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posted on 28 July 2015

Epoch of Belief, Epoch of Incredulity (27): Metanoia

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Epoch of Belief, Epoch of Incredulity (26) "Last Among Unequals" explained how Alexis Tsipras had moved from a position of "EUseful Idiot" to irrational actor in the Greek tragedy of negotiations with the Troika. The irrationality was confirmed when he proposed that a national referendum should be held on the acceptance of the Troika's conditions on July 5th - [i]. There is however method in his alleged madness. Since Angela Merkel has demanded an unequivocal response from Greece, a referendum will meet this demand. Also since the majority of Greeks favour Eurozone membership, the country will now have to face up to the economic cost of continued Eurozone membership.

The related issues of Eurozone membership and its economic cost will thus be put to a genuine democratic political test. Just to give the voters some extra food for thought, the Greek banks were closed - [ii]. Greeks will therefore have a week to experience what it feels like to have left the Eurozone. As the country then failed to pay the IMF on the 30th, they will also experience what it feels like to be a global economic pariah. These cruel lessons, should then in theory force the country to accept the Troika's terms.

The Troika's terms were neatly summarised in a ten point plan, which was submitted in English to the Greeks as capital controls were being imposed - [iii]. The EU big three of Germany, France and Italy then wasted little time underlining the fact that the referendum was on Eurozone membership and not about getting a better financial deal - [iv]. There is however the chance that, should the country survive this week of extreme economic stress, voters will conclude that it may actually be worth welching on their debts and living on the subsistence margins. The experience of Iceland also serves to show that there is life after default. The divisions in Greek society that this referendum will expose however will split the country apart, even if it does remain within the Eurozone.

The European Project's legitimacy is therefore clearly in doubt, if it destroys unitary states along the way to a unified fiscal and political elite minority membership club. Further marginalization of the disenfranchised, at the margins of the Eurozone, will therefore create the conditions for a more violent and undemocratic challenge to the undemocratic European Project structure in the future.

Epoch of Belief, Epoch of Incredulity (26) "Last Among Unequals" also explained how the "Euseful Idiots" Juncker and Tsipras had come to the end of their utility. Juncker's position, as head of the European Commission, was particularly challenged because of his failure to engage Tsipras in an all European solution that would have reduced the Anglo Saxon influence on the continent. His legitimacy is already challenged by his proximity to the Luxembourg tax evasion that has plagued the developed economies of Europe and North America. Feeling his credibility and tenure under threat, Juncker made a big show of being "betrayed" by Tsipras - [v]. His poignant sense of betrayal is more personal than that in relation to the European nations he represents.... for now.

In a sign that the noose was tightening around Juncker's neck, Wolfgang Schaeuble shot Juncker's messenger Martin Selmayr. Selmayr's treasonable offence has been his "Tweeting" of positive spin about the abortive negotiations of Juncker and Tsipras to create a European political solution that would bypass the Anglo Saxons. In particular, Selmayr had characterised the initial Greek proposal that got the markets so excited as a "good basis for progress" - [vi].

As Greece headed towards a referendum, the Bundesbank pushed it towards a default that would weigh heavily on public opinion during the referendum. Jens Weidmann opined that Mario Draghi was bending the rules on deficit monetization - [vii], by providing emergency funding to Greek banks that were using the funds to buy Greek debt.

In Draghi's words, there is the inherent warning about moral hazard of financing a country that is already technically insolvent. He then went even further, by voting against any further emergency lending to Greece - [viii]. The ECB took the decision to freeze the emergency support at current levels - [ix], clearly following Weidmann's wishes. The problem for Draghi, is that the Greek debt on the ECB's balance sheet is therefore worthless, calling forth the need for a potential ECB recapitalization event.

Ewald Nowotny tried to field the problem presented by Weidmann, when he made it clear that the ECB would have to first study the legality of continued emergency support for Greece, in the event that it defaulted to the IMF when the Emergency Liquidity Assistance (ELA) programme expired - [x].

If Weidmann has thought all this through, then he understands that the implications of his words go much farther than a Grexit; and encompass the awkward reality of an ECB capital loss that will need covering by the injection of equity capital. Presumably Germany will underwrite said recapitalization; and therefore increase its ownership and control of the ECB.

By implication, the Euro will therefore become a harder currency also; as it will become more like the old Deutschemark. A northern European could not prepare for the unwinding of the Eurozone and the attendant currency crisis, in any better way other than by hardening the Euro going into the crisis.

Weidmann has therefore signalled that Germany is preparing to harden the Euro in order for it to survive if the Eurozone collapses and/or otherwise. The Germans are acutely aware of the fact that the creators of the Euro did not build in a mechanism for its dissolution. Any dissolution would therefore be violent and very costly to the European economies. It is this fact that Tsipras has been at pains to leverage over, by making Greece's debts synonymous with the Euro's survival.

The Bundestag joined in the initiative to save and harden the Euro, when it came out in support of expanding Eurozone integration whilst simultaneously cutting off all talks with Greece until the referendum result is clear - [xi]. The ECB is equally as mindful of the lack of an orderly dissolution mechanism for the Euro - [xii]. It was therefore no surprise to see Ewald Nowotny claim that Greece's missed payment to the IMF was not technically a default - [xiii]. Euro bears beware of falling in love with that trade.

Wolfgang Schaeuble gave further support to the save the Euro thesis, when he opined that Greece could remain within the Eurozone even after a referendum No vote - [xiv]. A Greek default looked certain, when it signalled that it was unlikely to make the IMF June 30th deadline payment - [xv]. As it became clear that Greece would not make its payment to the IMF, Merkel and Hollande hardened their attitude by signalling that there would be no further concessions - [xvi]. This only served to embolden Tsipras, who then openly remarked that Greece would not be ejected from the Eurozone because the "immense cost" would be too large for the Eurozone to manage - [xvii]. Fully emboldened, he then went on to ask the EU for a two year bailout under the European Stability Mechanism (ESM) - [xviii]. The big question was whether the "betrayed" Juncker would fall for it; and have another swing at taking the Anglo Saxons out of the European equation.

When the IMF payment deadline passed with no payment, Merkel signalled that all new talks were on hold until the creditors had convened and the Greek people had voted - [xix]. In response Tsipras blinked and opined that the Troika's proposals could be the basis for future negotiations - [xx]. Merkel then relented and said that the door to a deal was still open, but not at any price - [xxi]. Going into the referendum, the Greek voters can now see a chink of hope; whether this is sufficient to make the majority accept the Troika's terms remains to be seen.

For those Greeks who hate Yanis Varoufakis, the incentive to vote Yes was strengthened when he promised to resign in the event of such a result - [xxii].

Epoch of Belief, Epoch of Incredulity (26) "Last Among Unequals" explained how the IMF was emerging as the key player in the Greek debt negotiations, in addition to acting as the focal point of the leading current global macro risks. Christine Lagarde increased the strength of the IMF last week, when she made it clear that the Greek referendum on the debt situation would be invalidated by the failure of the Greeks to make their payment to the IMF on June 30th - [xxiii]. Furthermore, future IMF support would be conditional upon Greece making the said payment deadline in full. Lagarde then hardened her position by saying that all talk was over until the Greeks had signed up for economic reforms; and by so doing signalled that a No vote would effectively end constructive dialogue - [xxiv].

The Greeks and their creditors were therefore not just on different pages, but in fact in two different books altogether. Having demanded that the Fed put rate hikes on hold until 2016, Lagarde then went further and undermined the case for any rate increases at all; by demanding that the FOMC drop its "dot" projections - [xxv]. FOMC policy and guidance will thus become part of the IMF's broader global mandate if Lagarde has her way. Lagarde has thus engineered the big global macro risk off event that is the precursor to the next risk on event for which she will take the credit.

The less than decisive response to the IMF's missed payment, signals that Lagarde will be playing her cards carefully in order to maintain control of the situation. Rather than appear to be the bad guy, by immediately calling a default, the IMF agreed to play it by ear and see how the land lies before calling the next shot.

By way of response, Janet Yellen used the mouthpiece of Jon Hilsenrath to acknowledge Lagarde. According to Hilsenrath, the Fed will only deviate, from its interest rate increasing path, if the fallout in Europe feeds back into the US economy - [xxvi]. It will be child's play to link any future weak US data, which occurs in response to expected Fed rate increases, to events in Europe.

The July Employment Situation report clearly played into the hands of such a child. In addition, the consolidated global PMI picture signals that the global headwinds are out there. The IMF also graded central bank QE a fail, for increasing wealth inequality.

Picking up on this theme, the BIS last week reported its own findings on central bank policy action since 2009. The BIS concluded that the "Zero Bound" is actually a problem in and of itself, by the nature of low (even negative) interest rates being both the symptom and cause of a general global "malaise" that has afflicted the real global economy whilst the financial economy has prospered - [xxvii].

The BIS therefore demands supply side economic reforms of the real economy to invigorate economic growth. This would seem to complement what the IMF is also concluding and suggesting as the way forward. With restive voters however, democracies have a tendency to continue to write cheques that they cannot honour. The risk is therefore that expansionary fiscal policies, in particular the experiment with Helicopter Money injected into the accounts of the poorly paid/unemployed, will be rolled out without the necessary supply side modifications to economies that prevent them from creating inflationary bottlenecks.

The PBOC is certainly having no truck with the IMF and the BIS. In the face of the kind of equity market bubble that both institutions used as examples of central bank policy failure, the PBOC cut interest rates as the bubble burst - [xxviii]. When this action failed to have the desired reaction in Chinese equity markets, as they buckled in the face of the Greek news, the PBOC then unloaded one of its biggest ever liquidity injections - [xxix]. Divergent policy maker responses to the same problems will therefore characterize the trading dynamics and volatility in the capital markets going forward.

The official American view on the Eurozone was articulated by Larry Summers - [xxx], himself an MIT alumnus like Mario Draghi. Summers poured invective on the Troika and Greece for adopting adversarial positions, on seemingly trivial basis point reductions in Greek spending for equally trivial financial support. In his opinion, both sides had failed to fundamentally address the problem and had actually made it worse. His praise was saved for his fellow alumnus Mario Draghi; thus confirming that America fully endorses the ECB's QE programme even though the growth and inflation signals from the Eurozone do not require it.

Summers also made it abundantly clear that the Anglo Saxon Saltwater School solution is optimal, rather than the Troika's own Freshwater School approach. This theme was continued by MIT thought leader Stanley Fischer; in a speech which encompassed all things from Greece, through the US Economy and even the Taper Tantrum's effects on the wider global economy. Fischer made it clear that, since US inflation is still weak and may be jolted lower by the global headwinds, the Fed will not rush into rate increases - [xxxi]. Emboldened and presumably elicited by the words of his former MIT chums, Draghi felt brave enough to expand the scope of ECB bond buying to state backed corporate bonds, thus running the risk of a clash with Weidmann over the sacrosanct ECB edict on deficit monetization - [xxxii].

Although not an MIT alumnus, Mark Carney is a true Anglo Saxon at heart when it comes to economic policy. He therefore joined the bandwagon calling for caution in relation to interest rate increases in the face of "acute" risks from the Eurozone - [xxxiii]. The Antipodean contingent has been showing recent signs of fascination with China and its alternative World Bank/IMF clone. Christine Lagarde has therefore focused attention and invective upon Australia, to get back with the Anglo Saxon programme.

Last week, the IMF ordered Australia to boost fiscal spending - [xxxiv]. There were signs that the message was heeded, when RBA Governor Stevens responded by saying that monetary policy would remain accommodative for some time - [xxxv].

He also bought into the new Anglo Saxon central banking theme, that macroprudential rules will deflate economic bubbles, when he further opined that his colleagues would need to apply said rules to the bubble that he is creating. Aussie Dollar bulls mind your eye. Canada, the Northern Dominion, is now also confidently expected to start easing again, after the recent disastrous economic data that showed economic contraction - [xxxvi].

Japan is plotting an interesting path in the face of global headwinds. Governor Kuroda would like some latent Yen strength, in order to give him the confidence to press on with some more QE. The weak economic data is unfortunately not obliging. Last week however, he found an important ally in Prime Minister Abe himself. Abe now finds himself forced to implement new policies to curb Japan's out of control debt spiral - [xxxvii]. No doubt the policies will include further tax increases, which create some inflation but create a much more sluggish consumer as a consequence.

As Abe is faced with further fiscal austerity measures, the Yen may therefore catch the bid that Kuroda is looking for, in order to get the green light for more QE. To capitalize on the Yen bid afforded by the Eurozone crisis, Kuroda was swift to opine on the destabilizing events there - [xxxviii]; and the need for global coordination to address them - [xxxix]. Another booming Yen carry trade will no doubt be Japan's contribution to the global coordination initiative. Kuroda received a boost, from a former BOJ hawk who has historically opposed his QE strategy, last week. Yakitoshi Funo opined that the 2% inflation target must be met[xl - ]; thus shifting his position to support the next wave of BOJ easing.


American readers: Happy whatever strange ritual you celebrate on July 4th.

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