E.g., 22-10-2019
E.g., 22-10-2019
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    Gavekal Research

    Daily - The Greek Drip-feed Continues

    The troika signaled yesterday that it is preparing to deliver another €8 billion tranche in Greek’s €109 billion bailout program, even while acknowledging that the country has failed to meet its 2011 targets. In our view, this is terrible news, for the following reasons:

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    Daily - The BOE's QE

    The Bank of England’s decision yesterday to start a second round of quantitative easing was almost drowned out by the noise about banking rescues out of Europe. But it was a genuinely important event with instructive features for the rest of Europe and the US. We have been saying since the beginning of the year that QE2 in Britain was much more likely to happen than QE3 in America and that inflation running at double its target rate would not...

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    Daily - The Consequences of the Dexia Bailout

    Since the start of the European crisis, the aim of policymakers has been to shelter sovereign bondholders, chief amongst them the banks, from taking losses on their holdings. And this for two reasons: firstly, the memories of Lehman, Citi, AIG, Fannie, etc… are still fresh in everyone’s mind. Secondly, European banks by and large remain almost as leveraged as they were three years ago (Dexia’s total assets are apparently worth 74x Dexia’s equity...

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    The Euro Debate Continues: A Leveraged EFSF?

    Last week European markets enjoyed a short-lived rally amid talk that a leveraged EMU war chest would be used to shore up Europe’s ailing banking system. One reason such a solution is being considered is that the size of the EFSF, at €440bn, is likely not enough to make a big enough dent in Europe’s growing sovereign debt problem. After all, there is some €3.3 trillion in outstanding GIPSI debt alone, of which a substantial €1.5 trillion is in...

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    Daily - The Risk of Recession and the Variable of Adjustment

    Looking solely at financial markets, it seems impossible to avoid the conclusion that we are heading straight into a global recession: most major equity markets have entered bear territory and registered new 52-week lows, commodity prices are plunging (see our Indicator of Economic Sensitive Prices chart below), spreads are widening everywhere, all currencies except for the US$ and Yen are feeling weak at the knees, etc... As one client put it...

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    Lessons from Ireland

    While George Soros recently said that Ireland should perhaps consider leaving the Eurozone (along with Greece and Portugal), the market does not seem to agree. Irish bonds have seen an extraordinary rally since mid-July, with the 10-year yield recovering from 14% to below 8%, and the two-year yield plunging from 24% to 7%. Thus, in the midst of one of the worst European crises in history, Irish bonds have proved to be the best asset class of the...

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    Garbage In, Garbage Out

    Faced with another bad call in a 1981 match against Tom Gullikson, John McEnroe famously screamed: “You cannot be serious!” Being an avid tennis player in his now very distant youth, Charles often feels compelled to utter those same words as he reads the financial pages. Most recently, his frustration concerns the growing worries about the outlook for UK GDP growth.

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    Daily - Is the IMF Set to Assume its Historic Role?

    The IMF has historically been charged with the task of delivering the news that elected politicians found simply too hard to convey. As the European crisis progresses, it seems increasingly likely that the IMF will once again be charged with this unpleasant task, this time by being the one to pull the plug on the bailouts to Greece. Indeed, it is painfully obvious that Greek debt needs to be restructured (a point made by Dominique Strauss-Kahn...

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    Gavekal Research

    Daily - Is the IMF Set to Assume its Historical Role?

    The IMF has historically been charged with the task of delivering the news that elected politicians found simply too hard to convey. As the European crisis progresses, it seems increasingly likely that the IMF will once again be charged with this unpleasant task, this time by being the one to pull the plug on the bailouts to Greece. Indeed, it is painfully obvious that Greek debt needs to be restructured (a point made by Dominique Strauss-Kahn...

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    Daily - Solving Italy

    As default risk moves up the food chain in Europe, one question we are being asked is whether Italy’s debt needs to be restructured, especially now that S&P has just downgraded Italy’s debt. Our first answer to this question is that it is too early to say; we need to wait to see what happens with Greece. But broadly speaking:

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    The Swiss Version of QE

    How far is the SNB willing to go to defend its new ceiling of 1.20 Francs per Euro, and for how long? The short answer is that, assuming the Euro remains, the SNB will likely defend the ceiling aggressively, so long as this is consistent with the SNB’s desired domestic monetary policy stance. Here is why...

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    Gavekal Research

    The Swiss Version of QE

    How far is the SNB willing to go to defend its new ceiling of 1.20 Francs per Euro, and for how long? The short answer is that, assuming the Euro remains, the SNB will likely defend the ceiling aggressively, so long as this is consistent with the SNB’s desired domestic monetary policy stance. Here is why...

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    Germany Really Will Pay

    Anxiety about the Euro has now intensified to the point where Eurocrats in Brussels talk openly about the risk that the Euro will break up and the US Treasury Secretary feels obliged to fly across the Atlantic to read the Riot Act to his European colleagues. As longstanding detractors of the Frankenstein currency, some of us here at GaveKal do not know whether to laugh or to cry about the apparent vindication of our Euroscepticism. Contrary to...

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    Daily - Overhangs and Uncertainties

    When it comes to the question of who will pick up the tab for capital misallocated under the Euro experiment, we have argued that there are three potential payers (Nordic taxpayers, current bondholders and the ECB) and three players (French civil service, Nordic governments and the Bundesbank). With each disappointing summit, it has become clearer and clearer that these three players cannot agree. In this sense, this weekend’s failure by...

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    Gavekal Research

    Daily - The Neutering of the Bundesbank and the SNB

    As financial markets continue to grapple with the many strands of the European crisis, we thought we would highlight that Europe is really dealing with two separate problems:

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    Gavekal Research

    An Imaginary Conversation Among the European Royalty

    A reader of Charles’ blog (see website) recently posted a very interesting vignette to the site. Non-French speakers please see the translation below in English.

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    Gavekal Research

    Daily - The Franco-German War and the Start of the Euro's Structural Bear Market

    The resignation of Axel Weber earlier this year led Charles to conclude that the Bundesbank would now be on the war path. As Charles explained in An Update on the Euro Debate, one thing he has learnt in his career is that the Bundebank “never forgives and never forgets.” Axel Weber’s resignation thus marked a new phase of hostility in Europe’s policymaking circles, and thus instability for financial markets.

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    Gavekal Research

    QSCB - 4Q11 - The Euro: Staring into the Abyss

    Until this summer, financial instability in the Eurozone seemed manageable and consistent with the notion of necessary "market discipline" to pressure GIPSI countries to reform. However since the collapse of Italian bond markets in July, and as global growth slows substantially, the crisis has entered a very different, incomparably more dangerous stage, making a "muddle through" no longer credible.

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    Daily - Will Government Misery Kill Corporate Prosperity?

    Amid the misery that debt-laden and teetering governments have suffered in the past two years, we have had the offsetting phenomenon of a very strong corporate sector (ex-financials, of course). Whipped into shape by competitive pressures of globalization, and greatly assisted by new management and just-in-time technologies (see Europe and the SAP Recession), OECD companies were able to nimbly respond to the disruptions caused by the Global...

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    Daily - Empty Shelves and Rising Inflation?

    Clearly markets are cynical of recent assurances by policymakers, or central bankers such as Ben Bernanke, that growth is not, in fact, cratering. And so are companies. Discussions with exporters here in Asia reveal that the July/August order books are decidedly underwhelming. Headline figures such as China’s PMI new orders and Korean IP are bearish, and the region’s tech and exporter stocks have sold off rather fiercely. Clearly, OECD retail...

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    Gavekal Research

    Daily - The Consequences of the CHF Ceiling

    Woody Allen once said: “we have reached a crossroad. One way leads us to despair and annihilation; the other to certain death. I hope we choose wisely.” We imagine that this is was how the Swiss National Bank felt yesterday when it decided to place a ceiling on the CHF-Euro exchange rate. Over the years, we have seen a lot of currencies being pegged (HKD, RMB, MYR, DKK…) to another, but the usual pattern is first a currency devaluation,...

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    Gavekal Research

    Daily - A Tough Start to the European Week

    Yesterday saw another worrying meltdown on the European markets. Granted, the US market was closed for Labor Day which meant lower volume, but this was still a significant development. All Euroland equity markets saw losses in excess of -4%, with the DAX being the worst performer, losing –5.3%. As money flowed out of equity markets, bond markets saw solid gains and 10-year Bund yields fell by –16bps to 1.85%, the lowest ever. As we highlighted...

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    Gavekal Research

    Daily - The Three Remaining Options to Save the Euro

    The challenge confronting policymakers in Europe is simple. European sovereigns are reflecting roughly €800bn in losses (poor real estate investments in Spain, civil servants getting paid too much in Greece, etc…) and the problem, of course, is that this loss has, for the most part, yet to be taken by anybody: Greek debt is still marked at par in the books of the ECB, most of the Greek commercial banks, insurance companies, etc… In turn, this...

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    Gavekal Research

    A Big Week for the Euro

    Our readers know we have long been structurally cautious on Europe’s single currency, due to its significant design flaws. These flaws have of course come to the forefront in recent years, and yet the Euro has pushed higher (in nominal terms and on a PPP basis). Our best explanation for this Euro resilience is twofold: 1) The fiscal/political situation in the US has recently looked just as bad, if not worse; and 2) the ECB did not loosen as...

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    Gavekal Research

    The Road to Hell is Paved with Good Intentions

    With losses on GIPSI bonds at roughly €600bn (basically marking the losses to market before the recent ECB intervention drove Italian and Spanish yields back below 6%) and if most of Europe’s sovereign debt is held by European financials (banks, insurance companies…) then it is fairly obvious that Europe is in big trouble—given that the total market cap of the S&P EMU financials sector is today a paltry €400bn.

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    Gavekal Research

    On Basel 3 and Solvency 2

    In their seminal work, The Monetary History of the United States, Milton Friedman and Anna Schwartz showed that one of the main factors behind the Great Depression was the Fed’s error in allowing US money supply to collapse. On Friedman’s 90th birthday, back in 2002, Ben Bernanke acknowledged this in a speech: “I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks...

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    Gavekal Research

    Daily - The Painful Resilience of the Euro

    In a recent piece on the Euro, our friend Simon Ogus of DSG Asia remarked: “Germans are already deeply unhappy with what is going on… and historically speaking, one would rather see Greeks on the streets than Germans’” Now as we have been highlighting (see A German Uberrumbelt), Germany’s simmering unhappiness could soon be coming to a boil, what with the September 7th constitutional court decision on the legality of the EMU bailout packages,...

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    Gavekal Research

    Daily - A Policy Accident or Surprise in the Coming Weeks?

    With financial markets on edge and economic growth decelerating almost everywhere, policymakers coming back from holidays will be walking a tight rope. So what potential surprises, or disappointments, will shaky financial markets have to stomach?

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    Gavekal Research

    Daily - A German Uberrumpelt

    Obviously something is still amiss in Europe. CDS on European banks remain elevated despite the retreat in sovereign bond yields of Ireland (now back to their November 2010 levels), Spanish, French and Italian sovereigns are still in misery territory, and equity markets remain very tentative despite attractive valuations (as yesterday’s DAX “flash crash” exemplified). It feels as if markets are bracing themselves for an unpleasant surprise;...

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    Gavekal Research

    Daily - The ECB's Stealth Rate Cuts

    This week there seems to be an inordinate amount of focus on what Ben Bernanke might say at Jackson Hole on Friday, and whether we are due for another round of QE from the Fed. However, the real news on central bank policy actually comes from across the pond: not only has the ECB been more aggressively buying assets of distressed sovereigns as part of its “solvency management” policy, but significant liquidity provisions have resulted in stealth...

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    Gavekal Research

    The Political Football of the French Credit Rating

    Following S&P’s downgrade of the US, it is obvious that no nation is now safe from losing its AAA status. This new reality has lately cast an uncomfortable spotlight on France. After all, with twin deficits above 10% of GDP, a debt to GDP ratio of over 84%, with total tax receipts already comfortably above 50% of GDP, the French government seemingly on the hook for both its domestic banks and the debt of its southern neighbors…the question...

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    Gavekal Research

    Europe's Purgatory and the Eurobond Yield

    Very understandably, more and more analysts and observers have now come to the conclusion that the only two passable roads for the Euro area are i) full-fledged federalism or ii) a complete dismantling of the system, and that any further “middle road” options would lead to a decade of misery. But while the probability of radical solutions has significantly increased, Europe’s delicate balance of forces nevertheless continues to argue for a more...

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    Gavekal Research

    French Economic Activity and the Primary Deficit

    After the Merkozy summit this week, the big news was undoubtedly the disastrous revival of the financial transaction tax proposal (see Daily—The European Bait and Switch). However, somewhat lost in the shuffle, the French President and the German Chancellor also proposed another idea, which has far more merit: to introduce a constitutional rule in every Euroland country banning the very existence of budget deficits. This is an interesting...

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    Gavekal Research

    Daily - The European Bait & Switch

    Most European GDP data releases have lately been coming in weaker than expected, with the whole Euro area growing a mere +0.2% QoQ, the weakest gain since the 2009 recession. Germany, the economic locomotive of Europe, also witnessed a substantial slowdown to +0.1% QoQ, while the French economy stagnated. Of course, some of this weakening should be expected. After all, Germany was not going to sustain the recent +4.6% YoY growth rate and the...

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    Gavekal Research

    Daily - Why Is the Euro Holding Up?

    In What Drives the US-Euro?, Francois introduced a model for the Euro-US$ exchange rate predicated on three drivers: the one-year interest rate differential, the Spanish CDS (as a proxy for EMU sovereign risk) and changes in the oil price; and since 2006, this model has displayed a solid correlation with the Euro. Today this model is showing that the Euro should be at €1.30 against the US$ (see chart on p. 2); but of course, the recent exchange...

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    Gavekal Research

    Daily - More Ugly Currencies Will Not Help

    Underlying the current market turmoil is a decline of confidence in the two main reserve currencies of the world, the USD and the Euro. While this may not yet be characterized as a fiat currency crisis, serious questions have clearly driven many to diversify into other fiat currencies (the CHF, Yen, AUD…), or move completely out of fiat currencies into zero-duration assets (gold, silver, fine wines…). This has driven the prices of these “...

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    Gavekal Research

    Daily - Who Will Lead Out of the Bear Market?

    Following yesterday’s further sell-off, almost every single equity market is now in bear market territory. Almost every equity market is also deeply undervalued against bonds, against gold and against real estate. And needless to say, almost every market is deeply oversold. So why aren’t investors (ourselves included) getting more excited about the opportunities currently offered up by equity markets? The easiest answer is that the uncertainties...

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    Gavekal Research

    Why We Have Not Seen a US$ Squeeze This Time

    As the last few days have made painfully clear, markets face a level of uncertainty that is high even on today’s standards. But one question that most investors (ourselves included) are struggling with is why, in this uncertain environment, the US$ is not faring better? Indeed, in recent months we have repeatedly laid out the case for of an international US$ Liquidity Crisis. This was largely based on the observation that the growth rate of US$...

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    An Alternative Euro End-Game

    Anatole’s scenario on the previous page is very interesting but there are a few serious hurdles, mostly pertaining to France’s willingness to go ahead with a non-German Euro. Indeed, the French vision of the Euro is anchored on three basic principles:

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    Gavekal Research

    The Way of the Sudo

    One of the greatest dangers for the Euro has to be the risk that Germany finally balks at having to come up with bailout after bailout to save its profligate neighbors. While we are certainly not there yet, it may be still be interesting to ponder how such a development could play out. Initially, this move could be triggered by a Constitutional Court judgment, mass resignations by Bundesbank directors or a conservative political rebellion...

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    Gavekal Research

    Will the Sell-Off Trigger More Policy Cooperation?

    What is causing the selling panic? As usual, there are many possible answers, but the two mentioned most often in market reports and newspaper headlines—the US credit downgrade and the crisis in Italy—are probably overplayed. The US downgrade may inspire lurid headlines, but it has to be viewed by the markets as a non-event or a joke. Indeed, US Treasury bonds enjoyed one of their biggest ever rallies the day after S&P’s announcement, and...

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    Daily - What Impact Will the Latest Currency Interventions Have?

    In the past 24 hours, we have witnessed the Swiss National Bank slash interest rates to as close to zero as possible while easing CHF refinancing options for domestic banks, and the Bank of Japan come into the market to push down Yen from close to its post-war high of ¥76.25/US$. Needless to say, both economies are struggling to cope with the overvaluation of their domestic currencies (even if the CHF is by far looking more expensive than the...

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    Daily - What Could Trigger a Rally in Equities?

    Two weeks ago, European policymakers supposedly delivered a solution to the crisis plaguing Southern Europe. Two days ago, US policymakers finally came to an agreement to prevent a technical debt default. But in spite of these apparent breakthroughs, risk assets are continuing to fare poorly: yesterday, the S&P 500 fell for the seventh straight day, its longest consecutive decline in three years, and the Dow marked its eight consecutive down...

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    Gavekal Research

    The Tour de France & European Bond Divergence

    As good Frenchmen, once in a while we watch the biggest bicycle race in the world, the Tour de France. It is always full of action and drama—much like last week’s events at the EU Summit (except there's a clear winner with the Tour de France). The most spectacular moments always occur in the mountains when the best rider leads without looking behind him and once in a while, as the incline gets steeper, one of the riders suddenly cannot...

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    Gavekal Research

    The EU Summit Plan: Problem Solved?

    The consensus view is that the outcome of the EU summit falls short of what is required to guarantee financial stability in Euroland, and it is hard to disagree with this conclusion. The probability of a huge market crisis in Euroland remains far too high for any investor to feel comfortable.

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    Daily - The Definitive EMU Solution: Round Six

    For the sixth time in 18 months European leaders have announced a definitive solution to the Euro crisis. Should this version of the final bailout be taken any more seriously than the first and second solutions to the Greek crisis in May and September 2010 or the Irish bailout of December 2010 or the Portuguese rescue package of March 2011 or the breakthrough vote in the Greek parliament of last month? The supposedly good news for markets was...

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    Gavekal Research

    The Unfolding Liquidity Crisis

    In The Threats To Our International Monetary System, we described the international monetary system as a road bound by two guardrails. One guardrail is a US Dollar Crisis: this typically follows a US-led boom, in which the US consumer parties hard, its Dollar rises and its current account deficit grows. This causes an excess of Dollars in the global system and generally leads to a US-led downturn (tech bust, the initial sub-prime bust...). The...

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    Gavekal Research

    Daily - Euro Crisis Spreads: Is France Next?

    In a reflection of the times, last week a client wrote in and asked what assets would be best to short to hedge the risk of a Euro implosion. Our answers varied. Charles said sell German equities, as eventually the burden will fall to the strongest state. Louis recommended Italy as the most likely “whale”. Francois reluctantly offered some short ideas, including on Spanish and Italian markets since the weight of financials and quasi-governmental...

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    Daily - Italy's Tough Choice

    Looking at the choices facing the latest EMU crisis country, Italy, provides a cross experiment for what Greece might do in two years’ time. Unlike Italy, Greece has a primary deficit—in other words, it depends on external financing to meet its budgetary needs. This has led some investors to express a certain cynicism vis-à-vis Greece’s motives: Sure, Greek lawmakers may be promising reforms now, but two years down the line, when the country...

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    Daily - No Choice But Reform for the OECD Welfare State

    These days, it is easy to feel despondent about the fate of the developed world, what with the bills rising for the bailout of the weaker EMU countries, Japan struggling under Herculean debt loads as it rebuilds from natural disaster, and now Moody’s putting the US on watch for a credit downgrade as Congress and the administration haggle over a debt-ceiling deal. And unlike even just three years ago, rich-nation governments now have much less...

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    The Euro's Design Flaw

    Since we are on the topic of Italy, let us look at the country’s structural growth rate (the seven-year average annual nominal GDP growth) against trends in its trade balance. First, here is a chart of the Italian coverage ratio (i.e., the ratio of exports to imports):

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    Daily - A Summer of Ultimatums

    In the past 24 hours, we have seen the Greek deputy finance minister announce that Athens would fall far short of planned asset sales (this can only come as a surprise to investors born yesterday) and the Greek prime minister publish an open letter to Eurogroup Chairman Juncker warning that Greece has done all that it could. Mr Panandreaou went on to say that the onus is now on European policymakers to meet in a closed forum, with no damaging...

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    Italy's Twin Deficits

    It was just a matter of time before the lack of economic growth in Italy produced a credit warning and it was thus not surprising to see Moody’s putting its Aa2 rating for Italy under negative credit watch last month. After all, Italy’s GDP grew by only +1% over the last four quarters, versus +2.75% in the rest of the Euroarea, and has effectively flatlined since end-2003 compared to a +10% GDP expansion for its EMU peers. Moody’s has logically...

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    Murdoch Stumbles

    When the aging leader of a wolf pack suddenly stumbles, the other wolves sense his weakness. When they do, they turn on him and tear him to pieces. Rupert Murdoch, universally regarded as the world’s most powerful media magnate, stumbled last week with his audacious decision to close down the News of the World following the tabloid’s phone-hacking and bribery scandals. Instead of limiting the damage at News Corporation’s British papers, the...

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    'Lazy Brits' and Undervalued Gilts

    Nearly a year ago, after Britain’s new Conservative government spelt out in full its highly restrictive fiscal policy, we noted that consolidation would be good for the economy in the long-term, but would also put Britain at greater risk of a double-dip recession than any other G7 country. Thus we argued that monetary policy would stay easier for longer in Britain than in the US or Europe, and concluded that British Gilts were probably the world...

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    Gavekal Research

    The Euro's Design Flaw

    Since we are on the topic of Italy, let us look at the country’s structural growth rate (the seven-year average annual nominal GDP growth) against trends in its trade balance. First, here is a chart of the Italian coverage ratio (i.e., the ratio of exports to imports):

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    Daily - EMU Shocks Are Becoming More Frequent

    For the past few months, we have argued that the international liquidity environment is deteriorating (see The Threats to Our International Monetary System) and that markets have started to behave as if a liquidity crisis was unfolding: from the growing spate of corporate scandals, to the sudden devaluation of small currencies (Belarus, Maldives, Kenya…) to the recent outperformance of the most visible US$ cash-generating assets (US Treasuries,...

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    Daily - Weaker EMU Data and Shakier Euro Fundamentals?

    After the last ECB meeting, the central bank ECB signaled that it would hike rates at tomorrow’s meeting (by using the “vigilant” phrase), in an attempt to pressure EMU CPI rates back down from the current +2.7% toward the ECB’s single medium-term target of +2%. In all likelihood, Jean-Claude Trichet will carry through with his promise (or threat). Yet we cannot help but wonder if he wished he had kept his intentions to himself, as recent...

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    Daily - Achieving a Default That is Not a Default

    Over the past week global markets have rallied for a number of reasons, including better US numbers, stability in earnings and falling oil prices. But the biggest wind at the markets’ back was likely the hope of a breakthrough on the European sovereign debt crisis. Not only did the new Greek austerity plan pass the Greek parliament, clearing the way for the next tranche of funding and ensuring no immediate default, but the market was also...

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    Ulterior Motives for China's Interest in the Euro?

    One of the greatest mysteries of the 18 months since the start of the Greek crisis has been the strength of the Euro. One of the most convincing explanations for this phenomenon has been the support for the Euro provided by China and other Asian governments and sovereign wealth funds. Many traders have noted that, regardless of any bad news from Europe during the London trading day, the Euro usually rebounded in Asia after the main forex...

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    Behind the ECB's Stubborness

    Europe’s dilemma is obvious enough: Greece has some €360bn of debt outstanding and this debt is currently trading at roughly 50c on the Euro. Now interestingly, because most of this debt is owned by commercial banks, or even the ECB directly, most of the €180bn “paper loss” has yet to be recognized and written off. Instead, a lot of the outstanding Greek debt continues to be marked at par with holders crossing their fingers that a solution will...

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    Daily - The Important Level in the World MSCI

    In April 2010, the MSCI peaked around 880 on fears over Greece and the end of QE1. In November 2010, the World MSCI pulled back from that level as emerging markets stopped being the force pushing global markets and economic activity higher. In March 2011, following the devastation in Japan, the World MSCI fell to 876 before rebounding hard; and today, the global equity index stands roughly at the same level, below its 200-day moving average, on...

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    What Drives the Euro-USD?

    In the ugly contest between the major currencies, few expected that the Euro would prove to be the least ugly. The resilience of the European currency has indeed been one of the biggest surprises of the past couple of years. The Euro may have lost value against the Swiss Franc, Swedish Krona, the Brazilian Real, etc., but overall it has been much stronger and more stable than the EMU existential crisis would have suggested. In and of itself,...

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    Daily - More Cracks in the Euro's Foundations

    On what fragile foundations powerful institutions are built! As Anatole pointed out last month in An Update on the Euro Debate, blowing up the Euro would not require a majority vote in a referendum, but merely a revolt from just one powerful political group in just one country—the Germans declining to pay, the Irish failing to assume their banks’ debt, the Greeks refusing to tighten their belts.... Interestingly, while all eyes have been on the...

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    Daily - Turkey's Monetary Experiment to Come to an End?

    As is well known, the virtually-zero interest rate policies of the major economies has put enormous stress on the world’s higher-growth and emerging markets. Some nations have responded by going with the flow and accepting the sizable currency appreciation (e.g., Indonesia and Singapore), some have sharpened their already well-honed manipulative defenses (China), and some have made feeble attempts to erect new capital barriers (Brazil, and more...

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    The US$-Euro From Here

    In recent years, the USD’s path of least resistance has been lower, except at times of crisis and financial market stress. And undeniably today, a number of potential “fat tail-risks” could shake markets. These include another flair-up in the EMU crisis, a crisis in one of the several countries around the globe currently exhibiting a high combination of trade and budget deficits (see p. 35 of our Quarterly), a shortage of Dollars abroad to...

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    The Myth of Internal Devaluation

    Most observers and economists seem to be convinced that one of the main issues facing the weakest European economies is that they do not have the option to devalue their currency to restore their allegedly lost competitiveness (see for example the previous page, or Kenneth Rogoff again recently in this FT article). The weak links are thus supposedly forced to embark on a “criminal” economic policy of internal devaluation, through real wage cuts...

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    Trying to Understand, and Failing Miserably

    In the good old days, back when schools could be relied on to teach useful things (like latin or calculus), settling a trade deficit between two European countries, say Greece and Germany, was simple. When Greece ran a trade deficit with Germany, the Germans in surplus could either spend their Drachmas on holidays in Greece, re-invest the proceeds into Greek assets or—more often than not—sell the Drachmas for Deutsche Marks. When nobody was...

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    Daily - Three Sources of Instability

    Our investing business is all about “Value”. To measure values we use currencies, though it is very hard to explain why currencies themselves have any value since in our world of fiat money the marginal cost of producing it is zero. This means that our investing business really has two sides: the easy one is trying to understand how the values are going to move vs. each other (i.e., bonds vs equities), making in the meantime the assumption that...

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    Gavekal Dragonomics

    CEQ Q2 2011 - Russian Far East

    Russian Far East: The bear and the dragon

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    Will the Krona Be a Victim of its Own Success?

    We have long argued that the Swedish currency has all the elements of a hedge against European risk (see The Nordic Hedge): an undervalued currency on a PPP basis, low public sector debt, buoyant economic growth, rising asset markets and widening interest rate differentials with the Euro.

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    GaveKal Daily - Political Tensions Make It Harder to Buy Time for EMU Deals

    Downgrades of debt outlooks for Italy and Belgium, the openly discussed and unresolved “restructure or not” question for Greece, Portugal’s recent tapping of the EFSF, a deceleration in the May purchasing managers’ indices, etc... Undeniably, the newsflow out of Europe has lately been rather poor. However, for us, the most unsettling news is coming from the increasingly disjointed political scene: after witnessing a week of protests led by...

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    An Update on the Euro Debate

    Investors currently have three major issues to confront: 1) The looming end of US quantitative easing, 2) Tightening in China and its potential impact on domestic growth and global risk assets and 3) The sustainability of Europe’s monetary union. Of these three issues, we have argued that the last one has the greatest scope for unleashing serious disruptions in global financial markets. This is why, on any given day, a good ten emails fly around...

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    GaveKal Daily - DSK and the Non-Inquisitive French Media

    The recent DSK scandal has once again brought the spotlight on the cozy and uncomfortable relationship between France’s political elite and a media which, in France, seems to abdicate all too rapidly and all too often its role as the fourth estate. But can French journalists really be blamed for being as passive as the Anglo-Saxon press currently makes them out to be? As Charlie Munger repeatedly says: ‘show me the incentives and I’ll show you...

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    GaveKal Daily - Poland and the Risks of Fiscal Stimulus

    Like most investors, we keep a wary eye on countries in the twin-deficits club. It is generally believed that once an economy has twin deficits that sum up to 10% or more of GDP, serious trouble is usually around the corner. Unfortunately, some of the world’s most promising economies are slipping towards this category amid the stresses of the past few years. Poland offers an example of how easy it can be to get into this situation, and how...

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    Bad News for Nabucco, Good News for Russia

    Europe’s Nabucco pipeline, a long-planned solution to reduce dependence on Russia for natural gas supplies, appears in peril. The targeted completion for the project, which would make Turkey the gateway to supplies from the Caspian region and the Middle East, has been pushed back until 2017, three years later than originally planned. EU Energy Commissioner Geunther Oettinger last week said delays could mean total construction costs will rise to...

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    Mervyn King as a Contra-Indicator?

    There was a time when central bankers used to pride themselves on their ability to surprise and confuse the markets. These days transparency and predictability are generally viewed as the hallmarks of sound central banking—except at the Bank of England, which seems to believe that confusion and obfuscation are back in style.

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    Northern European Prosperity and the Bund Hedge

    Europe’s strong GDP data published last week have provided a striking illustration of the themes we have outlined since the beginning of last year. They also point to the irony in holding German bonds as a hedge against EMU risk. But let’s look at the facts first:

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    GaveKal Daily - A Challenging Year

    Travelling around the world and meeting investors, we have lately found few happy souls. And to some degree, this makes sense as there have lately been few reliable, bankable trends aside from the weakness in the US$ and the strength in ‘weak US$’ asset plays (oil, mining, HK physical real estate...). However, as the past couple of weeks has shown, jumping on the “weak US$” band-wagon can be fraught with risk as:

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    Mitigating the "Sell in May" Rule

    The ‘Sell in May and Go Away’ rule has a pretty good reputation on equity markets. Its accuracy is usually presented in these terms: on average since year Y, the performance of equity markets from May to September (or October, depending on the version) has been much lower than from November to April. For example, since 1998 the S&P500 declined on average by -1.3% during the May-to-October period, and gained +4.7% during November-to-April....

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    UK Growth & Why Buying Gilts Makes Sense

    While the dollar tumbled this week in response to the US economy’s meagre 1.8% annualised growth rate, the pound was boosted by an almost identical British GDP figure. The bullish reaction in Britain, based on the view that the figure might have been even worse and that the Bank of England would start to tighten regardless in the autumn–seemed even more misguided than overly pessimistic view of the US statistics discussed on today’s Daily. The...

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    GaveKal Daily - Greece, the Ultimatum Game and a Modest Proposal

    Economists love to play games where the rationality of the players can be tested. One such game is called the ultimatum game, in which two players interact to decide how to divide a sum of money that is given to them. The first player proposes how to divide the sum between the two players, and the second player can either accept or reject this proposal. If the second player rejects, neither player receives anything. If the second player accepts...

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    An Aging Dividend for Korean Stocks?

    Like many other Asian countries, South Korea faces the demographic challenge of a rising dependency ratio and the peaking of its working-aged population (see chart). The country’s so-called “1958 Year of The Dog Generation”— equivalent to Japan’s “Dankai Generation”, but about 10 years younger as Korean baby boomers were born after the Korean War—will gradually start retiring in the next 10 years. It seems reasonable to expect the Korean economy...

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    GaveKal Daily - A Rising Political Backlash Against EMU Bailouts?

    Since Mrs. Merkel’s promise of ‘unconditional support’ made at Davos earlier this year, systemic risk across Europe appeared to be on the decline (see A Fragmentation of the PIIGS). However, as every investor knows by now, peace in financial Europe has lately been as stable as Middle-Eastern politics—and so, just when the market starts to price in the likelihood of a solution to the European fiscal mess, local politics usually rears its head to...

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    GaveKal Daily - What if Dollar Weakness Isn't Just About the Fed?

    We witnessed an interesting duel of sorts yesterday between two powerful central bankers—the ECB’s Jurgen Stark and the Fed’s William Dudley. Speaking at a dinner event in Hong Kong, Stark dominated the evening by delivering a series of well-aimed blows to the Fed’s monetary philosophy. He pointed out, for example, that “certain developed-world central banks” seem to have failed to abide by lessons learned in the 1970s—namely, that price...

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    Where the Fed Stands on its Mandates

    When Bernanke took the job as Chairman of the Fed, he took on the legal mandate "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." While the desirability of these multiple mandates is debatable, one can see why, in 2008-09, the Fed Chairman felt compelled to aggressively cut rates and buy long-term MBS and UST. Bank loans were contracting, unemployment soaring, CPIs and price...

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    In Europe, What is Priced In?

    I have a number of reservations about Charles’ arguments in his piece, An Old Man's Doubts. But rather than discussing all his points, I will focus on one question only: what is priced in? Charles and Anatole, along with the FT, believe that European markets are complacent about risks. Meanwhile, since the end of last year, I have argued that European markets offer attractive valuation in relation to risks. Indeed:

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    GaveKal Daily - The Implications of Iceland's No Vote

    Eighteen months ago, the gallows humour of bond trading floors was that the only difference between Ireland and Iceland was one letter and about six months. The timing may have proven a little off, and the end result may yet prove very different. However, the questions on the similarities between the two countries may be re-opened by this weekend’s overwhelming “No” vote from Icelandic voters who, for the second time around, have shown little...

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    GaveKal Daily - Is Oil the New Interest Rate?

    With Brent oil at US$122, and other commodities (gold, silver, corn…) making new highs, the single most important question confronting investors is whether oil has become the new interest rate. In a typical cycle, interest rates rise along with economic activity until nominal rates move above nominal GDP growth, triggering a slow-down in growth. However, in this cycle, the dovishness of central banks appears so deeply ingrained that commodity...

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    GaveKal Daily - Is Oil the New Interest Rate?

    With Brent oil at US$122, and other commodities (gold, silver, corn…) making new highs, the single most important question confronting investors is whether oil has become the new interest rate. In a typical cycle, interest rates rise along with economic activity until nominal rates move above nominal GDP growth, triggering a slow-down in growth. However, in this cycle, the dovishness of central banks appears so deeply ingrained that commodity...

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    GaveKal Daily - The Irish Hot Potato

    Last night brought a lot of news from the Euro Crisis front—currently in Ireland.

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    GaveKal Daily - Can Capitalism Work Without a Cost of Capital?

    It is obvious that central banks operate with four policy gauges:

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    GaveKal Daily - The "PIG" Test of the Euro Project

    The European debate continues to rage—including here at GaveKal. Readers of yesterday’s Five Corners page on the weekend’s European Council summit may have noticed that Anatole was unimpressed by the event, which he saw as stronger in rhetoric than action. “What the leaders did was deliver more speeches about their commitment to defend the European financial system,” he wrote. “They then agreed to meet again in another three months’ time to...

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    The Russian Hedge

    The recent events in Japan and the Middle East have considerably changed the situation on world energy markets—in particular for natural gas. First, a sharp decline in gas exports from North African countries needs to be compensated by deliveries of piped gas into Europe by other suppliers; second, the crisis in Japan has led China, Germany and others to re-examine their nuclear strategy, and consider other sources of energy—and here natural gas...

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    The Keynesian Divisor

    If government spending goes up, and if this increase is financed by debt, it is reasonable to believe, as Ricardo did (or Milton Friedman with his constant income hypothesis) that the existing growth rate is borrowed from the future. In other words, it is an illusory growth since government debt is nothing but a deferred tax .

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    Speeches Instead of Safety Nets

    After a tragic plane crash, all the leaders of the European Union are wafted up to Heaven and find themselves in a long queue, snaking off into the distance with no end in sight. After a few minutes, the presidents and prime ministers lose patience and start to grumble, shouting to an attendant angel: “Don’t you know who we are? We are the leadership of the European Union. We demand immediate entry to the VIP lounge.” The angel mumbles something...

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    Running with the Bulls in a World of Extreme Risk

    In the dozens of meetings we have had recently with clients in Europe and the US two messages have come through loud and clear. The first is that we at GaveKal are now worried about the short-term prospects for the world economy and financial markets. The second is that almost all the investors we meet have gone through the opposite transition. After asking repeatedly over the last two years: “is it time to sell this rally?”, we now find almost...

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    The Fragmentation of the PIGS

    One of the interesting similarities between the Eurozone crisis and the subprime crisis is how the contagion risks were initially downplayed. In 2007, Ben Bernanke tried to calm rising fears in the US housing market by estimating that subprime-related losses would hardly surpass a very manageable US$100 billion. Three years later, Jean-Claude Trichet argued that the Greek crisis was not a major issue for the Eurozone since Greece accounted for...

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    GaveKal Daily - Should Investors Buy on Dips?

    As investors think through the crucial question of whether to buy on dips amid the current turmoil, there are not too many comforts or certainties on which to cling. The price of oil is worryingly high and Middle East tensions remain heightened. And while most of the global media coverage from Japan has tended towards the hysteric, there is still a lack of clarity on the radiation threat in Japan and what a potential global “no-nuke” backlash...

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    GaveKal Daily - PIGS Do Well on a Risk-Off Day

    The future of Europe’s monetary union is one that the GaveKal team has debated vociferously (see EMU Debt Crisis, Part III), so it is no surprise that last weekend’s EMU deal was also received with various degrees of emotion. Indeed, our house views are in many ways a microcosm of the broader debate on the Euro. There are those who think this experiment will eventually fail, and good riddance when it does (Charles and Louis); those who think the...

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