Turning Japanese

With depressing predictability, Europe seems to be turning Japanese - see the link to an excellent article by the less-hysterical-than-usual Ambrose Evans-Pritchard. The reasons have been clear for along time for anyone with half a brain and half a memory. Like Japan, the Europeans have failed to properly clean up their banks balance sheets, instead hoping that time and inflation will gradually reduce the problems currently hidden away by the simple trick of hopelessly optimistic marking to market of many loan assets - creating the dreaded zombie banks that act as a buffer to credit and capital allocation rather than a conduit Like Japan, they have an ageing population. Like Japan, they have an overvalued currency. Like Japan, they have made minimal structural changes to an economic model that is clearly broken - in particular very inflexible labour markets. Like Japan, inflation is turning into deflation, and already has done in several eurozone countries. Like Japan, the central bank has made some noise but actually done very little.

Europe can still fix these problems relatively easily, but seems to lack the political will to do so. The French are making things worse by taxing everyone and everything, and then changing their minds whenever unions or farmers protest, the Italians are doing little except squabble, the Greeks seem to be trying to wriggle out of their commitments to the Troika, the Spanish and Portuguese are making the right noises but it's far from clear that even half of what they say will be put into practice. And of course the Germans are steaming ahead serenely, seemingly unconcerned by the fate of all around them. To be fair to Germany, it is only their frugality over the years and consequent economic strength now that is holding the eurozone together, but I'm afraid they will have to accept and ECB rate cut to help out their weaker neighbours and weaken the Euro or they risk tipping the whole thing over the edge into a new depression.

Strangely, the Euro itself is not in danger at present. As long as the politicians want it, it will survive. A fact that seems lost to most non-eurozone commentators. If one of the euro-sceptic parties gets into power somewhere though, then all bets are off. Marine Le Pen with her Front National in France looks the most likely at the moment, but none of them can be written off entirely.

In the meantime, prepare for more talk from the ECB, but only put money on a recovery once they've actually acted.

More can kicking....

So apparently the crisis is over. The Republicans caved in and now a budget a raise of the debt ceiling limit will ne signed by Obama later today. 

Rejoice, rejoice. 

Except the crisis isn't over. All they've done is put it off till January and February, when the new authorities expire. So we shall reconvene on this with a hangover in early January. And in the meantime the uncertainty persists, leaving a small economic hangover in it's wake as firms delay investments and spending. 

Meanwhile, in civilisation, the UK is doing quite nicely. I still like my long £ versus €.

Once more unto the breach

And so it looks like they really might breach the deadline and fail to get either a budget or a debt ceiling increase in place in time to avert a "technical" default.

This raises 2 questions in my mind.

Firstly how long does the default have to last to stop being "technical" and become actual, so to speak

Secondly, what happens if no one really cards? Both political sides are playing brinkmanship on the grounds that a default is so apocalyptic that it can never be allowed to happen, much like the

mutually assured destruction of the Cold War era. But with only 24 hours to go equity markets are broadly flat, bonds haven't sold off except for a few short dated bills which have eased a bit, and most of the world seems remarkably sanguine. Does this mean no one, except the Chinese government, really cares? And if so, then the supposed pressure on the politicians surely is less than expected, meaning it could drag on quite a while.

To be honest I'm not sure what this all means for markets or the US economy, though it surely can't be good news, but I'm starting to think a default, technical or otherwise, may not be anywhere near as bad as everyone fears. 

US default. THE END IS NIGH. Or not.

Personally, I really can't see a way that the 2 sides can agree to either the budget or the debt ceiling, but no doubt at some point they will. In the meantime there is the very real possibility that the US will default on some securities. Because treasuries apparently don't contain cross-default wording (most bond issuers have what is termed cross-default clauses. This basically means that if they default on one bond, they default on all - a strong incentive to not miss any coupon payments or maturities. The US government apparently doesn't have this. Maybe investors should insist on it in the future?) there will then be some defaulted US government bonds, and some non-defaulted - until they mature or a coupon is due anyway.

This will clearly cause havoc - especially in the repo market, where few banks or clearers have systems that are designed to allow differentiation between defaulted and non-defaulted US securities. As a result i imagine many will simply refuse to take any treasuries as collateral. Clearly very bad news, and many are saying this is another Lehman moment which will tip the world back into financial chaos.

I'm afraid I don't agree. The Lehman problem was in large part caused by its sudden and unexpected nature. No-one had planned for Lehman to actually disappear over that weekend. I had a bbq with a friend who worked for Lehman that weekend and we were laughing about him working for BofA, Merrill or Barclays on Monday, but none of us thought the company would disappear.

The difference this time is everyone can see it coming, and has had weeks, or even months if they had their eyes open, to get themselves sorted out. Yes there will be ructions, but most players will by now have contingency plans in place, and probably already in full swing. Other collateral than treasuries will be pledged in repo, investors are already shying away from short-dates treasuries. For the most part it will be a huge inconvenience, not a disaster.

I hope I'm right.