Thursday, May 8, 2014

Spain in Depression@Max Leverage

Globalization Collapsing in Broad Daylight
Today's economists will somehow tell us that they believe in market-based incentives for driving behaviour. Yet then on the other hand, they somehow fail to see that 0% interest rates subsidizes debt accumulation, thereby massively increasing leverage, all of which is doomed to fail disastrously, as we've only seen about a dozen times in the past decade.

How come this disconnect? Because they're soon-to-be-bankrupt dumbfucks. Case closed.

The Ponzi Model Doesn't Go In Reverse...

Ponzi Borrowing 101
Recently I showed this chart of Spanish 10 year bond yields. Now at 3%. 

As of this writing, the yield on U.S. treasury 10-year bonds is 2.6%, which is considered to be the "benchmark rate", upon which all other asset valuations are based. 

Meanwhile, Spain's unemployment rate is currently 26.7% i.e. depression levels. And Spain's sovereign debt (see below) is still growing at rate of 7% of GDP per year (i.e. the annual deficit). 


Spanish government debt to GDP

Here is where it gets interesting:
As we see below, the Spanish stock market is massively correlated to the Euro currency. However, Euro strength relative to the dollar has been solely a function of Fed policy being substantially more accommodative than ECB policy. Now however, the Fed is reducing liquidity even as the ECB's Mario Draghi signaled today that he is moving towards additional easing. So the Euro is now under extreme downward pressure. 

Given that Spanish stocks and bonds have been bolstered by carry trade inflows predicated upon a strong Euro, then what will happen when the Euro weakens?   That would mean that the cost of capital for Spain is implicitly going up for foreign investors who buy Spanish financial assets aka. carry traders.

The free lunch is ending because, the ECB can't support the economy (via greater liquidity) and the carry trades (via strong currency) at the same time. It was always a Faustian choice of employment versus return on capital.

Spanish stocks (red) with Euro (black)
Spanish stocks made a new multi-year high, just today even as the Euro is now rolling over.
This shit show does not go in reverse