Monday, 29 November 2010

Bond Vigilantes and Wikileaks

Q: What is the difference between the Bond Vigilantes and Wikileaks?
A: One is a shadowy transnational group dedicated to exposing the Truth at all costs and with the power to seriously embarrass governments, the other is Wikileaks.

Taken from the comments section of an article entitled "Will the euro survive?" at FT Alphaville.

No parallel between the Eurozone currency club and the federal system behind the US Dollar

The Irish Independent ran a story on Sunday November 29th which is worth reading for illustrating how troubled peripheral Eurozone states can best negotiate terms for EU bailouts...just threaten default.

With French and German policymakers issuing hyperbolic (and desperate sounding) statements in support of the euro currency on Monday as the markets seem not to be overjoyed by the Irish "rescue" package, the Achilles heel of the EZ currency club is becoming all too apparent.

The major flaws in the EMU and the procedural shortcomings of the EZ management system have been only too obvious since the Irish have had to air their dirty linen in full view of the world's financial media and analysts. But even more revealing has been the extent to which the German government in particular has had to back down on the issue of bond haircuts. The lack of resolve on the issue of how to allow insolvent, but totally inter-connected, banks to fail within a mechanism for re-structuring all stakeholders, including the claims of senior debt holders, is now the glaring weakness of the EZ and its interface with the global banking system.

One could even make the case that Europe is simply in the vanguard of the eventual unraveling of the many dodgy bank balance sheets which have been subjected to a low tech shell game of financial engineering with bad assets simply being shunted through a maze of obfuscation.

The architectural flaws of the EZ currency club are almost too numerous to mention but can be framed essentially in the following question - How does one expect a "union" to survive under a common currency, which has to be supported by a central bank, when any and all of the member states are free to issue as much debt in the collective currency as they deem necessary?

While the US dollar bloc is similarly exposed to hide the salami accounting shenanigans the lack of a parallel between the EZ currency club and the USD regime which is under-written by the truly centralized Federal Reserve system is highlighted by the Irish negotiating tactic alluded to above.

Imagine the circumstances where to take just one example, say California, threatened to default on its obligations and how this would impact the US dollar. It clearly would be a distressing circumstance and likely to cause major disruption in asset markets but would it trigger a cascading of defaults on vast numbers of daisy chain obligations denominated in US dollars? California is not obviously a sovereign in the same sense that Ireland is and the defaulting by the state of Ireland would have wiped out in a second hundreds of billions of euros of loans by global banks to not only Ireland per se but all of its banks which are subject to the guarantee of a state which had just defaulted. Would the capital markets be convinced if the ECB stepped in and was prepared to guarantee all of Ireland's obligations? What about the credibility of a promise by the EFSF (an SPV which derives its AAA credit rating from the creditworthiness of all EZ states - including the so called PIIGS!) to honor all of Portgual's and Spain's liabilities?

The US Federal Reserve could much more readily and convincingly undertake to protect debt holders in the case of a unilateral default by one of the US states than the European central bank, and this is underlined by the fact that the idea of a state like California declaring its currency independence from the USA and floating a rival currency seems like a nonsense.

When all of the impossibly awkward repercussions of the EZ bailout process and the flawed architecture of the underlying EMU are fully exposed - and they surely are close to that point already - the non-survivability of the euro currency will become obvious to all.

Tuesday, 16 November 2010

The EZ mess is getting very messy indeed

The metaphors regarding the messy state of affairs in the Eurozone are getting more graphical. This one from a Bloomberg article caught my eye

“The problem for the Irish state is that banking guarantee two years ago inextricably merged the country’s banking problems with the sovereign,” said Brian Lucey, associate professor of finance at Trinity College, Dublin. “It’s an omelette that is impossible to un-scramble at this stage.”

But just after composing this posting the following comments from the EU President were reported by Dow Jones and show that the mess is getting even messier.


The European Union won't survive if it fails to overcome a debt crisis plaguing the single currency area, the bloc's president Herman Van Rompuy said Tuesday.

"We're in a survival crisis," Van Rompuy said in a speech in Brussels hours from an assembly of euro finance ministers with Ireland and Portugal each teetering on the brink.

"We all have to work together in order to survive with the euro zone, because if we don't survive with the euro zone we will not survive with the European Union. But I'm very confident we will overcome this."

Ireland admitted Monday that it was holding talks about a rescue package of emergency aid, six months after EU nations had to rush to the rescue of Greece with a EUR110 billion bailout.

Portugal has also warned it is at "high" risk of needing financial support, unable to borrow money on open markets other than at prohibitive rates.


And just to round this out here are a couple of my own contributions to Twitter on the matters:

If EZ does crumble - the EU "center does not hold"- the EU project would, in hindsight, appear as fantastic technocratic folly built on hubris.

Apart from EZ "crisis", the failure of EU members to agree on a budget and not allow Brussels to set it, is starting to look like "constructive dismissal"

Sunday, 14 November 2010

Credit depends on a socio-cultural matrix of keeping promises

The current clash over monetary policy/currency debasement or manipulation, may well be a zero sum game or to cite other terminology, the US might win but it will be a Pyrrhic victory. It has even been suggested that the US policy of QE is a shrewd tactic which will reduce the burden of the national debt by enabling it to be "repaid" in dollars which have diminishing purchasing power.

There is almost certainly not a simple winner/loser dialectic at work here. There are both direct and external costs to a currency war where both sides will win some battles and lose others but the "war" will end in an economic stalemate or looking at the worst outcome, a depression culminating possibly in military conflict and/or a breakdown in the rule of law.

Some have argued that the US is being backed into a corner by China by its refusal to revalue the yuan and to encourage its consumers to save less and spend more. On the other hand China is effectively saying that their economic livelihood, including their belief that buying US Treasuries and agency debt represented a "store of value" and economic benefit, was based on a false premise that they presumed (perhaps due to misrepresentations) about US fiscal/monetary responsibility, and that this extending of credit is now being jeopardized by the monetization of US debt obligations.

At the end of the day monetary and credit systems are all about a socio-cultural matrix of shared beliefs (i.e. the Latin verb for belief is credere) and an assumption that promises made are going to be kept. Right now more of the world is having serious questions about whether the US (and many other nations) have either the intention or wherewithal to honor their financial obligations.

In that sense, and in my view in the longer term, the US especially, but other states as well, are not being shrewd but reckless.

Tuesday, 2 November 2010

Two key markets EUR/USD and S&P 500 ready for major moves?

The 15 minute chart for the S&P 500 futures over the last 48 hours or so reveals very clearly the two points that I have made in my Daily Form column regarding this key US benchmark index. The two arrows point to the two critical levels that are prevailing at present --- and both were touched within about 4 hours of each other.

The 1193 zone is clearly the top of the recent range and a failure to penetrate that level yesterday energized traders to immediately test the lower support level at 1173 as anticipated in the Daily Form commentary yesterday.

At present the futures in European trading are around the 1187 level (approx 62% of the swing high/low visible on the chart below).

The next 24 hours will be quite critical for this index, and if I had to guess (I don’t plan to trade this way however) I would be looking for a break above 1193 with perhaps a quick run towards the April high, but I would then be wary of an abrupt reversal.

If 1165 is taken out then there could be a scramble for the exits and if 1220 is exceeded then there would be a lot of large position traders within hedge funds that would be scrambling to cover. Either way there should be substantial range expansion which would lead to greater volatility and benefit option buyers and punish option sellers.



EUR/USD has reached into the apex of a key triangular formation which will need to be resolved soon. At the time of writing the euro is poised at the top of a descending trend line through highs which is seen on the 240 minute chart below.

Retreating from the technicals for a moment the fundamental position is that the announcement from the Fed regarding QE will highlight the almost impossible agenda for Ben Bernanke. On the one hand he faces the requirement to please the Administration and the consensus view that structural unemployment in the US needs more asset purchases (fallacious reasoning perhaps, but still politically expedient), and on the other hand the US is facing mounting of pressures from EM economies that the last thing that their markets need is even more hot money seeking out higher yields in their asset markets and forcing up the value of their currencies.

Despite a lot of attempts to try to smooth over the gaping cracks by policy makers mindful of the need for diplomatic rhetoric, it is worth emphasizing the point that there is a currency war already in effect and it is likely to get considerably more fractious.