Sunday, 17 November 2013

Europe's last weapon


Despite ECB’s recent rate cut, the Euro remains as strong as ever. It’s easy to imagine Mario Draghi pulling his hair out: just what does one need to do to force its currency lower and boost Europe’s peripheral economies, especially in a world where every other major central bank seems to be running the printing press at full tilt?
Sadly, the answer might be, to join them in the global exercise of quantitative easing. The favourite analogy I use to explain QE to my grandma goes like this: it’s sort of like persuading a massively obese man to do some exercise and walk to work by offering to buy his car for a price that he simply can not refuse. Despite the fact that many see QE as the very embodiment of evil, it’s still better than doing nothing, and that “nothing” seems to be an accurate description of the other politically-acceptable alternatives.

Europe ’s macro indicators have looked rather grim lately. One figure sums up the parlous state of affairs: the eurozone inflation at 0.7% is currently lower than that of Japan (1.1%). If it goes any lower, and as rates are already close to the zero bound, getting inflation back up again could be extremely difficult. In fact, it may be impossible. You can’t wait till you are caught in a storm to think about purchasing an umbrella.
Also, some economies in the eurozone are already in deflation. Would you buy something today if it were cheaper tomorrow? Countries that are undergoing structural reforms may well need negative real interest rates. Extremely low inflation militates against structural reforms.

What ammunitions does the ECB have left then? Rates can go lower but there is barely any room left. I can’t quite imagine negative deposit rates in a major currency. Of course the Swiss embraced this a long time ago, but somehow I feel that all things Swiss can effectively be confined to a little box that works in a parallel financial universe with zero gravity where expensive mechanical watches and mountain shaped chocolate bars operate in their own airport duty-free shop of Lalaland.

That leaves us with QE or something that subtly resembles it such as OMT and LTRO. My earlier comparison of QE to overpaying a fat man for his car is a little mean but fair. QE works by reducing the returns on assets like bonds to the point where other activities become interesting to investors. This is definitely a rather roundabout way of driving money into the real economy but it might just work.
It will not be easy politically by any means: open splits on national lines will emerge and Bundesbank will have an enormous fit. It might be unsuitable for Germany and might cause asset bubbles. But this is true in exactly the same way that the monetary policy pursued before the crisis was ill-suited for Spain and did indeed create a property bubble on those beautiful Spanish beaches. Any central bank tasked with the job of delivering a target rate of inflation in an union of vastly diverse economies will destabilise some of its members at any given point in time. This is akin to complaining that “each carriage of this train has its own engine and conductor!”. It’s a description of the whole damn point of a currency union.

I don't mean to imply that using the printing press is an intelligent choice for the ECB, nor is it a solution. Nevertheless, absent a revolutionary political change, it’s Europe’s last weapon. We can lament the political deadlock that has left Europe with a partially zombified financial system. But given a choice between zombies with and without QE, evidence probably support the former.

Monday, 1 April 2013

Cyprus: Mission accomplished?

Last night my newsfeed was full of pictures of a middle aged German woman in her black bathing suit while on vacation in Italy. Despite of the less than pleasant attention she received from the local Italian press, the German chancellor certainly deserved a short holiday following the Cyprus fiasco. From Angela Merkel’s point of view, the past couple of weeks have been if not a complete triumph, a respectable success. The German chancellor showed her constituents that she drove a brutal bargain.

The details of the Cyprus rescue have become increasingly clear and most publications talk about the €17 billion bailout calculated assuming that it would provide €7 billion for the banks and €10 billion for the government. It’s worth noting that the final plan provided not a single Euro for the banks who ended up having to raid their depositor base to come up with the whole €7 billion.
Of the €10 remaining billion, €7.5 billion is being used to refinance maturing debt. It doesn’t take an Einstein to work out that this debt is mostly pledged as collateral at the ECB. Consequently if the tiny island of Cyprus defaults it would take out a large portion of the equity capital of the ECB. While it is not a matter of public record it is estimated that Cyprus has guaranteed more than €10 billion of collateral at the ECB. So, the €7.5 billion is being lent to Cyprus in order to be paid right back to Europe. Given that, it is perfectly fair for me to say that on a practical level, the EU bailed Cyprus out for FREE!

The Troika is very emphatic about what the future of bailouts looks like. Nevertheless the head of the Eurogroup and Dutch finance minister Jeroen Dijsselbloem was pilloried for announcing that so-called “bail-ins” — forcing shareholders and large depositors rather than taxpayers to take the hit when banks fail - should become the norm in the eurozone.
The timing could not have been worse and his remarks immediately spooked the financial market. Aside from the incitement to panic, there is actually plenty to like about this in principle as it’s consistent, transparent and it doesn’t ask taxpayers to write blank cheques - we all know that blank cheques are a dangerous, dangerous species.  Mostly importantly, the new template is progressive – things that hurt only people with more than €100,000 tend to be.
Except it won’t work. The obvious issue is that depositors over €100,000 control enough money to overturn the European economy if they stampede. When I first started my career in derivatives trading, the first lesson I learnt was that the price for 1 billion is very different from the price for 1 million multiplied by 1000. You can not play and experiment with money on this scale unless you have planned a fully controlled detonation of a massively complex and fragile system.
Mr Dijsselbloem’s remarks would have been taken more kindly had the Cyprus operation gone well. It didn’t. The so-called rescue has inflicted massive, irretrievable destruction on the economy of Cyprus. The capital controls currently in place are draconian. There will be a forced rollover of debt. Cheques may not be cashed. Business working capital is frozen. Basic cross-border trade is severely curtailed. Credit card use abroad will be limited to €5,000 a month. And in spite of the above, the money will still leak out of Cyprus even if the island gets encircled with razor wire.

If Macdonald’s tested a new meal that killed 10% of the sample group, it is reasonable to assume that they’d hesitate with the global rollout of Cyprus HappyMeal. Instead, the Troika is clapping the dust off its hands, announcing that they think the Cyprus mission is accomplished, and looking to have another go somewhere else.

Sunday, 17 March 2013

When you cross the Cypriot Rubicon

I wake up on Saturday morning (okay, maybe midday) in a Warsaw hotel to the news that the people of Cyprus have been unceremoniously sacrificed as part of a 10bn bailout agreed in Brussels. The BBC reports that one man has parked his massive bulldozer(!) outside a Cypriot bank. Well, if 10% of your money was suddenly seized from you without any warning to “bail out” the banks, and the remaining 90% was completely inaccessible, it does seem somewhat logical to park your bulldozer in front of any one of the said banks.

The troika meeting where the above decision was taken started one hour after American markets closed for the weekend.  In the wee hours of the morning, the troika came to a conclusion and announced their idiotic plan to recoup cash directly from all bank deposits in Cyprus.
Specifically, Cyprus is imposing a levy of 6.75% on deposits of less than €100,000 - the ceiling for European Union account insurance, which is now effectively gone - and 9.9% above that. The measures will apparently raise €5.8 billion.
I heard various rumours about this previously, but never believed for one second that anyone would actually be foolish enough to implement what has been the biggest taboo in European bailouts to date - the  impairment of depositors.

They’ve crossed the Rubicon. So here is what I think will happen on the short term:
1. EUR/USD tanks. US treasuries sky rocket. Good thing I’m positioned the right way.
2. Cypriots empty all ATMs and banks in Cyprus. Yes the 10% might be gone but there is nothing stopping anyone taking out the remaining 90% now. A quick search found that the loan to deposit ratio for Marfin Laiki bank stood at 156%. Bad news.
3. Half of Cypriot bank tellers take a sick day on Tuesday.
4. Berlusconi and Grillo open bottles of champagne to celebrate being given the biggest piece of ammo they could have hoped for. They start running new campaigns telling voters their bank accounts will be empty if they don’t jump ship from the EU.
5. I can’t quite predict Russia’s reaction but undoubtedly not just Russians but very wealthy, and very trigger-happy Russians will be absolutely FURIOUS.

On a longer term:
Cyprus will NOT have a sustainable debt load of 100% by 2020. There is NO way. We know all too well that outrageously optimistic forecasts are being used once again to make it appear that this bailout will lead to sustainability. Even my 80 year old grandma can hear the unmistakable sound of the Cypriot can being kicked down the road.

Monday, 25 February 2013

Faces of Ferentari

I had no idea what to expect when Alex and Raluca took me to Ferentari. It’s supposedly one of the roughest places in Eastern Europe, the infamous base of drug dealers, prostitution and mob operations in Bucharest. More than 80% of its inhabitants illegally tap into the city’s electric/water/gas grid. When quizzed about the imaginary scenario where the police could start severing the illegal connections to the grid, the local residents said that violence would be their main weapon.

Despite all of that I went to Ferentari to see a children’s dance group on a rainy weekend. They all gathered in a place called the alternative education club, founded by Valeriu Nicolae, and ran by a network of extremely poorly paid but brilliant staff and volunteers. The children were phenomenal, they managed to stand on their heads, spin at furious speeds, freeze in mid air, and they did a variety of other unbelievable things with their tiny bodies. I was mesmerised. The kids were taught and choreographed by two professional dance instructors Laur and Andrei who had been volunteering at the club for years, spending countless hours helping their little prodigies perfect every routine.

I took pictures of everyone, zooming in on all the little faces that lit up when they performed. I doubt that I’d ever pressed the shutter in such rapid succession before. It was so heart warming and heart breaking at the same time, for I knew that behind all the bright smiles stood broken families, drug addicted parents, siblings locked up behind bars as well as the drudgery and hopelessness of living life in a ghetto.







Wednesday, 13 February 2013

A little reminder of spring

When I was rummaging through the photos, I came across these so I thought I'd post them. Just a little break from the winter doldrums.

a little reminder of autumn redskirt1