Debriefing the G20 summit: Ceci n'est pas une pipe!

Now that we have the G20 behind us, it remains to be seen how long this market can drive on the optimism and momentum that has been generated by that summit. The question remains whether the optimism that was present among the G20 leaders was prescient at best, or premature at worst.

When we scroll through the numbers we notice that a lot of packages were already committed to long before the start of the summit and should have been priced into the market last month. So from the $ 1.1 trillion headline there was a lot of “old money” in it.

The $ 1.1 trillion which was sold by Gordon Brown during the press conference as “additional money to support and restore credit, growth and jobs” is misleading. Let’s vivisect this spectacular amount:

• $ 500 bln are additional contributions to the IMF,
• $ 100 bln to the Multilateral Development Bank (MDB)
• $ 250 bln of Special Drawing Rights which the IMF can create itself
• $ 250 bln for international trade finance

Of the $ 500 bln promised to the IMF only $ 250 bln will be transferred immediately and this has already been confirmed by Canada, the EU, Japan and Norway before the summit. Japan’s contributions to this were already communicated back in November. The remainder has been left open and will be decided upon in future G20 summits.

As Capital Economics is arguing, it remains very unclear to which extent the UK and US are going to contribute to this action plan. Since it is money transferred to the IMF, quota’s need to be respected. If these were to be followed, the US might have to contribute up to 17% or $ 85 bln, and the UK 5% or $ 25 bln. Japan’s $ 100 bln promise exceeds their quote of 6% by far, so the UK and or US could try to argue their contribution to be less then their fair share.

$ 100 bln to the MDB will be spread over three years and to be divided between:

• The African Development Bank
• The Asian Development Bank
• The European Bank for Reconstruction and Development
• The Inter-American Development Bank Group

Per EM (Emerging Market) country only a $ 2-3 bln will or could be used for additional aid. Considering the impaired situation of EM, this amount is like a drop in the bucket.

The $ 250 bln of SDR’s will be printed by the IMF and can be considered as quantitative easing but organised by the IMF on a more global scale. However it will be less effective as the QE applied by the Fed-BoE-SNB-BoJ, as this money is stored on the bank accounts of the members, each according to their quotas. Only a fraction will be injected directly to the EM countries (approximately $ 100 bln).

Last but not least there is the $ 250 bln committed to get international trading back going. This will be spread over the next two years. So once again this is not $ 250 bln that will be injected into the system immediately. More importantly the majority of this will have to come from the private sector. The only explicit pledge at the moment is $ 3-4 bln for an aid programme managed by the World Bank.

The only way to get international trade going again is to do something about the Letter of Credit markets. As long as banks are not going to issue LoC’s commercial trade will remain anaemic.

Adding up all these numbers gives a less spectacular amount than the $ 1.1 trillion. It does not even come close to $ 250 bln of new money which would supposedly be injected immediately into the system

There are though a number of positive signs such as the commitment to prevent protectionist measures and stricter regulation, but an important test will be to which extent they translate all these well intended commitments into national legislation. It will be interesting to see regarding the protectionism issue whether the Obama Administration is going to withdraw their “Buy America” Act. (aka ARRA).

As far as regulation is concerned, we are already noticing two-three days after the summit a deep split between continental Europe and the UK. Britain opposes any form of authority given to a centralised European Regulator transformed from a national level.

Also the Council of Systemic Risk creates a split between the member states. The ECB under supervision of President Trichet is all in favour to bring this under its umbrella. Unfortunately, the UK is vetoing this and considers this too a breach of the sovereignty principle.

As you can see the G20 was all about the package and verbal spinning to talk the stock markets up. Even FED Chairman Bernanke on Friday repeated his comments from March, that he is seeing greens seeds of recovery in the economy. Of course one can understand they are not going to create more panic to the public, but it is a big gamble.

Very soon we will need much better data to confirm this optimism in the markets. If not, risk aversion could return very quickly. Many global central banks only began with QE measures in full force during March and so far the jury is still out on their efficiency. Lending remains difficult and as the slow bleed in global labour markets continues, investment demand is now also falling rapidly, regardless of credit availability. The actual trough in growth may be approaching, but it is still sufficiently far away to halt fresh risk-seeking flows as economic performance fails to impress. The volatiliy index (VIX) came down gradually but is still trading at substantial above normal levels indicating further nervousness in the market.

It will be very interesting to see whether we already get through earning season, kicking off tonight after NY close with Alcoa but the outlook on banks is already weighing on sentiment. Certainly Mr. Mike Mayo from Calyon reiterated that the problems in the banking sector are from over.

“While certain mortgage problems are farther along, other areas are likely to accelerate, reflecting a rolling recession by asset class," He continues by saying "New government actions might not help as much as expected, especially given that loans have been marked down to only 98 cents on the dollar, on average." We are also worried by about $ 7 trillion outstanding bank loans in private plus commercial real estate and consumer lending that the public private partnership does not focus on and will not fix. Mr. Mayo expressed similar concerns regarding those loans.

An interesting paper on this subject was published last week by John Hussman. (See link attached.) It describes very well the current situation and recommendations to get the banking sector out of this vicious circle.

http://www.hussmanfunds.com/wmc/wmc090330.htm


So we remain highly sceptical on the current rally and G20 hype and would use Magritte’s famous painting to characterize the whole situation: “Ceci n’est pas une pipe.”