Asset And Debt Bubbles In Periphery

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Includes: EDEN, EWL
by: Acting Man

Danish Banks – 'Liquidity Shock' Coming?

We have frequently reported on the Scandinavian housing and credit bubbles in these pages, as they are such a vivid illustration of how the current system of irredeemable free-floating fiat currencies tends to spread the effects of inflationary central bank policies far and wide, usually from the 'center' to the 'periphery'. Later, crises tend to develop in the periphery, which then spread from there back toward the center. For our most recent assessment of Denmark specifically, we refer you to this article from early August: "Danish Sorrows".

Credit Rating agency S&P, eager to avoid the mistakes it made during the US housing bubble, is on Denmark's case. Denmark's government meanwhile is just as eager not to step on the toes of the country's banks, and does so by refusing to acknowledge the existence of major risks. As Bloomberg reports:

"Denmark's government said it has no intention to ask banks to adjust a mortgage refinancing model that Standard & Poor's says exposes the industry to a liquidity shock.
One-year mortgage bonds used to finance loans as long as 30 years pose no risk to Denmark's $340 billion economy and banks shouldn't be forced to stop selling them, Business Minister Henrik Sass Larsen said.

"We don't consider the one-year adjustable-rate mortgage bonds a problem or a risk," Sass Larsen said yesterday in a phone interview from Copenhagen.
S&P said this month banks in Denmark's $500 billion mortgage bond market are putting themselves at risk by relying on a model that requires them to return to market every year. Industry efforts to mitigate those risks by spreading annual auctions over quarterly refinancings aren't enough, S&P analyst Per Tornqvist said this week. He warns that banks are unlikely to adjust their funding model without government guidance.
According to Sass Larsen, the industry has already done enough to address any funding mismatch.
"The refinancing risk has been distributed throughout the year, which makes it improbable they should carry a risk," he said. "Besides, they've performed very well during the financial crisis."

(emphasis added)

To summarize, here we have a $500 billion mortgage credit market in a $340 billion economy, which by itself is a world record as mortgage debt mountains go. And these debts, which have maturities of up to 30 years, are refinanced with one year commercial paper. And that, according to Denmark's officialdom, poses no risks whatsoever.

Are these people completely dense? Such maturity mismatches are the biggest risk to a banking system by far. The fact that the banks have 'distributed' the refunding rounds 'throughout the year' makes no difference at all with respect to this risk. If liquidity dries up, it is game over for Denmark's banks – it is that simple.

The idea that the performance during the recent crisis (which we take to be a reference to the euro area crisis) proves anything, is quite mistaken as well. While the euro area crisis was in full swing, Denmark was one of the perceived 'safe havens' inundated with capital fleeing from the euro area. Denmark's central bank reacted to that by cutting rates to zero and pumping up the money supply so as to avoid an increase in the Danish currency's exchange rate. It is no mystery that the system performed well in light of such a flood of liquidity. The problem is what will happen when confidence in Denmark's economy wanes and the liquidity spigot is turned off.

Mercantilist Quackery and the SNB

This policy is of course pursued by central banks in countries small and large all over the world and is based on the widespread mercantilist fallacy that a strong currency and the rise in imports and decline in exports often associated with it are somehow 'bad'.

Switzerland's leading monetary cranks have also just reiterated that they will keep the euro-CHF 'floor rate' (or 'ceiling rate', depending on how one looks at it) in place 'at all cost'. This is regarded as 'essential to protect the economy' (an economy, it should be mentioned, with an unemployment rate below 3%). The 'cost' is the fact that the money supply in Switzerland has more than doubled since Q4 of 2008. In short, the SNB has printed more money over the past five years than in its entire history up to 2008. For a recent report illustrating this madness, see our previous article "How Safe is the Swiss Franc?".

The Swiss case proves our contention made above, namely that bubbles caused by the policies of central banks in the 'center' tend to propagate into the periphery. Consider this quote from the Bloomberg article on Switzerland:

"Switzerland's monetary policy "depends largely on events abroad, notably the policies of the European Central Bank and the Federal Reserve," said Maxime Botteron, an economist at Credit Suisse Group AG in Zurich, who predicts the cap will remain in place until at least the end of 2014. "So long as they have expansive policy, the SNB will stick with its stance."

(emphasis added)

Of course as we now can see in Brazil, India, Indonesia, and so forth, it is even worse when the currency's value is falling steeply – the inevitable result of the policies that were originally pursued to keep it from rising! In this context it is worth noting what the SNB's president Thomas Jordan says about the Swiss Franc below. And of course the 'deflation' bogey is invoked again as well. How absurd is that with the money supply more than twice as large as five years ago? Of course a major bubble is well underway in Switzerland as well now – another one of the 'costs' the monetary quacks at the SNB deem worth paying. But at least they are 'monitoring the situation closely', so of course nothing bad can possibly happen.

"The franc still is very highly valued," SNB's Jordan told SRF. The Swiss currency traded at 1.2333 against the euro at 12:27 p.m. in Zurich, little from yesterday. Against the dollar it climbed 0.3 percent to 90.96 centimes.
[…]
"The Swiss economy remains fairly firmly in deflationary territory and as such the SNB's policy of zero rates and a minimum exchange rate will persist for some time," David Tinsley, an economist at BNP Paribas SA in London, said in a note.
[...]
Owing to the SNB's loose policy, the Swiss private real estate market is in the throes of its biggest upswing in two decades. The central bank has repeatedly sounded the alarm about borrowers overextending themselves.
To prevent the mortgage writedowns from hobbling economic growth, the SNB, which can't raise interest rates while keeping the cap, pushed for a bank capital buffer. The measure, set at 1 percent of mortgage-related assets, comes into force at the end of this month.
It can be increased to as much as 2.5 percent.
Regulatory measures, including the buffer, are "having a damping effect," Jordan said in the radio interview. "You can't say at the moment" whether further steps will be needed, he said. "We're monitoring the situation closely."

(emphasis added)

This is so bizarre that one doesn't know where to begin. First, here is a chart showing the 'deflation' from which Switzerland allegedly suffers:

Click to enlarge

(click to enlarge)

Swiss money supply measures M1, 2 and 3 via SNB. We have explained the composition of these measures in detail in this article. M1 is equivalent to narrow money TMS-1 in the US. It has increased by 120% since Q4 2008.

So the Swiss version of 'deflation' continues at full blast, with money supply growth recently accelerating even further. Mr. Jordan shouldn't worry so much about strength in the CHF – he should worry about what will happen when the market reassesses the situation and begins to sell his confetti currency.

The central bank has 'sounded the alarm' over the real estate bubble? How absurd is that? First it fosters the bubble with its policies, then it 'sounds the alarm' over it?

A regulatory capital buffer of 1%(!) against mortgages held (which 'could' be raised to – gasp!- a staggering 2.5% at 'some point') is supposed to rein in the bubble and 'prevent mortgage write-downs from hobbling economic growth'? On what planet do these people live?

Conclusion:

In Switzerland's as well as in Denmark's case – and the same holds for a number of other peripheral booms, such as those in Sweden, Norway, etc. (even if they all have their idiosyncracies) - there really are not too many possibilities as to how all of this will end.

Either the booms are going to be abandoned voluntarily by raising interest rates, which will create major trouble for overextended banking systems as the malinvestments of the boom are liquidated – or the central banks concerned continue with their monetary pumping until they have utterly destroyed the currencies they issue.

One should not make the mistake of thinking that the current period of relative calm indicates that there is no danger. On the contrary, the longer the inevitable busts are held at bay, the bigger the imbalances are likely to become and the worse the subsequent crises will be.

We believe that what the developments of the post Lehman era really mean is that we have arrived in the 'end game' phase of the monetary system that has been in place since Nixon's gold default in 1971. Debt and money supply growth are on a tear nearly everywhere. It is essentially the system's last stand. At some point one of the many cogs will break, and then all hell will break loose. Stay tuned.