France

Nowhere in S&P’s statement about “global economic and financial crisis”, did it clarify that sovereigns were hit due to backing their largest national banks (and international, US ones) which engaged in half a decade of leveraged speculation. But here’s how it worked: 1) Big banks funneled speculative capital, and their own, into local areas, using real estate and other collateral as fodder for securitized deals with derivative touches. 2) They lost money on these bets, and on the borrowing incurred to leverage them. 3) The losses ate their capital. 4) The capital markets soured against them in mutual bank distrust so they couldn’t raise more money to cover their bets as before. 5) So, their borrowing costs rose which made it more difficult for them to back their bets or purchase their own government’s debt. 6) This decreased demand for government debt, which drove up the cost of that debt, which transformed into additional country expenses. 7) Countries had to turn to bailouts to keep banks happy and plush with enough capital. 8) In return for bailouts and cheap lending, governments sacrificed citizens. 9) As citizens lost jobs and countries lost assets to subsidize the international speculation wave, their economies weakened further. 10) S&P (and every political leader) downplayed this chain of events.... The die has been cast. Central entities like the Fed, ECB, and IMF perpetuate strategies that further undermine economies, through emergency loan facilities and  bailouts, with rating agency downgrades spurring them on. Governments attempt to raise money at harsher terms PLUS repay the bailouts that caused those terms to be higher. Banks hoard cheap money which doesn’t help populations, exacerbating the damaging economic effects. Unfortunately, this won't end any time soon.

Last week we heard from Nomura's bearded bear as Bob Janjuah restated his less-then-optimistic scenario for the global economy. Today his partner-in-crime, Kevin Gaynor, takes on the bullish consensus cognoscenti's three mutually supportive themes in his usual skeptical manner. While he respects the market's potential view that fundamentals, flow, valuation, and sentiment seem aligned for meaningful outperformance, it seems actual positioning does not reflect this (yet). Taking on each of the three bullish threads (EM policy shift as inflation slows, ECB has done and will do more QE, and US decoupling), the strategist teases out the reality and what is priced in as he does not see this as the March-2009-equivalent 'big-one' in rerisking (warranting concerns on chasing here).

While his diagnosis of the balance sheet recessionary outbreak that is sweeping global economies (including China now he fears) is a useful framework for understanding ZIRP's (and monetary stimulus broadly) general inability to create a sustainable recovery, his one-size-fits-all government-borrow-and-spend to infinity (fiscal deficits during balance sheet recessions are good deficits) solution is perhaps becoming (just as he said it would) politically impossible to implement. In his latest missive, the Nomura economist does not hold back with the blame-bazooka for the mess we are in and face in 2012. Initially criticizing US and now European bankers and politicians for not recognizing the balance sheet recession, Koo takes to task the ECB and European governments (for implementing LTRO which simply papers over the cracks without solving the underlying problem of the real economy suggesting bank capital injections should be implemented immediately), then unloads on the EBA's 9% Tier 1 capital by June 2012 decision, and ends with a significant dressing-down of the Western ratings agencies (and their 'ignorance of economic realities'). While believing that Greece is the lone profligate nation in Europe, he concludes that Germany should spend-it-or-send-it (to the EFSF) as capital flight flows end up at Berlin's gates. Given he had the holidays to unwind, we sense a growing level of frustration in the thoughtful economist's calm demeanor as he realizes his prescription is being ignored (for better or worse) and what this means for a global economy (facing deflationary deleveraging and debt minimization) - "It appears as though the world economy will remain under the spell of the housing bubble collapse that began in 2007 for some time yet" and it will be a "miracle if Europe does not experience a full-blown credit contraction."

A triptych of greece, cement and resolutions.

Truthfully the only reason to be long stocks right now is in anticipation of more QE from the Fed at its January 25 FOMC meeting. However, the likelihood of more QE being announced at that time is slim to none. For starters, interest rates are already at record lows, so the Fed cannot use that excuse. Secondly the latest economic data out of the US, while heavily massaged, is showing some signs of improvement, which negates the need for more QE. And finally, Bernanke and the Fed are far too politically toxic for the Fed to begin another massive round of QE (the last one of $600 billion accomplished nothing) just for the sake of it.

When yesterday we presented the view from CLSA's Chris Wood that the February 29 LTRO could be €1 Trillion (compared to under €500 billion for the December 21 iteration), we snickered, although we knew quite well that the market response, in stocks and gold, today would be precisely as has transpired. However, after reading the report by Credit Suisse's William Porter, we no longer assign a trivial probability to some ridiculous amount hitting the headlines early in the morning on February 29. Why? Because from this moment on, the market will no longer be preoccupied with a €1 trillion LTRO number as the potential headline, one which in itself would be sufficient to send the Euro tumbling, the USD surging, and provoking an immediate in kind response from the Fed. Instead, the new 'possible' number is just a "little" higher, which intuitively would make sense. After all both S&P and now Fitch expect Greece to default on March 20 (just to have the event somewhat "priced in"). Which means that in an attempt to front-run the unprecedented liquidity scramble that will certainly result as nobody has any idea what would happen should Greece default in an orderly fashion, let alone disorderly, the only buffer is having cash. Lots of it. A shock and awe liquidity firewall that will leave everyone stunned. How much. According to Credit Suisse the new LTRO number could be up to a gargantuan, and unprecedented, €10 TRILLION!

As the buy-the-ratings-downgrade-news surge on European sovereigns stalls (following a few weeks of sell-the-rumor on France for example), the ever-ready-to-comment mainstream media remains convinced that the impact is priced in and that ratings agencies are increasingly irrelevant. UBS disagrees. In a note today from their global macro team, they recognize that while the downgrades were hardly a surprise to anyone (with size of downgrade the only real unknown), the effect on 'AAA-only' constrained portfolios is important (no matter how hard politicians try to change the rules) but of more concern is the political impact as the divergence between France's rating (and outlook) and Germany (and UK perhaps) highlights harsh economic realities and increases (as EFSF spreads widen further) the bargaining power of Germany in the economic councils of Europe. Furthermore, the potential for closer relationships with the UK (still AAA-rated) increase as the number of AAA EU nations within the Euro only just trumps the number outside of the single currency. This may be one of those rare occasions where politics is more important than economics.

The great lie that drives the fiat global financial locomotive forward is the assumption that there is no other way of doing things.  Many in America believe that the U.S. dollar (a paper time-bomb ready to explode) is the only currency we have at our disposal.  Many believe that the corporate trickle down dynamic is the only practical method for creating jobs.  Numerous others have adopted the notion that global interdependency is a natural extension of “progress”, and that anyone who dares to contradict this fallacy is an “isolationist” or “extremist”.  Much of our culture has been conditioned to support and defend centralization as necessary and inevitable primarily because they have never lived under any other system.  Globalism has not made the world smaller; it has made our minds smaller. By limiting choice, we limit ingenuity and imagination.  By narrowing focus, we lose sight of the much bigger picture.  This is the very purpose of the feudal framework; to erase individual and sovereign strength, stifle all new or honorable philosophies, and ensure the masses remain completely reliant on the establishment for their survival, forever tied to the rotting umbilical cord of a parasitic parent government. 

All you need to read.

Eurozone special: the only developed economy where credit markets still have a say.

A down day in the US on Tuesday could begin to trigger intermediate sell signals...~ Lee Adler

And so the latest inevitable outcome of the French downgrade from AAA has arrived, after the S&P just downgraded the EFSF, that pillar of European stability, from AAA to AA+. S&P adds: "if we were to conclude that sufficient offsetting credit enhancements are, in our opinion, not likely to be forthcoming, we would likely change the outlook to negative to mirror the negative outlooks of France and Austria. Under those circumstances we would expect to lower the ratings on the EFSF if we lowered the long-term sovereign credit ratings on the EFSF's 'AAA' or 'AA+' rated members to below 'AA+'." In other words, as everyone but Europe apparently knew, the EFSF is only as strong as the rating of its weakest member. And now the rhetoric on how AAA is not really necessary for the EFSF, begins, to be followed by AA, next A, then BBB and finally how as long as the EFSF is not D-rated all is well.

Despite disappointing auction results in France, the downgrade hangovers (sell the rumor, buy the news?), and increasingly likely Greek PSI talk epic-fail, most European sovereigns are rallying modestly on the day. Given the expected shift in the AAA benchmark used for margining (dropping higher yielding France 'AAA's as they are downgraded will lower AAA benchmark significantly and implicitly widen the yield differential for other sovereigns), it is perhaps no surprise that TPTB are active in BTPs (Italian bonds) but it appears that Portugal (admittedly illiquid) has been left to its own devices. Portuguese 10Y bond spreads to bunds just broke 1250bps, +180bps on the day and at record wides. Given the subordination concerns as ESM is accelerated, it is perhaps no surprise that the ECB's SMP has seemingly decided that Portugal has crossed the Rubicon into Greece territory.

The big news out of Europe on Friday was not S&P’s downgrade of 9 countries, France included. The ratings agency told us weeks ago that it might do this. No, much more important was the ECB’s saying in the bluntest possible terms that the EU leaders are backtracking on the fiscal compact agreed just 5 weeks ago by 26 of the 27 countries... Now the folks responsible for the actual writing of this fiscal treaty have only two weeks before the next EU summit to come up with something that satisfies both the EU heads of state — whose attempts to soften the terms show that they are apparently having second thoughts about giving away fiscal sovereignty — and the ECB paymaster. They’ll need to be as flexible as Chinese acrobats to make it work.

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