David Einhorn Throws France Under The Bond Vigilante Bus
David Einhorn, in addition to being a professional poker player, has a knack for simplifying things. A good example of this is his diagram of the Europe summit cycle, repeatedly presented on these pages in the past. He also happens to be a successful hedge fund manager. It is him in this last capacity that we focus on today, courtesy of his July 23 letter to investors. Largely uneventful, he describes in detail the performance of his various positions which lately have started taking on water: of note is his mention that he has cut his entire position in DELL "with a loss" saying "non-PC growth was smaller than we’d hoped and the PC deterioration was worse than we’d anticipated." Oh well - you win some, you lose some.
Far more important are his now traditional ruminations on Europe, and specifically the core, especially his observation that unlike last year, when France (no longer AAA at all rating agencies) and Germany were rarely seen in the same boat (on expectations of a French downgrAA+de which came and went), and when French yields would rise and those of Germany fell, this time both paradoxically trade in parallel. Yet while fringe blogs can lament the patently obvious and explain how France is not worthy of record low yields, sometimes it takes a more prominent figure to demonstrate to the market that the emperor is indeed naked. Sure enough France is wearing absolutely nothing at least according to David Einhorn.
To wit: "Under the new regime, France is now cozying up to its new anti-austerity, pro-money-printing allies, Italy and Spain. This makes sense when one considers that France's economy is more akin to that of its southern neighbors than it is to the German economy. Strangely, the French bond market hasn’t figured this out just yet." It will soon enough, and the result will be even more negative yields for the remaining core countries, as "75% tax for millionaires; 60 year old retirement age" France resumes its rightful place - blowing up together with the rest of the periphery.
On the first day of winter, lulled by the security of the European Central Bank’s Long Term Refinancing Option (LTRO), the bears went into hibernation. They stirred on the first day of spring and then, just one day into the second quarter, they woke up in earnest and the market’s relentless rise came to an abrupt end. April marked the beginning of a decline that continued steadily for the next two months. With many possible trouble spots coming back into view, the market can’t seem to focus on more than one crisis at a time. Once again, Europe’s woes took center stage.
In April, the LTRO “fix” began to wear off as bank customers in Europe’s periphery started contemplating what would happen to their savings if their nation left the Euro. Visions of bank statements not in Euros, but in ‘newly re-issued for the purpose of devaluation’ local currency, offered no twinges of nostalgia. National pride gave way to pragmatism as depositors in Spain, Italy and Greece began transferring money in droves from their respective local banks to less risky banks of other countries – particularly those with German names. The market took note of these incipient bank runs as peripheral sovereign bond spreads raced to new highs.
May brought the end of the “Merkozy” approach to the Euro crisis as the French voted out the austerity-loving Conservative and voted in Socialist President François Hollande. Under the new regime, France is now cozying up to its new anti-austerity, pro-money-printing allies, Italy and Spain. This makes sense when one considers that France's economy is more akin to that of its southern neighbors than it is to the German economy. Strangely, the French bond market hasn’t figured this out just yet.
By early June the market had given back all of its first quarter gains, and the crisis yet again came to a head. The European leaders took a cue from Groundhog Day and did as they always do: they announced yet another ‘Summit to Fix Everything’.
It is hard to blame the current European leaders for their inability to solve a crisis that has no real solution. Even the very best options range from awful to awful, so no one should be surprised when the political choice is “None of the above. Let’s put out a communiqué and hope that no one notices.” This remedy of, “Take one aspirin and call us in the morning – or, better yet, after our August vacation,” offered the market some welcomed pain relief, but the rally lasted about as long as it takes to metabolize an aspirin.
Some believe that Germany could alleviate the problem by simply whipping out its checkbook. Setting aside the likely German distaste for doing so, a simple analysis of Germany shows that its own fiscal situation isn’t so rosy, particularly if it is also headed toward recession. Were it to try to bail out its neighbors, there is the risk that they would all sink together. Germany already has its own fiscal commitments, and its economy is simply not big enough to bail out the rest of Europe.
Much to its chagrin, Germany doesn’t have the option of walking away either. The recent huge influx of deposits into “safe” German banks only serves to exacerbate the problem. The German banks don’t need the money, so they park it at the Bundesbank, which in turn lends it via the ECB back to the local banks that are losing deposits in Europe’s periphery.
Essentially, the bank runs also shift the credit risk of peripheral banks from the local depositors to the Germans. While the Germans kick and scream about not wanting to take on credit risk through Eurobonds, they are already taking on similar risk through the banking system.
The whole thing is such a mess – who can blame them for heading for vacation? Besides, this allows the politicians to position themselves to give the appearance of personal sacrifice, should they need to interrupt their Olympics cheering to make emergency phone calls.
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