Germany

Successive plans to restore confidence in the euro area have failed. Proposals currently on the table also seem likely to fail. The market cost of borrowing is at unsustainable levels for many banks and a significant number of governments that share the euro. In three short sentences, the Peterson Institute for International Economics' (PIIE) Simon Johnson introduces the clear and present danger that Europe has become in a comprehensive article on the deepening European crisis. The circular nature of the realization of sovereign credit risk realities and the subsequent effective insolvency of banks exacerbates a credit crunch and exaggerates problems in the real economy - most specifically in the periphery. Johnson outlines five measures that are needed to enable the euro area to survive but the big bazooka of up to EUR5tn just for the PIIGS is what the PIIE senior fellow fears as the ECB is pushed down a dangerous path. The coordination of 17 disaparate nations leaves the former IMF man greatly concerned as the unique nature of this crisis leaves "four economic, social, and political events as possible causes of systemic collapse with each at risk of occurring in the next weeks, months, or years and these risks will not disappear quickly." As European sovereign bonds are now deeply subordinated claims on recessionary economies, it is no surprise that Johnson ends by noting that Europe's economy remains in a dangerous state.

This is the scariest chart out of the IMF's World Economic Outlook report released today. Naturally it was purely included in there to emphasize the IMF's Mutual Assured Destruction point that Europe has to immediately proceed with fiscal easing (something which Germany will not agree to until it is too late, if then), or else this is what happens. And since this is Europe, and no fiscal resolution will come (but many, many, many summits are in store before the world figures this out), this is precisely the sad reality in store for Europe, and thus for the US and China, as 2012 will be the first year since the Second Great Depression in which official statistics will represent a global economic contraction. As for Europe's 4% decline relative to baseline: good luck.

• Fears Mount That Portugal Will Need a Second Bailout (WSJ)
• EU to Have No Deadline for End of Greek Talks (Bloomberg)
• Japan economy predicted to shrink in 2011 (AFP)
• Japan’s Fiscal Pressure Intensifies as Tax-Boost Plan Insufficent: Economy (Bloomberg)
• Berlin ready to see stronger ‘firewall’ (FT)
• Obama Speech to Embrace U.S. Manufacturing Rebirth, Energy for Job Growth (Bloomberg)
• EU Hits Iran With Oil Ban, Bank Asset Freeze in Bid to Halt Nuclear Plan (Bloomberg)
• China's Oil Imports from Iran Jump (WSJ)
• Croatians vote Yes to join EU (FT)
• Japan’s $130 Billion Fund Unused in Biggest M&A Year in More Than Decade (Bloomberg)
• Buffett Blames Congress for Romney’s 15% Rate (Bloomberg)

Back on December 30, we noted that a little known name in the US, but very well known in Europe, PetroPlus is having significant solvency issues as banks froze a $1 billion revolver. Less than a month later the situation has proceeded to the next evolutionary step, as Europe's largest refiner by capacity has announced it will file for bankruptcy protection. And while operations should not be impacted, the fact that this comes just as Europe imposes an oil embargo on Iran, virtually guarantees that the continent's gasoline prices, already among the highest in the world are likely to set off even higher, paradoxically even as end-market demand is at lows. The bankruptcy will also guarantee that European initial jobless claims will plunge, especially if the BLS opens a Brussels office and applies its own very unique brand of "logic" to Europe.

Hank Paulson started the extortion racket. Greek prime ministers practice it weekly. Now Christine Lagarde jumped in too. Taxpayers please step up to the plate. Or else—

There are consequences to this policy.

Two things of note in today's Rosie piece. On one hand he breaks out the 10 good and bad things that investors are factoring, and while focusing on the positive, and completely ignoring the negative, are pushing the market to its best start since 1997. As Rosie says: "The equity market has gotten off to its best start in a good 15 years and being led by the deep cyclicals (materials, homebuilders, semiconductors) and financials — last year's woeful laggards (the 50 worst performing stocks in 2011 are up over 10% so far this year; the 50 best are up a mere 2%). Bonds are off to their worst start since 2003 with the 10-year note yield back up to 2%. The S&P 500 is now up 20% from the early October low and just 3.5% away from the April 2011 recovery high (in fact, in euro terms, it has rallied 30% and at its best level since 2007)." Is there anything more to this than precisely the same short-covering spree we saw both in 2010 and 2011? Not really: "This still smacks of a classic short-covering rally as opposed to a broad asset- allocation shift, but there is no doubt that there is plenty of cash on the sidelines and if it gets put to use, this rally could be extended. This by no means suggests a shift in my fundamental views, and keep in mind that we went into 2011 with a similar level of euphoria and hope in place and the uptrend lasted through April before the trap door opened. Remember too that the acute problems in the housing and mortgage market began in early 2007 and yet the equity market did not really appreciate or understand the severity of the situation until we were into October of that year and even then the consensus was one of a 'soft landing'." Finally, Rosie steps back from the noise and focuses on the forest, asking the rhetorical question: "Isn't this still a "modern day depression?" - his answer, and ours - "sure it is."

Macro news from Europe has refuted claims made last week that the ESM fund would be doubled to EUR 1tln, with a German spokesman commenting that the country is not of mind that ESM resources should be increased to that level. Discussions concerning the management of the EFSF and the ESM from German members of parliament have spurred talks that the funds could be run in parallel and even together in an emergency scenario. The ECB’s Weidmann has commented on his confidence in the Eurozone and the German economy, stating that current stagnation is temporary and that we should see a recovery in the Eurozone during 2012. Financial stocks have shown volatility this morning following comments from French and German Finance Ministers that banking regulations may be relaxed under the Basel III agreement, however this was later denied by the German Finance Minister.

• IMF begging ECB for cash, ECB begging Germany for cash... all is well: Lagarde Says Europe Must Boost Firewall (WSJ)
• More rumors of inflation targeting: Bernanke near inflation target prize, but jobs a concern (Reuters)
• A Sears Wager Stings at Goldman (WSJ)
• Draghi Makes Euro Favorite for Most-Profitable Carry Trades With Rate Cuts (Bloomberg)
• Euro zone finance ministers to rule on Greek debt talks (Reuters)
• "Reserve Currency" - Iran Said to Seek Yen Oil Payments From India Amid Sanctions (Bloomberg)
• Hackers-for-Hire Are Easy to Find (WSJ)
• Florida’s Republican Primary Pits Romney Money Against Gingrich Momentum (Bloomberg)
• YouTube hits 4 billion daily video views (Reuters)
• Carnival CEO Lies Low After Wreck (WSJ)
• Fed Forecasts Could Awaken Treasurys (WSJ)

All you need to read.

The market will look for any signal on the pace of discussions over the ESM pre-funding details and the fiscal compact. Flash PMIs in the Eurozone and the IFO will also be key to watch given market fears over the activity impact of tight fiscal policy linked to the Eurozone fiscal crisis. Attention will likely shift to the US this week. Q4 GDP will likely exceed 3% mostly due to one-off drivers and less so due a genuine pick-up in final demand in our view. The FOMC statement and press conference are unlikely to lead to a change in US monetary policy. However, we will be focusing on the publication of the FOMC participants’ views of appropriate policy (specifically the path for the federal funds rate and guidance for the size of the balance sheet going forward). In addition, President Obama will give his State of the Union speech Tuesday night.

It took a few hours for Germany to tell not only Italy, but the ECB, to shove it. Earlier we reported that the Super Broke Mario Bros came begging on Germany's footstep, kindly requesting their daily allotment be doubled. Germany has now kindly responded. From Reuters: "German Finance Minister Wolfgang Schaeuble on Sunday rejected pressure to beef up the euro zone's permanent rescue facility, saying Berlin would stick to the agreement made in December for a lending capacity of 500 billion euros ($646 billion). "We are sticking to what was agreed in December," Schaeuble told public broadcaster ARD. "In March we will check whether that is sufficient." The draft treaty establishing the European Stability Mechanism (ESM) will be discussed by euro zone finance ministers on Monday and is likely to be approved by EU leaders at their summit on Jan. 30, euro zone officials have said." As a reminder, minutes ago when we reported the first leg of this now closed transaction we said: "Poor Mario apparently fails to grasp that for Germany a plunging Euro, and thus a surging export market to offshore trading partners, is the only thing that matters now that its endogenous mercantilist import, pardon, trading partners of the past decade, the PIIGS, have no more debt capacity to buy German exports. Although even a technocrat probably understands that one does not get a weak currency by bailing out the weakest links over and over. Expect the European crisis to be with us for a long time. After all, that's precisely what Germany wants." And what Germany wants, Germany gets.

With less than three months left until the Greek D-Day, and just over one month until the next 3-year LTRO, which will be the ECB's final chance to firewall off its banks with sufficient liquidity and brace for the worst if Greece fails to reach a consensual debt reducing exchange offer (which our colleagues in the German press don't think will be nearly enough), we finally get a glimpse of how the super broke Mario brothers really feel. According to a report in the German Spiegel, the ink is not even yet dry on the latest completely toothless EU Fiscal Draft (which will allow the €500 billion European Stability Mechanism to be enacted) and already we get the world's most insolvent hedge fund, pardon central bank, and Europe's biggest debtor demanding for more. "Italian Prime Minister Mario Monti and European Central Bank President Mario Draghi both support enlarging the capacity of Europe’s permanent financial rescue mechanism, Der Spiegel reported, without saying where it got the information. The news magazine said Monti is pushing for the European Stability Mechanism’s capacity to be doubled to 1 trillion euros ($1.29 trillion), and had made the suggestion to the German government. Der Spiegel added that Draghi supports the view that unused funds from Europe’s temporary rescue fund should be added to the ESM’s firepower when it comes into force." Well good thing the ECB is not printing money or else one would get the impression that the system is getting flooded with trillions of excess cash. It also also great that the next LTRO will not be up to €10 trillion, as first reported here, and as was finally noted by the German press.

Yesterday, Reuters' blogger Felix Salmon in a well-written if somewhat verbose essay, makes the argument that "Greece has the upper hand" in its ongoing negotiations with the ad hoc and official group of creditors. It would be a great analysis if it wasn't for one minor detail. It is wrong. And while that in itself is hardly newsworthy, the fact that, as usual, its conclusion is built upon others' primary research and analysis, including that of the Wall Street Journal, merely reinforces the fact that there is little understanding in the mainstream media of what is actually going on behind the scenes in the Greek negotiations, and thus a comprehension of how prepack (for now) bankruptcy processes operate. Furthermore, since the Greek "case study" will have dramatic implications for not only other instances of sovereign default, many of which are already lining up especially in Europe, but for the sovereign bond market in general, this may be a good time to explain why not only does Greece not have the upper hand, but why an adverse outcome from the 11th hour discussions between the IIF, the ad hoc creditors, Greece, and the Troika, would have monumental consequences for the entire bond market in general.

We were not at all surprised to learn this morning that not only has an agreement not been met ahead of Monday's critical Eurozone FinMin meeting (the first of many for 2012) in Brussels, but talks have "stalled". Dow Jones reports: "Talks between Greece and its private sector creditors over a debt writedown plan appeared to stall Saturday as the banks' top negotiator left Athens amid signs of fresh disagreements over how much Greece would pay its bondholders in the future. Officials close to the talks said they may not conclude before a meeting Monday of euro-zone finance ministers where a second bailout which will keep Greece from defaulting is supposed to be discussed. Without a deal on the write-down of the debt held in private hands, the loan can't be released. Institute of International Finance chief Charles Dallara, who has been negotiating with Greek officials on the bond swap plan for the last two days, left Athens Saturday as hurdles remained over the interest rate the new bonds would pay private sector creditors. "Right now there are no talks. There will be consultations with the EU and the IMF to determine where we stand and then we'll see. It (negotiations) has again become complicated with the new demands over the coupon," said a person with direct knowledge of the talks." Which is why any statements that Greece, or the ECB, has all the leverage are total rubbish - if Greece wanted to get the deal done over Hedge Funds' dead bodies, it would have. It hasn't. And yes, a forced cram down of UK-indentured Greek bonds is still a possibiliy, but we will shortly make all too clear that should Greece proceed with this last ditch scorched earth approach, it would mean a complete overhaul of the entire PIIGS bond market, and why a sell off in €800 billion of it would be imminent.