Mish's Global Economic Trend Analysis

Looking Beyond Portugal; Bundesbank President Says "Optimism Seems Premature"; Polish 10-Year Yields Hit 6.18%, Highest in 16 Months
Budgetary Delusions: Federal Deficit Charts from CBO Budget Projections
"World Comes Together to Save the Euro"; Japan Officially Joins the Battle

Looking Beyond Portugal; Bundesbank President Says "Optimism Seems Premature"; Polish 10-Year Yields Hit 6.18%, Highest in 16 Months

Posted: 11 Jan 2011 05:54 PM PST

Portugal is the recent flashpoint, but Spain and Belgium are on deck. Note too that sovereign spreads in Ireland and Greece are at record highs in spite of the alleged bailouts.

In response to the clearly not-contained crisis, Germany is considering expanding the bailout fund from 750 billion-euro ($966 billion) by as much as 25%. Meanwhile, it's time to look beyond Portugal to Belgium and Italy, and of course Spain.

Why stop there? Interest rates are soaring in European countries outside the Eurozone, notably Poland.

Looking Beyond Portugal

The Financial Times says Europe must look beyond Portugal.

Like the rival warring sides on a battlefield, European policymakers and financial markets left each other alone over the Christmas holiday. The new year, sadly, holds little prospect that peace will soon break out in Europe's sovereign debt crisis. Eurozone leaders must ensure that 2011 does not become a repeat – only worse – of 2010.

The imminent flashpoint is Portugal. Long mentioned in the same breath as Greece and Ireland – which have both accepted rescue packages from the European Union and the International Monetary Fund – Portugal has now taken their place as the most exposed eurozone state still reliant on market funding. The yield on 10-year Portuguese sovereign debt remains near euro-era highs, above 7 per cent. There are rumours of German pressure – denied by Berlin and Lisbon alike – for Portugal to take money from the European financial stability facility.

Portugal's problem is similar to Spain's. Stagnant productivity alleviated with excessive private sector borrowing resulted in a decade of huge current account deficits that were squandered instead of assisting reforms to increase growth. But private debts quickly turn into public ones when the alternative is a depression brought on by a private funding drought.

The costs of the financial crisis are being born by everyone from citizens to shareholders – with one exception: senior creditors to private banks, treated as sacrosanct. The sovereign crisis will not end until this false religion is unmasked. That means Europe's leaders must open a new front. If they want financial peace, they must prepare for war.

Bundesbank President Says "Optimism Seems Premature"

Please consider Weber Says 'Premature' to Be Optimistic on Containing Crisis

European Central Bank council member Axel Weber said it's too soon to assume Europe's debt crisis has been contained as the ECB steps up its purchases of government bonds to ease market tensions.

"The optimism of some observers seems premature to me," Weber, who heads Germany's Bundesbank, said in a speech in Frankfurt late yesterday. "There are several good reasons to look into 2011 with cautious optimism, not least the economic outlook. At the same time there remain -- also in Germany -- important challenges in terms of cleaning up the financial system and getting state finances in order."

Greek, Irish and Portuguese bonds rose yesterday as traders said the ECB bought the assets of the euro region's most indebted nations amid mounting concern Portugal will be forced to seek a bailout. Portugal auctions 2014 and 2020 bonds today. The turmoil has prompted calls for Germany to soften its opposition to expanding the region's 750 billion-euro ($966 billion) rescue facility.

"The outlook for 2011 depends on the extent to which the right lessons are drawn from the crisis," Weber said. "The responsibility for the debt crisis in the euro area lies primarily with fiscal policy, not with the financial markets. The affected countries must themselves restore the confidence that's been lost."

The ECB purchased Portuguese debt yesterday, said two traders with knowledge of the transactions, who asked not to be identified because the deals are confidential. A spokesman for the central bank declined to comment. Portuguese 10-year yields fell 12 basis points to 7.08 percent.

Polish 10-Year Yields Hit 6.18%, Highest in 16 Months

Bloomberg reports Poland Faces Highest Yields in 16 Months on Cuts to Pensions

The Finance Ministry faces yields of at least 6.18 percent on 10-year bonds, the most since an auction in May 2009, according to analysts at PKO Bank Polski SA, ING Bank Slaski SA, Bank Handlowy SA and data compiled by Bloomberg. Twenty-year debt may yield the most since an auction in September 2009.

Yields on 10-year Polish bonds climbed 17 basis points to 6.227 percent this month after the government said on Dec. 30 it plans to lower contributions to private pension funds, which as of November were the third-biggest holders of government debt, according to Finance Ministry data. The auction comes the same day as an offering of 10-year bonds from Portugal, the first from any of the euro region's most indebted countries this year.

"Market sentiment has worsened as there is a lot of uncertainty whether Portugal will get a bailout," Rafal Benecki, an economist at ING Bank Slaski, said by phone from Warsaw. "The long-end is risky because that's where the pension funds were calling the shots and we don't know what the market will look like after the reform takes effect."

The extra yield investors demand to hold Polish 10-year debt in zloty over German bunds rose to 335 basis points this week, the highest since Nov. 30. The cost of insuring European sovereign debt climbed to a record on concern backstopping the region's banks will overwhelm government finances. Portugal's Prime Minister Jose Socrates said yesterday his country doesn't need a bailout from the European Union and its 2010 budget deficit will be lower than forecast.

Crisis Will Escalate Until Haircuts Taken

This is not a matter of looking beyond Portugal, but rather of looking at the reason for the crisis itself: debts that cannot possibly be paid back. The market understands Greece and Ireland will default, otherwise yields and credit default swaps would not be at or near record levels.

Attempts to bailout country after country is itself destabilizing. Every increase in the bailout fund and every purchase by the ECB brings the crisis closer to the core - France and Germany. This is why Axel Weber is correct in voting against ECB bond purchases and Trichet is wrong.

Sovereign debt purchases do nothing but mask over the problem while loading up the ECB's balance sheet with garbage. In the end, what cannot be paid back won't.

In the meantime, Trichet has gone against everything he has ever stood for. His short-term effort to "save the euro" are the very things that may cause the Eurozone to break apart or the Euro to collapse long-term.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Budgetary Delusions: Federal Deficit Charts from CBO Budget Projections

Posted: 11 Jan 2011 09:06 AM PST

Can the budget deficit be solved by cutting earmarks? How about cutting 100% of all federal non-defense discretionary expenditures?

That is the question reader "David" asked and answered in the following email.

Hello Mish

Here is a chart I created using budget projections from the CBO. The main point is from now until 2020, we could eliminate 100% of all federal non-defense discretionary expenditures and still run a deficit.

I went back to the data after getting into one too many arguments with people who claim that we can solve our budgetary problems by eliminating government "waste" - the programs that study the sex lives of jellyfish and that sort of thing - without real cuts in entitlement programs.

Unless the Budget Fairy waves her magic wand, it's not going to happen.

David

US Federal Revenues and Expenditures 2000-2020

click on chart for sharper image

Data for the projections in the above chart is from a link found at the bottom right hand corner of the CBO Report Analysis of the President's 2011 Budget. The header says Additional Info "Budget Projections". Click on the link that says "data" to download an Excel spreadsheet.

Data for 2009 and before came from the CBO report Budget and Economic Information. There is a link on the right about halfway down that says "Monthly Reviews and Historical Data." Click on the "Excel" link to download a spreadsheet.

Entitlement Spending Growth

click on chart for sharper image

Both charts are from David who posts on the No Money No Worries blog.

Inquiring minds may wish to check it out.

Thanks David.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

"World Comes Together to Save the Euro"; Japan Officially Joins the Battle

Posted: 11 Jan 2011 12:08 AM PST

At long last, and after decades of trying, Japan may have found a way to weaken its currency: buy European bonds. The irony is that is not Japan's intent. The non-plan to weaken the Yen could conceivably "work" if done in size, although I rather doubt Japan commits that much. Regardless, it sure won't do a damn thing to "Save the Euro".

Please consider Japan Joins China in Assisting Debt-Crisis-Hit Europe

Japan plans to buy bonds issued by Europe's financial-aid funds, its finance minister said, joining China in assisting the region as it battles against a debt crisis that prompted bailouts of Ireland and Greece.

"There is a plan for the euro zone to jointly issue a large amount of bonds late this month to raise funds to assist Ireland," Finance Minister Yoshihiko Noda said at a news conference in Tokyo today. "It's appropriate for Japan to make a contribution as a leading nation to increase trust in the deal. We want to buy more than 20 percent."

The euro gained against the yen as the statements of support showed that the country with the world's second-largest foreign-exchange reserves, after China, may help stem the risk of the crisis spreading. Portugal's borrowing costs jumped last week as concern deepened that nation may be unable to avoid tapping the European Union's rescue fund.

"This signals that the world is coming together" to save Europe, said Noriaki Matsuoka, an economist at Daiwa Asset Management Co. in Tokyo. "But it's unlikely the euro will maintain its current strength. It's unclear whether the market will be able absorb all the bonds being issued by the problematic euro-zone nations."

Japan will use its foreign-exchange reserves to buy more than a fifth of bonds to be issued later in January by the European Financial Stability Facility, Noda said. Japan's reserves total $1.096 trillion, the government said today. That compared with China's $2.648 trillion, according to data compiled by Bloomberg.

"I think we cannot rule out the possibility that the Japanese government" may need to shift part of its reserves to euros from U.S. dollars to buy the bonds, Tohru Sasaki, head of Japan rates and foreign exchange research at JPMorgan Chase & Co. in Tokyo, said in a note to clients today.

"Japan's finally contributing to the stabilization of the global financial system," said Hiroshi Miyazaki, chief economist at Shinkin Asset Management Co. in Tokyo. "This is good news for the euro and it's good news for the global financial system. Since Japan has a current-account surplus, in some ways it has a responsibility to help those with a capital shortage."

A "Come Together" Tribute