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Europe's Mountainous Divide And Why Draghi's Words Fixed Nothing
Two weeks ago we noted the transmission channels that Mr. Draghi had pointed out having become broken, clearly enunciating the chasm that is developing in the interbank market. Goldman's Huw Pill takes this a step further and notes a 'red line' - running along the Pyrenees and the Alps - that has descended with banks south of this line having difficulty accessing Euro interbank markets, whereas banks north of that line remain better integrated and retain market access. This is the exact segmentation that Draghi worries is interfering with policy transmission (and thus affecting macroeconomic outcomes - in his view). Banks in the periphery have been 'red-lined' and while last week's ECB announcements initiated a policy response to this segmentation, the obvious (to anyone who actually comprehends the situation) reality is that ECB purchases of government bonds does not eliminate this 'red line'; only convincing markets through fundamental adjustment (fiscal consolidation, structural reform, and institutional building) will the red-line be lifted. This is highly improbable in the short-term and means an expectation of more direct intervention in bank funding markets (with all its encumbrance) will occur soon enough.
Goldman Sachs: Focus: Europe’s ‘red line’: Segmentation of the Euro interbank market is significant
Bottom line: A ‘red line’ has descended across Europe, running along the Pyrenees and the Alps. Banks south of this line have difficulty accessing Euro interbank markets, whereas banks north of that line remain better integrated and retain market access. As Mr. Draghi emphasised at last week’s ECB press conference, this segmentation is interfering with monetary policy transmission and thus affecting macroeconomic outcomes. Monitoring the intensity and geographical location of the ‘red line’ will remain crucial going forward, not least to assess the effectiveness of the policy measures announced by the ECB last week.
“… financial fragmentation hinders the effective working of monetary policy”. Mr. Draghi’s comments at last week’s ECB press conference have placed the segmentation of Euro financial markets at centre stage. In this daily, we explore the nature of that fragmentation, focusing on the Euro interbank markets.
Documenting the segmentation of the Euro interbank market. To explore this phenomenon, we compare cross-border lending before and after the onset of financial crisis using data from the Bank for International Settlements (BIS).
We use the BIS consolidated banking statistics. For each Euro area country, these data provide the foreign claims of domestic banks, broken down by the counterparty country. The data are gross insofar as intra-country positions are not netted out, but consolidated insofar as all branches and subsidiaries of banks are included in the figures for the country of the head office.
This treatment of foreign banks means that, for example, a loan from a German bank’s subsidiary in France to a French resident is treated as a German asset. As such, these data do not correspond to the ECB monetary statistics, which are our usual benchmark. Nonetheless, assuming no large changes in the activity of subsidiaries between the two periods we examine, this should not bias our analysis. Indeed, one could argue that foreign subsidiaries' loans to domestic residents also represent an important form of cross-border activity that should be captured when coming to an assessment of market integration.
From hot to cold: The periphery is being frozen out. Charts 1 and 2 show the row country’s bank claims on the column country’s banks, in 2008 Q1 and 2012 Q1 respectively. The numbers capture these claims expressed as a percentage of the column country’s (quarterly) GDP in 2008 Q1. Of course, representing the data in this form is not a neutral choice. But the basic insights revealed are not sensitive to our choice of scaling variable.
The charts are presented in the form of heat maps: ‘hot’ colours (red) reflect a high degree of financial interaction, whereas ‘cold’ colours (blue) point to financial isolation.
In 2008 Q1 before the failure of Lehman, integration of Euro interbank markets was high: i.e. Chart 1 is predominantly red. With the notable exception of Greece, banks in all Euro area countries have significant claims on all other Euro area countries. Ireland, Spain and Italy are all well-embedded into the Euro interbank markets.
In 2012 Q1 as the European sovereign crisis has intensified, integration has broken down: i.e. Chart 2 is predominantly blue. In particular, the three programme countries (Greece, Portugal and Ireland) have become isolated. Spain (and to a lesser extent Italy) are also drifting towards greater isolation, whereas among Germany, France and the Netherlands integration remains significant, albeit still diminishing.
A ‘red line’ has emerged in Euro interbank markets – and is shifting northwards. To draw on the credit rationing literature in economics, banks in the periphery have been “red-lined”, i.e. simply on account of their residency, they are being excluded from the Euro interbank markets.
This red line has long isolated the program countries. And it is now moving northwards: Italy and (especially) Spain are vulnerable. A ‘red line’ running along the Pyrenees and Alps cleaves the big-4 countries at the heart of the Euro area in two. Given the deep recessions being suffered in Spain and Italy, the implications for borrowers and the real economy – as well as for the ability of monetary policy to ease tight financing conditions – are self-evident.
Last week’s ECB announcements initiate a policy response to this segmentation. But ECB purchases of government debt in and of themselves will not eliminate the ‘red line’. Rather, rebuilding the confidence of international investors and northern European asset managers in the economies of the periphery and the sustainability (or “irreversibility” as Mr. Draghi has styled it) of their membership of the Euro area is crucial. This is where underlying macroeconomic adjustment – the fiscal consolidation, structural reform and institution building mentioned in last week’s ECB statement – are key.
But convincing the markets through fundamental adjustment takes time. Meanwhile, we may need to see more direct action by the ECB to breach the 'red line' dividing Europe's banks so as to support credit conditions and growth in the periphery. Our analysis here therefore offers further reason to believe that the ECB will intervene more directly in bank funding markets, as we suggested last week.
Source: Goldman Sachs
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YEAH BUT....
It doesn't matter that Draghi is a flaming idiot, that all plans and hopes are nonsense, only that enough computers believe this BS.
I see where euroland and US markets are up rather nicely in part on the solution to all the problems "over there".
sunny
There are no markets. There is only government announcements and phrasing to terrorize folks into not executing price discovery.
You can try to piggyback this and make money, but when you do you risk losing all of it in a few milliseconds.
This is not a place to have money. Buy some land and grow something sellable, like cotton or corn.
Of course, that requires you to get up and move from the screen, and incidently also extend your life 15 yrs health-wise.
Is Ireland the first one to botch away from the nation-state racket?
http://www.irishtimes.com/newspaper/opinion/2012/0807/1224321629744.html...
and instead join the kleptocratic transnational currency union racket ?
I thought they learned lessons when they gained their freedom/independence from the British. Then they go and fuck it up and get involved with that bunch on the continent. No wonder the state - ultimately there for the Irish - is being ignored. Slainte!
"The Irish,
The Men that God made mad,
For all their wars are merry,
Yet all their songs are sad."
- C. K. Chesterton
His words sure fixed the S&P. Glad there's nothing to see here. I was almost about to worry over nothing.
"To Infinity.....and Beyond."
Buzz Ben Lightyear
MANBERNKRUG!
When they start talking interbank lending you know the dream/nightmare has come full circle.
Super Furry Animals - "Mt."
I wasn't looking for a mountain
There was the mountain
It was a big fucking mountain
So I climbed the mountain
It was no ordinary mountain
It was a strange-looking mountain
But when I got to the top it was two foot tall
It was oh so small
But coming down from my mountain
There was nothing to stop me
Prepared for the future
Accomplished back left behind me
With a tortoise tempo
I move on gradually
My ship was leaking
"No danger," I said, "you can use my compass instead"
From a ring-o-ring-o-roses
As we had through history
From a land that is quite cursed
Here comes the cavalry
If the king stayed behind us
detached from reality
And when the time comes you will know what I mean
When we all fall down
I wasn't looking for a mountain
There was the mountain
It was a big fucking mountain
So I climbed the mountain
It was no ordinary mountain
It was a strange-looking mountain
But when I got to the top it was two foot tall
It was oh so small
My mind was scrambling
For a thought that was happening
Do we need more than diplomacy
To get us through tragedy
One thing is for sure
You can't beat solidarity
So on my return it was clear as day, it was all okay
I looked for the mountain
There's always a mountain
So make a molehill from the mountain
And banish all mountains
Now there's no more mountains
What else can there be?
And as sunset falls, the owl of wisdom told me
No matter where you go, there you are!
All that Draghi's words accomplished was to increase the price of petrol.
All these wise idiots calling for a 20% devaluation of the Euro in order to help the southern exporters seem to miss how expensive petrol is and that the exporters that remain are not that affected by currency fluctuations - those that were about winning on price lost to China a long time ago and went out of business...
But but inflation is going to save Spain, Italy and Greece ! /sarc
You can talk all you want about broken transmission mechanisms and convertibility risk, but the reason why the Northern banks are reluctant to lend is because they think their Southern cousins are concealing the reality of the situation. Look at the state of Spain - four years of denying the obvious has utterly destroyed their credibility. They know that the extremely smooth players may be calling on one line asking for credit, but on the other, they are moving their own money out, whether to Switzerland, Germany, London or further afield. Watch what they do, not what they say.
All banks are dressing up their balance sheet, and they all know that stress tests are a farce. These banks have so few unencumbered assets that are still good and a shit load of bad loans held at absurd prices, so only a fool would be an unsecured creditor. And there is nothing Draghi can do about that... You cannot fix a solvency crisis with cheap loans...
the end of the financial world will be bullish.
Food for thought for gold bugs like me. Never hurts to consider other opinions. From the FT:
Cash out of gold and send kids to college
By Peter Tasker
Just like the non-barking dog in the Sherlock Holmes story, the gold price has become strangely insensitive to the usual stimuli.
Unsurprisingly, investors are running scared. The global flight to safety has seen capital flood into “core” sovereign bond markets, driving yields down almost to vanishing point.
Yet, despite this perfect storm of financial instability, the gold price remains becalmed. In fact, over the past year gold bullion has behaved like a “risk on” asset, rising and falling in sync with stock markets.
This makes sense. For most of human history, the yellow metal existed as an alternative to conventional finance, a “store of value” that could be relied on in times of distress and crisis. Gold bugs may hate to admit it, but those days are long gone. Gold has become just another financial asset, as vulnerable to the shifts of investor sentiment as an emerging market. It is symbolic of today’s world that the largest exchange traded fund is invested in gold bullion, not equities.
So why has the golden dog suddenly gone silent? One likely reason is that the price has simply become too rich.
All the gold that has ever been mined is still in existence, but it continues to exist because it is sterile – quite literally useless. As such it is hard to value, except by broad rules of thumb.
The current bull market saw the gold price rise from $280 an ounce to $1,900 in 10 years. This is a rate of ascent comparable to some of the great historical bubbles, such as Japanese stocks in the 1980s, Nasdaq in the 1990s and Chinese stocks more recently.
In inflation-adjusted terms, gold remains within spitting distance of the all-time high it reached in 1981. After that it embarked on a 20-year bear market, which delivered a loss of 80 per cent in real terms and a far greater opportunity cost as other financial assets soared in price. Even now the total market value of all the gold in existence – which, remember, generates a return of precisely zero – exceeds the combined capitalisation of the German, Chinese and Japanese stock markets, with all the productive capacity they represent.
According to the website pricedingold.com, gold is at a 120-year high (at least) relative to US house prices. Likewise, it is at a 74-year high relative to US wages, at multi-generation highs relative to wheat, coffee and cocoa and at the same price relative to the cost of a Yale education as in the first decade of the 20th century.
Gold does not rise to these giddy heights by accident. A bull market of this scale requires widespread distrust of other financial assets, of the banking system, of capitalism itself. This was the case in the late 1970s, when Soviet expansionism and the bitter aftermath of the Vietnam war bred a growing pessimism about the future. When gold peaked in 1981, both equities and bonds were cheap by historical standards, having endured long grinding bear markets.
There are similarities in today’s political and financial landscape, but also some important differences. Bonds are expensive. If Sidney Homer’s History of Interest Rates is any guide, long-term interest rates are as low as they have been since Babylonian times. Meanwhile, we are twelve years into a global bear market in equities, but the US market, the world’s largest, is not cheap on such long-term measures as the Shiller price/earnings ratio and neither are the most popular of the emerging markets.
So where is the haven that offers protection against the turbulence of markets? Guess what: there isn’t one. Everything has become somebody’s idea of an asset class, from dodgy modern art to the copper that burglars strip from church roofs. Everything carries some risk of loss.
Even so, some assets offer more value than others. In Europe and Japan, optimism has all but vanished and Shiller p/e ratios are low. For sure, these economies face serious challenges, but, as the example of 1981 shows, that comes with the territory when assets are cheap. Even in a world of no capital gain, a case can be made for solid blue-chip equities purely on the basis of dividend yield, historically the main component of investment returns.
For those who are nervous of financial markets, there exists an obvious alternative. On the pricedingold.com numbers, you should cash out of gold, buy a nice house, hire some workers, send your kids to college and eat big breakfasts.
Peter Tasker is a Tokyo-based analyst with Arcus Research
It certainly hurts to consider opinions in the FT, which almost unfailingly disses gold at every opportunity.
Let's see. The return on cash (e.g. short-term bonds) is negative in many markets. The return on long-term bonds is slightly positive, but scary when the prospects of debasement and default are considered.
This leaves two major asset classes: gold for wealth preservation, and stocks for investing/speculating.
Gold going from $280 to $1900 was less than a 7-fold increase, which isn't much of a bubble. Gold went from $35 to $800 between 1970 and 1980, a 23-fold increase. The Nikkei and Nasdaq bubbles were comparable. Gold over $5000 might be a bubble.
If Sidney Homer’s History of Interest Rates is any guide, long-term interest rates are as low as they have been since Babylonian times.
This means that long-term bonds are as expensive as they have been since Babylonian times. So why doesn't FT conclude that now is the time to sell your long-term bonds? Answer: because FT is the tool of the bankers.
Gold naturally tends to appreciate relative to other assets because the amount of gold tends to increase by around 2%/year while GDP growth has tended to be much higher in the last few centuries. Also consider that until recently, most of the world's gold resided in Europe, North America, and Japan because people in undeveloped countries couldn't afford to own much of it. Now China and India have growing middle classes that want to own gold jewelry, watches, etc. too. So now the west will need to share its gold with Asia, resulting in much higher gold prices.
Good retort. I sure hope you are correct!
Any idea why greece looked like that back in 08?
Interesting propaganda piece, a tell actually, on Bloomberg radio after noontime today, whereon it was "absolutely denied" by some shill they had on to the effect that the Fed's repo move today had anything to do with monetary policy. Instead, we were left with the impression that the repo machinery, like an unused piece of machinery left out in the rain to rust, will freeze up if you don't fire the darn thing up once in while.
I think most ZHers already knew it was bullshit, but I guess TPTB felt the need to trot someone out to make sure that rationale was articulated in the media, and, hopefully picked up on. The real answer is that if it were true, why wouldn't you say nothing at all?