Greece, ECB QE or the Franc

Submitted by Jeffrey Snider  –  Alhambra Investment Partners

With Greece relenting on its game of chicken with the Eurozone noose, you have to wonder how much the ELA and the threat of total financial meltdown pushed that direction. From the view of credit markets in Europe, there was an unusual almost confidence in such an outcome from the moment of the election last month. Small wonder when Europe held essentially the trump card:

Some members of the governing council believe that if a solution is not agreed between Greek officials and the Eurogroup by the end of the week, then the ECB could have to review the solvency of Greek banks.

Not only could the ECB kick Greek bonds out of the broader, continental collateral pool, they could make financing for Greek financial firms next to impossible. In other words, there is no economics or even monetary economics at work here; the complexities were entirely political from the start, not that that is any special insight.

In fact, the economics are relatively straightforward, as “solvency” isn’t quite the right word for being used as a political hammer. You can’t be solvent one day and insolvent the next based on decree – either your assets sufficiently cover your liabilities or they don’t. The difference of this new financial system with the ultra-activism of central banks as political tools is that as the “market of last resort” (another of those completely unappreciated alterations to global finance) liquidity has been merged with solvency, and vice versa.

When central banks “control” and manage “markets”, for our own good of course, there is no daylight in which to render objective (as much as possible) verdicts about financial health. There is only conformity or nonconformity, regardless of what is contained in any single balance sheet. That is why European banks can buy up all the PIIGS debt they want without fear of solvency questions, as that former limiting factor is now entirely political.

This has tremendous implications beyond just Europe and the Greek drama that will not end (because actual solvency actually remains the problem regardless, reflected only occasionally by “unplanned” illiquidity). In the United States even, the Federal Reserve has performed a similar role expanding beyond TARP’s introduction of “nobody fails or everyone does.” Central bankers and policymakers call it a number of names, but “reach for yield” is no different than disabling by overwhelming market discounting of credit and default factors. That is why the FOMC issued the small but significant, if ultimately misplaced, notation last month over retail bond funds.

Credit prices everywhere in the world are not used any longer to set resource allocations and to drive economic growth efficiently. They are instead largely a tool of socializing economic function. The problem is that central bank control is never complete or comprehensive, even though central bankers have openly called for such things (especially Janet Yellen). To this point, though, they remain unable to penetrate much into the realm of global funding.

Take the case of the Swiss National Bank, where its peg to the euro was a similar proposition. But by commanding a “price” for the currency in euros, they simply moved stress elsewhere especially in funding (which currency movements have become signaling for). The more that stress built up, the greater the potential for violent backlash, as the Swiss yield curve had been indicating for many months. In the end, there was only so much “dollar” pain that they could undergo before it became too disorderly to handle under any terms.

So the credit markets in Europe have, if not completely stopped deteriorating, at least slowed that pathology. On the surface, the calmer conditions since the end of January seemed to suggest at least some measure of increasing sanguinity about Greece – and maybe rightfully so given the “agreement” purportedly in place today for a four month reprieve. However, I still have a hard time believing that fully, as there was no way for credit markets to anticipate such a political outcome, especially given the harsh rhetoric from all sides until now.

ABOOK Feb 2015 Europe Germany

It is entirely possible that the ECB’s QE has contributed to the changing mood, though if that was the case it is a rather dour assessment of Europe’s QE capabilities as credit markets haven’t shifted all that much in relative comparison to the hype over it. That is especially true when QE’s elsewhere have essentially been binary propositions, where they either do absolutely nothing or they gain major, sustained reactions.

While those two factors have to be considered, I wonder myself how much the change was actually due to the removal of the franc peg to the euro. Again, the SNB essentially activated a relief valve on not just its own financial system but against overflow effects in funding markets all over the world. The Swiss financial system is everywhere, and decay in that arena isn’t likely to stay so localized. I have very little doubt that Switzerland was a major component of “dollar” problems that broke out in December.

ABOOK Feb 2015 Europe Swiss

None of this is to suggest that anything is “fixed”, or even appreciably better. Only that “something” has offered a bit of a reprieve over the obvious and severe deterioration that drew so severe from December 1 into the middle of January. Since there were so many events clustered right within a week and a half, it is difficult to filter any potential responses to individual events. However, I cannot help but think that the SNB’s action was the most significant and effective (in the sense of removing an obstacle, not offering a more permanent fix as imbalance is still present and immense, just less immediate).

While this is just a guess on my part given what little data we can obtain, it is still wise never to underestimate the power of “dollar” problems.

ABOOK Feb 2015 Europe Eonia2