“CANUTE-LIKE EFFORTS” TO DEFY ECONOMIC LOGIC HAVE LED TO A CURRENCY COLLAPSE
Turkey is heading for “a vicious cycle of inflation and depreciation”, Timothy Ash of BlueBay Asset Management tells Tommy Stubbington in the Financial Times. With inflation running at 19.89% and the Turkish lira plummeting, there is talk of a new currency crisis.
The lira has lost 40% of its value so far this year. As of Tuesday it had recorded 11 successive record lows against the dollar in as many days, say Daren Butler and Nevzat Devranoglu on Reuters.
BACK TO 2018
The latest sell-off came after the central bank cut interest rates to 15%, the third cut since September. Interest-rate cuts reduce the attractiveness of lira-denominated assets, causing investors to sell them in favour of other currencies. At the new interest rate, savings in a Turkish bank account would earn a real return of -4.89%.
President Recep Tayyip Erdogan continues to believe that high interest rates cause inflation, despite ample evidence – not only in his own country – that the opposite is true. He has fired central bankers who didn’t toe the line on easy money.
“THE MSCI EMERGING MARKETS INDEX HAS FLATLINED THIS YEAR DESPITE GLOBAL REFLATION”
Things are starting to look a lot like 2018 again, when the lira “dropped precipitously amid a crisis in relations with the US”, say Jared Malsin and Patricia Kowsmann in The Wall Street Journal.
A plunging currency is “driving up the cost of [imported] food, medicine and other essentials for average Turks”. Some commentators fear a bank run. Yet despite growing signs of discontent, Erdogan appears determined to stay the course; indeed “he has intensified his calls for low interest rates”.
Things got so bad in 2018 that policymakers were eventually forced to reverse course with emergency interest-rate hikes, says Craig Mellow in Barron’s. That sent local stocks up by “a third in four months”. Yet few are betting on a repeat this time.
Since 2018, “Erdogan has replaced professionals at the central bank with yes men”. Global inflationary pressures are amplifying domestic problems, while Covid-19 continues to weigh on the important tourist sector.
EMERGING MARKETS DISAPPOINT
Trouble in one emerging market can quickly spread to others, says Shilan Shah of Capital Economics. Investors in the asset class may panic and sell indiscriminately. Yet any such “financial contagion” is likely to be “much more limited” this time than in 2018.
Turkey aside, most big emerging countries appear to have the foreign-exchange reserves they need to ride out any turmoil. What’s more, non-residents’ holdings of Turkish stocks and government bonds are down by two-thirds since 2018. Foreign investors won’t be panicking and pulling funds from Turkey – most of them have already left.
Thursday, 4 January 2018
Hugely important article on Europe - may or may not be entirely valid (a lot of speculation about the future) but crammed full of useful analysis you can use in essays. Daily Telegraph 4th January:
Eurozone’s fleeting boom is an illusion - Britain won't remain the sick man of Europe for long
Brexiteers must hold their nerve. By a twist of timing, the eurozone is briefly basking in economic glory while Britain languishes in relative stagnation.
It is an illusion of the economic cycle, magnified by Europe’s elastic snap-back from a needlessly severe recession. The EMU sorpasso over recent months looks more meaningful than it really is, yet it is inevitably creating confusion and will colour Brexit talks at a crucial juncture.
We can all agree that the UK economy has long been mismanaged. It needs a radical shift from consumption to investment if it is to avoid falling further behind the US and the rising powers of Asia. But one problem that it does not face is being left behind by the eurozone in any lasting sense.
OECD analysts think the region’s economic speed limit is around 1pc. The eurozone has been able to grow at well over twice that rate in recent quarters without running into trouble only because it has had a legacy output gap to cover. The UK is far ahead in the cycle.
It has been buying €60bn (£53bn) of bonds – down to €30bn this month – pushing its balance sheet to 41pc of GDP, much further than the US Federal Reserve ever dared to go. It has bought €130bn of corporate debt in a direct intervention in the credit markets.
Fiscal austerity has given way to net stimulus. Spain, Italy and France have all been flouting EU spending rules. If this heady cocktail cannot produce a catch-up boom, nothing can.
Yet this burst of growth is ephemeral unless the eurozone uses the opportunity to grapple with its own dysfunctional pathologies – rigid labour and product markets, non-performing loans, zombie companies, warped welfare incentives – and to reestablish the currency union on workable foundations before the next crisis hits. Little of this has happened.
The IMF’s Article IV report on the eurozone for 2017 is one long indictment of structural paralysis. “Unresolved legacy problems are holding back a stronger medium-term outlook. Risks are large and policy buffers remain thin,” it said.
Poul Thomsen, the IMF’s Europe chief, says the fundamental picture is getting worse. Intra-EMU divergences are becoming more extreme. Those countries that had the poorest productivity growth at the launch of the euro are falling even further behind. “The gaps in real per capita income levels have widened rather than narrowed,” he said.
Germany’s real GDP is 14pc higher than its pre-Lehman peak, while Italy’s GDP is still 6pc below and will not recover its previous output until the “mid-2020s” – amounting to two Lost Decades. What is extraordinary is that these two countries are still trying to share a currency union, given their starkly contrasting fates, and the lack of any sign that this is will ever self-correct.
Brussels admits that the eurozone’s slump from 2008-2015 was so deep that it crossed into hysteresis, the point where "cyclical unemployment becomes structural" and causes lasting damage to job skills and economic dynamism. Hysteresis is why austerity policies become inherently self-defeating if pushed beyond the therapeutic dose. They lower trend growth rates decades ahead, making it even harder to bring debt ratios back under control.
Youth jobless rates peaked at 56pc in Spain, and are still 38pc today. The shock was so profound – and went on so long – that a whole cohort of Spanish youth went through their twenties without ever holding a durable job, with subtle macro-economic effects. Variants of this occurred in Italy, Greece, Portugal, and to some extent in France.
There have been episodic bursts of reform in southern Europe and France – usually less than advertised – but the OECD still thinks the currency bloc is so sclerotic that it will hit capacity constraints long before it has reached what would be considered full employment in Anglo-Saxon states. In economic parlance, the "Nairu" floor for unemployment is 8.8pc, exactly where the jobless rate is today. The output gap has essentially closed, and in Germany it is long past closing.
The eurozone boom therefore contains the seeds of its own demise. The stronger the recovery now, the sooner it hits the buffers, and the sooner QE will have to end. ECB board member Yves Mersch warned this week that Frankfurt must be “very careful not to act too timidly and too late, and to fall behind the curve”.
This brings Italy into uncomfortable focus. ECB has bought €319bn of Italian debt and is essentially covering the Italian budget deficit. This has compressed bond yields sufficiently to head off a debt compound spiral. It has been a life-saver but it has not restored self-sustaining viability. The public debt ratio remains stuck above 130pc of GDP, at the outer limits for a country with no sovereign currency.
Italy must refinance debt worth 17pc of GDP next year without obvious buyers. Italian banks and foreign funds have been systematic sellers, rotating the proceeds into accounts in Germany or Luxembourg in what amounts to slow capital flight.
“The end of QE does not frighten us,” says the defiant Italian finance minister Pier Carlo Padoa. Yet it will certainly frighten bondholders if it coincides with the election of a radical anti-euro government in March. The Five Star movement of Beppe Grillo leads the polls at 29pc, while the ruling Democrats are in slow collapse. Five Star is no longer calling for the restoration of the lira but its manifesto flouts the basic rules of monetary union.
Spain is in better economic shape, to the extent that it has clawed back competitiveness by slashing relative wages in an "internal devaluation". But this should not be mistaken for good health. Productivity has not recovered. “Much of the post-crisis growth has been in lower-skill, lower-productivity sectors,” said the IMF.
My guess is that bond yields in both countries will spike high enough by mid-2018 to cause heartburn, and this time Germany will be in a less accomodating mood with the anti-euro Alternative fur Deutschland commanding 94 seats in the Bundestag, and snapping at chancellor Angela Merkel’s heels.
The ECB’s policies are becoming more intolerable for Germany by the month. Negative rates are destroying the business models of the local savings banks that fund the Mittelstand backbone of the industrial economy. QE has pushed the Bundesbank’s net credits through the ECB’s internal Target2 payments system to €880bn. It is becoming a backdoor "transfer union" without democratic consent.
The economy is overheating. The IFO confidence index has reached the highest level since 1969. The Bundesbank expects 2.5pc growth next year, twice the German speed limit, describing it as “clearly above the production potential”.
“It is very clear that monetary policy is too expansionary for Germany by any rule you care to use. The lesson of the past is that the longer this momentum goes on, the more dangerous it becomes, and I see a lot of dangers,” said Professor Clemens Fuest, head of the IFO Institute.
The ECB’s Mario Draghi can push Germany only so far. If he tries to stretch QE even longer to buy time for Italy and Spain, he risks further eroding – and ultimately losing – German political consent for monetary union. Yet what Germany needs is incompatible with what the Latin bloc needs.
IMF officials fear that sooner or later one country will be hit by an asymmetric shock, revealing the EMU system is as unworkable as ever
IMF officials fear that sooner or later one country (Italy) or region will be hit by an asymmetric shock, revealing that the EMU system is as unworkable as ever. There is still no fiscal union, and Germany is unlikely to offer Mr Macron much beyond the symbolism of a eurozone finance minister with no budget. The banking union lacks the genuine backstop needed to avert a repeat of sovereign/bank "doom-loop" that almost engulfed EMU in 2012.
Such a brutal denouement is a story for the next global downturn, not a looming threat for this year. What is likely to become clear in 2018, however, is that boom conditions are much harder to handle than the sluggish Goldilocks growth of early recovery. Deep rifts within monetary union are becoming visible again. The removal of the ECB shield may prove very painful for high debtors.
So if you think Britain looks like the crisis child of Europe right now, just wait a few months. Rivals abound.
If you want to know what proper “secular stagnation” looks like, go to Italy. The Italian economy has essentially gone nowhere since the turn of the century, which lest it be forgotten coincided almost exactly with the launch of the euro. Output today is roughly the same as it was then.
This might seem shocking enough; not even the Great Depression produced such prolonged misery. Yet the way things are going, Italians can look forward only to years more of the same.
Attention last week focused on the travails of Deutsche Bank, but the true epicentre of the latest leg in the European banking crisis is Italy.
Heroic efforts by the Italian prime minister, Matteo Renzi, to lance the boil and give his country at least a fighting chance of resumed economic growth are being stymied in Brussels by pen pushing adherence to new state aid and bail-in rules.
Europe won’t allow Italy to bail-out its banks, yet the EU won’t come to the rescue either. It is small wonder that Mr Renzi has taken to referring to the numbskulls of the European high command as like the orchestra on the Titanic. Rome burns, yet they just keep on fiddling as if nothing is wrong. Rarely has European pigheadedness over-ruled reasonable pursuit of the national interest quite so destructively. Greece threatened to be the straw that broke the EU's back; it may yet prove to be Italy.
The International Monetary Fund estimates that the Italian banking sector’s non performing loans amount to an astonishing 18pc of GDP. Attempts to set up a “bad bank” along the lines of Ireland and Spain to relieve the system of this giant overhang of rotten lending have fallen foul of the latest adjustments to state aid rules. At the same time, Europe insists on using Italy as a testing ground for new bail-in rules which would require Italian retail investors to accept haircuts on €200bn of subordinated notes they thought to be risk free. Politically, this is bound to be unacceptable.
If Europe’s elites had consciously set out to bring the whole house of cards tumbling down, they could hardly been more effective about it. The Treaty of Rome is where it all began; it may also be where it ends.
This is a research note put out by my friendly investment bank; some will be way too financial for you, so don't try and understand it all. Skim read it, get the gist, and then try and focus on the numbers, and about two thirds of the way down, what happens if one of these firms fails:
Earlier today, in its latest attempt to restore confidence in its brand and business model after suffering a historic stock price collapse, Glencore - whose CDS recently blew out to a level implying a 50% probability of default - released a 4 page funding worksheet which was meant to serve as a simplied summary of its balance sheet funding obligations and lending arrangements to equity research analysts who have never opened a bond indenture, and which among other things provided a simplied and watered-down estimate of what could happen if and when the company is downgraded to junk. Meanwhile, in a furious race to shore up as much liquidity as possible, Glencore - which a month ago announced a dramatic deleveraging plan - and its peers have been quietly scrambling to raise billions in secured funding. Case in point none other than Glencore's biggest competitor and the largest independent oil trader in the world, Swiss-based, Dutch-owned Vitol Group, whose Swiss unit Vitol SA earlier today raised a record $8 billion in loans. It is not alone. As Bloomberg reports, another name profiled previously here, privately-held (but with publicly-traded debt) Trafigura "won improved terms on a $2.2 billion loan refinancing deal on Oct. 1 via a group of 28 banks. Swiss commodity traders Gunvor Group Ltd. and Mercuria Energy Group Ltd. are also marketing credit facilities totaling $2 billion." Louis Dreyfus Commodities, the world’s largest raw-cotton and rice trader, said in its interim report last month that it had six revolving credit facilities with staggered maturity dates totaling $3.3 billion. In June, it amended and extended its North American facilities totaling $1.6 billion and in July it refinanced a $400 million Asian lending facility with the company securing an option to request an increase of $100 million. Noble Agri, the agricultural commodity trader majority owned by China’s Cofco Corp., attracted four new lenders to its $1.58 billion one-year revolving credit facility, people familiar with the matter said this month. In short - a race against time to pledge as much unencumbered collateral as possible for future funding needs, because as every CEO knows you raise capital when you can, not when you have to.
Yet this is odd, because even as the companies hold investor meetings and publicly comfort investors that they are adequatly funded and see no need for a liquidity-raising scramble, that's precisely what the world's commodity traders are doing. Bloomberg's take was more optimistic: "The transactions show banks are still eager to loan money to commodity traders even after debt concerns caused by wild swings in Glencore’s stock and bond prices." The new loans and refinancing signal banks are comfortable lending to commodity traders, whose business models allow them to profit from volatility and lower financing costs amid weaker prices for raw materials. According to Bloomberg, Vitol’s record credit facilities from a group of 57 banks were increased by a third after the initial $6 billion sought by the trading house was oversubscribed by $2.7 billion, the Rotterdam-based company said in a statement. The facilities, refinancing a debt package signed 12 months ago, are the biggest in the firm’s 49-year history, a Vitol spokeswoman in London said. Then comes even more spin: The loan package, coming after Trafigura last week agreed to lower lending rates, suggests some analysts don’t understand the business of trading houses, which can benefit from lower commodity prices and the current contango market structure that allows them to profit by storing oil because forward prices are higher than current costs. Actually analysts (at least credit) understand the business of trading houses very well; what Bloomberg's reporters don't seems to understand, however, is the principle of muturally assured megaleverage destruction, or the implied threat for a company's secured lending syndicate that a borrower which already has billions of exposure to banks has all the leverage in demanding even more debt. After all, should Vitol fail, it would lead to a cascade of bank failures as all the banks that have lent money to the giant commodity trader are forced to charge off their exposure, in the process leading to serial defaults among undercapitalized financial institutions. It is these institutions whose credit officers underwrote the loans, that are the ones who "don't understand the business of trading houses" because based on the recent collapse in publicly traded securities, they never modelled what happens to cash flows in a world in which the price of oil, copper, zinc, aluminum or other commodities, suffer a 50%+ plunge in prices. “Given the recent turbulence in the commodities space, we have been repeatedly asked by investors on the banks’ exposure to commodity traders,” analysts at Sanford C. Bernstein led by Chirantan Barua wrote in a note Monday. As they well should, and in order to avoid answering, the banks are perfectly happy to throw a little more good money after lots of bad money in order to avoid remarking their entire exposure to the sector to something resembling fair value. But the day of remarking is coming: as Bernstein calculates, commodity traders have raised at least $125 billion of debt, of which about $75 billion is loans. In other words, there is about $75 billion in secured debt, collateralized by either inventory and/or receivables collateral whose value has cratered in the past year, and as a result the LTV on the secured loans has soared. It is this that is prompting the panicked banks to be more eager to provide funds to the suddenly distressed energy-trading sector than even the borrowers themselves. And after all, if the banks do blow up, there is always the taxpayer-funded bailout as a last reserve. And here is a pop quiz to either analyst, or Bloomberg writers who don't "understand the the business of trading houses" - if you issue secured debt to shore up liquidity as a result of what is fundamentally a massively over-leveraged capital structure, does the pro forma debt increase or decrease. This is not a trick question. The good news for the Vitols of the world is that by pledging even more of their unencumbered assets to banks, they buy themselves a few more months, or quarters, of liquidity to pay down upcoming maturities and interest. Which is what Glencore did with its "doomsday" plan in early September... a plan which calmed the stock for all of two weeks before investors saw right through it for what it was: a desperate scramble to put lipstick on a declining-stage supercycle pig. In the meantime, the end result is this: companies that are even more levered to commodity prices in a world in which at last check commodity prices, a proxy for China's economy, are sliding. Which, incidentally, was our thesis in March of 2014 when we said that buying Glencore CDS is the best way to trade China's hard landing. This is precisely what happened. Which is why both the companies, and their lending banks, better pray that commodity prices pick upin the coming weeks and months, because for the Vitols, the Glencores, the Trafiguras, the Mercurias and so on, that is all that matters. Ironically, by levering up even more, they bought themselves some time now, but if and when the next leg down in the commodity supercycle takes place, the pain will only be that much greater.
Notes from a talk given on the global economy by Martin Wolf of the Financial Times
At the conference establishing the new Bretton Woods international system in 1944 - Keynes expressed concerns at the about how to manage global economic imbalances. Keynes wanted a monetary system that would automatically balance accounts and keep the interests of creditor and debtor nations more closely aligned.
Economic significance - as a result of the crisis, we are much poorer in aggregate than people expected ten years ago
United States
In the USA actual real GDP has deviated from potential output by 18%
More significant than the recession of 2008-09 has been that US growth has not returned to pre-crisis trend
This is a big break point in the economic history of the USA
Euro Zone
From a very slow growing trend, Euro Zone slowdown has taken the single currency area 14% below pre crisis levels
What is remarkable about the Euro Zone since 2010 has been how slowly it has grown - barely a recovery at all
Intellectual significance
Very few people expected a financial and economic crisis on this scale
The policy-making orthodoxy did not think it can happen to the developed world built around lightly regulated finance and many years of macro stability
Their belief in stable economies and stable growth has been truly shattered
Recall one of the key Hyman Minsky ideas - in actual economies run by real people running real businesses, stability breeds instability.
The simplest way to take on more risk is to increase the amount of leverage / debt and this is exactly what happened
As the financial crisis engulfed most of the world in 2007, the banking system was leveraged at a rate of around 40. Leverage of 20 is frightening
Fundamental macro shifts causing the crisis
Combination of factors came together to bring about extraordinary fragility in the economic / financial system
A global savings glut and an investment dearth led to a steep decline in real interest rates
Drivers of the global savings glut:
(ii) Big shifts in income distribution towards the top end - towards savers and away from spenders
(iii) Post 1997 the emerging world became net capital exporters after they started to run up huge trade surpluses
As real interest rates fell, housing sectors in countries such as Spain, the UK and the USA started to rise
House price booms triggered credit booms in many countries
In the UK we don't build houses, in the USA and Spain - they do. We now live with the most expensive housing in the world (an almost permanent feature of our economy)
In the USA and Spain, lending against property came to an abrupt end when their markets became saturated with excess supply
2015: We now live in a world where the real interest rate on low risk assets is close to zero and has been for six years - this is a key depression indicator
Global imbalances
The world moved to more savings relative to investment
Savings and investment need to balance
Balance happens by looking at growing trade imbalances on the current account of the balance of payments
Oil exporters, Germany & Japan, China and emerging Asia - these are the structural surplus countries
United States, UK and others - trade deficit countries
Emerging economies post 1997 crisis decided to go LONG dollars - i.e.build up rising / huge foreign currency reserves as a buffer stock against a future crisis
What Future for Greece?
The external and the fiscal adjustment in Greece has already happened. Greece needs structural reforms.
What is Greece breaks out of the system - e.g. brought about by ECB no longer supporting Greek banks - causing a run on deposits
Greek central bank would create it's own money - the new money would devalue dramatically
But how powerful would the effect of this?
If social order is maintained, Greece might start growing very rapidly - but it has a very weak external sector
Nobody really knows how the policy system would work in Greece outside the Euro - would they become another Argentina?
Can Monetary Union work without Fiscal Union?
Yes - If the economies are very similar - i.e. similar structures, competitive advantage
US is about diverse as Europe but that doesn't matter because they have many other institutions to help absorb shocks
Even if countries are heterogeneous providing people are prepared to take adjustments via changes in relative wages and migration
Modern welfare states make it very difficult to make this EU monetary union work in the long run
One options is that a northern monetary union will spin off
Banks falling to lend to businesses
Only 10% of the aggregate balance sheet of the UK retail banking system is lending to businesses
Extraordinary asymmetry when compared to mortgage lending
Banks don't lend to businesses because it is not sufficiently profitable
Central banks and interest rates
This is an extraordinary era for monetary policy among the major central banks of the world
Money from the central banks has been staggeringly cheap - this is completely abnormal
Nobody seems to be frightened of inflation
Enormous expansion of the central bank balance sheet arising from money creation
People are lending money to national governments at (minus) one per cent for thirty years
Even the governments of Italy and Spain can borrow for 30 years at 3% per annum
For the UK government to be terrified of debt is to be terrified of shadows
Policy lessons from the crisis and the aftermath
We need to think more seriously about economic orthodoxy - monetary policy hasn't changed, in essence the financial sector is the same - just much more highly regulated
Will cheap money and regulated finance bring about a sufficient robust recovery? There are big doubts
Financial sector remains highly leveraged - they fund their assets with 96% of debt and 4% of equity - shocks will lender them insolvent
Chicago Plan for narrow banking - separating out the money and payments system run by banks
World system is one with massive deflationary bias because everyone wants to run surpluses (fiscal and trade) and US cannot run a big enough deficit to support the world
