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    Gavekal Research

    The French Establishment Wins

    9
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    Gavekal Research

    Europe's Russian Advantage

    After many years of trying, in December Russia finally negotiated a deal to join the WTO. The last hurdle left is for the country’s parliament to ratify the agreement, which will probably be done after the next elections in early March. As we explained in The Four Merits of Russia’s Accession to WTO, Russia’s entry into the WTO is a momentous event—and is a positive development for an ailing Europe:

    6
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    Gavekal Research

    The OAT Hedge

    In a world in which most of the economic data continues to improve (signs of recovery in the US housing and job markets, renewed pick-up in Chinese financial deregulation, Japan finding its footing in spite of an overvalued Yen, Germany humming along even as Southern Europe collapses), the news out of France remains frankly uninspiring. Indeed, yesterday’s December trade balance report pushed France into a new record high trade deficit of €69....

    2
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    Gavekal Research

    The Non-Event Of French Elections

    There is a famous story about the last days of Constantinople. While the Turks were at the gates of the city, heated discussions were taking place inside the walls about whether angels were male or female. This is exactly how Paris feels these days, with candidates in the upcoming presidential elections debating the gender of angels, while ignoring the biggest dangers.

    0
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    Gavekal Research

    Positive EMU Growth Surprises?

    In the second half of last year, growth expectations for the Euro area plunged. As most advanced indicators of economic growth went from boom to bust territory, the consensus revised its projections for 2012 GDP growth from +1.75% in 2Q11 to -0.4% recently! This 2.65ppt swing was primarily led by deteriorating outlooks in Southern Europe and in France, but also by the prevailing assumption that the German economy would inevitably succumb to the...

    0
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    Gavekal Research

    A Hedge Against the Coming Euro BoP Crisis

    Over the past two years, the euro crisis has morphed from a sovereign crisis in a peripheral country (Greece), to a banking crisis, and back to a sovereign crisis in core countries (Italy, Spain). At every turn a “solution” is devised whose purpose is to “save” the euro but whose actual result is simply to push the crisis into new and more desperate terrain. The latest solution -- aggressive easing by the ECB -- means that the next phase of the...

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    Gavekal Research

    Does Friday's Nine-Country Downgrade Matter?

    This is undeniably the question that, over the weekend, every investor has had to ponder. On the one hand, it could be argued that rating agencies are, as always, a “day late and a Euro short” and simply telling the market what it already knows. After all, the yield on the Eurozone debt-weighted average 10-year bond yield rose considerably in October and November, to over 6% (see chart). The OAT-BUND spread also reached new record highs and has...

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    Gavekal Research

    Euro Woes and German Culpability

    The world watched with horror and fascination this week as investigators sought the cause of an entirely avoidable shipwreck in Italy that could have cost as many as 40 lives. Meanwhile, the cause of a much greater wreck—that of the good ship euro—is heaving into view. As Greece moves towards default, as France, Italy and Spain suffer credit downgrades, and as negotiations on last month’s fiscal treaty reach deadlock, the euro is heading for the...

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    Gavekal Research

    Checking the Boxes: Monday, January 16, 2012

    This is undeniably the question that, over the weekend, every investor has had to ponder. On the one hand, it could be argued that rating agencies are, as always, a “day late and a Euro short” and simply telling the market what it already knows. After all, the yield on the Eurozone debt-weighted average 10-year bond yield rose considerably in October and November, to over 6% (see p. 2). The OAT-BUND spread also reached new record highs and has...

    0
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    Gavekal Research

    The US and the UK are on Right Track

    Recently there has been a lot of talk about the supposed stark differences between the US and UK budget policies. Many argue that the UK policy path of aggressively cutting government expenditure is going to lead to a new recession; in contrast, the sure-to-be-reelected President Obama is said to be wisely staving off a double-dip by maintaining government spending at a high level. There is a slight problem with this view, however. It is not at...

    0
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    Gavekal Research

    Daily - Europe's Coming Balance of Payments Crisis

    In a recent piece (see Draghi in Control – But For How Long?), Charles argues that, thanks to the ECB’s aggressive liquidity provisions, Europe’s policymakers have likely managed to avoid near-term budget and banking crisis…but at the cost of an upcoming balance of payment crisis. Indeed, by forcing down the cost of capital for hapless European governments, and thereby postponing the hard medicine and removing any incentive for reform, the ECB...

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    Gavekal Research

    Draghi in Control, But for How Long?

    [INDENT=2]

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    Gavekal Research

    The ECB’s 489 Billion Euro Christmas Gift

    After much anticipation, 523 banks tapped the ECB for €489bn of its new 3 year loans-significantly exceeding market expectations closer to €300bn. This confirms our initial take that this new facility, with longer duration loans and easier collateral requirements, is a major development. But what exactly does it accomplish?

    0
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    Gavekal Research

    Daily - The UK in 2012

    To say something useful about the UK’s economic prospects in 2012, we have to begin by turning the clock back one year. At this time last year, the consensus view in the City of London was for Bank of England rate hikes to begin as early as May 2011 and for rates to be back around 2% by the end of the year! Given these absurdly hawkish monetary expectations amid over-optimism about UK growth prospects in the wake of the 2010 election, it was...

    0
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    Gavekal Research

    Daily - Europe's Tragic Ironies

    As highlighted by Christian Noyer’s latest comments, the French technocrats seem to feel it is a tragic irony that their country, rather than perfidious Albion, is at risk of losing its top-notch credit rating. However, while this past week has seen a number of tragic ironies, we are not sure this has anything to do with the Brits.

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    Gavekal Research

    The Triumph of Southern Italy over Northern Italy

    In Have Southern Europeans Bought Too Many BMWs?, my colleague argues that Italy’s balance of payments problem is not caused by the Euro, but instead by the China factor and rising commodities prices. Besides the fact that Italy would have better adjusted to the pressures of a rising China and higher commodities prices were it not for its artificially high foreign exchange rate under the Euro, this theory fails to explain Italy’s disappearing...

    0
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    Gavekal Research

    Have Southern Europeans Bought Too Many BMWs?

    We are often being told that the first decade of the Euro led to artificially low rates in the South, which provoked a credit-led consumption boom that allowed the poor guys in Valencia or Lecce to buy a BMW. This story is supposed to provide a colorful illustration of the intra-Eurozone imbalances accumulated over the last decade. Yet, as we show below, the deterioration of the Southern European trade balances with Germany has accounted for a...

    0
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    Gavekal Research

    The Long March of the Communist Economies

    As we look forward to the coming year, we can bet our bottom drachmas that French and Italian trade deficits are going to continue to crater. Industrial production in most European countries will continue falling (who will invest given the uncertainty and the constant changing rules?). Unemployment is going to go ballistic.

    0
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    Gavekal Research

    ...And Now for the Good News

    We reviewed some of the many downsides of the latest EU summit in Starting With the Bad News.... Now let us turn to the good news, at least for the Eurocrats and perhaps, in the short-term, for the European markets. The potential support from the ECB is the one part of the summit deal that could turn out to be much stronger than it seemed at first sight. While Mario Draghi’s public statements were less than helpful, they were presumably directed...

    0
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    Gavekal Research

    Starting With the Bad News...by Anatole Kaletsky

    Although the usual post-summit rally should not be too hard to orchestrate in the thin markets around Christmas, there was more bad news than good for the dwindling band of bureaucrats and politicians who are determined to save the Euro, regardless of the costs to the democracies and economies of Europe. We will begin with the “bad” news–partly because our bias is to treat bad news for the Euro as good news for the world and Europe, but mainly...

    0
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    Gavekal Research

    Daily: Fog in the Channel - Continent Cut Off

    At Queen Elizabeth II’s coronation in 1953 the Hakim of Bahrain came upon prime minister Winston Churchill sitting at the bottom of a staircase. He attempted to ingratiate himself to win British support for a Bahraini land claim against Qatar. By that point in the evening, Sir Winston was in no mood to discuss Arab territorial disputes. Later he instructed Britain’s resident in Bahrain: “Tell him that we never desert our friends.... Unless we...

    0
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    Gavekal Research

    Daily: EMU Crisis Fighting Intensifies - Will It Be Enough?

    No one expects leaders going into the current, umpteenth EMU summit to solve the existential problems of the Euro—much of which has to do with competitiveness and balance of payment issues. But investors are waiting for answers on three major questions related to liquidity and solvency issues in Europe:

    0
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    Gavekal Research

    Daily - Riding on a Wing and a Prayer in Europe

    Over the past 5 days, Italian 10y bond yields have dropped –122bp, Spain –142, Belgium –122, etc. This impressive rally has been driven by a number of factors: the recent coordinated central bank action to improve liquidity, the Italian austerity plan, the Sarkozy-Merkel deal on borrowing limits and penalties for deficit violaters. But of course the main force behind the rally is, as usual, a wing and prayer. Not only do EMU leaders have the...

    0
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    Gavekal Research

    Two-Tier Economies, Two-Tier Markets

    Print Version:

    0
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    Gavekal Research

    Daily - US Swaplines: What a Difference a Few Basis Points Make

    It would be easy to write off this week’s news on USD swaplines as a bit of technical trickery aimed at boosting market sentiment without any real costs. In fact, the adjustment to the Fed’s swap facility changed the very nature of the program in a way that greatly enhances its significance in today’s global financial environment. At the prior cost of 100bp over OIS, the USD swaps were analogous to high-deductible, catastrophic insurance—only to...

    3
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    Gavekal Research

    Daily - Swedish Democracy vs Eurocracy

    In early 2003, we found ourselves in Sweden at the time of furious national debate over the potential adoption of the Euro. Our view was then, as it is now, that the Euro was not a sustainable project and that Sweden would be much better off on its own. However, back then, this was not a popular opinion in the financial community and we were met with fierce opposition in pretty much all our client meetings that week. The main argument of the pro...

    1
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    Gavekal Research

    Kicking a Can Full of Worms Down the Road

    An unfortunate fact of the Euro era is that a number of nations have become increasingly uncompetitive (see France is Getting the Italian Disease). The result has been a lower structural growth rate (e.g., Italy has had no growth for 10 years) and from there the double malediction of growing external deficits and widening budget deficits.

    0
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    Gavekal Research

    Cutting Through the Noise in Europe

    Whatever the end-game of the ongoing EMU crisis, we can be sure of one thing: Europe will have to live according to its means and no longer according to how much it can borrow. Among other things, this implies:

    0
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    Gavekal Research

    The ECB Is Already Doing QE, Its Own Way

    The current pleas for the ECB to start “quantitative easing” often miss one important detail: the ECB is already conducting QE, in every way but in name. The two core elements of what is commonly referred to as QE are: 1) the expansion of the asset side of a central bank’s balance sheet, well beyond what is required to simply target short-term policy rates and with the aim of easing credit conditions; and 2) the expansion of a central bank’s...

    1
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    Gavekal Research

    On German Rebalancing

    One problem with the Euro is that it has turned all economic analysis into a black or white exercise. Take the German export strength since 2000. The conventional idea is that the Euro project allowed German businesses to push down wages, in turn increasing Germany’s export competitiveness. However, the reality is that the lower wage growth in Germany was a consequence of the post-reunification deleveraging and the resulting rise in...

    0
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    Gavekal Research

    Daily - Looming Balance Sheet Risks for the ECB

    Lately, as the EMU crisis intensifies, many of our clients have wondered when the ECB is going to get serious and start actual quantitative easing? Our first response to this question is that, semantics aside, the ECB has already effectively done €260bn worth (or $350bn) of QE thus far, and that figure is growing every week. This of course pales in comparison to the Fed’s QE operations of closer to $2 trillion. And given what is happening in EMU...

    0
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    Gavekal Research

    Daily - Approaching No-Man's Land in Europe

    Meeting with clients over the last couple of days, it is becoming increasingly evident that institutional investors are frantically shuffling through a menu of post-Euro scenarios. And some of the “Day After” visions under consideration are quite unsettling. For example, some expect Germany will be the exit country—but after reintroducing the Deutschmark they will express their disgust with their lesser-abled former union members by continuing...

    0
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    Gavekal Research

    Daily - End of the Bund Hedge?

    Until now, we have argued that the two best hedges to Euroland troubles are German Bunds and the US Dollar. While the Bund hedge has been the most effective to date, it is now starting to look a little shaky. Indeed, yesterday’s big news about the failed German bond auction, where 35% of the volume did not get bid (worst results since the introduction of the Euro), highlighted that German sovereign yields are no longer falling on bad news. And...

    0
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    Gavekal Research

    Daily - Has There Been a Bigger Policy Failure than the Euro in the Past Decade?

    Since early September, the debt-weighted EMU 10 year bond yield has shot up from 4.2.% to a new decade high of 5.5% (see chart). Behind this surge, one finds the recent wobbles of the Italian BTP market, the renewed concerns surrounding France’s triple-AAA rating and the fact that, for the first time since the European crisis started in earnest two years ago, German Bund yields are no longer falling in the face of bad news. Given this backdrop...

    0
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    Gavekal Research

    Daily - Looking for Signs of EMU-Related Funding Stress in Asia

    European banks are essentially the world’s most global banks—providing, for example, more US$ loans to the rest of the world than US banks do. Indeed, the EMU played a lead role in the growth in the global funding market from 2000-2007—when total global cross-border claims on average grew by +5% of global GDP every six months (see chart), rising as high as US$22.5 trillion before the bust in 2008.

    0
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    Gavekal Research

    An Update on French Bank Bond Holdings

    The common view in France is that French banks obeyed the Bercy and held their positions on GIPSI bonds through the storms of the past year. But based on 2Q11 data released yesterday from the French central bank, this seems to be way off the mark. Indeed, it seems that French banks have been selling GIPSI bonds massively from as early as 4Q10.

    0
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    Gavekal Research

    Daily - The Problem With Technocrats

    The replacement in Greece and Italy of elected heads of governments with career EU technocrats (ECB in the case of Greece, Federal Trade Commission in the case of Italy) raises a number of questions:

    0
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    Gavekal Research

    Daily - No More Road to Kick the Can Down?

    One of the many questions concerning the European economy in the past year is whether the relative strength of the Northern countries will pull the drowning southern nations to safer ground. With bond yields flaring up, banks in paralysis, equity markets battered and yet the Euro still not providing any relief through a significant external devaluation, the simple answer to this question would appear to be “no.” However, perhaps the safety boats...

    0
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    Gavekal Research

    A Q&A on EMU Procedure and the ECB's Powers

    With the EMU crisis deepening, we have received a number of technical questions on the ECB and EMU rules. We thought other clients might be interested in the exchange below:

    0
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    Gavekal Research

    Where Do We Hide?

    As our regular readers know, we have been arguing that the US currency is now very undervalued, especially against the Euro and the commodity currencies of the world. In our view, the US current account will almost certainly continue narrowing for the next two years:

    0
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    Gavekal Research

    Weathering the Crisis Through a European Barbell

    The huge uncertainties in the EMU have understandably paralyzed many European investors this year—and as the Italian and French crises illustrate, the fear factor is here to stay. It is possible, however, for investors to structure portfolios which not only provide shelter from the fallout, but produce very reasonable returns.

    0
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    Gavekal Research

    Good and Bad Bubbles

    As we have often argued, there are two kinds of bubbles and two ways to finance them. The best kind of bubbles take place in productive assets (canals, railways & the internet) and are financed primarily by equity. When these bubbles burst it is of course very painful for the equity holders, but when it is all said and done, the world is still left with more productive assets and the banking system is still relatively intact.

    0
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    Gavekal Research

    Daily - The Doomsday Machine Part Deux?

    In the midst of the Lehman crisis, we wrote about the The Doomsday Machine Unleashed in which banks, under mark-to-market rules, were forced to sell assets into a fire sale, thus perpetuating a cycle of doom. In other words, the incompetence of regulators gravely aggravated an already deadly situation. Most rational actors would think lessons had been learned here—yet amazingly, three years later, European policymakers may be setting in motion...

    0
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    Gavekal Research

    Daily - The Euro's Moment of Truth

    As much as we hate to do so, we have little choice but to return to the unfolding Euro debacle where, with Italian bond yields now touching 7.4%, the battle lines are now very clear. As we have argued before, either the ECB steps in and purchases risk assets very aggressively in a manner reminiscent to what the HKMA did in 1998, or a number of Southern European countries, and perhaps even France, will be forced to impose capital controls, shut...

    0
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    Gavekal Research

    Daily - The Bond Market vs the ECB

    One of the more important features of financial markets is that they are supposed to send messages about future economic conditions. But deciphering these messages has been particularly difficult in the past few months. In very short time spans, the stock markets were alternatively signalling that the world was coming to an end...or perhaps not. For a moment there it appeared that emerging markets would be the first fatality...but then not. One...

    0
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    Gavekal Research

    Daily - The G20 Today and in 2008--the Difference Three Years Makes

    It is somewhat fitting that France should be the country hosting the upcoming G20 summit. The country that gave us Asterix, a national soccer team that goes on strike during the sport’s world cup, and a Rugby world cup team that could not even agree on what day its games were. Yet like with Asterix or the French Rugby team, France also has a history quashing strife and egotism when it matters. Unfortunately this French trait—discord followed by...

    0
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    Gavekal Research

    Daily - MF Global: A Special Kind of Dolphin?

    While we are still waiting for the whale of the current liquidity squeeze to emerge (see The Unfolding Liquidity Crisis or Was This The Bottom?), yet another dolphin has floated to the surface in the shape of MF Global. This one, however, is far more interesting and important than the ones that recently preceded it (Sino-Forest, Olympus, etc.) in that MF Global is (as far as we can remember) the first company to ever go bust for holding so-...

    0
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    Daily - The Greek Referendum - Democracy vs Eurocracy

    Yesterday’s announcement by Prime Minister Papandreou that Greece’s latest fiscal plan and settlement with the European Union will be put to referendum is the logical conclusion of a process which, after two years of belt tightening, continues to promise more pain and little light at the end of the tunnel. Consider the following: even if the EU and the Greek government’s rosy assumptions are met (and there is little in the recent track record to...

    0
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    Gavekal Research

    Why Has the Pound Been So Strong?

    The Pound has always traded between the Dollar and the Euro (and before that the Deutschemark). There has literally never been an extended period in which Sterling has fallen against the Dollar, while the Euro has gone up:

    0
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    Gavekal Research

    Will the Euro Devalue at Last?

    The strength of the Euro against the Dollar continues to puzzle many investors and observers. However, beyond the short-term fluctuations of the EUR/USD associated with the risk-on/risk-off trades, the logic underpinning the strength of the Euro looks pretty clear.

    0
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    Gavekal Research

    Crucial Stress Tests Ahead for Spain

    Visiting Spain in this crisis time provides a very different impression than reading the macroeconomic surveys on the country. Over the last 10 years Spain has not just built ghost cities along its coast, it has also invested massively in state-of-the art infrastructure. The network of high-speed trains is now one of the very best in Europe—with most large cities at less than 2.5 hours from Madrid—while roads and airports, which used to be the...

    2
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    Gavekal Research

    France is Getting the Italian Disease

    I followed the events of the last week in Europe with considerable amazement. Clearly, much effort was made by all involved not to address the real issues. That in itself is to be expected, but it was disappointing to see that almost all the financial media swallowed the bait and talked endlessly about a bigger EFSF, bank recapitalizations, haircuts, etc.

    0
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    Gavekal Research

    How Will Europe Pick the Rentiers' Pockets?

    In any given economy, the entrepreneurs, rather than the rentiers, are traditionally the risk-takers. The Euro, however, has led to an enormous transfer of wealth from Europe’s entrepreneurs to its rentiers (which includes the increasingly bloated public sector). There are now too many rentiers and not enough entrepreneurs and, in our view, the ongoing European crisis is the inevitable result of this wealth transfer.

    0
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    Daily - Is Europe Behind the Rally?

    Earlier this week Anatole argued that we should not expect much from the EMU deal to be announced at the October 26th summit (see Daily—Germany Plays Hardball at EU Summit), but that markets would rally anyway. Clearly he was being too optimistic—there was in fact hardly a deal at all. There were broad agreements but no plan for executing them; e.g., some €106bn is required/earmarked for bank recapitalizations, but no word yet on whether the...

    0
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    Daily - Facing the Music

    As an English friend of ours put it to us recently “you know the world is turned on its head when I feel compelled to support France at rugby and Germany at brinksmanship (see The Road to Hell is Paved by Good Intentions).” And as we head into the 14th EU “crisis summit” in 21 months, most investors that we talk to seem to have rallied to the German point of view that bondholders (rather than the taxpayer or the ECB) should take the losses for...

    0
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    Daily - Germany Plays Hardball at EU Summit

    Angela Merkel has consistently promised to do “whatever it takes” to preserve the Euro. With equal consistency and persistence she has always added a modest qualification – “I mean, of course , whatever it takes, apart from the two things that would actually work”. Those two actions would be the creation of Euro-bonds joint and severally guaranteed by Germany along with all the other Euro countries, or large-scale purchases of government bonds...

    0
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    Daily - The Paradigm Shift Behind the European Crisis

    In the early 1980s, the then Citicorp chief Walter Wriston famously declared that “countries don’t go bust”; that was just before Mexico and most other Latin American sovereign issuers hit the wall and reminded banks and bondholders of the dangers of countries issuing debt in a currency that cannot be printed. “Plus ça change, plus c’est la meme chose”, and today with most Southern European nations finding it increasingly expensive to roll over...

    0
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    Is the ECB Aiming for 'Stealth Cut' to 0.75%?

    Recent moves by the ECB are more significant than some may realize, and could prove significantly bearish for the Euro/USD as excess liquidity is flooded into the system by the end of the month. And yet the Euro has risen since the ECB announcements on October 6th, likely for the following reasons:

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    The Case for European Exporters to the US

    Since very early on in the EMU crisis, we have recommended a strong overweight of European exporters in European equity portfolios. And even if these stocks look quite expensive now versus the completely depressed domestic-European stock universe, we see little reason to recommend a change in this strategy. On the contrary, many recent developments suggest that the non-European economic environment will remain more hopeful than the European one...

    0
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    Gavekal Research

    What the OAT-Bund Spread is Telling Us

    The 10-year spread between French and German sovereigns closed at nearly 100bps last Friday, its highest level since 1995, and not that far from its peak of 125bps reached just before the Maastricht referendum of September 1992. This follows the collapse of French banking shares, poor economic news, and populist political posturing ahead of the general elections of May/June next year. Importantly, the most recent leg in the widening of the Oat/...

    0
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    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:

    0
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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...

    0
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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...

    0
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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...

    0
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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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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    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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