ECB Needs To Intervene In Spanish Debt Crisis Or Game Over

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Spanish 10year bond yields hit over 7%, the magical number after the downgrade yesterday. Clearly this is unsustainable when coupled with the banking crisis that Spain is also experiencing. Ambrose Evans Pritchard in the The Telegraph discusses the need now for the ECB to enter the scene.

We’re facing maximum tension. The situation is unsustainable over time,” said the country’s finance minister Luis de Guindos. Yields on 10-year Spanish bonds yields punched to almost 7pc, above levels that triggered ECB intervention to back stop Spain last November.

“The ECB needs to intervene very quickly or it is game over,” said Nicholas Spiro from Spiro Asset Management. “There is a whiff of capitulation in the air.”

The dramatic escalation comes just days after the eurozone agreed a €100bn rescue package for the Spanish state to recapitalise its crippled banks. “It is very worrying. Markets are behaving as if the eurozone is heading for break-up,” said Jens Sondergaard from the Japanese bank Nomura.

France’s industry minister Arnaud Montebourg said the markets were flying out of control because the ECB was failing to take charge. “We need an ECB that does its job,” he said.


“We must have a real circuit breaker,” said Sondergaard. “The question is whether the ECB will now blink and go down the route of quantitative easing (QE)”.

He said the ECB should slash interest rates by half a point to 0.5pc and “pre-commit” to half a trillion euros of QE over coming months, blanketing the Spanish and Italian bond markets.

Nomura said the ECB must act with overwhelming force rather than engaging in piecemeal bond purchases that fail to restore confidence and have the toxic side-effects of pushing existing bondholders down the credit ladder — the dreaded effect of “subordination”.

“The eurozone has the wrong policy mix across the board. Fiscal policy is too tight; monetary policy is too tight; and the tough regulation of the banks is coming at the wrong time. Together it is all pushing the eurozone to breaking point,” he said.

Spanish premier Mariano Rajoy said in a private letter to EU leaders last week that the ECB is the only body with firepower and nimbleness able to contain the crisis at this point.

Well, one things for sure, somethings gotta give.


How Would The Euro Be Broken Up?

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Ambrose Evans-Pritchard writes about how the gurus nominated for the prestigious Wolfson Economics Prize discuss the breakup of the euro. First up is Neil Record from Record Currency Management.

“The consequences of a completely unplanned ‘Exit’ are likely to be catastrophic,” said Neil Record from Record Currency Management, one of the five qualifiers.

Mr Record believes piecemeal exits by one country at a time – the most likely outcome on current policy settings – would be “a recipe for continuous crisis”. There can be no such half-way house in any case. As soon as one country leaves EMU, the euro will lose its aura of inevitability. The charisma drains away.

He advocates a secret German-led “Taskforce”, with a French cameo role for the sake of “legitimacy”. Any broader planning would leak. The European Central Bank and the European Commission would be kept in the dark since they are “not well-equipped to design the demise of their own ‘great project’”.

“Failure to maintain secrecy would almost certainly lead to a complete freeze in the markets, making it impossible to finance eurozone member states’ deficits. This could accelerate a vicious circle … and possibly overwhelm the ECB. This is the stuff of nightmare,” he wrote.

The Taskforce would drop its bombshell on EU leaders on a Saturday morning. There would be a return to national currencies the same day. Any attempt to preserve a core euro would be unworkable since complex contracts worth hundreds of billions would leave a legacy of “ruinous litigation”, he said.

The only option would be to “force the legal frustration of all outstanding euro contracts” by abolishing the currency altogether. This would wipe the slate clean.

And what happens straight after it?

North European banks would face a brutal devaluation of Club Med debt. They would have to be recapitalized by their governments. The ECB would be shut down, with power reverting to national capitals.

Such a framework would allow Europe to “prosper again”. Foreign exchange markets would adjust “very quickly” once the boil was lanced. “Exit could start a new vibrant period in Europe’s history,” he said.

Then Jens Nordvig and Nick Firoozye from Nomura said

once the first state leaves EMU there will be a chain-reaction to Spain or Italy, causing havoc for currency swap contracts, and interest rate derivatives. “We believe that even if a break-up begins to unfold in an ‘onion-peeling’ fashion, it will eventually spin out of control and turn into a ‘big-bank’ break-up of the eurozone. An Italian default and exit would likely bring down large parts of the eurozone banking system.”

French banks would buckle, setting off a crisis that would push French public debt towards 120pc of GDP. “Capital controls would be a distinct possibility, at which point the euro would be obsolete”.

Mr Nordvig said policy makers must face the hard truth since credit markets are already pricing in a 30pc chance of Italy defaulting. “Euro adoption was supposed to be ‘irrevocable’, but the genie is out of the bottle. Foreign investors around the world, as well as institutions within the EU, are already trying to make contingency plans for a eurozone break-up. There is even evidence that some regulators outside the eurozone are asking banks to submit contingency plans for various eurozone break-up scenarios. Against this background, the cost-benefit analysis of planning ahead versus pretending that a break-up is not possible has shifted.”

EU leaders must spell out contingency plans right now to calm investors, above all by clarifying the jurisdiction of €14.2 trillion of debt. There should be a new European Currency Unit (ECU-20) ready to redenominate assets, if needed.

Catherine Dobbs, a former algorithms expert at Gartmore has a slightly different view on this

calling for a new settlement currency if the bloc splits into a hard core and weak periphery. Old euros and euro contracts would be treated equally. “There will be no impact on the solvency of financial institutions that have euro-denominated assets and liabilities that are unmatched,” she said.

Jonathan Tepper from Variant Perception said

Exit is the cleanest way to “re-balance Europe” and end the deflationary bias in the system. This may mean “crystalising losses” but they already exist in any case.

Mr Tepper said there have been at least 100 currency break-ups or exits over the past century, including the Austro-Hungarian union (the closest parallel), and Soviet, Czechoslovak, and Indian unions. They offer a roadmap of orderly divorce. The experience can be quick and liberating.

Devaluation episodes in Asia (1997), Russia (1998) and Argentina (2002) show the pain is sharp but short, followed by growth within two to four quarters. Dire warnings proved wrong in each case. Argentina rocketed back with 26pc growth over the next three years.



Greece Default Has Damaged Market Confidence In Euro

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Although Greece’s default restructuring of its bonds has temporarily relieved the pressure and paved the way for a new rescue package, it has also damaged the markets confidence in investing in PIIG bonds even further. On the one hand the euro authorities have broken some many promises that its hard to believe anything they say. Norway’s sovereign wealth fund has decided on investing in the PIIGS because after all the ECB was exempt from taking a hit during Greece’s restructuring.

The fund, under Norway’s finance ministry, voted against the Greek debt deal on the grounds that European institutions were exempted from losses and given “special” treatment. “It’s very important to create trust in the markets. To create trust you have to stick to the rules,” said director Yngve Slyngstad.

What happens if the same deal was extended to Portugal. Pimco’s Mohamed El-Erian is not so confident in private investors doing well out of a Portuguese restructuring  and said

Portugal will need a second rescue as the original package of €78bn (£65bn) falls short, setting off a political storm over EU rescue costs.

“Unfortunately, that is how it will be. It will make the financial markets nervous because they are worried about a participation of the private sector,” he told Der Spiegel over the weekend.

To put it in context

If the Greek haircut formula is ultimately extended to Portugal, private creditors can expect to lose everything. The EU and the International Monetary Fund already own most of the debt, reducing everybody else to cannon fodder status. Mr El-Erian said EU leaders are deluding themselves if they think they have solved Greece’s problems. “The Greek package is going to fall apart quickly. Bridges built to go nowhere can collapse at any time,” he said.

The IMF said in its latest report that Greece remains “accident prone” and may need further help and more debt haircuts if the economy “fails to respond rapidly enough to reforms”.

It warned that a “disorderly euro exit would be unavoidable” if the EU cuts off support. Such an outcome would threaten the IMF itself with unprecedented losses.

Source: Telegraph (Ambrose Evans-Pritchard)

Euro Breakup – French Style

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Ambrose Evans-Pritchard writes of an article at L’Observatoire de L’Europe website which outlines plans by French economists of plans to orderly breakup the Eurozone. Although unlikely at this stage, it does give an idea of hwo it could be achieved and what may possibly happen.

“National currencies should be recreated in each eurozone country”. There will be a short transition period of dual notes as old euros are stamped by country (‘U’ for France) until new francs etc are printed. (This is what happened when the Austro-Hungarian monetary union fell apart in 1919.)

The new exchange rates will be determined by a formula that takes into account the accumulated inflation differential and trade balances since the launch of EMU.

The devaluations/revaluations will be set against a new unit of account reflecting the average weighting of the old euro (not anchored on the new D-Mark).

“The public debt of each state will be converted into the corresponding national currency, whoever the creditors may be. By contrast, the external debt of private entities will be converted into the European accounting unit. Even though this helps the stronger countries and penalizes the weak, it is the only feasible way to uphold preceding contracts.”

This will be achieved via Bank Holidays.

“All governments will declare a bank holiday for a limited period. They will temporarily close banks to determine which are viable and which will need to apply to the central bank.”

The central banks will lose their independence, returning to their pre-1970s status. (Quite right too. Central banks beyond democratic control are an outrage.)

Either devalue the Euro first of devalue the new currencies afterwards.

The new currencies will be fixed for a period, then subject to a dirty float with 10pc margins. The economists said the whole operation would be easier if the euro first saw a big depreciation on global markets.

If Germany did not like this, France could precipitate the euro slide by abrogating the Giscard Law of 1973 – which banned central bank financing of state debt. (I don’t really understand this point.)

There you have it. Would it work? Any thoughts?

The group of twelve economists are of course in the eurosceptic camp, not in any way linked to the Sarkozy team. What is new is that they are gaining a platform. They are: Gabriel Colletis, Alain Cotta, Jean-Pierre Gérard, Jean-Luc Gréau, Roland Hureaux,Gérard Lafay, Philippe Murer, Laurent Pinsolle, Claude Rochet, Jacques Sapir, Philippe Villin, Jean-Claude Werrebrouck.

Draghi To Push LTRO to €1.5 Trillion

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So good is the job Mario Draghi doing with the LTRO that there are reports that he is about to add another €1 trillion in February to the existing €500 billion in loans. The LTRO is being used effectively in buying up sovereign bonds and keeping things at bay.

Alberto Gallo from RBS said Draghi’s €489bn loans to banks at 1pc for three years (LTRO) is having all kinds of toxic side-effects, which is disturbing given that the Financial Times splashed today that the banks may draw down another €1 trillion at the second LTRO in late February

The banks are certainly stepping up purchases of Club Med and Irish sovereign bonds, the so-called Sarkozy “carry trade”. They also bought 62pc of the latest debt issue by the EFSF rescue fund in January, up from a quarter in the previous issue.

This might explain why it’s so hard to get credit in the economy. Like that’s going to help the recovery. 😉

While the banks are buying more sovereign debt, they are cutting credit to the rest of the economy, with falls of 2.4pc in Italy and Portugal in December, and 0.8pc for the eurozone as a whole.

Source: Ambrose Evan-Pritchard

Asia spurn German Bonds


As reported today by Ambrose Evans Pritchard in the Telegraph, Asia investors and Central banks have begun to sell off German Bonds. This is the first sign of Asia pulling out of the Euro zone and losing fate in the Euro.

Andrew Roberts, rates chief at Royal Bank of Scotland, said Asia’s exodus marks a dangerous inflexion point in the unfolding drama. “Japanese and Asian investors are for the first time looking at the euro project and saying `I don’t like what I see at all’ and fleeing the whole region.

“The question on everybody’s mind in the debt markets is whether it is time to get out Germany. The European Central Bank has a €2 trillion balance sheet and if the eurozone slides into the abyss, Germany is going to be left holding the baby. We are very close to the point where markets take a close look at this, though we are there yet,” he said.

Jean-Claude Juncker, Eurogroup chief, fueled the fire by warning that Germany is no longer a sound credit with debt of 82pc of GDP. “I think the level of German debt is worrying. Germany has higher debts than Spain,” he said.

“It is comforting to pretend that southerners are lazy and Germans hardworking, but that is not the case,” he said, slamming France and Germany for their “disastrous” handling of the crisis.

German Bunds have already lost their status as Europe’s anchor debt. The yields of non-euro Sweden are now 20 basis lower for the first time in modern history. Danish and UK yields are higher but have closed most of the gap over recent months.

It was reported by Reuters on Wednesday of Junckers worries on Germany.

“I consider the level of German debts to be a cause for concern,” Juncker said.

Germany has higher debts than Spain,” he added. “The only thing is that here (in Germany) no one wants to know about that.”

So there you go Germany, you are well able to throw your weight around and point fingers but you are not so perfect yourselves. After all, the bailouts for Greece, Ireland, Portugal was to pay back your banks that were in trouble 😉

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