Monday, 28 March 2011

Sovereign annuities

Comment on the launch of "sovereign annuities" [note: they aren't annuities] over at I can't seem to comment over there. Not sure if I've been banned or something, but this worth noting. While the sarcastic tone is well deserved for the accompanying launch commentary - "there is no risk of default" (I wonder how the Financial Regulator feels about statements like that??), it might be worth noting that there could be some traction for the index linked issues if they pay Irish inflation, something to which Irish pension schemes are currently exposed to and against which they only have a rough hedge in the form of Euro inflation. Pension schemes would of course be sensible to combine such assets with appropriate Credit Default Swap cover.

Friday, 11 March 2011

Ireland's nuclear button

There is a popular theory going around that Ireland has some form of nuclear button at hand in the event of negotiations with EU partners on our debt problems and their assistance don't go as we had planned.

The hypothesis is that if they don't give us what we want we will default and German banks, or the German economy will be at threat.

Just a quick reality check here. While the sums involved are indeed extremely large and will be fatal to the Irish economy, they are a fatal threat to neither the German banks involved nor the German economy. What they would be is a severe financial irritant.

What those debts are, under potential default, is a massive political concern for Angela Merkel and the German electorate. Irish default would be enough to be extremely annoying politically the very people we are trying to get something out of.

So the more we talk about such a possibility, the more trenchant the German government is likely to become as they attempt to send the message to their voters that they (Germans) won't be picking up the tab. That strikes me as completely counterproductive from an Irish perspective.

Thursday, 10 March 2011

Markets sense a Euro end game

If you want to see the best indicator of market expectations for the likelihood of widespread fiscal failure in Europe, you need look no further than the shorter end of the Irish yield curve.

Ireland is supposed to be backed by a line of credit that will float our finances for maybe 2-3 years. You shoud (should) feel relatively comfortable about lending to the Irish government over such a term given that they the EU/IMF credit line will provide funding for close to that period. And up until only a few months ago markets appeared to feel that way. Not so now. 3 year Irish bonds are yielding 9% to maturity.

Markets have a high expectation of a default event. The only way you could be fearful of such a scenarion would be if you believe the much trumpeted EU support fund, the EFSF, will burn through its €750 billion leaving nothing additional for Ireland to call on. The only place such demand will be coming from is Spain pretty much.

And this fear doesn't really appear to have hit the media headlines yet. This is the markets say that the Eurozone is going to default.

Monday, 28 February 2011

Talking tough with Europe - the markets watch

As predicted and expected, it looks like a Fine Gael/Labour coalition government is in prospect for Ireland. While the two parties need to talk turkey before consummating their marriage, their is at least one policy area where we can already surmise the certain direction of the new government.

Debt restructure/negotiation. That means, reconsidering the position of creditors of those limited liability entities formerly known as Irish Banks. as well as some form of renegotiation of funding terms from the EU.

As has been commented on already be knowledgeable commentators, the only outcome of use to Ireland will be one that significantly reduces or curtails the prospective national debt burden, which is already at a level that arguably is not manageable.

So, is there likely to be any success on this score from FG/Lab? Monday morning gave us an early glimpse of the view of financial markets who are looking at nothing else:

So the early running on that question appears to be "no".

Thursday, 13 January 2011

New year's predictions

Well, only one really.

What, one may ask reasonably, could be a potential political patch that would leave the German and French governments free and willing to expand their support of the European Financial support mechanism? (stump up promises to back lots more borrowing).

Here is a tip. Keep an eye on the corporate tax rate.

Let's say I wouldn't be too surprised to see somebody float the idea that a Eurozone (maybe, at the risk of enraging the UK, EU wide) corporation tax levy.

Most likely something drafted in such a way that it prescribes a centrally remitted tax of, say, 10% (initially) on corporation profits, subject to a total corporation tax burden in any country of something like 30%.

Surprise surprise, German (and French) domiciled companies would not be subject to any additional tax. Ireland? well....

Tuesday, 14 December 2010

Go ahead, punk. Make my day.

Dirty Harry understood that for a threat to have any effect it had to be credible. He didn't stick a banana in the face of some criminal low life, but a 44 Magnum (the most powerful handgun in the world, that would blow your head clean off).

In all the trivial inanity surrounding the AIB bonus fiasco I have seen all manner of stupid nonsense aired, but the latest "threat" by the minister that AIB will have its future capital funding withheld if the €40 million in bonus from 2008 are paid is up there with the best.

I can only imagine that the Chairman of AIB, or whomever took the call from Brian Lenihan had to restrain himself from the most obvious response - "or what?". Brian Lenihan isn't a fan of the movies. He has confused his Dirty Harry with his Indiana Jones, by bringing a knife to a gun fight.

But on a serious note, Brian (he's not the messiah, he's just very naughty boy), is most certainly penny wise and pound foolish. Hooray!!!! he has saved the taxpayers €40 million. Shame he is and will be (jointly) personally responsible for costing us up to €100 billion. And he stillr efuses to turn off the tap.

But the sad indictment on the country is that electorate cheered!

Thursday, 2 December 2010

Quantitative easing in a monetary union - not as easy as it sounds

The Eurozone is heading gradually off on a path that might require the authorities to consider a large scale QE policy.

If government debt becomes too large to manage, then one way out of the pickle is to create lots of inflation that will erode the stock of debt over time. It is smoke an mirrors or course, as it does not create any wealth, but simply creates a transfer from bond holders to governments. The losers tend to be pensioners, since they are the bond holders in society in the main and receivers of fixed income directly or indirectly from long term government bonds. But that is a distributional issue tangential to the purpose of this post.

This post is to ask a more practical technical queston. How exactly would QE work in the Eurozone? Normally, say in the US or UK, the Central Bank would buy government debt for new money. This increases the amount of money in circulation, which if enough, will create more than enough liquidity which will then, in effect, be given away by banks who in the end won't be able to find any counterparties to deposit it with - because all the banks will have more liquidity than they want or need.

More money in the economy per unit of output produced will mean the ratio of Euros to output (GDP) will increase. The value of money will erode, which is inflation. In a previous post I have described how inflation then leads to a reduced burden on those in debt who have borrowed over a long term. Basically this means governments.

Now what is interesting here from a Eurozone perspective is that there are usually two distinct things going on here. There is the liquidity and eventual inflation that the QE produces. However, just as importantly, the act of buying government bonds for money retires some government debt. The Central Bank is owned by the government, so those bonds purchased can effectively be written off. In other words, what has happened is that the government, via the Central Bank, has called in its bonds and swapped them for an extremely cheap form of liability, or debt, that it will never have to repay - money; Dollars, Pounds etc. which are merely another form of government liability (although sitting on the balance sheet of the central bank).

Do you start to see the question here?

In the US the Fed would buy Federal bonds. These are debts owned by all Americans. They can be retired (swapped) for fresh dollars in the manner I described. The US government debt is both reduced and deflated.

However, what of the Eurozone? Whose government bonds will be purchased? And after that, can we employ the same logic and retire those debts, letting some countries off the hook?

The answer to the first question is that we can and probably would buy the debt of those countries that are prospectively insolvent , that have too much debt. Step forward Ireland. The answer to the second question is that we can, but with the full realisation that the rest of Europe would be bailing our Ireland, Portugal, Greece, etc. by swapping the debt incurred by those nations for liabilities (Euros) owned by all of Europe. The inflation that would ensue would adversely effect all the normal losers in this process (those pensioners in particular that I mentioned), but those losers in Ireland will have benefitted by the reduction in Irish debt that will allow.

Who will like this solution?

  • The Irish, Greek, Portuguese, Spanish governments
  • Irish, Greek, etc. state and civil service pensioners
  • Irish, Greek, etc. taxpayers

Who will not like this solution?

  • German pensioners
  • German taxpayers

Those who might or might not like this solution?

  • Irish, Greek etc. private pensioners (they will have their pensions eroded by inflation, but governments will be better able to afford to maintain higher level of public services - especially health)

It sure makes QE in Europe one hell of a political minefield, something I have not yet seen mentioned in the media.

Just as an aside. Where might a QE program start? Where better than a purchase of the €80bn plus in Irish government debt held by the ECB in Repo. agreements?