European bonds were not a “safe haven” asset last week while equity markets were cratering, which suggests that the world’s creditors are finally rediscovering sovereign risk. From Tom Luongo at tomluongo.me:
“The problem with socialism is eventually you run out of other people’s money.”
— Margaret Thatcher
For months myself and very few others have been warning about the problems in Europe. That the real problem isn’t in the U.S., though it’s certainly a mess, it is in Europe.
It’s why I focused so hard on Brexit. Would the U.K. actually get out of the EU before it all came crashing down around the deaf and now stunned Brussels technocrats?
A U.K. outside of the EU meant localizing a major problem on the backs of those that 1) engineered it and 2) cheered it as they literally stole hundreds of billions of pounds from them.
But while everyone has been focused on the melting equity markets and what the high priests of monetary wizardry at the central banks were going to do, did anyone notice the complete collapse of European bonds last week?
I could go on with this but I think you get the point.
If Brexit and the coronavirus end the EU, then some good will have come from the latter. From Alasdair Macleod at goldmoney.com:
The EU and euro face a sudden deterioration in economic conditions due to the coronavirus, which seems certain to widen the differences between Germany and the spendthrift Mediterranean members. But a more immediate problem is the increasing likelihood that the ECB will lose control over financial asset prices, particularly those of government bonds.
In the short-term, it seems likely the euro will rise against the dollar as currency and financial distortions, principally in the fx swap market, are unwound. However, the eurozone faces a developing financial crisis comprised of the following elements: a collapse in economic activity, escalating payment failures, a drastic contraction of bank credit and a collapse in bond prices, as well as the medium used to buy them (the euro).
Eventually, Germany is could go it alone by introducing a gold-backed mark, which will only happen after the European Project is finally abandoned.
Brexit came as a shock to the political bureaucracy that comprises the European Union. They had, and still have an ostrich-like stance with their heads in the sand and their rear ends exposed to passing dangers. Their economic incompetence has been exposed for all to see as well as their political ineptitude.
Zero and negative interest rates are catching up to European pensions. From Tyler Durden at zerohedge.com:
When one thinks of pensions crisis, the state of Illinois – with its woefully underfunded retirement system which issues bonds just to fund its existing pension benefits – usually comes to mind. Which is why it is surprising that the first state that may suffer substantial pension cuts is one that actually has one of the world’s best-funded, and most generous, pension systems.
According to the FT, millions of Dutch pensioners are facing material cuts to their retirement income for the first time next year as the Dutch government scrambles to avert a crisis to the country’s €1.6 trillion pension system. And while a last minute intervention by the government may avoid significant cuts to pensions next year – and a revolt by trade unions – if only temporarily, the world finds itself transfixed by the problems facing the Dutch retirement system as it provides an early indication of a wider global pensions funding shortfall, not to mention potential mass unrest once retirees across some of the world’s wealthiest nations suddenly finds themselves with facing haircuts to what they previously believed were unalterable retirement incomes.
There are junior high school students who know more about how economies function than most of the world’s central bankers. From Tyler Durden at zerohedge.com:
Any hopes that the replacement of Mario Draghi, who on Halloween left the ECB more polarized than ever, as the core European nations revolted against the Italian’s profligately loose monetary policy in an unprecedented public demonstration of discord within the European Central Bank…
… with the ECB’s new head, former IMF Director and convicted criminal, Christine Lagarde would result in some easing of tensions, were promptly crushed when Lagarde picked up where Draghi left off, calling on Germany and the Netherlands to use their budget surpluses to fund investments that would help stimulate the economy, in a sharp rebuke that will not win the former French finance minister any friends in fiscally conservative Germany.
In an appeal to Germany’s sense of solidarity, and in hopes that Germany’s memory of hyperinflation has faded enough, Lagarde said that there “isn’t enough solidarity” in the single currency area, adding: “We share a currency, but we don’t share much budgetary policy for now.”
Mario Draghi is all-in on wacko monetary nostrums—like negative interest rates—that haven’t worked in either Europe or Japan. From Tom Luongo at tomluongo.me:
Last year I asked whether Turkey would be “City Zero in Global Contagion.” That question was based on the crisis unfolding in the Turkish lira which materially threatened a number of major European banks, especially those in Italy.
This week highlighted something really interesting for me that, I think, sets in motion a similar thesis about Turkey but for much different reasons. The sovereign debt crisis will come about purely because of a failure of confidence in institutions.
Competence is the key to staying at the top of human dominance hierarchies, not force. Those built on competence tend to last and those built on force are, at best, meta-stable for a specific period of time.
The difference between what’s happening in Turkey with President Erdogan taking control of the Turkish central bank and the end of Mario Draghi’s term heading the ECB cuts to the heart of this issue of competence versus force.
You can’t inflate your way to prosperity. From Alasdair Macleod at mises.org:
Last week, the ECB announced the reintroduction of targeted long-term refinancing operations for the third time. TLTRO-III is scheduled to start from next September. The idea is to make yet more money available for the banks at attractive rates on condition they increase their lending to non-financial entities.
The policy is justified because the ECB sees growing signs the Eurozone economy is stalling, possibly badly. The weaker Eurozone economies are moving into outright recession, and Germany’s motor exports appear to have dramatically slowed, putting a constraint on her whole economy.
The ECB’s reintroduction of TLTRO is an offer of yet more monetary and credit inflation, despite the evidence that unprecedented waves of monetary inflation in the last ten years have failed in all the objectives for which they were designed, except two: governments have continued to get the funds to spend without meaningful restraint, and insolvent banks have been preserved.
Only two months after its asset purchase programme officially ended, the inflationists are at it again. But one wonders why the ECB bothers to delay TLTRO-III until September. If it is such a good thing, why not introduce it now?
The short answer to the question in the title is no. Alasdair Macleod explains why. From Macleod at mises.org:
Despite the ECB’s subsidy of the Eurozone’s banking system, it remains in a sleepwalking state similar to the non-financial, non-crony-capitalist zombified economy. Gone are the heady days of investment banking. There is now a legacy of derivatives and regulators’ fines. Technology has made the over-extended branch network, typical of a European retail bank, a costly white elephant. The market for emptying bank buildings in the towns and villages throughout Europe must be dire, a source of under-provisioned losses. On top of this, the ECB’s interest rate policy has led to lending margins becoming paper-thin.
A negative deposit rate of 0.4% at the ECB has led to negative wholesale (Euribor) money market rates along the yield curve to at least 12 months. This has allowed French banks, for example, to fund Italian government bond positions, stripping out 33 basis points on a “riskless” one-year bond. It’s the peak of collapsed lending margins when even the hare-brained can see the risk is greater than the reward, whatever the regulator says. The entire yield curve is considerably lower than Italian risk implies it should be, given its existing debt obligations, with 10-year Italian government bonds yielding only 2.55%. That’s less than equivalent US Treasuries, the global risk-free standard.
Government bond yields have been and remain considerably reduced through the ECB’s interest rate suppression and its bond-buying programs. The expansion of Eurozone government debt since the Lehman crisis has been about 50% to €9.69 trillion. This expansion, representing €3.1 trillion, compares with the expansion of the Eurosystem’s own balance sheet of €2.8 trillion since 2009. In other words, the expansion of Eurozone government debt has been nearly matched by the ECB’s monetary creation.
Bond prices, such as that of Italian 10-year debt yielding 2.55%, are therefore meaningless in the market sense. This has not been much of an issue so long as asset prices are rising and the global economy is expanding, because monetary inflation will keep the fiat bubble expanding. It is when a credit crisis materializes that the trouble starts. The fiat bubble develops leaks and eventually implodes.
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