Let’s begin with a blind flash of the obvious: the entire process of further deferral of Greek debt payments is a high form of the classic ‘exercise in futility’. (Except for possibly one somewhat stealthy aspect we will explore below.) There are very few (if any) who believe that Greece can actually work its way out of its Debt Black Hole. While we will explore that further below, the reasons to provide them more liquidity on the path to insolvency may be obscure, but are relevant to the broader European financial community and global economy nonetheless.
Which leaves the only question right now whether we will all be partaking in French Toast or somewhat more problematic Greek Toast this week or sometime soon?
Interesting word ‘toast’. It not only has a nominal meaning, but also other implications which are so very much more diametrically opposed than almost any other term. In addition to the obvious reading of mildly roasted piece of bread, there is the brief, often laudatory expression of congratulations or respect. And based upon the previous contentious nature of the open warfare between the German Finance Ministry and European Central, the French are deserving of toasts on several levels due to their recent efforts to avoid the worst ramifications of the Greek debt crisis; along with one other point that is worth noting. On the other hand, the kudos certainly due the Greek government for toughing it out this week can only be accorded partial congratulations in light of the broader financial and social situation… and likelihood that Greece ends up as the other vernacular connotation of the word ‘toast’: completely burnt, and damaged beyond any reasonable chance of repair.
The release of 60 million barrels of crude oil from the international Strategic Petroleum Reserve is at best an exercise in futility, and at worst a blatant political abuse of something that should be reserved for true strategic crises. This is supposed to be for major supply disruptions of a significant magnitude. That was the case during Hurricane Katrina, which disrupted almost all production from the Gulf of Mexico. That the current move is ostensibly to supplement supplies due to the interruption of shipments from civil war-torn Libya is specious at best (more below.)And that the powers-that-be have openly admitted a significant driver behind yesterday’s action is their consideration that the weakness of the global economy a ‘crisis’ revisits a point we made previous. Part of the return to the 1970s politico-economic environment is the degree to which pronouncements from the political class sound so disconnected as to be literally incredible (i.e. lack any credibility.)
And that certainly appears to be the case here. The major US action releasing 30 million barrels from its Strategic Petroleum Reserve in coordination with other International Energy Agency participants releasing another 30 million is nothing less than politicians looking panicky about public disappointment with the weakness of the economic recovery. And there were many other, more meaningful solutions available that would have further weighed upon already weakening energy prices in a far more sustained and significant manner. In the event the US administration is using a short-term, ultimately ineffective cheap-shot approach to offset some of the damage from its significantly failed economic and energy programs. This looks like nothing so much as Enviro-Socialist Barack Obama attempting to bolster his extremely weak poll numbers; substantially driven by rapidly disintegrating support for his approach to the economy.
The downgrade of the near term economic forecast from the Fed was not necessarily a surprise after such soft US employment and housing data and the effects of the earthquake and tsunami in Japan. Yet, the fact that all Mr. Bernanke had to offer was continued accommodation that would be short of further QE and his confidence that things will get better ‘later’ did not play well. In fact, while still clinging to the notion that inflation factors were ‘transitory’, he did cite the many levels on which the damage to the consumer was likely extensive in the short term.
Yet, neither he nor the inquisitors from the financial fourth estate got around to the degree to which inflation was going to remain more than transitory. [For more on that, see yesterday’s post Greek Government Passes Confidence Vote… Will the FOMC and Bernanke As Well?] And the equities were seemingly more sensitive to that burden on “final demand” (as central bankers like to call end-user consumer activity) than when we presumed Mr. Bernanke’s accommodative stance would once again carry the day, as it had back in late April and on other previous occasions. Of course, in spite of the success of the Greek government confidence vote, that situation remains extremely fraught as well. There is a significant question over whether the ultimate implications of the deep debt hole in which Greece finds itself becomes more prominent in the market’s perspective than the near-term liquidity-infusion rescue attempts. Together those set up the prospect of a serious failure in equities much sooner than previously anticipated; including a more pronounced extension of the ‘risk-off’ trade that has dominated since the bin Laden euphoric exhaustion high back on May 2nd.
In a classic example of ‘buy the rumor, sell the fact’, weak economic data that the equities had managed to ignore as they anticipated a successful outcome to the Greek Parliament confidence vote seems to have finally caught up with them this morning. However, that was to be expected, as there are still many aspects of the Greek debt deferral situation which need to be implemented (not the least of which is their approval of the next austerity program by next week) prior to the major stressor of the equities being fully mitigated. And as the equities move forward, it will become more apparent that defraying any worsening of the European Debt-Dilemma doesn’t really do much for the global economy. Greece might present a significant financial risk, but its direct economic impact is minuscule.
In fact, fiscal reform in the US should really begin to bite sometime soon, as it will be advanced as part of any US debt ceiling increase deal. That and the cooling in previous strong sister economies like India and especially China will mean much more than Greece not defaulting for now. And while we do not believe the FOMC statement or Mr. Bernanke’s press conference will present much risk to the equities, there is always an outside chance of a mistake; either of expression or inference. It’s all about ‘transitory’ and ‘accommodation’.
If there is one thing we can count on after the last couple of days, it is that communication from central bankers or finance ministers accepting as reality current weak economic tendencies or expressing the need for further control on the financial industry are not very helpful in an equity market that has already assumed a ‘risk-off’ mentality. That will continue to be important into the release of the Federal Reserve Beige Book this afternoon. And then there is another, far broader, general factor which is significantly reminiscent of the sort of 1970s style markets we have noted we have been back into for some time now: Official dislocation from the reality of the financial or regulatory situation.
In that regard, Mr. Geithner’s comments yesterday were nothing less than delusory. Criticize London for “light touch” regulation when the major source of the theory and practice of exotic over-the-counter derivatives was the United States? And while quite a few financial firms in London might have followed suit once the party was rocking, it is now well established and broadly admitted fact that the US regulatory failure on all fronts was most egregious: including the central bank, other regulators, the rating agencies, internal strategic and tactical controls within the financial services industry, and a general lack of willingness on the part of the financial fourth estate to sound the clarion call on all that abuse and neglect (with a few notable exceptions such as Gillian Tett of the Financial Times who was questioning reduced covenants and off-balance-sheet holdings of banks as early as 2005.)
But the real failure at present is not so much a lack of regulation as where the regulatory environment is headed. And while Mr. Bernanke was quick to point out the lack of ability to fully assess that involving environment because it is “…too complex…” (sound familiar?), there was one hero who consistently has risen to the occasion and was not afraid to ask the right questions yesterday.