Tag Archives: Credit

Twilight of the Euro? by Hans-Werner Sinn

The euro has not been a success, and it’s probably just a matter of time before Europe puts it out of its misery. From Hans-Werner Sinn at project-syndicate.org:

Twenty years after the formal creation of the euro, few can honestly say that the single currency has been a success. After fueling a massive credit bubble in Southern Europe in its first decade, it gave rise to an array of complex monetary-policy and transfer schemes in its second – and more trouble is looming as it enters its third.

MUNICH – In May 1998, irrevocable conversion rates for the currencies that would be merged into the euro were implemented. In a sense, this makes the single currency just over 20 years old. The first decade of its life had the feeling of a party, particularly in Southern Europe; but the second decade brought the inevitable hangover. Now, as we enter the third decade, the prevailing mood seems to be one of increasing political radicalization.

The original party was a cornucopia of cheap credit, which capital markets happily issued to the countries of Southern Europe under the protection of the euro. For a while, these countries finally had enough money to increase public-sector salaries and pensions, as well as spur private consumption and investment.

But the credit flooding into these countries created inflationary bubbles, which burst when the 2008 financial crisis in the United States spread to Europe. As capital markets refused to extend further credit, Southern Europe’s previously halfway-competitive but now overpriced economies soon ran into serious trouble.

The Southern Europeans’ response was to start printing what they could no longer borrow. Aided by the European Central Bank – which loosened its collateral policy for refinancing credits and increased its tolerance for emergency liquidity assistance and credits under the Agreement on Net Financial Assets – they drew hundreds of billions of euros out of the monetary system through so-called Target overdrafts. And from 2010 onward, they were the recipients of EU fiscal rescue packages.

But, because financial markets viewed these rescue packages as insufficient, the ECB, in 2012, issued a promise to cover unlimited member-state government bonds under its “outright monetary transactions” program, turning them into de facto euro bonds. Finally, in 2015, the ECB launched its quantitative-easing program, whereby member states’ central banks bought €2.4 billion ($2.8 billion) worth of securities, including €2 billion of government bonds. Accordingly, the eurozone’s monetary base grew dramatically, from €1.2 trillion to over €3 trillion.

To continue reading: Twilight of the Euro?

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Italian Bonds Tumble, Triggering Goldman “Contagion” Level As Political Crisis Erupts In Spain, by Tyler Durden

Italy’s new anti-establishment coalition government is making all sorts of noises not designed to make creditors feel comfortable. They’re responding by raising Italy’s interest rates. From Tyler Durden at zerohedge.com:

When it comes to the latest rout in Italian bonds, which has continued this morning sending the 10Y BTP yield beyond 2.40%, a level above which Morgan Stanley had predicted fresh BTP selling would emerge as a break would leave many bondholders, including domestic lenders with non-carry-adjusted losses…

… there has been just one question: when does the Italian turmoil spread to the rest of Europe?

One answer was presented yesterday by Goldman Sachs which explicitly defined the “worst-case” contagion threshold level, and said to keep a close eye on the BTP-Bund spread and specifically whether it moves beyond 200 bps.

Should spreads convincingly move above 200bp, systemic spill-overs into EMU assets and beyond would likely increase. Italian sovereign risk has stayed for the most part local so far. Indeed, the 10-year German Bund has failed to break below 50bp, and Spanish bonds have increased a meager 10bp from their lows. This is consistent with our long-standing expectation that Italy would not become a systemic event. That said, should BTP 10-year spreads head above 200bp, the spill-over effects onto other EMU sovereigns would likely intensify.

Well, as of this morning, the 200bps Bund-BTP level has been officially breached. So, if Goldman is right, it may be time to start panicking.

Ironically, almost as if on cue, just as the Italy-Germany spread was blowing out, a flashing red Bloomberg headline hit, confirming the market’s worst fears:

  • SPANISH SOCIALISTS REGISTER NO-CONFIDENCE MOTION AGAINST RAJOY.

This confirmed reports overnight that Spain’s biggest opposition party, the PSOE or Socialist Party, was pushing for a no-confidence motion again Spain’s unpopular prime minister. The no-confidence call follows the National Court ruling on Thursday that former Popular Party officials had operated an illegal slush fund, as a result of which nearly 30 people were sentenced to a total of 351 years in prison.

To continue reading: Italian Bonds Tumble, Triggering Goldman “Contagion” Level As Political Crisis Erupts In Spain

Tales from “The Master of Disaster”, by MN Gordon

Rising interest rates will deflate asset prices. From MN Gordon at economicprism.com:

Daylight extends a little further into the evening with each passing day.  Moods ease.  Contentment rises.  These are some of the many delights the northern hemisphere has to offer this time of year.

As summer approaches, and dispositions loosen, something less amiable is happening.  Credit markets are tightening.  The yield on the 10-Year Treasury note has exceeded 3.12 percent.

If yields continue to rise, this one thing will change everything.  To properly understand the significance of rising interest rates some context is in order.  Where to begin?

In 1981, professional skateboarder Duane Peters was busy inventing tricks like the invert revert, the acid drop, and the fakie thruster, in empty Southern California swimming pools.  As part of his creative pursuits, he refined and perfected the art of self-destruction with supreme enthusiasm.  His many broken bones, concussions, and knocked out teeth earned him the moniker, “The Master of Disaster”.

But as The Master of Disaster was risking life and limb while pioneering the loop of death, the seeds of a mega-disaster were being planted.  In particular, the rising part of the interest rate cycle peaked out in 1981.  Then, over the next 35 years, interest rates fell and these seeds of mega-disaster were multiplied and scattered across the land.

Credit and Asset Prices

The relationship between interest rates and asset prices is generally straightforward.  Tight credit generally results in lower asset prices.  Loose credit generally results in higher asset prices.

When credit is cheap, and plentiful, individuals and businesses increase their borrowing to buy things they otherwise couldn’t afford.  For example, individuals, with massive jumbo loans, bid up the price of houses.  Businesses, flush with a seemingly endless supply of cheap credit, borrow money and use it to buy back shares of their stock…inflating its value and the value of executive stock options.

To continue reading: Tales from “The Master of Disaster”

Why the Financial System Will Break: You Can’t “Normalize” Markets that Depend on Extreme Monetary Stimulus, by Charles Hugh Smith

The global financial and economic system rests of a foundation of debt, and there’s no way to change that without widespread pain. From Charles Hugh Smith at oftwominds.com:

In a nutshell, central banks are promising to “normalize” their monetary policy extremes in 2018. Nice, but there’s a problem: you can’t “normalize” markets that are now entirely dependent on extremes of monetary stimulus. Attempts to “normalize” will break the markets and the financial system.
Let’s start with the core dynamic of the global economy and nosebleed-valuation markets: credit.
Modern finance has many complex moving parts, and this complexity masks its inner simplicity.
Let’s break down the core dynamics of the current financial system.
The Core Dynamic of the “Recovery” and Asset Bubbles: Credit
Credit is the foundation of the current financial system, for credit enables consumers to bring consumption forward, that is, buy more stuff today than they could buy with the cash they have on hand, in exchange for promising to pay principal and interest with their future income.
Credit also enables speculators to buy more assets than they otherwise could were they limited to cash on hand.
Buying goods, services and assets with credit appears to be a good thing: consumers get to enjoy more stuff without having to scrimp and save up income, and investors/speculators can reap more income from owning more assets.
But all goods/services and assets are not equal, and all credit is not equal.
There is an opportunity cost to any loan (i.e. credit), as the income that will be devoted to paying principal and interest in the future could have been devoted to some other use or investment.
So borrowing money to purchase a product or an asset now means foregoing some future purchase.
While all products have some sort of payoff, the payoffs are not equal. If I buy five bottles of $100/bottle champagne and throw a party, the payoff is in the heady moments of celebration.  If I buy a table saw for $500, that tool has the potential to help me make additional income for years or even decades to come.
If I’m making money with the table saw, I can pay the debt service out of my new earnings.

Did the Economy Just Stumble Off a Cliff? by Charles Hugh Smith

It would be no surprise if the economy has faltered. The only surprise is how long it took. From Charles Hugh Smith at oftwominds.com:

The signs are everywhere for those willing to look: something has changed beneath the surface of complacent faith in permanent growth.
This is more intuitive than quantitative, but my gut feeling is that the economy just stumbled off a cliff. Neither the cliff edge nor the fatal misstep are visible yet; both remain in the shadows of the intangible foundation of the economy: trust, animal spirits, faith in authorities’ management, etc.
Since credit expansion is the lifeblood of the global economy, let’s look at credit expansion. Courtesy of Market Daily Briefing, here is a chart of total credit in the U.S. and a chart of the percentage increase of credit.
Notice the difference between credit expansion in 1990 – 2008 and the expansion of 2009 – 2017. Credit expanded by a monumental $40+ trillion in 1990 – 2008 without any monetary easing (QE) or zero-interest rate policy (ZIRP). The expansion of 2009 – 2017 required 8 long years of massive monetary/fiscal stimulus and ZIRP.
This chart of credit change (%) reveal just how lackluster the current expansion of credit has been, despite unprecedented trillions of stimulus pumped into the financial sector.
Here are two other snapshots of debt: margin debt and private credit. Both have hit new highs.
Note the tight correlation of margin debt to the S&P 500 stock index: when punters borrow more on margin to buy more stock, stocks keep rising.
When credit stops expanding, the economy stumbles into recession.

We Do These Things Because They’re Easy: Our All-Consuming Dependence on Debt, by Charles Hugh Smith

Debt is, as SLL has said numerous times (see Debtonomics Archive), the foundation of both the US and global economy. From Charles Hugh Smith at oftwominds.com:

A world in which “we do these things because they’re easy” has one end-state: collapse.

On September 12, 1962, President John F. Kennedy gave a famous speech announcing the national goal of going to the moon by the end of the decade. (JFK’s speech on going to the moon.) In a memorable line, Kennedy said we would pursue the many elements of the space program “not because they are easy, but because they are hard.”
Our national philosophy now is “we do these things because they’re easy”– and relying on debt to pay today’s expenses is at the top of the list. What’s easier than tapping a line of credit to buy whatever you want or need? Nothing’s easier than borrowing money, especially at super-low rates of interest.
We are now totally, completely dependent on expanding debt for the maintenance of our society and economy. Every sector of the economy–households, businesses and government–all borrow vast sums just to maintain the status quo for another year.
Compare buying a new car with easy, low-interest credit and saving up to buy the car with cash. How easy is it to borrow $23,000 for a new $24,000 car? You go to the dealership, announce all you have to put down is a trade-in vehicle worth $1,000. The salesperson puts a mirror under your nose to make sure you’re alive, makes sure you haven’t just declared bankruptcy to stiff previous lenders, and if you pass those two tests, you qualify for a 1% rate auto loan. You sign some papers and drive off in your new car. Easy-peasy!
Scrimping and saving to pay for the new car with cash is hard. You have to save $1,000 each and every month for two years to save up the $24,000, and the only way to do that is make some extra income by working longer hours, and sacrificing numerous pleasures–being a shopaholic, going out to eat frequently, $5 coffee drinks, jetting somewhere for a long weekend, etc.
The sacrifice and discipline required are hard. What’s the pay-off in avoiding debt? Not much–after all, the new auto loan payment is modest. If we take a 5-year or 7-year loan, it’s even less. By borrowing $23,000, we get to keep all our fun treats and spending pleasures, and we get the new car, too.

Our Financial Buffers Are Thinning, by Charles Hugh Smith

The 2008 financial crisis almost sunk the global financial system, and the backup systems to prevent meltdown are weaker now than they were then. From Charles Hugh Smith at oftwominds.com:

The fragility of our financial buffers will only be revealed when they fail in the next crisis.
While buffer has a specific meaning in chemistry, I am using the word in the broad sense of a reserve resource that absorbs the initial destructive impacts of crises or system overloads. Marshland along a sea coast is a buffer against destructive storm waves, for example.
A savings account acts as a buffer against financial drawdowns or losses of income that would otherwise quickly cascade into a full-blown crisis.
Redundancy of resources can act as a buffer. If an airline maintains an aircraft in reserve, this reserve plane acts as a buffer against the disruption to the airline’s scheduled flights should one of its aircraft be unexpectedly removed from service by a mechanical failure. The reserve aircraft can replace the plane that was withdrawn from service with minimal disruption.
Stockpiles act as buffers against supply disruptions. A storage tank of oil buffers a refinery against any delay in its incoming shipments of crude oil. Supplies of food and water buffer against severe natural disasters that disrupt regional water service and food deliveries.
Credit can act as a financial buffer against unexpectedly high expenses or declines in revenue. If a tire on our vehicle goes flat during a road trip and we only have a few dollars cash, a credit card buffers the disruption by funding the replacement tire and labor.
But over-using credit can end up thinning our financial buffers. If someone starts using their credit card not as an emergency buffer but to augment their cash income–in effect, acting as if the borrowed money was a pay raise rather than a loan–their credit line diminishes to near-zero and when they actually need credit for an emergency, it’s no longer available.
A key feature of buffers is that it’s difficult for observers to tell if they’ve been thinned to the point where they can no longer stave off disruption. Outside observers can’t tell if the oil storage tank is full or empty, or if an individual’s credit card is maxed out or has a completely untapped credit line.