Western policy chaos

Look, I’m not a bear by nature. And frankly, I’m a bit tired with the grim macro outlook. But it is what it is and today it’s most definitely taken a turn for the worse.

Contagion is now rampant in ten and two year bonds at the core of Europe. Here are the charts:

Italy two year:

And the ten year:

Spain two year:

Spain ten year:

Similar breakouts are apparent for Irish and Portuguese yields, with rises also in Greece and Britain. German yields have collapsed.

It doesn’t take Einstein to figure out that the EU crisis has entered a new phase. Is it the end game of default?

Perhaps for Greece, where it seems the rescue package has run aground once more, according to the WSJ:

Euro-zone finance ministers are bogged down in debate Monday, as a proposal mapped out for private-sector participation in Greece’s next bailout appears to face impossible hurdles.

Leaders had agreed the price for a second Greek rescue package would be participation by private-sector creditors. However, they said at a June 19 meeting that the participation must be substantial, voluntary and wouldn’t result in selective default.

“They now see all three are not possible,” said one EU official. He was already separating himself from the strategy, adding, “We never thought it was a good idea.”

Another official said the voluntary participation “is not going forward.”

“It’s over,” the official said.

… At the heart of the issue: Credit-rating companies have made clear that any significant effort to make private creditors pay for the bailout would be treated as a debt default for Greece. Most top officials–chief among them European Central Bank President Jean-Claude Trichet–have said letting that happen is unacceptable. However, a number of EU officials doubt the ECB would precipitate a banking crisis in Greece by rejecting government debt as collateral.

That leaves Europe with a stark choice: Either make European taxpayers responsible for funding Greece indefinitely, or shift some of the burden to private creditors and suffer a debt default.

After months of trying to find a middle ground, none has emerged. That has sent finance ministers back to the drawing board, and it is becoming clear that a breakthrough before the August summer holiday is unlikely.

However, at the same time, the EU is moving to water down rating agency powers. From Reuters:

Banks in the European Union face curbs on how much they can depend on ratings from credit agencies to calculate the size of their capital safety cushions.

Michel Barnier, the EU’s financial services chief, said he will make the proposals as part of his reform to bring EU bank capital requirements in line with a global accord known as Basel III that will increase the size of capital buffers.

“To limit overreliance, we will be strengthening the requirement for banks to carry out their own analysis of risk and not rely on external ratings in an automatic and mechanical way,” Barnier said in a speech.

“We will also make other concrete proposals before the end of the year to limit over-reliance todeal with insurance, asset management and investment fund sectors,” Barnier also told the European Securities and Markets Authority (ESMA).

The draft law is due to be published on July 20.

Peter De Proft, director general of the European Fund and Asset Management Association (EFAMA), told Reuters many investment firms already do their own credit analysis. “It will be more difficult for the smaller ones,” De Proft said.

Moody’s angered the EU this month by downgrading Portuguese debt despite the country securing an EU bailout.

Barnier said the “absolute minimum” must be to improve transparency in how agencies reach such decisions.

And meanwhile, over the Adriatic, Italy is being drawn in despite a not unreasonable macroeconomic position. From the NYT:

In recent days, Italy has become Europe’s next weak link after Greece, Ireland and Portugal and Spain, harmed in particular by a power struggle between Prime MinisterSilvio Berlusconi and his finance minister, Giulio Tremonti. The dispute threatens to turn the euro zone’s third-largest economy, after Germany and France, into one of its biggest liabilities.

On Monday, the Italian government struggled to rein in the tensions, as fears rose that political paralysis could make it harder for Italy to embrace the austerity demanded by outsiders to reduce one of the highest debt levels in the world. European policy makers also sought to figure out how they would put out a bigger fire if Italy were to succumb.

…“Italy is too big to fail,” said Moisés Naím, a senior associate in the international economics program at the Carnegie Endowment in Washington. “If Italy really gets hit by contagion because of political mismanagement, it would be a threat not only to the euro zone, but to the global economy.”

Political soap operas in Italy — especially those featuring Mr. Berlusconi — are nothing new. Nor did they usually matter much to financial markets, even after the debt crisis hit Europe. The widespread problems in Italy’s economy, which has been sluggish for the better part of a decade, also rang few alarm bells.

What’s more, Italy’s banks are sound; they never speculated in a housing bubble. The current annual budget deficit is low, at around 4.6 percent of its gross domestic product. And while Italy issues the largest amount of bonds of any euro zone country, Italians own about half the debt, making it less vulnerable to the follies of financial markets.

But with interest rates rising, Italy’s economy is not growing fast enough to cover an accumulated debt load of 120 percent of gross domestic product, the second-highest in Europe, after Greece. The International Monetary Fund expects growth to rise only slightly, to 1.3 percent in 2012.

This all has the whiff of chaos about it. As George Soros argues today, the EU needs a Plan B. Perhaps the EU will ride to whatever rescue is required at the eleventh hour once more. However, the policy paralysis that is apparent surely means further market pressures before that happens, at best.

And sadly, as I’ve noted for months, the backdrop for this increasing instability is increasingly weak, with the same policy chaos gathering pace across the Atlantic where both monetary and fiscal policy is also paralysed. From Gavyn Davies:

Particularly worrying is the growing evidence that the US economy is struggling even to hold unemployment constant, while fiscal and monetary policy have both become moribund for the time being. The markets still seem confident that US growth will spontaneously reignite in coming months, without requiring any help from expansionary policy. If they are wrong, there are few signs that US policy would be able to respond quickly or coherently.

No-one has been able to find anything good to say about last Friday’s US employment report. Those who initially tried to claim that faulty seasonal adjustment processes were responsible for the sluggish performance of the labour market were soon shown to be wrong. This left a uniformly bleak picture, with every aspect of a normally multifaceted report showing that the US economy is now failing to create enough new jobs to keep unemployment constant, given the underlying rise in the labour force.

The three most important economic statistics in the US each month – or at least the ones which have by far the biggest impact on the markets – are the payrolls report, and the two ISM surveys on business activity. This is what they look like:

The setback in these critical reports since economic growth hit a peak in February is unmistakable. Admittedly, the slowdown is not at present any greater than the similar one which occurred in the early summer of last year, a slowdown which was subsequently reversed. Furthermore, there are some factors, like the impact of the Japanese earthquake on the supply chain, and the rapid rise in energy prices, which should start to work in the other direction fairly soon. These are presumably the grounds for what remains of the markets’ lingering optimism.

However, the policy back-drop is entirely different from last year. Then, the Federal Reserve was unwilling to see any significant drop in economic growth, because it was worried about the possibility of outright deflation. Ben Bernanke has consistently argued that the onset of deflation is a non-symmetrical risk, which justifies the use of urgent and unconventional policy measures. This year, by contrast, he says that US inflation is “above target”, and probably does not believe that he could win the support of the FOMC for QE3 unless the economy and markets get much worse first.

The great bear market rally of 09/10 and the underlying global recovery was built upon the bedrock of fiscal and monetary policy integration and success across the Western world. That singular achievement is now falling apart.

David Llewellyn-Smith


  1. HnH…isnt it time we faced reality and just accpeted we are headed for a depression. As the Daily Reckoning Crew (a bunch of Macro doomsdayers that you get tired of) have argued since 2007 – you dont get rid of a 30 year debt binge with a few budget cuts and a bit of money printing/shuffling

    All the policy tricks in the world have done NOTHING to fix the world economy since 2007

    Surely there is now the need to listen to those that have been ignored…Steve Keen, the Austrian Economists…

    These guys in charge are just out of soltions and making these matters drag out for decades…all the while misallocating resources and turning their citizens against each other.

    • Stav,

      I think the Austrians need to be brought in, yes. But not at the head of the table. Th gold standard is just as unworkable as the current system.

      If it were up to me, I’d have central banks much more schooled in Austrian thought so that they acted earlier to rein in cyclical excess and hence misallocation. Shorter cycles. More recessions. Less debt. A balance of Keynesian and Austrian influences.

      But that doesn’t solve today’s problems. And yes, again, it is fair to describe the Western world’s travails as a slow motion depression.

      • Perhaps if Europe just tripled the cost of its Carbon Trading Scheme it would help create jobs of the future and launch the Low Carbon Economy for “the sake of our children and children’s children” etc?

        Greece should lead the way. The time to act is now!

    • With due respect, the Austrian economists need to be brought in and shot – it is their theories on austerity measures that is providing a fig leaf to cover the bond holders from their inevitable haircuts.

      Steve Keen would be aghast if he finds out you have clubbed him with the Austrians.

      • Mav, most Austrian economists I read would have the bondholders and shareholders take haircuts, or even go to the wall.

        Clearing up malinvestments after a debt laden boom and doing so quickly is better than a debt deflation funk that could last a decade.

        Being able to do so whilst cushioning the rest of the economy (who were not at fault) is not within the scope of time (i.e its too late, or measures are not in place) or within ideology (i.e right want to protect businesses, left want to protect labor)

        Thus, a stalemate.

        • Montgomery Burns

          they “get” moral hazard. but pretty much anyone who isn’t getting kickbacks “gets” moral hazard.

        • Look at Ireland, and what is proposed for the bondholders, and some are pension funds, and the king hit is the government going after the pension funds. Sweet deal.

        • Totally agree with HnH – the Austrian approach is too pure to be applied no. It just cant be placed on top of the Keynesian/Welfare/Warfare state we have now become so attached to. But I also think they have a lot of good things to say about innovation, about moral hazard, about malinvestment, about recoveries and about the foolishness of the central banks.

          Prince is also spot on…

          “Clearing up malinvestments after a debt laden boom and doing so quickly is better than a debt deflation funk that could last a decade.

          Being able to do so whilst cushioning the rest of the economy (who were not at fault) is not within the scope of time (i.e its too late, or measures are not in place) or within ideology (i.e right want to protect businesses, left want to protect labor)”

          I agree 100% with this sentiment. But I would argue that we do not know how a depression will affect people…we dont know who ‘deserves to suffer a drop in standard of living’….etc.

          So cushioning the blow, softening the impact and all the other political catchphrases that are obviously neccesary to maintain popular support seem to allow the politicians to favour some over others…and usually it is the most powerful and influential that get the Government assistance.

          I believe that a free market world with little or no Government interference would see the flourishing of a generous civil society.

          I honestly believe the Government crowds out the natural tendancy of people to help each other. – Exhibit A: QLD Flood appeal was overtaken by a flood tax that had people in fury.

          Why did the Government feel the need t9o tax us and then give it back out on our behalf, because they wanted to be the ones at hte press conference telling us THEY (politicians) are here to help.

          When will people see that they dont care about looking after us…they care about the maintenance of their own power.

      • Seems like Geithner has flip-flopped and now conveys “Keynesian economics has failed”


        “Keynesian economics has not worked. At best, it has given us a small reprieve from the restructuring that must happen. Our government can’t fight the forces of economics any better than we can fight the forces of nature. Large stimulus measures will not bring the desired results. We have to suck it up and take some pain. We can’t go on spending money that we don’t have to fix a problem that can’t be fixed. If we tried, it would be just be a waste of time and precious financial resources. We can no longer afford to throw good money after bad.”

          • few trillion dollars?? where? How can a few trillion dollars of Keynsian stimulus pass by unnoticed?

            oh yeah.. it never happened.

          • Mav…I think its safe to say the US leadership team comprising of Geitner, Obama, Bernanke and before him Paulson have allowed for trillions of taxpayers money to be misdirected in a failed Keynesian inspired stimulus attempt.

          • Stavos, Lets get the facts/figures straight before you go squillions again.

            TARP ($800 billion??) was used to save the “free market” from itself .i.e. re-capitalise the private banks + AIG + GM.

            Stimulus (~$700) – 1/3rd of it was tax cuts.

            None of the above programs even remotely resemble a Keynsian approach.

        • For what it’s worth Nod, that quote is actually not what Geithner said it’s what the author wishes Geithner had said.

          Geithner said:

          “We don’t have the ability (because of the overhang in housing and the problems in the financial sector) to artificially engineer a stronger recovery.”

          Not as blunt but still a hell of a lot different than what he was saying a year ago. Seems like the US might be finally seeing the problem for what it is.

          • Thanks JAson…agreed the accurate quote is more interesting…but it is still carefully crafted:

            “We don’t have the ability (because of the overhang in housing and the problems in the financial sector) to artificially engineer a stronger recovery.”

            “a stronger recovery”…this implies that they can engineer a recovery of some kind…I disagree with this view. Its not a recovery if it is ‘artifially engineered’…its a fake recovery.

            Recovery will only take place when the debt is purged and consumers and business can invest again.

            HEnce why we need a depression to start again…he now knows this and that is why Geitner is about to quit.

            They have given up…teh KEynesain experiment will be dead and buried forever following this calamity.

          • Cheers guys, I should have phrased it better. Been reading too many MSM articles 🙂

      • Well, which economists are pushing the “government austerity measures is the solution” meme then? It is certainly not the Keynesian economists – that would be blasphemy.

        Is there a third category called Free Marketeers or Ayn Randians, who want to dress up the bailout of bondholders as a bailout of the government ? 🙂

        • The Free Marketeers/Austrians whatever you want to call them are pushing:
          – for massive cuts to Gov spending as it is wasteful and detracts from GDP as it has to be paid for by future taxes etc…
          – for lenders to lose their shirts if they lent to people that cant pay back
          – for the economy to be cleaned out by a depression that gets rid of the zombie banks/businesses/politicians that dont work any more

          They accept this will cause pain…and for being honest, they get cast aside as crazies.

          Go figure

          • Yes the truth is now for crazy people, cause im in the mad house.
            But the truth cannot be denied and the laws of nature will conquer even though some people will need to learn the hard way.
            Guilottines sound good.

        • People who believe in the free market would expect bond holders to do their nuts on a bad investment.

          Find me an Austrian economist who believes that a bad investment should be bailed out. Bailouts is the domain of Keynesians.

    • divide and conquer.
      rape and pillage.
      when the majority have had enough, then the fun will begin.

  2. It is time media stopped reporting what the rating agencies have to say on the matter – they should have sent the price signal to the bond markets a looong long time ago – it is too little and too late, even for the banks to stop listening to the rating agencies – they should have done that years ago.

    The GFC gave us an indication that the “unregulated” Ayn Randian utopian “free market” version of the global credit market has failed and the Euro crisis has driven the final nail into that coffin.

    If the dead market starts walking again, it is the zombie version, kept barely alive by a virus called moral hazard.

    • Mav, governments and rating agencies were compromised by big business to help create this environment and consolidation phase we are now entering.

      Here’s a quote from Ayn Rand:

      When you see that in order to produce, you need to obtain permission from men who produce nothing;

      when you see that money is flowing to those who deal not in goods, but in favours;

      when you see that men get rich more easily by graft than by work, and your laws no longer protect you against them, but protect them against you…

      you may know that your society is doomed.

      • Mind you, I love Ayn Rand’s novels. But her work of fiction has been appropriated and hijacked by rent-seekrs to get rid of government regulation.

        • Even fiction can have real world meaning. Rand new what she was saying and the effect is could have.

          Agreed it has been hijacked, but so has Keynes!! Much more so!

          Keynes is now used as the justification for any hair-brain spending proposal put forward by Government

          • A free market could work if the cost of the experiment is worn by the one who holds the experiment

    • Mav, despite claims to the contrary there remained govt intervention up to and through the GFC.

      There is a long history of central banks intervening to bail out problem banks. This is one of the main reasons that risk was pretty much ignored by market participants and everyone went for it as soon as they were let loose. not only are there bailouts, but there have been no prosecutions of the perpetrators. there should be a lot of failed companies and a lot of financial executives in prison.

      If we had an unregulated “free market”, all of those firms would have gone bust, bondholders wiped out and the productive assets sold on so the economy could start again. A lot of the executives would be in prison and/or bankrupt. But in the current environment nobody has any ‘skin in the game’ and so has nothing to lose when things go bust.

      Its disingenuous to blame ‘free markets’ when there has been and continues to be heavy govt intervention and no law enforcement.

    • there never was a ayn rand free market sport, the interest rates and policies are gov controlled, along with tax collecting(stealing) especially taken income and property “tax”, thats very wrong. If i steal somebodys money then i go to jail, but when the tax theives come its ok? hypocrites.

  3. I expect the US debt ceiling to be lifted on the day, and we’ll roll down the road for a few more years. In most western countries it’s hard to get consensus on the small issues let alone the sort of monetary policy we need. That my view looking now, and at history.

    However, I’m not sure if anyone has seen this Google tool, but it farms IMF data and you have a whole range of economic selections you can choose, and plot. You can put any country in, but this one is setup for Europe, and up until now you can see the sad tale. The 2011 + years are based on the IMF’s projections so I don’t believe it at all, but historically this is a good tool to look at.


  4. game is over,
    GFC II (so called European FC) is here

    BTW. Italy is not across Adriatic Sea from Greece but across Ionian Sea 🙂

  5. New technology has given financial institutions incredible powers that are covertly used to radically re engineering how things are governed globally.

    There is a fundamental power shift from governments to financial institutions through capital re allocation. We are witnessing an old word dying and a new world birthing.

    Financial markets are the new battlefields. This is evident in Europe. These financial institutions are calling the shots using the Keynesian battle plan.

    • they are insolvent thats all, they rely on people getting into debt to make money and collect taxes, but now the majority cannot pile on more debt and they refuse to allow these bad debts to clear and take losses or close down if need be.

      • Indeed Ponz.

        The system has mathematically reached it’s tipping point limit – it will purge and I’m guessing it’s also gonna be ugly.

  6. Do any roads go on forever ? The can will at some point in time reach the end of the road, it may look like the end but there might be a few bends left!

  7. The Argentinian solution is an option. A generation has lived the dolce vita on a self indulgent debt binge without any consideration for the next generation.
    The idea that the next generation of Greeks , Spaniards, Americans are just going to pick up the tab just ain’t gonna happen. More like the bondholders will end up with about 20-30c to the dollar alla Tango.

  8. steve keen isn’t an austrian. from this thread, it sounds like many are ready to condemn the school with only the slightest familiarity with its methodology.

  9. Not the rosiest of outlooks. I reckon the US, if it could rediscover optimism and jobs, set aside petty political aspirations, well, it could get there. The EU, not so sure. The derivatives market, that sword of damocles, is precariously positioned. I have always been gloomy about the longterm outcome of the derivatives market, a market estimated at between $700 trillion and one quadrillion!!! WTF. Out of control.

    Ambrose Evans Pritchard on EU and ratings agencies.

    A brief look at why it may all get much worse:

    And lack of will in the US can only lead to further decline, it jobs they need:

    And again, my personal major global concern, the derivatives market. It is contagion in this market that would really spell trouble – everywhere – not limited by geographic region. The chart at the end, how Italy effect on bond/cds market could be greater than the Lehman’s effect….and we know what that led to:

    Oh well, cheers!

  10. for those who are into technical analysis, there’s quite an impressive head and shoulders on the italian 10 year bond yield. the breakout gives a target of between 7.5 and 8.5% yield, from a 5% neckline.


  11. 2012 will not be the end of the world per se but rather the end of a system that to many equates to the end of the world.

  12. Governments nearly everywhere are facing fiscal and monetary doom. The only place worth investing in now, is the Southern States of the USA and some of the central ones. The reason is; no urban growth constraints; low, stable, urban land prices; pro-growth, pro-business, fiscally responsible State and local governments; and “right to work” labour laws.

    There are other factors, but the above are “sufficient indicators”.

    So much for the “failure of free markets”, I say. The key to economic survival hangs on FREE MARKETS in urban land development especially, and free markets in hiring and firing. It is “planning” and nanny State that is the problem, not “free markets” per se.

  13. Just one point re the US, one of the most succesful states has been Nth Dakota, not a lot of people, enjoying benefits of natural resources and strong agricultural commodity prices but also they have a state owned bank, which structuraly has avoided a lot of the excesive lending practices of its private peers, the bank is seen as part of the community as well. Maybe a combination of government owned banks and private banks should be part of the solution.

  14. El Zorro Dorado

    Regretably, there are no policy options available to resurrect a dead cow. You can try all the hocus-pocus you like, but when the die is set there is no way out. The fundamentals of the European debt and EuroZone crisis have been clear for months…all that has happened is that the positive members of the EU and EZ have played for time to allow their banks to bunker down, strengthen their collective and individual balance sheets, and off-load what they can. The day of reckoning seems well past–as often happens in spin-laden cases like this. But it ( wide-spread default) will happen… and the parody of a modern-day Nero in Washington will exacerbate the situation mightily. If they can survive until the holidays then plan for a Septemeber/October fiasco … and then on. Watch out.