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Tears for Two-Tiers
Over a number of years I had professional involvement with two-tiered markets. I’m not sure I can remember them all. Spanish A and B Pesetas come to mind. There was a two-tiered French Franc for a bit. I think Belgium had two markets as well. South Africa was two-tiered for years; Venezuela and the Philippines the same. At one point or another, all of the countries in South America were two-tiered. One of the more famous two-tiered markets was the Russian Ruble.
My interest in two-tiers was that they were (generally) exploitable. The markets had these features:
- Tier (A) was priced controlled by the central bank. There were limits on who could access this rate, and for what purpose.
- Tier (B) was not supported by the central bank, and floated freely in price; subject to supply and demand and the whims of the market.
- The price of A was always “rich”.
- B always traded very cheap relative to A.
- Liquidity for B was weak (hence exploitable).
Of course all this business of As and Bs is 25-30 years old (and long since forgotten), so you might ask why am I writing about it today?
The reason is that Mario Draghi is a few days away from creating the biggest two tiered market in history. The Arbs will make a fortune. And like all two-tiered markets, Mario’s will ultimately fail.
Draghi has hinted that his “I’ll do anything” plan was to cap yields on Spanish and Italian short-term paper. There have been recent “leaks” (bullshit – this was deliberate) that Super Mario will target the ECBs firepower to maturities of three-years and under.
I believe the leaks will prove true. Draghi is going to cap the short end for Spain and Italy. I think those caps will be generous (high caps do not get the monetary transmission Draghi wants). To have a measurable effect, the Spanish curve would have to be: 1Yr =<1%, 2Yr = <1.5%, 3Yr = < 2.0%.
If Draghi was bent on destruction, he could (temporarily) achieve these results for the Spanish bond market. In this modern example, the “A Tier” would be Spanish - < 3-year paper. The price would be controlled by the ECB; it would trade “rich” relative to the bond spreads today. It would trade very rich relative the bond yields on paper with maturities 5 years and out. There would be limitations on the Spanish Treasury on how much new paper they could issue in the three year window.
Existing bonds with maturities > 3-years would be the “B Tier”. Those bonds (and any new ones Spain tries to sell) will be tainted. There will be no promise of any price support. Long-dated paper will be functionally subordinated to shorter-term issues. This will be reflected in the price. The long-end for Spain will be sacrificed. In this environment, liquidity dries up. Spreads widen out. “Sharpies” will make bucks.
Did I mention that two-tiered markets don’t last very long? That they are a clear and present sign of economic disease? And they always end badly?
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Here is the outline of what Draghi will say according to the Squid :
Goldman Has The Most Devastating Description Of The ECB's New Bond Buying Scheme - Business Insider
the good the bad and the ugly...of the fiat ponzi world.
who will cry for argentina when she has nothing left to nationalise?
Who will cry for Portugal when her money will make it impossible to buy a loaf of bread?
Who will cry for Spain when her RE will be more costly to maintain than to junk?
Who will cry for Germany when the petrol car will become a luxury?
Who will cry for the Oligarchs when WS-DJ hits 5000 mark?
Blue eyes, singing the blues... blue suede shoes just walk on by.
Sounds like a ten year hike around blueberry hill, without the thrills.
Illusion of well-being and perpetual economic growth is being replaced by tragic consequences of reality of infinite increasing of indebtedness, taxes and inflation. Instead of promoted global happiness, time of zombie banks, zombie currencies, zombie states, zombie companies, zombie jobs and zombie individuals has arrived. World is in chaos from which there is only one exit: To change the way money works!
Alternative business opportunity for companies and creative professionals. And that’s not all! If you have music or design talent you can participate in contest for best song and best design:
International Contest: Business Reorientation Of Failed Society To Sustainable Currency
You got it partly right, money is a human construct. With moral hazard at an all time high and fraud remaining the status quo, nothing changes until all the bad debt and zombie banks, zombie currencies, zombie states, zombie companies, zombie jobs and zombie individuals are purged from the system.
Another age of tyranny is upon the entire "civilized" world, unless you are one of the robber barrons in tier "1", get back to work and stop complaining about the theft of the value of your labor through all kinds of manipulated paper promises. The kleptocrats come from families who were here before you and they want their rent and will kill to make sure it is paid.
Perfectly described LoP
...now what to do about it?
My tip, Stop Paying Your Taxes ...watch the world pefected for a Bankers Paradise collapse in 3, 2, 1 when you stop feeding their front Sales & Invoice Collection office, Govt
It will happen and probably has already begun as more commodity producers fall into bankruptcy (if you a re not making money, you can't pay taxes). Patience, preparation. History is very clear on what happens once real goods and services stop getting delivered, hedge acordingly.
What is not being said is that "as if by magic", the long-dated bonds will turn into short-dated bonds if you hold them for long enough.
So arb action for the bonds 'just' longer than 3 years will take their price up to close to 3 year bonds (tending to flatten the yield curve).
Unless you believe that the ECB action will have a limited timeline only?
Does this Draghi move create jobs? Inspire confindence?
Bruce you wrote a good article. I enjoyed that.
You might want to add that the Euro itelf is also already becoming 2 tier.
It is only a tiny effect but many Germans already refuse to hold Greek Euro notes and systematically sort through Euro bills and spend as quickly as possible while holding on to their German Euro notes or convert to gold or Swiss Francs and hold them in safe deposit boxes or under the matress.
Nominally of course there is no difference between Greek and German Euro notes but just like in Argentina when the Argentine Peso was linked 1:1 to the US Dollar a taxi driver would always prefer to take US Dollars and give back Argentine Peso as change. It was already happening 3 - 4 years before Argentina finally fell apart and dropped the US Dollar peg. I expect the same thing in Europe - look for the first signs on the street where the population spontaneously refuse to take Greek Euro notes or spend them as soon as they get them or dump them in German banks and convert them to electronic German Euros.
This is already happening. The signs are there that the population of Europe no longer fully trust the Euro.
MiniCooper, while I think it makes sense for a private person that wants to hoard EUR cash notes to have a preference on which letter of the alphabet they have stamped on, in terms of any "Exit" scenarios it would not make sense for the ECB not to accept "exit" notes.
The reason is simple: the cash in physical forms account for a minuscle portion of the whole thing.
Remember how an exit scenario really works:
A - Country X expropriates during a weekend all EUR-denominated accounts and changes them with the new fiat
B - at the same time all internal EUR debt is converted to the new national currency
C - then the 1:1 conversion rate is left floating -> immediate devaluation of the new currency as per plan
D - then the external debt is "sorted out" - painful process
E - meanwhile, the National Bank is EUR-"rich", and this hoard is carefully spent to navigate the time until "normality" and external debt can be used again (and this depends on how point D was sorted out)
Nowhere you'll find a need to expropriate EUR physical paper notes from the public and nowhere you'll find a need to repudiate those - again, very small in the great scheme of things - notes.
"very small in the great scheme of things - notes"
Very small indeed, in these days of credit and debit (and EBT) cards for almost all purchases in developed countries.
The USA has a two tiered system also,gold and silver eagles or paper and zinc dead presidents,tough decision.
Two-tiered market; sounds like what people pay on loans (prime +6%) versus what banks pay to the FED for taxpayer money (-0.05%).
Two-tiered market sounds like a Scottrade or Schwab transaction taking 3 seconds online at the proles computer, versus the HFT machine on the backbone of the exchange doin' it in .003 milliseconds.
Two -tiered market sounds like GM getting bailed out because it's American, but Americans paying to bail out failed companies and NOT getting bailed out for the same reason.
The Europeans (and USA) are buying their own bonds. These transactions are a circular whirlygig, a top, a toy.
When they become too toxic for even foolish pension and retirement funds and speculators to buy the gig will be up.
What will they do then? Why, bail out the fucking banks again!
If money is not tied to ANYTHING tangible other than an accountants "books" in binary form - the debt and printing are infinitely fungible!
As is already happening, people will ask themselves why they leave their money in a bank, why they go to work, and why they pay taxes.
well said eb!
Keep buying gold and silver coins.
By God, I think you have got this one right...
Of course all this business of As and Bs is 25-30 years
No Bruce its not.
controlled by the central bank there are limits on who could access
Chinese yuan is now a two tier market. B market is in Hong Kong.
I agree with his analysis regarding two-tier markets:
http://dareconomics.wordpress.com/2012/09/04/mainstream-media-still-hope...
Bruce, im curious if the Germans, or other EU members have a say in this, or or this truly a "charter" issue for the ECB where they can say "F-off!"?
The Germans can leave--this will speed it up.
Good to have a little more time.
... a little more time to bore the bond vigilantes into moving from Europe on to Japan...
Reminds me of China's two tiered currency system of old (80s and into the 90s): Ren Min Bi Yuan (RMB) and FEC Yuan (foreign exchange certificates). There were two officially published rates, etc.
Ostensibly, Chinese shops could only sell to foreign devils in FEC, and FEC could only be procured with foreign exchange (dollars). But it only worked at places like the "Friendship Store", owned by the government and where only the most un-resourceful of foreign devil tourists would shop, or at the "travel agent" (also owned by the government - but unfortunately the only way for a foreign devil to buy a ticket out of China). So you had to carry two sets of bills: one gritty and universal and one clean sham to constantly remind you of your "guest" guai lou status. FEC notes were occasionally useful as emergency toilet paper for those foreign devils unfortunate enough to have exchanged a large amount of Berstankes for them.
Say what you want, but the Chinese are (or used to be) savvy to how gray and black markets work (the ultimate two tiered system). American sheeple will understand it too once the only free market is the gray market. That day is coming sooner than most think. When it does, pre 1964 "currency" will suit me just fine on the street.
"Change-a-money?" . . . .
"Change-a-money?" . . . .
There is still 48 hours for someone to throw the fucker Monti over a bridge!
The Philippians? You were trading currencies in biblical times? That's an old head,
Well, I'm pretty old, but not that old.....
I fixed it. Tks.
b
Bruce, In your opinion is exit and devaluation with debt repudiation the only possible solution?
The fact is the two tiered market has existed for years now. In point of fact it was created by Trichet...all that Mario is doing is institutionalizing it. Since the so called "periphery" is too weak and lacking in the political will to resist the "simplicity of the euro" there can be no greater fait accompli since Napoleon himself crossed the Alps into Northern Italy. It will be interesting to see actually if France offers any resistance whatsoever. Should this plan proceed they could be relegated to "second tier status" within the EZ for decades.
BK, another informative post...thank you
ZIRP (and NIRP) is all they have left to continue the Ponzi. Bill Gross was right (before he was wrong). Financial Repression is here to stay. "Hand it over Grandma".
To most, ZIRP is NIRP. Economic cannabalism of the underclasses is what is happening and likely will continue until something big breaks. "Hand it over Grandma" is about spot on. The debts won't be paid by future generations. They are going to be squared away one way or another much sooner.
it will happen because nobody in the ECB Council ever heard about French Francs and Spanish Pesetas, eh?
New wine in old bottles. Thanks, Bruce.
I wonder how much relief Spain and Italy might get if their short term borrowing rates are capped. It would be interesting to see the maturity distribution for Spanish and Italian debt.
I think a better (better = desperately outrageous) play would be to create tiers of sovereign credit quality. How about super sovereign bonds? Maybe they could call them NATO bonds . . . and get Benny in on the play.
Then here in the U.S., we'll issue National Security bonds. All previously issued Trashuries will be subordinate to National Security paper which will, of course, be backed by the full faith and credit of the U.S. Marine Corps.
This shit could go on for decades . . .
This shit could go on for decades . . .
Christ, I hope not. And it looks to me like the wheels are slowly, finally coming off the bus.
Mind you... it looked that way 3 years ago too, so maybe you're right - we have another 20 years of central planning disaster to look forward to! Egads! :-(
Bruce: How do they impode?
Tier A is eliminated. The devalued Tier B is what is left. This happens when Mario's support ends (a few months before). It will end.
The flaw in the two-tier is that it is not sustainable. Tier A rewards bad behavior. Tier B punishes consumption. This is true for currency regimes. I believe it will be true when Draghi creates the tiers in the bond market.
More market intervention won't work for long. The Germans will not write a blank check.
I remember the plan was/is for ESM to buy PIIGS bonds, then the ECB will exchange them for core (German, etc) bonds, thus sterializing the operation.
The ECB only has a limited amount of core bonds to exchange.
The so called "unlimited" bond buying has a limit, because they must be sterialized.
The PIIGS will need more funding than they can get on the limits of the short-end, and thus will be dipping into the Tier B when they exceed commitments.
Thus either the PIIGS implode due to severe austerity, or they implode due to runaway interest rates on the long-end (Tier B) as they have to move out the yield curve to satisfy deficits that exceed limits.
The ECB plan is not reflationary. This will not stop the implosion of the GDP, corporate earnings, etc..
Perhaps the best time to short Europe will be when they finally put this implosion plan into action, if it takes that long for the market to figure this is an implosion plan.
TBTP know very well that this is an implosion plan designed to end the sovereignty of nation-states of Europe and institutionalize the centralized control of and deepen the debt slavery. It is a "all for one, one for all" Great Depression "we all suffer equally" plan.
ECB's plan will add no NET assets to its balance sheet, and thus is as deflationary as Operation Twist:
http://finance.yahoo.com/blogs/the-exchange/europe-unlimited-bond-buys-only-short-term-fix-132207053.html
I had pointed out in one of my recent comments, that the Fed has added no NET assets since QE2 ended in 2010. This is why the global PMI is sinking into contraction. The ECB's plan thus will do nothing to stop this contraction, and will probably accelerate it, since it will require the PIIGS to commit to austerity when requesting a bailout.
The global stock markets will eventually figure this out, perhaps not until after the Fed does an actual QE3 with new asset purchases, that the globe will thus continue to roll over into an avalanche implosion of global GDP.
Contrary to government reports, China's GDP is probably growing at less than 1.2% and maybe even contracting:
http://finance.yahoo.com/news/wheels-coming-off-chinese-economy-18552415...
Sometime after there is no QE3 on Sept 13, the markets should figure this out and crash, especially as corporations decrease their earnings forecasts, e.g. as FedEX did today.
It is still possible that we get one more up leg on this hopium rally, with the $VIX declining again. However, although the Slow STO is rolling over, the $VIX has moved up towards end of each day and is hasn't yet broken back down below the 50dma.
Just a provocative speculation: perhaps the Germans don't have the capacity to choose anymore. Perhaps their "choice" is, as we speak, being debated by the Chinese and the Russians.
The US would have a voice in the matter if we could find it, but it appears the US could not find its ass with two hands and a GPS these days. So Russia and China it is. They are probably fans of the status quo - Russia benefits from stability for its NatGas market, and China buys capital equipment from Germany and on balance might net benefit from a weaker but stable Euro.
In which case the German people will have about as much say in the matter as the US people do with respect to QE3 or the TSA... that is to say, none.
How long is that CHF peg going to last?
(Like cardboard houses in a hurricane ... )
Bruce, is this 2 tier just a shuffling of the pack (debt) behind which the goalposts are being moved and the economic winners and losers will be decided?
...having said that the history of these bi-planes you say everyone's going to crash and burn ultimately
yes
Will they write any check?
That is the question.
If the issue had been forced before the Greek non-default default (or was it a default non-default?), I think Germany would have made a sizeable committment.
Too much has now bubbled to the surface of the EU swamp for Merkel to have plausible deniability.
I think the Germans "will do whatever it takes" to end the bad joke the EU/euro have become.
barliman
Anything to buy a little bit more time.
Bruce:
This perspective is why I alwaiys enjoy your posts!
- Ned
{and, of course, the very occasional time that I might tweak you a bit, all in fun ;-) }
Thanks Bruce. I was wondering how this Super Mario thing was going to end.
How could you possibly be wondering such a thing? It will end in embarrasment; the search for scapegoats, martial law, and ultimately the demise of the Euro; which was a construct of French Socialists to avoid the embarrasment of periodic devaluations against the German Mark; it's just that simple.