Credit jitters - Market Update on Ireland - the game is changing

Big sell-off in late afternoon on Irish Banks senior debt thanks to the comments from the Finance Minister:

"Finance Minister Michael Noonan has said Ireland will go to our European partners with a plan to impose significant losses on the senior bondholders in Anglo Irish Bank and Irish Nationwide Building Society.

He was speaking in Washington after meeting the IMF and the US Treasury Secretary Timothy Geithner.

Mr Noonan said the Government will seek to impose losses on senior bondholders in Anglo Irish Bank. He said that around €3.5 billion in senior unsecured, unguaranteed bonds issued by Anglo Irish Bank and Irish Nationwide Building Society should have losses imposed on them.

Mr Noonan said he had discussed this with the IMF, who supported the strategy.

The Finance Minister said these banks are no longer normal entities and are more like warehouses for bad debts. In that context, he would be going to our European partners to propose significant cuts in the money to be paid to the bondholders.

Mr Noonan also revealed that he had asked Mr Geithner to support Ireland's effort to cut the interest rate paid on the European parts of our bailout programme. He said Mr Geithner agreed to support Ireland's effort and would speak to the French in connection with this."

Senior bonds for both entities got whacked after these comments:

Source: the market...

Anglo Irish has 3.1 billion euros in unsecured senior bonds not covered by a state guarantee.
Irish Nationwide Building Society, (which by the way is being merged with Anglo Irish), has 601 million euros worth in unsecured senior bonds not covered by the state guarantee as well.

Both have already cost 35 billions euros worth of bailout funds courtesy of the Irish taxpayer.

Ireland seeks to go after Anglo's senior bondholders - Reuters
From Reuters:
"No euro zone government has imposed losses on senior bank bonds, which are ranked on a par with depositors, but senior unsecured debt amounting to 320 million euros was subjected to a 41.2 percent haircut when Danish bank Amagerbanken failed in February."

The game is changing.

Meanwhile all is not well at Bank of Ireland either:

Shareholder Anger Erupts At Bank Of Ireland Meeting - WSJ

"The bank, which is already 36% owned by the Irish government after receiving EUR3.5 billion in bailout aid, needs EUR5.2 billion more in capital and new buffer reserves, mainly to make good lending excesses during the boom years."

I wrote in December 2010 in Europe - The end of the Halcyon days that:
"Either bondholders of Irish banks debt agree take a haircut on both the sub and senior debt, or the Irish Goverment will have to cut more spending, which means more austerity for the Irish people."

We have reach that point.

Portugal and Ireland drifting wider still:

Source CMA

French banks as well today have been put under pressure by the rating agencies due to their exposure to Greek debt.
Moody's Investors Service placed the three largest French banks on review for a possible downgrade.
The three banks are:
BNP Paribas, down 2.55%.
Credit Agricole, down 2.49%.
Societe Generale, down 2.48%

French banks CDS wider on Moody's rating threat:

Source CMA


EUR/USD is down 2% today on these news to around 1.4165:

Itraxx 5 Year Financial Senior CDS was wider today by 16 bps at around 178 bps whereas the Itraxx 5 Financial Sub widened by 26 bps, market being around 304-310, 6 bps bid-offer spread...ouch.


"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."
Henry Ford

Fool me once, shame on you; fool me twice, shame on me...

My thoughts are with all the Japanese people following the ongoing tragedy.
"神さまが守るように"
"kami sama ga mamoru youni"
"May God protect you."

"Japan is a very rich country and has a high savings rate and has the capacity to deal not just with the humanitarian challenge but also the reconstruction challenge they face ahead."

US Treasury Secretary Tim Geithner
Tuesday 15th of March 2011.

Geithner does not believe that there is a risk Japan could sell their US Treasuries to raise cash in order to respond to the damages caused by both the earthquake and the tsunami.

And the reason why according to US Treasury Secretary is that "Japan has a high savings rate":

Japanese getting older = Bad for savings Tim...

Yeah right Tim! Spot on!
This is purely and simply incorrect to stay polite. Get your facts right...I am not surprised to hear this from the man who was in charged of regulating the US banks while at the New-York Federal Reserve Bank from 2003 until 2009.

Are we witnessing at this very moment the demise of the US dollar?

Japan might be finally calling another bluff from the US by dumping in size their US Treasuries to rebuild their economy.

I previously wrote about the Bluff Call of 1971 - the Nixon shock and the collapse of the Gold Standard.

Is it payback time for Japan following the disaster of the 1985 Plaza agreements? (please refer to the post: Analyze this!).
As a reminder from my previous post, another former quote from Tim Geithner:

"On June 1, 2009, during a question-and-answer session following a speech at Peking University, Geithner was asked by a student whether Chinese investments in U.S. Treasury debt were safe. His reply that they were "very safe" drew laughter from the audience."

China is not stupid. I wrote specifically on the fact that China is well aware of what happened to Japan with the Plaza Agreements of 1985: The end of the American Dream, the call for trade barriers and the rise in populism....

Please find enclosed the link to the Chinese view on what happened to Japan following Plaza in 1985:

Revaluation of Japanese Yen, a historical lesson to draw: analysis

Maybe Japan has no choice but to cash in on its holdings to rebuild its country and repatriate Japanese Yens. At least this is what the FX market is betting on, given this evening huge price action and surge in JPY versus the USD from around 80 to an amazing 76 JPY for one USD to now back to 79...Crazy...

Japan selling their US Treasuries would be driving up interest rates.

Prior to the dramatic events happening in Japan, Bill Gross, from PIMCO, the authority on bonds, announced to the world he had dumped all his US Treasuries from his flagship fund: “Yields may have to go higher, maybe even much higher to attract buying interest,”
Yes, Bill Gross expects a sharp increase in interest rates within the next few months. If Japan starts dumping some of its US Treasuries holdings (around 885.9 billions USD as of January 2011), you can be assured Bill's expectations could materialise. China cut its holdings of US treasury bonds by 5.4 billion USD to 1.15 trillion USD in January, reported sina.com.cn, citing the U.S. Department of Treasury.

During the 1995 Kobe earthquake, the Japanese repatriated 30 billion USD worth of U.S. government bonds, equivalent to about 13 per cent of its Treasury holdings at the time.

This time is different?

The Great Pretender - the Bluff Call of 1971 - the Nixon shock.

In 1971, one of the greatest poker game ever played came to halt. It marked the end of the Gold Standard and the convertibility of the US dollar in Gold.

In this post I will revisit this great moment and highlight some of the contributions of one of the great adversary of Keynes to this moment, Jacques Rueff.

The context of the Nixon Shock of 1971:

http://en.wikipedia.org/wiki/Nixon_shock

"By the early 1970s, as the costs of the Vietnam War and increased domestic spending accelerated inflation, the U.S. was running a balance of payments deficit and a trade deficit, the first in the 20th century. The year 1970 was the crucial turning point, which, because of foreign arbitrage of the U.S. dollar, caused governmental gold coverage of the paper dollar to decline from 55% to 22%. That, in the view of Neoclassical Economists and the Austrian School, represented the point where holders of the U.S. dollar lost faith in the U.S. government’s ability to cut its budget and trade deficits.

In 1971, the U.S. government again printed more dollars (a 10% increase) and then sent them overseas, to pay for the nation's military spending and private investments. In the first six months of 1971, $22 billion dollars in assets left the U.S.[citation needed] In May 1971, inflation-wary West Germany was the first member country to leave the Bretton Woods system — unwilling to deflate the Deutsche Mark to prop up the dollar. In order to prevent the dumping of the Deutsche Mark on the open market, West Germany did not consult with the international monetary community before making the change. In the next three months, West Germany’s move strengthened their economy; simultaneously, the dollar dropped 7.5% against the Deutsche Mark.

Because of the excess printed dollars, and the negative U.S. trade balance, other nations began demanding fulfillment of America’s “promise to pay” - that is, the redemption of their dollars for gold. Switzerland redeemed $50 million of paper for gold in July. France, in particular, repeatedly made aggressive demands, and acquired $191 million in gold, further depleting the gold reserves of the U.S. On 5 August 1971, Congress released a report recommending devaluation of the dollar, in an effort to protect the dollar against foreign price-gougers. Still, on 9 August 1971, as the dollar dropped in value against European currencies, Switzerland withdrew the Swiss franc from the Bretton Woods system."

The great imbalances we have witnessed in the last couple of decades come from this defining moment of the summer of 1971, when the great poker game played by the US came to halt as more and more countries called their bluff, worried by the US deficits. The agressive demands coming from France had been initiated by the advisor of General de Gaulle, Jacques Rueff, Keynes greatest opponent.

"The conditions which formerly were able to give rise to the ‘gold exchange standard’ have changed. The currencies of the Western European States are restored, to the extent that gold reserves of the Six today equal those of the Americans … This means that the custom of ascribing a superior value to the dollar as an international currency no longer rests on its initial foundation – I mean America’s possession of the largest share of the world's gold. This unilateral facility which is granted to America is serving to cloud the idea that the dollar is an impartial and international medium of exchange, when it is a means of credit belonging to one State … Gold has real value."

- Charles de Gaulle, February 4, 1965.

With great power comes great responsibility.
Stan Lee - Spiderman

The abuses of Bretton Woods.

The US have behaved irresponsibly for too long, putting us all at risk.

The privileged status of the US which was granted under the Bretton Woods arrangements, made it possible for the US to run a deficit that would never disappear while the dollar standard prevailed. Jacques Rueff concluded that this privileged status would inevitably lead(dollar standard and associated deficits) to a global economic crisis that would end in tears, an event akin with the Great depression. This is the situation we are currently going through.

Jacques Rueff has proven to be right and the Keynesians dangerously wrong.

A recently published biography on Jacques Rueff by Christopher Chivvis, The Monetary Conservative, is reviewed using the below link. It gives you a brief insight on Rueff's belief and contributions to economic policies:

http://www.realclearmarkets.com/articles/2010/09/14/book_review_the_monetary_conservative_by_christopher_s_chivvis_98667.html
http://74.217.243.103/publications/pubID.2261/pub_detail.asp

The clear abuse from the Dollar domination was very clear with the 1985 Plaza Accord of the 22nd of September 1985. I went through the consequences for Japan in a recent post relating to the bogus currency wars and the attitude of the USA towards China. Japan's never fully recovered from the economic suicide they committed by allowing the Yen to rise very fast again the US dollar.

The US survived the Saving and Loans Crisis by pushing Japan to the floor, and ruining in the process their largest creditor at the time. The US are attempting the same game with China today, this time around let's all hope they will fail. China is trying to curb hot money pouring in as well as taming inflation. They recently raised one year lending rate to 2.5%. It is becoming extremely difficult for China to slow hot money flows. Some countries have already implemented capital controls.

For Jacques Rueff, the only solution to remove the great current imbalances, would have been to reform the system and avoid a currency like the US Dollar to play the role of the world's leading currency or any other currency. Would a return to a Gold Standard work? Or a Bancor currency as advocated by Keynes? Bancor was indeed proposed before Bretton Woods led to the US Dollar assuming the role of the World's currency. Both Rueff and Keynes did not want the US Dollar to be the prevailing currency. They both understood the risks.

Tim Geithner's latest proposal targeting trade deficits and surpluses is basically an attempt to go back to Keynes Bancor proposal.

Felix Salmon recently wrote a post on Geithner's proposal in Seeking Alpha:

http://seekingalpha.com/article/231671-tim-geithner-s-poor-imitation-of-john-maynard-keynes

"Tim Geithner has proposed to his fellow G-20 finance ministers that trade surpluses and deficits be capped at 4% of GDP. The idea is already running into criticism from countries that run big trade surpluses."

QE2 is the nuclear option the US are currently playing with. They are willing to export inflation to the emerging markets to force their hands.

Ambrose Evans Pritchard in an article published in the Telegraph on the 10th of October discuss what is currently happening, paving a road to a potential new Bretton Woods, and the removal of the US Dollar as world reserve currency.

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/8054066/Currency-wars-are-necessary-if-all-else-fails.html

"The atomic bomb, of course, is quantitative easing by the Federal Reserve. America has in effect issued an ultimatum to China and G20: either you stop this predatory behaviour and agree to some formula for global rebalancing, or we will deploy QE2 `a l’outrance’ to flood your economies with excess liquidity. We will cause you to overheat and drive up your wage costs. We will impose a de facto currency revaluation by more brutal and disruptive means, and there is little you can do to stop it. Pick your poison."

The US are playing the Great Pretender game.

The United States has had the luxury of being in a position to avoid economic adjustment in spite of its deficits for too long. It is time to adjust to the reality and stop pretending.

The Great Pretender
The Platters/Freddie Mercury:

Oh yes I'm the great pretender (ooh ooh)
Pretending I'm doing well (ooh ooh)
My need is such I pretend too much
I'm lonely but no one can tell

Oh yes I'm the great pretender (ooh ooh)
Adrift in a world of my own (ooh ooh)
I play the game but to my real shame
You've left me to dream all alone
...

Analyze this

Allied Irish CDS Sub, you know the score from the previous post (Source CMA DataVision):



Anglo Irish CDS Sub on the 6th of October, can you spell default? (Source CMA DataVision):



and on the 7th of October, this is how it looks like for Anglo Irish Sub...2743.85 bps on the 5 year CDS...300 bps wider!



Debase this! Check out the evolution of the USD since 1971 against:

Japanese Yen:



Have a look at 1985 on the Graph and the huge rise in the Japanese yen following the 1985 Plaza Agreements which spelt economic disaster for Japan and the crash of the Japanese economy and the Nikkei index at the same time. 1985 to 1990, 240 to 120, bring it!

At around 82 JPY per USD I don't expect the BOJ to stay idle...

Swiss Franc:



and the evolution of the US dollar versus the Euro since 1999:



An interesting view of the evolution of Fed Funds Rate since 1950:



And the evolution of Oil prices since 1940:



Gold is continuing its steady rise:



At the same time we have Secretary of Treasury Timothy F. Geithner still gesticulating around China and the ongoing Debasing game taking place. Pathetic...

http://www.treasury.gov/press/releases/tg894.htm

"The Framework, called the "Framework for Strong, Sustainable and Balanced Growth," was designed to create stronger incentives for rebalancing growth, as the world recovered from the crisis, with higher savings in countries like the United States, complemented by reforms to strengthen domestic demand in surplus countries like China, other emerging economies, Germany, and Japan.

Alongside this "Framework" we agreed to give emerging economies a greater stake in the most important institutions for economic and financial cooperation, to increase the resources available to the international financial institutions, and to make the G-20 the centerpiece of cooperation, replacing the role traditionally played by the G-7."

Dear Tim, I don't think you have a choice in relation "to give emerging economies a greater stake in the most important institutions for economic and financial cooperation." Guess it is a done deal with China, India and Brasil...

"We have moved aggressively to do our part to help bring the world out of crisis. We are working very hard to repair our financial system, to fix what was broken, and to reduce the future risk of financial crises here at home. We have seen a very significant increase in private savings by households. Our external deficit has fallen sharply, and we are financing at home a much larger share of the fiscal deficits we inherited."

Wow!
Who in the first place put us ALL in this mess? Was letting Lehman Brothers going down a wise decision? I don't think so. In relation to reducing the future risk of financial crisis, I disagree, banks are still too big to fail. Fannie Mae and Freddie Mac are a joke and should be gradually winded down. The commercial real estate disaster is still an ongoing concern: 129 banks down this year so far and counting.

Hey Tim, where were you working before taking up the role of Secretary of the Treasury? Weren't you president of the New-York Fed from 2003? Were you not in charge of supervising and regulating financial institutions? Great work!
In May 2007, did you not work on reducing the capital needed to run a bank? Great timing! Was the "excellent" Lawrence Summers your mentor previously? It would explain a lot...

Nice one Tim, just like you tried to talk to the Chinese about how safe it was to invest in the US...
"On June 1, 2009, during a question-and-answer session following a speech at Peking University, Geithner was asked by a student whether Chinese investments in U.S. Treasury debt were safe. His reply that they were "very safe" drew laughter from the audience."



Tim, you can always send your CV to your buddy Hank Paulson, I am sure he can help you land a good job at Goldman Sachs...

Tim also added in the same speech:
"That brings me to the second policy challenge: we believe it is very important to see more progress by the major emerging economies to more flexible, more market-oriented exchange rate systems. This is particularly important for those countries whose currencies are significantly undervalued.

This is a problem because when large economies with undervalued exchange rates act to keep the currency from appreciating, that encourages other countries to do the same.

This sets off a damaging dynamic, described first by my former colleague Ted Truman, as "competitive non appreciation." Over time, more and more countries face stronger pressure to lean against the market forces pushing up the value of their currencies. The collective impact of this behavior risks either causing inflation and asset bubbles in emerging economies, or else depressing consumption growth and intensifying short-term distortions in favor of exports.

This is a multilateral problem. It is unfair to countries that were already running more flexible regimes and let their currencies appreciate. And it requires a cooperative approach to solve, because emerging economies individually will be less likely to move, unless they are confident other countries would move with them.

This problem exposes once again the need for an effective multilateral mechanism to encourage economies running current account surpluses to abandon export-oriented policies, let their currencies appreciate, and strengthen domestic demand."

The message is that the US is concerned that everyone is devaluating at the same time and they would like to be the only one playing this game to restore competitiveness. Tim would also love China to explode like Japan did after the 1985 Plaza Agreement. Unfortunately, dear Tim, Chinese are not stupid and are well aware of the risks. If the US hadn't based 70% of its GDP on Consumption and was actually producing more and exporting more, they would not be in such a difficult situation.