Category: Uncategorized

Just as we discussed last week, Monti has delivered a tough budget which comprises both tax savings and incentives.

The standard narrative in Italy is that the advent of the Euro saved the Italian economy. Three standard reasons are given: the Lira kept on being targeted by speculators and its peg to the ECU and DM had to be devalued on a semi-regular basis; the conditions for joining the club, which were imposed by the Prodi-Amato administration forced Italian finances to become more virtuous; and finally, the lower cost of borrowing would have allowed the budget deficit and the cost of servicing the stock of debt much lower.

Most of the above benefits did indeed take place for most of the previous decade, which saw record low borrowing rates, primary budget surpluses, and a conservative approach to government spending post the Lehman crisis which meant that Italian finances didn’t appreciably deteriorate after 2008, unlike the United States’ and the UK’s, for example.

However,  and counter intuitively, the price paid for these virtues was a transfer of wealth from the productive areas of society which stopped growing as unit labour costs went up in absolute and relative terms and made Italy less competitive, to the ‘rentiers’, which had lower nominal returns on their fixed income portfolios, but enjoyed an incredible appreciation in the value of their real assets. These effects are easily spotted: Italy barely grew in the last decade, as a strong currency made it less competitive vis a vis not only China, but also Germany, but the price of a square meter of prime real estate in Rome and Milan is now in the same league of London and Paris, and certainly higher than Frankfurt and Berlin.

The fair way to deal with this problem, which we understand Mr. Monti  ‘gets’, is to reduce taxation on the productive part of the economy, by lowering payroll taxes, and making the labour market more flexible, and at the same time taxing big property wealth and increasing the pensionable age. These measures would have a combined effect of reducing youth unemployment, reducing unit labour costs, increasing consumption, and ensuring a degree of fairness to the fiscal adjustment which will improve the chances of it being accepted by the nation.

The question seems to be once again, “Will Berlusconi run again for PM after promising he wouldn’t, then saying he was thinking about it, then denying, and then leaking that he might?” And if does run, why would he do it knowing that the only unknown would be how big the loss is going to be?

The answer to the first question is that Bersani’s triumph in the primaries makes it more likely that he will end up running. The answer to the second question is always the same. Berlusconi doesn’t need to win, he needs to stay relevant not only for his legacy, but also to be able to have something to trade against his legal issues, still unresolved. A good result for Berlusconi would see Grillo and Bersani taking votes from each other and a PDL at between 10-20% in third place that would be able to say, let’s keep Monti for the good of Italy, and by the way, sort out the legal cases.

It is surprising that given this cacophony, the Bund BTP spread is down to 300bps or below. Here there may be two answers. The first is that the market sees through the B ploy and likes the idea of a Monti Bis. The second is that markets are now otherwise preoccupied and haven’t reacted yet…in which case, this spread may have seen its lows at least until mid-next year…

We observed early this year that the curious process of consulting firms becoming fund of funds’ managers was becoming more common. As Niki Nataranjan acutely observes in her recent piece (http://t.co/d7g683ei) investors are going to find it more and more difficult to distinguish between advisors, managers, and consultants.

The crunch will come in two ways. First of all, in the classic consultant model, performance was something to oversee, not to produce. The two are rather different, and require different skills. Further, it is not clear how these manager-consultants will react to negative performance or negative relative performance.

They will fire themselves?

We observed early this year that the curious process of consulting firms becoming fund of fund managers was becoming more common. As Niki Nataranjan acutely observes in her recent piece investors are going to find it more and more difficult to distinguish between advisors, managers, and consultants. The crunch will come in two ways. First of all, in the classic consultant model, performance was something to oversee, not to produce. The two are rather different, and require different skills. Further, it is not clear how these manager-consultants will react to negative performance or negative relative performance. Will they fire themselves?

Two months seem to be a very long time in finance and politics. It didn’t take much for the Draghi effect to translate into lower spreads and record bond issuance by European banks and other corporates. Until last August, the likes of Unicredit, Monte Paschi, Banco Popolare, but also Enel and Generali, were having a tough time to issue debt at acceptable cost. Even the Italian government had to pay record yields on short dated paper. However in the last 60 days everything seems to have changed. Paper issued in the summer is now trading ten points above, and all the above issuers have inundated the market with new issuance at continuously tighter spreads. Even the famous Bund/BTP spread has tightened back to 330bps. Retail investors seem they cannot get enough of it.

The market is clearly back to Risk-On, and big time, but the question as always is: will it last? If we take the US version of QE, the answer is that it may last for quite some time, and we are hearing that hedge funds and other pundits who were caught not long enough are continuing to add to positions. However, Europe is different, because unlike the US where there is only one person talking at one time, Europe will continue to be a cacophony of different spins and interests. Currently the odds seem to have turned back in favour of keeping Greece in the Euro and allowing Spain to use the EU facility with minimum stigma…but we wouldn’t bet on a smooth ride.

A few months ago we commented that Draghi had to threaten to use a bazooka in a similar way to how the SNB does to keep the CHF at acceptable levels for Switzerland. As it happens Draghi wasn’t able to get the Germans to agree to a Swiss style ‘red line’ on yields, but by pledging unlimited firepower, he has made the first real and solid attempt at keeping the Euro zone together since the crisis started.

Also worthy of note is the fact that he has compressed the BTP/Bund and Bono/Bund spreads probably without any meaningful purchase for the time being, but rather relying on the ‘announcement’ effect. Should he need to make sizeable purchases in the future, when the markets will test him (note, when, not if…) he will sterilise the creation of money supply with bill sales, thereby comforting the Bundesbank on the inflation front.

We all know that the Euro zone’s definitive solutions must be political, but by using an umbrella first, with his August pronouncement of ‘we will do all that is necessary’ and with his September unlimited bond purchases pledge, Draghi has gone as close as he could to the bazooka effect. Bravo!

This article was written by Emanuel Arbib – check out the Google+ profile for more updates.

Draghi’s comments at the ECB press conference are yet another attempt to buy time without deploying the bazooka that the markets have been looking for a long time now. However, as unpalatable as it will be to make use of it, it does give Spain and Italy an ultimate parachute should things turn really ugly. This should be seen as a positive development and a clear message that if all else fails, the Euro will be saved when a (fiscally responsible) member state in trouble asks the ECB for assistance, and this will be given.

The problem is still the same, markets will test nations and the ECB to the brink, and this could mean Spain losing market access in the next weeks, at which point the market will test exactly how this ‘bailout of last resort’ works in practice.

I’ve just been quoted in a Reuters article about European bank shares rising. Here’s the article.

One of the benefits of European monetary integration was going to be the elimination of the uncertainty of the movements in currency rates so as to increase cross-border transactions and create the largest ‘domestic’ market in the world.

In order to remove that uncertainty the architects of the euro have unfortunately created much deeper anxieties and uncertainties. The reality in southern Europe right now is that savers are spending their time trying to protect their wealth from the spectre of bank failures, devaluations, and capital controls. Investors are demanding a high premium to invest in Italian and Spanish bonds, and entrepreneurs have to compete in an open global market with German (and French for the time being) competitors paying a fraction of their cost of capital. These economic distortions pale in comparison with the old threat of a lira or peseta devaluation of yesteryear.

The main point to consider is that these economies, including those like Spain and Italy which are on the path to fiscal consolidation, will never be able to meet their deficit targets with the real economy slowing down and going backwards due to the combined effects of increased taxation, lower disposable incomes, high relative interest rates, and anxiety about the future. The longer it takes to find a real solution, the more painful it will be to solve the issues at hand, without discounting popular discontent which at some point may force a reversion to populist measures.

On Friday I was quoted in a Reuters article on European shares posting a fall. Here’s the article. It’s also syndicated on Business Recorder.