Why am I holding Euros???

The most obvious question to oneself these days, especially if one's a fund or an institutional, is Why aren't we bailing out of Europe...If you're the client, the question to your advisor: Why are you holding on to Euros?  The obvious explanation is: cognitive dissonance. The hypothesis was advanced by  psychologist Leon Festinger (1957).It became popular among political pundits and business types quite rapidly when, years later,  Newell and Simon* integrated Festinger's insights into their own hypothesis concerning human problem-solving.

The Newell-Simon model as it is now labelled, named after Allen Newell and Herbert Simon,  describes how human beings make decisions, ie. solve problems. It becomes especially enlightening when it describes how people react during the intellectual logistics of problem-solving: the intelligence phase, design phase and choice phase.

How do investors react to conflicting attitudes: you hold Euros but everyone calls a crash.

Decision-makers, when in doubt,  will "listen" 'more' to information that supports their belief system than to information that disrupts or questions their belief system.  The underlying hypothesis is that the individual seeks to reduce dissonance or accompanying discomfort created by conflicting information that undermines his position. He will settle for 'satisficing' information without claim to making the optimal decision.

But in many cases, he will side with inputs that justify his original position. Of course, the more individuals are rationally bound (you don't have all the info) the more they will attempt to adjust in a timely satisficing way to the facts. If the former, You could be a die-hard and lose your pants and that of your clients, notwithstanding the information;  if the latter, you could be pragmatic, give yourself and others the benefit of the doubt, and bail-out. After all, the well-known economist and investor John Maynard Keynes evoked the perfect reaction to relieve the dissonance: "When the facts change, I change my mind. What do you do, sir?"

So why are some investors still holding on to the Euro securities...for the same reasons that some European leaders keep promoting austerity measures for public policy notwithstanding the adverse results being generated in  Greece, Spain and Italy.

The dissonance:
Firstly, even though things are difficult in Europe, they're difficult all-around the world. Some will argue that they're already overexposed in equities, in BRICs, in US and other sovereign currency-issuer securities, and even gold-it can collapse on a wind-shift....after which deliberation they move on and argue the next....

...Eurozone economies are not in as bad a condition as selected data suggest. It's quite reasonable to experience hiccups during 'policy transitions' after traveling over rocky roads. And Southern European roads are very rocky according to northern Europeans. Things will smooth themselves out over time. The worst case is if Greece defaults. Let it exit. Nudge Greece out gracefully. The Zone is saved.  This is the message that is being conveyed by European leadership as social tensions in certain countries become more forceful. If that doesn't work out as planned....they move on and argue the next....

...Europe is 'too big to fail'. (Remember Lehmann et al). The US and China won't let it happen- this is Europe, not some mismanaged bank. Some refer to this position as highly speculative; other would consider it quite realistic. Either way, their rationalization recalls Lord Byron's popular but mistranslated line found in his Childe Harolde's Pilgrimage :

   When falls the Coliseum, Rome shall fall;
   And when Rome falls--the World.'

The Eurozone rendition is "When falls the Euro, Europe shall fall; And when Europe falls---the World."

It would carry more credence if it was the US, however.

Here's my take:  If China's growth is projected downwards, if Germany's order book starts doesn't refill to 2010 levels (I don't think it will refill for a long while) and  growth in the US is revised downwards, then you should have bailed to liquid USD, until the facts change!!! If you didn't, think about it.

*I credit Fictional Reserve Barking, Oct 2, 2011, author (Circuit, ) and reader  (JHCraw) for the reference to Herbert Simon's work.

Europe! It's not too late to reverse austerity

Europe! It's not too late to reverse austerity 

The article is cross-posted on Fictional Reserve Barking.  We wish to thank the editor. Readers are invited to post comments on either blogs.

Months ago we outlined the challenges that presented themselves to Italy and Greece, and to Germany, France and the United Kingdom.  We opted against austerity, trusting that the technocratic appointments of Messrs Monti and Papademos could transform governments in Italy and Greece, and enable their respective legislatures to both recommend alternative and optimal public expenditure policies and to restrain policymakers from endorsing imposed fiscal restrictions while constraining budgets any further.

Unfortunately for the global economy and markets, Messrs Monti and Papademos initiatives did the contrary.  They aspired towards the heroic in adhering to a sub-optimal detriment and have now emerged as the scapegoats for political and investment désenchantées.

More ironic is that both men had very little to do with the original debacle.  They were recommended to their nation’s legislatures to clean up a mess.  Instead, as a result of attempting to implement austerity measures, they have generated more anxiety in world markets than expected.

Unfortunately, the recent economic deterioration and rising social tensions within their respective economies has become their responsibility, and the political disenchantment surfacing within the electorate is also their responsibility.  Worse still, the time for apologetics is long past and is now irrelevant.  At jeopardy is their leadership, the credibility they endorse for their visions of the future and the overall well-being of their citizenry.

Mr. Draghi and Mrs. Lagarde have voiced a redemptive message.  Both had professed that the worst was over.  For instance, in a speech on March 26 of this year, Mr. Draghi said the following:

“I would like to take this opportunity to provide you with my assessment of the current situation in the euro area and shed light on recent signs of improvements in the overall outlook.  I would particularly like to draw your attention to the effectiveness of the policy measures implemented by the Eurosystem, the EU institutions and national authorities.  And to remind you of the measures that we all must continue to pursue over the coming months and years with great diligence in order to continue on this path of stabilisation.”

As for Mme Lagarde, on March 18 of this year, the Managing Director of the IMF sought to reassure the audience of the 2012 China Development Forum with the following statement:

“There are signs that strong policy actions—especially in Europe—are making a difference. Financial markets have become a little calmer…”

Yet, Spanish yields are rising, as are those of Italy and Greece, and there is more and more talk of a potential third bailout for Greece although the IMF and the ECB have reassured the investment communities that changes in Greece are being introduced as promptly as possible and will be enacted effectively.

Any remnant stress in markets, according to the institutional duo is a result of the misperception by the interested communities that the consolidations proposed by the ailing economies cannot be achieved.

The emerging doubt on behalf of investment communities and investors in general should not be surprising.  After all, it’s their money and it’s their perception that underscores investment decisions.

One daresay that the investment community saw the collapse of the system much earlier than either the IMF or the ECB, although the leadership of the latter two has been proactive in attempting to stabilize investor sentiment and mitigate between some form of restraint and investment in growth and employment.  Notwithstanding, the reassessment that further bailouts will be necessary is now the swan song of European austerity politics.

Unfortunately, European policymaker perceptions of the bond markets are completely skewed as a result of their own biases.  What is difficult for them to appreciate is that there is no basis left for growth.  Unemployment is up, with Spain leading at 23.6% followed by Greece at 21.0%.  And in those Eurozone countries where unemployment rates are low, many of the employed are part-time workers and, as such, susceptible to labour volatility during these turbulent times.

Moreover, capacity utilization in the manufacturing sector over the last four quarters is dropping across the Eurozone at alarming rates.  Order books are not being filled as quickly as desirable, and their durations and size are shorter than required to support additional investments.  As a result, business investment is stalling as management constrains expenditures and saves its liquidity for dividends in lieu of growth to stabilize share values, foreboding that equity markets react adversely to this dilemma and possibly falter.

What most pundits expected from the emerging markets may not be realized: trusting that BRIC plug the slowdown in Europe, with China leading the way.  Unfortunately, there is no plug.  Most informed observers now mitigate between a slowdown and an ease in aggregate demand, with China’s future growth rates in question.  Projections for the region suggest that China’s growth potential could be in the midst of a major contraction with rates dropping to 7.5% from anticipated 8% and over.

Given the above, the most difficult challenge in domestic politics is for any Government to admit that it followed the wrong track.  There is no shame in being part of a bigger bloc of nations that propound fiscal consolidations even if austerity is showing itself as being the ineffective solution to the Eurozone’s financial crisis, a crisis which is now becoming an economic and political crisis.

It actually takes great courage in admitting that the austerity programs recommended may not work out.  The experiences of other nations in the matter, elicit danger signals that can’t be overlooked.  In such a case, the consolation is that if one’s admission is timely, the Government may come out of an unfortunate situation looking respectful and remarkably diligent.  There is still time for Europe to turn back its political agendas before turning the wrong corner.

Austerity Contracts Italy and in turn Germany

ISTAT, Italy's National Statistics Institute has had a busy December 2011-end.  ISTAT released October's monthly stats. The results are not good. In fact, the results were not good for any of the critical markings: the releases confirmed decreases in the Orders, Production in Construction, and Trade Balance. Then, ISTAT published Italy's quarterly GDP. 

Notwithstanding the bleak setting above-mentioned, Italy's national accounts are particularly alarming.

The decease in GDP suggests that the Austerity measures being promoted by the Euro-Area and traditionally recommended by the IMF for struggling economies are counterproductive: detrimental to the health and growth of the Italian economy. That's not new. The results are, however, significant because they offer the economist-Prime Minister Mario Monti an acid test that the austere remedy preferred by the markets, in the longer run, will weaken the economic infrastructure of the country, induce social tensions and may trigger social unrest thereby further stiffening Italy's already fragile capacity to access reasonably priced funds from future markets. After all, once reimbursement of capital is made, there is no obligation on the part of the investor to revisit and refinance a palliative patient.

For the obstinate, the position that austerity is not necessarily linked to contracting economies is a reasonable stance. In fact, for the majority of austerists, if one can coin the label, there is no necessary relationship between austerity measures and contracting economies, where contraction is usually defined as an economy in which gross domestic product weakens for two consecutive quarters.

Orders were down in October 2011 by 4.8% over the same month in the previous year 2010. In October 2011 the seasonally adjusted industrial new orders index decreased by 1.6% with respect to September 2011 (-1.0% in domestic market and -2.4% in non-domestic market). The percentage change of the average of the last three months compared to the previous three months was -2.3 (-0.7 in domestic market and -4.7 in non-domestic one). Although adjusted industrial turnover index, which measures current dollar sales was up by 1.1% for the same periods, the medium and longer term effect of orders is critical to the growth and stability of the country, whereas industrial turnover results are an historical metric that is already integrated into the fourth quarter's projections. Traditionally, orders underscore the basic fabric of small and medium business which constitute the majority of regional economies in central and southern Italy. The significant indicator to watch is the Order Book, especially for export orders since Eurozone orders will certainly decrease all around given the need to cut back on spending: consumer spending will drop and business will limit its investments in order to buffer cash for a 'transition' towards a better investment climate.

Germany, on the other hand appeared to be steering through the storm. Unfortunately, recent indicators, especially the Order Book for Exports is designing a pessimistic future. Counterbalance to a drop in export orders is a suggested increase in consumer spending. I think pundits are overly optimistic about Germany's population continuing to bear the load of a European economic stall. Not only is unemployment inching up in 2012, savings will also inch up and business investment will decrease quickly and for a prolonged period.

The lesson of Austerity is that its negative effects profuse through the system much more quickly than market reinvestment. Once markets realize that an economy is slowing down, they will forestall decisions to reinvest capital, which in turn will stall growth. Austerity leads to a vicious circle and insidious downturn,especially during a global slowdown. We said it in an earlier post:

Evidently, once investors realize that the longer term confidence required to justify purchasing Eurobond securities is not justified by output figures from the region's business sector, then even if your brand name is Germany, and even if the rating agencies mark you tops,  it won't help keep yields down. Germany is as susceptible to being dumped as is Italy and its next candidate France which witnessed its yields increase, and its yield gaps widen against the German counterparts. There is no Immune Boutique in this Shopping Mall. There isn't any vote of confidence for Germany; rather it signals that investor concern is becoming pandemic within the Euro-Area and no sovereign, especially a non-sovereign issuer, is immune.

and we will repeat again: Mrs. Merkel, like all others including Mr. Monti, is neither immune to the consequences of Austerity nor to the whims of the markets. It's time to change tune before the audience boos the performance or rather lack thereof.

Fictional Reserve Barking invites Keynes and Godley  to Dinner 

Fictional Reserve Barking (FRB), not yet completed its first anniversary from inception, has assumed the role of one of the most daring commentaries on national and international political and economic policy on the B-sphere. Admittedly sympathetic to post keynesian monetary theory, FRB has again challenged the reasonableness and timeliness of everyman's expectation that Central Bankers cause and hence should solve all the problems of Government and Public Finance. In its December 31, 2011 issue, FRB has demonstrated again why it is considered a must and best read for economic policymakers and pundits alike. Never faltering from its underlying prescriptive mission, FRB continuously substantiates the empirical legitimacy of its optics, realigning and calibrating vision as the facts require, but never wavering on the paradigm invoked.

To say that Fictional Reserve Barking and its prolific author Circuit, is merely a keynesian sounding board is to demean the intellectual prowess of its endeavor. To even suggest is to stunt the brilliant insights that Circuit and moreso the FRB's Wall of Fame profess. And Wall of Fame it is! Among the cherished heritage FRB preserves and promotes, one finds classic Keynes, Galbraith, Godley in continuous medley with such contemporary classicists Lavoie, Seccareccia, Volcker, Bernanke, Wolf, Wray, Krugman, Mosler, Lerner,  the BIS. Never admonishing, always respectful, FRB is a classical Podium of Great Policy in the making.

As one of its readers noted a while back, FRB never assumes as own the merit of others: it is by far the most serious and integral online conversation in political economy in the language, similar to Martin Wolf of the Financial Times for both scope and depth, and come the day, as notorious.

You may not agree with the script , but you never move on offended. Accessing FRB is like sitting back for a brilliant and enjoyable conversation over the dull-made-glamorous. There was a time when accountants and investment bankers were boring. Then they became glamorous-pin-up persons for the young and ambitious. History has shown them rich yet infamous and forever dull. FRB makes policymakers, economists and central bankers the new pin-ups: exciting, audacious, bright and magnanimous when they have courage, but not necessarily rich. Therein lies the rub! or is it the crux?

The latest FRB commentary on the role of the Bank of Canada in defining economic policy and delimiting monetary responsibility from fiscal initiatives, and then going on to analyze the impact of deficit spending on household and business investment is a superb application of Godley's sectoral balance to Canadian political economy and the planning process for 2012 Canadian public finance.

Take the time to savor the latest Classic on Carney, Household Debt, Bank of Canada and Government spending:

It'll change the way you look at economic policy.

Happy New Year.