The good germans don't always tell the truth...

Much has been said already about how the markets and therefore, savage capitalism rules the world. Almost none, about political nonsense blaming on the markets when confronted to their decisions. By not talking clear to their constituents, politicians are playing a 'no winner' game, which isn't the same as a draw. Whether moral or not, markets don't risk a penny if they will lose it. Political flaw works in the opposite way. Politicians will risk with populism, when losing. The ethical movements of our politicians can be questioned, but democracy is not always a reasonable output. Voters are willing to support nonsense as long as this nonsense never becomes real. Our politicians democratic transactions need to examined by truth and nothing but the truth.

State of the World's economy (US, Japan, UK and the EU)

The current financial position (private and public indebtedness, fiscal balance, trade balance, savings rate) of the European Union (EU) is much better than any of its major partners. Therefore, why prospects are so bad? The potential growth of the european economy to pay off its debts, maintain a sustainable health of public finances (high cost of unemployment and social security), pursing trade surplus that will secure current european wealth is unclear. Investors are pushing for single markets rules such as fiscal union with single european VAT, corporations tax rate and labour code, which needed to be implemented as the Euro was introduced.

German contribution to the European Financial Stability Facility (EFSF)

Together with neighboring France (both AAA debt issuers), they make up for 47% of the total fund liabilities. The effective interest rate to which the fund is borrowing from the markets nears Germany's borrowing interest rate (at lowest in history). The fund (rated AAA by major credit agencies), will rescue european States unable to finance themselves at the markets. Currently, Ireland and Portugal are among countries rescued under this financial facility programme (Greece has been bailout under another financial programme that includes the EU and the IMF). To be able to lend the fund needs to borrow as low as possible. Austria, the Netherlands and Finland may add credibility to the fund but with their low stakes they aren't dissuasive. Moreover, two big AAA countries with deep influential markets like Germany and France are in need and while French banks credibility struggles at the markets risking France's AAA rate with them (France will have to bail out its Banks), German contribution to the fund is the only credible source for the markets. To dismiss current debate in Germany as 'simply german greed' denotes a lack of understanding on how financial markets work. Germany is risking its AAA rate, will have eventually to bail out its banks (again) and already has a higher debt in proportion to its GPD (over 82%). Therefore, germans need to decide, whether they want to be Europe's paymaster or not? But why are we here?

GDP or Y = C + I + G + (X - M)

Y represents a country's total gross domestic product (GDP) or its income. C stands for consumption of individuals, I equals the total investment in the country (public and private), G represents the net position of government (taxes vs expenditures) and its trade balance (X for exports vs M for imports).

One can lie in politics but in math, it is not that easy. Because most of Germany's income comes from trade balance (Exports), Germany needs healthy financial customers that will pay off for its high quality goods. About 65% of all german goods are sold in the European Union, establishing that a disruption inside the Union will have direct consequences on german companies. This is partially true but for different reasons. The hard truth is that politicians in Germany have been playing “the jobs card” to actually cut middle class salaries, benefits and therefore, inflating company balances, big managers salaries and DAX profits. If Germany is exporting more than ever, its workers are earning less than ever (discounting inflation real salaries are at 1991 levels), government is asking for less corporate tax; what are companies doing with their export income? Just sticking it on rich shareholders pockets while export jobs represent less than 18% of total employment.

After the Hartz reforms, DAX dividends (pay out to shareholders) together with profits has soared to levels never seeing before in the German Federal Republic. The corporate tax rate together with the effective corporate tax rate (what companies really pay after discounting credits and exemptions) has been at its lowest since the foundation of the Federal Republic in 1949. In the meantime, poorly paid jobs have flourished together with the amount of workers applying for government assistance because their wages are too low to live from.

Politicians are responsible for decisions like: reaching poverty line salaries, no federal minimum wage, low company taxes, higher profits, higher dividends, rising inequality and rising poverty.

Living in a deflationary world

The culture of 'low and cheap' has arrived to stay. Politicians convinced by the idea that 'tax credits and exemptions' (less State revenue) together with lower social charges for employers and low workers salaries would push costs down and therefore, boost economic activity is flaw because german economic activity is directly attached to its partners performance. In 2008 as global trade collapsed, Germany saw its GPD shrink by 5% (higher pace since the WWII). In the meantime, politicians were 'rescuing' regional banks (Landesbanken) well-fed with subprime mortgages that added up 15% in debt to GPD. The german economy is a reflection of global demand: as world trade grows, German exports rise not so workers wage.

Politically flaw and intellectually dishonest

Under this 'deflationary world scheme' a worker's salary is considered a 'company cost'. But does it? Of course not. A worker's salary is its capacity to buy (purchasing power), acquire goods and services available in the markets. Therefore, higher salaries (increase demand) mean higher consumption (increase profit). Increase demand and increased profit, means companies can put more money into the bank, pay their staff more and pay dividends to shareholders. Why not in Germany? Because politicians would have to confront their own lie: 1.export policy means salaries won't rise at parity with economic activity. If the wages of the neighbors ain't rising, yours can't rise either. 2.Export jobs which account for almost 18% of all jobs are ruling over the rest because companies not only finance campaigns but lobbies for friendly laws. 3.Inequality will continue growing because workers aren't shareholders and therefore, aren't profiting from 'export gains'. The workers will continue to pay (working for less) and the shareholders will continue to profit. 4.Most german workers can't buy their own products and moreover, you aren't in charge of your future.

Good Europeans vs Bad Europeans

While politicians labeled countries and their citizens as good and bad based on economic premisses (debt, deficit, indebtedness, trade balance) they failed to come up with the truth. In 2003 while Ireland and Spain where among the outstanding countries fully complying with the Maastricht Treaty, Germany and France asked for 'relaxed conditions' breaking up the rules for the first time. Who was bad back in 2003 or who's lying now? On past August, politicians of the two countries proposed a 'true economic government'. Certainly, we have only hear one part of the story and there's much to be say.

Currencies and the reckless neighbor...

Super QE, or beggar-thy-neighbour

Sep 6th 2011, 13:43 by Buttonwood

CURRENCIES don't tend to move 7-8% in one day in the modern era but the Swiss National Bank has achieved the feat today. It announced a "minimum" exchange rate target of 1.20 francs per euro ( hereis the announcement) and the markets fell into line. In reality, the target rate is a ceiling, not a floor; if you turn the cross-rate round, the Swiss want the franc to be worth no more than 83.33 euro cents.

As was remarked in a previous column, the Swiss franc has been rivalling gold as a safe haven and the authorities are worrying, as the statement shows, about the deflationary threat. So it will create Swiss francs to buy "unlimited" amounts of foreign exchange. Since the target rate is based on the euro, presumably it will buy euros. Traditionally, we think of central banks as pursuing the opposite policy; using its foreign exchange reserves to buy the domestic currency (like the UK's doomed effort in 1992). But this is doing the opposite, creating Swiss francs to accumulate reserves. And, in theory the scope is unlimited; the Bank of England ran out of resources in 1992, but the SNB can create francs without number.

Other countries have used QE without explicitly aiming to drive down their exchange rates, although the Bank of England has broadly welcomed the decline in the pound and QE enthusiasts cite the decline in the dollar as an example of the success of the Fed's policy. But this is shock-and-awe stuff and makes one wonder whether other countries will follow suit. As Chris Turner, head of FX strategy at ING, comments

This marks a major new round in the currency war. Could not Japan also set a minimum USD/JPY exchange rate at 75 as a means to battle deflation?

Any policy as aggressive as this is bound to have some side-effects, both domestic and international. The Swiss had been attempting to weaken their currency by a more roundabout route, repurchasing Treasury bills and diverting the money into bank deposits. This policy had already had the effect of making interest rates negative, in the very practical sense that UBS was charging institutional customers who held excess deposits in their accounts. The trouble with this strategy is that most currencies are currently paying little-or-nothing; investors might not mind paying 1% to hold a deposit if they felt the Swiss franc was set to rise 5% a year against the dollar or euro. And as Geoffrey Yu of UBS points out, this approach was limited in scope; deposits had ballooned from Sfr30 billion to Sfr230 billion in just a few weeks, already more than the Sfr200 billion target.

Eventually, one would expect such money creation to fuel inflation. The Swiss monetary base is already 50% of GDP (the equivalent figure for America is 18%) but there are no signs of inflation yet. There are also questions about the financial health of the SNB and about the potential losses if this strategy fails (the losses incurred on previous interventions have sparked calls for the governor's resignation).

The international side-effects may be even greater. It seems that all countries would like to see their currencies decline bar the Chinese who will only let the renminbi strengthen gradually. Some currencies must rise, however, and the Europeans may not be too happy to see the Swiss trying to drive the euro up, especially if the Fed opts for a third round of QE. And what will the Swiss buy exactly? A report in the Frankfurter Allgemeine Zeitung suggests the cautious Swiss have been buying French and German government bonds, not Italian or Spanish (let alone Greek) debt..

But this has had unfortunate consequences. As Mr Yu remarks

It is highly likely that the SNB inadvertently made things worse for themselves (and everyone else); swiftly diversifying into German paper in large amounts caused periphery spreads to widen which only increased market fears and the subsequent risk aversion forced the euro lower (against the Swiss franc)

This process may continue if the Swiss live up to their promise to buy unlimited amounts of euros. Worse still, the Swiss may still attract deposits from elsewhere who may still despite the currency's perceived safety. Some of the flows into Switzerland may be coming from alarmed Italian and Greek depositors. As Simon Derrick of BNY Mellon comments

Rather than recycle these funds back into the markets they came from the (Swiss) money will be invested into French and German debt (if we believe the FAZ story). In other words, the money continues to flow from the south to the north of the continent (albeit by a slightly indirect route).

It is all a bit reminiscent of the 1930s. When countries went off the gold standard, they gained a competitive march on their rivals, increasing the pressure for such countries to leave the standard as well. If one country devalued by 10%, the next might do so by 15%. QE may similarly begat more QE.

David Bloom of HSBC has a further reflection on the consequences.

We have long argued that the Norwegian krone is a better safe haven play than the Swiss franc. In every respect, the krone has superior qualities. However, the market will now fear that if it pushes the krone (or the Singapore dollar) too far. there will be push back from the various central banks. The market must fear this will cause a sharp escalation in the currency wars. The only safe haven that will not do QE, put in capital controls, or complain about its strength is gold. It must emerge as the winner.

UPDATE: In response to various comments, I don't think this issue is a matter of patriotism or Anglo-Saxon perspective; see the quotes of Mr Yu from Union Bank of Switzerland, for example. This has indeed been a tactic pursued by many countries including the British; a recent blog note pointed out that the pound has undergone a record devaluation in recent years. The Swiss are very much reacting to pressure that has arisen from the actions of other governments; it is still worth pointing out that their actions will simply shift the deflationary pressures elsewhere, a game of "pass the parcel".

Multinationals and their finance engineering...

Goldman Sachs' UK tax bill falls 34pc after drop in profits

The London-based business of Goldman Sachs cut its tax bill for the first half of the year by just over a third after the US investment bank was a hit by a fall in profits.

Lloyds Blankfein, chief executive of Goldman Sachs, which saw first-half pre-tax profits at its London-based business fall by 17.4pc

By Harry Wilson 06 Sep 2011

In its accounts for the first six months of 2011, Goldman Sachs International recognised a tax credit of $156m (£96m), largely as a result of a $153m paper rebate on UK corporation tax.

The "rebate" cut Goldman Sachs International's tax bill for the period by 34pc to $303m after the bank accounted for its overpayment of UK corporation tax in previous quarters after being overly bullish on the prospects for its business.

Under UK law, companies must pay corporation tax on a quarterly basis based on their projections of their full-year profits.

The size of Goldman Sachs International's writeback of its corporation tax for the first six months of the year demonstrates the speed with which markets have deteriorated in 2011 amid the panic caused by the eurozone sovereign debt crisis.

First-half pre-tax profits at the London-based business fell by 17.4pc year-on-year to $1.21bn. Revenues from the bank's institutional client services business fell 44pc to $2.17bn, largely as a result of falling revenues from the fixed income, currencies and commodities division.

Businesses such as fixed income sales and trading, as well as commodities, were big earners for Goldman Sachs but have been among the hardest hit by the downturn in trading volumes as investors become more risk averse.

Last month, it emerged that Goldman Sachs International had invoked a clause in the contracts of its senior London-based staff to cut their basic salaries back to their pre-crisis level.

In common with other major investment banks, including Citigroup and UBS, Goldman Sachs increased basic salaries as bonuses were cut back in the wake of the financial crisis in 2008.

According to its latest filing, Goldman Sachs International paid taxes of $459m in so-called "provisions and other timing differences" in the first half of this year. This is more than double the $210m the bank paid out last year.

The majority of this payment is understood to be made up of income tax on bonuses paid to London-based staff of Goldman Sachs.

State: European Union, capital city: Frankfurt, President: Jean Claude Trichet