The Mad Euro Project Just Got A Lot Madder

Feeding a Monstrous Pile of Debt.

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

Under Mario Draghi’s radical stewardship, the ECB seems determined to push the limits of monetary experimentation. And by all accounts, it’s succeeding.

This week saw numerous eurozone governments sell bonds at negative rates, an economic anomaly that has no place in a rational world. Even some mainstream economists still seem confused by it. Unfortunately, thanks to the tireless efforts of central bankers around the globe, we stopped living in a rational world a long time ago.

Feeding a Monstrous Pile of Debt

The latest government to enjoy the perks of negative-interest-rate living is Portugal. That’s right, Portugal, a country that four years ago was selling 12-month notes with an average yield of 6% amidst fears about the government’s ability to service its monstrous debt pile, is now able to sell €1.1b billion of 12-month debt at a -0.06% yield. In other words, if investors hold the bonds to maturity they will actually pay the Portuguese government – a government that doesn’t yet exist – for the privilege of holding its debt.

This is despite the fact that Portugal has not only a perpetually stagnating economy but also one of the highest debt-to-GDP ratios in the world. After four years of so-called “austerity,” Portugal’s combined public and private debt is now a mind-blowing 530% of GDP, with total corporate debt expected to reach 240% of GDP.

Most of the country’s public debt is foreign owned, and while there aren’t any reliable figures on who exactly owns the private debt, it is a fair bet that it is also mainly foreigners (and, of course, local banks). In other words, the country’s heavily-levered corporate sector is sitting upon the granddaddy of tick-tocking debt time bombs.

Even compared to the total debt amassed by all the other rickety economies of Southern Europe, Portugal is punching well above its weight. Italy has a total debt ratio of 369.5% and Spain, 418.3%. Even Greece, a country that barely has an economy left to speak of, has a debt ratio (354%) significantly lower than Portugal’s.

Yet that didn’t stop Portugal from becoming the latest country to join Europe’s far from exclusive sub-zero debt auction club. Spain also became a member of the club on Tuesday after selling €3.5 billion worth of 12-month bonds at a -0.049% yield, leaving one to wonder how long it will take before Greece’s government of reformed leftists receives a membership form in the mail.

No Government, No Problem?

None of this should be happening. Indeed, in a parallel universe where Quantitative Easing and negative interest rate policy have not been invented and big bankrupt banks are actually allowed to go bankrupt, none of this is happening. Unfortunately, in this universe, it is.

Perhaps the most unfathomable aspect of the mad rush to buy Portugal’s negative yielding debt is that the country doesn’t even have a government to speak of, after last month’s general elections gave no party a clear majority. In fact, the country doesn’t even have a projected budget for 2016.

If there is to be a government at some point in the near future, it’s almost certain to be one composed of left-wing parties that have already been branded too dangerous for office by the country’s president, Anibal Cavaco Silva.

Before deciding whether to ask socialist leader Antonio Costa to form a government, Silva spent the last week or two doing what all politicians do when they don’t know what to do – i.e. consulting the opinion of some of the country’s top bankers. According to Reuters, Portuguese bankers appeared cautiously optimistic that any future Socialist government would stick to the course of budget consolidation despite concerns among some investors that it might prove spendthrift.

“If Antonio Costa is named the next prime minister, I’m confident that he and the Socialist Party will have the required sense of responsibility to keep the country on a rigorous path and will guarantee the stability of the financial system,” said Banco BPI’s eternally optimistic CEO Fernando Ulrich.

“Just How Low Can Mario Go?”

In the end Silva will have little choice but to name Costa prime minister. It’s only then that we will find out just how determined the new coalition parties are to fulfill their election pledges and reverse the previous government’s austerity policies – policies which, it’s worth noting, have done next to nothing to improve the country’s hideous debt trajectory or put its stagnant economy back on something remotely resembling a growth path: in the last quarter Portugal achieved just 0% growth despite access to virtually free debt.

Meanwhile, the question on investors’ minds is, “Just how low can the Grand Master of European financial alchemy, Mario Draghi, go?” The answer to that question appears to be: “much lower.” There is already a growing consensus that the European Central Bank will unveil a fresh round of “stimulus” at its December meeting.

And it’s for that reason – and that reason alone – that the governments of deeply dysfunctional economies like Portugal and Spain are able to sell their debt to foreign or domestic investors for cheaper than free. In today’s eurozone experiment, it’s not so much that fundamentals have taken a back seat; they’ve left the car altogether. By Don Quijones, Raging Bull-Shit.

Passos Coelho, when still Prime Minister of Portugal, knew “what to do.” After signing the €78-billion bailout, he embraced the Troika’s agenda with abandon. Public spending was slashed, taxes were hiked, wages were cut, and public assets and services were privatized, while the public debt continued to balloon. But now there’s a price to pay. Read… Is the Troika About to Lose Control of South-Western Europe?

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  16 comments for “The Mad Euro Project Just Got A Lot Madder

  1. Bruce Adlam says:

    If we continue on this path of more and more debt to avoid recessions maybe the ultimate price we pay is Democracy itself

    • Jungle Jim says:

      Several years ago, Mario Monte the “technocrat” who was appointed by the EU to supervise Italy’s finances remarked that the the major obstacle to the success of the euro was democracy. He wasn’t joking either. That is why they fight so ferociously to prevent referendums.

  2. CrazyCooter says:

    I don’t really trade, so I haven’t dug deep into the subject of dark pools and the like, but is it some kind of pricing manipulation at auction?

    So … who buys the bonds at negative interest rates?

    CBs? Pension funds? Rationally, there are slightly positive yielding bonds out there that are nice and liquid (e.g. US treasuries) that are certainly better than NIRP bonds, albeit a different currency. Certainly hedge funds are not buying them (haha – 2 and 20 for NIRP bonds).

    The only answer I can rationalize are other CBs who are in just as bad a shape … or … I will bid your bonds negative if you bid mine negative … in a sort of CB circle jerk … hoping to take the bond complex along for the ride.

    No one else really has an incentive.

    So, let them … and hold physical cash. Euro still has the 500 note, right? I am a prince who can’t sleep on a pea, but a lump of 500 euro’s under my butt makes me sleep like a baby!

    Besides, I like the return of physical cash in a deflationary environment.



    • MC says:

      I haven’t seen a €500 note in four year, a €200 in two and even €100 bills are becoming scarce. They aren’t being withdrawn from circulation: they are being hoarded. Call it a postulate to Gresham’s Law.
      Physical gold has disappeared as well: a large chunk of it was sold to Swiss refineries, smelted and shipped in ingot and bullion form to India, whose appetite for the yellow metal seems insatiable, and rightly so. India is the heir to some of the world’s oldest civilizations and that taught them never to trust the government, especially when it comes to money. Whose who still own gold (like me) hold to it like there’s no tomorrow: in the past two years physical has outperformed all currencies bar the US dollar.

      Regarding bonds. The retail market has completely dried up. Nobody wants to pay Italy or even Germany to lend them money.
      Banks and insurance companies are still forced into purchases by regulations but their enthusiasm has much waned and, whenever possible, they unload this debt upon their own central bank through the ECB QE program which has been expanded to include corporate bonds only two notches removed from junk.

      The funny thing is our banking system is awash in credit but, and here’s the most astonishing thing, it seems to have become concentrated in just three sectors: housing, financial engineering and consumer credit.
      And even there, and despite lowering lending standards to unheard of lows, something broke.
      The much hoped for revival of the 2003-2008 housing bubble which was supposed to propel growth in Spain and Italy to new dizzying heights just hasn’t happened. Consumer spending remains horrible (look at shipping rates from China to the Mediterranean and Northern Europe).
      The only things the ECB has to show to its credit are yet another automotive bubble (more of which in a minute) a boom of German exports.
      But those German exports have some pretty stiff competition from the likes of Japan and South Korea for a dwindling market and, to make matters worse, Germany is the third most vulnerable non-commodity economy to the present slowdown in China after Taiwan and Japan. Even assuming the present deflation (as in letting air out an overinflated balloon) doesn’t worsen, these three countries face some pretty trying times, especially given the late great US consumer cannot help automated lathe and escavator manufacturers.
      That leaves automotive, but not all is well. Manufacturers seem to have learned some tricks in China to boost their numbers without actually boosting sales: see the practice of registering cars which are then left to rust in dealership parking lots or sold after six months for less than half the RRP to savvy buyers.

      As too many people told me the problem is very simple: there is no money and those who have money don’t want to spend it. Even the fabled 1% seems to have lost a lot of its appetite.
      There’s a brand new Gucci store right in front of my main bank. It’s always deserted and the huge staff always looks bored out of its skull, staring at the door for somebody to walk in. And for the first time ever, Louis Vuitton authorized its shops to offer discounts (the side effects of living with very fashionable women… you learn a lot about luxury brands whether you like it or not!).

      I have this feeling instead of simply admitting ZIRP’s and QE don’t work, Draghi will go full Kuroda mode if not farther.

    • Mel says:

      I read somewhere that government bonds, even negative interest rate bonds, could be useful collateral in repo deals, or something like repo deals. Presumably such deals would promise to return enough to cover the cost of owning the bonds. While this explanation contains several good-looking words, it makes no sense to me. But nothing else makes sense either.

    • Petunia says:

      The short answer to why negative interest rate bonds get purchased is that many financial products require the managers to be fully invested in a particular kind of bond. This makes it impossible for the fund manager to stay in cash or diversify, even when it is a better strategy. If you own an annuity, which you purchased because it only invested in govt bonds, that manager is required to continue trading in that type of bond, even if the return is terrible. Bond funds are the typical investors, as are insurance companies, and 401K type pensions.

    • Kam says:

      Crazy Cooter:

      That is why governments are trying to shame you/legislate you out of holding cash. Cash under your mattress in the logical result of NIRP. At least your $10,000 in cash today is still $10,000 in 12 months from now. Unless you are compelled by law to be stripped of your money by forcing you to put it in a bank.

      Central Bankers are like quack doctors. They feed you candy until you have such a bellyache that you are immobilized. When you tell them your problem, their solution is always the same- more candy. Then you die a slow agonizing diabetic death.

      Central Bankers- the disease that purports to be the cure.


  3. Peepot says:

    yes yes …. this is crazy … it makes no sense…. these guys must be stupid, corrupt… they are going to blow up the world!!!

    I’ve heard it all before.

    But if you were in the elite — i.e. a billionaire … would you stand for this? So you get to increase your fortune by a few billion on the back of these policies but so what — the world IS going to blow to pieces and your billions are likely to vapourize.

    So the question remains – WHY are the elites pursuing these seemingly insane policies.

    WHAT do they fear?

    Obviously they fear something a whole lot if has led them to pursue policies that are GUARANTEED to blow up the economy.

    This is what they fear:

    THE PERFECT STORM (see p. 58 onwards)

    The economy is a surplus energy equation, not a monetary one, and growth in output (and in the global population) since the Industrial Revolution has resulted from the harnessing of ever-greater quantities of energy.

    But the critical relationship between energy production and the energy cost of extraction is now deteriorating so rapidly that the economy as we have known it for more than two centuries is beginning to unravel.

    • CrazyCooter says:

      I saw this on ZH originally (2013) and linked here twice since then. I like long term macro views, so not discounting the premise presented, but you are characterizing the thesis in a micro context.

      Short term, the billionaires got nothing to fear, as long as their wealth isn’t a complete paper ponzie. If they own enough real assets and their debt isn’t out of control, they are wealthy and powerful off into the sunset.

      The premise you are presenting with your link is that the species is f**cked, mostly due to a high net energy life style/economy and more or less decreasing input of cheap energy. This is on the whole true, but complicated, varies by region/demographic/geographic, and not nearly as neat and simple as presented in your comment.

      So, do us a favor and throw some numbers on your opinion, so we know when to expect what. Plus or minus a few years is alright in my book. But to be clear, tell us WHEN you think this, that, or the other is going to happen.



  4. Nick Kelly says:

    Mario is channeling John Law- the man who brought paper money to France in the mid- seventeen hundreds. The final collapse of his scheme was a cause of the French Revolution.
    The attraction then and now is similar- a bankrupt state that can only paper over its spending.
    On the other hand no rational solution can work, because non- industrialized countries like Greece and Portugal don’t belong in the same currency as the industrialized ones. ( I am part Greek- I am also not very wealthy and don’t pretend I can afford things I would like)

    Let’s look at it simply: anti- austerity mavens love to rave about the multiplier effect in conjunction with the blessed service sector.
    But neither Greece or Portugal makes cars. Therefore, all the cars in either country can only be purchased from another country. The only service sector that is of any use for this is the tourist sector. It is the only service sector that can provide funds from outside the country, balancing the funds that leave when a car is purchased.
    (Countries that have large financial sectors can sell services to other countries, e.g. insurance, but not these two)
    The only other option is exports.
    One of the advantages of the old currencies was that this was easier to understand. Everyone knew you couldn’t buy a VW or Fiat with drachmas, they would have to be converted.
    The other advantage, as almost everyone agrees, is that back when the drachma could be devalued, the all-important tourist sector could be made more attractive to spenders including those from a car manufacturer.
    But why not just do it in euros- lower prices in euros?
    Because the service sector is not the public sector. The public sector in Greece is huge. The services consumed by a tourist- food, lodging, entertainment etc. are also consumed by a Greek civil servant.
    In his 2011 book ‘Boomerang’ Michael Lewis ( The Big Short etc. ) reports that a Greek civil servant made more than his German counterpart- paid in euros.
    Maybe one way of illustrating the conflict of interest between the public sector and the private sector is this: during the Depression a Canadian Federal employee ( Dominion Civil Servant) saw his ( it was usually a ‘he’) standard of living rise, in spite of two 5 percent wage cuts. This was at the expense of the private sector- he could bid more for an apartment.
    That’s the definition of standard of living- it’s relative. You don’t say that a millionaire in 1920 is not well-off because he doesn’t have TV or even, most likely, a refrigerator.
    You could only lower the cost of a Greek holiday in euros without further increasing the internal Greek disparity if ONLY tourists were allowed the discounted price. But that Tourist Card will soon be counterfeited.

    The only problem with winging it is landing. So since we are all in a mad house (negative interest rates) I’m going to join the party. How about this: when you arrive in Greece at the customs, you hand over your euros and they give you twice (or 1.5) as many back. ( The serial numbers prove the originating euros came from outside the country)
    You then proceed on your holiday.
    But where will they get the euros to do this?
    From Draghi, the source of many Greek euros.
    But instead of disappearing into the maw of government- they will go directly into the tourist sector.

    hy eh how youor buy your tickert

    • CrazyCooter says:

      I live in the US, so maybe I am detached from the s**t y’all gotta shoulder, but my read of it from across the Atlantic is that Germany is doing financially what they failed (twice) to do militarily (to Europe). Your elite signed up for it, lined their pockets, and stuck you little guys with the tab.

      No one (in leadership) is really interested in solving anything; they just want their outcome – which is control of the continent. I think this the core reason NIRP exists and all the other crazy stuff going on at the monetary level (see comment up thread). It won’t – it can’t – work, but that isn’t going to stop them. Until this thing goes totally tits up, y’all are stuck with the bottom of the outhouse while Germany camps the throne.

      That said, the Euro leaders are a sort of vassal state to the US, so this Russia thing is really gumming things up for them in terms of trade/economics. I think the west really underestimated it’s hand and the betting is on … cards yet to be laid down … and the pot getting fatter … rolling Russia. One of the biggest tells, in this regard, was the Russian CB rate hike earlier this year, which halted and reversed trades (so insiders could cover naked shorts) at the expense of their clients. That is when I knew it was on. I also think the West seriously miscalculated and is looking for cover. Since then, things have escalated in Syria and not too long after Europe is neck deep in Moo’s killing people.

      It is all down hill from here unfortunately. Best if luck.



      • MC says:

        Germany has not tried to take over the Continent by sheer force of their economy, trust me on this. Their political class, as shown this year in the international theater, would make Otto Von Bismarck roll over in his grave through its weakness and lack of direction.

        What happened is that once currency barriers were removed, it was pretty much over for the already struggling manufacturing industries of Italy, Greece, Spain, Portugal and to a lesser extent France.
        German firms have always been far better capitalized and productive than their Southern competitors due to far more conductive fiscal and labor policies and crushed them. Take away the currency part and it’s exactly the reason why in the 70’s and 80’s Japanese consumer electronics companies such as Sony and JVC crushed their US and European counterparts.

        The problem with the euro is very simple: it allows Germany to sell far more than it should (both inside and outside the EU) and it allows Italy and Spain to get in debt far more than they should.
        If we want to use a metaphor, it would akin to the old mark being undervalued and the lira and the peseta being overvalued.

        The situation is unstainable long term and cracks are already developing. For example the much vaunted austerity seems to have the exact opposite result than what it was originally conceived: all countries embracing it end up far more in debt than before. See Portugal. Also powerful enough countries are able to openly thumb their nose at the much vaunted German fiscal discipline (which apparently doesn’t apply to their banks, which are in far worse shape than Japanese ones were in 1989): Italy recently announced a grandiose public spending and tax break program which will be wholly financed through issuance of new debt. €15 billion or a similar silly figure for 2016 alone. Not a word from Frankfurt and Berlin, proving correct the old saying that if you owe the bank ten grands, you have a serious problem, but if you owe the bank ten million the bank has a serious problem.

  5. David Soble says:

    Apparently, people are having trouble with finance 101. The banks and pension funds buy the negative rate bonds because as the ECB drives rates even MORE NEGATIVE, the older bonds which have smaller negative rates actually appreciate in value. It is all about getting a capital gain by selling a LESS NEGATIVE RATE BOND.
    The ultimate answer is that soon you will buy a bond and the government will keep all the principal, but send you a thank you note on the redemption date. That is Draghi’s proposal for next year. Happy New Year subtitled in English, when will the madness end.

    • Wolf Richter says:

      This only works for traders, those who sell the bond right after the rate gets cut further. If you hold it till maturity, which insurance companies and pension funds often do, then you’re screwed, and you lose money. And that loss in guaranteed. Finance of the Absurd 101.

      • Toddy says:

        And like all bubbles, NOBODY thinks they’re left holding the bag. They all operate under the intention of selling to a sad schlubb before maturity… Until they don’t, because nobody is buying. And that will be the Big Bang.

        • d says:

          Its almost like they are trying to force all the small holders into gold.

          So they can do an FDR. Legislate the price down, and legislate you sell it to them, at that reduced price.

          Its becoming that, money, land, and gold, are in fact, not the things to have.

          Therefore the things to “Have ” are what is in demand.

          Which is why the GM seed companies are trying to control the supply of non reproductive seeds to agriculturalists.

          Banks, contrary to common belief, are not the entity’s people need to fear and loathe.

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