Greece + Credit + Japanese Wages = A Terrible Cocktail

Includes: EWJ, GRE, TLT
by: Erwan Mahe

For the past several weeks, certain ECB governors, whose "sense" of timing was painfully illustrated in July 2008, are arguing that, since the economic situation on the eurozone has returned to "normal" (?), the extraordinary accommodationist monetary policies set up at the height of the recession must now be "deactivated".

Their reasoning is totally wrong, if we base ourselves on credit fundamentals (but, of course, why would the ECB ever take any interest in such a subject?), especially given that the situation on the eurozone remains quite extraordinary, despite the fulminations of Trichet, Weber, Stark and miscellaneous sidekick (and not in the good sense of the term).

This drive to tighten the screw is more psychological in that it is based on the notion that money is both "dirty" and "sacred" and that it must not be distributed (even in the form of loans) generously and especially not to just anybody.

As such, it should come as no surprise that the notion of "velocity" is completely lacking from our central bank's reasoning and that this same institution failed miserably in understanding the consequences of the death of securitisation when it hiked key interest rates in mid-2008 while the Fed had already begun cutting rates in September 2007.

Without rehashing price, money supply and European loan statistics, all of which fell far short of the ECB's targets, the cohesiveness of the EU itself is what is now under attack.

In fact, the main reasons for the current turbulence include the decision last December to end the 1-year LTRO, enabling banks to refinance eurozone governments, which I dubbed at the time as the hypocrite's QE and, especially, the ECB's decision to tighten collateral eligibility requirements for Refi operations, just as Greece's credit rating was about to further downgraded.

It is ridiculous to allow the refinancing terms of an EU member-state to be subject to the decisions of US credit rating firms, whose credibility was reduced to zero by their huge errors in CDOs and others.

It is for all the above-mentioned reasons that I consider this situation to be extraordinary.

Investor sentiment changes from one minute to the next, based on statements by the political leaders of the countries concerned. They can move Greek bond prices by several percentage points very quickly. In the meantime, everyone will be paying close attention to the European Commission tomorrow, as the first leaks jibe perfectly with the scenario of a loss of tax sovereignty as we have been predicting since the beginning of this crisis.

As Mr. Almunia said:

Additional measures will be asked for once lateness has been reported, We will accept no lateness. A system as precise and strict has never been set up until now.

However, while this peripeteia must be settled so quickly, it is still nothing more than the tip of the iceberg in the debt-deflation process about which I have harped more than Penelope has on her canvass.

And isn't the collateralisation of Greek debt, put forward in these lines yesterday, also a step in this debt-to-equity swap process?

The evolution of credit is what really counts in terms of the upcoming major economic aggregates, including corporate earnings figures (stock markets), prices (inflation-bonds).

And in this regard, the latest news remains as worrisome as ever.

Check out Lenders Are Holding Firm, Says Fed, a photograph of the sector in the United States, as seen by CEOs on the site,

Just one morsel:

Banks maintained tough underwriting policies on commercial and industrial loans in the fourth quarter, while tightening terms on credit lines.

In the UK, we have learned that the Bank of England key indicator, M4, "broad money” minus lending to intermediate financial corporations, contracted £7.6bn in December.

The 3-month growth rate of this M4 measure declined 0.5%, which may created some doubt in the minds of BoE governors during their meeting this week when they discuss the future of their QE programme.

In Europe, the performance of credit indicators, such as money supply and loan volumes, were pathetic, as outlined in these lines last Friday (Thaler's Corner 29-01-10: Credit" is the past participle of Credere, as in believe).

And the plans in Europe to drastically cut budget deficits, like that laid out by Christine Lagarde today in Brussels, will surely not help matters, despite sentiment that they are going in the right direction.

However, it is above all the consequence of this process on the Japanese economy that is most striking, and the most anguishing for the eurozone.

Check the changes in wages paid in Japan, which plunged steeply in December, down 6.10% on an annual basis.

This was the 19th consecutive monthly decline in overall household wages.

In 2009, the average monthly wage in Japan came to Y315,164, which is the lowest level since the BoJ began monitoring this aggregate in 1990.

And the decline in variable pay at the end of the year fell 15%, the steepest decline since…1959.

In this context, it is difficult to see how Japan will be able to (at last) escape from its Deflation Trap, as the BoJ, despite pulling up its sleeves, takes its time before moving to the doing Whatever it takes stage to defeat, once an for all, the deflationist Gorgone.

Wages in Japan

Hardly brilliant…

Although we are cautious on our strategy in the near term, as we hope for better levels to set up delta negative strategies on indices and delta positive strategies on interest rate options, we remain structurally favourabe to fixed rate instruments (mainly 3-10 year eurozone government debt) and reticent toward risky assets.

Disclosure: Long 20 years OAT 0% Coupons, EDF Corp 5 Years 4.5%.