The Hellenics Play "Quien Es Mas Macho?"

For those who enjoy high-stakes financial drama, there is an exciting contest going on now between Cyprus and Greece as to who can push the Troika the furthest without turning it away for good. Neither country has yet been able to make the Troika “agree” to its “demands”, as if this were a business transaction between equals.

"The troika has not accepted the Democratic Left’s demands," the Greek finance minister informed the media. The DL, one of the coalition partners, has refused to agree to the labor reforms required by the Troika.

“The EU is obliged to change the ways and means of addressing the crisis,”  Cyprus president Dimitris Christofias grandly declared to his people, as if he had a say in the matter. The Troika got so frustrated with the Cypriots’ refusal to agree to labor reforms that it flew home and has not scheduled a return visit. Christofias said that he expected the troika to return "as soon as possible”. That was last week, and the Troika still hasn’t called him back to set a date.

Both countries are supposed to run out of cash in mid-November, so they are dancing on the edge of the precipice. They know that Europe will agree to almost anything to prevent them from leaving the eurozone, which they think gives them leverage.

They are playing a very risky game, because it isn’t Europe who has the final say on whether they get the money or not. That rests with the elected representatives of the very stingy German and Finnish people, who have reserved the veto power to themselves. A few emollient phone calls from Hollande or Monti, or a few desperate phone calls from Athens or Nicosia, are unlikely to sway many votes in Helsinki or Berlin.

The backdrop to these discussions is the fact that both economies are in free-fall, and that relying on their published statistics requires an act of faith that only a devout eurocrat could summon. I think that their economies are shrinking faster than reported; I think that their governmental cash receipts are declining rapidly despite tax hikes; and I think that their true fiscal deficits are frighteningly large and growing. I believe my deduction over their reported statistics.

If there is one thing that I learned in the credit business, it is that the financial statistics of bankrupt companies and countries always turn out to be, shall we say, not 100% accurate in retrospect. If you rely exclusively upon reported numbers, you may be seriously misled. Of course, in the case of Greece, it doesn’t take a Mensa member to know that they cook their books and prosecute  their statisticians for not cooking them adequately. In the case of Cyprus, I lack such anecdotal data, but I suspect the worst.

Anyway, D-Day is supposed to be November 12th, when the eurozone finance ministers meet in Brussels. The plan is that the Troika will have the Greek and Cypriot agreements in hand for the ministers to review. That is only ten business days from now, so suspense is starting to build.

We know that Merkel wants to present the Bundestag with a neatly-wrapped package deal for all of the bailouts at once: Greece, Cyprus, Spain. That can’t happen because the Hellenics need their money right now, whereas Spain hasn’t even applied yet. So Merkel will be forced to ask the Bundestag to OK the distasteful Hellenic deals on their own. That will be a bitter pill for the German people and media to swallow. Sadly, I am not an expert in Finnish politics, so I can’t handicap the parliament’s vote on the bailouts, but I have to imagine that they won’t pass by general acclamation.

Whose idea was it to give voters a say in such important matters?

Cyprus Could Explode Before Greece

“All of the political parties rejected the troika proposals for the abolition of    
CoLA, scrapping of the 13th salary, supervision of co-op banks by the Central Bank and the privatisation of semi-governmental organisations. When it came to drawing the ‘red lines’ the political parties were unanimous. None of the parties would dare disagree, because they would be publicly crucified for supposedly adopting the anti-worker positions of the troika and serving the interests of big capital.”
----Editorial in the Cyprus Mail, Oct.21st, 2012

“We know that we will not accept terms that will destroy the popular strata; abolish working peoples’ gains and sell off for pittance public property to big capital. We shall also stand on the side of the class-based trade union movement in the mobilisations it is planning if the Troika insists on its policies. That is to say, we shall not enter into a procedure that will negate us and that will be in complete contradiction with our ideology and history.”
---Statement by AKEL, the communist party of Demetris Christofias, the Soviet-educated president of both Cyprus and the EU, at the International Meeting of Communist and Workers' Parties, Brussels, Oct. 2nd, 2012

"Cyprus plans to contact international lenders on Monday evening to invite them to the island for final talks on a comprehensive aid package for the Greece-exposed island."
--Reuters, Oct. 22nd, 2012

I admit that I have been crying “wolf!” on the eurozone crisis for almost three years now, but I will now do it again. I think that the first country to  exit the eurozone may be Cyprus, and soon. Cyprus is a an economic, financial and political mess, worse than Greece, and it may not be too big to fail.

I have been following the Cyprus situation closely because Cyprus seems like the most scary sovereign credit in the eurozone. Cyprus has always had a powerful Communist Party, and it has always had a bit of an anti-western orientation, given its peculiar history (explained in Christopher Hitchen’s history of the island). Some may recall that Archbishop Makarios was viewed by the US as the “Castro of the Mediterranean” for his leftism.

In 2008, the people of Cyprus elected Demetris Christofias as president for a four-year term. Christofias, a marxist educated in Moscow during the Soviet period, headed the Cyprus Communist Party, known as AKEL. Earlier this year, Christofias became the president of the EU, which is not a purely ceremonial role.

I dare say that the Cypriot banks were never in terrific condition, given the nature of the Cyprus economy and the close relationship with Greece which has never been the “land of good loans”. However, the recent default by Greece on its government bonds and the collapse of the Greek economy have wiped out the Cyprus banks, which are now insolvent on an intergalactic scale. The cost of bailing out the Cyrus banking system is now estimated to be in the range of 100% of GDP. Some of that is worthless Greek bonds, some of that is bad loans in Cyprus and Greece, and some of it is not to be looked at too closely. One of the banks’ deadbeats is reportedly AKEL itself. Just don’t ask.

There is indeed an irony in that Cyprus needs a bailout from Big Capital at a time when it is led by a Communist, and that the EU, which is trying to figure out a way to bailout Cyprus, is headed by...Cyprus. But that’s not the problem. The problem is that Cyprus’ government, both president and parliament, are not cooperating with the Troika. Greece has learned to go through the motions of cooperation, agreeing to preposterous conditions it has no intention of implementing. Cyprus, by contrast, isn’t agreeing to any of the Troika’s demands (see the editorial in the Cyprus Mail above).

Cyprus needs the biggest bailout in the history of sovereign credit (100% of GDP), will run out of money next month, and yet continues to stonewall the Troika, not only in private but also in public. Christofias has reportedly said that “he would be out demonstrating with the unions” if the troika insisted on abolishing automatic COLAs for Cypriot workers. This could be face-saving political posturing before capitulation:  it is hard to sell austerity when you are the anti-austerity party.

I may be proved wrong next month as the Troika’s conditions are agreed and the bailout check is ultimately wired to Nicosia. Europe has many good reasons to want to get Cyprus over with in order to focus on Greece and Spain. The current EU plan is to bundle the bailouts of Cyprus, Greece, Spain and maybe Slovenia into one package for the German and Finnish parliaments to approve.

But there are still those two big hurdles: agreement to the austerity plan by Cyprus’ government and political parties; and approval by the German and Finnish parliaments. None of those will be automatic or even easy. In fact, there are reports that the Bundestag is turning against bailouts in general.

Default, debt repudiation and deposit redenomination would an interesting maneuver, as the Cyprus banks are stuffed with Russian and Chinese deposits (in euro).

Foreign Policy Questions For Presidential Debate

Questions for the President:
Whom do you consider America’s most important strategic allies? Enemies?
Do you consider Israel to be an ally or a dependency?
Why did your government encourage Hosni Mubarak to leave office?
Has America’s strategic position in the region improved since the overthrow of Mubarak?
Why did your secretary of state boast about killing Muammar Qadaffi?
Why is the CIA supplying weapons to the Syrian uprising in the clear face of Russian opposition?
How would you characterize current US-Russian relations today?
If you could turn back the clock on the Arab spring, what would you have done differently?
Do you believe that Israel’s security could be guaranteed with a hostile and armed Palestine on both sides?
Do you believe that Arabs should be allowed to live in Israel?
Do you believe that Jewish settlers should be allowed to live in Palestine?
At what point would you draw the line with respect to the Iranian nuclear weapons program, such that you would consider a military solution?
Why is the US providing billions in aid to Pakistan including its military?
How would you characterize America’s economic and strategic relationship with China?
Why have you maintained the trade embargo with Cuba? What purpose does it serve?

Questions for Gov. Romney:
Do you support a Palestinian state on the West Bank and Gaza? If not, then what is your solution to the Palestinian problem?
How do your aggressive foreign policy goals square with the fact that Russia and China  have a veto on the Security Council?
What role do you see the Security Council playing in the conduct of foreign policy under your administration?
How many carrier battle groups do you think the Navy needs?
Which major defense procurement programs or other programs would you end?
What is your position on the $400 billion F-35 fighter program?
What are the reasons that you think the US should go to war the next time?
How many wars can the US be fighting at the same time?
Do you agree with the overthrow of the leaders of Tunisia, Egypt, Libya and Syria?
Would you prefer an elected Islamist to a secular dictator in the Middle East?
What do you see as the strategic role for NATO?
How big should NATO be?
Would you reduce the number of US troops stationed in Europe and Asia and the rest of the world?
Do you support membership in NATO for Ukraine and Georgia?
Would you go to war with Russia over Georgia’s breakaway republics?
Do you see any chance that the US could become a more “normal country” with respect to foreign policy?
What should be the limits to US intervention in foreign countries?

Who Will Lead The Revolt Against Germany?

“Mr. Hollande has sought to reduce Germany's dominance over Europe's anti-crisis strategy, and open up Europe's debate over solutions to other voices. Since Mr. Hollande's election victory over Mr. Sarkozy in May, France has tried to play the role of a broker between Germany and southern European countries, including Italy and Spain, which are seeking more-generous European help against recession and financial-market strains.”
---WSJ, “Summit Reveals Wider Franco-German Discord”, Oct. 19, 2012

That seems to be the main takeaway from the just-concluded EU summit: that Hollande has chosen to directly challenge Merkel’s leadership of the union. I interpret this in two ways: (1) the good news is that the needy South is building a political coalition against the cold-blooded North; and (2) the bad news is that the Southern coalition appears to prefer public whining to real political action. But I hope I am mistaken about that. Maybe they are biding their time.

Of the three Southern leaders, clearly the intellect is Monti. I think that he grasps the enormity of the problem facing Europe, including the need for reflation. But, because Italy is not yet in the direct line of fire, his strategy is to lay low and work behind the scenes. For now, he prefers to work on structural reforms to make Italy a better credit (with market access), rather than launching a frontal assault on Frankfurt and Berlin.

Hollande seems to have the guts to take on Germany, but I am not sure that he fully comprehends the need to actually depose Germany from its leadership position in the EU and the ECB. The last sixty years of French foreign policy have focused on bringing Germany in, not on pushing her out. That would be a big step.

Rajoy appears to me to be wholly out of his depth, but I am not really in a position to pass judgement on him yet. I agree with what he doing (demanding as much as he can get), but I doubt that he understands the urgent need to take over the governance of the ECB. He is the most radical, but he is not radical enough. Begging for a bigger IV drip will not save Spain. Only a revolution in the eurozone can do that.

But there is hope. These three men have enormous political power in Europe, and they should be able to craft a large bloc of sympathizers out of the 17 members of the eurozone. As the next few months demonstrate that Europe is facing a future of endless zero growth, and as each of them fail to hit their fiscal targets, one hopes that they will realize that, as Mrs. Thatcher would say, there is no alternative.

It is a shame that, aside from dear departed Sarkozy, no European leader has dared to question the baneful role of the ECB’s single mandate of price stability. That is the intellectual breakthrough which is needed. It is ironic that the breakthrough occurred in the US, which is not facing zero growth, rather than in the eurozone, which is becoming a textbook example of Fisher’s debt-deflation spiral.
Europe needs to stop being afraid of the Bundestag, the Bundesbank, and the Constitutional Court. They don’t rule Europe and they don’t even have a veto.

Moody's Keeps Spain At Investment Grade

Two weeks ago I commented on Moody’s rating on Spain, which was on review for downgrade:
“My guess is that the rating will go to Ba2 with a negative outlook. In my opinion, while Spain will be helped in the short-term by the eurozone’s “crisis-management framework”, it is doomed in the end to default and redenomination, as long as the ECB sticks to its price-stability suicide pact.”
(Spain On The Brink Of A Downgrade To Junk, Oct. 2nd, 2012)

My prediction was incorrect. Yesterday Moody’s confirmed Spain’s rating of  Baa3 in advance of Spain’s planned EUR 4.5B bond sale on Thursday. The rationale for the rating confirmation can be capsulized as follows:
“Moody's believes that the combination of euro area and ECB support and the Spanish government's own efforts should allow the government to maintain capital market access at reasonable rates, providing it with the time it needs to stabilise public debt over the next few years. Ultimately, the Spanish government's ability to refinance maturing debt will depend on the credibility of its efforts to reduce its large fiscal deficit and reverse the rising public debt trajectory.”

The core element of Moody’s decision is that the ECB’s bond-buying program will enable Spain to maintain access to the private debt market as it slowly gets its fiscal house in order. Over time, Moody’s expects Spain to stabilize its debt trajectory and thus make it once again a creditworthy borrower on its own. Moody’s also believes that the ongoing bank recapitalization program will restore confidence in the banking system, presumably curbing deposit outflow. The risks cited by Moody’s are a lower growth outlook, a Greek exit, and insufficient ECB bond purchases to bring down yields.

As I indicated above, I take a more negative view than does Moody’s. This is because I see no hope for a stabilization of Spain’s debt trajectory as long as there is no nominal economic growth in Spain and the eurozone. It is very hard to grow government revenue in a zero nominal growth environment. In the recessionary world in which Spain lives, it is painful to raise government revenue while cutting social spending.

Moody’s is certainly right to say that the preservation of Spain’s market access “will depend on the credibility of its efforts to reduce its large fiscal deficit”. I am in no position to judge the resolve of the Rajoy regime in implementing austerity. Presumably they will have no choice, given the conditionality of the aid program. But I can say that imposing austerity on Spain in the midst of a recession will be deeply unpopular and not without controversy. Spain is not Finland.

What to expect going forward? Spain will next have to apply for aid from the Eurogroup and agree the terms. Then, the parliaments of Spain, Germany and Finland must approve the deal. (Yes, Finland too.) That needs to happen over the next month or so. If the bailout deal goes through, then the onus will be on Mr. Draghi to do “whatever it takes” to bring down Spanish yields. Rajoy has asked for a ceiling of a 2% spread over Bunds, versus the current 4%. That seems like a reasonable request to me. There is nothing to prevent the ECB from making it happen.

QE3 Has Started, Only It Hasn't

I think that I have figured out why the Fed’s balance sheet has not grown since the announcement of QE3. The reason is that the NY Fed’s Open Market Desk has been buying Agency MBS which, for some reason, has very long settlement periods (60-90 days). Almost none of these have hit the balance sheet yet. The desk’s buying pattern (found on the NY Fed’s website but not on the FRB’s)  is entirely consistent with the announced program for QE3, at $15-20 billion per week:
9/13-19: $17.5B
9/20-26: $20.0B
9/27-10/3: $19.3B
10/4-10: $15.0
= $71.5B

I have been incorrect in saying that QE3 hasn’t started yet; the order-placement has indeed started, but it hasn’t been paid for. The Fed has been buying on the Lay-Away Plan. This means that the Fed has already created demand in the market for agency MBS, but the monetary base won’t expand until the Fed actually buys the securities and creates the money to pay for them on the deposit side.

From a monetary policy perspective, I have been correct: the monetary impact of QE3 has not yet been felt, only the demand for agency securities. I don’t know the weekly volume in agency MBS, so I can’t assess how significant these $15-20B purchases are, but the agency market is a second order effect, and not a monetary one. (The Fed’s political cover for this operation is that it is helping Harry and Hilda Homeowner by lowering mortgage rates.)

While I have been wrong about the Fed’s dereliction of duty, I haven’t been wrong about the monetary impact of QE3: it hasn’t been felt yet. The first settlements have just begun, and will reach full force next month. The Fed’s balance sheet and the monetary base will start to grow by $40B/mo. Slow but not nothing, and mildly bullish for equities, ceteris paribus.

IMF Calls On Germany To Allow Spain Bailout

There is a lot of drama going on at the IMF meeting in Tokyo this week. It is about Spain. The whole world is calling upon Europe to end the drama and bail out Spain now. The IMF added its highly influential voice to the chorus yesterday, with Lagarde saying that "the ESM and the OMT need to be deployed.” The head of the IMF’s financial department said that "the European Stability Mechanism and the bond purchase program of the ECB must be perceived by markets as real, not virtual.” Strong words.

The financial media report that Merkel has advised Spain not to apply because she can’t get an aid package through her side of the parliament. FM Schauble’s mantra is that “Spain has not asked for aid”, which is a bit disingenuous.

The Spanish media are not silent about this story. El Pais reported that “opposition from the ranks makes neither Merkel nor Schäuble interested in an early request for help from the Spanish government.” The paper reports that Merkel has the votes on the opposition side, but not on her side, and she doesn’t want to legislate without her own coalition: “They want to avoid a new bitter debate about billions in disbursements to eurozone partners, given the tense previous votes on Spain, Greece and the German contribution to the ESM bailout mechanism.”

Dow Jones reports that a vote on the Spanish bailout could split Ms. Merkel's coalition ahead of German national elections in fall 2013. “A growing number of conservative backbenchers are opposed to further taxpayer aid for other euro members.”

So, Spain needs a rescue soon, the IMF and EU governments want the matter addressed urgently, but Merkel can’t or won’t introduce a bill. 

Spain is not going to admit that it needs a bailout but can’t get one. FM De Guindos denies that there is a problem: "The instrument is real, not virtual. Because it is real, it is ready to be used at any moment. It is available. It is available in October, in November, in December.” He reiterated the bromide Spain doesn’t need a bailout, and that it is perceived as a good credit by institutional investors: "There is a much more optimistic sentiment now than a few weeks ago. There is interest for Spain's public debt." What else is he supposed to say?

Given that this stand-off has the IMF worried, it’s fair to say that it’s not an imaginary problem. However, Europe will continue to subvene further billions to Spain through ECB-funded bank purchases of government bonds, so nothing will happen soon.

In fact, next week Spain is planning to sell EUR3-4 billion in new bonds (to its banks, presumably). This sale will coincide with the EU summit in Brussels, where poor Mrs. Merkel will undoubtedly be the subject of much attention. I would not be at all surprised if the EU leaders have trouble drafting a consensus communique, as they did last time. I don’t see Hollande, Monti and Rajoy settling for more eurospeak about solidarity. There could be some drama then too.

The Bundestag Is Blocking Spain's Bailout

Here’s what we do know: the Spanish economy is imploding, government revenues are falling despite higher taxes, and the bank run continues. Spain is running out of runway, and something will have to happen.

Europe has told Spain that, if she applies for assistance from the Eurogroup and agrees to the Troika’s terms, the ESM will lend directly, and the ECB will buy Spanish bonds in the secondary market.  This would appear to be the obvious next step.

However, Spain has not yet applied for assistance, and has given three reasons for not applying. First, she says she doesn’t need the money, which is a blatant but understandable lie. Second, she says that she won’t apply until the Troika’s terms are known, and the ECB is more explicit about the size of its intervention in the bond market. Rajoy doesn’t want Spain to be living on an IV drip like Ireland and Portugal, and who can blame him? Thirdly, Spain will not apply for aid unless she can be assured of receiving it. That’s the really scary part.

According to Reuters:

“Germany has sent Spain strong signals that it should hold off because German Chancellor Angela Merkel is wary of presenting a fresh aid request to her parliament, euro zone sources say. Spanish officials see more risks to moving ahead quickly without assured German backing, than in delaying a request.”

There you have it: Even if Rajoy were satisfied about the terms of the deal he needs, he can’t apply because Merkel won’t put it before the Bundestag. Given all the happy talk in Brussels and Frankfurt about how Europe is moving forward to resolve the Spanish crisis, there is only one problem: the Bundestag. Nothing can be done for Spain or anyone else unless the Bundestag approves. Not all Eurozone parliaments, just one: Germany’s. The entire fate on Europe hangs upon the political calculus of one country’s legislature. That’s because of the rulings of the Constitutional Court.

I will admit that it is very unfair to Germany to put her in this very awkward position, where she alone has a veto over the Spanish bailout. Perhaps when General Clay was “helping” the Germans to write their constitution, he should have made it a bit less democratic.

Be that as it may, this is Europe’s latest problem: “The Germany that can say no”.  It is telling that Merkel and Schauble are telling Spain to wait. Presumably they hope that the Bundestag will be more accommodating when Spain is teetering on the edge of default. That’s reassuring.

It used to be that one thought that Rajoy was negotiating with Europe over Spain’s bailout. It is now clear that he is negotiating with the Bundestag, which is much less charitable. At this inopportune juncture, democracy decides to rear its ugly head.

QE3's Market Impact Will Be Visible by Next Spring

Will QE3 raise stock prices? My answer is yes, but the impact will be quite small at first and will only become visible with the scale of its impact on the  Monetary Base (the Fed’s securities portfolio).

First of all, we need to recognize that the Fed’s balance sheet has not grown since May of 2011,  seventeen long months ago. There has been zero monetary stimulus for over a year. Second, we need to recognize that although the Fed promised to start QE3 on September 13th, it has not yet started. Don’t ask me why. I can imagine a number of (unsatisfactory) reasons why QE3 hasn’t started, but it hasn’t started. The Monetary Base is still the same size that it was in May, 2011. The Fed has provided no explanation for the one-month siesta.

Therefore, we can’t make any empirical statements about the impact of QE3 on the Dow, because there is no QE3 yet. Assuming that Bernanke gets his act together, QE3 should get started by the end of this month. The Fed’s announced schedule for QE3 was to buy $23B in September and $40B in October. That means they will need to buy $72B between now and the end of the month (since the MB has declined by $9B since the FOMC announcement). I’m not holding my breath; the Fed appears to be taking its public promises as very general guidance.

The amount, $72B, is peanuts, as it would represent an increment of only 3% on the Fed’s balance sheet. This is why the impact of QE3 will only be felt cumulatively, as the little bits start to add up over the next six months. Six times $40B is $240B, which would represent a 9% growth in the Fed’s balance sheet, which becomes more significant--but that’s next April. Even when QE3 gets started, it won’t be an adrenaline injection; more like a cup of coffee.

If there has been no bond-buying by the end of this month, I will expect an explanation!

S&P Takes Spain To The Brink Of Junk

S&P downgraded Spain today from BBB+ to BBB-, joining Moody’s at the bottom of investment grade, along with a negative outlook (obligatory these days).

Their summary rationale for the downgrade is as follows:

“(1) The deepening economic recession is limiting the Spanish government's
policy options. (2) Rising unemployment and spending constraints are likely to intensify social discontent and contribute to friction between Spain's central and regional governments. (3) Doubts over some eurozone governments' commitment to mutualizing the costs of Spain's bank recapitalization are, in our view, a destabilizing factor for the country's credit outlook.”

S&P is arguing that GDP will continue to decline; that the country’s governability is becoming ever more difficult; and that there is no assurance that the Eurogroup has the willingness or the ability to restore market confidence in the creditworthiness of the Kingdom or its banks.

S&P is particularly peeved that Europe reneged on its promise to provide ESM money to recapitalize Spanish banks. S&P must now add the cost of the bailout to Spain’s debt ratios.

S&P’s overall view is consistent with Moody’s and with my own, except that I am much more pessimistic. I do not view Spanish government bonds as an  investment suitable for widows and orphans, due to its many speculative elements. Spain belongs squarely in the Ba/BB category, because no matter what happens next, it won’t  transform Spain into a stable, investment-grade credit. And Spain will go to junk over the next month or two, you can count on it.

What is of interest in S&P’s extended rationale is the emphasis it places on governability, which is certainly warranted. As in both Greece and Italy, the government does not command the parliament, and cannot simply push through its agenda. The Rajoy government appears to be weak, and to be playing to the gallery rather than dealing with a national crisis. One can see Rajoy as being canny in refusing a bailout until it meets all of his (reasonable) demands, but that doesn’t make him a powerful leader in Spain. Time will tell on that score.

With regard to the inopportune resurgence of aspirations for regional independence, here’s what S&P has to say:

“With local elections approaching and many regional governments facing
significant financial difficulties, tensions between the central and regional
governments are rising, leading to substantially diluted policy outcomes.
These rising domestic constraints are, in our view, likely to limit the
central government's policy options.”

It is ironic that the regions are simultaneously demanding bailouts and independence, which takes the hispanic equivalent of chutzpah. This, as S&P observes, complicates the political challenge of uniting the nation behind an austerity program acceptable to the IMF.

S&P also expresses concern about the breakdown of the credit process in Spain due to bank deleveraging, with the price of credit for corporates becoming prohibitive, and the availability of credit for SMEs disappearing. As we know, when credit flows remain blocked, the heart stops beating.

S&P gives Rajoy no credit for his policy of refusing to apply to the Eurogroup until he knows what he’s going to get and what he has to do to get it. They say:

“We view the Spanish government's hesitation to agree to a formal assistance program that would likely significantly lower the sovereign's commercial financing costs via purchases by the ESME and ECB as potentially raising the downside risks to Spain's rating.”

I don’t agree with that sentiment. In my view, Rajoy is smart not to make Ireland’s mistake by agreeing to drink poison in exchange for life-support. He needs a free bailout of his banks, an ECB deposit guarantee, unlimited ECB purchases of  government bonds, and reflation. If all he is offered is pocket change, he should hold out until he gets what he needs, and I applaud that. That is the only way for Spain to avoid eventual default.

There is no evidence in S&P’s commentary or Moody’s that they fully understand the hopelessness of the PIIGS’s outlook as long as price stability remains ECB policy. No amount of austerity and bailouts can restore economic growth. As long as the denominator in D/GDP is declining, the only way to stabilize the ratio is to impose losses on bondholders. That is much more costly than 5% inflation.

S&P and Moody’s are correct in observing that Spain’s credit is deteriorating. What they don’t grasp is that, under present circumstances, there is no way to avoid creditor losses. It’s already happened in Greece which was, of course, “unthinkable” until it happened.