Thursday 30 September 2010

Ireland in the need of a lucky Shamrock...

Anglo Irish Bank is definitely a black hole for the Irish Government.

I wrote about zombie banks and zombie hotels in Ireland recently.

It looks the zombie bank is decaying more rapidly than expected, pushing the Irish budget in very dangerous waters.

"Ireland faces €34bn bill for Anglo Irish Bank, forced to redraft budget."

"The country has so far ploughed €29.3bn into Anglo Irish Bank, and the country's Central Bank said on Thursday the lender could need an additional $5bn under a worst-case scenario."

In the previous post about Zombie banking in Ireland I indicated the below:

"Total support for Anglo Irish amounts to 22.9 billions Euros so far and will cost 25 billions to the Irish taxpayers according to its CEO Mr Aynsley but S&P put the figure at 35 billions Euros."

Looks like the CEO was a bit too optimistic on his forecast...

But there is also Allied Irish bank and Irish Nationwide in the need of additional support...

"Allied Irish Banks will need to raise an additional €3bn by the end of the year. Support for Irish Nationwide will rise to €5.4bn from €2.7 bn. The €40bn bailout of the banks has cost Irish taxpayers the equivalent of 20pc of GDP."

This is an horror blockbuster movie in the making...When fiction goes beyond reality.

The worst case scenario according to the Guardian is summarised below. I'll go for the worst case given the previous excellent forecast from Anglo Irish's CEO thank you very much.

Murphy's law: 'Everything that can possibly go wrong will go wrong'."

Murphy Junior's law: "My father is too optimistic."

Bailout breakdown:

"Anglo Irish Bank €29.3bn (including €22.9bn already committed by government) – could rise to €34.3bn in worst-case scenario
Allied Irish Banks up to €6.5bn (including €3.5bn already invested by government)

Bank of Ireland €3.5bn (it says it does not need any more capital from government)

Irish Nationwide Building Society €5.4bn (including €2.7bn already committed by government)

Educational Building Society €350m (further requirement for €440m and possibly more expected to come from its new buyer)

Total €45bn, rising to €50bn in worst-case scenario."

By the way NAMA is also taking over 3.35 Billions GBP worth of Ulster loans...

I started drafting this post on the 30th of September, and given I was travelling, a lot of news have been unravelling during my trip:

Allied Irish was nationalised and on the 6th of October, Fitch downgraded Ireland from AA- to A+...

"The ratings could be downgraded further if the economy stagnates and broad-based political support for and implementation of budgetary consolidation weakens," Fitch said.

Get ready for some more downgrades...

"Unlike Greece this spring, it has cash. It has already secured all its borrowing needs until mid-2011. “We’re absolutely funded until next July and we’re not obliged to go to the markets,” says Mr Lenihan. Ireland’s average cost of borrowing this year, moreover, is the same as last year at 4.7 per cent – not the 6.9 per cent reflected by the spike in spreads last week, at which, obviously, no borrowing was taking place."

Well, Mr Lenihan, given the obvious downgrades Ireland just been hit with, get ready for a surprise in mid 2011 when you come back to the market for more funding...

Anglo Irish is a monster that should had never been let to grow unchecked. Where were the regulators and why the government did not step in earlier?

The Financial Times article quoted above goes through the rise and fall of Anglo Irish:

"Anglo Irish Bank, the bank responsible for 90 per cent of Ireland’s €40bn taxpayer-funded bail-out, was originally involved in financing the import of fridges and washing machines for Irish housewives after the trade reforms of the 1960s, writes John Murray Brown."

"By 2007 the bank was half the size of Bank of Ireland and, on a market capitalisation basis, it was briefly Ireland’s largest bank in July that year, valued at a scarcely credible €13.3bn."

"But, like the property market, Anglo was heading for a fall. Essentially a monoline business, it was concentrated in land and development property lending. It is thought 10 developers accounted for half its loan book."

What a sick joke...10 developers = 50% of the loan book. Have they heard about risk concentration?

"It was only later in January 2009 that the government was forced to nationalise Anglo, after another run on deposits following revelations that Sean FitzPatrick, its powerful chairman and former chief executive, had not disclosed to auditors that at the end of 2008 he had €87m of personal borrowings from the bank."

Conflict of interest for Sean FitzPatrick?

I would like to advise Mr Abramovich to get a new team of portfolio managers for his investment vehicle Milhouse.

"Roman Abramovich’s investment vehicle is threatening to sue Ireland over its treatment of junior debtholders in this week’s bail-out of several Irish banks."

Very amusing indeed...

"The bond held by Millhouse was yesterday trading at about 62 per cent of face value, implying that holders do not think they are likely to be paid back in full. But it is above similar bonds from Anglo, which are trading at between 20 and 30 per cent.

Subordinated bonds pay higher yields than senior debt to reflect the fact that they are more likely to take losses if the issuer gets into difficulties."

There are some greedy people, they are some stupid people, and they are also some stupid greedy people.
There is no free-lunch when you buy risky sub debt...If his team had done a proper risk assesment of their investment (which they are supposedly paid for...), they would have seen that the government guarantee's expiry was running out on the Thursday 30th of September.

There should not be bailout for stupid investors....

My very first post on this blog in 2009 was about Dubai and the stupidity of some "portfolio managers":

"Perception of the credit worthiness on Dubai World was all about implicit guarantees from the Dubai Government. Investors invested believing in implicit support. Probably the same investors who believed in the sacro-saint AAA rating issued on dodgy CDOs and CLOs as a gauge of credit quality of the underlying pool of assets in the structure. Probably the same investors who believed that a callable LT2 bond will be called on the call date by the issuer, because it has been market practice in the past. How suprised they were when Deutsche Bank, nearly a year ago in December 2008, decided not to redeem some sub debt on the date of the call! Investors trade sub debt based on the date of the call to calculate the price of the bond."

For Dubai World Debt, if the credit analyst or portfolio managers had done "properly" their job in assessing the risk, they would have read in the bond offering documents that there never was no implicit guarantee from Dubai government and not even a legal guarantee. They just assumed it.

Same applies for the "talented" portfolio managers running Milhouse, they got attracted by the yield of the risky sub debt and believed in an implicit guarantee which had an expiry date which everyone knew about, except them maybe...

My message to them: get real. My message to Mr Abramovich, I know some very talented portfolio managers out there, out of job and very cheap. It might be time for Milhouse to upgrade...

Ireland 5 years CDS is trading wider todat at 451.78 bps, Cumulative Probability of Default is at 32.50 % (Source Credit Market Analysis Ltd).

Anglo Irish Debt Swaps May Pay Out on Burden Sharing:

"There are 674 credit-default swap contracts insuring a net $390 million of Anglo Irish’s senior and subordinated debt, according to Depository Trust & Clearing Corp. data. It now costs 5.2 million euros in advance and 500,000 euros annually to insure 10 million euros of the bank’s junior bonds for five years, implying a more than 82 percent probability of default, according to data provider CMA."

Bye bye Anglo Irish...The game is over.

"The Anglo Irish rescue package will cost every man, woman and child in Ireland as much as 7,500 euros."

The Irish Taxpayers must be thrilled.

And Abramovich should start writing down some of his investment in risky Irish Bank sub debt:

"Lenihan said that, while senior bondholders will be paid in full under the bailout, legislation is being prepared to “address the issue” of junior bondholders taking a loss on their investments."

"After the U.K. government nationalized Bradford & Bingley Plc in 2008, it changed the rules to allow the troubled lender to defer interest on its subordinated debt without that legally constituting a default. Its failure to pay still triggered credit-swaps protecting all the Bingley, England-based bank’s bonds in July."

There will be a restructuring on the debt and a CDS event.

I don't think the current Irish Government will get re-elected...

Sunday 26 September 2010

Debase Jumping...

No it is not that all doom and gloom. There are still some bright spots in the World Economy.

While the US and the UK are busy debasing their currencies to revive their exports, Asian currencies are booming and their currencies are surging ahead. While European countries and the US are struggling to power ahead given their respective stricken economics, the Asian story is impressive.

“The economic growth story has spurred fund inflows into Asia,” said Yuji Kameoka, a Tokyo-based senior economist at the Daiwa Institute of Research. “That adds to the appreciation pressure for Asian currencies.”

Marc Faber : I think that the Yuan will continue to appreciate against the US Dollar along with the other Asian currencies because China with its large reserve can basically force the other currencies in Asia also upwards by buying them , I do not think that China is terribly concerned by say ten or twenty percent appreciation of the Yuan against the US dollar but what I do not like is to be pushed around by someone like Mister Obama ......well basically we are in an Olympic game in the world to depreciate currencies we do not have trade wars like in the thirties when you have import restrictions and essentially trade barriers , but countries , in my opinion a mistake they try to remain competitive by having a low currency , and so everybody in the world try to lower the value of its currency ....i think the Asian currencies including the Chinese Yuan will continue to appreciate , this year the Malaysian Ringgit is up ten percent the Thai Baht is up almost nine percent and the stock markets of Malaysia Thailand Philippines Indonesia are all up in US dollar terms between fifteen and thirty five percent ..., I think we live in a new world in which emerging economies will have a larger and larger share of wealth , stock market capitalization it doubled in the last ten years already and stands now at twenty two percent of global market capitalization , I think in ten years time emerging economies could be fifty percent of the global stock market capitalization ....etc....
Sept. 24 (Bloomberg) -- Marc Faber, publisher of the Gloom, Boom & Doom report, discusses the outlook for the Chinese yuan. Faber, speaking from Chiang Mai, Thailand, with Deirdre Bolton on Bloomberg Television's "InsideTrack," also discusses gold prices and expectations for the Standard & Poor's 500 Index.

I agree with Marc Faber, and so would have agreed Angus Maddison, author of Contours of the World Economy 1-2030 AD (great book!).

I previously focused on long term macro trends.
I previously posted on the 1st of May that in this environment Asian Currencies would do very well:

"In terms of macro investments, Asian currencies will rise against the Euro, USD and GBP. Fixed Income Emerging Markets funds will do very well in this new environment given their lower probability of defaults depending on the country they are exposed to (South Korea, Singapore, Taiwan, Maylasia, Indonesia are attractive)."

"The Bloomberg-JPMorgan Asia Dollar Index, which tracks the region’s 10 most-traded currencies excluding the yen, climbed to a two-year high. The Philippine peso gained 0.3 percent to 44.055 per dollar and India’s rupee was up 0.4 percent at 45.65 as of 2:53 p.m. in Mumbai. China’s yuan climbed 0.1 percent to 6.7121 and reached 6.7085, its strongest since official and market exchange rates were unified at the end of 1993."

And it is only the beginning for Asian currencies due to the debasing game being played in the West.

"South Korea’s gross domestic product grew 1.4 percent in the three months through June from the first quarter, compared with a July estimate of 1.5 percent, the Bank of Korea said yesterday. The International Monetary Fund on Sept. 1 increased its forecast for the nation’s 2010 gross domestic product to 6.1 percent from a July estimate of 5.75 percent. The won remains “undervalued” and the central bank can still raise interest rates, it said."

2010: Where is the Growth?

and where will it be tomorrow?

Asian Sovereign Bonds and Quasi Sovereign Bonds are still offering nice returns for limited risk:

Outperforming Bunds:

"JPMorgan Chase & Co.’s index of Asian local-currency debt excluding Japan returned 13.2 percent in 2010. Global sovereign bonds returned 3.8 percent in that period, Bank of America Merrill Lynch indexes show. Bonds gained 6.2 percent in the U.S., 6.6 percent in Germany and 2.3 percent in Japan. An index tracking Greece, Ireland, Italy, Portugal and Spain fell 1.9 percent.

Asian bonds beat stocks by the most since JPMorgan started tracking the figures in 2003 as the MSCI Asia Pacific Index of shares excluding Japan fell 4.5 percent, including reinvested dividends. China’s yuan debt gained 3.2 percent in 2010, according to an HSBC Holdings Plc index, while the Shanghai Composite Index of stocks dropped 25 percent as the government curbed lending to avert a real-estate bubble."

Currencies, Yields:

"Malaysia’s ringgit, Indonesia’s rupiah and China’s yuan are among the 10 best-performing emerging-market currencies this year. Ten-year government bonds yield 3.88 percent in Malaysia, 4.92 percent in South Korea and 8.23 percent in Indonesia, compared with 2.95 percent on U.S. debt."

Gold, Asian currencies...the only way is up.

Monday 20 September 2010

Bid me up Scotty!

Junk Bonds Reach Par for First Time Since 2007: Credit Markets

"Investors in U.S. junk bonds are wagering they’ll be fully repaid for the first time since before the credit-market seizure, dismissing concerns the economy will return to a recession and trigger a rise in corporate defaults.

Average prices on high-yield debt rose above 100 cents on the dollar yesterday for the first time since June 2007 after falling as low as 55 cents in December 2008, Bank of America Merrill Lynch index data show. Bonds due in 2031 from Ford Motor Co., which fell 22 months ago to 12 cents on concern the automaker would fail, are trading above par for the first time in more than five years."

At the same time:

"Commercial paper outstanding declined for a fourth straight week, reaching a record low. The seasonally adjusted market for commercial paper, which typically matures in 270 days or less and is used to finance everyday business activities such as payroll and rent, fell $22.9 billion to $1.036 trillion in the week ended Sept. 15, the Federal Reserve said yesterday on its website. The market has contracted from $1.377 trillion in October 2009."

The market, which companies typically use to finance routine costs such as payroll and restocking shelves, is at its smallest size in two months and is roughly half its 2.2 trillion USD peak in August 2007 when the credit crisis broke.

This not a good sign given commercial paper is the cheapest and most flexible way for corporations to get their hands on cash!

In fact US bankruptcies are still rising:

Business and Non-Business Filings
Years Ended June 30, 2006-2010:

Year Total:
2010 1,572,597
2009 1,306,315
2008 967,831
2007 751,056

And the Asset Backed Commercial Paper market is a shadow of itself:

So how do americans cope with the current downturn? Consumer loans...

GRAPH: US consumer loans expanded more than 42% since the beginning of 2010 and 36% YOY:

Can you read into this? I'll help you, DOUBLE-DIP!

The excellent David Rosenberg sums it all nicely in in the latest "Breakfast with Dave" MARKET MUSINGS & DATA DECIPHERING from the 20th of September 2010:

"What more can you say? I mean, can we really sit back and conclude that government policies have been successful when real median household incomes are down 4.8% over the 2000-2009 decade? That’s even worse than the 1970s when under Nixon, Ford and Carter we saw real median incomes drop 1.9%. We are at a point where so many people have fallen below any acceptable level of income that half the country doesn’t pay any tax. Even with record use of food stamps and stepped-up jobless insurance benefits, the number of folks living below the so-called poverty line jumped 10% last year — an apparent economic recovery year — to 43.6 million people.
So, we have 1 in 6 Americans either under or unemployed and another 1 in 7 who live in poverty and somehow we have a legion of economists and strategists who see what we are in some typical recession-recovery cycle on our hands. Just read the editorial of the current Economist for how mainstream the “muddle through” view has become — downside risks are widely seen as marginal because we have never seen a real “double-dip” recession before.
Reminds us of how everyone was saying back in 2006 not to worry too much about housing risks because national home prices have never declined before on a year-over-year basis. Remind us of how we shouldn’t worry about recession risks in 2007 because the Fed never did tighten rates sufficiently to really invert the yield curve all that much and that there has never been a recession without a policy-induced inversion of the yield curve. And then, through 2008 all we heard was that history teaches us “not to fight the Fed.” So it’s really encouraging to hear how everyone is back to the “it’s never happened before so don’t worry about it” mentality."

"Everyone has this view that growth will merely be slow but that there will be no double dip. Nobody seems to entertain the notion that we may still be in a recessionary state. After all, the UofM confidence index averages 73.7 in recessions and 90.9 in expansions. So not only is the index 24 points below what is consistent with growth, it is also seven points below what is typical of actual recessions. That is why this is more likely a ‘single-scoop’ recession than a ‘double dip’ ... we likely never fully emerged from the one that began in late 2007."

On Gold beating record after record, David once again sums it up perfectly:

What is amazing is that there are just about as many naysayers about gold out there as there are bond bears. Until the investment elite catches on, the odds of these two asset classes continuing as relative outperformers are quite high because no bull market ends until the masses fall in love with the asset or security in question.
What makes the gold story so interesting is that bullion has so many different correlations — with inflation, with the dollar, with interest rates, with political uncertainty — and it also has different faces. This year, for example, gold has shifted from being a commodity towards being a currency — the classic role as a monetary metal that is no government’s liability. This year, there are three events have catapulted gold into currency status, and they all involve attempts by governments around the globe to devalue their own currencies or at least jeopardize the sanctity of the central bank balance sheet:
1. The ECB’s decision to allow non-investment grade bonds as collateral on its balance sheet.
2. The Fed’s decision not to allow, as was planned, an unwinding of its pregnant balance sheet with obvious implications for the growth rate in the monetary base.
3. The decision by the Japanese government to unilaterally intervene in the foreign exchange to reverse the yen’s strength.

Nobody wants a strong currency, and nobody, outside of a few small countries, wants higher interest rates, and now, we have rising U.S.-Chinese trade tensions. Greek bond yields remain at punitive levels and are currently pricing some probability of default. In addition, Ireland seems to be experiencing intense financial difficulties that have compelled the ECB to step in for support. The Mideast peace talks don’t seem to be going anywhere. The U.S. political backdrop is one of intense uncertainty and the most likely scenario post-November 2nd is one of gridlock. How can gold not thrive in this environment?"

Ireland CDS 5 year is now trading at 445 bps, which represents now a 32% of Cumulative Probability of Default. Ireland was trading at 387 bps on the 15th of September. The yield on Irish 10-year notes stands at 6.48 percent from 6.29 percent, compared with 2.47 percent for German bunds that mature the same year, amid concern that nation will need more financial aid.

and Irish banks are doing just fine...

As long as countries are busy debasing their currencies, as long as countries are in the process of lowering the standard of living of their population like I discussed in my previous post, Gold will continue to go up.

VIX is now getting cheaper still at 21.47. Complacency seems to be prevailing again, as in April this year.

"My dear brothers, never forget, when you hear the progress of enlightenment vaunted, that the devil's best trick is to persuade you that he doesn't exist!"

Charles Baudelaire, French poet, "Le Joueur généreux," pub. February 7, 1864

The end of the American Dream, the call for trade barriers and the rise in populism...

Flying an American flag upside down is not necessarily meant as political protest. The practice has its origin in a military distress signal; displaying a flag in this manner is "a signal of dire distress in instances of extreme danger to life or property".

Tyler Darden in the blog Zero Hedge, published a recent post (19th of September)courtesy of Gordon T. Long of Tipping Points. It goes through the structural and demand problems the US faces and the collapse of standard of living we are witnessing.

"In rent we trust"...the American dream in home ownership has been whacked. Declines in home prices have made it no more expensive to buy than rent in about half of larger markets around the US.

"Thanks to falling home prices and record low mortgage rates, it now costs less to own than it has in the past decade on a mortgage-payment-to-rent basis."

"Because house prices will keep falling in most places. Prices are still dangerously high compared to incomes and rents. Banks say a safe mortgage is a maximum of 3 times the buyer's annual income with 20% downpayment. Landlords say a safe price is a maximum of 15 times the house's annual rent. Yet on the coasts, both those safety rules are still being violated. Buyers are still borrowing 6 times their income and putting only 3% down, and sellers are still asking 30 times annual rent, even after recent price declines. Renting is a cash business that proves what people can really pay based on their salary, not how much they can borrow."

"House prices do not even have to fall to cause big losses. The cost of selling a house is 6% because of the realtor lobby's corruption of US legislators. On a $300,000 house, that's $18,000 lost even if prices just stay flat. So a 4% decline in housing prices bankrupts all those with 10% equity or less."

Another interesting fact:

"There are 70 million Americans born between 1945-1960. One-third have zero retirement savings. The oldest are 64. The only money they have is equity in a house, so they must sell. This will add yet another flood of houses to the market, driving prices down even more."

Even young graduates have become disillusioned, will they be able to therefore repay their student loans?

"Student loan amount has exceeded the total credit card debts for the first time in the American history.":
The total outstanding student loan is worth 850 billion USD and the most worrying factor is that some students do not even know on how much they owe and to whom...

Negative equity have also made it difficult for their parents to recoup the educational expenses through a home equity loan...

The house is no longer an ATM in the US, the consequences of high unemployment and deleveraging is that the use of credit cards is falling very fast, and so will comsumption ultimately...

Falling houses prices, high unemployment, and negative equity have a big impact on US labor mobility:

The latest record of Gold, which to me doesn't come as a surprise, is a testimony of the policies followed by the US which is debasing their currency and therefore lowering the standard of living of the population in the process.

Because the Chinese are not letting the Yuan raise fast enough, the US authorities are now crying foul play. Their threats could have very nasty consequences, if China and the US enter a trade war.

"Sander Levin, chairman of the House of Representatives Ways and Means Committee, said he would wait to hear Treasury Secretary Timothy Geithner's testimony on Thursday before he decides whether to move forward on the bill."

"The bill might violate World Trade Organization rules, draw legal retaliation against U.S. businesses and shut down trade in inputs from China that U.S. industry needs, said Camp, who represents the troubled industrial state of Michigan."

"Levin said he wants to enlist other countries to pressure China to raise the value of the yuan but he also endorsed the use of duties against Beijing's currency practices."

Another "bright" politician who has studied history and the consequences of Smoot–Hawley Tariff Act of 1930...Levin is just following the voice of Paul Krugman. I prevously posted why Paul Krugman is dangerously wrong.I concluded in the post: "It is up to the US to resolve their trade imbalances by being more competitive and to increase the amount of goods and services they export...should the US target as well Japan and Germany with higher tariffs?"

Should all the countries with trade surpluses be targeted?

The US are trying to do what they did to Japan from 1985. In 1985 the Plaza Accord was signed between Japan and the US where Japan agreed to let its yen currency appreciate against the dollar. Unfortunately for you Mr Geithner, the Chinese are not stupid and will not bow like the Japanese did and they have studied what happened to Japan, unlike American politicians...

Just the facts:

"We all know that the rapid growth of Japanese economy after the WWII was to a large extent driven by its fast expanding foreign trade based largely on the low exchange rate of yen. Therefore, the sharp yen revaluation enforced by the "Plaza Agreement" hit badly and directly the country's foreign trade, throwing readily Japan's economy, which depended heavily on foreign resources, into a "yen revaluation depression", (that is, depression brought about by the yen revaluation). In 1986, Japan saw its total export volume shrank by 15.4 percent, real GDP growth dropped by 1 percentage point; the industrial and mining production index decreased by 0.2 percentage point and the unemployment rate broke the highest record after the war.

To shake off the depression the Japanese government and banks adopted a series of stern policies and measures. One of them was the unprecedented "financial relaxation" policy, in which Japanese banks cut interest rate for five successive times and finally fixed it at the extremely low level of 2.5 percent. Under the prevailing financial liberalization and reduced capital demand for entity economy, the large amounts of abundant funds instigated by the extremely-low interest rate swarmed to stock and real estate markets, resulting in sharp expansion of economic bubbles with stock and land prices to soar up at the core. By the end of 1989 the Nikkei average stock price had climbed to 389,000 yen, expanding two times in four years! While during 1998 alone the land price around Japan's three major metropolitans rose by 43.8 percent, the Tokyo Rim rising even by 65.3 percent.

In early 1990s, the economic bubbles created by the yen revaluation suddenly blew up, plunging the nation into an unprecedented recession, from which the country has been trying to struggle out till today. During the recession lasting longer than a decade, almost all the important economic indexes registered the worst post-war record. By then Japan had completely lost its long-term advantageous position held in the after-war pattern of western economic growth, especially that over the US. To some degree we should say, after years of efforts as set out at the "Plaza Agreement", America finally has defeated its biggest rival in the field of international trade."

The US are asking China to play Kamikaze economic policies "à la Japan".

This is the game being played by the US...So is it foul play or fool play? I will let you make your own judgement.

About the rise of populism, no surprise there:

It is gathering pace everywhere, the trend is your friend... The rise of populism is highly correlated with recession periods and severe unemployment throughout history, have a look at my previous post:

Tea Party in the US, far-right in Sweden, etc.

Populism on the rise in the Nordic region

The Left under siege in Europe

"Globalization is a reality. And this makes most leaders today realize that populist illusions can't be sustained before they collapse into stagnation and leave their political supporters deeply disillusioned. You can't inflate away your troubles or allow mountains of debt to build up if, as a country, you have to make your living in a globally competitive environment... Building prosperity requires caution and patience. It requires time. Populism is a short cut that doesn't work."

Fernando Henrique Cardoso, former President of the Federative Republic of Brazil for two terms from January 1, 1995 to January 1, 2003.

Monday 13 September 2010

The Hurt Locker

Definition: noun. a period of immense, inescapable physical or emotional pain.

The Hurt Locker and the problem of the liquidity trap.

Paul Krugman's definition of the liquidity trap, the Keynesian view:

[a] liquidity trap may be defined as a situation in which conventional monetary policies have become impotent, because nominal interest rates are at or near zero: injecting monetary base into the economy has no effect, because base and bonds are viewed by the private sector as perfect substitutes. By this definition, a liquidity trap could occur in a flexible price, full-employment economy; and although any reasonable model of the United States in the 1930s or Japan in the 1990s must invoke some form of price stickiness, one can think of the unemployment and output slump that occurs under such circumstances as what happens when an economy is trying to have deflation — a deflationary tendency that monetary expansion is powerless to prevent.[29]

Excellent comment this week by R. Glenn Hubbard, dean of the Columbia Business School and former Chairman of the Council of Economic Advisers under President George W. Bush, and Peter Navarro, a professor of economics at the Merage School of Business at the University of California-Irvine:

"The fundamental flaw in Washington’s stimulus logic is the incorrect assumption that America’s current economic woes began with the 2007 recession. In fact, the roots of our slow-growth problem date back at least a full decade.

From 1946 to 1999, GDP grew annually at 3.2 percent, but since then, we’ve only averaged about 2.5%. On a cumulative basis, this seemingly small difference adds up to about 10 million jobs we failed to create.

What these statistics add up to is not a short term cyclical downturn, but rather longer-term trouble driven by four major structural imbalances in America’s GDP “growth driver equation.”


From 1946 to 1999, consumption averaged 64 percent of GDP but over the last decade, that share jumped to 70 percent. This increase was fueled not by rising wages, but rather by a housing bubble and a mortgage refinancing wave that turned American homes into ATM machines. This overconsumption has been mirrored in a low saving rate and a second major structural imbalance – underinvestment.


Business investment in research and development, technological innovation, and the new productive capacity required for the job creation process has been the single most important missing ingredient in our economic recovery – and for renewed long-term prosperity. Yet the current administration seeks only to raise the regulatory and tax burdens of business.

Chronic trade deficits:

These have been equally destructive. During the 2000s, our current account deficit more than doubled and likely reduced our annual GDP growth rate by a half a percent or more.

Excessive government spending:

This spending has provided some short-term stimulus. However, an overfed Uncle Sam represents the ultimate seed of destruction through upward pressure on taxes and interest rates and a stark future of sharp cuts in defense, education, and infrastructure spending."

"Over the long — and short — term, in implementing any stimulus, we should favor tax cuts to stimulate business investment as the best way to stimulate job creation. Reducing the fiscal burden of entitlement programs is also essential to restoring prosperity."

Federal Government Debt: Total Public Debt

In relation to the raging inflation/deflation debate, Bill Gross at PIMCO has decided to put a wager on it. A 8.1 billion USD wager...quite meaningful (notional value of derivatives position tied to the Consumer Price Index).
They bought inflation floors in size...

"Inflation floors, structured as options on the consumer price index for all urban consumers, are similar to insurance. The buyer of the contract pays a premium at the outset in return for the right to receive a payment after 10 years should the CPI decline during this period."

The bet is that the USA will not be like Japan and are not on a verge of entering a similar lost decade as Japan did.

As I previously discussed in relation to the heated deflation/inflation debate, we are going through a deleveraging period, which meant deflation in some asset prices (real estate, etc.) but inflation in other items, such as food items (up 16% since 2009). In a previous post I argued you could have both deflation and inflation at the same time as currency values are being debased. The latest new record of Gold is of no suprise and the trend is up and up, given we can expect a second round of QE in November in the US.

The rise in food prices are strong inflationary forces at play which is probably creating a lot of headaches for the Bank of England given its inflation target of 2%. You can therefore expect the UK to rise interest rates sooner than expected which will coud increase the risk for a double-dip recession due to the current constraints in household balance sheets. I hope Mervyn King still has plenty of ink in his pen, as he will definitely have more letters to write to the chancellor in the coming months...

We think the possibility that the U.S. goes 10 years with stagnant or falling prices is remote,” Mihir Worah, the head of Pimco’s real return portfolio management team, said in an e- mailed response to questions. “The options were priced at rich levels to the underlying” risk, added Worah, whose funds invest in Treasury inflation protected securities."

"Pimco Chief Executive Officer Mohamed El-Erian said last month the chance of deflation in the U.S. is around 25 percent."

Deflation then inflation is still the ongoing theme, which might lead us to Stagflation 70s style.

The latest inflation figure in the UK is of no surprise: August's consumer price inflation came in at 3.1 %. QE is working just fine...I kept saying the results of QE would be more inflation down the line, in April, in March...

"Inflation has been above the central bank's 2pc target since December 2009 although policymakers have argued that it is largely down to one-off factors and should subside over time."

Can the policymakers please specify the time frame? They won't...

High UK inflation no conspiracy:
By James Mackintosh

Jacques Rueff, a great French economist clearly saw the strategy behind Keynes General Theory of Employment which is currently being used in the UK with QE:

"Keynes came up with a subterfuge. The central bank should cause price inflation during a slump, he proposed. Rising prices for 'things' meant that salaries - in real terms - would go down. That was the greasy scam behind Keynes' General Theory of Employment, Interest and Money: inflation robbed the working class of their wages without them realizing it. The poor schmucks even thank the politicians for picking their pockets: "salary cuts without tears," Rueff called them."

Bill Bonner also adds in his hommage to Jacques Rueff the following:

"Rueff died in 1978. Had he lived, he probably would have been as surprised as we have been by the stamina of the monetary horses. Except for a brief rest while Paul Volcker was managing the stables, they have run from bubble to bubble... delivering more liquidity wherever it would do the most damage. All the while, inflation continued to cut the price of labour. Between 1974 and 1984, real wages fell as much as 30%. Then, more moderate levels of inflation held them down for the next 24 years.

But Rueff’s insight comes with a warning. The faith-based, dollar-dependent monetary system is like a loaded pistol in front of a depressed man. It is too easy for the US to end its financial troubles, Rueff pointed out, just by printing more dollars. Eventually, this “exorbitant privilege” will be “suicidal” for Western economies, he predicted."

Bill Bonner concludes:
"Paul Volcker put the pistol in the drawer. Ben Bernanke has found it. And Jacques Rueff must look on in amusement to see what happens next."

"Until the 1970s, classic Keynesian economists seem to have believed that it was impossible to have a stagnant economy along with an aggressive monetary stimulus program. In slumps, central banks should print money, and more money, to stimulate via government spending and bank lending. Of course, while such Keynesian solutions may not stimulate the economy much (not with real jobs anyway), they do lead to inflation, and then price inflation, especially in severe slumps. Hence, stagflation..."

"Krugman's monetary solution to a liquidity trap is sustained inflation, where the central bank reverses fears of future deflation by instead causing an increase in the price level through massive monetary pumping (Krugman estimates this to be in the area of $10 trillion, borrowing the figure from a prior study conducted by Goldman Sachs)."

Housing in the US is still in the hurt locker:

More pain to come unfortunately. There is a huge shadow inventory that needs to be worked through. Banks reposession runs unabated. Housing starts at rock bottom still.

"RealtyTrac, an online foreclosure sale site, will release its monthly numbers on Thursday, but sources there confirm the number of repossessions will come in just shy of 100,000 for the month.
That is the highest since the site began tracking in 2005. July's repossession number was the second highest on record. The last highest was 93,777 in May of 2010."

U.S. Home Prices Face Three-Year Drop as Supply Gains:

“Whether it’s the sidelined, shadow or current inventory, the issue is there’s more supply than demand,” said Oliver Chang, a U.S. housing strategist with Morgan Stanley in San Francisco. “Once you reach a bottom, it will take three or four years for prices to begin to rise 1 or 2 percent a year.”

Gains Versus Inflation

"If the market doesn’t fall to its natural bottom, price gains in the next five to 10 years won’t keep pace with inflation as the difference is made up “on the backend,” said Barry Ritholtz, chief executive officer of FusionIQ, a New York research company. Price increases that fail to at least match inflation are the same as reductions in value, Ritholtz said."

"The Obama administration’s effort to help mortgage holders, the Home Affordable Modification Program, or HAMP, is another source of future inventory as owners with new loan terms re- default, Ritholtz said. About half of the modifications done in 2009 were behind in payments by the first quarter of 2010, according to the Treasury Department."

‘Day of Reckoning’

The belief has been: if we stimulate sales with a tax credit and delay foreclosures with modifications, the market would stabilize,” said Ritholtz, author of “Bailout Nation.” “We’re just putting off the day of reckoning and drawing out the pain by not letting the housing market hit its bottom.”

Insanity: doing the same thing over and over again and expecting different results. Albert Einstein.

Just the facts on housing in the US:

"Owners of about 11 million homes, or 23 percent of households with a mortgage, owed more than their property was worth as of June 30, according to CoreLogic. Another 2.4 million borrowers had less than 5 percent equity in their houses and probably would lose money on a sale after paying broker fees and closing costs, CoreLogic said Aug 25."

Deep sea fishing: Housing starts still at rock bottom

From the excellent Calculated Risk blog:

"The excess supply is keeping pressure on residential investment, and therefore on employment and economic growth. As new households are formed, the excess supply will be absorbed - but this is happening very slowly."

"It takes jobs to create households, and usually housing is the key driver for employment growth in the early stages of a recovery. So this is a trap: the excess supply means weak employment growth, leading to few new households, so the excess supply is absorbed slowly - putting off more robust employment growth.

The excess supply is also pushing down house prices (prices are just starting to fall again). Lower prices will eventually help clear the market, however lower prices will push more homeowners into negative equity."

"Negative equity frequently leads to distressed sales (short sales or foreclosures), and losses for lenders."

It will take a long time to clear the mess in US housing. A long, painful process to clear the excesses of the housing bubble.

Saturday 11 September 2010

Honey, I Shrunk the Balance Sheet...

This crisis is very acute because it is a Balance Sheet Recession and the implications will be severe for many years to come, given the extent of the repairs that needs to be achieved following the catastrophic damages inflicted by the cheap credit fuelled bubble we have been victims of.

The Balance Sheet Recession:

In an article published by Roger Altman (chairman and CEO of Evercore Partners and former deputy Treasury secretary in the Clinton Administration) in the Financial Times, we have a very good summary of the damages inflicted to Households and the implications for the recovery.

"What is unusual is that this is a balance-sheet driven recession, centred on the damaged financial condition of both households and banks. These weaknesses mandate sub-normal levels of consumer spending and overall lending for about three years.

In contrast, most postwar recessions had a different sequence – rising inflationary pressures, a monetary tightening to counter them and, then, a slowdown in response to higher interest rates. This was the pattern of the sharp 1980-81 slowdown.

None of that happened here. Instead, we saw a housing and credit market collapse that caused enormous losses among households and banks. The result was a steep drop in discretionary consumer spending and a halt to lending. To see why recovery will be slow, we can look at the balance sheet damage. For households, net worth peaked in mid-2007 at $64,400bn (€47,750, £43,449bn) but fell to $51,500bn at the end of 2008, a swift 20 per cent fall. With average family income at $50,000, and falling in real terms since 2000, a 20 per cent drop in net worth is big – especially when household debt reached 130 per cent of income in 2008."

You can clearly see in the graph below the severity of the damages inflicted to US households in the current recessions compared to previous ones:

Furthermore on Balance Sheet Recession:

"Recessions as described or dissected by Econ 101 are income-shock driven, not balance-sheet shock driven. Typically, rising inflation compels the Fed to tighten money and raise interest rates and the predictable slowdown follows as (a) business investment contracts because of higher funding costs (b) causing all the industries and suppliers associated with that investment to contract (c) laying off their workers and cutting their orders to their own suppliers (d) leading to further employment contraction (e) decreased consumer spending (f) decreased demand for business products and services, and so on until inflation is tamed and the Fed can ease off the brake and back onto the gas.

Alternatively, of course, a single sector can become a bubble unto itself (the dot-com boom or the S&L crash of the 1980's) or an exogenous shock (the OPEC price spike of the early 1970's) can prompt a recession, but the single-sector bubbles are typically self-contained and parochial in scope and the exogenous shock bring forth a plethora of innovation and plain old readjustments (turn down the thermostat and stock up on sweaters?) that hasten recovery.

This time is different.

This time everyone--households, small businesses, big busineses, banks, investment banks, and yes, law firms--has seen their net worth hosed. The problem with recovering wealth is that it takes so much longer than it does to recover income."

The fall in networth implies that everyone is working hard to repair balance sheets.
This produces weak demand for funds and credit. It will take years to go through the deleveraging process.
Households and Companies are moving from profit maximization to debt minimization.
Everyone is hoarding cash. Cash is king. According to the Federal Reserve, businesses are hoarding about 1.8 trillion USD in cash.

Consumer Credit Collapsing and Banks Hoarding Cash as well:

David Rosenberg in his Breakfast with Dave article on the 16th of August, analyses the cash hoarding situation and implications:


"The banks are still sitting on an unprecedented cash hoard and doing nothing with it. Consider that on a 13-week rate change of basis:

C&I loans are down at a 1.2% annual rate.

Home equity lines of credit are down at a 4.1% annual rate.

Residential mortgages are down at a 2.9% annual rate.

Commercial real estate loans are down at a 9.2% annual rate.

Credit card loan balances are down at a 6.7% annual rate.
Meanwhile, cash on bank balance sheets have expanded at a 10% annual rate over this time frame and purchases of government securities have ballooned at a 21.3% annual rate. In fact, since the end of June, the banks have bought a huge $83 billion of government/agency bonds, the third most over such a short time frame. Just in case you were wondering who has been the culprit behind this phenomenal rally in the Treasury market."

Households in the US are deleveraging big time:

And they are deleveraging at an incredible fast rate:

How far will debt to income fall?

We can see a big surge in the amounts in personal savings in the US:

At the same time the government is trying to make up for the big drop in consumer spending by running a huge deficit!

What are the implications of a Balance Sheet Recession and why Japan is a very bad exemple to follow in a Balance Sheet Recession:

In his latest weekly letter, John Mauldin quotes Charles Gave, writer as well as founder of the excellent Macro Research house Gavekal:

"The only way that one can expect Keynesian policies to break the 'paradox of thrift' is to make the bet that people are foolish, and that they will disregard the deterioration in their balance sheets and simply look at the improvements in their income statements.

"This seems unlikely. Worse yet, even if individuals are foolish enough to disregard their balance sheets, banks surely won't; policies that push asset prices lower are bound to lead to further contractions in bank lending. This is why 'stimulating consumption' in the middle of a balance sheet recession (as Japan has tried to do for two decades) is worse than useless, it is detrimental to a recovery.

TPC from the excellent website "The Pragmatic Capitalist" does a great job as well in analysing the deleveraging process induced by this acute Balance Sheet Recession:

Businesses and consumer are using their surpluses to pay down their debts and increases their savings due to the damages they have suffered in the dowturn as well as increased uncertainties instead of spending or investing.

Keynes argued that in a liquidity trap, consumers and businesses are so fearful to spend or invest that they hoard cash, this is excactly what is happening right now. And because the Federal Reserve cannot lower interest rates below zero, it runs out of room to force more money into the economy.

What could be a solution to reverse the course?

How could the Balance Sheet be rapidly repaired?

Tax cuts stimulate the economy when they involve reductions in tax rates!

Permanent cuts in marginal rates of the payroll tax, capital gains tax and double taxation of dividends could be positive to stimulate investment as well as employment.
The negative dynamics such as anticipated future tax increases are the main reason why consumers and companies are hoarding cash.

Instead of having an already inefficient stimulus, how about 1 trillion USD in tax cuts? Would we need more? Would that restore confidence? Entice people to invest and recruit? Would that help small businesses to drag us out of the recession given they have always pulled the economy out of a recession when they thrive?

Tax cut would be appropriate given it would increase consumer's credit lines. The consumer would either consume more or save more (and maybe buy Goverment bonds in the process...).

Economic 101 reminder:
GNP = C + I + G + NX


C = consumption spending by individuals
I = investment spending (business spending on machinery, etc.),
G = government purchases
NX = net exports

Consumer spending typically equals two-thirds of GNP.

Reducing taxes, pushes out the aggregate demand curve as consumers demand more goods and services with their higher disposable incomes. Supply side tax cuts are aimed to stimulate capital formation. If successful, the cuts will shift both aggregate demand and aggregate supply because the price level for a supply of goods will be reduced, which often leads to an increase in demand for those goods.

How about cutting corporate taxes?

Here is what Peter Ferrara in Forbes, thinks about it:

"Here are the components of a plan that would work to restore economic growth precisely because they do focus on governing economic incentives. America's corporations suffer from a federal corporate tax rate of 35%, close to 40% with state taxes. This is the second-highest rate in the industrialized world, just a bit behind Japan, which may cut its rate soon. The European Union cut its average corporate tax rate from 38% in 1996 to 24% in 2007. Germany and Canada each recently adopted a top corporate rate of 19%, with Canada's slated to fall further to 15%. India and China have lower corporate rates as well.

Ireland adopted a 12.5% corporate rate in 1988, when it had the second-lowest per capita income in Europe. Today, Ireland enjoys the second-highest incomes in Europe, and it raises more in corporate taxes as a percent of gross domestic product than the U.S. does with a tax rate three times higher.

For the U.S. economy to remain internationally competitive, the federal corporate rate should be slashed to 20%. The heavily burdensome federal corporate capital gains rate should also be cut from 35% to the current individual rate of 15%, and that individual rate and the dividends tax rate of 15% should be made permanent. The capital gains tax is a second level of taxation on capital, not a loophole providing lower rates for capital income."

We need to do whatever we can to boost the private sector:

"The reduction in rates improves incentives for savings, investment, business creation and expansion, job creation, entrepreneurship and work by allowing people to keep a greater percentage of the reward produced by these activities."

Also Peter Ferrara makes a very important point:

"In addition, America needs deregulation to unleash the private sector to produce more oil and natural gas, from offshore and onshore, and to build more nuclear power plants. This would build a powerful energy industry, adding to GDP and creating jobs."

Why America needs urgent deregulation and massive investment from the private sector in the Energy sector?

John Mauldin told us why in his latest letter:

"If the US is going to really attempt to balance the budget over time, reduce our personal leverage, and save more, then we have to address the glaring fact that we import $300 billion in oil (give or take, depending on the price of oil).

This can only partially be done by offshore drilling. The real key is to reduce the need for oil. Nuclear power, renewables, and a shift to electric cars will be most helpful. Let us suggest something a little more radical. When the price of oil approached $4 a few years ago, Americans changed their driving and car-buying habits.Perhaps we need to see the price of oil rise. What if we increased the price of oil with an increase in gas taxes by 2 cents a gallon each and every month until the demand for oil dropped to the point where we did not need foreign oil? If we had European gas-mileage standards, that would be the case now.

And take that 2 cents a month and dedicate it to fixing our infrastructure, which is badly in need of repair. In fact, the US Infrastructure Report Card (, by the American Society of Civil Engineers, which grades the US on a variety of factors (the link has a very informative short video), gave our infrastructure the following grades in 2009: Aviation (D), Bridges (C), Dams (D), Drinking Water (D-), Energy (D+), Hazardous Waste (D), Inland Waterways (D-), Levees (D-), Public Parks and Recreation (C-), Rail (C-), Roads (D-), Schools (D), Solid Waste (C+), Transit (D), and Wastewater (D-).

Overall, America's Infrastructure GPA was graded a "D." To get to an "A" would requires a 5-year infrastructure investment of 2.2 trillion dollars.

That infrastructure has to be paid for. And we need to buy less oil. And we know price makes a difference. The majority of that 2 cents would need to stay in the states where it was taxed, and forbidden to be used on anything other than infrastructure.

(And while we are at it, why not build 50 thorium nuclear plants now? No fissionable material, no waste-storage problem, and an unlimited supply (at least for the next 1,000 years) of thorium in the US. The reason we chose uranium was to be able to produce nuclear bombs, among other reasons.) We'll get into this and more when we get to the chapter on the way back for the US."

Why not try something else rather than pointless Government spending, which is no substitute for real growth coming from a repaired private sector.

As a conclusion let me quote Brian S. Wesbury and Robert Stein in an article published in Forbes:

"There are many positive alternatives that are not being formally discussed. This is a mistake. And more to the point, the last time the government tried to bail out the economy with drastic action, we ended up in the Great Depression. If we really want to "change" the way government and the private sector interact, why is the U.S. government still trying the same old policies that failed in the past? Tax cuts have worked before, so if deficits don't matter, why not try a different kind of surge--a private-sector, incentive-creating one?"

Friday 10 September 2010

The Hangover...Some guys can't handle credit...

Socrates: “All I know is that I know nothing.”

Another must read this week, the latest from the author of Liar's poker and the Big Short, Michael Lewis in Vanity Fair:

"The tsunami of cheap credit that rolled across the planet between 2002 and 2007 has just now created a new opportunity for travel: financial-disaster tourism. The credit wasn’t just money, it was temptation. It offered entire societies the chance to reveal aspects of their characters they could not normally afford to indulge. Entire countries were told, “The lights are out, you can do whatever you want to do and no one will ever know.” What they wanted to do with money in the dark varied. Americans wanted to own homes far larger than they could afford, and to allow the strong to exploit the weak. Icelanders wanted to stop fishing and become investment bankers, and to allow their alpha males to reveal a theretofore suppressed megalomania. The Germans wanted to be even more German; the Irish wanted to stop being Irish."

So true...I could not agree more with Michael Lewis.

Michael goes on:

"The resulting dumping of Greek bonds onto the market was, in the short term, no big deal, because the International Monetary Fund and the European Central Bank had between them agreed to lend Greece—a nation of about 11 million people, or two million fewer than Greater Los Angeles—up to $145 billion. In the short term Greece had been removed from the free financial markets and become a ward of other states.

That was the good news. The long-term picture was far bleaker. In addition to its roughly $400 billion (and growing) of outstanding government debt, the Greek number crunchers had just figured out that their government owed another $800 billion or more in pensions. Add it all up and you got about $1.2 trillion, or more than a quarter-million dollars for every working Greek. Against $1.2 trillion in debts, a $145 billion bailout was clearly more of a gesture than a solution. And those were just the official numbers; the truth is surely worse."

Some additional sobering facts about our dear European Greeks:

"In just the past decade the wage bill of the Greek public sector has doubled, in real terms—and that number doesn’t take into account the bribes collected by public officials. The average government job pays almost three times the average private-sector job. The national railroad has annual revenues of 100 million euros against an annual wage bill of 400 million, plus 300 million euros in other expenses. The average state railroad employee earns 65,000 euros a year."

Gee and we are lending some money to these guys? You've got to be kidding me...not.

At least the Greek banks were not as stupid as the other European and US ones in the subprime debacle:

"Virtually alone among Europe’s bankers, they did not buy U.S. subprime-backed bonds, or leverage themselves to the hilt, or pay themselves huge sums of money. The biggest problem the banks had was that they had lent roughly 30 billion euros to the Greek government—where it was stolen or squandered. In Greece the banks didn’t sink the country. The country sank the banks."


Here is another interesting fact about Greek politics during election, another courtesy of Michael Lewis great article:

“The first thing a government does in an election year is to pull the tax collectors off the streets.”

Lies damn lies and statistics:

“At Salomon we used to call [the head of the Greek National Statistical Service] ‘the Magician,’ ” says Xafa, “because of his ability to magically make inflation, the deficit, and the debt disappear.”

"In 2000, after a flurry of statistical manipulation, Greece hit the targets. To lower the budget deficit the Greek government moved all sorts of expenses (pensions, defense expenditures) off the books. To lower Greek inflation the government did things like freeze prices for electricity and water and other government-supplied goods, and cut taxes on gas, alcohol, and tobacco. Greek-government statisticians did things like remove (high-priced) tomatoes from the consumer price index on the day inflation was measured. “We went to see the guy who created all these numbers,” a former Wall Street analyst of European economies told me. “We could not stop laughing. He explained how he took out the lemons and put in the oranges. There was a lot of massaging of the index.”

And after joining the Euro, this is what the Greeks did with the help of Goldman Sachs (the guys that created the wonderful Abacus transaction as well...):

"To remain in the euro zone, they were meant, in theory, to maintain budget deficits below 3 percent of G.D.P.; in practice, all they had to do was cook the books to show that they were hitting the targets. Here, in 2001, entered Goldman Sachs, which engaged in a series of apparently legal but nonetheless repellent deals designed to hide the Greek government’s true level of indebtedness. For these trades Goldman Sachs—which, in effect, handed Greece a $1 billion loan—carved out a reported $300 million in fees. The machine that enabled Greece to borrow and spend at will was analogous to the machine created to launder the credit of the American subprime borrower—and the role of the American investment banker in the machine was the same. The investment bankers also taught the Greek-government officials how to securitize future receipts from the national lottery, highway tolls, airport landing fees, and even funds granted to the country by the European Union. Any future stream of income that could be identified was sold for cash up front, and spent."

So, there you have it, the big question on everyone's mind is about the possibility of a Greek Default. Can it happen and will it happen? The only people that can let it happen are the Greeks themselves and looking at their outstanding records, I am pretty sure you can guess by now what the answer is...

Everyone wants to believe Greeks will not dare to default, because it is more a convenient truth and more reassuring to think they will act wisely and will not dare the unimaginable:

The head of the Greek National Statistical Service wasn't nickamed the Magician for nothing.
The Greeks got it so well for so long because, as per Stephen Macnik a researcher from the Barrow Neurological Institute in Phoenix, Arizona, said in an article from Wired Science:

"Tricks work only because magicians know, at an intuitive level, how we look at the world"

Read More

Stephen also adds:

"Even when we know we're going to be tricked, we still can't see it, which suggests that magicians are fooling the mind at a very deep level."

As reminder, this is a clear picture on the evolution of the 5 year CDS price for Greeces since January 2010:

Greece unfunded liabilities problem is massive, more than 800% of GDP!

10 year Greek Bond Yields are creeping up closer to record level of May:

A default of Greece is therefore clearly in the pipeline.

James Mackintosh in his column from the FT says a Greek default is unlikely in the next two years assuming the government can cling on to power. Buying one to two year great bonds might therefore be very tempting for high yield seeking investors, but it is not for the faint-hearted.,s01=1.html

For Ambrose Evans-Pritchard, in the Telegraph:

"Political doubts are also surfacing in Greece. This week's cabinet shuffle by premier George Papandreou is a tilt to the populist wing of the PASOK party, hinting at austerity fatigue after the economy shrank 1.8pc in the second quarter. The EU debt agency Eurostat said Athens has not yet provided documents on the country's hidden debts."

Ambrose indicates also:

"A column by Fintan O'Toole in the Irish Times said the problem had become too big for Ireland after rescue costs escalated to €25bn, and possibly higher. "The choice is now stark: do we go on being "good Europeans" at the cost of destroying our own society or do we become "bad Europeans", lose the trust of our European partners, but save ourselves?"

"There comes a point of existential crisis when even the meekest of countries has to put its vital national interests (first). We are at that point now," he said, deeming it the job of the ECB to shore up Anglo Irish if it thinks default poses systemic risk."

The Irish are more disciplined than the Greeks in tackling their difficulties and are already taking drastic actions in respect to their crippled banking industry and seriously damaged economy. The major issue with the current crisis is the very large amount of damage inflicted to the household balance sheet in many countries.

The road to recovery will be unfortunately very long for many Europeans countries.

The final question is how long can the Greeks, the Irish, the Portuguese, the Spanish people endure the pain of the hangover?

Reminder of the US Hangover for US my next post, I will look at Household Balance sheet and forward implications...not a rosy picture to say the least...

The 4 Trillion dollar hangover...

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