Europe: More of the Same

I haven’t written anything recently about the Europe financial crisis because…little has changed.

Still the same old “kicking the can down the road.”

I am in the same place as Stephen King, chief economist at HSBC: “The totality of financial claims in now too big to be supported by the new economic reality.  In this world of economic permafrost, someone, sometime, will have to accept losses.  Will those losses accrue to taxpayers, recipients of public services, equity investors, bondholders, domestic debtors or foreign creditors?” (http://www.ft.com/intl/cms/s/0/c3451258-da07-11e0-b199-00144feabdc0.html#axzz1XSP5Pmbe)

His answer: “…any resolution seems a long way off.”

The response from the international capital markets?  Fear!

Yesterday the ten-year government bond of Germany closed at 1.88 percent; the ten-year United States Treasury bond closed at 1.99 percent.  Never thought I would see rates like this in my lifetime.  

The fear is driving investors into the safest things that they can get their hands on.  And, within this “flight to safety”, Europe…and the United States…just plods along with business as usual. 

Although we don’t agree with his prescribed remedy, Mr. King and I agree with what was written by Martin Wolf this past week. (http://www.ft.com/intl/cms/s/0/079ff1c6-d2f0-11e0-9aae-00144feab49a.html#axzz1Wbu6HxQ0)  Mr. Wolf argued that the major problem behind all the “pussy-footing” around is that there is a substantial lack of leadership on the world scene. (http://seekingalpha.com/article/290934-struggling-with-a-great-contraction)

This lack of leadership comes out in so many ways.  Just take the case of Greek bonds and the value at which these bonds are carried on the balance sheets of European banks.  It seems as if these European banks can do just about anything they want to in terms of writing down the value of the Greek bonds they hold.

Floyd Norris writes in the New York Times: “British banks were most willing to swallow bad medicine and admit the bonds were worth far less than par value. Some German banks were equally forthcoming, but others were less so. Italian banks seem to have done as little as they could, but did take write-downs. French banks went the farthest to find ways to act as if Greek bonds were just fine.” (http://www.nytimes.com/2011/09/09/business/european-banks-apply-slippery-standards-on-greek-bond-valuations.html?ref=business)

So much for the “strong” rules and enforcement actions of international accounting and banking standards supposedly coming out of Europe.

Oh, yes, these are the European regulators that gave us the “stress” tests that were such a laughable matter.

The reason, to me, that no politician wants to stand up and take a strong position is that there are no good short-run solutions to the problems at hand.  The difficulty in taking a strong, longer-run position is that people are currently in pain and politicians must focus on “muddling through” to prepare themselves for the next election.

After all, the number one job of the politician is to get himself or herself re-elected. 

The difficulty faced by the politician is captured in the sub-heading of the New York Times article “Europe Steers Into a Zone of Uncertainty.   This sub-heading reads, “Path Out of Debt Crisis Involves Pain and Time.” (http://www.nytimes.com/2011/09/09/world/europe The /09europe.html?_r=1&ref=todayspaper)

Imposing more “pain” is not a good way to get re-elected and taking too much time to achieve results does not match the timing of the politician’s next election.

And, where does the pain start?

Let me quote King once more:  “someone, sometime, will have to accept losses.”

Many of the governments in Europe are fragile because of the sovereign debt crisis.  Many of the banks in Europe are fragile because of the sovereign debt crisis.  There is rioting in the streets in Europe because of the efforts of governments to cut back budgets or raise taxes.

Yet, these same governments and public officials will not accept the reality of the situation…and so the crisis continues.

Steven Erlanger, tin the New York Times article just mentioned writes the following: “most experts agree that Europe’s crisis will persist until it adopts a far tighter fiscal and monetary union, expels weaker economies or divides into two, with different currencies. 

The hope among experts and economists is that the changes, if carried out with skill, may allow Europe to further isolate Greece and its unsustainable debts from other countries, reducing the risk of contagion and buying time for other countries to fix their budgets and work on how to better centralize control of fiscal policy. Though abstract on the surface, the changes will provide more flexibility to bail out or further restructure Greek debt, to aid Italy and Spain with their bond sales and even to recapitalize some European banks, weakened by their exposure to sovereign debt in the form of Greek, Portuguese, Spanish and Italian bonds.”

Notice three things: first, the reference to “experts”; second, the statement “if carried out with skill”; and third “though abstract on the surface.”  Sounds like success is just around the corner. LOL

It took fifty years or so to create this financial crisis.  We are not going to get out of it “overnight” and we are not going to get out of it without more pain. 

Again, “someone, sometime, will have to accept the losses,” regardless of what the “experts” say.

This is what happens when you become a “debt junkie.’

Struggling With A Great Contraction

Martin Wolf of the Financial Times recently returned from vacation.   It is interesting to see where this “top” economic commentator stands after taking off from his weekly writing for a full month. 

His view on his return: The major economies of the world are “Struggling with a great contraction.” (http://www.ft.com/intl/cms/s/0/079ff1c6-d2f0-11e0-9aae-00144feab49a.html#axzz1Wbu6HxQ0) His concern is not with the possibility of a “double dip” recession, but with something more sustained.  He asks, “How much deeper and longer this recession or ‘contraction’ might become.  The point is that, by the second quarter of 2011, none of the six largest high-income economies had surpassed output levels reached before the crisis hit, in 2008.”  Hence, the great contraction.

The turmoil in financial markets that was seen in August, he contends, tells us, first, that “the debt-encumbered economies of the high income-countries remain extremely fragile”; second, “investors have next to no confidence in the ability of policymakers to resolve the difficulties”; and third, “in a time of high anxiety, investors prefer what are seen as the least risky assets, namely, the bonds of the most highly-rated governments, regardless of their defects, together with gold.”

A pretty succinct summary…what?

There is too much debt around which means that all the efforts that governments are making to get the economy moving again face the up-hill battle of over-coming the efforts people, businesses, and local and regional governments are making to reduce their debts. (http://seekingalpha.com/article/285172-when-debt-loads-become-too-large)

While national governments deal with their own excessive debt loads and deficits, their central banks have responded with undifferentiated policies to flood banks and financial markets with sufficient liquidity in order to provide time for banks, consumers, businesses, and local and regional governments to “work out” their positions as smoothly as possible. (http://seekingalpha.com/article/290416-quantitative-easing-theory-need-not-apply)

The hope seems to be that “time will heal all things.”

Whereas there is too much deb around, there is too little leadership.  I will quote Wolf on this: “In neither the US nor the eurozone, does the politician supposedly in charge—Barack Obama, the US president, and Angela Merkel, Germany’s chancellor—appear to be much more than a bystander of unfolding events.” (http://seekingalpha.com/article/285658-if-the-economy-is-a-football-game-we-need-new-strategies)

If there are no leaders, then policy decisions tend to be postponed as long possible, and then, when a result is finally forthcoming, the outcome is more like a camel, something that appears to be an inconsistent piecing together of incompatible parts.

And, this is supposed to produce confidence?  To quote Mr. Wolf again: “Those who fear deflation buy bonds; those that fear inflation buy gold; those who cannot decide buy both.” 

The point being that it is not a time to commit to the future, to invest in real assets or investments.  Hence, the economies of the “high-income” nations stagnate, unemployment remains excessive, and public confidence continues to be depressed.   

Such a general condition argues for a continuance of the economic malaise and not a more robust recovery any time soon.  Hence, the great contraction.

Mr. Wolf still has hope: “Yet all is not lost.  In particular the US and German governments retain substantial fiscal room for manoeuvre…the central banks have not used up their ammunition.”  

But, this hope is based on the existence that leadership in these governments will arise.  Policy makers will come to their senses: “The key, surely, is not to approach a situation as dangerous as this one within the boundaries of conventional thinking.”  

Therein lies the problem.  Mr. Wolf is looking for the hero to ride in on her/his white stallion and provide the leadership necessary to clean up the mess and get things going forward on the right path. 

He has just argued, however, that that leadership does not seem to exist.  So, where is the leadership going to come from?

With all the debt loads outstanding, just how much can be done to overcome the drag on the spending and the economy coming from the efforts of many to de-leverage. 

The Federal Reserve and the European Central Bank have flooded the world with liquidity.  Their effort here is to give banks, consumers, businesses, and governments time to work out their bad debts.  This also provides time for banks and others to fail, consolidate, and/or raise capital without causing major disruptions to the whole financial system. Banks in the United States continue to fail, banks in the US and Europe continue to consolidate, and banks in the US and Europe continue to raise capital. 

Since debt seems to be the major problem here, the only other major suggestion that has been made that could relieve the credit crisis is to relieve debtors of some of their debt burden.  This would mean that some parts of the debt would need to be written off.  Whereas many have suggested such a program, the difficulty of creating such a problem is in the details and no one seems to have come up with any acceptable details of such a program.  Some have suggested that inventing such a workable and just program of debt reduction is nearly impossible.

So, we are back to square one…there are no “good” options.  And, when there are no “good” options, potential leaders tend to disappear into the woodwork.  It is easy to “lead” when you can create credit without end and encourage everyone to own a house and attempt to guarantee people jobs for their lifetime.  But, real leaders are the ones that can stand up and lead when there are no good options.

It is just that few want to be “out front” when none of the options are nice and comfortable.      

The Debt Crisis: It Ain't Over Until It's Over!

The people in charge, both in the United States and Europe, still believe that the problem we are facing is a liquidity problem.  They, therefore, continue to come up with plans that “kick the can down the road a little further” but fail to come up with any solutions that will allow us to move on into the future.

For three years now, I have been arguing that the problem is not a liquidity problem but a solvency problem. 

There is too much debt outstanding in the world!  People, businesses, and governments cannot carry this debt much further, their debt load is unsustainable. 

This is a solvency problem.

Liquidity problems are short-lived problems.  They have to do with the ability of an asset holder to sell assets into the market place at prices that are near to the value of the assets on the balance sheet of the asset holder. 

Liquidity problems arise because the two sides of a market have different information sets.  The sellers of assets have a different set of information than do the buyers.  Because of this, the buyers generally take a little vacation until they have more information about the asset prices and regain sufficient confidence in the amount of information they have to begin trading again.  At this time the liquidity problem goes away.

Central banks (and other government agencies) may intervene in the market providing a floor to asset prices until such time as the buyers start buying again.  This is the “classic” function of the central banks to provide liquidity to the banking system.

Solvency problems are different.  When solvency problems occur, the holders of assets know that the value of their assets are below that recorded on their balance sheets.  They are reluctant to sell the assets or recognize the value of the assets because any write down of the value of the assets would have to be taken against net worth and this might threaten the solvency of the economic unit that holds the underwater asset.

A solvency problem is a “sell” side problem whereas a liquidity problem is a “buy” side problem.

Economic growth or price inflation may help asset prices regain their balance sheet value.  However, in the absence of either of these forces, market prices may remain below the book value of the asset and this threatens the existence of the household, business, or government.

There is too much debt outstanding in the world!  Whoops, I said that before?

Much of the debt is underwater.  Economic growth or inflation are not coming along fast enough or strong enough to “buy out” this underwater situation.  Hence, the threat of insolvency exists for many people, businesses, or governments. 

Sooner or later asset values are going to have to be written down!

Continuing to postpone the day when they are going to be recognized just creates more and more uncertainty.

The fact that the people running the governments in America and Europe can’t come to grips with this just creates even more uncertainty.   

This uncertainty is the biggest factor in the marketplace right now.  With so much uncertainty in the world, market participants jump this way and that way in response to almost any new bit of information being released. 

And, my guess is that this volatility will continue until people recognize the nature of the problem they are facing.  Until the people running things accept the fact that the crisis they are facing is a solvency crisis and do something about it, this uncertainty and volatility will just increase. 

As Yogi Berra said, “It ain’t over ‘til it’s over.”

Until people realize it is a solvency problem and propose solutions to “get it over with”, the situation will continue. 

Now we know what it is like to live in a world without leaders!    

A Strong Dollar?

“It is very important to the United States that we have a strong dollar.”
So said the United States Secretary of the Treasury.

Yes, Paul O’Neill said that.

Oh, yes, John Snow said that.

And, Hank Paulson.

Oh, you say, that the quote is attributed to Tim Geithner, who made the statement yesterday at a news conference of Asia-Pacific finance ministers.

As my good friends would say, “you have to walk the walk, not just talk the talk!” Or, in the case of those looking on, “watch the hips, not the lips!”

The only public person alive today that, in my mind, has any credibility on this issue is Paul Volcker. And, it is Paul Volcker that has written, “A nation’s exchange rate is the single most important price in its economy; it will influence the entire range of individual prices, imports and exports, and even the level of economic activity. So it is hard for any government to ignore large swings in its exchange rate…” (This quote is found on page 232 in the book “Changing Fortunes: The World’s Money and the Threat to American Leadership” by Paul Volcker and Toyoo Gyohten, Times Books, 1992.)

The United States government has no credibility left when it comes to the value of the United States dollar.

During the administration of Bush 43, the value of the United States dollar fell by 37% against an index of major currencies from February 2002 to March 2008 while the dollar fell in value by 45% against the Euro from February 2002 to July 2008.

The United States dollar did rebound at the time of the financial crisis: up 19% against the index of major currencies and up 23% against the Euro.

However, since February of this year the United States dollar fell back by about 13% against the index of major currencies and by about 15% against the Euro.

In watching the hips, not the lips, we see, for the United States government, potential cumulative fiscal deficits of $15 to $20 trillion over the next 10 years. We have a banking system with almost $1.1 trillion in excess reserves during the two week period ending November 4, 2009. We are faced with an unknown “exit strategy” to remove these excess reserves on the part of the Federal Reserve System.

And all this with several other “shocks” on the horizon. Obama “owns” Afghanistan now and it is totally unknown what his “new strategy” for that country will mean in terms of more government spending. Then there is the health care initiative. Obama has said that the program should not add “one dime” to the deficit, yet all indications are that whatever is passed will add to the deficit, although we don’t know what that amount will be. Then there is the climate change bill along with some other proposals that are setting in the wings.

Oh, yes, people within the administration have suggested that the rest of the TARP money, whatever that amounts to, can be applied to reducing the deficit. Whoopee!

I hear the Obama administration talking the talk. I don’t see them walking the walk.

And what about Bernanke. He is staying particularly silent these days. Oh, yes, we learned from the New York Times earlier this week that he is letting Barney Frank do all his talking for him.

The strong dollar is, at present, a myth!

It will continue to remain weak and its value will continue to trend downward for the foreseeable future.

How far am I looking forward?

I will continue to believe that the dollar will remain weak until someone emerges that has some credibility. Right now, I don’t know where that person is going to come from.

Forthcoming Regulatory Changes?

Reading the Wall Street Journal Saturday morning, I saw the headlines, “Bush Administration Rushes Regulatory Changes Before Time Is Up.” See http://online.wsj.com/article/SB122489005913868559.html?mod=todays_us_page_one.

My heartbeat accelerated. I started reading the first paragraph…”The Bush administration is hurrying to push through regulatory changes in politically sensitive areas such as endangered-species protection…WHAT!...health-care policy…Huh?...and other areas.”

The article stated that this is the rush to “cement new regulations” by pushing through “last-minute changes” intended to cement the legacy of the out-going President. These regulations are consistent with the philosophy of the current administration and are aimed toward stamping the imprint of the administration on Washington, D. C. before its turns out the lights on January 19, 2009.

Whoa! I thought we had a financial crisis…one brought on by insufficient regulation…a crisis that is now spreading deeper and deeper into the bowels of Main Street…and the world. What about the progress of the bailout of all the financial institutions of the country, the rescue of homeowners that are facing foreclosure, the plans being announced daily to lay off thousands of more workers, and the deepening recession? What about the financial world that is going to exist after the collapse of 2008 and the institutions and regulation that are going to define the “game” and its players in the future?

The problem is that when it comes to dealing with the financial crisis, this administration…the gang that couldn’t shoot straight…doesn’t have a consistent vision or philosophy to deal with the economic and financial situation. We saw this in the “breakdown” of former Fed Chairman Alan Greenspan in his appearance before Congress this past week. Greenspan commented that he was in “a state of shocked dis-belief”. Helicopter Ben…the current Fed Chairman…is tossing billions and billions of dollars out into the world! And, Treasury Secretary Paulson is running around trying this plan…and then changing the plan…and then changing the plan again…and then changing the plan again…

The problem is…no one is in charge…and no one has any idea what to do.

Need I say it again…the ‘decider’ has decided to take it on the lamb…the leader of the free world is no where to be seen.

Perhaps we should take some sage advice from Anna Schwartz who was the co-author with Nobel prize-winner Milton Freidman of “A Monetary History of the United States”. An interview with Ms. Schwartz appeared in the most recent issue of Barron’s, “Tearing Into the Fed and Treasury Plans” (October 27, 2008). I don’t agree with all Ms. Schwartz has to say, but here is some wisdom I think is very important for all of us to consider.

“The way you clear up problems in the credit market is through coming up with a clear, understandable plan and then executing it precisely.

My hope is that they will solve the problem by doing a bang-up job. But there’s already been talk about having to come back for more money. The risk of being unclear and doing things ad hoc is that you gradually destroy faith in the financial system…

…if we keep making things more uncertain, and feeding the fear without minimizing the problems, we could eventually make it so that Americans lose faith in their financial system.”

I just don’t see where the “clear, reasonable plan” is going to come from. Also, at the present time, I don’t see where the people are that are going to “execute the plan precisely.” And, with the economy falling deeper and deeper into a recession, a leader has not yet arisen that is providing us with the “philosophy and vision” we need to guide us through the recovery.

The scary thing coming out of the interview with Ms. Schwartz is the concern about a “loss of faith” and the “feeding of fear”. Where is the leader we need?