Notes From Underground

The budget negotiations and political maneuvering that have clogged the airwaves and the capital flows are now kicked further down the road and financial markets can again resume crunching data and analyzing fundamentals and technicals. It became a distraction as the television pundits and anchors opined on the impact of the “Washington Standoff.” The worst part of the entire drama was the constant parade of corporate CEOs warning Congress about the damage being done to the U.S. economy.

TO YOU CORPORATE BLOVIATORS AND POSERS: The fact is that Congress continues this game because most of you CEOs spend corporate treasure on LOBBYING in an effort to undo most legislation. The TAX CODE is a kaleidoscope of  loopholes because of the huge amount of money thrown at legislators to manufacture  tax preferences for the chosen. The reams of paper that constructed the DODD-FRANK legislation and the AFFORDABLE CARE ACT were the results of the spread of corporate money in an effort to defang the legislation. Two-thousand pages to draw up a new financial regulatory law only because of all the exemptions and obfuscations paid for by lobbyists. So you CEOs, I advise you this: While you point the finger of BLAME at Congress, there are three fingers pointing back at you. If the lobbying to death of any and all legislation would end, the country may well get some quality discussion on significant budgetary changes.

***Now, for all those wondering,Germany’s Chancellor Angela Merkel has yet to form a new government. While Merkel achieved a solid electoral victory in September, it did not give her an outright majority and therefore a coalition partner is required. It seems that the Green Party has opted out of being a coalition partner with the Christian Democrats (CDU) and leaves Merkel pursuing a grand coalition with the Social Democrats (SPD). The question left for the Chancellor is what demands the SPD will make to partner with the CDU. Merkel laid out four main tasks facing the next German government as reported in the Financial Times by Quentin Peel:

1. Eurozone crisis;
2. Dealing with the soaring costs of energy as Germany subsidizes the transition from nuclear and coal to alternative energy sources;
3. Coping with a population issue of an aging work force; and
4. Reforming the structure of the German Landers and their need for infrastructure investment

It seems that the CDU/SPD have agreement on all but the issue of reforming the LANDERS (states) and how to finance the cost of development. The SPD does not have much latitude in negotiations because a failure to form a coalition will mean that new elections will have to be called–not a promising outcome the SPD. If the anti-euro AfD Party is given a second attempt at winning the needed 5 percent threshold it could be problematic for Germany and Europe.

Further word from Europe involves the continued stance by Germany on the issue of haircuts on creditors in case of a bank default. Germany opposes taxpayer bailouts of banks and is pushing for junior creditors and possibly large depositors to bear the greatest losses in any bank rescue (BURDEN SHARING). The European Stability Mechanism is funded with 500 billion euros to backstop bank collapses but the Germans want creditors to be first in line  to absorb losses. In an FT article, “Berlin Eyes Haircut to Protect Taxpayers In Bank Rescues,” Alex Barker writes: “So far efforts to arrange a sizeable and credible taxpayer backstop are floundering …. Germany is pushing in the opposite direction. It wants to make tapping eurozone funds even harder. Whether they know it or not, creditors are being shuffled into the firing line.”

In a Bloomberg article today, “Draghi Turns Judge on Europe banks as ECB  Examines Accounts,” it becomes even more apparent that task of creating a credible European Banking Union is very difficult because of German intransigence over the issue of indemnifying the legacy costs of so many European banks. Complicating the issue even more is that even the German Finance Minister Wolfgang Schaeuble does not favor German taxpayers picking up the tab for debt-stressed peripheral banks. Further, the idea of a banking union and the ECB applied stress tests is to break the feedback loop of national banks loading up on their own sovereigns debt. “Officials must contend with the danger that the link between banks and governments that the banking union project aims to break may in fact be getting stronger. ECB data for August show that Italian banks are holding more of their own government’s debt than at any time since the debt crisis began.” (Underline that for emphasis)

The fact that it is Italian banks loading up on Italian sovereign debt allows us to understand why the yield differential between BUNDS and BTPs. Both 10-year notes are at the narrowest levels in two years. No wonder the German Bundesbank is angry about a banking union. If Italy were to implode the ECB would be forced to bail out the Italian banks because of the huge hit to sovereign bonds. This is the ultimate sense of a moral hazard and it is the German citizenry’s deep pockets that will provide the funds. Buying European bank stocks … hmm, that is some kind of risk.

***As the Washington political drama played out, there was much discussion about the Chinese and Japanese moving to unload U.S. debt and maybe even have the Chinese YUAN become a reserve currency. This makes for great discussion, but the process of such an action will be a long drawn out affair. Any immediate Chinese moves to liquidate its DOLLAR holdings would cause a collapse in the international financial system, which the Chinese would certainly not desire. In an FT article, Professor David Li of Tsinghua University advises that China should cut back its lending to Washington. China should some cut back purchases and sell some holdings and replace U.S. Treasuries with:

1. Stock in multinational companies doing business in China;
2. Purchase more bonds in place like Germany or Australia so as to diversify away from the U.S.; and
3. Purchase utility stocks and other dividend-paying companies in mature market economies.

So the call is for diversification not an act of economic suicide. Also, China can always purchase the hard assets of commodities it needs, from soya beans to industrial and precious metals. Back in June, I advised paying close attention to the price of GOLD in terms of Chinese YUAN. The key level was 7185 yuan to an ounce of GOLD. If the Chinese are intent on diversifying away from the DOLLAR, the GOLD/YUAN will be an important barometer. Check your charts for levels you deem important.

Tags: Angela Merkel, China, Congress, Dodd-Frank, ESM, Germany, Mario Draghi, U.S. budget negotiations, Wolfgang Schaeuble, Yuan

This entry was posted on October 16, 2013 at 8:09 pm and is filed under Debt Market, ECB, Europe, United States. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.