Eurozone relief as China pledges debt bailout

By Andrew Cave

The move, which will be a relief to struggling eurozone countries including Greece, Portugal and Ireland, was announced as Mr Wen continues his four-day trip to Europe, arriving in Britain last night from Hungary and going on to Germany on Monday night.

China's plan to continue to invest in the continent's volatile sovereign debt market comes as efforts continue to prevent Greece's financial crisis making it the first nation to be forced out of the euro.

"China is a long-term investor in Europe's sovereign debt market," Mr Wen said at a press conference with the Hungarian prime minister, Viktor Orban.

"In recent years we have increased by quite a big margin our holdings of government bonds. We will consistently continue to support Europe and the euro."

He added: "China is ready to work with Europe to share opportunities, cope with challenges and achieve common development and to make unremitting efforts for stable development of the world economy and an in-depth development of China-Europe ties."

Mr Wen's comments, made before boarding a flight to Birmingham, came after a week in which EU leaders committed themselves to staving off a Greek default provided that the prime minister, George Papandreou, pushes through a package of budget cuts next week.

As a signal of China's enthusiasm for doing deals with Europe, Mr Wen signed 12 trade deals with Hungary and agreed to finance more of the country's debt.

His openness in pledging his support will also bolster the UK Government's hopes of strengthening Anglo-China ties during his time in the UK, when he will tour the Chinese-owned MG car factory in Longbridge and attend a UK-China summit at 10 Downing Street tomorrow.

Writing in today's Sunday Telegraph, Jim O'Neill, chairman of Goldman Sachs Asset Management, said that the eurozone should look east for solutions to their continuing debt problems. He said that it is likely that sovereign wealth funds would be keen to invest.

Mr O'Neill said: "Perhaps Europe's leaders should try to put some of their differences aside and offer Asia's yield-hungry investors an even bigger kicker to help solve the crisis.

"As Italy has showed for much of the past 30 years, if you can keep growing and keep financing costs below your nominal growth rate, then you can just about cope with a lot of debt. Unless the Club Med countries get their yields down, it is an impossible burden. Europe's leaders have got to really decide whether they want European monetary union or not, and if so, it is time to act big."

Yves Mersch, a member of the European Central Bank governing council, warned yesterday that a Greek sovereign debt default would lead to financial chaos across Europe, adding it was up to the parliament to deliver on its austerity promises. In Athens, Greek ministers urged wavering members of the ruling Socialist party to do their duty in a knife-edge vote in parliament this week and back painful austerity measures that lenders demand as the price for fresh bailout loans.

Finance minister, Evangelos Venizelos, offered to talk to any MP who might have concerns. "I believe that the sense of responsibility will ultimately prevail; the God of Greece is great," he said.

A two-day general strike is planned this week to coincide with the votes, following a rolling series of strikes at companies including Greece's dominant electricity producer, PPC, which is slated for privatisation next year.

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Italian Banks Plunge, German Yield Spread Widens on Debt Concern

By Marco Bertacche, Elisa Martinuzzi and Francesca Cinelli

Italy’s markets watchdog said it will investigate trading in bank shares after the country’s biggest lenders posted their largest decline in two years. 

Part of the slump was due to automatic stop-loss trades, an official for the regulator said by telephone today. The watchdog hasn’t ruled out market manipulation. UniCredit SpA (UCG), Italy’s biggest bank, and Intesa Sanpaolo SpA (ISP), the second-largest, led lenders lower, falling 5.5 percent and 4.3 percent respectively. Both stocks were briefly suspended after breaching limits on intraday swings. 

Bank stocks tumbled amid concern the European debt crisis may spread just as lenders face scrutiny from regulators over capital levels. Italian 10-year bonds also fell, increasing the additional yield investors demand to hold the securities over benchmark German bunds to the most since the euro was introduced in 1999. 

European leaders meeting in Brussels today attempted to staunch the crisis, vowing to stave off a Greek default as long as Prime Minister George Papandreou pushes through a package of budget cuts next week. 

“Contagion fears keep re-emerging as long as credible, lasting solutions in Greece are pending,” said Christian Weber, a Munich-based strategist at UniCredit. 

Officials at Intesa Sanpaolo and UniCredit in Milan declined to comment. Intesa closed down 7.6 euro cents at 1.707 euros and UniCredit fell 8 cents to 1.363 euros, its lowest price since April 2009.

Silvio Berlusconi

Moody’s Investors Service said yesterday it may downgrade 13 Italian banks because they are vulnerable to a cut in the government’s credit rating. The firm had said last week it may cut the sovereign rating because the turmoil in Europe could drive the country’s borrowing costs higher. 

“The downgrade by Moody’s may be furthered to encompass the long-term debt,” said Thomas Laschetti, a trader at Tullett Prebon Ltd. in London. “That is enough to create the right environment for deleveraging exposure to the sector.” 

Prime Minister Silvio Berlusconi said today the country’s banks are “well capitalized.” Speaking at a summit of European leaders in Brussels, Berlusconi said he wasn’t worried about Moody’s comments about the country’s banks. 

Intesa and UniCredit are among the five Italian banks that are also being stress-tested by European regulators next month to assess whether they have sufficient capital. 

The European Banking Authority yesterday updated its stress tests to take into account extra trading losses that banks may face on their holdings of sovereign debt from crisis-hit European Union countries including Greece.

Remaining Uncertainty

Italian banks are also seeking to raise money from investors to bolster capital. Unione di Banche Italiane ScpA (UBI), Italy’s fourth-biggest bank, fell 0.9 percent to 3.784 euros. The lender may struggle to lure buyers to its 1 billion-euro ($1.4 billion) rights offering, which closes today. The bank is selling eight new shares at 3.808 euros for every 21 held. 

“There is still uncertainty surrounding the sovereign risk and bank capital requirements,” said Paul Vrouwes, who helps oversee about 20 billion euros of shares at ING Investment Management in The Hague. “Italy’s economy is struggling more than other nations.” He doesn’t plan to buy UBI stock. 

Banca Monte dei Paschi di Siena SpA (BMPS), which is seeking to raise 2.2 billion euros in a rights offering that runs through July 8, fell as much as 5 percent to 51.95 euro-cents, a record low. The shares are available for 44.6 euro-cents in the offering. 

European Central Bank President Jean-Claude Trichet said this week that the link between the region’s debt crisis and its lenders is “the most serious threat” to financial stability in the European Union.

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NOT TECHNICALLY BANKRUPT, BUT ECONOMICALLY BANKRUPT

by Cullen Roche

Talk about cutting off your nose to spite your face! It looks like the Republicans are going to get their pound(s) of flesh from the debt ceiling discussions. And the economically ignorant Democrats are going along for the ride. President Obama’s fundamental lack of understanding with regards to the current economic predicament in the USA (the balance sheet recession) is going to result in spending cuts in order to avoid the mythical insolvency of the USA. According to the Associated Press, the President is in talks to make a “significant” reduction in the size of the deficit:

“The White House has proposed raising about $600 billion in new tax revenue, including ending subsidies to oil and gas companies, an idea that failed in the Senate.

The administration also would tax private equity or hedge fund managers at higher income tax rates instead of lower capital gains rates, change the depreciation formula on corporate jets and limit itemized deductions for wealthy taxpayers. It also has called for repealing a tax benefit for an inventory accounting practice used by many manufacturers.

But Republicans are demanding huge cuts in government spending and insisting there be no tax increases.

Ahead of his meeting with Obama, McConnell said Democrats’ calls for tax increases do not amount to a “serious” position.

“It is my hope that the president will take those off the table today so that we can have a serious discussion about our country’s economic future,” McConnell wrote in an editorial that appeared Monday on CNN.com.”

Of course, this is all stemming from the myth that the USA is about to “run out of money”. The US government sets a political limit on the amount of government issued debt which is called the “debt ceiling” (see here for a more in-depth discussion). This is entirely political. There is NOTHING operationally that constrains the USA’s debt issuance. The USA issues its own currency and has no foreign denominated debt.

There is simply no such thing as the USA “running out of money”. In this regard, they are never revenue constrained and the only thing stopping the US government from spending money is the willingness of politicians to vote on these changes. This is nothing like a household, business, US state or European nation – all of whom are revenue constrained. The real bogey with regards to government spending is inflation and the effects of this spending via mal-investment, spending in excess of productive capacity and the resulting lower standard of living. There is simply no such thing as a traditional US government “default” – as in, not having enough money to meet your obligations.

The USA could suffer a form of insolvency in the name of hyperinflation, but there is almost nothing about the current state of the US economy that is consistent with past cases of hyperinflation. More importantly though, there are no signs that markets are even remotely concerned about a US insolvency (even if you were silly enough to believe it could happen). Both USA credit default swaps and US government bond rates are among the lowest in the entire world. And the myth of a potential surge in interest rates is sheer nonsense as the Federal Reserve controls the yield curve via the monetary policy that serves ZERO funding purpose and only helps to drain reserves while targeting the Fed Funds rate.

In short, these politicians have absolutely zero clue how the US monetary system actually functions. They have failed to properly diagnose our problems (a balance sheet recession) and are now implementing policy that will prove destructive. All in the name of a bankruptcy that can only happen if they decide to let it happen! So buckle up America. In their fight for power the politicians are about to “help” us avoid a technical bankruptcy while bankrupting us economically.

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GREECE, IRELAND AND PORTUGAL DEFAULT PROBABILITIES ABOVE 50%

By Surly Trader

I see headlines like, “Euro Maintains Gain on Greek Debt Optimism” and I am just not sure what everyone else is looking at. As far as the credit default swap market is concerned, Greece has already defaulted, it is just a matter of when and in what form. Ireland and Portugal are basically at levels that share a similar fate. Next question is whether Italy and Spain fall into the hole.

Assuming 40% recovery rate, which might be high for Greece

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The Strategic Petroleum Reserve drawdown

by James Hamilton

The International Energy Agency announced on Thursday that its 28 member countries had agreed to release 60 million barrels from their combined strategic stockpiles. The U.S. plans to contribute half of this total, all in the form of sweet crude. Thirty million barrels represents about 10% of the U.S. strategic petroleum reserve of 293 million barrels of sweet crude oil, and about 4% of the entire 727 million barrels stockpiled in the U.S. SPR.

To think through the effects such a move might have, suppose that there were no changes in production or private inventories. The two million barrels per day released from the IEA program would represent 2.3% of the 87 million barrels per day currently being produced globally. If for illustration we assume a short-run price elasticity for oil demand of 0.1, the result would be a 23% decrease in the price for the month of July, after which the price would return to its previous value.

That of course is not what’s going to happen, because it would make no sense for anyone to sell oil for 23% less in July than you could get for it in August. If oil is cheaper in July than August, you’d want to buy more of that cheap oil in July, store it, and sell it back at a profit in August. If it were completely costless to store oil and if there were no urgency to sell it now rather than later at the same price, the outcome would be that the release from the public SPR would be matched by an equivalent increase in private inventories with no effect at all on the price.

But that’s not what’s going to happen either, because it’s not costless to store oil and because with constant prices and positive interest rates it’s always better to sell now rather than later. The actual effect we’d expect from a one-time release from the SPR would be a more modest effect on the price spread out over a longer period of time, with much of the initial release going into private inventory and eventually being sold back out of private inventories. For example, suppose the 60-million-barrel release results in an extra 10 million barrels ultimately being consumed over each of the next six months. The resulting flow (333,000 b/d) would represent about 0.38% of daily supply, which again using the 0.1 elasticity would be predicted to keep the price about 3.8% lower than it otherwise would have been for a period of about 6 months or so. That price decrease would be front-loaded, with the biggest impact in the first month, and the price gradually rising back to its original level after six months.

When the SPR release was announced on Thursday, the http://online.wsj.com/article/SB10001424052702303339904576403570929000178.html">price of Brent fell 6.1% and West Texas Intermediate was down 4.6%. 

Some traders may anticipate that there will be further SPR releases. The Libyan conflict has been estimated to have taken about 1.5 mb/d of light, sweet crude off the market. The IEA described the SPR release as intended to “help bridge the gap until sufficient additional oil” is produced by oil-producing countries. If the gap still needs bridging a few months down the line, perhaps potential oil buyers anticipate that Thursday’s announcement is just the beginning.

Jim Brown sees the IEA move as a miscalculation, arguing that most of that lost Libyan production is not going to be restored even if Libyan leader Muamar Gaddafi were immediately removed, that much of the advertised increase in Saudi production may go to their own consumption, and that Chinese consumption has continued to increase despite the disruptions in North Africa. Speaking of which, the Chinese might see a temporary drop in prices as an opportunity to add to their own SPR. To the extent that happens, we’re getting back to the no-effect scenario.

Another possibility is that prices were heading lower anyway, and all the IEA move did was to help them jump to an appropriate level more quickly. This is how I would interpret the claim that speculation was a factor keeping oil prices higher than they otherwise would have been, and seems a more plausible rationale for the move than the temporary bridge story.

In any case, the deed is now done, and the IEA has run an interesting experiment for us in how oil markets function. But I would recommend against further SPR sales, regardless of the final outcome of the current effort. The reason is that I see the long-run challenge of meeting the growing demand from the emerging economies as very daunting, and in my mind is the number one reason we’re talking about an oil price above $100/barrel in the first place.

A one-time release from the SPR, or even a series of releases until the SPR runs dry, does nothing whatever to address those basic challenges.

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Gold Replaces AAA

By Guest Author

The problems with Greece are not an isolated case. Solving the Greek crisis without a reflection on a long chain of monetary and economic errors would be a complete waste of money. Our political leaders should look far beyond the Greek problems and evaluate their economic and financial policies over a period as long as 40 years. 

Greece an anecdote in a long history

Greece gets so much attention, that some start to believe that if we give Greece the necessary funds, problems will start to disappear. Worse: one year ago, Europe was convinced that Greece was mostly a problem of speculation. Creating a “money wall” also known as The European Financial Stability Facility (EFSF), would deter speculators and restore stability in the eurozone.

The European politicians also forced the ECB to open their gates, and forget the very principles on which the ECB was founded. The ECB’s balance sheet was flooded with debt from PIIGS countries,happily transferred from European banks.

Meanwhile at the other side of the ocean, the US Federal Reserve has been continuing its programs of “unconventional monetary stimulus”. It is indeed an unorthodox policy, that will undermine the basic principles on which the US central bank has been founded almost one century ago.

The gradual end of orthodoxy

Step by step, the political leaders have been dismantling the discipline, orthodoxy, and safety mechanisms on which, after long periods of crises, the financial system was built . They included (amongst others):

• Gold based central banks and currencies
• Controlled leverage of commercial banks
• A strict division between retail and corporate banking activities
• Budgetary discipline
• Money supply control
• Strict financial controls and regulations, no “parallel” or shadow banking system
• Independent central banks
• …

All these fundamentals have been disappearing or have been strongly weakened over the last 40 years. The end of Bretton Woods marked an important change of policy. In the Eighties and Nineties, the banking sector went on a mergers and acquisitions binge. In the US , banks started coast to coast consolidations. As from the early Nineties, as the Maastricht Treaty formed a basis for the single currency, Pan-European banks slowly emerged on the Old Continent. Walls between merchant and retail banks started to disappear. Finally, a shadow banking system boomed over the last ten years on the back of so-called innovation: derivatives, hedge funds, and off-shore financial centers boomed.

The disappearance of AAA

One of the consequences of this long period of monetary unorthodoxy, is the end of major triple-A (AAA) countries. Japan lost its supreme status long ago, and is slowly fading to a junk status. The US is on the brink of losing its top-notch status, as it is hitting the so-called debt ceiling. The debt to GDP ratio of the US government is around 100%, and this comes on top of substantial private debt levels accumulated in the Greenspan years.

In Europe, Germany is still a AAA, but with highly leveraged banks and an important aging problem, the CDS markets have been increasing the default premium very slowly. As Germany takes on more guarantees and loans to save the eurozone, the inevitable might eventually occur. As a consequence, big AAA-countries have seen their top quality fading. Some smaller countries have kept their top quality status, but they do not have the liquidity to become an anchor for the world financial system.

It is no wonder, that seasoned investors have lost their faith in big and liquid AAA-debt . Only central banks continue to defend the intrinsic quality of big indebted nations. But it is a sign of the times, that the US Federal Reserve has been the biggest buyer of US Treasuries lately.

Gold price as an indicator of unease

The steep rise of the gold price has been called a bubble by many observers, including Nouriel Roubini and George Soros . The charts below show the gold prices in EUR and USD over a long period. The recent climb looks similar to the first giant leap of the gold price in the Seventies. That came after a period of high inflation and monetary instability. The chart also shows that the US Treasury had been selling its gold reserves (expressed in KTon) substantially.

In Europe, gold sales have been increasing as from the Nineties. This has been done as “a diversification strategy”. Central banks argued that gold did not yield a dividend or coupon, and that government debt of triple A countries was just as good, but with a yield. The Belgian National Bank for instance sold most of its gold reserves between 1992 and 1998 at prices of 250 and 400 USD/Ounce (current gold price > 1500 USD/ounce). Other central banks have executed similar policies.

Ironically, the rise of the gold price has offset most of the losses of this policy (the gold price quadrupled after the gold sales).

Gold prices will continue to climb as long as central banks apply unorthodox monetary policies.

I do not believe that gold is the bubble, debt is the bubble, and gold is just mirroring the rise of debt.

The ECB is at an important crossroad in that regard. If the Greek bailout results in further buying of debt paper by the ECB, this will end in loss of confidence in the single currency. 

Big declarations and reassuring words of politicians, central bankers and (bank) economists will not change this gradual process. Therefore, the solution to the Greek crisis might just become another step further down a long road of unorthodox policy, that is pushing the World Financial System to the verge of bankruptcy.

Stopping this process, requires a broad view on what has gone wrong (see above), and breaking with the policies of the architects of this derailment: Alan Greenspan, Ben Bernanke, and other prophets that refer to Keynes. 

Trading places

Central banks in emerging countries have been big buyers of gold. The fundamentals of these countries have also been strongly improving, with low public debt levels and strong current account surpluses. Developed countries have seen a degrading quality of their fundamentals: increasing public debt levels and public deficits. The Anglosaxon and PIIGS countries have combined this with important current account deficits. As a consequence, the quality of western debt has been declining, and emerging market debt of selected countries (China, Brazil, Russia,…) has been increasing.

Where “emerging” was once seen as low quality, and developed as high quality, we are witnessing a process of “trading places”.

ECB

The Germans have been experiencing a growing unease with the policy of the ECB. May 2010 has marked an important break in their confidence. The euro has been built on German principles of monetary stability, as written in the Maastricht Criteria . Countries with a stable currency like The Netherlands, Austria, Germany and Finland have been only ready to convert their national currencies into the euro, on the basis of a strict adherence to Maastricht and the independence of the ECB .

Ten years later, the very basis on which the stability of the euro has been based, is fading. It is not too late to adjust this process, and get back on the right track. “Pacta sunt servanda” is an important principle, in this case, Maastricht should be executed .

It is just another anecdote, but today Mario Draghi - former Senior Executive of Goldman Sachs in the period 2002-2005 and said to be aware of off-balance sheet financing tools offered to Greece by Goldman Sachs in this period – has been officially nominated as the next ECB president. It is just another small step in the further dilution of norms and standards of our monetary system.

Can someone give me the e-mail address of Paul Volcker please?

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