Italian bond market
Below we look at the Italian bond market, the ECB and the over-all risks facing a global economic “recovery” driven by, well… debt.
All That Was Rome
Lately Karma has been playing itself out in the percolating disaster that is the Euro Zone in general and the Italian economy in particular.
The combination of political hypocrisy, capitalist/socialist bi-polarity and a nation increasingly tired of shouldering the immigration burden of the never-ending “war on terror” (aka boom to the military-contractor industrial complex) is slowly approaching its day of reckoning in what was once “all that was Rome.”
Oh, and perhaps you’ve also noticed the cracks in the Italian bond market?
But as tragic as the Italian story currently playing itself out may be, it is in fact little more than yet another metaphor of the greater comedic tragedy of what years of central-bank “faking it” has done to slowly unraveling our global markets, from Napoli to Nashville…
More on that below…
Musings on Form Over Substance
For now, let us first pause to consider the Italian tragedy in the backdrop of certain basic values—you know, such philosophical matters like accountability (vs. dishonesty) and such economic basics like supply and demand (vs. fantasy).
Take for example a best-selling novel.
If, after years of carefully constructed paragraphs, deep research and a flair for harmonious prose, one was to sell a million copies of an exceptional book, then the accolades of a best-selling status would and should be accepted with some degree of pride and honor, no?
That is: job well done.
Yet, if one were to discover that the author of those books was the beneficiary of a rich uncle who bought each of the million copies himself, then technically the book is indeed a “best seller,” but in reality, we could not honor it as anything more than a ruse of form over substance, no?
Sadly, such a ruse is playing itself out in real time among our so-called global market “recovery” status, which is slowly revealing itself as nothing more than an historically unprecedented case study in form over substance, fantasy over reality.
In other words, our so called “global recovery” meme is little more than a central bank driven fantasy in which false credit has been given to false saviors. The “economic engineering” of over $15T in post-08 central bank money printing buys time, not solutions. It represents a massive example of form over substance.
I’ve written of this growing chasm between macro reality and market fantasy elsewhere, in particular with regards to such themes as the great chasm between Main Street and Wall Street, real accounting vs Ex-Items accounting, media spin vs. market truth or the staggering dishonesty that is evidenced in everything from the balance sheet of Amazon to DC’s reporting of inflation.
In short, todays markets, economies and reports are ripe with examples and metaphors of a world that seems to have lost its philosophical and economic mind as well as values.
And as if we needed one more example of the absurd, let’s pause to consider, well: Italy…
The Italian Uh-Oh Moment
Italy. My mind is steeped with memories of romance in Florence or long drives along the coastline from our home in France to the soft sunsets off the Amalfi coast. Italy, so much beauty. And yet, today, beneath it all: so much mess…
I suppose this is what happens when you combine massive debt, easy (i.e. printed and low rate) money, insolvent banking systems, demographic nightmares, and a stalling GDP with a rising populist majority.
That is, you get the proverbial “uh-oh moment” in everything from politics to bond spreads.
Democracy Italian Style?
Recently, for example, a populist coalition (i.e. the Northern League and Five Star Movement) threatening to the Leave the European Union achieved the consent of 51% of the Italian voters. That’s what we call democracy.
The Italian President’s response? Well, it wasn’t very democratic…
As is often the case, when the powers that be don’t like what the voters are saying, they find a clever way to well, simply ignore the majority. (History, unfortunately, tends to punish such tactics in the long run…)
But for now, Italian President Mattarella, despite the will of his people, wants to bring in an IMF “place holder” to act as temporary Prime Minister, opting for a delaying of reality (and consensus) in favor of stalling and wishful thinking.
This may give Germany and other EU proponents time to quell the anti-EU sentiment rising in Italy…Or maybe not? Either way, democracy in Italy looks a bit challenged.
That is Mattarella, like his pal Mario Draghi at the ECB, doesn’t want to see the Euro Zone unfold, and hence will do (or at least try) “whatever it takes” to keep the forced “union” alive. Which means for now they will do “whatever it takes” to keep the Italian economy from tanking.
Such conviction is understandable. Unfortunately, however, conviction alone has never been enough to defy the longer-term laws of gravity or the forces of market mathematics. In sum: Italy may be screwed anyway.
Neon Signs from Italy’s Bond Market
Why? Very simple—and also very familiar. It comes down to the elephant in the room ignored by all the great, centrally-bank driven “recoveries” of the post-08 “miracle”—that is, it all comes down to DEBT.
Italy, by the way, has too much of it.
How do I know this? The same way we all do. I just look at its bond market.
Recently, and in the course of just one week, the yield on Italy’s short-term (2 year) sovereigns skyrocketed from negative .25% to positive 3.5%. As for the Italian 10-Year paper, its yield shot from 1% to over 3% in less than 20 trading days and is now more than likely facing a ratings downgrade.
Folks, such sudden and dramatic drops in bond pricing–and hence climb in bond yields–are not the result of a normal or “priced in” economic recovery.
Rather, such spikes (and credit sell-offs) are neon-red flashing warning signs of just how fake, distorted, bloated and appallingly dangerous a central-bank (i.e. debt) driven “recovery” really is.
If you don’t believe me, let’s look at the math rather than the adjectives. For example, let’s start with the obvious.
That is, ask yourselves how a broke country whose debt to GDP ratio is over 130% could have so much bond buying strength that its yields once enjoyed a compressed range between negative .25% and 1%?
The ECB: Another Case of Faking It
The answer is simple: they’ve been faking it. Or put more simply, while the Italian economy has been in free fall for years, the ECB’s money printer in Frankfurt has been artificially propping its bond market to the tune of $525B in artificial demand/bond purchasing (from sovereign bonds to insolvent Italian bank paper).
In short, Italy’s rich uncle at the ECB has been buying all its books, giving Italy the shaky illusion of being a “best-seller.” (Meanwhile, Italy owes an additional $500B in country-specific loans to Germany, the Netherlands and others…)
But the ECB can only fake it for so long… It has been printing so much money since 2011, that its balance sheet ($5.3T) is now 25% greater than even the bloated Fed here in the US, but with a GDP that is 10% smaller.
It’s all smoke and mirrors folks. Pure, debt-driven fantasy. A fake “best-seller.” It’s precisely what von Mises warned us of.
Furthermore, with the ECB and neighboring sovereigns reluctantly buying Italy’s bonds for years, bond-traders across the globe did the next obvious (and forward-guided) thing that any trader staring at a free-lunch would do: they front-ran the market, buying even more and more unwanted bonds in lock step with the ECB, and thus further propping up an otherwise fatally sick credit market.
In short, front running the ECB (as with the Fed in the US) has helped push yields to floor and bond prices to the moon—creating a credit bubble that will pop even faster if the ECB begins to taper its bond-buying program (like QT in the US) as proposed by year-end.
Of course, there are those who blindly believe the central banks in general (and the ECB for Italy in particular) will come in to save the day, that is: print more money and buy more of what is not worth buying—unpayable sovereign debts.
Perhaps those same folks think the central banks may one day just buy all the debt in the world? Problem solved?
But we know that the central banks in general and the ECB in particular are running out of dry powder and thus magical options.
But even should the ECB temporarily reverse course and resume more aggressive QE (i.e. continue to print money), such a band aide for the European bond bubble would just create an instant crisis in the form of a Euro FX/currency meltdown against the USD.
After all, printing money to solve debt problems is akin to drinking wine rather than vodka to fix a drinking problem.
And hence Italy is now caught between the ultimate rock and a hard-place, that is: a choice between a skyrocketing yield/rate crisis or a currency/inflation crisis.
Template of a Bond Bubble
In the meantime, such bogus central-bank policies and circumstances can (and have) buy time as well as an image of temporary stability, one which is nevertheless beginning to unravel before us—i.e. in Italy.
But far more importantly, those very same policies and circumstances also create something even more grotesque: an ignored bond bubble.
And what do all bubbles eventually do?
Thus, when we see yields shoot up 300 points in 3 days, we should recognize the first hissing signs of a massive pop down the road.
What we’ve been seeing recently in Italy, by the way, is just the tip of an iceberg, the first signs of a much greater carnage to come in its teetering debt market—all thanks to the not-so-brilliant (and ironically Italian) leadership of the ECB.
Maybe that why 51% of Italian votes want out of the EU19?
Italy: The Next Domino to Fall in the EU?
Italy is indeed worth watching. It is one of the sickest horses in the global glue factory, and its debt burden is a telling kink in the fake armor of a central-bank driven illusion of strength.
Watch Italy closely, for it may be the first post-Brexit domino to fall in the increasingly over-burdened/indebted Euro Zone whose market fate, incidentally, is deeply tied to our own.
Sadly, of course, the problems for Italy, are not unique. Germany too is poised to see a similar shift from its current and artificially compressed (coiled spring) yields to sudden and swift spikes as bond sell-offs begin there as well.
And remember: when yields spike, the entire bull party ends—and ends horribly.
That is, each of these markets share the common denominator and illusion of believing a central bank has more influence over market forces than such old-fashioned notions of productivity, profits, manufacturing and of course real rather than printed forces of supply and demand…
I am concerned that the current hubris and faith which the global markets have given to a handful of central banks will soon go down in history as one of the gravest experiments/mistakes ever made in attempting to engineer prosperity from the top down.
In 08, we should have taken our lumps. Instead, we bought a recovery and placed it upon a central bank and national credit card whose expiration dates are getting closer each day.
When the debt (i.e. bond market) gets too big, and the money (i.e. productivity) is gone, we all know what happens next: a big, fat, ugly, fast and furious sell-off. We saw the first hints of this in Italy last week.
Rome, like any empire, was not built in a day. But all shiny surfaces built upon sand—i.e. debt, can collapse in seconds.
Needless to say, be careful out there.