. We have been talking about Greece since February 2010 (see European politicians hammered from both sides) and had repeatedly warned that the Greek crisis was far from over. So, we are not so concerned about this. That is not to say that we aren?t concerned at all, but we are saying this to remind our readers to keep things in perspective.

What we are more concerned are the unexpected and unanticipated mishaps. That could be war, geo-political tensions, which the financial markets are currently underestimating the likelihood. We have to include the economic (or rather, political) situation in China. It is well-known that China intends to transition its economy away from investment towards consumption. That will definitely result in Chinaslowing down and paring back their demand for Australia?s commodities. But as we said before, What Black Swan can hit China?, this too is also highly anticipated. But take note, the slowdown in the Chinese economy is a political event. The real estate crash that is happening inChina right now is an act of political will by the Chinese government. A lot of Chinese property developers are in financial trouble today because they failed to anticipate the determination of the Chinese government to burst the real estate bubble. Previously, the Chinese government was weak with regards to reining in the bubble and as a result, they lacked credibility when they announced the latest bubble-fighting policies. But unfortunately for the property developers, the Chinese government was serious this time and that was the Black Swan for them.

Regarding China, the million dollar questions that we would like to know are:

  1. Will the slowdown of the Chinese economy veer outside the designs of the Chinese government (i.e. crash)?
  2. When that happens, the Chinese government will definitely intervene. The question is, will they be successful in arresting the unanticipated crash?

In Australia, we already have our hands full dealing with the stress that is currently affiliating our economy (due to the effects of Peak Debt and the planned Chinese economic slowdown). A Chinese economic crash will be the trigger that breaks the straw.

Notice the change of narratives in the financial markets?

Tuesday, July 6th, 2010

At around January-February this year, when the global financial market first suffered a correction, the narrative was about the sovereign debt of Greece. That had the implication on the Euro. Back then, the US dollar rose and gold fell. The fact that gold fell was not something that can be rationally explained. That?s because if there?s a lack of confidence in a major fiat currency (the Euro in this case), then the alternative should be gold. But as we wrote in How To Foolproof Yourself Against Salesmen & Media Bias, there?s a difference between what should happen and what will happen. This is example of a divergence between the two.

In May this year, the narrative was again on Greece, the other PIIGS countries and by implication, the Euro. Gold and US dollar rose. This time round, gold?s move was rational.

Fast forward to today.

There?re a lot of indication that the narrative is back in the bears? favour (see Mr Market is in the bear camp). But this time round, there?s a difference between May?s bearish narrative and today?s bearish narrative- European sovereign debt (and by extension, the Euro) story is no longer part of the narrative. The more prominent story is the growing expectation of a double-dip recession. As we wrote in Keep up spending- Who?s right? Europe or America?,

The expected (assumed is the more accurate word) recovery in the United States seems to be stalling. China is enacting policies to slow growth. Europe is mired in sovereign debt problems.

This narrative carries the implication of a return to deflation. The signs of deflation include rising US dollar and falling asset prices. Our guess is that in the context of this new narrative, gold in US dollar terms may be under pressure. A rising USD implies a falling AUD, which will mitigate some of the falls in gold price in AUD terms.

In the near term, stocks may be oversold and may rebound slightly. But according to the narrative of the bigger picture, the bears are still in charge.

Bad luck for investors- confluence of two headwinds

Thursday, May 6th, 2010

For those of you who are active traders/investors, you can surely sense that the feel of fear is coming back to the financial markets. The more prominent narrative for this fear is Greece (plus Portugal, plus Spain). It was just less a month ago that the financial markets were shrugging off the possibility of a Greek default (see Is the Greek debt crisis over?). Back then, investors were ?satisfied? with just a ?40-45 billion ?bailout? package. Now, according to the narrative of the media, even a ?100+ package is not enough to ?satisfy? investors. Not only that, the contagion is now spreading to Portugal and even Spain. So, does it mean that in less than a month, the financial markets suddenly see the light that Greece cannot pay its debts?

That goes to show that the financial market is very often illogical and irrational. When you look at the big picture, it should be clear that this is a deep-rooted problem that cannot be solved with a meeting. As we wrote in All quiet on the Greek front?,

But make no mistake, this story is like a trench warfare that will play out over a period of years (see Currency crisis: first countries in the line of fire- PIIGS). It will engulf more than Greece- vulnerable  countries include Portugal, Italy, Ireland and Spain.

The financial markets, being irrational as it is, will alternate between fear and optimism. We wouldn?t be surprised if this current bout of fear turn back to optimism after another high-level meeting/announcement will appear to ?solve? the problem. Then perhaps some time later, another bout of panic will return. In a way, this is like ?trench warfare? in which neither side is able to gain ground permanently, as they grind each other down. In the same way, the forces of deflation and inflation will battle each other, as money printing (which is the only way out of this crisis) will grind down the value of paper money (euro).

For Australia, there is another headwind- the coming slowdown of China. Marc Faber even go as far as saying that China is likely to crash in 9 to 12 months. Since the global economy is already battling the crisis in Europe, a crash in China will be another serious blow.

This is just bad luck for those who are holding long positions! So, what if China crash? Keep in tune!

Is the Greek debt crisis over?

Sunday, April 18th, 2010

When you read the latest statement on monetary policy decision of the Reserve Bank of Australia (RBA), you will find that they believe that the Greek sovereign debt crisis is contained for the moment:

The concerns regarding some sovereigns appear to have been contained at this stage.

The language is reminiscent of the start of the sub-prime mortgage problems. Currently, it seems that the global financial markets are shrugging off the possibility of a Greek government debt default, which has a wider implication on the Euro as a currency, which in turn has a wider implication on the global financial markets (see All quiet on the Greek front?).

But dear readers, do not be fooled by this apparent calm. Sure, the concerns looked ?contained? but the problems are still simmering. To let appreciate this situation, look at the following facts:

  1. Greece has to pay 4% more for their debt than Germany, the most credit-worthy nation. That?s roughly twice the margin from January 2010, at the height of the financial market jitters.
  2. The most recent attempt by the Greek government to raise money was very undersubscribed.
  3. Greece needs around ?50 billion in 2010, of which around ?25 billion is needed by June.
  4. After 2010, the Greek government needs to refinance its debt at 7-12% of its GDP.
  5. Greece budget deficit currently sits at 12% of GDP and must be financed as well.
  6. Greek government debt is forecasted to be over 150% of GDP by 2014.
  7. The current ?bailout? package by the EU and IMF is around ?40-45 billion, which is short of what the Greeks need at ?50-75 billion.
  8. The ?bailout? package requires:
    1. ? that Greece must exhaust its ability to borrow from the financial markets first before accessing the package.
    2. ? unanimous agreement among EU members.
    3. ? the debt will be provided at market rates, rather than on concessionary terms (although under new proposals full market rates will not be used).
    4. ? full participation of the IMF, which means the IMF will have a say in the (usually stringent) conditions for the loan.
    5. ? meet Germany?s condition that the EU framework for future bailouts be changed.

As you can see, the Greek problem is going to be more like a trench warfare than a blitzkrieg. It will probably take years, taking down lots of casualties on the way.

Mind you, Greece is not the only country. There are other countries like Portugal, Ireland, Italy, Spain and UK who are going to face the same problem over the next few years. The question is, while the trench warfare is going on in the Greek front for the next couple of (or few) years, can the global financial markets remain orderly when one or more of the Portuguese, Irish, Italian, Spanish and British fronts are opened simultaneously?

Fingers crossed.

All quiet on the Greek front?

Sunday, March 14th, 2010

It’s less than a couple of months ago, financial markets around the world were panicking over Greek government debt default. Speculators like George Soros were probably short-selling Greek government bonds, which in itself will result in rising interest rates for the Greek government. That in turn would increase its debt servicing burden, which would make it even more likely for the Greek government to default. This is like the positive feedback loop that we talked about in Thinking tool: going beyond causes & effects with systems thinking. Those speculators holding Credit Default Swaps (CDS) will have a perverse hope of seeing a Greek Government default.

Today, it seems that this story is a non-issue for the market. Has the story ended?

We afraid this is just the beginning. The Greeks had merely just announced on an austerity plan and some of its people are taking to the streets in protest. As you can read from European politicians hammered from both sides, there will be many parts to this story. Much of the ugly political and legal sausage making process will be happening behind closed doors, which means you wouldn’t get to read them in the media. That will lull many into a false sense of calm.

But make no mistake, this story is like a trench warfare that will play out over a period of years (see Currency crisis: first countries in the line of fire- PIIGS). It will engulf more than Greece- vulnerable? countries include Portugal, Italy, Ireland and Spain. While the Euro may stage a counter-rally here and then, it is most likely to be in a secular down-trend.

As Marc Faber said, the Greek austerity measures will cripple the Greek economy:

Austerity measures may end up making the Greek economy weaker, which means tax receipts will be reduced. That in turn may even make it harder for the Greek government to service its debt. When that happens, you will see speculators moving in again, resulting in another panic quite some time later. This is what we will call the Part 1, Act 2 of the story.

In the meantime, even if the speculators’ hands are tied from touching Greece (by government regulations), they may be setting their sights at countries like Spain or Portugal. That’ll be Part 2, Act 1 of the story.

European politicians hammered from both sides

Tuesday, February 16th, 2010

As observers of what’s happening around the world, we find the spectacle of what’s happening in Europe as juicy as soap opera plots. With so many internal contradictions within the cast of characters, we can be sure the outcome will be unpredictable and explosive (literally). Even if the Greeks get bailed out tomorrow, you can be sure that there will be another episode in the drama that will throw a surprise twist to the story.

We will look at the first character in the cast- Germany. At the heart of the European Union is Germany. Without Germany’s economic strength under-girding the union, the euro-zone economy would only be a pointless rump. Under-girding the German economic strength is the Teutonic spirit of discipline and efficiency. The brutal efficiency of the Germans allowed their exports to increase steadily both as a share of total European consumption and as a share of European exports to the wider world. Reflecting the Teutonic discipline of the German people, most of them are against the idea of bailouts. As Most Germans want Greece thrown out of euro reported,

A poll for popular newspaper Bild am Sonntag found that 53pc of Germans wanted Greece to be expelled from the euro if necessary in the coming months. Two-thirds were adamantly against German money being put towards a bail-out of the troubled country, the paper also found.

Thus, any German politician contemplating a bailout on Greece will have to keep one eye on the public opinion. This is something that will be looming on the back of Angela Merkel’s mind during the negotiations for a bailout package.

German politics is only one impediment to bailouts. There are also legal impediments to bailouts. Article 104 of the Maastricht Treaty (and Article 21 of the Statute establishing the European Central Bank) actually forbids one explicitly. Thus, for legal reasons, a bailout cannot be called a “bailout.”

Yet, despite the reluctance of the German people to save Greece, the German banking system (and by extension, the European banking system) is reportedly to be exposed to Greece. This is another dilemma faced by the German government.

Contrast the Teutonic spirit of the Germans with the profligate and undisciplined ways of the Greeks. The Greek government’s budget crisis did not arise out of the blue. It was several years in the making. As European Central Bank Chief Economist J?rgen Stark said in an interview (see European Central Bank Chief Economist: ‘Everyone Is a Sinner at the Moment’),

An economy doesn’t lose its competitiveness overnight. Greece covered it up for a long time with an extremely generous spending policy. For example, consumer spending was stimulated with pay increases in the government sector. We here at the ECB were vocally critical of this development several years ago.

Today, we even heard from a foreign news report that the Greek government, with the aid of Wall Street, used Wall Street’s dodgy tactics of using currency derivatives to disguise loans. Not only that, there were accusations of the Greek government using doctored statistics to cover up their dismal economic performance. The rot was reportedly extended to the grass-roots level- Greek citizens as a whole, tend to under-declare their tax liabilities. We have no comment on how true these allegations were, but all these are indicative of the rot in the system.

Thus, from the German perspective, any rescues will have strings attached. In fact, the strings will be very stringent. The highly disciplined German people will undoubtedly not tolerate anything less. In practice, this may mean German control of the ECB and Greek fiscal policies. Whatever the outcome of the conditions imposed on a bailout, it has to be as unpalatable as possible so as to send a signal to the other profligate PIIGS countries (see Currency crisis: first countries in the line of fire- PIIGS) not to expect any moral hazard.

If only it is that simple.

The Greek people, on the other hand, are already protesting against any austerity measures to rein in their government’s budget deficits. As this BBC news article reported,

Thousands of Greeks have rallied against deficit-cutting measures during a national public sector strike.

The unions regard the austerity programme as a declaration of war against the working and middle classes, the BBC’s Malcolm Brabant reports from the capital.

He says their resolve is strengthened by their belief that this crisis has been engineered by external forces, such as international speculators and European central bankers.

“It’s a war against workers and we will answer with war, with constant struggles until this policy is overturned,” said Christos Katsiotis, a union member affiliated to the Communist Party, at the Athens rally.

We can imagine that should there be any German-style discipline imposed on them, the entire nation will descend into flames. This is something that will be looming in the back of Greek Prime Minister George Papandreou as he enters the negotiation table. Judging from the mood of the Greek people, they are ripe for the rise of a demagogue blaming their country’s woes on international ‘speculators’ and European central bankers. So, even if the Greek government accept the stringent conditions attached to a bailout, the Greek people will not. The question is, will the Greek government collapse as a result? Investors buying into the ‘good’ news of a Greek bailout may well be confronted with such a Black Swan event within a relatively short space of time.

So, would the path of least resistance be an excommunication of Greece from the euro?

Again, there are complications. Firstly, there is no clear-cut legal mechanism to ‘expel’ a nation. Next, the question will be what to do with the debt owed by the Greek government? Also, should that happen, what will the other PIIGS nations (that are next in the line of fire) think?

There are many twists and turn in this drama. That’s why, up till now, the only progress so far are announcements of solidarity and intention.

An economy doesn’t lose its competitiveness overnight. Greece covered it up for a long time with an extremely generous spending policy. For example, consumer spending was stimulated with pay increases in the government sector. We here at the ECB were vocally critical of this development several years ago.

Currency crisis: first countries in the line of fire- PIIGS

Thursday, January 21st, 2010

In our previous article (Next phase of GFC is when governments go bust), we wondered how can someone protect their savings in the event of currency crisis. Since the word “currency crisis” is a very broad term that can cover all kinds of scenarios, there is no one-size-fit-all solution to this problem. Hopefully, our musings will give you a better idea of where to start investigating and seek professional advice.

As we mentioned before in our previous article, there is a downward trend in many governments’ credit rating. The next stage of the GFC will see governments going bust. The main thing to understand is that this event need not necessarily be imminent. Also, you must not make the mistake of seeing that as a singular event- in reality, it will be a sequence of events punctuated by calm in between, as each country is at different stages of the fiscal cycle. The reason why we say that is because there are plenty of investment tip-sheets, newsletters and reports persuading people to buy their wares by giving the impression that government defaults are imminent events that will happen all at once. The mainstream media is not too helpful too. As investors, you have to be clear that there are time-frames and order of sequences in these events. Not only that, some of these events may not happen at all.

With that, we will continue. Please note that we are not ‘predicting’ or forecasting the future. What we are presenting is just a rough sketch of what may possibly happen.

Currently, the most vulnerable countries to default are the PIIGS countries (Portugal, Italy, Ireland, Greece and Spain). It does not mean that all of them will blow up tomorrow. Marc Faber reckons that a couple of them will blow up within the next two years. Even though we do not know which ones and when exactly it will happen, one thing is clear- since these countries uses the Euro, the viability of the Euro as a currency will be put in question. As we said before in Is this a bear market rally or a turning point?,

The European Union is an economic union but not a political union. Therefore, the European Central Bank (ECB) does not have the same level of authority and political support as the US Federal Reserve. Individual nations using the Euro as their currency cannot simply print money to bail out their financial system because they have surrendered their economic sovereignty to an intra-national authority. To do that, there can be a situation whereby taxpayers of say, Germany, are asked to bail out the taxpayers of say, Spain. Politically, this is too much to ask.

This is where the uncertainty lies. There will be political and legal wrangling on what to do with these wayward PIIGS nations. Will the Euro survive the wrangling? No one knows. Since financial markets hates uncertainty, the Euro will continue to face downward pressure (which is happening right now). Of course, if it is suddenly clear that the Euro will not survive, then its value will be zero straight away. Should that happen, there will be a currency crisis, derivative meltdown (as an effect of PIIGS default or implosion of the Euro) and another global financial panic this very second. Since it is not clear yet, the Euro will continue its orderly descent. In the meantime, the financial markets will keep on guessing while the European authorities will not reveal much of what’s happening in the discussions behind closed doors.

Now, the question is, against which currency will the Euro depreciate against? Someone once said, if currencies are in a beauty contest, the winner will be the least ugly one. The US dollar, even though it is flawed and may not survive as a currency in the long run, has more time on its side. It is less ugly than the Euro. As far as the eye can see, it is more likely to survive longer than the Euro. Therefore, we will see the US dollar ‘strengthening’ against the Euro.

If you are one of the citizens of the PIIGS countries and if it so happen that it is your country that is going to blow up, then there’s no better time to prepare than right now.

In the next article, we will turn our eyes to the next sequence in the time-line.

Will the US dollar collapse?

Tuesday, December 12th, 2006

As we mentioned in The ABCs of hedging, the first step in hedging our investments is to subject our portfolio to ?war-games,? where we work out how it may perform under various economic what-if scenarios and come up with strategies to counter the unfavourable outcomes.

Today, we look at one possible scenario?the decline (or collapse) of the US dollar.

Lately, we are again hearing that central bankers are murmuring about diversifying their foreign reserves away from the US dollar. Does it mean that there is an imminent liquidation of their US dollar reserves? Well, this is not the first time they murmured about it and it is definitely not in their (including the Federal Reserve?s) interest to see a collapse of the US dollar. The Chinese, with their US$1 trillion of reserves, would not want to see their stockpile of US dollars to lose significant value. The same goes for the Japanese and the oil-rich Middle-Eastern nations. The US too, would not want to see their dollar collapse as that would result in soaring inflation in their homeland. Therefore, we do not expect mass selling of US currency reserves by central bankers in the near term.

On the other hand, it is open knowledge that the status quo is unsustainable. This morning, we heard that Alan Greenspan (the former US head of Federal Reserve) warned investors in a business conference in Tel Aviv to expect a few years of dollar weakness. He further said that is imprudent to hold everything in one currency. This prompted a further slide of the US dollar against the Euro. The US has the dubious honour of having the world?s greatest trade deficit. If not for the fact that the US dollar is (maybe ?was? is the more appropriate word) the world?s reserve currency, the US would be consigned a banana republic long ago. The world cannot lend to the US indefinitely. Sooner or later, they will demand a pay back. The moment they decide that the US will not and is unable to repay its debt, what will happen to the US dollar? What will happen to the global financial system when that happens?

Thus, this situation is akin to an individual owning the bank money. If he owes the bank a million dollars, he is in trouble. But if he owes the bank a billion dollars, the bank is in trouble?if he goes bankrupt, a large portion of bank?s loan portfolio will be wiped out, rendering the bank insolvent. The US owes the rest of the world so much money that they cannot afford to let the US go ?bankrupt.? But the rest of the world knows that sooner or later, the US will go ?bankrupt.? (Of course, a country cannot be bankrupt in the same way as individuals do because there is always the option to print money to remain solvent. But the end result will be just as horrible?hyperinflation.) What can be done?

We are all living in a precarious situation. We shudder to think of the day when a black swan event happens. On that day, whoever owns gold will have a lot of friends.