Tuesday, 29 May 2018

From Worse To Bad

A week ago, I wrote that global bond yields were set to gap higher.  Typical of the way these things happen, in the days that followed,  US Bond yields instead of rising towards 3.50% fell back.  Today they have fallen back to around 2.86%.  But let's look at why.

In the post, I wrote that, as I had suggested at the start of the year, we are either at, or approaching a number of inflexion points.  One such point here is that contrary to what has been the case over the last few years, rises in official US interest rates are now likely to act to strengthen the Dollar.  I set out the reasons for that in the post.  Now look at what has happened.  In the last few weeks the Dollar has been strengthening.  The Pound has already fallen from over $1.40 down to just over $1.32 today.  But, inevitably, the most notable effect has been on emerging market currencies, which have started to drop significantly against the Dollar, a problem for them, as many of their imports are denominated in Dollars, so a rising Dollar means imported inflation for them.

Turkey, has been one such country.  But, it has other factors.  It is sliding ever closer to dictatorship under Erdogan.  He has recently spoken about taking direct control over the Turkish central bank.  The Turkish Lira then began to fall precipitously, and Turkish bond yields spiked higher.  Eventually, as the Lira continued to drop, the Turkish central bank was forced to step in to defend it, reminiscent of Britain in 1992, and raise official interest rates.  Turkish rates have risen now to over 16%, just as the UK raised rates in 1992 to 15%.

But, Turkey is not alone,  The latest example is Italy, where the election of the right-wing nationalist coalition of Five Star and the neo-fascist Liga already spooked the markets.  Protected by being a member of the Euro, there is no Italian currency to be attacked, but as with the Eurozone Debt Crisis of 2010, that has meant the focus has centred on Italian government bonds, and now given that over the last 8 years the ECB has stuffed the mouths of commercial banks with cheap money, encouraging them to buy their country's sovereign bonds, that has also fed through in to an attack on the already shaky Italian banks who are likely to go bust, if all of the Italian bonds sitting on their balance sheets get turned into toilet paper.  What makes that situation worse, is the very fact that over the last few years, the ECB's LTRO, and then outright QE programme has meant that all of these worthless bonds have been pumped up to ridiculous levels, to the extent until this crisis, Italian bond had lower yields than UK Gilts!

The situation in Italy has highlighted the situation in Spain, once more, especially given its own political crisis surrounding the corrupt government of Rajoy.  And, that, in turn has flowed over to a sell off of Portuguese bonds.

In short, the rise in the price of US bonds, fall in their yield, is not a reflection of them being a good place to be, only that they are a relatively safe haven compared to all these absolutely awful other places.  The rise in the price of US bonds, is simply a reflection that hot money has rushed out of all these other places, causing their currencies to drop, and bond yields to surge, and into the relatively safe haven of the US.  For all the reasons previously set out, that will not last either.

Back in 2015, I wrote that the new Syriza government could not bend.  If it did, I argued, the result would not be some return to a centrist government, but a turn by the Greek people to the only other option - Golden Dawn.  In the event, Syriza did bend, and they are now facing being wiped out at the next elections.  But, in the meantime, the ECB effectively arranged for the Greek debts to be wiped out, and short term loans have been provided.  But, as Syriza themselves initially recognised, none of that resolved the underlying structural problems of the Greek economy, which requires capital not liquidity.  For now, Golden Dawn is not waiting to take over in Greece, the Greek people seem to have the good sense to have rejected them, and to recognise that life for them outside the Eurozone, let alone outside the EU, would be much worse, despite the unnecessary suffering imposed on them by the irrational programme of austerity, demanded by the EU's conservative leaders.  Instead, its across the EU that those irrational conservative polices of austerity have had their effect, in that direction.

The conservative EU leaders have wasted the eight years since 2010.  They should have recognised, particularly after the crisis in Greece, Cyprus and elsewhere that those old conservative economic policies were dead.  What Greece, and other EU countries required was not austerity, but bold fiscal expansion, to create the kind of 21st century infrastructure that would bind the EU together as a modern state, and create the networks, and foundations for balanced economic growth.  Instead, intent on the delusion of being able to reflate asset price bubbles, and thereby protect the illusory paper wealth of the richest private capitalists, they pressed ahead with austerity to restrain economic activity and investment, alongside massive money printing to further hyper inflate the prices of bonds, shares, and property - the very policy that had led to the 2008 financial crash, and the 2010 Eurozone Debt Crisis, in the first place.

The result has been Brexit, rising support for right-wing nationalists like Le Pen, Wilders, the AfD, the Austrian Freedom Party, Orban in Hungary, Law and Justice in Poland, and Five Star and the Liga in Italy.  Its time the EU leaders woke up and smelled the coffee.  Italy is not Greece, and now they have a problem.

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