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When debt contagion arrives…

Now it looks like no matter what Europeans are trying to do, and how many summits politicians rush to put together, things just keep getting worse.

If PIGS (Portugal, Italy, Greece and Spain) were to ‘fly ‘, and debt contagion were to spread, and Europe’s Lehman moment finally to arrive, you probably want to at least have a slightest hint of where the next domino is likely to fall. That’s the purpose of this short post.

The following four charts are from researchers at BIS, including my former Brandeis teacher Steve Cecchetti.  I suggest that everybody take a minimum of five minutes going through these tables. For nerds like me, I stick them on the wall in my office.

All debt:

[singlepic id=17 w=240 h=180 float=]

Government debt:

[singlepic id=19 w=240 h=180 float=]

Household debt:

[singlepic id=20 w=240 h=180 float=]

Corporate debt:

[singlepic id=18 w=240 h=180 float=]

 

Why German bond yields are rising?

From WSJ, what it signals when the German bond yields are rising:

Yields on German 10-year government bonds have risen 0.25 percentage point in the past week to 2.15% even as the euro-zone crisis has deepened. Until now, whenever the crisis has intensified, German yields have fallen and the yield premium for southern European bonds has risen. This shift is a sign the end-game is approaching.

The difference is that buyers of U.S. and U.K. debt can be certain which country’s debt they are getting—and what currency it is denominated in. The euro-zone crisis is becoming binary. One possibility is greater integration, such as common bond issuance, which implies greater costs for Germany and fiscal dilution. The other is break-up, which implies costs for every country but which may favor short-dated German paper given the possibility of currency appreciation.

EU entered recession, likely a long one

According to Paul Kasriel at Northerntrust, most likely the EU entered recession this quarter.

[singlepic id=16 w=420 h=315 float=]

“The Greek tragedy morphed into an Italian comedy. Now, it has become a French farce”. Bank credit is set to slow down or contract.

Of course, the European Central Bank (ECB) could step in to create some of the credit that EU MFIs otherwise would be creating under normal circumstances. But the ECB fears that quantitative easing would somehow sully its Bundesbankian reputation. How ironic that the ECB, a central bank ostensibly sympathetic to an Austrian approach to monetary policy, would not try to maintain a normal amount of credit creation when MFIs were unable to do so. Europeans, get ready to join your Japanese brethren for a lost decade. It did not have to happen for the Japanese and it does not have to happen for the Europeans. But given the intransigence of Japanese and European central bankers (with the exception of British central bankers), it will.

Euro = Failure

“You are all in denial. By any objective measure the euro is a failure. And who exactly is responsible, who is in charge out of all you lot? The answer is none of you because none of you have been elected; none of you have any democratic legitimacy for the roles you currently hold within this crisis.”

 

 
 

Ferguson on global re-convergence

Economic historian Naill Ferguson on the six “killer apps” (or institutions) in the West that generated the Great Divergence since 1700s, up until the recent rise of China.  And he argues that gap between the West and the East is coming to an end, with China fast catching up with the West, leading to a re-convergence of the world economy.

In the interview, Naill Ferguson had many claims in his sharp observation of the history. However, despite being deeply intriguing, most of his claims remain to be just hypotheses.  As a China watcher, I am not so certain at this moment that China’s surpassing of the US on per capita income level is inevitable, although I am positive that China’s total GDP will pass the US in no time.

For readers who are interested in the topic of the Great Divergence and Re-convergence, I would recommend two additional readings: The first is a classic by Ken Pomeranz, “The Great Divergence: China, Europe, and the Making of the Modern World Economy; and the second is by Ian Morris, “Why the West Rules -For Now.

 

US 30-year fixed mortgage rate reached new low

Who would have thought the mortgage rate would actually go down below 4%?  Two historical lows since mid-70s, 3.96% on Oct. 6 and 3.99% on Nov. 10, 2011.

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What’s been holding back the recovery

Jim Hamilton shares his insights into a puzzling question: housing sector accounts for less than 5% of the total economy, yet why it, along with auto sector, tends to drive the US business cycle.

Two of the most important sectors in U.S. business cycle fluctuations are autos and housing. For example, in the 2007:Q4-2009:Q2 recession, real GDP fell on average at a 2.7% annual rate, with autos and housing accounting for about half of this decline all by themselves.

… Although autos and housing make a very significant contribution to changes in GDP growth rates over the business cycle, they represent only a small part of the level of total GDP. Over 1947-2011, spending on motor vehicles and parts only amounted to 3.5% of total GDP on average, while housing was less than 4.7%. But the fluctuations in spending on new cars and homes are so volatile, these percentages change quite a bit over the cycle, rising well above average during expansions and falling in contractions. For 2011:Q3, motor vehicles and parts represented 2.4% (or close to 30% drop) of the level of GDP, while residential fixed investment was only 2.2% (more than 50% drop).

The fact that the levels remain so low today relative to their historical averages means that housing construction and automobile manufacturing have fallen well below what’s needed to keep up with growing population. That suggests the potential for a significant positive contribution from these two sectors if the recovery could ever get back on track.

 

Read the full post here.

 

What’s Euro’s endgame?

Chris Wood shares his insights on what’s likely the endgame of European sovereign debt crisis.

He predicts it will be either a move from monetary union to fiscal union, or a complete breakdown of the Euro. He thinks the first scenario is more likely and Germany will eventually budge.

 

Then, Jim Rogers comes in with his thoughts:

Italy in trouble…

According to WSJ, less than two weeks after European leaders unveiled an agreement that was designed to bolster confidence in the region, the yield on Italy’s 10-year debt drew close to the 7% mark, a line in the sand of both practical and psychological importance to the market.

[singlepic id=9 w=400 h=300 float=]

Psychologically, 7% has become a beacon due to the fact that Greece, Portugal and Ireland each sought bailouts soon after their debt reached these levels. While analysts said it is too simplistic to say that Italy will be forced to ask for support if its 10-year debt yields 7%, they said the recent selloff is taking the country to the tipping point.

A sharp slide in bond prices pushed yields to their highest levels since the inception of the euro. The two-year yield rose a staggering 0.60 percentage points to 6.04% while the five-year yield climbed 0.37 percentage points to 6.56%.The 10-year yield was up 0.27 percentage points to 6.60%, having hit a new high of 6.62% earlier Monday.

[singlepic id=10 w=500 h=375 float=]

 

Update 1 (on Nov. 10, 2011)

Italian gov. bond yields continues to soar, now above 7% threshold. See the chart from WSJ below:

[singlepic id=13 w=400 h=300 float=]

It seemed that Europe is gradually approaching its own Lehman moment.  What’s different, compared to previously trouble of other smaller PIIGS, is that the latest escalation fed fears that the euro-zone debt crisis is starting down its most perilous path: going from a storm raging among small countries at Europe’s fringe to one that strikes a major economic power.

Also, Italy’s debt load of €1.9 trillion ($2.6 trillion) is the second largest in Europe, behind Germany’s, and the fourth largest in the world. Next year, more than €300 billion of debt comes due, and Italy must continually tap markets to refinance it.

 

What’s wrong with America’s job engine?

A nice video/graphical analysis from WSJ: