Steen's Chronicle: Maximum Intervention meets Crisis 2.0 - Negative outlook

Dear Friends,

Latest thought. Steen

 

Maximum Intervention to take us to Crisis 2.0

We'll start with our conclusion: We took profit on the long risk position from August 24th  @ 1152-00 SPX – and move to a net negative position (done @ 1190-00 in SPX in the immediate wake of the FOMC) based on our disappoint that the US & EU debt crisis is moving into the next phase with little good news – Operation Twist in the US and an uncertain EFSF ratifying period in Europe.

The long position in August was based on my dominant macro theme: 'Maximum Intervention' which is a fancy way of saying: policy makers will have at least one more – and massive – go at trying to save the world through macro intervention, though in essence is more of the same: an extend-and-pretend exercise of buying more time. The call has been successful despite the serious deterioration in the political climate surrounding the EU debt crisis.

Herein lies an important lesson regarding policy makers: 'It is at the time when you least expect the risk of 'intervention' that it will happen' – the policy makers go from finding no common ground to suddenly agreeing on something new and often drastic. The history of the EU since World War II has been like that.

The first big step was taken last night at the US FOMC meeting – as the Fed moved to Operation Twist and decided to roll it mortgage bonds into new ones. The next policy responses could include the following:

• Extending Greek debt
• The Fed indicating a move towards nominal targets for inflation- and unemployment. Following up on Bernanke's 2002 speech detailing his view on how to avoid Japanisation through bigger and more explicit policy targets.
• Potential for further move from the SNB forcing the EUR/CHF rate higher (1.2500 floor?)
• A European Monetary Fund or similar (already being discussed openly)

This is all well and good – but considering an economist like me with limited knowledge and contacts can pre-announce the expected policy responses we get something similar to the Heisenberg uncertainty principle in quantum mechanics, namely: the more you know and observe the present positions and policies and the current situation, the less certain you can become of where it is all leading.

Combining these two principles – the knowledge of the inevitability of the next intervention with the uncertainty of where it will take us will likely be disappointing for the near term: We do expect Germany to come through on the last minute of the last day to "save the system". We recognise the political willingness to keep the system going is higher than generally perceived. We also know that the ECB will ultimately move to QE/money printing. But nevertheless, we also realise that time is running out on any best or even second best solution for Europe as the timeline for the politicians is far behind what the financial markets wants to see implemented.

Even with all the good intentions, which are not always obvious, the politicians need dramatically to secure a medium- and long-term solution that is in line with both the Maastricht agreement, but also the German constitutional court in Karlsruhe. This is not something that can be done overnight or even from quarter to quarter and it is an increasingly dicey proposition from a legal standpoint.

We had a unique chance in 2008, when the financial crisis created havoc and turbulence, to facilitate a "new contract" with labor markets and the banks to recreate a competitive labor units cost level and a re-solvency of the banks.

The term re-solvency is a German one, and goes to explain a process where someone drowning in debt re-sets themselves to deal with the debt and liquidity at a tolerable level to re-establish solvency.

This is exactly what is needed in today's Europe. If we agree to 'democratise the loss' as we 'socialised the debt' in 2008, then we are moving forward. What happened from 2008-2011 was an attempt to keep things going and deny the problems laid bare by the crisis with money printing, chiefly in China and the US. In Europe, we indirectly did the same thing by expanding the fiscal imbalances in order to prop up a banking system full of liabilities and non-tradable assets.

At no point have we come closer to "moving on", where we stop dealing with past mistakes and move towards new measures for securing the jobs and growth needed for getting ourselves out of this debt crisis. Only through activating the 'lost generation' of youth across Europe will we have the dynamic societies enabled to implement lasting structural changes.

We need Crisis 2.0 to facilitate these changes – when Chancellor Kohl in 1998 was asked by German reporters how he would convince the Euro-sceptic German voters to embrace the Euro – he took a long pause, clearly thinking and then responded: 'Die Realiteten': reality.

The reality is that we need to break down the walls that are impeding our progress, whether these are constitutional or otherwise. But before we reach that moment of realization and take the next leap,  I think there is an increased risk of seeing one more ugly risk off scenario  - one that actually helps to align the currently too-complacent political calendar and potential solutions with the market calendar. Maximum Intervention is the name of the game at present, but the solution is Crisis 2.0 – getting these two to meet is what the next 90 days is about.

--
Steen Jakobsen
New work e-mail: sj@saxobank.com (please use if possible)

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