When the debt atoner tweets, listen

When the debt atoner tweets, listen

I can’t quite get my head around Twitter. But Holger Zschaepitz can.

Don’t worry, I’m going to use his first name.

Holger is the economics editor of a major German newspaper called Die Welt. I check his Twitter feed, if that’s what it’s called, every day. And it’s very fulfilling.

Especially recently. I found seven charts there which I think you need to see. They explain the past. And predict the future.

The first one is about where we’ve just been:

‘If year ended now, it would be worst on record in terms of % of global assets in neg total return territory (63 out of 70, i.e. 90%) on dollar-adj basis, DB says. Follows 2017 where 1 out of 72 assets had neg return. 2018 partly due to strong dollar, local currency not so extreme’

In other words, the highest ever proportion of assets fell in value this year, if you measure in terms of US dollars. And almost as many if you measure in terms of each assets’ local currency.

The recent stock market belting wasn’t just in the stock market. It was everywhere. More widespread than ever.

This ruined the idea that diversification works. Assets weren’t negatively correlated.

Bloomberg explained the fallout like this:

‘One of the toughest years for financial markets in half a century got appreciably worse Tuesday, with simmering weakness across assets boiling over to leave investors with virtually nowhere to hide.’

Investors who diversified their portfolios didn’t get the benefit they were promised.

But why did markets fall?

Italy’s budget battle took centre stage in October, when the market plunge accelerated. And so the next few charts are about Italy.

I’ve been predicting a financial crisis triggered by Italy since February. And my book about that prediction launches here in London next Tuesday. It’s called How the Euro Dies, which gives away the ending.

Holger’s charts are piling on the support for my predictions…

The first one shows how support for the euro is falling in Germany and rising in Italy.

The reason is a little odd. In recent weeks, the populist Italian government has proclaimed it wants to stay in the euro and reform the EU after the coming May European elections. The Italians don’t want to leave the euro; they want to control it.

The Germans, having realised their currency is about to be commandeered by southern Europe, are mortified.

Between 1973 and 1999, Italy had to devalue its currency against the Deutschmark by 80%, the peseta by 76% and the French franc by 52%. In the run-up to the euro, the Italians had to abandon the European Monetary System fourteen times in 18 years.

How anyone thought the Italians would manage to stay in the euro mystifies me. But according to the politicians and the polls, they’re going to try.

The only trouble is, not all the Italians are buying into their government’s plans. At least, not with their money, reports Holger:

‘Oops! Italians rebuff govt spending plan by shunning retail debt. Nation’s first offering of inflation-linked bonds targeted at retail investors since turmoil in May garnered lowest amount of orders for BTP Italia issue since they were introduced in 2012.‘

If the Italian people aren’t willing to lend money to their government to implement the crazy fiscal plans they voted for, who will?

Possibly no one.

The European Central Bank certainly doesn’t look like it will buy Italian bonds. After funding Italy’s deficits for years, those purchases are now waning:

Next month, the ECB is expected to announce it will stop buying altogether. Then, we’ll discover what the market really demands Italy pays on its debt.

Not that interest rates aren’t out of control already. This chart from Holger’s Twitter feed shows that something shifty is going on.

On the horizontal axis, we have credit ratings. The further to the right, the less creditworthy you are. According to debt ratings agencies, anyway. (The Italian government raided their offices in the last European debt crisis…)

On the vertical axis is the spread – the amount of interest that Italy has to pay over and above safe borrowers like the US and Germany. As you can see, Italy is paying a very high amount of interest compared to other countries.

But here’s the thing. Portugal’s spread is about half as much, despite pretty much the same credit rating. If the ratings were accurate, then the rate should be about the same.

There are two possible explanations. Either ratings agencies are giving Italy a free pass, or financial markets are wrong.

I think I know which.

Next month, the ratings agencies must, by European law, publish their ratings review schedules for 2019. We’ll find out which day ratings agencies take a long hard look at Italy’s financial position. And consider coming clean with the public.

If they downgrade Italy enough, the ECB will be legally prevented from buying Italian debt, even to bail the country out during a crisis.

But what about Italy’s stimulus plans? Aren’t they going to rescue Europe like Pink Batts saved Australia?

Not according to Holger’s Twitter account:

‘Costs of #Italy populist policy exceed planned stimulus, Natixis says: Fiscal stimulus desired by Rome will inject €29bn/year. Higher yields on govt & bank bonds will lead to increase in interest paid on debt each year of €49bn, decline in stocks lead to €70bn in capital loss.’

In other words, so far, the fiscal stimulus plan has led to such a loss of confidence in Italy’s debt position, it wiped out the supposed gains. I haven’t included the chart that goes with the quote, because it’s incredibly confusing.

Where to from here for Italy? Holger has the answer to that, too.

The next act in Italy’s budget debacle is all about whether the EU will sanction Italy or not. This week, everyone agreed the Italians are definitely going to violate the rules. But will they be punished?

Holger lays out the process this would follow:

In other words, your news will be full of Italian budget strife for months.

And eventually, something will go dreadfully wrong.

Until next time,

Nick Hubble Signature

Nick Hubble,
For The Daily Reckoning Australia