Well, I had been warning this would happen. Credit default swaps measuring risk on five-year sovereign German debt touched 90bp yesterday and look set to rise above French debt for the first time in the near future. The current spike follows a warning by Deutsche Bank that Germany’s economy will contract by 5% this year as industrial exports collapse at the fastest pace since the Great Depression. I have been warning about this looming problem in my EU Bonds posts for some time now. Germany’s export driven economy is heaviliy dependent on fluctuations in world trade, and German industry is very dependent on Eastern Europe (which is more or less the focal point of the current global crisis at this stage). In addition, German savings went to fund investments in many of the riskiest assets, hence the need for a very large bank bailout. So moving forward things do not look that marvellous for German public debt, and another wave of health and pension reforms will now need to be put in the works as the population ages rather more rapidly than is desireable for stability.

Strangely, and again as I have been pointing out, despite an evident lack of substantial reform in recent years, France’s economy is preforming noticeably better than Germany’s, and the reasons for this will surely form part of the post crisis post-mortem.

Some indication of the headaches which are now looming, and of the fact that the market for German debt may not be as liquid as many had imagined, can be found in the statement from the Head of the German Federal Finance Agency this morning that Germany may increase sales of short-dated securities at the expense of longer-term or index-linked bonds if government borrowing rises more than forecast this year. Carl Heinz indicated that Germany was fortunate in this sense since the appetite for debt maturing in 12 months or less is “huge” as money managers are currently rather reluctant to deposit cash with banks. Germany will need to sell more debt this year than at any time since the end of World War II as Chancellor Angela Merkel increases spending to cushion the economy against recession, and the government plans to sell a record 323 billion euros ($414 billion) this year, almost 50 percent more than the 220 billion euros sold last year. The issuance will comprise 149 billion euros in bonds with maturity over one year and 174 billion euros of shorter-dated money-market securities.

So I think we should forget about stereotypes here, since this whole situation is now extremely fluid, and, of course, in need of rapid attention from EU leaders . Maybe instead of asking ourselves whether Germany can bail-out Ireland the question we should be asking ourselves is whether Portugalcan bail-out Germany?

And in case some of you simply think this is a joke, be careful what you ask for, since David Beers, head of sovereign ratings at Standard & Poor’s told Reuters this morning that the weakness of the global economy could be expected to have an impact on some countries’ credit ratings, and that he expected more sovereign ratings downgrades than upgrades this year, especially in the light of financial market concerns about the health of public finances.

Russia’s economy contracted at an annual rate of 8.8 per cent in January, according to the latest statement by the Russian economy minister. This data point, which provides us with the latest confirmation that a very sharp contraction is now taking place in Russia, follows last week’s announcement by economic development minister Elvira Nabiullina, economic development minister, that the economy shrank by 2.4 per cent between December and January. Industrial production also fell 16 per cent year-on-year in January, while there was a 17 per cent decline in construction.

It also gives us some indication of the viability of VTB’s Russian GDP Indicator (as posted here) which indicated a year on year rate of contraction of 4 percent in January, down from December’s 1.1 percent decline, and November’s 2.1 percent expansion. This is somewhat under the actual reading, but it is an estimate in real time (we got this at the start of February) and it was by far the nearest estimate I have seen. The Russian government is currently forecasting a contraction of only 2.2% for this year, which has to be way, way too optimistic as things presently stand.

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Well in some countries it never rains but it pours, as they say. Following the news that Ukraine GDP contracted at an annual rate of 20% in January, today we learn that S&P have cut Ukraine’s long-term foreign currency rating to CCC+, seven levels below investment grade. Ukraine’s rating is now the lowest in Europe and at the same level as Pakistan. S&P left the outlook negative, suggesting there may be more to come.

To give us all some idea of what this means contracts to protect Ukraine’s government bonds against default now cost 59.5 percent upfront and 5 percent a year, according to CMA Datavision prices for credit-default swaps today. That means it costs $5.95 million in advance and $500,000 a year to protect $10 million of bonds for five years. The cost is higher than for any other government debt worldwide. Continue reading →

Japan’s exports plunged by 45.7 percent year on year in January, producing a record trade deficit, as recessions in the U.S. and Europe, and a sharp downturn in China crushed demand for the country’s machinery, cars and electronics. A drop of this size is truly staggering.

“People are coming to realize that Japan is in deep trouble,” said Hiroshi Shiraishi, an economist at BNP Paribas Securities Japan Ltd. in Tokyo. “Considering what’s happening on the export side, and the implications that has for the domestic economy, the yen is clearly not a buy.”

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Close enough that prominent people are raising the spectre of capital account flight already underway.  Today saw a bleak op-ed in the Irish Times by former European Commissioner and GATT/WTO head Peter Sutherland.  Now Sutherland arguably got his hair singed on the other side of the crisis as a RBS Director (a position relinquished a few weeks ago).  His key point is that a crisis could originate not from directly within the public finances (at least the finances as they were) or from bad loans of banks but from a loss of bank deposits and in that sense very much an emerging market style of crisis —

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Let’s flash back quickly to yesterday (Monday). The big news of the day (at least as far as Central and Eastern Europe went) was that a number of East European central banks had reached an agreement to try to bolster their currencies via their first coordinated action since the start of the global financial crisis.

Czech, Polish, Hungarian and Romanian central bankers all agreed to speak publicly about the damaging effects of exchange-rate swings, according to the statement read by Romania’s central bank Governor Mugur Isarescu at a news conference in Bucharest. His counterparts in Prague, Budapest and Warsaw issued similar statements during the afternoon. The four currencies all gained significantly on the day. The Hungarian central bank even kept interest rates on hold to boost the currency, even though this will lead to an even sharper economic contraction and even higher unemployment. But how long did it all last?

Well, now fast forward to today, and a press conference in Brussels, attended by EU Commission President José Manuel Barroso and Hungarian Prime Minister Ferenc Gyurcsany. The message was meant to be that the Hungarian government was on the right path, and was going to receive full backing from the European Union. And how did our good prime minister “talk up” the currency?

“We’re in serious trouble indeed,” the Hungarian prime minister said.

And how did the forint react?

The sell-off on the forint market was almost immediate, and the Hungarian currency abruptly and sharply fell to over 303 to the euro from its earlier and hard won level of 297.

True all the talk about Latvian downgrades (see previous post) and East European weakness didn’t help, and the kind of verbal strategy decided on yesterday was always a sign of weakness rather than a sign of strength. As Danske Bank said in a report yesterday:

The markets might try to test whether this is just verbal intervention or whether the CEE central banks would be willing, for example, to hike rates to defend their currencies. The markets will be watching over the next days for more direct intervention in the CEE FX in the form of coordinated intervention and/or rate hikes. However, if they see that the talk is not being backed up by action, the depreciation of the region’s currencies could resume.

Still, you might have thought the policy would have lasted a little longer than 24 hours, and that the Hungarian people would have been a bit better served by their leaders.

And the Swedish Krona clearly didn’t like the news.

Standard & Poor’s Ratings Services today said it had lowered its sovereign credit ratings on the Republic of Latvia to ‘BB+/B’ from ‘BBB-/A-3’ and removed the ratings from CreditWatch negative, where they were placed on Nov. 10, 2008. The outlook is negative…….

We believe the necessary process of private sector deleveraging is likely to continue over several years, during which time real incomes will decline, testing Latvia’s commitment to both its exchange rate regime and its obligations under the EUR7.5 billion assistance program from the IMF, EU, and other official lenders. The adjustment is made more difficult as external demand for Latvia’s key exports continues to decline.”

The negative outlook reflects the likelihood of a further downgrade later this year or in 2010 if we believe the government is wavering from its economic agenda in a manner that intensifies currency pressures and risks delays in disbursements from official creditors. If the Latvian financial sector retains access to international markets at reasonable cost, economic prospects brighten on the basis of improved competitiveness, fiscal targets are met, and the near-term prospect for Eurozone entry improves, the ratings could stabilize at the current level.

Standard & Poor’s also said it had placed its ‘A/A-1’ sovereign credit ratings on the Republic of Estonia, and its ‘BBB+/A-2’ ratings on the Republic of Lithuania, on CreditWatch with negative implications. Which means that both of these may be up for downgrades in the not too distant future. Continue reading →

In a currency union, with no homegrown currency to devalue (relative to your main trading partners), internal price deflation is really the only option for addressing a proce competitiveness problem. But (as I explain here) this is a very difficult road to follow as the Irish government are currently discovering. Excesses on the upside were easy, and (more or less) popular, but on the downside they are another matter altogether.

The Irish government is facing growing calls to abandon the centrepiece of its economic recovery plan after large-scale public protests at the weekend organised by the main trade unions.

A controversial proposal to impose a levy on the pensions of public servants – effectively a pay cut for the 350,000 state employees from ministers to local authority workers – drew 100,000 ordinary people on to the Dublin streets on Saturday in a protest organised by the Irish Congress of Trade Unions.

The levy is the centrepiece of an economic stabilisation programme announced last month aimed at curbing a ballooning budget deficit which, even with the proposed savings, is set to reach 9.5 per cent of gross domestic product this year. This is more than three times the fiscal benchmark set by the European Union.

Just following up on PO’Neill’s post (here) on the IMF loan to Serbia, where he says:

Finally, since this request would seem to shave another $2 billion of whatever headroom the IMF thought it had for such programs, getting them more space to lend might soon be a priority agenda item at the London Summit.

This is absolutely the point. The Financial Times today quotes Simon Johnson, a former IMF chief economist now at the Massachusetts Institute of Technology, to the effect that : “We are seeing the consequences of the lack of IMF resources. Programmes are probably undersized because the IMF is worried about running out of money.” and Ken Rogoff, another former chief economist, who said: “The IMF doesn’t have nearly the resources to backstop all of eastern Europe.”

Mr Rogoff echoed calls from Robert Zoellick, World Bank president, for the EU to take a leading role in rescuing eastern Europe. But the European Commission has already spent nearly €10bn ($12.6bn, £8.8bn) of its €25bn rescue fund on Hungary and Latvia, and EU governments have yet to provide more resources.

According to the FT the IMF, which has $142bn in quickly available resources and $50bn it can raise rapidly, recently finalised an agreement to borrow an extra $100bn from Japan and is seeking a further $150bn from other member governments. The question no one seems to be thinking about is the “what if” one of possible defaults. If the IMF borrow $100 billion from Japan, and the loans are defaulted on, then who covers the debt, or do we just turn the IMF into another “bad bank”? I don’t think people are being at all responsible here.

Ukraine, Belarus and Serbia all have shrinking and rapidly ageing populations, the possibility of defaults here are high, in each case, and it is quite possible we will see continually shrinking GDPs which will effectively turn these countries into IMF economic protectorates (in the absence of some other multilateral agency being created in the mid term to handle the problem).

Hungary and Latvia both look like being dangerously close to default come 2012 if emergency measures are not taken soon (the IMF programmes as currently structured simply cannot work, in either case), and they could quickly be followed down the same road by Bulgaria and Romania. Basically we need some sort of order putting back into this whole situation before things simply get out of hand, simply talking about reform of the IMF quota system is absurd at this point. Europe needs to act, and act decisively. Above all we need something which is sorely lacking from our leaders at the moment, a feeling that they are able to rise to the scale of the problem and start to act, rather than simply react. If you think what we have so far is bad, you just wait till you get to see what comes next.