18/7/2013: QE or Not-QE... spot the difference?

My recent exchange with @LISwires on the issue of risks involved in both continued QE and pursuing an exit strategy.


The tweet the started it: "Both are… RT @LISwires: QE is "Treacherous" RT @livesquawk: Roubini: Fed Exit Strategy Will Be 'Treacherous' fw.to/gWL3DCg @CNBC"

Explaining my view that QE & Exit strategies are both consistent with structural and grave risks are:

[Both QE and exit is] like being between a rock and a hard place... inside an iron pipe… Exit = QE = non-QE = stimulus = austerity = disaster. The whole point of a structural depression is EXACTLY that!

In a normal recession, one half of the economy's 'cart' gets stuck in the 'mud'. In a structural depression, the entire cart is in the middle of a quick sand trap.

The ONLY thing that would've worked was direct injection of funds to write down household & corporate debts, & in some cases - restructure sovereign debt too. We missed the boat on this by engaging in LTROs/OMT/ESM/EFSF/ESF/EBU/EMU… stupidity of tinkering along the edges. Hence [having engaged in wasting resources on marginal solutions], from here on - it is vast pain over long term. The choice was made by our 'leaders' in ECB/EU/IMF/National Governments/NCBs.

The real failure of economists/economics is NOT our inability to forecast disasters. It is in our inability to see the size & nature of disaster AFTER it hits.

Note: my reference to the direct recapitalisation solution can be traced to this: http://trueeconomics.blogspot.ie/2010/05/economics-16052010-eu-on-brink.html

18/6/2013: The Size of the Eurotanic's Bad Assets Iceberg?

Europe's Non-Performing and Doddgy Banking Assets are a Mount Everest-sized iceberg that no analyst in the Commission or the IMF or the BIS or the ECB or any National Central Bank or... ok, keep inserting official sources, is capable of recognising or estimating.

Thankfully, here's a handy range:

1) Courtesy of the ZeroHedge: http://www.zerohedge.com/news/2013-05-17/europes-eur-500-billion-ticking-npltime-bomb the Eurotanic is heading straight into a EUR500bn chunk of ice.
2) Courtesy of Les Echos, it's EUR1,000bn: http://www.lesechos.fr/entreprises-secteurs/finance-marches/actu/0202834793278-une-bombe-de-1-000-milliards-d-euros-pour-les-contribuables-europeens-576506.php and that's just for 'bad banks'.
3) My own view - the number is well ahead of both. This is a consistent view expressed as early back as, for example, http://trueeconomics.blogspot.ie/2010/05/economics-16052010-eu-on-brink.html and even earlier. Euro area will require some EUR3 trillion in monetary 'assistance' of permanent (or very long-term) nature. The drivers for this are: (a) legacy bad and poor quality assets, (b) stagnation-induced corrections yet to come, and (c) interest rates and ECB exit-induced household and corporate insolvencies crunch looming on the horizon.

17/6/2013: Deutsche, AIB and Cypriot Banks: 3 links

Back in 2011, I wrote about the extreme leverage ratios in some of Europe's top banks: http://trueeconomics.blogspot.ie/2011/09/13092011-german-and-french-banks.html. Deutsche Bank was at the top of the list. Now, 19 moths later it seems others are catching up: http://www.reuters.com/article/2013/06/14/financial-regulation-deutsche-idUSL2N0EO1D220130614.

And while on topic of banks, let's check this one for the record: http://www.independent.ie/business/irish/aib-will-not-repay-35bn-cash-it-owes-to-the-state-29337833.html. I wrote about this in Sunday Times last weekend, in passim, but this is more comprehensive article.

Another link of worth on the topic of banks is Cyprus banks fiasco history from ZeroHedge: http://www.zerohedge.com/news/2013-06-17/guest-post-real-story-cyprus-debt-crisis-part-1

17/6/2013: On Debt of the Nations & Euro Crisis: 2 links

Update from the ZeroHedge on the Debt of the Nations: http://www.zerohedge.com/news/2013-06-04/debt-nations

Worth a read!

And while on the case of crises (for whatever you might read about Reinhart and Rogoff debate, debt overhang is a crisis) we have an excellent contribution by Dani Rodrik on solutions for the Euro area crisis: http://www.project-syndicate.org/commentary/saving-the-long-run-in-the-eurozone-by-dani-rodrik

Thought-provoking and comprehensive summary (albeit I do not necessarily agree with all of Rodrik's conclusions).

17/6/2013: ESM Rules Book Draft

Reuters recently reported [Updated: link is here http://pdf.reuters.com/pdfnews/pdfnews.asp?i=43059c3bf0e37541&u=2013_06_17_11_43_b16e8d8f95d140d2a6693737fcd98885_PRIMARY.pdf  H/T to @Taleof2Treaties] on a document prepared for the Eurogroup meeting in Luxembourg that puts forward more detailed set of rules for ESM deployment in recapitalising the banks.  The rules, as seen by Reuters, involve:

• A private sector bail-in to be required before any ESM contribution can be made. More on this below; and
• The ESM will apply a two-tier test in deciding whether recapitalisation can be carried out: the capital must fall below critical adequacy levels, and the bank must be considered systemic for the eurozone as a whole, not a national system. Which means in the case of Ireland - no recapitalisations of ANY irish bank, neither BofI, nor AIB, nor Anglo. Per ESM rule book, the whole country can go insolvent, as long as Deutsche Bank or Credit Agricole are still floating.

When a bank gets into trouble, the Euro-Troika: ECB, the European Commission and the ESM,

• Will stress-test / value bank’s assets. Euro-Troika will set the required level of capital the bank will require, thus opening the process to the transfer of foreign-held liabilities onto the shoulders of the country taxpayers. For example, suppose an Irish bank X holds 10% of its liabilities against external foreign subordinated lenders. In normal case, these would be forced to take a haircut first. But Euro-Troika can determine that is must make good on full 10%, thus transferring liability fully to the sovereign of bank X domicile via the first requirement that the sovereign must step in ahead of any ESM recapitalization. 
• After determining the amount of capital required, the ESM will also determine if the bank has the minimum legal common equity Tier 1 ratio, currently at 4.5%. If the bank does not meet the minimum, the government would inject between 10% and 20% of the funds shortfall. The ESM will provide the residual.
• If the government cannot meet the demands for 10-20% injection, the ESM will not step in to recap the bank
• Once the bank is recapitalised using ESM funds, ESM will take equity in the bank and will engage in setting bank strategy and business model. The ESM will also track bank performance to targets and will also have power to change bank management and board. This will be a major departure from the modus operandi of the Irish authorities, but to what extent it will be effective / significant remains to be see. After all, pro forma changes can be put in place with minor alteration to the pre-crisis status quo.

The document says ESM will deal with legacy assets, which is an ambiguous statement, but potentially holds some hope for Ireland.

17/6/2013: Latvia's Mistake

An excellent piece by ex-IMF Ashoka Mody for Bruegel blog on Latvia's bizarre, one-way (the wrong way) bet on entering the Euro: http://www.bruegel.org/nc/blog/detail/article/1108-latvia-in-the-eurozone-a-bet-with-no-upside/

Mody - having completed pensionable tenure at the IMF - is now going 'free agent' so political correctness can be set aside. He argues, quite correctly, that Latvia's membership in the Euro simply ties its hands on currency valuations and interest rates, without giving it anything tangible in return.

"But the economics does not favor euro adoption by Latvia. The Latvian authorities are giving up the extremely valuable option of floating their exchange rate at a future time. And what may be the offsetting gain? Establishing policy credibility is not one of them. Having proven to the world that Latvia will endure the most intense economic pain to preserve its exchange rate parity, why is a further commitment needed? If the argument is that a future government may be irresponsible and the country may be faced with a new crisis, it is presumptuous to judge that the floating option will not be right one at that time. Binding a future government in this manner is particularly overreaching given how little Latvian public support there is today for a move into the Eurozone."

"More importantly, long-term competitiveness requires a healthy pace of technical change and higher quality products. …If Latvia does successfully climb the technology ladder, it will do as well outside of the Eurozone as inside it; but if it fails that bigger competitiveness challenge, it will face an unpleasant rerun of its recent crisis. Again, Portugal offers a warning: the competitiveness problems that forced a painful adjustment under the Exchange Rate Mechanism in 1993 remerged less than two decades later."

Crucially, per Mody, "...the Eurozone is itself largely dysfunctional. By the admission of its own stewards, the “monetary transmission mechanism” is inoperative. Put simply, when the ECB changes its interest rates, its member countries feel no impact. It is as if the countries were operating on their own. This may improve with time. Those in the Eurozone have no choice; but does Latvia need to rush into this setting?

Indeed, if there was a moment for Latvia to float its exchange rate, this would be it."

Mody does not ask the other question: Why would the euro zone want so urgently for Latvia to join? The answer to this question is even less palatable politically and economically. Euro zone does need another country with a clearly divergent economy and no real dynamic of convergence (shallow growth across the euro zone and still crisis-driven dynamics in Latvia). Nor does Latvia suit the euro zone core - with slower growth and lower inflation targeted by demographically challenged Germany et al. Which means that the only reason for Latvia to be welcomed by the euro zone is geopolitical. Just the same as the only reason for Latvia to enter the euro zone is geopolitical as well. Both, the club and the entrant smell Russia in the distance and feel their early 20th century-stuck fears.