http://prudentbear.com/index.php/creditbubblebulletinview?art_id=10670
“Here Comes The Policy Response!”
- May 25, 2012
For more than a year now, I have posited the thesis that unstable global finance is highly vulnerable to a problematic bout of de-risking and de-leveraging. The unfolding European debt crisis was viewed as the likely catalyst. Importantly, as this thesis began to play out during 2011’s second-half, it was my view back then that “developing” financial systems and economies would prove more susceptible than generally anticipated. The consensus viewed China and the developing world as robust - and that, in the unlikely event of an expanding European crisis, they would prove a source of stability, much as they did back in 2008/09.
It’s been my view that several years of extreme financial excess and resulting imbalances created latent fragilities throughout the “developing” world, certainly including China, India, and Brazil, as well as more generally throughout Latin America, Asia and Eastern Europe. The LTRO-induced rally in global risk markets pushed out the resolution of this thesis. Yet with the European debt crisis now spiraling out of control, the markets have turned increasingly focused on the health of the “developing” world. There are global elements that recall the environment heading into the collapse of Asian currency pegs and economies back in 1997/98.
For the week, the Indian rupee declined 1.7%, the Philippine peso 1.4%, the Indonesian rupiah 1.1%, the South Korean won 1.1%, and the Thai baht declined 0.8%. Over the past month, the rupee is down 5.1%, the South Korean won 3.7%, the Malaysian ringgit 3.0%, the Singapore dollar 2.8%, and the Thai baht 2.5%. Curiously, the Chinese renminbi declined 0.3% this week, increasing its one-month loss to 0.6%.
May 25 – Bloomberg: “China’s biggest banks may fall short of loan targets for the first time in at least seven years as an economic slowdown crimps demand for credit, three bank officials with knowledge of the matter said. A decline in lending in April and May means it’s likely the banks’ total new loans for 2012 will be about 7 trillion yuan ($1.1 trillion), less than an estimated government goal of 8 trillion yuan to 8.5 trillion yuan, said one of the officials…”
The above referenced Bloomberg article was one more piece of evidence that a major Chinese Credit slowdown has commenced. The article noted comments from the director of the Chinese Academy of Social Sciences, who stated that lending from China’s four largest banks (40% of lending) had increased a meager $5bn during the first 20 days of May. This follows April’s weaker-than-expected loan growth that was fully 30% below March lending. Sinking demand for Credit is consistent with data pointing to rapidly slowing demand for apartments and autos, as well as mounting inventories and excess capacity throughout the economy.
So far this month, the Shanghai Composite has declined 2.6%. South Korea’s Kospi is down 8.0%, with stocks down 13.9% in Hong Kong, 5.7% in Taiwan, 6.4% in India, 6.7% in Indonesia, and 5.3% in the Philippines. Credit default swap prices are up 22 bps so far this month in South Korea, 23 bps in China, 56 bps in Indonesia, 25 bps in Malaysia, 24 bps in Thailand and 44 bps in the Philippines.
In Europe, the situation this week went from bad to worse. The 18th emergency EU summit was acrimonious and unproductive. It is clear that with its new Socialist President, the political landscape has shifted dramatically in France. Importantly, the breakdown of the German and French policymaking axis has only made the policymaking backdrop more dysfunctional. In a quote worthy of note, French President Hollande this week asked: “Is it acceptable that some sovereigns can borrow at 6% and others at zero in the same monetary union?” Not surprisingly, this line of thinking - and his hard line approach with the Germans - has been warmly embraced in Spain and Italy. We’ll see if the Germans can be bullied.
The thought is that, with Greece at the precipice and Chancellor Merkel under intense political pressure internationally, throughout Europe and even within Germany, the German position must soften. Indeed, there were reports that Germany is working on a “six-point plan” to stimulate European growth. Reports (Spiegel), however, suggest that the focus is on fostering targeted growth through the creation of “special economic zones.” There is no indication the Germans are softening their stance against Eurobonds, the ESM borrowing from the ECB, or European-wide deposit guarantees.
Importantly, officials from Germany’s Bundesbank have taken a harder line. Strong comments were heard today from Bundesbank President Jens Weidmann. From MarketNews International: “The European Central Bank has reached the limit of its mandate, especially in the use of its non-conventional measures, ECB Governing Council member Jens Weidmann said… ‘In the end, these [measures] are risks for taxpayers, most notably in France and Germany,’ the Bundesbank chief told France's daily Le Monde.” In reference to Eurobonds, Mr. Weidmann stated (from Reuters) that ‘this debate irritates me a bit… You cannot give someone your credit card without having the means to control the spending.” Earlier in the week, it was the Bundesbank that was taking a hard line with respect to Greece living up to its EU commitments. As capital flight and bank solvency become critical issues, it’s the ECB that controls the purse strings.
While it remains obvious that Greece is Europe and the euro’s weakest link, it is also apparent that the financial and economic situation in Spain is weakening rapidly. With the Spanish economy faltering and the banking system hemorrhaging, the situation has turned perilous. Spanish 10-year yields ended the week at 6.27%, as fears of a massive bank capital shortfall and stressed regional governments weighed further on market confidence.
Trading in Bankia, the struggling Spanish lender, was halted today ahead of another government recapitalization plan. Only two weeks after the government took a 45% stake with a euro 4.5bn capital injection, the Financial Times is reporting that the Spanish government “is poised to invest up to 19bn euro in its most troubled lender… in a bold attempt to end market skepticism about the health of the country’s banking sector.” We’ll see to what extent such a move actually bolsters confidence and slows deposit and capital flight. It will surely give more credence to estimates for a capital shortfall as high as $250bn for Spain’s faltering banking system.
If things weren’t bad enough, today from Reuters (Fiona Ortiz): “Spain’s wealthiest autonomous region, Catalonia, needs financing help from the central government because it is running out of options for refinancing debt this year, Catalan President Artur Mas said on Friday. ‘We don’t care how they do it, but we need to make payments at the end of the month. Your economy can’t recover if you can’t pay your bills,’ Mas told a group of reporters…”
When Spain imposed a level of “austerity” at the federal level to rein in out of control deficits, regional governments just kept borrowing and spending. They’ve now apparently hit the wall. Reuters noted that 17 regions have $45bn of debt to refinance this year. Over the past two years, Catalonia has borrowed through the issuance of “patriot bonds,” although with “a quarter of all Catalan savings… already in patriot bonds” retail demand is apparently sated. Bank borrowing is expensive – and risky for the banking system. Invoking a term becoming troublingly common throughout Europe, officials in Catalonia are calling for the “mutualization” of region debt loads.
Wednesday was one of those days that left a bad feeling in the pit of my stomach. European shares were getting hammered. Spanish, Italian and periphery bonds were under heavy selling pressure. Emerging equities were under pressure, and key “developing” currencies were under heavy selling pressure. Interestingly, Credit default swap prices were rising meaningfully for key “developing” countries such as Brazil and Mexico. U.S. stock prices began sinking, with the S&P500 falling below the 1,300 level. There was notable weakness in the stocks of major multinational companies with significant exposure to the developing economies. Things looked bleak. Miraculously, U.S. stocks rallied sharply to lead recoveries in global risk markets.
I think I understand the bullish view for U.S. stocks and our economy. I am the first to point out how the U.S. economic system, predominantly fueled by Treasury Credit, is these days strangely immune to stress associated with global de-risking/de-leveraging. Yet we live these days in highly-integrated global financial and economic systems. “Risk on, risk off” is a global dynamic; the hedge funds, leveraged speculators, international financial conglomerates and global derivatives markets link all markets and economies tightly together.
It is not a low probability that a cataclysmic event is unfolding in Europe. Over the past twenty years, cataclysms have been anything but rare occurrences (1995, ‘97, ‘98, 2000, ‘01, and ‘08 come quickly to mind). European finance is not functioning effectively; policymaking is dysfunctional; confidence is breaking down; and the region’s economies are in serious trouble (I know, "markets are oversold”). It is also apparent that major Credit Bubbles in China, India, Brazil and elsewhere are showing their age. While talk of capital flight from Greece, Spain and Italy garners most of the focus, there are maladjusted economic/financial systems round the globe that are quite susceptible to de-risking/de-leveraging dynamics and attendant reversals in “hot money” flows. Heightened global market stress, bouts of financial dislocation and a resulting global economic slowdown now appear likely. The extent to which dollar carry trades (shorting/selling dollar instruments to finance the purchase of higher-returning global risk assets) have accumulated over the years remains an important unknown.
My broad Credit-centric framework analyzes the situation in terms of a series of interrelated global Bubbles. Developing economy Bubbles appear increasingly vulnerable to the bursting of the European Credit Bubble. Speculators, investors and corporations have over recent years positioned for ongoing dollar devaluation versus emerging currencies. Hedge funds have enjoyed spectacular windfall returns, while U.S. multinationals have benefited from an international profits bonanza. And while I appreciate the notion of U.S. stocks and our economy as today’s so-called “least dirty shirts,” I at the same time see the potential for major disappointment and dislocation. The U.S. Bubble may very well prove resilient – but I don’t expect our risk markets to avoid what is potentially a radical change in the global financial and economic backdrop. And when things looked like they might spiral out of control mid-week, market excitement was almost palpable: “Here Comes the Policy Response!”
No comments:
Post a Comment