MarketNeutral
27th April 2010, 02:53 AM
http://beforeitsnews.com/ckfinder/userfiles/0000000000000198/images/greece%20soveriegn%20yield%20curve%202010-04-26.gif
To summarize the problem, let's start off with a look at the Greek yield curve, see attached, compared to where it was last week. As you can see, the white curve (today) spikes at the 2 year maturity with yields over 13%, up 6% in the last week. That's got to cause anyone who cares to have a headache. I reported recently that many banks are not accepting Greek government debt in financing transaction, and I cannot imagine that this situation has changed. For any interest rate to go up 6% in a matter of a week, it means that the market has been abandoned by many investors.
At the heart of the recent fall-out in Greek bond prices, are continued comments from the German finance minister, that they have not approved the rescue package for Greece. Although the EU has supposedly approved 30 billion Euros for Greece, of which Germany is a party to, along with 15 billion Euros from the IMF, there is much dissension within Germany, and Angela Merkel's political situation could become precarious if they go along with the rescue package. So perhaps the comments out of Germany's finance minister is Merkel's way of playing both sides of the fence. And subsequently, this morning, Merkel has said that details still need to be worked out.
While Greek sovereign debt is not that big a market, many EU banks have exposure to many Greek entities. And while many view Greece as being a small part of the world's financial system, there is much overlap with the financial system of Europe. Many banks could ill-afford for Greece to default. Likewise, it would become a problem for the EU to kick Greece out of the EU, since much of the money which Greece owes the EU banks is in Euro's, and kicking them out of the Euro could devalue the new currency which Greece, and Greek entities will be able to repay this debt back with. It is estimated that the EU's exposure to Greece adds up to hundreds of billions of Euros, 273 billion Euro's by one estimate that I picked up this morning.
In any event, it is quite problematic, now that the Greek debt woes are showing signs of bursting at the seams. How would a Greek default play itself out? First off, if Greece defaults over the near term, then it is likely that the EU package did not go through, and that Greece will leave the EMU (European Monetary Union), and would likely return to the Drachma. In order for Greece to make a come-back, the new Drachma's would have to be worth less than the Euro, but convertible on a one to one basis with the Euro, as far as Greek company's debts to the rest of the EU. Assuming the devaluation is 30%, then that would represent 80 billion Euros of debt forgiveness. That is far more expensive than coming up with a 45 billion Euro rescue package to the government. This scenario is hypothetical, but should give you an idea as to what the consequence is if Greece is allowed to default. In turn, 80 billion of Euros in losses to the rest of the EU's banking system will cause other complications, and the ensuing ripple effect.
Behind the ambiguous statements coming out of Germany is the German populace, which does not feel as if they are supposed to have greater fiscal discipline, so Greece can have less. (The fact that unions in Greece are demonstrating and going on strike, means their heart is somewhere else). That is the crux of the problem, and what is creating uncertainty as to Germany's intentions. Angela Merkel has gone on record saying she was against a Greek bailout, unless Greece does much to solve its budget deficits. The moral hazard of a Greek bail-out might only encourage other countries to expect EU aid, notably Spain, Portugal and Ireland. This situation seems analogous to me of how the US acted with its rescue operations of various financial firms in 2008. Hank Paulson was too chicken to see what would happen if he allowed various financial firms to go out of business, to the point where the supposedly independent Fed lent money against hotel loans, derivatives and CDO's, in violation of its authority. As we can see today, a solid year past the end of the recent crisis phase, plenty of people remain pissed off about the bail-outs.
Another analogy with Greece is the subprime market debacle in 2007. Subprime securities were blowing up all through 2007, even as the stock market was making a new high, in October of that year. In fact, subprime origination companies were going out of business on a weekly basis during 2007, while portfolios which owned this paper were going into liquidation as the values of these types of subprime securities dropped in 2007. It was widely stated by Ben Bernanke and many others in the know, that the subprime problem was a contained situation. And so it is today, with many folks seemingly indifferent to what happens in Greece.
Back at the ranch, global stock markets are at post crisis period highs, with an Alfred E Newman, "What me Worry" look on its face. This brings me back to the underlying cause of the Subprime problem, and the current problem in Greece: the proliferation of debt, which when created in excessive quantities, will not get repaid in full. And like the subprime borrower, Greece has assumed that they will be able to continue to borrow money to re-finance an ever growing pile of debt. As the lenders to Greece have determined, it is not worth it to them to support the Greek bond market, and to assume that Greece will be able to make good on its debts. And this explains why Greek debt is now at 13%. The whole gig is a shell game, and the assumption has always been that the borrowing entity had enough assets to make good on its debts. And while Germany has every incentive, and a national self interests to see that Greece does not default, there is something in their national psyche which is appalled at the idea of lending Greece money because they have been too prolifigate in the past.
* China: How about everyone who has collectively lent the US government trillions of dollars? How much more debt do we need to create in order to whack the confidence out from under our own debt markets? Just today, there is talk that China is going to undertake another $588 billion stimulus package. China is an economy which is supposedly growing at a 12% pace, and they need more stimulus? (China's year over year GDP growth has not been less than 6% for the last 15 years). Let me tell you what I think is going to happen. China will enact some sort of stimulus package, and in order to do so, they will print money to enable this type of spending. In turn, they will continue to inflate the local money supply, which is two times its GDP. This is like the US having a $28 billion M2 Money supply, which would be almost four times its current level.
And with this as a back-drop, China will allow its currency to freely float, to appease the US and everyone else. What we do not realize is that China will sell as much Yuan as investors want. They have already been doing this by virtue of their large money supply.
China reminds me of Iraq under Saddam Hussein. We might not have liked what Saddam was doing, but at least we, for the most part, knew what he was doing. So it is with China and their fixed exchange rate for their currency. It is very predictable, even if we do not like the fact that China has much cheaper labor than we will have for a long time to come.
Going back to a floating Yuan, what will the Obama administration say if the Chinese currency weakens from 6.8 Yuan/dollar, to 8 Yuan/dollar. Is this a dramatic race to the bottom? Guess what, we will still accuse the Chinese of manipulating their currency. And how will this play out? The only option left for China at that point would be to cut back on the stimulus, or take money out of the system. And unfortunately for the US, they might even start to sell dollar assets, so they can buy back their now cheaper Yuan. This would put pressure on US rates to rise higher, and the US becomes Greece. My gut instinct tells me that there will be some sort of currency calamity as a result of the US's push on China to devalue its currency. We do not realize that China is already running a currency devaluation program by virtue of its money supply, and the inflation they are engendering. This will back-fire on the US, and perhaps bring about a US debt problem sooner.
* The Fed - on Friday, CNBC reporter Steve Leisman broke the story that Fed Reserve Bank members are feeling quite uneasy about the large MBS portfolio which they own, and will want to start selling it off. I cannot imagine what will happen if the Fed sells off this much mortgage debt without pushing up interest rates and in turn, hurting the economy. Perhaps the Fed will sell MBS and buy treasuries, so their balance sheet does not shrink. This would also serve the purpose to allow the Fed to not put duration into the market, just pressure on mortgage rates. Or perhaps, this is just another example of the Fed talking a tighter monetary policy but keeping policy quite loose. There is a Fed meeting this Wednesday, so let's see how that plays itself out.
http://www.loandebt.com/content/greece-china-and-fed
To summarize the problem, let's start off with a look at the Greek yield curve, see attached, compared to where it was last week. As you can see, the white curve (today) spikes at the 2 year maturity with yields over 13%, up 6% in the last week. That's got to cause anyone who cares to have a headache. I reported recently that many banks are not accepting Greek government debt in financing transaction, and I cannot imagine that this situation has changed. For any interest rate to go up 6% in a matter of a week, it means that the market has been abandoned by many investors.
At the heart of the recent fall-out in Greek bond prices, are continued comments from the German finance minister, that they have not approved the rescue package for Greece. Although the EU has supposedly approved 30 billion Euros for Greece, of which Germany is a party to, along with 15 billion Euros from the IMF, there is much dissension within Germany, and Angela Merkel's political situation could become precarious if they go along with the rescue package. So perhaps the comments out of Germany's finance minister is Merkel's way of playing both sides of the fence. And subsequently, this morning, Merkel has said that details still need to be worked out.
While Greek sovereign debt is not that big a market, many EU banks have exposure to many Greek entities. And while many view Greece as being a small part of the world's financial system, there is much overlap with the financial system of Europe. Many banks could ill-afford for Greece to default. Likewise, it would become a problem for the EU to kick Greece out of the EU, since much of the money which Greece owes the EU banks is in Euro's, and kicking them out of the Euro could devalue the new currency which Greece, and Greek entities will be able to repay this debt back with. It is estimated that the EU's exposure to Greece adds up to hundreds of billions of Euros, 273 billion Euro's by one estimate that I picked up this morning.
In any event, it is quite problematic, now that the Greek debt woes are showing signs of bursting at the seams. How would a Greek default play itself out? First off, if Greece defaults over the near term, then it is likely that the EU package did not go through, and that Greece will leave the EMU (European Monetary Union), and would likely return to the Drachma. In order for Greece to make a come-back, the new Drachma's would have to be worth less than the Euro, but convertible on a one to one basis with the Euro, as far as Greek company's debts to the rest of the EU. Assuming the devaluation is 30%, then that would represent 80 billion Euros of debt forgiveness. That is far more expensive than coming up with a 45 billion Euro rescue package to the government. This scenario is hypothetical, but should give you an idea as to what the consequence is if Greece is allowed to default. In turn, 80 billion of Euros in losses to the rest of the EU's banking system will cause other complications, and the ensuing ripple effect.
Behind the ambiguous statements coming out of Germany is the German populace, which does not feel as if they are supposed to have greater fiscal discipline, so Greece can have less. (The fact that unions in Greece are demonstrating and going on strike, means their heart is somewhere else). That is the crux of the problem, and what is creating uncertainty as to Germany's intentions. Angela Merkel has gone on record saying she was against a Greek bailout, unless Greece does much to solve its budget deficits. The moral hazard of a Greek bail-out might only encourage other countries to expect EU aid, notably Spain, Portugal and Ireland. This situation seems analogous to me of how the US acted with its rescue operations of various financial firms in 2008. Hank Paulson was too chicken to see what would happen if he allowed various financial firms to go out of business, to the point where the supposedly independent Fed lent money against hotel loans, derivatives and CDO's, in violation of its authority. As we can see today, a solid year past the end of the recent crisis phase, plenty of people remain pissed off about the bail-outs.
Another analogy with Greece is the subprime market debacle in 2007. Subprime securities were blowing up all through 2007, even as the stock market was making a new high, in October of that year. In fact, subprime origination companies were going out of business on a weekly basis during 2007, while portfolios which owned this paper were going into liquidation as the values of these types of subprime securities dropped in 2007. It was widely stated by Ben Bernanke and many others in the know, that the subprime problem was a contained situation. And so it is today, with many folks seemingly indifferent to what happens in Greece.
Back at the ranch, global stock markets are at post crisis period highs, with an Alfred E Newman, "What me Worry" look on its face. This brings me back to the underlying cause of the Subprime problem, and the current problem in Greece: the proliferation of debt, which when created in excessive quantities, will not get repaid in full. And like the subprime borrower, Greece has assumed that they will be able to continue to borrow money to re-finance an ever growing pile of debt. As the lenders to Greece have determined, it is not worth it to them to support the Greek bond market, and to assume that Greece will be able to make good on its debts. And this explains why Greek debt is now at 13%. The whole gig is a shell game, and the assumption has always been that the borrowing entity had enough assets to make good on its debts. And while Germany has every incentive, and a national self interests to see that Greece does not default, there is something in their national psyche which is appalled at the idea of lending Greece money because they have been too prolifigate in the past.
* China: How about everyone who has collectively lent the US government trillions of dollars? How much more debt do we need to create in order to whack the confidence out from under our own debt markets? Just today, there is talk that China is going to undertake another $588 billion stimulus package. China is an economy which is supposedly growing at a 12% pace, and they need more stimulus? (China's year over year GDP growth has not been less than 6% for the last 15 years). Let me tell you what I think is going to happen. China will enact some sort of stimulus package, and in order to do so, they will print money to enable this type of spending. In turn, they will continue to inflate the local money supply, which is two times its GDP. This is like the US having a $28 billion M2 Money supply, which would be almost four times its current level.
And with this as a back-drop, China will allow its currency to freely float, to appease the US and everyone else. What we do not realize is that China will sell as much Yuan as investors want. They have already been doing this by virtue of their large money supply.
China reminds me of Iraq under Saddam Hussein. We might not have liked what Saddam was doing, but at least we, for the most part, knew what he was doing. So it is with China and their fixed exchange rate for their currency. It is very predictable, even if we do not like the fact that China has much cheaper labor than we will have for a long time to come.
Going back to a floating Yuan, what will the Obama administration say if the Chinese currency weakens from 6.8 Yuan/dollar, to 8 Yuan/dollar. Is this a dramatic race to the bottom? Guess what, we will still accuse the Chinese of manipulating their currency. And how will this play out? The only option left for China at that point would be to cut back on the stimulus, or take money out of the system. And unfortunately for the US, they might even start to sell dollar assets, so they can buy back their now cheaper Yuan. This would put pressure on US rates to rise higher, and the US becomes Greece. My gut instinct tells me that there will be some sort of currency calamity as a result of the US's push on China to devalue its currency. We do not realize that China is already running a currency devaluation program by virtue of its money supply, and the inflation they are engendering. This will back-fire on the US, and perhaps bring about a US debt problem sooner.
* The Fed - on Friday, CNBC reporter Steve Leisman broke the story that Fed Reserve Bank members are feeling quite uneasy about the large MBS portfolio which they own, and will want to start selling it off. I cannot imagine what will happen if the Fed sells off this much mortgage debt without pushing up interest rates and in turn, hurting the economy. Perhaps the Fed will sell MBS and buy treasuries, so their balance sheet does not shrink. This would also serve the purpose to allow the Fed to not put duration into the market, just pressure on mortgage rates. Or perhaps, this is just another example of the Fed talking a tighter monetary policy but keeping policy quite loose. There is a Fed meeting this Wednesday, so let's see how that plays itself out.
http://www.loandebt.com/content/greece-china-and-fed