Notes From Underground

Over the weekend there was a new and improved G-20 communique, which was supposed to offer reassurance that the primary economic decision makers have things under control. It is disconcerting that so much time was spent discussing the global uncertainty posed by BREXIT for the global equity markets have deemed the British vote to Leave the EU as non-event (at least for now) and maybe even a positive for the Davos elite to adjust previous policy decisions. It appears that some G-20 members look forward to dealing with the U.K. on trade issues outside an EU establishment that is reticent to foster trade agreements because of German and French elections scheduled for 2017.

The previous agreed deal between Canada and the EU has been relegated to a vote by 27 different parliaments rendering the accord dead on arrival. The recently crafted TTIP accord between the U.S. and EU has been fraught with problems as German and French unions have taken to the streets in protest against certain pieces of the trade agreement. It seems that British trade negotiators will have far more latitude outside the restraints of the EU anti-trade lobbyists. It was only at the May G-7 meeting that former U.K. Prime Minister Cameron was castigated for kowtowing to the Chinese in striking business agreements with China.

The G-20 spent way too much time on Brexit and should have spent more time on discussing the GLOBAL BOND MARKETS, but so it goes. Always take the safe route when looking for consensus on global financial issues. The G-20 had very little to say about currencies except calling for countries to avoid policy decisions that are solely directed at depreciating their currencies. Today, there was a Reuters article titled, “G20’s Deference For China’s Economic Policies Irks Japan.” It seems that the Japanese were the only nation raising concerns over the sustained weakness in the yuan even as the YEN has continued to appreciate. The Japanese are pointing the label of “kowtowing” at many others besides the Brits. Rumors are swirling about a large Japanese fiscal stimulus effort, which may be about  the Chinese effort of weakening its currency.

A sidenote from the G-20 meeting was the recent moves in Italian bank stocks in a response to the vast amount of Italian Nonperforming Loans. Italian Finance Minister, Pier Carlo Padoan told his fellow G-20 cohorts, “We are going in the right direction, there is no risk in terms of systemic stability.” How many times have we hear the all clear signal from policy makers over the last few decades only to awake to a crisis? A bigger problem for the ECB and all European domestic banks is if the BIS were to actually change the rules on zero risk weightings for all sovereign debt since the Italian central bank and domestic institutions are loaded with Italian government bonds in a county with a debt-to-GDP ratio of 136%. HMMMM.

***It’s interesting to see corporate Japan’s recent moves to utilize the recent strength of the YEN. Softbank announced a purchase of the British software giant ARM. Given the recent weakness of the POUND it’s a smart play, especially versus the YEN as the POUND is 23% lower for the year. Komatsu joined in the acquisition game by acquiring the U.S. based heavy equipment maker Joy Global in an effort to consolidate global manufacturing. The Japanese have taken the strategy of the U.S. multinationals in the 1960s, 1970s and 80s when an overly strong dollar became the mechanism of global purchases. A classic case of Gresham’s law in which bad money pushes out good. The Japanese are using what they believe is an overvalued currency to make acquisitions of quality assets. We need to watch for more purchases as long as the relative strength of the YEN continues.

***At last Thursday’s press conference, Mario Draghi provided us with more three card Monti. The Financial Times’ Claire Jones asked the first question, which was about the ECB running out of BONDS to buy. Ms. Jones raised a very important issue in asking if Draghi would push to relax the rules and MOVE AWAY FROM THE CAPITAL KEY RULE under which the BANK currently operates. Other journalists followed up with related questions on this issue after Mario totally avoided a genuine answer. The capital key purchase criteria means that the ECB can only buy the sovereign or corporate debt in amounts equal to each nations percentage investment in the ECB capital account. If the amount of German debt obligations is lacking and the ECB decides to purchase other sovereign debt, the German Constitutional Court may have serious issues with the ECB acting to bail-out various sovereign nations.

President Draghi maintains that the ECB has flexibility in its bond purchases, but I believe the German High Court may rule differently. This is why Draghi needs to lift the QE level so as to be able to increase the speed of amassing debt. Draghi went so far as to declare the QE program an unmitigated success as the crushing of credit spreads means that fragmentation within the EU is over. BUT AT WHAT COST AND FOR HOW LONG? Again, the question remains: WHO GUARANTEES THE ECB (AND I CARE NOT ONE IOTA ABOUT DRAGHI’s PRAISING OF HIS COUNTERFACTUAL)? Where would we be without the ECB’s massive LTRO, TLTRO and OMT programs? I am not buying the argument and certainly not buying the bonds for any long-term investment.

Tags: Brexit, Chinese Yuan, ECB, EU, G-20, global bond markets, Japanese yen, Mario Draghi, QE, trade agreements

This entry was posted on July 25, 2016 at 2:42 pm and is filed under Currency, G-20, Uncategorized. 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.