After a week in which currency markets had taken centre stage we saw some political side-effects of the moves and rhetoric on Friday. After the intervention by the Bank of Japan last Wednesday the Yen exchange rate has remained fairly stable so far and is now at 85.66 versus the US dollar and 112.19 versus the Euro. I see that in some places this is being described as a success,whereas to my mind if you are going to say that you need to add so far or short-term to the sentence. What Japan needs/wants is for the exchange rate to improve over the medium and long-term as her main business is manufacturing and if you think about it to Nissan,Sony,Toyota et al a few days of improvement is irrelevant in the overall scheme of things.When they look forward and make plans it will be based on expected exchange rates over the next few years or longer.I often see the time spans of financial markets projected onto physical businesses without such caveats.
On the political side the US Treasury Secretary Mr.Geithner had issued a strongly worded criticism of Chinese exchange rate policy as he feels that the Yuan is undervalued leading to an improvement to China’s balance of trade and hence her economy. The next step of this is Mr.Geithner’s real beef in that it is likely to increase the US balance of payments deficit and reduce growth in the US. This did not go down well in Beijing. In addition in what seems unlikely to be a coincidence Japan detained a Chinese fishing boat and her captain after it was found near to some disputed islands.The rhetoric from China which followed this was rather strong.
“If Japan acts willfully, making mistake after mistake, China will take strong countermeasures, and all the consequences will be borne by the Japanese side,”
Those with longer memories will remember not dissimilar disputes with the Soviet Union and the Russia over disputed islands in the past turning out to be proxies for other issues.
These continued what seems at this time like a relentless surge upwards on Friday. The Commodity Research Bureau spot index rose by 3.65 or 0.77% to 475.18. This means that it has now risen by 23.6% over the last year and on that subject apologies for the number I put in my article of Friday which had it at 18%, I have just spotted what I did wrong! Over the past year the strongest component has been foodstuffs which have risen by some 34.8% leading us again to thoughts of “agflation”. And also to thoughts of how such price influences will affect workers at a time when wage rises as likely to be low or non-existent. This has a lot of implications which follow on from a possible fall in real wages.
A metal which could be a commodity if its price was not far too high has seen rallies too recently and the price of gold is now US $1283 and it has rallied by some 17% this year making it one of the better investments of 2010. Silver has also been strong and is now at US $20.96 perounce. To my mind these rallies indicate fear and uncertainty and may also indicate fears for fiat money. Accordingly such rallies sit oddly with the rally in banking shares we have seen as precious metal investors and bank share investors must at this time have virtually opposite views on what will happen next.
The Irish Problem gets worse
After writing about the escalating problems for Ireland from the continued deterioration in prospects for her banking sector mostly caused by Anglo-Irish bank which is fast becoming a dragging anchor on the whole of Ireland I expected a rough day for Ireland on financial markets. It turns out that it was a very rough day. If we look at her government bond market we saw the following, ten-year government bond yields rose to 6.36%. If we look at the wider Irish government bond market as the Irish Stock exchange calculates an all bond index then we see that it fell on the day by 1.54%. It also calculates an under 3 year index and this fell by 0.66%. There are two reasons why I look at the short end of the curve when many others only look at longer benchmarks. The first is that it is a sign of whether a central bank and a government have control of their own debt markets and to see how far official interest rates stretch down the maturity spectrum. As the official interest rate is 1% and we see that Ireland’s shortest dated bond (November 2011)yields 3.09% then we can see that even in the short-term maturities there are worrying signs. I also look at these maturities as they are an area where the European Central Bank often buys if it intervenes. Well on Friday the ECB did buy in some 10 million Euro tranches but as you can see it did not help much. There was some hyperbole about there being no buyers for Irish bonds reported in the press but as I have just pointed out there was at least one.
Part of the problem is that under official estimates Ireland is expected to have a fiscal deficit of 11.6% of GDP and this is after a quite severe fiscal austerity programme which will reduce the deficit by 5.5% of GDP this year. Many are now adding to this further expected losses at Anglo-irish and other Irish banks. As an example Standard and Poors feels that Anglo-Irish will cost another 10 billion Euros in addition to what has been budgeted for. In addition there are problems with the National Asset Management Agency or NAMA which was expected to make a profit but now it looks like it would need a rise in property prices of around 10% to achieve this. Unfortunately the latest data is that Irish residential property prices have fallen by 9.8% and commercial property has fallen by 8% since NAMA was instituted, and these numbers are only until the end of June for residential prices and the fear is that they have fallen further since then.
In a development which was unlikely to improve things on Friday the Irish Prime Minister Mr.Cowen gave an interview to RTE the Irish broadcaster in a state which I believe the Victorians described as “tired and emotional”. This was followed by headlines saying that in future he would be more careful with his social life. The Irish Times has labelled it a very Irish hangover.
In itself a rise in yields does not immediately affect Ireland as the bonds she has issued all appear to be fixed-rate according to the National Treasury Management Agencies website. However it does affect her when she issues new stock as they are likely to have to be issued at a higher more expensive yield. I notice that the Chief Executive of NTMA has said that “there is a good following of Irish bonds.” I notice that in one rather amusing reply someone has pointed out that the Pied Piper had a good following too!
This is important because tomorrow Ireland will issue some four-year and some eight-year bonds.The yield on these will have to be paid by Ireland for the next four and eight years respectively so higher yields have a real cost at this point and it stretches into the future burdening her taxpayers for some time. However there is a further significant level which is the range between 5% and 5.25% where Ireland could expect to get funding from Europe’s European Financial Stability Fund. Any yields above this would beg the question as to why Ireland did not become the first user of this. Rather conveniently the EFSF has received credit ratings from one or two ratings agencies this morning so they too think there is a danger of it being called upon. If we look at Friday’s levels the four-year bond is likely to be below this yield level but the nearest bonds to an eight year benchmark yielded 5.97% and 6.14% respectively so well over.
I remain of the view that I expressed on Friday that for Ireland there would be gains from calling in the EFSF or indeed the IMF to help it out. As she has a severe austerity programme in place she is likely to find that the help would not have too high a price in this area and if she can access cheap funding it would help calm things down as in such a situation one of the biggest problems is fear itself. Indeed IMF money may be accessible at around 3%. It would to my mind help to stop a potential downward spiral and buy Ireland some much-needed space.
This space would allow Ireland to deal with such matters as the “Croke Park Agreement” of last year which effectively excuses public sector workers from meaningful wage reductions in the next few years. In such a situation this not only sends the wrong message but it also means that others will have to take more than their fair share of the burden of austerity. This is an agreement which,in my opinion only brings shame on the parties involved.
Portugal has trouble too
Whilst much of the media concentrates on Ireland there are also problems in Portugal. These problems are somewhat different but they are having if similar effects on Portugal as they are on Ireland. There is one real contrast between the two and that is that the Irish economy had very strong economic growth in the early part of this century whereas Portugal has had slow economic growth for twenty years or so now. So in contrast to the former Irish Tiger we see perhaps an example of what is called in Japan a lost decade.
Adding to these problems we saw a group of opposition finance spokesmen and former finance ministers openly speculating that Portugal may need to call in the IMF. They used an interesting phrase in their discussion about Portugal not being able to issue debt which has significance for the EFSF as I discuss below. At the end of the trading day Portuguese ten-year government bond yields had risen to 6.26% and she too will be awaiting her own bond auction on Wednesday with trepidation.I notice that many called her recent bond auctions a success which I have to say I found slightly odd. Having to issue ten-year bonds at a yield of 5.97% is not a success for Portugal’s taxpayers who have to pay this interest for the next ten years.
I find myself giving the same advice to Portugal that I have to Ireland. There is likely to be merit in acting first and calling in the EFSF/IMF.However her problems are different to Ireland’s and the question would remain exactly how is Portugal going to find some sustained economic growth as even recent economic booms have in the main by-passed her.
The European Financial Stability Fund
As this is now ready for action and even has some freshly minted credit ratings you might think that everything is fine. Well in the euro zone universe that is not entirely true as you see as ever there has been some ambiguity. For this to come into action countries must lose access to debt markets but a definition of exactly what this means is missing. In true Euro speak fashion I would imagine that it means whatever they want it too!
However for a country to access funds it would have to stop being a contributor and that requires a unanimous vote. We have seen Slovakia for example vote no to Greek aid so it is not a done deal.