The Great Debate UK
By Laurence Copeland. The opinions expressed are his own.
Not many people seem to have noticed, but something almost unthinkable has happened in the Credit Default Swap (CDS) market recently. It is now one point cheaper to insure against a default by Her Majesty’s Government than by the Federal Republic of Germany. Given that only a few months ago, Markit was quoting twice as much to insure against a default on gilts as on bunds, this is a major change – but what is it telling us?
The message is unclear, but my guess is it is not quite the one which Britain’s Chancellor, quite reasonably from his point of view, would have us believe. Yes, the market has faith in our ability and willingness to repay – but that is far from the whole story.
The hint is in the fact that Japan (with its enormous government debt, even before it gets very far with post-tsunami reconstruction) and post-downgrade USA also have low CDS rates. As I have pointed out many times before in these blogs, what we have in common with Japan and America, apart from rockbottom government bond yields and associated low CDS rates, is the freedom to print our own currency. The fact that the three of us have massive debt burdens is therefore regarded as irrelevant. By contrast, this freedom is denied to euro zone countries, who are supposed to repay debt out of government revenue, which makes their creditworthiness dependent on their ability to collect tax and their prospective future growth rates which will determine the size of their tax base. Although Germany has a reasonably modest debt-to-GDP ratio, it cannot straightforwardly print money to repay its creditors. Add to that the fact that the market is finally waking up to the realisation that Germany is coming under heavy pressure to shoulder the debt of the rest of the euro zone, and its debt level suddenly seems far less modest.
It is often said that the markets can only concentrate on one thing at a time, which seems strange – but how else to interpret the current state of affairs? How else can one explain the willingness of the market to lend unlimited amounts to America even though the Fed has made it plain that it will carry on printing money until inflation revives and the dollar gets even weaker? It certainly makes sense for investors to ignore the negligible risk of a CDS-triggering default by Britain or America – but leaving aside CDS rates, even if outright default is ruled out, why would anyone want to buy five-year gilts or U.S. Treasuries at yields of barely 1 percent?
The euro zone debt crisis has now spread from the sovereigns – after the ECB came in and purchased Italian and Spanish debt – to the banking sector. Although the EU authorities put in place a short-selling ban, which has another week to run, the banking sector is back at the pre-ban levels or in some cases even lower.
Europe’s banks are by and large less capitalised than their U.S. peers. They are also exposed to Europe’s sovereign debt and European loan books. Even if a member state manages to avoid a default, growth is now slowing and we could be in line for another recession that would most likely increase bad debts and further erode banks’ profits.
The UK, USA, the PIIGS (Ireland and Italy are together in the same stye), France is in poor fiscal shape – OK, Germany is ostensibly living within its means, but it looks a lot less solvent when you remember that it has underwritten the rest of the euro zone (in large part, to protect its own irresponsible banks). In any case, as I have argued in previous blogs, this or a future German Government is likely to cave in to the pressure from its own electorate and from inflationist economists at home and abroad to join the party and spend, spend, spend. Only Australia and Canada, riding high on the commodities price boom, and a handful of small countries, look stable.
Where will it all end?
With inflation, almost certainly, but beyond that, it is hard to say. However, there is one prediction I would offer for the medium to long term outcome, and it applies not only to the euro zone, but to Britain and America too – in fact to the whole of the comfortable, complacent industrialised world – and it is this.
Whenever I see photos of Chancellor Merkel these days, I’m reminded of the lugubrious features of the creature in the Restaurant at the End of the World, as it recommended to guests which part of its own anatomy they should eat. The details of the “Deal to Save the Euro” are still mysterious and have been given a misleading spin in the official releases, but one or two points seem clear.
First, the package is a compromise – a little bit of default (as required by a reality check) plus assistance to Greece which looks very generous but is still not enough to give it a realistic chance of paying its remaining debts. So the can has been kicked further down the same road yet again.
Have you ever wanted to write a major speech for Pope Benedict to deliver? What would you say? How much leeway would you have if you were chosen to be the papal ghostwriter?
Having just got back from a couple of days in Hannover, I couldn’t help but be struck by the dominance of the local news agenda by two topics – and the almost complete absence of a third. Taking the British media at face value, I might have expected a city in near-panic, with people nervously scanning menus for safe dishes to order and maybe antiseptic handwashing facilities being hurriedly installed in public places. In fact, the town looked exactly as I remembered it from my last visit a few years ago, with E.coli rarely mentioned either in conversation or on the 24-hour TV news channels.
In fact, apart from endless replays of the goals from Tuesday night’s football (Germany versus Azerbaijan, a real clash of the Titans that must have been!), the news was all about the remote risk of a meltdown in the country’s nuclear power plants, and the anything-but-remote risk of meltdown in what is left of the Greek economy.
-Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own.-
The Governor of the ECB, Jean-Claude Trichet has raised interest rates by 0.25 percentage points – and quite right too. For us in the UK, blaming rising prices on temporary disturbances in the world’s commodity markets is a figleaf to hide the fact that we are actually embarking on a partial default-by-inflation. For Europe, it is a different story. For one thing, the Germany-Austria-Netherlands bloc is, if not booming, at least chugging along at a highly respectable rate, and as the ECB Governor said today in response to a question about the impact of the rate rise on Portugal, his job is to set interest rates for the Eurozone as a whole, not just for the benefit of one of its smallest and weakest members.
from Global News Journal:
The consensus view in Germany is that Angela Merkel's abrupt reversal on nuclear energy after Fukushima was a transparent ploy to shore up support in an important state election in Baden-Wuerttemberg. If indeed that was her intention (she denies any political motive) then she miscalculated horribly. Her party was ousted from government in B-W on Sunday after running the prosperous southern region for 58 straight years. But what if Merkel was really thinking longer-term -- ie beyond the state vote to the next federal election in 2013? After the Japan catastrophe she may well have realised that her chances of getting elected to a third term were next-to-nil if she didn't pivot quickly on nuclear. There are two good reasons why that is probably a safe assumption. First is the extent of anti-nuclear sentiment in Germany. A recent poll for Stern magazine showed nearly two in three Germans would like to see the country's 17 nuclear power plants shut down within 5 years. The nuclear issue was the decisive factor in the B-W election. And you can bet it will play an important role in the next national vote -- even if it is 2-1/2 years away. The second reason why the reversal looks like a good strategic decision from a political point of view is the dire state of Merkel's junior partner in government -- the Free Democrats. It was the strength of the FDP which vaulted her to a second term in September 2009. But now it looks like their weakness could be her undoing in 2013. Merkel probably needs the FDP to score at least 10 percent in the next vote to give her a chance of renewing her "black-yellow" coalition. Right now the FDP is hovering at a meagre 5 percent and it is difficult to see how they double that anytime soon. The nuclear shift widens Merkel's options in one fell swoop. Suddenly the issue that made a coalition between Merkel's Christian Democrats and the Greens unthinkable at the federal level has vanished. Her party set a precedent by hooking up with the Greens in the city-state of Hamburg in 2008. Now she has more than two years to lay the foundations for a similar partnership in Berlin. By then voters may see Merkel's nuclear U-turn in a different light. And only then will it be truly clear if it was a huge political mistake, as the Baden-Wuerttemberg vote suggests, or a prescient strategic coup.
– Laurence Copeland is a professor of finance at Cardiff University Business School. The opinions expressed are his own. –
Supporting Ireland to the tune of a few billion quid must look like a no-brainer to the British Government. We should not make the same mistake as the Germans, who managed to get the worst of both worlds over Greece – forced by the scale of their bank exposure to support Greece, but providing the money with ill will, causing bitterness rather than gratitude – and now repeating the error in the Irish case.
Ireland’s banking crisis reached boiling point this week. The Irish authorities are still adamant the country doesn’t need a bailout and are trying to draw a distinction between a sovereign bailout (which Irish Prime Minister Brian Cowen, Finance Minister Brian Lenihan et al claim they don’t need) and banking sector support (which they most definitely do).