Negative Interest, Loans, Submarines, and Attack Corvettes

After taking a Holiday hiatus from the blogosphere, I thought I’d jump back in with one of my favorite topics of late — Europe.  Scanning the foreign papers today I came across two interesting articles; both of which centered on Germany.

Story #1:  Earlier today, Germany held a 6-month bond auction of $3.9 Billion Euro ($4.9 Billion).  The auction was so successful, that the yield actually came in negative.  That is, “investors” are paying Germany 0.01% interest for the privilege of owning these bonds!  In that light, the 0.86% yield on a US 5-year doesn’t seem so bad.

Story #2:  Greece is planning on doing some significant defense spending.  In and of itself, that isn’t too surprising.  They’ve long had a territorial dispute with Turkey involving Cyprus and a sometimes-deadly maritime border dispute in the Gulf of Aegean.  What I found interesting was that a large part of the Greek hardware purchase is to be two submarines manufactured in Germany.  So, if I have this right…  Through various funding mechanisms Germany loans money to Greece to keep it from going belly-up.  Then, Greece buys submarines from Germany using the borrowed funds.

You really can’t make this stuff up.

The epilogue to Story #2:  Over Greece’s forecast period of 2011 – 2016, here is a list of other expected military procurements:

  • Fourth-generation fighter jets
  • Maritime patrol aircraft
  • Advanced jet trainers
  • Armored vehicles
  • And my personal favorite… Attack Corvettes!

I don’t know what an Attack Corvette is, but I want one.  Maybe once the Greek bankruptcy is officially declared I can pick up a low mileage, slightly-used AC at a distressed price.  Better get a Carfax, though.

Achtung Baby!

Surprisingly negative news from the German bond market this morning set the stage for yet another day of losses in global equities.  The $6 billion Euro 10-year bond auction failed to find adequate bids, resulting in the Germans being forced to take down over $2 billion Euros of their own bonds.

This was the worst bond auction in Germany since the introduction of the Euro.

The ripple effects were instantaneous, with yields in Italy and Spain rising to the point where the ECB was forced to intervene and lend pricing support.  Further, the Euro fell dramatically versus the USD and the US equity futures tumbled.

Since November 15, the Dow Jones Industrial Average has fallen nearly 7%.

The prevailing school of thought regarding this auction goes something like this:  German bond buyers essentially went “on strike” in order to pressure Germany into allowing the ECB to exercise more power to stem the crisis.  It would be nice if that school of thought turns out to be true.  Otherwise, the word contagion comes to mind.

But, Germany wasn’t alone in pressuring the markets today.  China and Belgium had a hand in the mess as well.  China’s Purchasing Manager’s Index fell to 48 (a number below 50 indicates contraction).  This sent commodities (as well as stocks) broadly lower.  As for Belgium, a rumor began circulating that they will be unable to pay their share of the Dexia bailout.  This would place the burden of the bailout on France — and this is a burden that could result in a French debt downgrade.

As is usual on these “flight to quality” days, US Treasuries were aggressively purchased; with the 10-year yield falling to 1.9%.  This is somewhat ironic, considering the uber-committee managed to squander its opportunity to begin working off the US deficits just a few days ago.

We continue to favor high cash balances and well-hedged income positions in this environment.  Holding cash with a negative real yield is painful… but not nearly as painful as the alternative.