Via Peter Tchir of TF Markert Advisors [14],
Austerity is dead! Long live Spending!
Futures are up, Italian and Spanish bonds are up, CDS spreads on them are at least 10 bps tighter, and MAIN is 3 bps tighter on the day (though I have this feeling I better type fast as we are starting to fade off the best levels).
Lots of little things seem to be contributing to the strength, TXU earnings, no economic data, auctions that raised the required money, etc., but there does also seem to be a belief that Germany finally “gets it”. That Germany is finally going to relent on their demands for austerity.
The first question is “what is defined as austerity?” Programs that are providing money today, that is quickly re-circulated into the economy because it is paying for people to live should not be cut – that is bad austerity. Raising taxes in general is probably bad austerity, but what about actually collecting taxes on all those who have avoided paying what they owe? Plans to reduce long term benefits must go forward, minimal current cost to the economy, but necessary for any long term solution. So while “austerity” hasn’t worked, it is not all bad, and some forms need to be maintained to have any hope that the situation can be turned around in the future.
The second, and more important question, is “why does any sane person think spending for growth will work?” Just pause for 1 moment. How were these massive deficits built up? Was all the spending frivolous? I don’t think so. A lot of spending was meant to target growth in certain areas. It is just very difficult to achieve. If spending to get growth was so easy in a global economy, the U.S., the current king of spending, would have Chinese like GDP growth. It is not that easy to spend your way to growth. I’m sure at some level, Solyndra received money because there was a real belief somewhere that it was a good investment for growth. GM might be used as an example, but I’m not convinced that the government spending did anything more than private capital would have done in the wake of a real bankruptcy. The excitement over “spending for growth” is almost mind-boggling, because it basically goes against a decade of history showing the inability of governments to spend and achieve real growth. But, there is one part that does make sense, at least from a Wall Street perspective.
So the final question is, “who will finance all that spending?” Ahhh, the real reason Wall Street is enthusiastic about spending for growth. The only way a spending for growth campaign can begin, is with another massive round of balance sheet expansion by central banks. That has been great for banks and wall street, while less clear what it has done for the economy, or anyone without a significant portion of their wealth in stocks. If Spain announced a big new spending campaign, would anyone really believe it would work? What would they do? Build more homes to get construction going? How would that help when an unpopped real estate bubble is part of the problem (actually the bubble has burst, it just hasn’t been recognized on banks’ and cajas’ balance sheets). Would investors who aren’t excited about lending 5 year money at 4.75% suddenly line up to buy all this debt thinking the new spending initiatives (which increase debt in the short term) will really work? I don’t think so. Buying new debt in an environment where countries feel free to spend and run deficits because austerity doesn’t work, will only frighten private capital. So the central banks of the world will have to step up again and provide the funding. I don’t think that is a good thing, but can see why some do, and can really see why some of those pushing the most for a return to debt issuance and spending and central bank intervention would want it – because they benefit, not because it will work.
The reality is that spending won’t solve anything. It will grow debt faster than the spending can improve the economy. Stopping longer term austerity programs will make the future debt to GDP ratios look even more horrific. There will ultimately need to restructuring on a massive scale.
It is no co-incidence that more and more sovereign debt is being funded by institutions in that country. It is specifically to make leaving the Euro easier. An Italian pension plan for example has both its assets and its liabilities in Italy. A conversion back to Lire is manageable in a situation like that. Yes, the pension plan’s redenominated Italian Lire bonds may trade down because of the devaluation, but their pension obligations would also be redenominated at the same time, offsetting a lot, if not all of the pain. The same is true in the banking sector. Corporations won’t have that luxury as many are global, but it may explain why Italian and Spanish companies have been busy issuing debt. So returning to traditional currencies has the least impact on the country and the Eurozone if the debt is largely held internally. That is the direction the countries and the ECB have been moving, so don’t ignore this as a more likely real solution.
Debt restructuring in terms of coupon reduction, notional reduction, and maturity extension are all real possibilities too. If countries learned anything from Greece, it is that by waiting too long, and accepting more Troika money than the private sector wrote-off, the problem doesn’t go away. Restructuring early and harshly is far better than waiting and doing it in bits and pieces, and it has to affect ALL creditors. One reason that the ECB hasn’t resumed its SMP just yet is that countries aren’t sure how much they want to owe the ECB. The ECB has proven itself to be an unhelpful partner in restructuring. Watch what the ECB does (or doesn’t do) and ask yourself why.
So “Austerity Now” may be over, but killing something that didn’t work, isn’t the same as solving the problem. Going back to the norm that caused the problem in the first place, hardly seems like a solution either. Currency reversion and/or debt restructuring will be the ultimate end-game.
We get a deluge of housing data out this morning. I expect it to disappoint, but at this stage I’m not sure another housing disappointment does anything for the market. It would merely confirm what is becoming a consensus view – that the actual weather actually played a role in making the winter numbers look better than they might otherwise have been.
Good luck with the rest of the day, though I suspect that once Europe goes home we will do nothing but watch every move in AAPL like we did yesterday afternoon. In the meantime I hope I can get the Don Maclean American Pie song out of my head on “the day austerity died”….