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Trust Greece - To Default
By ALEN MATTICH
A DOW JONES NEWSWIRES COLUMN
In a not very subtle way, the Greek government is blackmailing the euro zone.
To paraphrase, the Greek finance minister said that if the Germans don't continue to bail Greece out, Greece will destroy the single currency.
George Papaconstantinou's actual words to the Financial Times were:
"Restructuring [of Greek debt] is not going to happen.. It would be a fundamental break to the unity of the euro zone."
But the message is the same. That's because, notwithstanding Greek promises to bring the country's finances under control, it is beyond belief that the Greek government can, or is even willing to, enforce the sort of austerity necessary to do so. As long as it cannot or will not, the rest of Europe--which, in effect, means Germany--will have to keep pumping money into the country. Otherwise, Greece will default on its debt. Given that a default of an individual member state is unworkable within the single-currency regime, this means a Greek withdrawal from the euro. And if Greece drops out, the markets are likely to force other "peripheral" European members out.
But how do we know the Greeks can't and won't meet the stringent criteria set out by the International Monetary Fund and the European Union?
Michael Lewis, the author and financial journalist, gives a good account in the latest issue of Vanity Fair. Bear in mind the Greek government, by its own admission, routinely lied about just about every relevant statistic it published, while Transparency International rates Greece, together with Romania, as the most corrupt European Union country, ranking it lower than Ghana, Montenegro, Georgia and Tunisia. So because Greek statistics are so untrustworthy, anecdotal accounts are as good as you're going to get.
Lewis points out that it is reasonable to assume that almost everyone in Greece, including members of Parliament, lies about their tax position. Indeed, not paying taxes is endemic and cultural and unlikely to change soon, not least because the legal process of pursuing tax cheats is so endless, routinely lasting more than a decade, that the authorities don't bother. And because bribery is so much part of the system, on those occasions when tax cheats are caught, they can usually buy their way out of trouble.
For the Greek tax system to be restructured, the country first has to restructure its legal system and somehow end its culture of corruption. No Greek government has a hope in hell of forcing these changes.
Even if you do believe Greek statistics--a very, very foolish proposition for someone investing his own money, though easier to do if you're, say, the European Union and are spending taxpayers' funds--they don't look particularly attractive.
During the first eight months of this year, tax revenues rose 3.3% year-on-year against an official target of 13.7%. True, part of that shortfall will have been caused by a deeper-than-expected economic downturn, triggered by the sovereign-debt crisis. But a third of the Greek economy is underground, unidentified, much less subject to tax. It is a safe bet that the more taxes the government demands, the more the productive part of the economy will hide.
But wait, say supporters, what about the fact that Greece has cut public-sector wages by 15% and operating expenditure by 50%.
First, it would be unrealistic to assume that the Greek government is not massaging these figures to look good. Greeks have always sought the easy way to credibility: trust me, they say. And then they've turned around and lied and, historically, defaulted.
A safe assumption would be that revenues are even lower than reported and that expenditure is even higher. Never mind audits by the European Union and the IMF. It is not in either's interest to force a Greek default. So they will play along with fudges and even outright lies as long as they're not too egregious. But what are acceptable grey areas to them are unlikely to be so for prudent investors.
Second, even with enormous rescue schemes and preferential interest rates, the Greek debt load is proving impossible to contain. The interest bill on its debt during the first eight months of this year was 7% up on the same period last year. Unless the Greek government manages to somehow run a surplus in the not-too-distant future (which is unlikely for the reasons listed above) it will have to continue to be bailed out. The alternative is a debt death spiral and default.
So given the Greek government faces an impossible situation, what incentive does it have to offer much more than cosmetic changes--especially if it believes that the German commitment to the euro is greater than its revulsion at having to keep bailing Greece out? In a word, none.
Clear
China Talk Resurfaces In Euro Market
By KATIE MARTIN
Of DOW JONES NEWSWIRES
LONDON -- Speculation that China may be buying euros to indirectly hold down the yuan is once again circulating around the currency markets as observers struggle to explain a burst higher in the single currency Thursday.
The euro surged against the dollar mid-way through European trading hours, and most analysts attributed the move to a successful auction of Spanish government debt. A number of pre-existing orders to buy, clustered just above $1.30, also appears to have played a role.
Some believe that curious forces could be at play, however. In particular, China is seen as a possible source of euro buying as it seeks to hold down the broad value of the yuan, which has recently hit a series of record highs against the dollar.
"You can never prove it, but maybe this is some Chinese buying," said Lutz Karpowitz, a currencies analyst at Commerzbank.
The People's Bank of China's news department couldn't be reached for comment Thursday.
Amid ever-increasing international pressure on China to allow greater and faster strength in the yuan, the PBOC has allowed the yuan to climb unusually quickly against the dollar of late, with its key dollar-fixing rate dropping to a record low of CNY6.7181 Thursday. That marks an appreciation of around 1% in the yuan over the last eight trading days--a small shift for most major currencies, but a significant move for the tightly controlled yuan.
That kind of currency strength, while modest, poses a risk to China's exports by making the country's products appear more expensive abroad.
A weaker dollar against other major currencies would be a neat way to counteract that pressure, as it dents the yuan's value on a trade-weighted basis. "It's very convenient for Beijing," said Karpowitz. Another investor, who didn't wish to be named, agreed that this explanation "makes sense."
Ideas such as these are common features of the rumor-packed currency markets, and China's involvement is all but impossible to prove or disprove.
Many analysts find this explanation for currency shifts farfetched. Nonetheless, this theory has cropped up a number of times since China dropped its direct dollar peg in June, particularly around intraday currency moves that are tough to explain.
Thursday's jump in the euro arguably fits that description. It has gained sharply this week as investors have turned more pessimistic about the dollar, but the backdrop for the euro itself isn't too great, either, with shaky data on German business sentiment and on euro-zone industrial output in recent days.
Thursday's Spanish government debt auction was smooth and successful, with the treasury selling EUR4 billion of long-dated debt with a lower price tag than many had expected. Still, previous auctions along these lines have tended to move the currency only if they are judged unsuccessful. Positive results rarely boost the euro so strongly.
Meanwhile, China is under sustained pressure by the U.S. to let the yuan, often also called the renminbi, climb much faster than it has done to date.
"A spurt of renminbi appreciation in the last few days may not be enough to dampen growing anger in Washington at how slowly the Chinese currency has moved since the de-facto peg was loosened in June," noted Mark Williams, senior China economist at research firm Capital Economics Thursday.
"Publication of the U.S. Treasury's report on currency manipulation, due in mid October, provides the next potential flashpoint," he added.
At 1245 GMT, the euro was trading at $1.3056 against the dollar. At around 1100 GMT, it hit the day's peak of $1.3110, according to trading system EBS, marking a total climb of almost 0.6% since its rapid short-term ascent began earlier in the session.
---By Katie Martin, Dow Jones Newswires; 44 20 7842 9346; katie.martin@dowjones.com
--(Liu Li in Beijing contributed to this article.)
Signs That Fear May Make A Comeback Soon
By KEN ODELUGA
Of DOW JONES NEWSWIRES
LONDON -- After the heady days at the height of summer, volatility, like the weather, has cooled off sharply, leading some market watchers to suggest the time is ripe for a rebound in risk aversion indicators.
Judging by the recent trajectory of the Chicago Board of Exchange's CBOE Volatility Index, or VIX, also known as the "fear index," one could say the "fears' that it measures have fallen markedly in the space of the last four months.
In fact, given that VIX mathematically expresses market expectations of near-term volatility conveyed by S&P 500 stock index option prices, it's clear that at the very least, equity market players have become more sanguine of late.
The VIX's 52-week high is 48.20, which it hit May 21, 2010. Since May, VIX has recovered to its current level of just over 22.
Since the start of the summer, marked roughly by deep concerns about the fiscal issues in "peripheral" European countries, such as Greece, several developments have served to calm the risk picture somewhat.
In July, most major European banks were judged to have passed "stress tests." Even amid doubts about the tests' validity, the calming effect on markets was real enough.
And there has been a steady series of reasonably well taken-up bond auctions in Greece, Spain, Portugal and elsewhere, including Thursday's sale of EUR4 billion worth of Spanish ultra-long government bonds, the maximum Spain's treasury had intended to sell.
More recently, noted Manuel Oliveri, currency strategist at UBS, "our risk index has moved back into negative territory (i.e. positive on risk), suggesting that risk aversion has decreased markedly during the last few weeks." He cited data showing an improvement in U.S. labor market conditions as signalled by the latest monthly payrolls, decreasing "expectations for a double-dip recession."
However, he cautioned that signs this week could be taken as a warning. "The BOJ's stance on intervention policy [and the BOJ's actual intervention this week] supported some of the observed market behavior. Stocks and crude oil, however, have failed to benefit strongly from the renewed increase in easing expectations....this may provide a first warning signal to risk assets for the weeks to come, and speaks against becoming to bullish on risk sentiment."
Oliveri notes, under such conditions, the USD/CAD pair "would be one way to play a return of risk aversion. USD/CAD indeed keeps a strong correlation to risk sentiment and hence USD/CAD upside would be the result of a renewed rise of risk aversion."
At 1400 GMT, USD/CAD traded at 1.0263.
---By Ken Odeluga, Dow Jones Newswires; +44-20-7842-9297; ken.odeluga@dowjones.com
Tokyo's Yen Shift Poses Trader Puzzle
By RICHARD BARLEY AND SIMON NIXON
A DOW JONES COLUMN
How should investors respond to Japan's surprise intervention to curb the strength of the yen? That depends largely on whether the intervention turns out to be a political gesture, limited to the roughly Y2 trillion so far spent; or something more like the 2003-2004 intervention when the Ministry of Finance intervened to the tune of Y35 trillion. Western policymakers, believing the exercise to be misguided and potentially damaging, will be hoping for the former; but Tokyo certain has room in its budget plans to fund a bigger program.
In the foreign-exchange markets, the initial impact on exchange rates other than dollar-yen has been limited. While the yen has fallen 3.3% against the dollar, the dollar hasn't gained against other currencies. But if the yen is no longer a one-way trade, investors could switch to commodity currencies like the Australian dollar, says BNP Paribas. If dollar weakness causes emerging currencies to gain, the risk is that central banks elsewhere in Asia and Latin America also intervene to stem currency appreciation.
Tokyo's move is also likely to affect fixed-income markets, particularly as the Bank of Japan seems intent on leaving the funds in the market, making this intervention a form of quantitative easing as well. Japanese government bond yields fell Wednesday and could fall further if more liquidity floods into the market. But it will be crucial to watch Japanese fiscal policy, since further quantitative easing could increase sovereign credit risk. Japanese sovereign credit-default swaps have so far remained flat at 67 basis points.
Of course, it's possible a lower yen will succeed in boosting Japanese exporters, which over time will be reflected in investors switching out of bonds into equities. But exports have never been Japan's problem: the real issue is the lack of domestic demand. And on that score, Tokyo's intervention, by reducing the value of domestic earnings, may be self-defeating. That would point to Japan's actions being a political gesture, albeit a futile one. Tokyo's rhetoric suggests otherwise.
--(Simon Nixon is European editor of Heard on the Street. He can be contacted on +44 207 842 9206 and simon.nixon@wsj.com. Richard Barley is a writer for Heard on the Street. He has covered the European corporate credit market in one form or another since 1998. He can be reached at +44-20-7842-9406 or by email: richard.barley@dowjones.com)
Waning Recovery Fuels Global Uncertainty
By MARK WHITEHOUSE, MARCUS WALKER AND JOANN S. LUBLIN
Of THE WALL STREET JOURNAL
The global recovery is still on track, but it's looking increasingly likely to be a long slog for much of the developed world.
Just over a year after the recovery started, its initial vigor has abruptly subsided, thrusting the world into a new period of uncertainty. Hopes of a U.S.-led recovery have faded as American consumers retrench. Bursts of growth in Japan and Germany are waning or expected to do so. China and other big developing nations are still growing strongly, but at a slower rate than they were not long ago.
"We were waiting for the second stage of the rocket, and it just fizzled out," says Ethan Harris, head of developed economics research at Bank of America Merrill Lynch in New York.
Two early boosters of the recovery -- stimulus spending by governments and inventory rebuilding by businesses -- are fading fast. Policy makers have limited options for providing further stimulus. The big question is whether, and when, consumer spending and business investment will pick up the slack.
So far, the evidence is mixed. The burgeoning ranks of consumers in developing economies could provide a boost. But companies in the U.S. and Europe remain reluctant to do the kind of hiring needed to fuel a revival of consumer spending.
"I don't think anything positive is going to happen this year," says Carol Bartz, chief executive of Internet company Yahoo Inc., which hasn't increased its staff in the past couple of quarters. "Unless the U.S. settles down, the globe can't settle down."
Reflecting the uncertainty, most countries' stock markets are well below their peaks in the spring. The Global Dow index, which tracks the performance of 200 blue-chip companies world-wide, closed at 1871.81 Friday, down 10.3% from its April high of 2087.12.
The dominant outlook for the global economy: A long period of lackluster growth, with little progress in bringing down unemployment in the hardest-hit advanced economies such as the U.S., Ireland and Spain. Some parts of the world most likely will do fine. But the chances of a much better outcome have become more remote, while the risk that things could get worse is significant.
Here are three scenarios for the global economy over the coming year:
Feeble Growth
In recent weeks, data from around the world reveal a growth downshift. Companies that had been rushing to restock their inventories are now ordering only what they need to meet existing demand, affecting the entire global supply chain.
A measure of business activity compiled by J.P. Morgan Chase & Co. fell to 53.9 in August, above the 50 mark that signals growth but below the April peak of 57.7. Growth in world exports slowed to an annualized rate of 7.4% in this year's first half, down from a spectacular 47.5% in last year's second half.
At Duke Energy Corp., which supplies electricity to many manufacturers in the Midwest and Southeast, Chief Executive Jim Rogers says that despite an initial rebound, he doesn't expect industrial sales to "claw back" to prerecession levels until 2014. Over the past 30 years, he says, "there has never been a recession where the recovery has been so anemic as this one."
The stalling growth comes as policy makers are curtailing stimulus spending or, in the case of China and other Asian countries, tightening credit to avoid overheating. Economists at Goldman Sachs Group Inc. estimate that, in the U.S., the declining flow of government money will subtract about one-half percentage point from annualized growth in the three quarters to come, and more later.
In Europe, governments from Greece to the United Kingdom have begun cutting spending and raising taxes to reduce budget deficits. Even fiscally stronger Germany plans to trim spending next year. The belt tightening is likely to slow growth in the 16-nation euro zone economy, which grew at a brisk 3.9% annualized rate in the second quarter thanks to strong domestic demand and stellar German exports.
"The elephant in the room is fiscal tightening," says Julian Callow, an economist at Barclays Capital in London.
The European economy tends to lag behind the U.S., which suggests more weakness to come. German exports and new industrial orders fell in July, a first sign that the slowdown in world trade is affecting Europe's biggest economy.
Nancy McKinstry, the American-born chief executive of Wolters Kluwer NV, a global information-services company based in the Netherlands, says she expects the tepid growth to last through next year. "It will really be into 2012 and 2013 before we see things recover on a global scale," she says.
In the U.S., it is consumers who are retrenching. U.S. retail sales
Brave New Banking World, Same As The Old One
By ALEN MATTICH
A DOW JONES NEWSWIRES COLUMN
There are three bits of news relating to the banking sector worth bearing in mind Monday.
First, bank shares responded positively to details of the new regulatory agreement concerning bank capital levels. Second, pay for the City of London's junior bankers jumped 12% on the year, according to an industry recruitment firm. And finally, the sovereign debt yield curve is steepening.
All three suggest that the brave new banking era will be a lot more like the bad old pre-Lehman one than is healthy. Which means more moral hazard and more financial market catastrophe over the coming years.
On the face of it, the banking regulators have instituted some tough new capital and liquidity rules. The minimum amount of equity banks will have to hold is going up to 4.5% from 2%. Tack on a just in case capital buffer and that Tier 1 ratio rises to 7%. Finally, there's a pro-cyclical capital requirement. In good times, banks will be forced to hold even more capital to prevent excess lending.
So why should Europe's banking shares tack on a near 2% gain in early trade? Because the requirements will be imposed only very gently over eight years or so. And banks almost universally already meet most of the capital requirements. That's because regulators have colluded with them over asset valuation, allowing absurdly overpriced valuations to create the illusion of strong earnings which, in turn, were tacked on to the capital base.
The jump in salaries, and a return to boom time bonuses and hiring practices, merely follows on from banks' expectations strong earnings growth will be maintained--new regulations notwithstanding. OK, so some of the rise in wages reflects the paring back of cash bonuses, which are being replaced by share options. But to all appearances, the difference for those employed in the industry between now and the years before Lehman are trivial.
As for the rise in longer dated bond yields, this points to an expectation that government-subsidized earnings will keep running for a long time yet. Banks can borrow fantastically cheaply from central banks and then invest the money straight into longer dated bonds. The yield differential looks like free money. But it is in fact a central bank-engineered transfer of wealth from prudent savers to bankers. Long dated yields are rising because investors realize inflation will be picking up in the years to come. And inflation will be picking up because central bankers are committed to very low short rates for a very long while. Inflation will provide the additional boost of lifting the value of assets on banks' books.
In other words, bankers, as ever, are the biggest winners to come out of the disaster they were so instrumental in creating.
But that doesn't mean things can't go wrong.
John Hussman, the fund manager, points out Wall Street's profit margins are 50% above historic norm. And profit margins are mean reverting.
"A great deal of what represents paper wealth (in the banking sector), created out of nothing but a sharpened pencil, will be wiped away in the coming years, because there are not sufficient cash flows behind those asset valuations," he wrote in his latest weekly note.
When the next accident happens to the industry--and, because reform is superficial, while moral hazard has been reinforced, this will happen sooner rather than later--governments and central banks will no longer be in a position to rescue the banks. The public will not stand for it and any effort to do so would undoubtedly be met with lynch parties.
But until then, savers and prudent investors will continue to be punished and bankers rewarded.
(Alen Mattich is a senior reporter and has been writing a column on market strategy for seven years. He can be reached at +44-20-7842-9286 or by email: alen.mattich@dowjones.com)
Japan Ozawa's Forex, Funding Talk Would Face Major Tests
By ANDREW MONAHAN
Of DOW JONES NEWSWIRES
TOKYO -- Japan's shadow shogun, Ichiro Ozawa, wants to step into the limelight, but could his currency and fiscal policy proposals stand up to the glare?
Many investors are doubtful. Their concerns are mounting as the ruling-Democratic Party of Japan power-broker tries to oust Prime Minister Naoto Kan as party president in a Sept. 14 election in which only party members vote. Polls suggest the vote could go either way.
Ozawa has talked a tougher line than Kan on the need for currency market intervention to curb the soaring yen. He has also proposed unorthodox steps--issuing no-interest bonds and securitizing government assets-to fund spending increases he advocates.
The talk is bold, but would be difficult to turn into effective action. That means even if Ozawa becomes prime minister the yen could continue to strengthen, hurting the country's key export sector.
Ozawa has called for around Y2 trillion in fresh economic stimulus, which he himself admits may require more Japanese government bond issuance.
That in turn could pressure JGB yields higher, as investors demand a greater premium for lending money to a government increasingly at risk of a future fiscal crisis.
If Ozawa wins, it would likely be by a thin margin, leaving the DPJ fractured and the political landscape uncertain. Ozawa "would not be able to secure Y2 trillion" unless he could form a coalition to circumvent the split parliament, said Goldman Sachs economist Chiwoong Lee.
A Kan win could also lead to an early general election, as Ozawa and his supporters may threaten to bolt from the party.
"In either case, the likelihood of currency intervention would be reduced," increasing the chance of further yen gains, said Masafumi Yamamoto, chief foreign exchange strategist in Japan for Barclays Capital.
Even if Ozawa manages to win and take the reins of government, he would still be constrained by international expectations that Japan won't intervene.
"Japanese currency policy won't change even if a new Ozawa administration takes over, as he will face the same difficulties regarding intervention that Kan has," said Osamu Takashima, chief foreign exchange strategist at Citibank Japan.
Chief among the hurdles is an agreement among the Group of 20 wealthy and developing nations not to conduct competitive currency devaluations, Takashima said. Japan has joined the U.S. and other countries in criticizing China for keeping the yuan weak, making it even harder for Tokyo to justify any intervention, analysts say.
Still, any sharp drops in the dollar below Y80 could prod the government, whether led by Ozawa or Kan, to wade into currency markets, traders say. The dollar traded at Y84.05 late Friday in Tokyo.
But as Japan would be acting alone in any yen-selling campaign, without the help of the U.S. or other countries, the effects could be limited. The size of the foreign exchange market has increased dramatically since 2004, when Japan last conducted intervention, which even then had a limited effect. A recent survey from the Bank for International Settlements shows that trading between the dollar and yen has nearly doubled between 2004 and 2010.
"It's not easy to change market trends," given the market's massive size, said Kenichi Nishii, senior manager in the foreign exchange sales department at Bank of Tokyo-Mitsubishi UFJ. The example of the Swiss National Bank, which tried and failed to halt the Swiss franc's rise earlier this year, proves that point, Nishii said.
Ozawa's rhetoric on funding would also likely run into inconvenient market realities.
Issuing zero-coupon bonds, to keep interest rates from rising, would be meant to tap the savings of Japan's expanding elderly population as such bonds would be made exempt from inheritance tax. But as only 4% of the population is wealthy enough to be subject to such taxes, critics have assailed the proposal as likely to benefit only the rich.
The lost tax revenue would mean "net government revenue would be almost zero, so this would not contribute to fiscal consolidation," said Chotaro Morita, head of Japan fixed income at Barclays Capital in Japan.
Meanwhile, Ozawa's proposals to securitize some Y200 trillion government assets to create funds for policy spending likely would likely meet with a "very muted market environment for such products," said Takahira Ogawa, director for sovereign ratings at Standard & Poor's.
Other analysts also expressed doubt about Ozawa's funding ideas.
Proceeds from Ozawa's proposed programs "will not likely change the fundamental fiscal arithmetic that either stronger tax revenue performance or continued expenditure restraint, or both" are needed to reduce th
Merkel Calls For EU Common Energy Policy
AFP
RIGA, Latvia -- The European Union needs a common energy policy that would take into account smaller nations, German chancellor Angela Merkel said during a visit to Latvia on Tuesday.
"We need to do a common energy policy which will take in account everyone," Merkel told reporters.
"This may be beneficial to talk about closer co-operation between eastern and central European countries and Russia," she said.
On her official visit to Latvia, Merkel met Latvia's Prime Minister Valdis Dombrovskis Tuesday to discuss issues of energy, economic and scientific co-operation, and the relationship with Russia.
Latvia, along with Estonia and Lithuania, are the "energy islands' within the 27-nation European Union, all dependent on the Russian energy supplies.
The nations have been working on establishing energy connections with Sweden and Poland. The three Baltic nations fear that Moscow could use its gas domination to push forward its foreign policy in the region scarred by the 50 years of the Soviet occupation.
"I think that in any case, the time has come for Latvia, Russia, and Germany to intensively work on the intensification of the relationships," Merkel said after a meeting with Latvia's President Valdis Zatlers.
A Baltic nation of 2.2 million people, Latvia broke free from the Soviet Union in 1991. In 2004, it joined the EU and the North Atlantic Treaty Organization.
Can Europe's Governments Hold The Line?
Posted by Terence Roth
Strikes and other protest actions that now have spread from Greece to Europe's big economies cast a cloud over European Union reforms and economic recovery.
Scenes from France and the U.K. this week are confirmation that Europe's political elite haven't sold workers and households on the austerity thing. Brussels and national leaders are nobly pursuing fiscal rehab, but their electorates aren't going down without a fight.
That's dangerous, with financial markets and ratings agencies never blinking when looking for signs of weakening on deficit-reduction programs.
France could become the toughest test. Say what you will about a retirement age at a generous 60 years. French workers are now told they need to work another two, AND pay higher taxes during their working lives for good measure.
U.S. workers would shake their heads in disbelief at retiring at that age with full benefits. But they aren't in Lille or Lyons and haven't paid into a generous system for others that now looks more elusive for them.
Expect similar actions elsewhere in Europe as the austerity programs decided in the spring begin turning into law after the summer break.
The earliest endgame will come in Greece. The long-suffering Greek treasury now is paying nearly 12% interest on its 10-year bonds, an unsustainable rate that is 9.6 percentage points more than the Germans pay.
At one point, the Greek treasury won't be able cover debt servicing unless the market gives it slack, which sure doesn't appear likely soon. That means a possible restructuring and another euro crisis.
Governments in the rest of Europe, tempted to lower the steam with a few concessions, need only take a trip to Athens.
-For continuously updated news from The Wall Street Journal, see WSJ.com athttp://wsj.com.