In a blog posted on 22/09/2011 I suggested that in order to contain the contagion of the sovereign debt crisis, Italy, Spain and other major countries could tap their domestic markets which enjoy a high saving ratio and would be much more stable than International Institutions.
This blog is to elaborate on the potential use of such issues.
The launching of such bonds could be undertaken now even if the funding program for the rest of the year is already covered. The funds would be used to prevent the outstanding bonds in the secundary markets yielding more than say 5.5 to 5,75%. Taking into account the marketing expenses to place in the retail market the overal cost would reach say 4%. Therefore the current discounts would present profit opportunities.
The gradual replacement of International Investors by domestic savers and Institutions would stabilise the market of the sovereign bonds of the States concerned.
The ECB would no longer be the sole supporter of the secundary markets of the States concerned.
Finally, the more important objective would be to shield the major States concerned from contagion from Greece. If this is achieved a more realistic restructuring of the Greek Debt could be contemplated with a significant haircut (50 %).
The markets are longing for remedies which look credible.
Saturday, 24 September 2011
Thursday, 22 September 2011
Sovereign Debt Crisis in the EU: A new approach
In order to contain the risks of contagion of a possible default by Greece followed by Portugal and Ireland, the current consensus involves,
- the need to substantially recapitalise the Banks in particular the systemic ones,
- the unswerving commitment of the ECB to purchase in the secundary market whatever amounts of sovereign bonds from Italy and Spain are needed to prevent their yields to exceed 6% p.a. and
- the unlimited provision by ECB of liquidity to the Banks against collateral.
The judgment underlying the prescription summarized above, is that a default by Greece and other small countries would contaminate the sovereign debt of Spain and Italy. In turn this would have a devastating impact on several systemic EU banks.
The suggestion explained in this Blog argues that if contagion can be contained - that is the assurance that Italy Spain will not default - then the situation of the systemic Banks in the EU should not be a major concern. For example if it is established that Italy will not default, then it becomes clear that one of the top French Banks has been unduly savaged by the market and that it does not need that much fresh capital.
The suggestion also stipulates that what creates a risk in the sovereign debt market is the fact that a significant proportion of the debt is held by International Institutions which are volatile, fearful of any rumor and essentially destabilising: 39% for Italy, 44% for Spain, 55% for France, 57% for Belgium,72% for Ireland, 75% for Portugal, 78% for Greece. The main exception is the USA - 48% - since it benefits from the dual position of issuer of the world reserve currency, and main recipient of the emerging economies exports, in particular the BRICS.
A short term solution would therefore involve the issue by major States (France, Italy, Spain) in their domestic markets of War Loan type of bonds.
The issues would yield a small but not insignificant coupon (2,75 to 3% p.a. ?) carry some tax advantages (marginal rebates), possibly prizes - to add some lottery excitement -.
They would be placed by all retail networks, Banks, Post Office, Savings Institutions, under a program launched with patriotic undertones.
The proceeds of such domestic bond issues would be used to redeem or buy in the secundary market (initially at a discount) the bonds held by International Investors.
It is clear that the sovereign debt domestically held poses much less of a risk, as the situation of Japan shows. Its sovereign debt amounts to 200% of GDP but it is mainly held domestically. This is one of the main reasons why it is not the subject of a market panic.
In admittedly oversimplified terms, it is unlikely that a State would default to its domestic creditors when it has the power to tax them.
Over the past decades, International Institutions have increased their holdings of sovereign debt thanks to the globalisation of the financial markets, coupled with the convenience for Investment Banks to go to the wholesale market for the placement of huge amounts of bonds.
As a result domestic pools of savings have been neglected. Traditionally, several continental countries enjoy significant savings ratios. And yet in current conditions, private investors simply do not know where to invest: insignificant interest on deposits, declining stock markets, fragile and illiquid real estate markets with the exception of major capital cities where the prices are overinflated.
In short, private investors may well be very interested to subscribe.
If not as advocated by JP Fitoussi G Galateri and P Well (Fiancial Times of 15/09/2011) they could be coerced to do so as a last resort measure.
Once the fear of default by a major sovereign issuer has been dispelled, the various countries of the EU would still have to put their budgets in order. But they would do so without the feverish pressure of the international markets.
Moreover the enhancement of the sovereign debt would improve the standing and borrowing conditions of the corporations and the Banks of the States concerned.
Many Banks wouls still need additional capital but the threat of having to set up provisions for billions of sovereign debt holdings, would have been neutralised.
- the need to substantially recapitalise the Banks in particular the systemic ones,
- the unswerving commitment of the ECB to purchase in the secundary market whatever amounts of sovereign bonds from Italy and Spain are needed to prevent their yields to exceed 6% p.a. and
- the unlimited provision by ECB of liquidity to the Banks against collateral.
The judgment underlying the prescription summarized above, is that a default by Greece and other small countries would contaminate the sovereign debt of Spain and Italy. In turn this would have a devastating impact on several systemic EU banks.
The suggestion explained in this Blog argues that if contagion can be contained - that is the assurance that Italy Spain will not default - then the situation of the systemic Banks in the EU should not be a major concern. For example if it is established that Italy will not default, then it becomes clear that one of the top French Banks has been unduly savaged by the market and that it does not need that much fresh capital.
The suggestion also stipulates that what creates a risk in the sovereign debt market is the fact that a significant proportion of the debt is held by International Institutions which are volatile, fearful of any rumor and essentially destabilising: 39% for Italy, 44% for Spain, 55% for France, 57% for Belgium,72% for Ireland, 75% for Portugal, 78% for Greece. The main exception is the USA - 48% - since it benefits from the dual position of issuer of the world reserve currency, and main recipient of the emerging economies exports, in particular the BRICS.
A short term solution would therefore involve the issue by major States (France, Italy, Spain) in their domestic markets of War Loan type of bonds.
The issues would yield a small but not insignificant coupon (2,75 to 3% p.a. ?) carry some tax advantages (marginal rebates), possibly prizes - to add some lottery excitement -.
They would be placed by all retail networks, Banks, Post Office, Savings Institutions, under a program launched with patriotic undertones.
The proceeds of such domestic bond issues would be used to redeem or buy in the secundary market (initially at a discount) the bonds held by International Investors.
It is clear that the sovereign debt domestically held poses much less of a risk, as the situation of Japan shows. Its sovereign debt amounts to 200% of GDP but it is mainly held domestically. This is one of the main reasons why it is not the subject of a market panic.
In admittedly oversimplified terms, it is unlikely that a State would default to its domestic creditors when it has the power to tax them.
Over the past decades, International Institutions have increased their holdings of sovereign debt thanks to the globalisation of the financial markets, coupled with the convenience for Investment Banks to go to the wholesale market for the placement of huge amounts of bonds.
As a result domestic pools of savings have been neglected. Traditionally, several continental countries enjoy significant savings ratios. And yet in current conditions, private investors simply do not know where to invest: insignificant interest on deposits, declining stock markets, fragile and illiquid real estate markets with the exception of major capital cities where the prices are overinflated.
In short, private investors may well be very interested to subscribe.
If not as advocated by JP Fitoussi G Galateri and P Well (Fiancial Times of 15/09/2011) they could be coerced to do so as a last resort measure.
Once the fear of default by a major sovereign issuer has been dispelled, the various countries of the EU would still have to put their budgets in order. But they would do so without the feverish pressure of the international markets.
Moreover the enhancement of the sovereign debt would improve the standing and borrowing conditions of the corporations and the Banks of the States concerned.
Many Banks wouls still need additional capital but the threat of having to set up provisions for billions of sovereign debt holdings, would have been neutralised.
Tuesday, 4 May 2010
A realistic approach to the Greek crisis
Over the past months the Greek crisis has taken on dramatic proportions, creating a serious risk of disintegration of the Euro-zone.
With enormous difficulty, the members, jointly with the International Monetary Fund, have committed loans amounting to 110 billion €uro. On its side the European Central Bank has finally resolved to derogate to its announced policy: it will continue to accept Greek paper as valid collateral. A program of quantitative easing is also mentioned as a further and last measure.
As a condition to this extraordinary help, a punitive program of cost cutting is imposed on Greece which faces a decade of deflation or at best very low growth. Perhaps more ominously social unrest is looming, the consequences of which could be far reaching.
And despite this extraordinary effort, skepticism prevails. Both the Greek debt and the €uro continue to be dumped in the markets. If we take into account the possibility of a crisis affecting other members (Portugal, Spain) it is clear that this approach is bound to fail, with devastating consequences.
Is not it time to step back and recognize that Greece faces a problem of solvency beyond the pressing liquidity needs?
The successful precedent of the Brady Bonds could be used to support an entirely different approach to the problem.
The Banks holding Greek Bonds (French, German, others) would be invited to swap them for newly issued obligations on the same terms but with much longer maturities - 20-30 years. Actuaries calculate that this restructuring would be equivalent to a “haircut of 20 to 25%” (because of the low interest rates for a considerable number of years). This may be sufficient to restore Greek solvency whilst at the same time providing the needed liquidity. Instead of committing hard cash the members of the Euro-zone (Germany, France , others) would underwrite the ultimate repayment of the bonds. The Banks involved would sacrifice the extra yield that bonds issued on the open market would command, but no loss as regards redemption. They could also refinance this paper with the European Central Bank.
Concomitant with the restructuring, Greece would be invited to resign from the Euro-zone perhaps temporarily. Greece could continue to use the €uro for its international transactions including the billing of services such as tourism. But the drachma would be reintroduced for the domestic economy.
This realistic approach would achieve several objectives:
- It would save the €uro-zone from gangrene from the poor performers: gangrene of the financial system and perhaps more importantly spreading of social unrest.
- It would send a strong signal to other potential defaulters to put their house in order before it is too late.
- It would crystallize a reality: so long as the members remain sovereign states, the €uro-zone must function as a club. In the last resort the members unwilling or unable to comply with the rules must be expelled.
- Finally it should galvanize the whole Community to improve the monitoring and coordination of policies, leading perhaps to closer institutional links, once the current crisis of Euro-skepticism is overcome.
Over the past months the Greek crisis has taken on dramatic proportions, creating a serious risk of disintegration of the Euro-zone.
With enormous difficulty, the members, jointly with the International Monetary Fund, have committed loans amounting to 110 billion €uro. On its side the European Central Bank has finally resolved to derogate to its announced policy: it will continue to accept Greek paper as valid collateral. A program of quantitative easing is also mentioned as a further and last measure.
As a condition to this extraordinary help, a punitive program of cost cutting is imposed on Greece which faces a decade of deflation or at best very low growth. Perhaps more ominously social unrest is looming, the consequences of which could be far reaching.
And despite this extraordinary effort, skepticism prevails. Both the Greek debt and the €uro continue to be dumped in the markets. If we take into account the possibility of a crisis affecting other members (Portugal, Spain) it is clear that this approach is bound to fail, with devastating consequences.
Is not it time to step back and recognize that Greece faces a problem of solvency beyond the pressing liquidity needs?
The successful precedent of the Brady Bonds could be used to support an entirely different approach to the problem.
The Banks holding Greek Bonds (French, German, others) would be invited to swap them for newly issued obligations on the same terms but with much longer maturities - 20-30 years. Actuaries calculate that this restructuring would be equivalent to a “haircut of 20 to 25%” (because of the low interest rates for a considerable number of years). This may be sufficient to restore Greek solvency whilst at the same time providing the needed liquidity. Instead of committing hard cash the members of the Euro-zone (Germany, France , others) would underwrite the ultimate repayment of the bonds. The Banks involved would sacrifice the extra yield that bonds issued on the open market would command, but no loss as regards redemption. They could also refinance this paper with the European Central Bank.
Concomitant with the restructuring, Greece would be invited to resign from the Euro-zone perhaps temporarily. Greece could continue to use the €uro for its international transactions including the billing of services such as tourism. But the drachma would be reintroduced for the domestic economy.
This realistic approach would achieve several objectives:
- It would save the €uro-zone from gangrene from the poor performers: gangrene of the financial system and perhaps more importantly spreading of social unrest.
- It would send a strong signal to other potential defaulters to put their house in order before it is too late.
- It would crystallize a reality: so long as the members remain sovereign states, the €uro-zone must function as a club. In the last resort the members unwilling or unable to comply with the rules must be expelled.
- Finally it should galvanize the whole Community to improve the monitoring and coordination of policies, leading perhaps to closer institutional links, once the current crisis of Euro-skepticism is overcome.
Wednesday, 7 April 2010
Opinion on the International Monetary situation and related Issues
The official concept of a glut of savings in poor countries paired with unrestrained consumption in the USA - hailed as saving the world economy - tends to hurt the layman's common sense.
I would instead place the emphasis on the wide gap of the costs levels between the West and say Asia.
This provide an easy explanation for the low level of inflation and interest rates: the entry of billions of workers,underpaid, in a globalised world.
The gap is so wide that any revaluation of the Yuan within the constraints of the possible (10% ?) would not solve he problem.
In my view the solution lies in a gradual increase of consumption in China and other newly industrialised countries. To be broad and firmly anchored, it should go in tandem with a social evolution: the continued emergence of middle classes aspiring to increased wealth, social protection and political freedom.
In a recent article published in the Financial Times, the chief economist of Goldman Sachs, Jim O'Neill argued that consumption was gathering momentum in China faster than anticipated.
In any case the process will take a few years.
2 - The current disequilibrium was naturally institutionalised when President Nixon decided to severe the link between the Dollar and Gold in 1971. The international monetary architecture became based on the sole Dollar. It induced the USA to consume beyond their means by paying their bills in IOU - reinvested in Treasury Bills. As we all know, this does not make sense as an investment in view of the low interest rate and depreciating currency.
The bizarre flow of capital from the poor (China) to the rich (USA) can only be understood in that perspective: the need to sterilize the huge proceeds from exports, combined with the promotion of the latter, and more importantly, the lack of alternatives.
In this context it is highly desirable that the €uro survives the current crisis. Since the members remain sovereign states, the €uro zone should function as a club. Certainly, improve the monitoring and coordination, but in the very last resort expel the members who do not comply with the rules. This may result in the partial default of Greece. But in any case a rescheduling of its debt on more realistic terms seems necessary.
The perspective of a possible expulsion would achieve a dual objective: make clear to each member the need to implement the required reforms (such as the pension system in France), and not least, introduce the concept of various categories of membership: with a core of nations more open to closer political links, another group only interested in a free trading zone (Britain), and finally those eligible to a privilged partnership but not membership (Turkey?).
Japan missed the opportunity three decades ago to replicate for Asia the role fulfilled by London in the 19th century: providing equity and financial loans (not export credit) to fund the industrialisation of the then emerging countries (America). But this remarkable nation of industrialists, engineers and traders did not graduate to the level of international financiers. Had Tokyo supplied capital (equity) to the rest of Asia, both its own situation and the global system would now be a lot healthier. As a result the international role of the Yen is focused on the "carry trade " speculation. Sadly, vast amounts of capital capital were wasted in real estate bubbles or in depreciating US Treasury Bills.
My guess is that the Chinese will be far more audacious when they are ready. Perhaps we should not wish that this happens too soon, and in any case not before we have put our house in order.
In Conclusion, I do not think that China should be pressurized on the artificially low exchange rate of the Yuan. Gradually domestic consumption will increase in the developping world and provide huge growth opportunities for the international economy. The West should do what it can to facilitate the emergence of middle classes and avoid interfering or lecturing their governments as this would stir their national pride.
At home the Western nations should reduce the indebtedness and the deficit, sort out the pension system by extending the working life, and deal with the silly abuses in the essential Health Care Institutions.
Finally our financial centers should be refocused on socially worthy goals, by reducing the overinflated speculation in derivatives - the Tobin Tax should be adopted - and also forbid the obscene remuneration of certain investment Bankers and Hedge Fund Managers. They discredit the system to the point of placing it at risk.
Albert Gabizon
I would instead place the emphasis on the wide gap of the costs levels between the West and say Asia.
This provide an easy explanation for the low level of inflation and interest rates: the entry of billions of workers,underpaid, in a globalised world.
The gap is so wide that any revaluation of the Yuan within the constraints of the possible (10% ?) would not solve he problem.
In my view the solution lies in a gradual increase of consumption in China and other newly industrialised countries. To be broad and firmly anchored, it should go in tandem with a social evolution: the continued emergence of middle classes aspiring to increased wealth, social protection and political freedom.
In a recent article published in the Financial Times, the chief economist of Goldman Sachs, Jim O'Neill argued that consumption was gathering momentum in China faster than anticipated.
In any case the process will take a few years.
2 - The current disequilibrium was naturally institutionalised when President Nixon decided to severe the link between the Dollar and Gold in 1971. The international monetary architecture became based on the sole Dollar. It induced the USA to consume beyond their means by paying their bills in IOU - reinvested in Treasury Bills. As we all know, this does not make sense as an investment in view of the low interest rate and depreciating currency.
The bizarre flow of capital from the poor (China) to the rich (USA) can only be understood in that perspective: the need to sterilize the huge proceeds from exports, combined with the promotion of the latter, and more importantly, the lack of alternatives.
In this context it is highly desirable that the €uro survives the current crisis. Since the members remain sovereign states, the €uro zone should function as a club. Certainly, improve the monitoring and coordination, but in the very last resort expel the members who do not comply with the rules. This may result in the partial default of Greece. But in any case a rescheduling of its debt on more realistic terms seems necessary.
The perspective of a possible expulsion would achieve a dual objective: make clear to each member the need to implement the required reforms (such as the pension system in France), and not least, introduce the concept of various categories of membership: with a core of nations more open to closer political links, another group only interested in a free trading zone (Britain), and finally those eligible to a privilged partnership but not membership (Turkey?).
Japan missed the opportunity three decades ago to replicate for Asia the role fulfilled by London in the 19th century: providing equity and financial loans (not export credit) to fund the industrialisation of the then emerging countries (America). But this remarkable nation of industrialists, engineers and traders did not graduate to the level of international financiers. Had Tokyo supplied capital (equity) to the rest of Asia, both its own situation and the global system would now be a lot healthier. As a result the international role of the Yen is focused on the "carry trade " speculation. Sadly, vast amounts of capital capital were wasted in real estate bubbles or in depreciating US Treasury Bills.
My guess is that the Chinese will be far more audacious when they are ready. Perhaps we should not wish that this happens too soon, and in any case not before we have put our house in order.
In Conclusion, I do not think that China should be pressurized on the artificially low exchange rate of the Yuan. Gradually domestic consumption will increase in the developping world and provide huge growth opportunities for the international economy. The West should do what it can to facilitate the emergence of middle classes and avoid interfering or lecturing their governments as this would stir their national pride.
At home the Western nations should reduce the indebtedness and the deficit, sort out the pension system by extending the working life, and deal with the silly abuses in the essential Health Care Institutions.
Finally our financial centers should be refocused on socially worthy goals, by reducing the overinflated speculation in derivatives - the Tobin Tax should be adopted - and also forbid the obscene remuneration of certain investment Bankers and Hedge Fund Managers. They discredit the system to the point of placing it at risk.
Albert Gabizon
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