Germany to Directly Supervise Spain's Budget Reforms

We have long maintained that the ongoing sovereign debt crisis in Southern Europe will precipitate further European integration. (See Another Step Forward in the Creation of the United States of Europe). With the second Greek bailout a done deal, the market's attention has again shifted to Spain. Last week yields on Spanish government bonds were once again up at 5.5%.

Today Dow Jones Newswires reported that a German government delegation will fly to Madrid to

corroborate first hand the government's reforms and assess the true risk of the new deficit target

Reading between the lines this means that representatives of the German government will have a direct

Increasing Likelihood of Policy Error in China

With the upcoming once-in-a-decade leadership transition, many inconsistencies are showing up in China's monetary and fiscal policies. The most famous example was with the relatively small city of Wuhu in southern China, which tried to implement incentives to spur home purchases, only to retract them later, with a fairly unconvincing explanation. More recently the government of Shanghai announced a plan to ease restrictions on purchases of second homes, which is certainly at odds with the central government's stated goal of trying to cool the housing market.

Undoubtedly a lot of the inconsistencies are due to different entities and midlevel communist party

Another Step Forward in the Creation of the United States of Europe

In politics crisis only brings opportunity for radical reforms. As WhatIf mentions in a previous post, the ongoing situation in Greece will only help further the fiscal consolidation of the Eurozone. And now the next step along that long road has officially been made. According to this Reuters article,

"If the Greeks aren't able to succeed themselves with... (the austerity measures), then there must be stronger leadership and monitoring from abroad, for example through the EU," added Roesler, chairman of the Free Democrats (FDP) who share power with Chancellor Angela Merkel.

Germany is thus openly asking that Greece give up a token of sovereignity in return for their next bailout. Of course this will certainly not pass this time. But the fact that this radical (some may say outrageous!) step has been suggested and is even considered, very much indicates the future direction of European integration.

Chinese Real Estate in Broad Decline

We have already seen anecdotal evidence of sharp price cuts by property developers eager to move inventory of unsold homes (China's Housing Crash is Gathering Momentum) or sharp drops in the most speculative luxury vacation home market (Property Prices in "China's Hawaii" Down Almost 30%). The market reversal is now spreading with Dec marking the third month in a row of negative average growth of home prices in all of China. Moreover, according to Reuters, prices dropped in 52 out of 70 cities. The situation is far from desperate but can get worse very fast with the government continuing efforts to reduce property speculation, developers losing access to funding and new home sales slowing to a crawl. The real trouble will probably start when prices in all cities start dropping at the same time.

Imminent Greek Exit Positive for the Euro

The drive for ever more "austerity" in Greece is having the opposite results. It is pushing the Greek economy further into recession, reducing tax revenues, worsening the country's fiscal deficit and debt load, and thus only necessitating further belt-tightening. It is a vicious cycle with no way out. Even the IMF has acknowledged that and it is now becoming clear that the only choice is bankruptcy or a Euro exit. An option that was politically inconceivable 6 months ago is currently on the table. (See Greek Euro Exit Weighed By German Lawmakers on Bloomberg.)

From the beginning it has been somewhat ill-defined notions of contagion, exacerbated by forced "voluntary" debt forgiveness that has lead the crisis to spread into Spain and Italy. So much so that even the troubles in non-Eurozone Hungary lead panicked investors to dump EU government bonds and the currency (see previous WhatIf post).

With Greece out, the situation would appear manageable and in retrospect Fitch's warning of "cataclysmic' collapse of the common currency would likely mark the low for the Euro against other G-7 currencies. At the time the panic was running so high that investors were willing to pay to lend their money to safe-haven Germany (see prior WhatIf post on negative German yields). Time is running out for Greece and it will likely reintroduce the drachma, putting an end to this chapter of the Euro crisis and giving a major boost to the Euro.

Japan's Budget Mess

It is sometimes hard to make heads or tails of the political bickering in Japan's parliament, but matters look like they are getting serious. And seriously against prime minister Noda's intentions to raise consumption tax. A few lawmakers have already left his party (the DPJ) in protest against the tax hikes under consideration. At the same time the government's fiscal position is only getting worse, with a record 49% of next year's budget to be financed by bond issuance. Clearly raising taxes would hurt the already stagnant economy, so what can be done?

In some sense Japan has a problem that many countries wold love to have - strong currency and no inflation. A central bank can can always print more of its own currency - the constraints are only that this makes it weaker against other currencies and stokes inflation. But for Japan both of those in moderation are what it needs. So the BOJ should follow the Swiss Central Bank and weaken the yen, which should give a boost to the economy and automatically increase tax revenues.