Macro Commentary: We Are Moving To Disneyland
From Peter Tchir of TF Market Advisors
After a recent trip to Disneyland the kids decided we should move there. The vote amongst the children was unanimous. So, are we moving to Disneyland? No! There votes don't count. They are not the decision makers. What does this have to do with anything going on in the markets? I think everything. I think it may provide the best lens with which to watch the noise out of Europe.
There are only 2 countries that really need to be watched closely, and 1 in particular.
Germany, the strongest economy in the Eurozone, the country with the strongest balance sheet, is against massive expansion of the EFSF. They are against proposals that trick their people into providing promised EFSF money, only to lever it up massively. They, the only ones who seem to have gotten the concept of what AAA is supposed to mean, say it is a stupid idea. They are the adult in the room. They have managed their way through the entire crisis better than anyone else. It is mostly their money that everyone else wants to play with. Whatever is coming out of Germany is most important because they have the money, but should also be listened to since they are the only ones who have been consistently right.
France. We will come back to them in a moment.
Greece. Yes Greece is 110% committed to austerity and yes at every review their debt needs are 120% greater than projected. Realistically you can only be 100% committed to something, and it is not clear that Greek is even that committed to austerity, and it is clear that it isn't working. Debt levels can be greater than 100% of projections and Greece has rarely disappointed on that account. Why will any of this change? Why won't Greece just have a bigger and worse default 6 months from now? Greece is along for the ride. They will say anything to keep getting money but will be very careful about what they actually do.
The United States. Let's not forget our own debt situation. Debt to GDP is high. Current deficit is high. The economy is weak at best. We have lost a AAA agency. In spite of 2000 some odd pages of Dodd-Frank all we have learned from the economic crisis is "TARP" and "No Lehman Moment". It is amazing to me that somehow we have defined the problem as having let Lehman fail and the solution as TARP, in spite of evidence that they were only small parts of the overall situation. In any case, we should be more worried about out own plans and their credibility than running around in complete confidence that we understand all the world's problems. And heck, we aren't even part of the direct family, this is like the crazy uncle in the corner putting in his 2 cents. If the IMF takes a bigger role in the new massive bailout, will taxpayers here revolt? We can say what we want, but Europe is unlikely to pay too much attention.
Barroso, Junker, and the EU in general. Their whole life and livelihood are tied to the Eurozone remaining the Eurozone. The more integration, the better for them. Every statement uttered by them is self serving. Period, end of story. Ignore them.
The rating agencies. I am not a big fan of them, and generally prefer to ignore them, but S&P has already come out saying the new plans risk the AAA rating of the top countries. Other than Germany, where the bond market, like those of Japan and the USA, could shake off the downgrade, the rest of Europe would face additional funding pressures. France is already starting to diverge from Germany in terms of funding costs. Last thing it needs is the AAA taken off the table. I cannot disagree with the view of the rating agencies at all. If the US could be downgraded, at least in part due to stupid economic decisions made by politicians, Europe abandoning any prudence to avoid a Greek default, would qualify.
IMF. Why do we still have an IMF when most of the countries that are funding it, are negotiating directly with the recipients on other packages? The only thing the IMF does is hide how much money the US and the EU are giving to the bailout because it requires a second step. We read that the IMF is giving 10 billion, but the reality is the US is giving 4 billion and the EU is giving 4 billion. It just makes it more politically palatable to keep the IMF around. There are also enough cozy jobs at the IMF that no one really wants to examine it too closely. They can say a lot, and even do a fair bit, but they are under a lot of pressure to not lose money and do seem to be treading carefully. Their opinion is important and real, but actually seems mostly rational.
The BRIC's. They have money (how much is debatable) and are willing to use it. But they already contribute some through the IMF, already own some bonds outright, and are definitely NOT a charity. Whatever they do, it will be out of their own self-interest. Anything that sounds too good to be true, is. These countries do not act as a block, in fact they compete with each other, and they all have strong nationalistic priorities. Since they have money, it is worth listening to what they say. But listening carefully. Russia has said they "will invest in bonds of the eurozone('s strong countries)" Reading only half of a sentence can create a false impression of what they are willing to do. Our positions always skew how we read a headline, but it seems that we have wilfully chosen to ignore caveats in the statements coming out of BRIC countries to feed the false optimism.
The Banks. They don't need money, but want cheap funding lines. They don't need capital, but wouldn't mind if governments made it available at off market rates. They don't need capital or money if the governments which just pay par for all their bonds. Banks are their for the benefit of their management, their employees, and their shareholders (in that order). They will say and do what they need to get the best deal possible for banks - it's why people invest in them. They clearly made a lot of horrible decisions to get to this point, but they are in full lie, deny, and counter-accuse mode to get what they want. They pull out the "Lehman Moment" card any time it seems as though the EU has come to its senses and will allow some sovereign defaults in order to support a simplified, but stronger world.
Italy. They are just having fun. They are part of the problem and part of the solution. They are so big, the EU can't let them fail. They are so big, they could walk away if they wanted. It is hard not to picture Berlusconi sipping wine with some colleagues and some "friends" asking them what strings they want him to pull the next day. I think they don't care that much because it will come out fine one way or the other and in the meantime it seems like its fun for them. They don't seem particularly serious about austerity, but certainly aren't opposed to getting some leveraged EFSF money. For all the talk about the problems Italy is having funding, their average 5 year yield from 1999 until the end of 2008 was 4%. Yes, it is currently close to 5%, but if we really live in a world where a country having to pay rates 1% above their long term average is unsustainable, then we are in deep trouble. Seriously, think about it. 5% isn't great, but it is a long way from crisis mode, and to "fix" this, we are going to create leveraged EFSF?
ECB. They are so deep into this mess that it is hard to tell what is real or not. They have spent so much money buying bonds, at such bad prices, that a lot of what they say has to be taken as posturing to protect their legacy. Trichet is the only Frenchman who can say the word sterilization and keep a smile on his face. They have done a lot, it is worth paying attention to them since they have power, but they have an agenda to hide their big losses from open market bond purchases. In the end they will either have to print, find some bizarre program to take them out of their positions, or ask member countries for more money.
France. Since Germany seems to be fighting the plans to lever up EFSF, then one can only assume that France is the adult that is pushing it. I am not sure what they are thinking. They seem to be too afraid of default. Too afraid of the Lehman moment. Too afraid of their own banks. The world seemed about as ready as possible to accept a Greek default coming into this week. Instead of pushing the button and letting Greece default and working incredibly hard and ensuring that liquidity and capital are sufficiently available, they stepped back, and with a wave of the hand decided they can create some bigger bold plan. Maybe it is all the jokes about France constantly surrendering that made them decide not to retreat. Retreat is not always bad, and living to fight another day has a lot benefits. Maybe the fact that the French still control the IMF and ECB gave extra confidence, but this latest push makes no sense to me. I think France in particular is at risk of losing its AAA rating even before a plan gets implemented. Its finances aren't that great. Its debt already trades significantly behind that of Germany, and now they seem willing to subordinate their own finances to prop up banks and weak countries. The original EFSF was a drop in the bucket compared to this. Proposing the plan may be enough to force a downgrade, accelerating the crisis rather than kicking the can down the road. Their position is nonsensical, particularly when the market was prepared to deal with a Greek default. Whatever the result of this push to lever up EFSF, the Eurozone will become more complex, more intertwined (in the bad way that two cars in a high speed head on collision become intertwined), and who knows what the unintended consequences will be.
I think the European leaders should go to some management bonding exercise and spend a weekend with a psychologist who tries to talk them out of their fear of default. Their fear of default is bordering on irrational, and maybe they need to be reminded of it. Maybe they should also be reminded that they represent their people and have some shred of responsibility to do what their citizens want.
Anyways, back to the headlines, but I think if you filter out who to listen to, the outcome becomes more clear. In the meantime, it seems like 3% daily moves with big intraday volatility will be the norm.
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