In January 2010, when everybody was predicting a dollar collapse, I wrote in 11 Big Surprises for the Next Decade:
1. The Collapse Of The Euro- With Germany having such a different economy than the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) the weaker economies of the Euro region had a choice- to leave the Euro or to suffer massive deflation (since prices were too high and devaluation impossible due to the fact that they didn’t have control on the currency). Massive deflation meant budget deficits north of 10% of GDP and with no monetization possible the sovereign debt market of the PIIGS started to collapse. Some countries tried to cut the budget, which brought severe civil unrest while the economy continued to deteriorate. Others refused to physically reform which resulted in further revolts in their sovereign bond markets. The first domino to fall was Greece- when the yield on the 10 year government bond reached 8% percent it was clear that without a bailout from Germany they where bust, and bust they went. Like after the collapse of Lehman Brothers, the collapse of Greece caused a general panic in the markets, with government bonds of the rest of the PIIGS collapsing since it was clear that Germany will not bail them out. European banks refused to lend to each other and the havoc was over only when the rest of the PIIGS left the currency.
Despite efforts by the EU and the EMU bureaucrats to delay the inevitable I held to my initial prediction.
ON THE DAY THE EURO TOPPED I RECOMENDED SHORTING THE EURO AT x3 LEVERAGE. SINCE THEN IT HAS ALREADY FALLEN ALMOST 3%. (See my recommendations at the Investment Portfolio)
Why the European Stress Test is Meaningless
In a well organized marketing campaign the Europeans have published the so called “stress test”. Just seven European banks failed and were ordered to raise their capital by 3.5 billion Euros . The test was supposed to check how 91 banks in 20 countries would handle another recession in a desperate attempt to restore investor confidence after the PIIGS (Portugal, Ireland, Italy, Greece and Spain) debt crisis caused havoc in sovereign debt markets and after serious problems in eastern started to appear in the last week, mainly in Hungary. The survey marked down on bank books the sovereign debt of the fragile countries with high foreign debt exposure, with 23.1 percent on Greek debt, 14 percent of Portuguese bonds, 12.3 percent on Spanish debt.
In a further movement to a centralized communist utopia, a group of 25 bureaucrats at a small London office named The Committee of European Bank Supervisors (CEBS) was suddenly put in charge of determining the fate of the European banking system. If only life would have been so simple…
It is a known fact that bureaucrats and basically anyone in power like the status quo maintained, and if they could get it their way no big bank will ever fail. They won the first battle in 2008 and bailed out the world financial system. However they are about to discover what the Soviet Union discovered- When no one is allowed to fail eventually the system fails, and this case implies a default by governments. That is the true story behind the so called- “Sovereign Threat”.
A Short Story of a Greek Tragedy, a Euro Crisis and an Inevitable Collapse of The Monetary Union
The European economies are not competitive since the labor and production costs are too high (thanks to the labor unions) and they are not likely to generate the tax revenue necessary to pay off their bondholders. The problem with Greece is that it is being run by the socialists which are clueless of what to do. They were given a timeline to reduce their debt as a percentage or their GDP but the measures they take are not pro-growth. The current administration has cut down pensions but hasn’t done anything about privatizing many state-owned companies that are not profitable and are being subsidized by the taxpayers. They haven’t lifted many monopoly rules in sectors such as transportation, energy, and electricity, and increased taxation.
The Euro Crisis- Budget Cuts Are Doomed To Fail
It is no coincidence that countries such as the UK and Iceland, which had massive domestic bubbles don’t suffer large unemployment like Greece, Ireland, Portugal and Spain. The UK and Iceland could devalue and thus wages went down via the exchange rate mechanism and not in nominal terms. In the PIIGS, unemployment will stay in depression levels until:
a) They leave the Euro
b) Nominal wages fall, probably below the minimum wage.
The price level there is too high and wages most go down on the international level, while the budget cuts needed for these countries to remain solvent during a deflationary depression enforced on them by Germany via the Euro are so staggering that no modern democracy will be able to handle. As the riots in Greece have shown, any government in the world that will try to make public spending cuts in double digit percentage points will not survive. Not to talk about the fact that will need to lower the minimum wage during a depression, an action never done by any government.
The Euro Crisis and the Euro Collapse- Germany is Pushing Greece Into Debt Deflation
There is a big difference between a liquidity problem and a solvency problem. When a company or a country has enough assets to cover its liabilities but they have a problem raising the money they need to pay off the loan they have a liquidity problem. But when an entity has more debt than it can serve than it has a solvency problem and in that case more debt and loans will only dig it into a bigger hole. Greece has a liquidity problem since it has much more debt than the economy can serve. Germany and the Euro are perhaps will to give them loan in attractive interest rates but unless they are willing to consistently transfer money from the core of Europe to the weak countries those countries are doomed.
If German politicians think they can convince their citizens to fund Greece's recklessness through transfer payments all I have to say to them is GOOD LUCK!
The importance of the income balance
The following is a summary of the PIGS dire position(excluding Italy), courtesy of Ricardo Carbral.
Take a good look at the income balance of the PIGS. These four countries have a combined income balance of -5%. That means that in order for them finance themselves they need a 5% surplus of inflow of foreign capital every year. FDI is not a long term solution since it will only make matters worse in the long run (It will increase the total debt burden even more!)
One option would be to have a trade surplus of 5% every year until their income situation is balanced. But the Euro is making sure that will continue to have a deficit as all the projections for 2011 clearly show. Mind you that these countries are in a severe recession/depression. If they grow(as their politicians hope) they will have an even larger deficit!
And what will a larger trade deficit mean? It will mean that every year they will owe even more money to foreign creditors, which will cause their income their income balance to worsen.
With a current account deficit of 6.5% of GDP, these countries need an extra 150 billion dollars every year from foreign creditor. And this number will increase over time since, a)they run a trade deficit and b) their interest payments have gone up.
If you add Italy to the picture, which has a current account deficit of 55 billion dollar the amount grows to over 200 billons dollars.
The main question remains a political one. How long before the public in the PIGS will refuse for more austerity and at what stage will the public in Germany and other northern countries refuse to transfer more fund to their monetary partners in the south?
The financial markets are becoming once again extremely nervous, with the euro falling sharply and the yields on the PIGS government bonds falling. They are setting the stage for act II of the Euro Crisis.
How is austerity going?
Since the Euro is too cheap for Germany and too expensive for the PIIGS it shouldn’t come as a surprise that their economy has been rocking:
The first-quarter growth figure for Europe's biggest economy also was revised upward Friday to 0.5 percent more than double the initial reading of 0.2pc. "The recovery of the German economy, which lost momentum at the turn of 2009/2010, is really back on track," the Federal Statistical Office said as it released the preliminary second-quarter figures. Economists had expected second-quarter growth of less than 2pc. In year-on-year terms, output rose by 3.7pc.
The rest of Europe is not in such great shape
Italy trapped in slow lane as political crisis deepens
Rome said new registrations dropped 26pc from a year earlier, led by a 36pc fall for Fiat. "It is a complete disaster for everybody. The prime minister needs to take charge," said Filippo Pavan Bernacchi, head of the trade lobby Federauto.
Fiat’s chief executive Sergio Marchionne said Italy is the only part of the world where the resurgent company has not made a profit over the last eighteen months. "Italy’s industrial network cannot compete as it is," he said.
Mr Marchionne is embroiled in a showdown with Italy’s trade unions, demanding a radical overhaul of working practices before agreeing to fresh investment. "We want to run the plants. There is nothing obscene about that, but here in Italy it seems like we are asking for the moon," he said.
Italy has weathered the crisis of the last three years in good shape, thanks to modest private debt and the firm hand of finance minister Giulio Tremonti.
However, political risk is rising as the ruling party of premier Silvio Berlusconi breaks apart over claims of corruption, masonic conspiracies, wire-tap abuses, and attempts to interfere with the courts and free speech. Mr Berlusconi’s attempts to silence his erstwhile ally and chief critic Ginafranco Fini have back-fired badly, leading to revolt that has stripped the government of its parliamentary majority.
In Ireland branded grocery price survey shows 14% drop in prices
The National Consumer Agency (NCA) today published the findings of its latest, and largest ever, branded grocery price survey. The survey compares the price of a basket of 103 branded grocery items in Tesco, Dunnes Stores and Superquinn, and a basket of 87 items when SuperValu is included.
The survey shows that the multiples' prices have dropped in the region of 14% between January 2009 and July 2010. The report is the third of the NCA's segmented pricing surveys and follows over the counter medicines and doctors and dentists.
The results show virtually no price difference on branded goods between Tesco, Dunnes Stores and Superquinn, with a difference of only €1.14 or 0.4% between the cheapest and most expensive for a basket of 103 items.
The cost of this basket was cheapest in Dunnes Stores at €279.62, and most expensive in Superquinn at €280.76. The cost of the basket in Tesco was €280.69. This compares to a price difference of 4% in July 2009 between the cheapest and dearest for a basket with 68 items.
On the basket of 87 common products surveyed across Tesco, Dunnes Stores, Superquinn and two SuperValu stores, the total difference between the cheapest and most expensive was €5.75, or 2.4%.
Commenting on the findings, Ann Fitzgerald, Chief Executive of the National Consumer Agency, said: "The results show that while grocery prices have dropped across the board, over the past 18 months, there is evidence that the most powerful retailers in the State, between them controlling 70% of the market (Tesco, Dunnes Stores and SuperValu. Source: Kantar Worldpanel, data to 13 June 2010), are still price matching in core branded items to a significant degree, albeit at much lower levels than in 2007 and 2008.
"This suggests that competitive pricing is still not a feature of the Irish grocery market and to address this there is a real need for a new entrant to the market to offer consumers a real alternative."
The latest survey reveals that while the principal retailers have reduced the price of core branded items over the last 18 months, the rate of reduction has now slowed and retailers are now competing mainly on the basis of special offers and promotions and by juggling frequent but small price changes on individual items.
Spanish Crisis Threatens Second Front as Catalonia Rates Rise
Prime Minister Jose Luis Rodriguez Zapatero may face a second front in his battle to contain Spain’s fiscal crisis as borrowing costs for the country’s regional governments climb.
Catalonia, which accounts for a fifth of Spanish gross domestic product, has been shut out of public bond markets since March and the extra yield it pays over national government debt has almost tripled this year. Galicia, in the northwest, has asked to freeze payments of debt it owes the central government and the Madrid region postponed a bond sale last month.
Spain’s regions, which borrowed at similar rates to the central government before the global credit crisis started in 2007, are key players in Zapatero’s drive to get his budget in order and push down the country’s borrowing costs. They control around twice as much spending as the state, employ more than half of all public workers and piled on debt during the recession.
“If investors focused more on the problems in the regions, they would be less optimistic on Spain’s central government debt, and see that the rally in July was a bit overdone,” said Olaf Penninga, who helps manage 140 billion euros ($182 billion) at Rotterdam-based Robeco Group, and sold Spanish bonds last year. “If the central government has to help the regions it would aggravate an already bad situation.”
Greek economy shrinks a further 1.5%
The Greek economy shrank by a further 1.5% in the second quarter of the year, Greece's statistics agency has said. That adds to 0.8% decline in GDP recorded for the first three months of the year, suggesting that the decline in the economy is speeding up.
Greece's GDP has fallen 3.5% since this time last year.
The country has been forced to bring in severe public spending cuts since it sparked a Europe-wide debt crisis earlier this year. Greece's statistics agency Elstat said the "significant reduction" in public spending had contributed to the deepening of the country's recession. Economists said they were not surprised by figures, and blamed the "uncertainty" surrounding the government's austerity measures for the falls in GDP.
"Economic activity seems to be declining at an accelerated pace due to high uncertainty and the gradual implementation of austerity measures," observed Nikos Magginas, senior economist at the National Bank of Greece. The total decline in GDP during 2010 is forecast to hit 4%, according to the European Union and the International Monetary Fund.
A raft of austerity measures has been announced by Greece since December last year. They include a pay freeze for public sector workers and reform to the tax and pensions systems.
Irish debt under fire on fresh bank jitters
Spreads on Irish 10-year bonds reached 297 basis points over German Bunds on Wednesday amid reports the European Central Bank (ECB) is intervening to shore up Irish debt, a reversal of the bank’s plans to withdraw emergency support. The euro fell almost three cents against the dollar from $1.32 to $1.29.
Patrick Honohan, governor of Ireland’s central bank and a member of the ECB’s council, dismissed the bond jitters as yet another spasm by jumpy and emotional markets.
“The spreads are a setback for our hopes of a narrowing to reflect the fiscal credibility of the country. I don’t look at them every day but at this level they are ridiculous,” he told The Daily Telegraph, speaking at his office in the heart of Dublin.
He said critics are failing to recognise the dynamism of Irish exports as the country quickly returns to a current account surplus, or the revolution in public accounts as tax reform kicks in.
- Patrick Honohan, governor of Ireland’s central bank
The latest jitters stem from the escalating costs of Ireland’s rescue of Anglo Irish Bank. The European Commission revealed this week that it had approved government support worth €24.3bn (£20bn) for the bank, significantly higher than estimates by Dublin earlier this spring.
Dr Honohan fumed at the mere mention of Anglo Irish, which brought the country to its knees two years ago in much the same way the Icelandic banks crippled their host state.
“They were egregious, in a league of their own,” he said. “If it hadn’t been for them the losses would have been manageable. The net cost to the Irish state of recapitalising the banks is €25bn, or 15pc to 16pc of Irish GDP. It is nearly all the result of Anglo Irish.”
Dr Honohan is a poacher-turned-gamekeeper, an arch-critic brought in last year to clean house at the central bank. A professor at Trinity College Dublin, he used to work for both the IMF and World Bank.
He had condemned the government just a few months before his appointment in a paper entitled "What went wrong in Ireland". His long-standing argument is that the genuine Celtic Tiger of the 1990s gave way to a foolish credit bubble over the next decade under “complacent and permissive” bank regulation and the failure of the political class to understand that a small economy on the edges of a currency union must use fiscal policy to prevent overheating.
“There was complacency about joining the single currency in a number of countries. People thought things would take care of themselves, and they have had more than a wake-up call,” he said.
The cardinal error in Ireland was to stand idly by as the ECB’s ultra-low interest rates set off an explosive property boom. Real rates averaged minus 1pc for almost a decade.
Instead, the government made matters worse by relying on “fair weather” taxes – capital gains, property, and corporate taxes – that created windfall revenues and flattered public accounts, until it all ended with a crash.
Dr Honohan knows as well as anybody that Ireland has little headroom for error. The IMF expects public debt to reach 96pc of GDP by 2012, near the tipping point when debt dynamics become unstable.
Under Ireland’s rescue programme the viable core of Anglo Irish’s business will be cut from the wreckage and relaunched as a new entity. Bad debts are already parked at Ireland’s National Asset Management Agency (NAMA) at an average “haircut” of 50pc.
Portugal Q2 Trade Deficit Widens
Portugal’s trade deficit widened to EUR 4.99 billion in the second quarter from EUR 4.55 billion recorded during the same period of last year, a report by the Statistics Portugal showed on Monday.
In the second quarter, exports climbed 15.4% year-on-year to EUR 8.98 billion from EUR 7.79 billion last year. At the same time, imports rose 13.2% to EUR 13.97 billion from EUR 12.34 billion a year ago.