Postings to this website will resume on  December 27th

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e-mail me john@thegoldwatcher.com

N.B. LINK TO KITCO PRICES &PRIMER ON DOLLAR STRENGTH OR WEAKNESS & THE PRICE OF GOLD 

Precious Metals	Date and Time	Last (Bid)	Change due to Strengthening of USD	Change due to Normal Trading	Total Change
Gold	Dec 22, 2011 09:39	1608.60	-1.45-0.09%	-4.95-0.31%	-6.40-0.40%
Silver	Dec 22, 2011 09:39	29.28	-0.03-0.09%	-0.01-0.05%	-0.04-0.14%
Platinum	Dec 22, 2011 09:39	1415.00	-1.30-0.09%	-8.70-0.61%	-10.00-0.70%
Palladium	Dec 22, 2011 09:39	631.00	-0.60-0.09%	-0.40-0.07%	-1.00-0.16%

Energy	Date and Time	Last (Bid)	Change due to Strengthening of USD	Change due to Normal Trading	Total Change
Crude Oil	Dec 22, 2011 09:38	98.99	-0.04-0.04%	+0.36+0.36%	+0.32+0.32%

Base Metals	Date and Time	Last (Bid)	Change due to Strengthening of USD	Change due to Normal Trading	Total Change
Copper	Dec 22, 2011 09:39	3.3935	-0.0061-0.18%	+0.0273+0.81%	+0.0212+0.63%
Nickel	Dec 22, 2011 09:38	5.5226	-0.0153-0.18%	-2.9616-34.84%	-2.9769-35.02%
Aluminum	Dec 22, 2011 09:38	0.8847	-0.0016-0.18%	+0.0026+0.30%	+0.0010+0.12%
Zinc	Dec 22, 2011 09:38	0.8352	-0.0015-0.18%	-0.0030-0.36%	-0.0045-0.54%
Lead	Dec 22, 2011 09:38	0.8858	-0.0016-0.18%	+0.0066+0.75%	+0.0050+0.57%

 Today’s encouraging picture from Kitco:

Precious Metals	Date and Time	Last (Bid)	Change due to Weakening of USD	Change due to Normal Trading	Total Change
Gold	Dec 20, 2011 13:38	1615.10	+11.00+0.69%	+10.20+0.64%	+21.20+1.33%
Silver	Dec 20, 2011 13:38	29.54	+0.20+0.69%	+0.54+1.88%	+0.74+2.57%
Platinum	Dec 20, 2011 13:38	1428.00	+9.70+0.69%	+10.30+0.73%	+20.00+1.42%
Palladium	Dec 20, 2011 13:38	625.00	+4.20+0.69%	+13.80+2.28%	+18.00+2.97%

Energy	Date and Time	Last (Bid)	Change due to Weakening of USD	Change due to Normal Trading	Total Change
Crude Oil	Dec 20, 2011 13:37	97.47	+0.68+0.72%	+2.74+2.79%	+3.42+3.51%

Base Metals	Date and Time	Last (Bid)	Change due to Weakening of USD	Change due to Normal Trading	Total Change
Copper	Dec 20, 2011 13:38	3.3506	+0.0181+0.55%	+0.0376+1.14%	+0.0557+1.69%
Nickel	Dec 20, 2011 13:35	8.4593	+0.0454+0.55%	+0.1511+1.83%	+0.1965+2.38%
Aluminum	Dec 20, 2011 13:38	0.8851	+0.0048+0.55%	+0.0094+1.08%	+0.0142+1.63%
Zinc	Dec 20, 2011 13:33	0.8463	+0.0046+0.55%	+0.0058+0.69%	+0.0104+1.24%
Lead	Dec 20, 2011 13:33	0.8808	+0.0048+0.55%	+0.0044+0.50%	+0.0092+1.05%

US Dollar Strength, Weakness and the Price of Gold: A Primer

Kitco Link for US R$ Strength , weakness & the price of gold Primer

 Chart courtesy www.sharelynx.com 

Background to the gold price correction:

The recent gold price correction, though steeper than expected, hasn’t come as a surprise. The final paragraph of the 10th December Goldwatcher posting refers. There is also commentary in The Goldwatcher posting of September 13th 2001 Gold and Economic Uncertainty that followed the major fall in the gold price from all time peaks.

Gold closed last night at $1583 after hovering round $1550-  a touch below  the $1600 200 day moving average. The gold price now is $1570. At times today it has been both $20 higher and lower. A substantial fall below $1600 will be seen by market technicians as confirming the gold bull  market trend is vulnerable to correction.

It’s clear now the flow of funds is no longer moving  in the direction of gold to the extent it has been. The main reason is size matters and the gold market isn’t large and liquid enough to absorb multi billion dollar transactions without price distortion. Substantial pools of funds are flowing to US and German Government debt securities, the destinations seen as safest and most liquid. Another main reason for the gold price correction may be economic slowdowns in China, India and the other Asian economies that accounted for recent surges in demand.

The euro crisis hasn’t been solved yet:

Europe’s affairs may be on course to some stability following both the ‘agreement’ reached by Europe’s leaders, the funding for banks announced by ECB Chairman Mario Draghi,  funding being arranged in new European facilities and funding expected from the IMF. But, at this stage, nothing is solved. The issues ‘agreed’ to  are not complete agreements or even heads of agreement. They are only Memorandums of Intent.

And, more to the point, Europe has serious solvency issues.  Some debts will never be paid and many major banks are to all practical purposes insolvent. Today Fitch have again downgraded ratings on a futrther five major European banks.

This Bloomberg interview with Michael Platt, a hedge fund manager with a $30 billion portfolio, is explicit on weaknesses with Europe’s cohesion and bank insolvency risks. In the interview he makes these points:

The euro crisis is worse than the 2008 Lehman crisis; he is totally risk averse and  holds funds in 2 year U.S. treasuries and German Bunds;  a euro break up ill have drastic consequences but there is no willingness in Europe to share or transfer wealth in a sustainable way; the ECB has no mandate to bail out Europe; refinancing Government debt at 5% to 6% is unsustainable; Italy could blow out next year; austerity will worsen the deficits that must be eliminated; the investment opportunity is not now but post the blow up - as happened in 2009.

Conclusions:

Though price volatility affects the suitability of any asset acquired as a safe haven the euro crisis, banking solvency, sovereign solvency and debt issues and the debt and political  issues in the United States still support the utility of gold as insurance against major disruptions.

Gold price valuation, motivation, timing,  strategies, and associated subjects are all  addressed in The Goldwatcher book.  This blog is not advisory.

 # Note : The ECB funding announced for regional banks  has led to commentary suggesting the proceeds will be the ‘big bazooka’  used to purchase sovereign securities . I see difficulties with these suggestions and, for this analysis, am treating the ECB funding only as necessary liquidity support for banks. May comment further when more information is available.

#Note added 16.11.11 : Link to article suggesting yield compression seen on European bond markets today result of the new ECB facility. No comment yet from the ECB 

The St Pauls occupation & The Occupy Everywhere Mobocracy:

‘Jesus would spend Christmas with the St Paul’s Cathedral protesters‘  the Archbishop of Canterbury, Dr. Rowan Willims said (on December 5th,) declaring Christ would be there ’sharing the risks, not just taking sides.’ Their demonstration, he said,  expressed ‘ a widespread and deep exasperation with the financial establishment.’ So we can assume the Archbishop won’t be on board with initiatives to insulate The City aristocracy from effective regulation.

Are we heading for an aristocracy versus mobocracy confrontation in Britain?

There’s surprisingly little debate in the media defining the aspects of the proposed pan-European regulation that British financial services must be protected from. Surely it’s not the disgraceful and unforgivable  failure of regulation  now officially declared responsible for the multi billion collapse of RBS Bank, - since bailed out and owned by the British taxpayer. Or the greed, negligence and possibly criminal acts that led to the hundreds of billions and possibly even trillions of pounds lost over the last few years. Losses following irresponsible and probably fraudulent conduct within major financial institutions.

By and large the British public share the ‘widespread and deep exasperation with the financial establishment.’identified by the Archbishop, the members of Britain’s ‘occupy everything’ mobocracy and our partner nations in Europe. Yet financial services are a major, traditional, valuable and, by and large,  honourable contributor to our economy.

I suggest the best we can do now is get a spotlight on the actual aspects of our financial services the Prime Minister  insists must be protected. With this information we will be in a better position to understand the extreme opposing positions adopted by both Prime Minister Cameron and other colleagues in Europe

Support for The City is shared across the British political spectrum:

Yesterday’s debate in Parliament gave the impression all conservatives support exempting our financial services establishment,’The City’ aristocracy,  from European regulation. There is also an impression  all labour party members are against the exemption. The reality is different.

I have attended several think tanks and other discussions on Europe where  non interference with The City of London has often been discussed. The most passionate and uncompromising support for exempting The City I ever  heard came from a well known labour member of The House of Lords.

# Note : This post was first published at 7.06 on December 13th . The original post has been deleted to correct the arrangement of illustrations. 

Note added 12th November 2011:

This post will be updated later today after Mr. Cameron accounts to UK Parliament.  The following links reference the issue:

# Tweet from  BBC Journalist Joe Lynham on Italian interest rates:

BBC_Joe_Lynam Joe Lynam BBC Biz 

 Italian bond yields have jumped 3.3% this morning. Is this a judgement on the Euro saving summit last Fri?

# From Spiegel article ‘Coalition of the unwilling’ on proposed Euro pact:

 ’It is completely unclear, however, whether this intergovernmental treaty is in accordance with EU law. Even Elmar Brok, a member of the European Parliament for Germany’s conservative Christian Democratic Union (CDU) and one of Merkel’s close associates, wrote a letter to the chancellor warning her against a treaty outside the framework of the Treaty of Lisbon. Such an agreement, Brok argued, would be “illegal.” 

‘The legal departments of the European Commission, European Central Bank (ECB) and the European Council, which represents the member states in Brussels, also internally voiced doubts over the construct. At a meeting of the so-called sherpas (the representatives of the participating governments tasked with making preparations for international meetings) on the eve of last week’s summit, a heated debate erupted between Merkel’s European adviser, Nikolaus Meyer-Landrut, and the head of the legal department at the European Council.’

…………………………………………………………………………………………………………………….

Back to the blog as posted on 12th November

The outcome of yesterday’s  Euro summit  that most affects British Goldwatchers is Prime Minister Cameron’s veto of the European Union’s proposed treaty change. While the subject is being reviewed for a blog posting links to commentary  of interest will be posted @TheGoldwatcher on Twitter

The good news: no Lehman moment for Europe yet

Fears of an imminent euro crisis have been doused. Decisions on a binding ‘fiscal compact’ taken at yesterday’s leaders  summit and,  substantial liquidity support for regional Banks announced by ECB President Mario Draghi on Friday,  will probably be sufficient to avert a ‘Lehman moment’ for Europe.  For now anyway.

Now the bad news: Blood, sweat and teargas.

The Eurogeddon issues most feared until yesterday relate to excessive sovereign and private debts, unfunded state social programmes, rising unemployment, demographic changes,  bank failures, contagion, recessions, contractions and depressions. Conditions all aggravated by excessive leverage, excess capacity and insufficient aggregate demand to support employment and economic growth.

Current remedies proposed include arranging a substantial pool of funding to insulate sovereign debt from market forces. At the same time new deficit limits, budgetary restrictions and disciplines are  being introduced aimed at achieving rapid and drastic debt reductions.

Economic growth has not been prioritised and, absent a growth plan, economic and social conditions in troubled euro states are likely to go from bad to worse. The paradox of thrift and vicious circles of declining employment and increased social funding compound the problems

Policies relying on austerity have been described as ‘blood sweat and Teargas. Unless policies for growth are also priotitised the danger of Mobocracy looms large.

Note on the gold price:

It’s likely gold has been supported to an extent by speculating on Eurogeddon.  As speculators run for the exits it won’t be surprising to see some correction in the gold price.  Others with different motivation and strategies may see buying opportunities. The case for owning gold as protection from the  range of risks menacing us remains compelling.

.

Today’s headline news  & commentary is directed at the ‘Europe’ summit meeting. It’s still in progress.  The outcomes are too critical and  complex for a blog posting now that adds anything to the commentary accessible in the Financial Press and other informed sources.

I will continue Tweeting @TheGoldwatcher referencing interesting commentary and other input that may be useful. A Goldwatcher posting will follow after the meeting ends and implications have been analysed.

NEW WORLD GOLD COUNCIL REPORT & ASSET ALLOCATION

Introduction to World Gold Council report published today:

‘During a period of extraordinarily serious economic uncertainty in the eurozone, continued concerns about economic growth in the US heading into an election year, and the possibility of an economic slowdown in China, we wanted to examine the relevance of gold as a strategic asset for euro-based investors to protect their portfolios and to mitigate the systemic risks being faced.

A new study from New Frontier Advisors (NFA) was commissioned by the World Gold Council to address these concerns.

The NFA’s respected optimiser is used to analyse the statistical significance of gold for adding diversification value to an investment portfolio from the currency base and perspective of a € based investor. It takes a conservative strategic return expectation that the long-term real return of gold is equal to zero.

The findings suggests that an optimal strategic allocation to gold for euro-based investors ranges from 2-3% for the most diversified and lowest risk portfolios, to between 4-9% for portfolios split 50/50 between equities and bonds and as high as 10%, for portfolios with the majority of assets in equities.

 The NFA study makes a valuable contribution towards the World Gold Council’s own body of investment research, adding further third-party evidence to the case for gold as a foundation asset which provides insurance against extreme events. We believe that the relevance of gold as a strategic asset is likely to continue to grow in a world characterised by sluggish economic performance, poor investment returns, currency wars and high individual and systemic risk. Gold has unique properties which can protect European investor’s portfolios against the systemic risks being faced.

Download the report on The World Gold Council website .

To access report you may have to register

STANDARD & POORS F&Q ON EUROZONE DOWNGRADES

Credit FAQ: Factors Behind Our Placement Of Eurozone Governments On CreditWatch Standard & Poor’s Ratings Services today placed its long-term sovereign ratings on 15 members of the European Economic and Monetary Union (EMU or eurozone) on CreditWatch with negative implications. We now think that there is at least a one-in-two chance that we will lower each of the ratings that we have placed on CreditWatch. We have also maintained the CreditWatch negative status of our long-term rating on Cyprus and placed its short-term ratings on CreditWatch with negative implications. The CC/Negative/C ratings on Greece have not been placed on CreditWatch. WHAT PROMPTED THE CREDITWATCH PLACEMENTS? In our view, systemic stress in the eurozone has risen in recent weeks and reached such a level that a review of all eurozone sovereign ratings is warranted. We believe that this systemic stress emanates from five interrelated factors. We also believe that these factors influence the creditworthiness, in varying degrees, of all the members of the eurozone. Banks operating in the eurozone have tightened credit conditions markedly. They have done so in response to: (i) higher prospective capital requirements from the European Banking Association or from Basel III; (ii) worsening asset quality both in their loan books and their government bond portfolios; and (iii) a spike in their marginal funding costs. Banks and portfolio investors alike have also started to require significantly higher risk premiums for an increasing number of eurozone sovereign issuers, including ‘AAA’-rated sovereigns. In addition to country-specific factors (such as high borrowing requirements in the first quarter of next year), we believe that these higher premiums reflect: (i) prospective changes in the composition of these governments’ creditor classes (with official creditors, enjoying presumed preferred creditor status, having a greater share of outstanding debt); (ii) changes in the regulation of credit default swaps and their perceived utility as hedge vehicles; and (iii) the lower capacity of some government bond market makers to carry inventory. The open and prolonged dispute among European policy makers over the proper approach to provide official assistance on behalf of the EU and the funding amounts necessary to reverse declining investor sentiment, which we believe is in turn negatively affected by what many investors consider to have been reactive and insufficient policy responses to date. High levels of government and household indebtedness. The government indebtedness has led most eurozone governments to undertake fiscal consolidation programs to stabilize their debt to GDP ratios and thus to restore fiscal room to manoeuvre. High household indebtedness coupled with rising economic uncertainty has increased precautionary household savings in an attempt to reduce leverage in an uncertain economic climate, thereby reducing consumer spending. Weakening growth prospects for 2012. In our view, signs of what we see as Europe’s approaching recession were foreshadowed in the so-called periphery and the economic strain is now increasingly being felt in the eurozone’s core of France and Germany. The composite purchasing managers index (PMI) for France and Germany dipped below the 50-point mark in October–typically a signal of recession–continuing the downtrend it started in September. Also, in October Italy’s composite PMI recorded its sharpest monthly decline since 2009. In revising our forecasts for 2012, we have once again lowered our 2012 real GDP growth forecasts. We now expect a mild recession in the first half of 2012 in the eurozone, ahead of a modest pick up in the second half of the year. We anticipate eurozone real GDP growth to average 0.4% next year. (see “European Economic Outlook: Back In Recession”, published Dec. 1, 2011) We believe that the deteriorating macroeconomic outlook is partly reflecting the declining confidence of economic agents in European policymakers’ ability to arrest the current financial crisis. We assign a 40% probability of an outright recession with negative GDP growth in the eurozone for 2012 (see “The Specter Of A Double Dip In Europe Looms Larger”, published on Oct. 4, 2011). WHY ARE YOU TAKING THESE ACTIONS NOW BEFORE A MAJOR SUMMIT? We are of the view that the upcoming European summit on December 8 and 9 provides an opportunity for policymakers to break the pattern of what we consider to have been defensive and piecemeal measures to date, overcome individual national interests and preferences, and advance a credible response to the crisis that would go far towards restoring investor confidence. We believe that the risks of a deepening and broadening of the crisis have risen markedly and the repercussions of this development will in our view be felt across the monetary union, considering the interconnectedness of the EMU economies and financial markets. If the response of policymakers is not viewed by investors as robust, we believe market confidence could take another, possibly steep, drop downwards, meaning higher refinancing costs for banks and governments, further deceleration of credit and demand, and an even greater required fiscal consolidation effort to arrest deteriorating credit dynamics. Our CreditWatch actions signal our view of the risks to eurozone sovereign creditworthiness should the summit not generate an effective and credible response. The confluence of negative developments described above has in our view significantly raised the stakes for the upcoming summit. We believe that the failure to present a strategy that would in scope and content address investors’ concerns could weigh more heavily on financing conditions than what we observed in the aftermath of previous summits and significantly exacerbate recession risks. WHAT SORT OF RESPONSE BY POLICYMAKERS DO YOU THINK MIGHT ADDRESS THESE CONCERNS? When making his inaugural address before the European Parliament on Dec. 1, 2011, ECB president Mario Draghi spoke of a “new fiscal compact”. The details of this fiscal compact are for government officials to determine, but to be considered credible, it would likely need to imply, for example, a greater pooling of fiscal resources and obligations as well as enhanced mutual budgetary oversight. We believe that without such an agreement, the relatively high perceived credit risks associated with specific sovereigns might restrict the willingness of the ECB to step up its interventions under its Securities Markets Programme (SMP) for the implicit purpose of staunching further declines in government bond prices. We observe that previous summits’ initiatives to counter the adverse market conditions through enhanced mechanisms surrounding the European Financial Stability Facility (EFSF) have by themselves not had the desired impact. It is our view that national governments would need to continue to pursue reforms in order to bring production and consumption more into balance in their respective economies. For debtor nations, this will likely entail not only greater public sector savings but also measures that boost exports and increase the flexibility of labour, product, and service markets. As the European economy slows, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand shrinks in line with citizens’ concerns about job security and disposable incomes, eroding the revenue side of national budgets. We believe that a strong and credible commitment to a balanced reform agenda by governments whose bonds have come under particular pressure will furthermore likely be an additional prerequisite for the ECB to engage in a more aggressive intervention policy. In principle, the fact that new governments have taken office (or are about to) in Italy, Greece, Spain, and Belgium could bode well for accelerated policy implementation. Nevertheless, we anticipate that the ECB will remain wary of moral hazard, especially following the perceived hesitance in the implementation of measures in Italy following the ECB’s expansion of bond-buying to include Italian bonds in August 2011. This might make a significant front-loading of reform legislation in debtor countries another precondition for the ECB to deploy more of its monetary flexibility, complementing the governments’ eurozone-wide policy response. For creditor nations, the rebalancing could, for example, entail not only greater EU fiscal transfers but also measures to raise productivity in the non-tradable sector, which could create demand without exacerbating external imbalances (see “Who Will Solve the Debt Crisis”, Nov. 10, 2011). HOW ARE THESE CONSIDERATIONS TAKEN INTO ACCOUNT IN YOUR RATING ANALYSIS? The five key factors that form the foundation of our sovereign credit analysis are the relevant government’s: (i) institutional effectiveness and political risk, (ii) economic structure and growth prospects, (iii) external liquidity and international investment position, (iv) fiscal performance and flexibility, as well as debt burdens; and (v) monetary flexibility (see “Sovereign Government Rating Methodology And Assumptions”, published June 30, 2011). We see three of the five factors as particularly contributing to our review of the risk profiles of eurozone sovereigns. Political. In addition to the protracted debate about the nature of the eurozone’s systemic stress and the needed remedy, we see the consistency, predictability, and effectiveness of policy coordination among eurozone institutions as potentially unsupportive of eurozone sovereign ratings at current levels. The consensual European decision-making process has in our view led to a slow and reluctant response to the crisis. Policymakers appear to have acted only in response to mounting market pressures, rather than proactively leading market expectations in a way that might have better supported and strengthened investor confidence. We take the view that the defensive and piecemeal nature of this response has helped expand the crisis of confidence in the eurozone, prompting the likelihood that aggressive policy measures will be needed to rekindle investor appetite in eurozone government debt. External liquidity. For countries in net external liability positions, including the eurozone’s peripheral economies, we see growing risks to the funding of their external requirements. In our view, financial institutions located in countries in net external asset positions (such as Germany) also face pressure where the quality of those assets is deteriorating. Deleveraging by European banks is intensifying, as they reduce their balance sheets amid worsening funding conditions, look to bolster their capital ratios, and address concerns about deteriorating asset quality among their borrowers. By our estimates, a sample of 53 large eurozone banks from 12 countries will face bond market maturities of an historic record of over €205 billion in the first quarter of 2012, which is 1.5 times the average first-quarter amount between 2006 and 2011 and over twice the respective maturities that fell due in the third and fourth quarter of 2011. The above-referenced maturities do not include private placements, which are a significant part of banks’ funding strategies in some eurozone countries. While we expect large European corporations to rely more on bond markets to finance themselves, we believe small and medium size enterprises and households will experience tighter credit conditions, implying lower investment and weaker growth. Regarding eurozone sovereign borrowing requirements, we believe that those governments that rely heavily on non-resident funding are particularly at risk of impaired market access, and that “home market bias” explains part of the recent bifurcation by yield of eurozone members’ sovereign debt markets. (See “Why Trade Imbalances For Creditors As Well As Debtors In The Eurozone Are Weighing On Growth”, Dec. 1, 2011.) Monetary flexibility. We will analyze the policy settings of the ECB to address the economic and financial stresses now being experienced by eurozone sovereigns. In particular, we will examine the potential impact these policy settings will have in both staunching the eurozone’s increasing output gap and ameliorating its currently dislocated debt markets. As described above, we believe that the monetary policy reaction to the financial crisis will at least partially depend on the crisis response by European policymakers. WHEN WILL YOU RESOLVE THE CREDITWATCH STATUS? We expect to resolve the CreditWatch actions after the European Summit to be held on December 8 and 9. We typically resolve CreditWatch actions within 90 days, although we will attempt to resolve them sooner, if possible. We aim to announce the outcomes for all affected eurozone governments at the same time. HOW FAR COULD YOU LOWER THE RATINGS ON CREDITWATCH? We believe at this juncture that our long-term ratings on Austria, Belgium, Finland, Germany, Luxembourg, and the Netherlands are not likely to fall by more than one notch, if at all. We believe that our long-term ratings on the other 10 eurozone sovereigns are not likely to fall by more than two notches, if at all. RELATED CRITERIA AND RESEARCH Sovereign Government Rating Methodology And Assumptions, June 30, 2011 Standard & Poor’s RPM Measures The Eurozone’s Great Rebalancing Act, Nov. 21, 2011 Who Will Solve The Debt Crisis?, Nov. 10, 2011 European Economic Outlook: Back In Recession, published Dec. 1, 2011 The Specter Of A Double Dip In Europe Looms Larger, published on Oct. 4, 2011 Why Trade Imbalances For Creditors As Well As Debtors In The Eurozone Are Weighing On Growth, Dec. 1, 2011 The ratings on France, Germany, The Netherlands, Italy, and Belgium are unsolicited. Media Contact: John Piecuch, New York (1) 212-438-1579, john_piecuch@standardandpoors.com Analyst Contacts: Moritz Kraemer, Frankfurt (49) 69-33-99-9249 Frank Gill, London (44) 20-7176-7129 John Chambers, New York (1) 212-438-7344 Sovereign Ratings The Goldwatcher post with an extract of the S&P downgrade is moved to the DELETED POSTINGS Page

 Map courtesy Speiegel on line

 A  new fiscal compact for the Eurozone:

Mario Draghi, the new ECB President,  set a pragmatic course to a eurozone ‘fiscal compact’ in his first presentation to the European Parliament yesterday. Briefly and unambiguously he explained  why the eurozone needs a new fiscal compact that will serve as the foundation for ‘other things,’ insisting the right sequence of interventions matters. In his words:

‘Fundamental questions are being raised and they call for an answer. At the heart of these questions are not only the credibility of governments’ policies and the actual delivery of the promised reforms, but also the overall design of our common fiscal governance.. What I believe our economic and monetary union needs is a new fiscal compact – a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made.’

Chancellor Merkel echoed the message this morning. In an address to the Bundestag she vowed to create a “fiscal union” across the eurozone with wide-ranging powers to avert catastrophe, saying the process was already under way as part of the “marathon” effort to solve the European debt crisis.adding “Anyone who, a few months ago, had said that at the end of the year 2011 we would have taken very serious and concrete steps towards a European stability union, a European fiscal union with powers of enforcement, would have been considered crazy,” “Now, this is exactly what’s on the agenda. We’re almost there. Of course, there are difficulties to be overcome. But the necessity of such action is widely recognised. We’re not just talking about a fiscal union but starting to create one. I believe you can’t overestimate the importance of this step.”

Not everyone will agree with the fiscal union  proposals and treaty changes will take time. Chancellor Merkel spoke of a marathon. Policy makers are on the right tracks now and are no longer in denial. But time may not be on our side and  Europe isn’t out of the woods yet. 

Where do we go from here?

Headline facts:

From recognising that policy makers have found the right tracks to concluding they are bound to succeed calls for a giant leap of faith.  We will all have our own opinions. But we can’t have our own facts. Here are some headline facts worth following:

Fact 1:Presumably some  European leaders,  Parliamentarians, central bankers,  investment bankers, economists, newspaper editors, journalists and others knew Greece was bust long before the first bailout was launched – and if they didn’t they should have.

This detailed timeline on the ECB website tracks events related to the euro crisis from the first bailout a year and half back in May 2010. We know now Greece never even met the criteria for eurozone membership and that a default by Greece,  or any other small eurozone country, can trigger a chain of  over leveraged bank failures with potentially devastating global consequences.

Fact 2: If you want to cure an illness you must start with the right diagnosis. Economic setbacks in Eurozone countries have been wrongly treated as  common garden recessions. In fact they never were. They were a result of a contraction’ more akin to a depression than a recession.  Harvard Professor Kenneth Rogoff explains this in a recent article The Second Great Contraction.  An extract with the gist  of his analysis follows at the end of this posting.

Fact 3: Violent knee jerk reactions can be a dangerous way of making course corrections - whether in public policy, economics or everyday domestic affairs. We all know that if we are driving a car at speed and suddenly slam our foot hard on the brake pedal we risk skidding, losing control and ending  up in a collision or a ditch. Policy makers often forget this.

Fact 4: Plans proposed to resolve the eurozone crisis based only on austerity, without an accompanying plan for growth,  won’t work.(The paradox of thrift.)  But sound plans that address problems and revive economic growth are likely to win global support.

Fact 5: If the eurozone breaks down completely,  or splits  into two groups - one with Germany and the strong economies and the other with weak economies, the German ‘euro’ will be a very strong currency. That won’t be good for Germany’s exports.

Fact 6: A chain is only as strong as it’s weakest link.

Now for some opinions:

Martin Wolf’s  FT article a few days back titled  What the IMF should tell Europe addresses key policy challenges for eurozone leaders. These challenges are core to the interests of Goldwatchers and  I posted this reader’s comment on the article:

Bailouts are contrary to Europe’s treaties. Wypolz and other European economists have called the bailout of Greece a ‘cardinal sin. We know of course it was really undertaken to bailout French, German, Greek and other banks in an attempt to avert another banking crisis. Am not sure it has achieved this. . Agreements to take voluntary haircuts by banks lending to Greece who also waive CDS protection aren’t convincing, Dexia’s distress also suggests something is rotten at the core of the system . Probably 30/40.50 times leverage. .

Without the ECB acting as lender of last resort Europe’s leaders will be fighting windmills and pouring more money down a bottomless pit as the eurozone goes from crisis to crisis. . This week it’s Italy in the spotlight, next week it could be France and, when the rot sets in even Germany will be on the ropes.  (note added: The graphic for Martin Wolf’s column is a large tipper truck,  with IMF boldly painted on the sides, ditching a full load of euro bank notes into a bottomless pit.)    

A chain is only as strong as the weakest link. Currently the ECB doesn’t have the mandate or resources from its constituent eurozone central banks, or the authority from its political masters, to act as lender of last resort. The euro isn’t going to survive in its present form without a lender of last resort, The ECB needs to be empowered now. The IMF will be supportive.  But it’s not their role to be center stage.

It’s also clear that growth has to be a top priority in the overall restructuring equation. If the ECB has to create money against sovereign debt it must have the power to. .An orderly exit for Greece should also be arranged and, as Roubini advises, Italy may also need to restructure its debts now.

Martin Wolf in his article comments ‘Unwilling to focus on the critically ill patient in front of it, eurozone leaders spend their time on designing an exercise regime to ensure he never has another heart attack.” 

Yes the ‘critically ill patient’ must face up to the real world now. The alternative will be a disorderly collapse of the eurozone and the end of the united Europe project.. A tragic and costly outcome in monetary, economic and social terms and one that, even at this late stage, can probably still be avoided. 

 The Second Great Contraction:

 The extract from Kenneth Rogoff’s article on the Second great Contraction mentioned above follows:

 Why is everyone still referring to the recent financial crisis as ‘…the“Great Recession”..(this) is predicated on a dangerous misdiagnosisof the problems ..leading to bad forecasts and bad policy…(and) creates the impression that the economy is following the contours of a typical recession, only more severe…a deep recession that can be subdued by a generous helping of conventional policy tools, whether fiscal policy or massive bailouts.

‘But the real problem is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation…

 ‘A more accurate, if less reassuring, term for the ongoing crisis is the “Second Great Contraction.” The first “Great Contraction” of course, was the Great Depression, The contraction applies not only to output and employment, as in a normal recession, but to debt and credit, and the deleveraging that typically takes many years to complete…The aftermath of a typical deep financial crisis is something completely different..in a “Great Contraction,” problem number one is too much debt.

‘..If governments that retain strong credit ratings are to spend scarce resources effectively, the most effective approach is to catalyze debt workouts and reductions…’ ‘ the eurozone must have policies for economic growth and adjustment.…..If fiscal deficits are to disappear, households and companies have to spend more. Policy must help to achieve this.

Chancellor Merkel has spoken of averting a catastrophe. But will policy makers entertain a scheme that ‘transfers wealth from creditors to debtors, either through defaults, financial repression or inflation? Or, put more bluntly through reflation and money printing  We are still at the start of that ‘marathon.’

The case for owning gold remains compelling.