Rubini Eyes 'Perfect Storm' and Bond Market Revolt ...
...German Central Bank Says Greek Default Would Not Destabilize the Euro; Time to Short Treasuries?
In a radical departure from the viewpoint of Jean-Claude Trichet, the president of the German central banks says Greek Default Would Not Destabilize the Euro
Bundesbank President Jens Weidmann raised the pressure on governments to agree to a Greek bailout without the European Central Bank taking part in easing the country's debt burden, saying the euro can withstand a default.
Weidmann said the ECB was unwilling to turn its emergency bond-buying program into a "lasting institution" and that Greece's implementation of austerity measures and asset sales was crucial to securing the handout to prevent a default. He spoke in an interview with German newspaper Welt am Sonntag.
"If the commitments are not met, that cancels the basis for further funds from the aid package," Weidmann told the newspaper. "This would be Greece's decision, and the country then would have to bear the surely dramatic economic consequences of a default. I don't think this would be sensible, and it would surely put partner countries in a difficult situation. But the euro would even in this case remain stable."
Weidmann's depiction of a default as a liveable outcome contrasts with warnings from fellow ECB officials Lorenzo Bini Smaghi and Christian Noyer, as well as European Union Economic and Monetary Affairs Commissioner Olli Rehn, who described it as a "Lehman Brothers catastrophe" last week.
Zero Hedge commented on the Radical Change To ECB's Tune
Translation: we now believe our banks are well enough reserved for what comes next. It also means that the rift with the ECB, which will be exposed as near-insolvent courtesy of using Greek collateral for tens of billions of loans that will have to be impaired, is now terminal.
I concur that ZH provides one possible answer, and a logical one.
However, my top answer is that at long last, someone (in this case the German central bank) was stricken with an unexpected dose of common sense and recognizes a default is coming. To mitigate the damage, Weidmann may have lied about the consequences, and the preparedness of European banks.
Is there any reason to believe Weidmann is attempting to do anything but contain the damage in case Greece defaults?
I covered the prospect of lies in Politicians 'Lying Through Their Teeth' on Greek Aid (and Everything Else Too).
Thus, while it's possible European banks are prepared for default, it's equally possible, if not more plausible, they are not, and that Weidmann is lying about it.
Will the Default be Orderly or Disorderly?
A default is given. The question now is whether that default will be orderly or disorderly. If a default is coming, it makes no sense to throw more money at it. Indeed history shows the sooner the truth is admitted the less the haircuts.
The sad reality of the matter is the "Tortured Body Will Surrender" because Greece is Insolvent
Prolonging the agony by extending Greece more loans will only increase the losses and I suggest the German central bank has come to that conclusion.
US Reserves Bailing out European Banks?
The discussion on Zero Hedge regarding The Fed's $600 Billion Stealth Bailout Of Foreign Banks Continues At The Expense Of The Domestic Economy, Or Explaining Where All The QE2 Money Went is more problematic.
The Fed does not give money away, the Fed loans it. Lending money to foreign banks does not prepare them for a Greek default.
Nor does that loan come "at the expense of the domestic economy" as Zero Hedge suggests, except in the general sense that it fueled a liquidity bubble, driving up asset prices and the price of food and gasoline.
In summary, instead of doing everything in its power to stimulate reserve, and thus cash, accumulation at domestic (US) banks which would in turn encourage lending to US borrowers, the Fed has been conducting yet another stealthy foreign bank rescue operation, which rerouted $600 billion in capital from potential borrowers to insolvent foreign financial institutions in the past 7 months. QE2 was nothing more (or less) than another European bank rescue operation!
I respectfully disagree. US banks are not lending because they are capital constrained (not reserve constrained), and because there are too few qualified businesses that want loans.
Giving more reserves to US banks would not do a thing. As I have pointed out on numerous occasions, lending comes first reserves second.
Fictional Reserve Lending Revisited
Once again let's review Fictional Reserve Lending And The Myth Of Excess Reserves
Inquiring minds are reading BIS Working Papers No 292, Unconventional monetary policies: an appraisal.
The article addresses two fallacies
Proposition #1: an expansion of bank reserves endows banks with additional resources to extend loans
Proposition #2: There is something uniquely inflationary about bank reserves financing
From the article....
The underlying premise of the first proposition is that bank reserves are needed for banks to make loans. An extreme version of this view is the text-book notion of a stable money multiplier.
In fact, the level of reserves hardly figures in banks' lending decisions. The amount of credit outstanding is determined by banks' willingness to supply loans, based on perceived risk-return trade-offs, and by the demand for those loans.
The main exogenous constraint on the expansion of credit is minimum capital requirements.
A striking recent illustration of the tenuous link between excess reserves and bank lending is the experience during the Bank of Japan's "quantitative easing" policy in 2001-2006.
Japan's Quantitative Easing Experiment
Despite significant expansions in excess reserve balances, and the associated increase in base money, during the zero-interest rate policy, lending in the Japanese banking system did not increase robustly (Figure 4).
The analysis by the BIS is consistent with analysis by Australian economist Steve Keen and Fran Shostak as noted in Fiat World Mathematical Model. The simple fact of the matter is reserves have little to do with bank lending.
That aside, I certainly agree with Zero Hedge that the Fed ought not be doing all this lending to foreign banks.
Rubini Eyes "Perfect Storm" Including a US Bond Market Revolt
A "perfect storm" of fiscal woe in the U.S., a slowdown in China, European debt restructuring and stagnation in Japan may converge on the global economy, New York University professor Nouriel Roubini said.
There's a one-in-three chance the factors will combine to stint growth from 2013, Roubini, who predicted the global financial crisis, said in a June 11 interview in Singapore. Other possible outcomes are "anemic but okay" global growth or an "optimistic" scenario in which the expansion improves.
"There are already elements of fragility," he said. "Everybody's kicking the can down the road of too much public and private debt. The can is becoming heavier and heavier, and bigger on debt, and all these problems may come to a head by 2013 at the latest."
Bond Market 'Revolt'
World expansion may slow in the second half of 2011 as "the deleveraging process continues," fiscal stimulus is withdrawn and confidence ebbs, Roubini also said.
In the U.S., a failure to address the budget deficit risks a bond market "revolt," Roubini said.
"We're still running over a trillion-dollar budget deficit this year, next year and most likely in 2013," Roubini said in a speech in Singapore on June 11. "The risk is at some point, the bond market vigilantes are going to wake up in the U.S., like they did in Europe, pushing interest rates higher and crowding out the recovery."
In Europe, officials need to restructure the debt of Greece, Ireland and Portugal, and waiting too long may result in a "more disorderly" process, Roubini also said.
Time to Short Treasuries?
I discussed the possibility of a bond market revolt on June 1, in a video discussion with Aaron Task and Henry Blodget: Will the Bond Market Eventually Force Congressional Hands?
In response, several people asked me if it was time to short treasuries. The answer is I don't know. In 2008, I advised against that action. In fact, I was steadfast yields would plunge. Shorts were clobbered.
Now, I don't know. There may be a flight to safety trade on, or not. The market could revolt next week or two years from now. This is a big change in my position in 2008 and even 2010.
5-yr, 2-yr, and 1-yr yields all hit new lows in October of 2010. The long-end of the curve did not follow. That was it for me on the long-end, at least for now. The bull market in treasuries is likely over.
The downside is obvious, and the next major move in yields is North. If the Fed does try QE3, the bond market could revolt. Right now, until the Fed does something new, the treasury market can go either way.
I see no particular edge in shorting long-term treasuries now, but that certainly does not mean buy them.