Ireland suffers as her politicians and the Euro zone dither, whilst Portugal waits on the sidelines

Before I address the latest developments in the Euro zone crisis I would like to draw your attention to two other factors which are at play in world markets at this time. The first follows on from the issues concerning China that I discussed last week particularly in my article on the 11th of November. The inflation fears I discussed are starting to have an impact on the Chinese stock market as the Shanghai Composite Index has fallen by 3.98% this morning and after the heavy falls on Friday we now have a fall of 8% in three days. We will have to see how European and US equity markets respond to this.

Long-term and government bond yields are rising: not what QE2 was supposed to provide

Also we have seen declines in government bond prices and rises in interest rates/yields in places which are not directly influenced by the Euro zone crisis. For example the ten-year UK gilt or government bond now yields 3.26% which whilst still low in historical terms has risen by one-third of a percentage point recently. In spite of the commencement of US government bond purchases by the US Federal Reserve under the new so-called QE2 programme which started on Friday we have seen US yields rise recently too. For example her ten-year yield is now 2.91% and her long bond or thirty-year now yields 4.37%. This is not what you might read elsewhere as many journalists have reported falls in US government bond yields since QE2 began in spite of the fact that what really took place was a shift in the shape of the yield curve(which I discussed on the 8th of November)  and this has now been replaced by rises. On the day of the FOMC meeting I established some benchmarks for future reference and the ten-year yield has since risen by 0.34% and the thirty-year by 0.46%. So if you argue that one of the objectives of QE2 or Ben Bernanke’s Bazooka was to reduce longer-term interest rates you can only look at the numbers and say that at this point the policy is not working.

The Euro zone crisis

The general trend of an increase in longer-term interest rates does not help the Euro zone in its crisis as even its benchmark German government bond market has seen rises in yields. This does matter because in essence this is where any bailouts will be financed! So the rise of around 0.15% in German ten-year bund yields will have an impact on current talks in the Euro zone crisis. Also if I may mention a country whose name will only be whispered at the talks that of Spain her ten-year government bond yields have been steadily moving higher through this phase from around 4% to the current 4.56%. I was doing some research yesterday by reading some Portuguese articles and there was an interesting theme, the Portuguese feel that they are the first line of defence for Spain. This is not quite what you will hear from public pronouncements.

Ireland

Late last night there was the first sign of a crack in Irish resistance to receiving an aid package from the Euro zone. In an interview with RTE Prime Minister Cowen said this, “We have to discuss these matters with partners as to how best to underpin financial and banking stability within the euro area”. So perhaps there will be some real negotiations today. For the moment markets are giving Ireland the benefit of the doubt but this lull will not last for ever.

There appear to have been discussions which involve the Euro zone rescue fund stepping in directly to bail out Irish banks and I wish to be clear that I feel that this would be a retrograde step. The reason for this is simple, Ireland’s plight is now so bad she may have to cut herself adrift at some point from parts of her banking sector and so EU support for the sector could lead to Ireland’s range of options going forwards being hamstrung.

There have also been some strange goings on at the Irish central Bank to say the least. I was discussing the situation online with Lorcan RK who follows these matters closely and he pointed out that the “other assets” section on the balance sheet of the Irish central bank has recently increased by some 20 billion Euros.This is not the sort of thing you do by mistake is it? Except there has been no explanation at all. Some might think that the Irish central bank feels it can undertake its own version of Quantitative Easing with what is more than ten per cent of Irish economic output.

The thoughts of Bono of U2

When I discussed the tax wheeze used by Google recently where it moves its money through various jurisdictions to avoid tax I have to confess I had forgotten what one of Ireland’s most famous son’s had also done. This was discussed back in 2009 on the Tax Justice Network.

For over 20 years, U2 benefited from Ireland’s non-taxation of creative income. But in 2006, the government had the audacity to cap the tax break at 250,000 euro annually. So U2 promptly incorporated in the Netherlands, where its royalties would only be subject to a 5% tax rate as opposed to Ireland’s 12.5%. Nothing illegal, but it’s a little hypocritical when someone who wants developed country governments to give more money to poor countries doesn’t want to pay his fair share of taxes.

The criticism looks fair enough to me when you consider Bono’s moralising over the years however he did reply in the Irish Times because he did not think it was fair.

I can understand how people outside the country wouldn’t understand how Ireland got to its prosperity but everybody in Ireland knows that there are some very clever people in the Government and in the Revenue who created a financial architecture that prospered the entire nation.

As I am a fan of some of U2’s music I guess the phrase “heroes with feet of clay” seems appropriate and of course Bono does now have the opportunity to pay his taxes again at home to support his own country in its hour of need.

Greece’s fiscal problems continue to increase

Yesterday as discussed in the comments section on here new figures for Greece’s finances were released by Eurostat. The details are that the new revised numbers for 2009 numbers are a fiscal deficit of 15.4% of her Gross Domestic Product and a National Debt of 126.8% of GDP. This affects the expected numbers for 2010 as they start from a worse position and they are now for a fiscal  deficit of 9.4% of GDP  and a National Debt of 144% of GDP. If you look at my update of October 22nd you can see that I was expecting these numbers so they are not a surprise in themselves but they will one more time lead to a fall in Greek credibility.

Comment

It used to be considered frightening that Greece would have a national debt to GDP ratio of 150% in 2013 or 14 and now it will arrive next year. The sad news is that the minute she returns to international bond markets she will immediately be insolvent. For readers who have not followed this situation Greece does from time to time issue short-term bills but does not offer bonds at this time, she did have plans to do so but they look ever more unrealistic.

The aid scheme looks ever more permanent and I hope the countries which provided it took my advice and used finance which lasted longer than the originally intended period of 3 years.Also there will have to be even more austerity measures if Greece is not to break the conditionality for the aid package. The dangers of a downward-spiral are increasing. Perhaps the decline in Greece’s circumstances is a warning to Ireland.

Portugal

The Portuguese Finance Minister Mr. Santos had this to say yesterday.

The risk is high because we are not facing only a national or country problem. It is the problems of Greece, Portugal and Ireland. This is not a problem of only this country…………This has to do with the euro zone and the stability of the euro zone and that is why contagion in this framework is more likely. It is not because markets consider we have similar situations. They are only similar in what concerns markets, but as I said they are very different.

In this as I have written before there is an element of truth Portugal’s situation is different from Ireland’s and indeed Greece’s. It is also true that it must be difficult being something of a bridesmaid in the current Euro zone negotiations as Ireland has taken the foreground and it appears that Portugal may have to wait. Once the Irish situation comes to a head then the markets and the media will turn their focus to Portugal. However he went onto weaker ground when describing Portugal’s austerity programme which until recently had led to an increase rather than a decrease in public expenditure and this out-turn has been a significant factor in the way markets have become more difficult for her.

The European Central Bank steps up its debt purchases

The Securities Markets Programme has been very active recently and I discussed the issues relating to this on the 9th of November. There is something of an irony here as members of the ECB Governing Council had begun to suggest it would be wound down and one of the opponents of the programme Axel Weber had suggested it should be ended. Instead it is having to be expanded and according to the data just released the SMP has announced purchases of some 1073 million Euro’s of debt in the week up to last Friday. So we now know the actual state of bond markets in Portugal and Ireland last week was even worse than it appeared as their dreadful performances up until bail out rumours gathered force were after support from the ECB.

One other area where the ECB is very active is in that of liquidity provision to Ireland which you could consider a type of backdoor bailout as it now has reached some 130 billion Euros or one years Gross National Product for Ireland. If there is any truth in the rumours that there are the beginnings of a run on some of the Irish banks it may have to provide even more liquidity to them.

Comment

This crisis has had various features. Perhaps the strongest has been the way that the politicians of the Euro zone have been proved to be so out of touch with reality. As I look at their shock and awe package I see two vehicles they constructed for this. The first the EFSF I have discussed many times on here seems ill-equipped to deal with the problems it is likely to encounter. For example it was always likely to face a situation of rising interest-rates and hence costs in any situation it was likely to be called on. I believe that one of the reasons for the delay in dealing with Ireland has been exactly this, an instrument created for political bluster needs to be converted into something which actually works and this is proving to be not so easy.

The other route of accessing the 60 billion of funds under the control of the European Commission is starting to trouble me too. We were told that the funds would be provided by the 16 Euro nations but I am starting to wonder if its funds can be disentangled from the other nations in the EU. Should it prove to be the case that the funds will be contributed too by the other nine nations there will be considerable dissent, not only from the UK.

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16 thoughts on “Ireland suffers as her politicians and the Euro zone dither, whilst Portugal waits on the sidelines

  1. Hi Shaun,

    Interesting article as always. I would like to know your views regarding the following issue:

    In the Greek media, speculation is arising regarding the “intentions” of the troika, which visited Athens again yesterday. Some media tend to state that “The EU (note, the EU, not the ECB) understands that the correction achieved in 2010 is satisfactory, and thus is sympathetic to spreading the measures needed to be taken in view of the increased deficit/debt over a longer timee period”.

    Some others, just state that the troika is adamant that even more measures need to be taken, in order to achieve the currently outlined end-of-2011 target on-time.

    My reasoning is the following: The new data (as you may know, most of these data where debts of “wider state agencies”, such as the public bus service organization in Athens, and others), seem to considerably tip the balance against Greece’s status in both deficit and perhaps more importantly, % of debt in terms of GDP.

    If the current austerity plan, in its original form, did dictate some monstrous pay-backs in 2013/2014, I find it impossible 100% to carry the current plan out, with monstrousx2 adjustments needed.

    What do you foresee happening? Do you think that the “spreading of the crisis” to other PII(G)S members plays a role in what’s going to happen?

    I’d like to have a mini-discussion with a non-Greek on this topic, and this is why I ask you.

    Thanks,

    Ioannis M

    PS: The reason I’m asking is because the time is nigh for me to decide whether to stay in Greece a little longer, or not. A major part of my decision will be influenced by the events to take place by the end of the year, but hey, an independent opinion never hurt anyone!

    • Hi Ioannis

      I know that you have been reading me for a while and know that I suggested a haircut for Greece’s debts as the problems built. Once that was not done it was hard to see how she could escape the mathematics of her problem. Over the last 6 months as the economy has deteriorated and more problems have arisen the economics/mathematics has got worse. As I have written today it is even less likely that she can escape insolvency. If you look at timescales she is starting to look insolvent in the short-term as well as the medium and long-terms.

      What do I expect to happen? If you project forwards what the Euro zone/troika has done so far then they are likely to obfuscate and waffle. However I feel that they are now split with the more Germanic influences wanting to insist on conditionality,which would involve more pain for Greece in terms of austerity. I find it hard to see this ending well and there is a theme here with the reply I have just given to Chris about Ireland of private-sector bondholders not sharing in the financial pain.

      I expect Ireland and then Portugal to end up in the same EU aid boat as Greece fairly shortly. It is hard to be precise with a timescale because if you look at how things have played out so far it would appear that the elected politicians of Europe have quite a capacity for self-delusion….

      I worry about Spain. In terms of bond yields she is a long way from the countries I have just mentioned but there have been more than a few instances of,ahem, questions arising about her statistics, sound familiar?

      Whatever you choose to do,good luck with what must be a difficult decision.

  2. Shaun, why do you think the long term rates are rising? Are the bond markets anticipating the positive affects on the US economy of the USD going down in value?

    • Hi Sean
      I think that several factors are at play at once. The first is tactical is that some investment houses such as Goldmans Sachs felt that QE2 would prioritise some of the longer-dated bond issues and presumably got clients to invest in this area. Since this did not happen they have probably sold out or are sitting on a loss.

      However QE2 on its own is likley to lead to some hoping for more growth and others to be worried about inflation. Whichever way you spread that mix it is unlikely to be good for long-bond (30 year) yields of below 4%. So a higher yield is in fact a logical response almost whatever camp you are in on QE2.

      I think inflation fears are more likely with QE2 than QE1. If I put aside my personal view which is that QE invariably brings inflationary issues and look at it entirely neutrally then one might argue that QE1 was in response to an economic crisis. Accordingly bond markets may have reviewed it favourably or at least not seen it as an outright negative. However if you take that view then you have a problem with QE2 because as I reported in the run-up to it whilst the US economy had showed signs of slowoing there was not a QE1 type crisis.

      I also wonder if there is a threshold up to which bond markets will accept Quantitative Easing but after it they worry about the implications of so much debt sitting on a central banks balance sheet.

      Rather ironically the US dollar has risen since QE2 was announced….. But as I have argued before some of any QE inspired fall is likely to take place before the event if it is well forecast so now the waters start to get a little muddy.

  3. Regarding the long term rates rising, are these outside the 5-6 year maturities targeted by the Fed?

    I’m surprised you didnt mention Meryn’s letter to Mr Osborne on 3.2% Oct inflation. What surprises me is this : the monetary framework invites the BoE to write to explain what policy they will be implementing to bring the rate of inflation back to target. The answer appears to be none. The reason for that appears to be : a) factors are temporary b) forecasts say it will come down on its own. Is this meeting the MPC remit? When do temporary factors become not-so-temporary? Did the remit allow judgments to be made on forecasts, without policy. Isnt the truth here that we have a deflationary monetary policy operating in an inflationary environment.

    Did you see that the BoE are winding down aspects of the Asset Purchase Facility and promising to start the secured commercial paper facility to get working capital to SMEs. Shame this was not heralded earlier.

    Finally, as at end of April 2010 the BoE say that Irish banks accounted for 10% of UK commercial property lending and 14% of UK lending to hotels and restaurants. Lets hope the ECB continue to support UK developments, hotels and restaurants. On this score, did these banks convert euros to sterling to make the loans ?

    • Hi Shire
      To you first question yes in principle with the nuance that whilst some longer-dated bonds will be purchased by the Fed there will not only be fewer than one might pro-rata expect but also that there were expectations of a more than a pro-rata amount of purchases.

      As to the inflation figures and Mr.King I have plenty of thoughts but on a busy day I thought that the Euro zone was more pressing. I had most of an article ready because contrary to what I was just reading on the BBC website it was always likely that this months numbers would be up. As to the APF I feel that this has been rather badly handled and does not reflect much credit on the Bank of England.

      I am not sure of the Euro/£ of the loans you mention but as Bank of Ireland owns Bristol and West and has a savings deal with the Post Office some of the lending will have been financed by £ deposits.

  4. You can only kick a Euro can so far down the road before it sinks into a pothole full of dirty water.
    We are now at that stage, though the Irish, in full blarney mode, are looking backwards while walking forwards and there is about to be a big splash.

    • Hi Mr.K
      I am replying to both comments in one go and yes it is poor timing. But if you will sign up to strategies you do not believe in with the hope you will never actually have to do it then life as we all now has a horrible habit of bringing it to your attention.

      Just as a further point of reference. Two of the sixteen nations have yet to fully ratify the EFSF so that may be another reason why it is not yet in operation. For those interrested the two countries are Slovenia which you might expect and Belgium which you might not.

  5. this is not about bailout money or IR. Cb’s can print, in fact generate any amount they wish with a few keystrokes, at no cost. The back room dealing concerns conditions (nobody will hear about until it is too late) attached to the bailout. All PIIGS et al. will lose some sovereign rights or national privileges to the banksters w/o the populace having any say in or vote on it.

  6. Hello, in fact the outcome of Portugal’s austerity measures started in May are not yet fully known but the 7.3% deficit promise will be fulfilled according to the country’s analists, and even accepted by the opposition parties. So that bit is safe for now, as the country can show it can control its finances. The biggest plight will come next year, with an even more austere “austerity pack”, which includes cuts in public servant wages, tax increase, and lots more, the idea is to bring the deficit down to 4.3% . I am sure if Portugal can guarantee that, we are back into the safe zone. I am an optimisit and I kinda trust our Finance Minister he is a very efficient man and seems to know what he’s doing. Personal opinion of course

  7. “Long-term and government bond yields are rising: not what QE2 was supposed to provide.”

    I still think that this was a strategic move by the Fed. The long term interests of the US are best served by –
    – devaluing its debts and helping the government slowly reduce the deficit
    – rebalancing from mortgage financed consumption back towards exports
    – a solvent reserve bank! (hence fairly short dated Treasuries if you expect rates to rise at some point)

    I am convinced that Ben Bernanke is nobody’s fool – he definitely isn’t stupid (SAT score 1590 so IQ probably >150, economics degree from Harvard summa cum laude), and I bet he’s a lot more pragmatic than most people give him credit for – you need a lot of guile to manoeuvre yourself into a job like his.

    • Judged by his actions, it’s not at all clear to me that Bernanke is nobody’s fool. IQ, academic achievement or political guile do not equate to wisdom. Like Greenspan, he seems a one-trick pony. Meet each supposed crisis with a massive reflation, and keep on reflating long after the crisis point has passed. Distort asset prices, reward speculation, promote unproductive investment. Enjoy the temporary wealth effect,and cross your fingers that this will boost GDP sufficiently to mask structural issues. Repeat until asset prices and speculation are so out of hand that a truly frightening crisis is precipitated. Then repeat again for good measure, and pray that this time, the pattern won’t repeat, and that somehow, it will all miraculously resolve itself. Some chance.

      • I agree that intelligence and political acumen do not necessarily lead to good decision making. If you take Bernanke at face value, then you are right that he is a one trick pony. There are two alternative interpretations you could make though –

        1. He only has limited tools at his disposal (i.e. monetary policy). The government must do their part, and perhaps he is simply guilty of trying to compensate for their failures as best he can.

        2. Perhaps it is naive to take him at face value. Fed policy could be part of a wider plan, coordinated with government officials, to secure a number of different policy objectives (i.e. financial stability, debt management, influencing BOP and exchange rates).

  8. Bernanke (like all his central bank counterparts) is like an overenthusiastic young ward doctor. The patient is in post operative pain and intravenous morphine is given.This makes the patient sick so an anti nausea is given .The patient is still sick so receives another anti nausea.Morphine is stopped because of the sickness and codene is tried,then tramadol.

    In the end the patient is sicker than ever and constipated to boot.Recovery,in fact,takes longer than if no medication had been given and no-one not least the patient.knows what in this cocktail has caused more harm than good.

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