Won’t pay, Can’t pay

Don Corleone: Why did you go to the police? Why didn't you come to me first?
Bonasera: What do you want of me? Tell me anything. But do what I beg you to do.
Don Corleone: What is that?
[Bonasera gets up from his seat and whispers into the Don's ear; for a long moment the Don is silent]
Don Corleone: That I cannot do.
Bonasera: I will give you anything you ask!

Look around and the world is completely distorted with variety many easing programs at work:

In Europe,

• A bankrupt Greece still able to borrow when it may go for more rounds of haircuts;
• Spain with world beating unemployment being able to borrow under US or UK rates;
• Italians who can restore their economy to health through a currency devaluation but continue with the union given the massive short term disruption and the free money keeps the politicians hooked on;
• The French have slipped into recession and the continue to hope in their 35-hr weeks will suddenly get more productive with more doses of free money from the ECB;
• Finally, the Germans which held back their wage growth through better settlements with unions post the German union (unlike rest of Europe) and is in effect underwriting the union however much they do not want have slipped into a recession as majority of their exports are to EU countries with bond yields a quarter of what they used to be 10 years back;
• Europe as is currently will continue to paper over these problems (Growth and inflation will remain below 1%. Euro-area EPS is at 2009 low!!) and chug along as far as they can. They fear caused by two wars of independent jockeying continue to haunt them as moribund their current economic situation be. They may head to fatal Japanese concoction of high leverage and bad demographics.

Country	Current 10 yr bond	10 yr back
US	2.58%	4.12%
UK	2.54%	4.84%
Australia	3.73%	5.47%
Japan	0.56%	1.39%
France	1.39%	4.06%
Germany	0.99%	4.03%
Italy	2.36%	4.21%
Greece	5.72%	Does it matter
Spain	2.20%	4.05%
Brazil	11.60%	-
India	8.64%	-
China	4.16%	-

The Japanese want to get inflation, currency devaluation and with that growth to withstand Chinese aggression. But given the debt situation, demographics and lack of productivity growth this strategy while creating an environment for corporate earnings expansion is slowly resulting in a situation where BoJ maybe the only buyer of the bonds. This will surely result in continued depreciation of the yen and potentially a point where bond sales gather such pace that the BoJ loses control over monetary policy.

Towards end July I had written, “Only alternative central bankers have to manage the scale of the adjustment is to keep running behind market expectations” and Yellen did exactly that but before that cut productivity estimates by a quarter for the future and saying she is still concerned about labour market. This game of building expectation and then pulling back will continue.

China’s economic troubles continue to get worse. “Issuance of trusts for real-estate projects, which target wealthy individuals, slid to 30 billion yuan ($4.9 billion) this quarter from 67.8 billion yuan in the three months to June 30, the least since the start of 2010, data from research firm Use Trust show. Borrowing costs are rising as developers face $9.1 billion in bonds and loans maturing by year-end.” Total financial credit has surged to 251 percent of gross domestic product from 147 percent at the end of 2008 (US had hit 350% in 2008 and is now down to 260%). But they are stuck with their addiction to leverage to ride over their issues. Three days back PBOC let another US$81bn to the 5 top banks at very low interest to create some more “methamphetamine” (for those who have not yet seen Breaking Bad these is a synthetic drug abuse substance).

As the Chinese economies slow resource countries like Australia / Brazil are already seeing the impact. Their bond yields should continue to see downward pressure.

We are seeing a global phenomenon of excessive liquidity keeping rates below normal with the central banks acting to counter balance the moves of the other which creates currency related stresses. This bond yield suppression will cause severe stress to retirees as their pension plans will result in serious deficit or they will need to work much longer.

Don Draghi: Why did you go to the police? Why didn't you come to me first?
50 year old European: What do you want of me? Tell me anything. But do what I beg you to do.
Don Draghi: What is that?
[Gets up from his seat and whispers into the Don's ear; for a long moment the Don is silent]
Don Draghi: That I cannot do.
50 year old European: I will give you anything you ask!

Post Scripts

• Uttar Pradesh has 80 seats to Lok Sabha. UP’s per capita income Rs.37,359 while all India is Rs.74,920. Now imagine adjusting seats for per capita income of the state, UP will be down to 40 seats. Imagine the positive impact this will have Indian politics pushing politicians to become more development oriented and this adjustment can be carried out for every Lok Sabha election.
• The Chinese President Xi Jingping visited India. India should have offered to build a pipeline to transport Middle-Eastern oil & gas via pipelines running from Bay of Bengal to Southern China reducing the dependence on the Malaccan straits. This could give them some respite from the American navy in Malacca straits and would have been an interesting back drop to the US trip. Anyways, our Russian friends would have taught us how to manage the pressure in the pipelines!!