Tag: EuroZone

The current policy of austerity that is being forced on the European Union by Germany and England has been called “financially futile, economically erroneous, politically puzzling and socially irresponsible” by economists and monetary experts. Author and derivatives expert, Satyajit Das, writes in the first part of his series on “The Road to Nowhere, Part 1 – Fiscal Bondage” at naked capitalism that the December 2011 European summit to resolve the euro crisis was a failure:

The proposed plan is fundamentally flawed. It made no attempt to tackle the real issues – the level of debt, how to reduce it, how to meet funding requirements or how to restore growth. Most importantly there were no new funds committed to the exercise.[..]

The plan may result in a further slowdown in growth in Europe, worsening public finances and increasing pressure on credit ratings. This is precisely the experience of Greece, Ireland, Portugal and Britain as they have tried to reduce budget deficits through austerity programs. This would make the existing debt burden even harder to sustain. The rigidity of the rules also limits government policy flexibility, risking making economic downturns worse.[..]

The fiscal compact did not countenance any writedowns in existing debt. It also did not commit any new funding to support the beleaguered European periphery. Germany specifically ruled out the prospect of jointly and severally guaranteed Euro-Zone bonds. Instead, there were vague platitudes about working towards further fiscal integration.[..]

Instead of dealing with the financial problems of the central bailout mechanism (the EFSF – European Financial Stability Fund), European leaders chose the re-branding option.

Actions, or rather inactions, have consequences.

As I predicted in a message to Credit Writedowns Pro subscribers on Monday, statistics have shown that the German economy has finally succumbed to the deflationary economic policy of the euro zone.

   Germany showed first signs of feeling the pain from the euro zone’s debt crisis as the economy shrank in the last three month of 2011, despite outperforming its peers for main part of the year thanks to strong domestic demand and exports.

   Gross domestic product (GDP) grew 3.0 percent in 2011, preliminary Federal Statistics Office data showed on Wednesday, below the previous year’s growth rate of 3.7 percent – the fastest since reunification – and in line with a Reuters poll estimate.

   But GDP contracted by around 0.25 percent in the fourth quarter of 2011, an official from the Statistics Office added.

   “Germany cannot isolate itself so easily from tensions within the euro zone. In addition the export sector is facing a difficult period given the fall in global demand,” said Joerg Zeuner, chief economist at VP Bank.

Harrison wrote in November in the New York Times

that Europe is already in a double-dip recession. Already two months ago, the Markit Eurozone Manufacturing Purchasing Managers Index, which measures activity across Europe in services and manufacturing, had fallen to 50.4, the lowest since September 2009. The divider between expansion and contraction is 50, so Europe was still expanding. But last Wednesday, Markit data indicated that the situation has since deteriorated; the latest data showed a drop in private sector activity in the euro zone for the first time since July 2009. Moreover, the data are poor in the core of the euro zone as well as in the periphery, with Germany and France’s economies stalling as well. The sovereign debt crisis and the fiscal consolidation implemented to deal with it have taken their toll.[..]

Until the banks take substantially more credit write-downs and recapitalize, this crisis will continue and get worse.

The downward spiral is evident throughout Europe with even the strong German economy feeling the effects of erroneous policies

The German economy expanded faster than any other Group of 7 nation last year, official data showed Wednesday, but the stress of the euro crisis and a slowing global economy appear to be already weighing on output.

Germany expanded by 3 percent last year from 2010, the Federal Statistical Office said in Wiesbaden. It noted, however, that the growth came mostly in the first half of 2011, and estimated that the economy actually contracted by about 0.25 percent in the fourth quarter from the prior three months.

Some economists now predict another contraction for Germany in the first three months of 2012, which would meet the usual definition of a recession as two consecutive quarterly declines in output.

And austerity measures in Greece are making their budget deficits even worse:

Greece’s budget deficit widened last year as an austerity-fuelled recession cancelled out much of the extra revenues the government was hoping to raise through emergency taxes, data showed on Thursday. The central government budget gap widened 0.8 percent year-on-year to 21.64 billion euros ($27.45 billion) last year, according to figures from the finance ministry.

David Dayen at FDL News Desk thinks it is probably worse since “the EU uses a different measure to assess the Greek budget.”  He points out that even with increased taxes, the fall in tax compliance from an already lax system has reduced income. It all looks good on paper but that’s not the reality of what is actually in the treasury.

There is some hope that Europe’s leader are waking up to reality that there needs to be a growth strategy, although it may not be enough, or soon enough, to reverse the spiral.

It is a crisis in the € zone. The divergent trends in the € zone are too large. It is not an “optimum currency area”

It’s not just government, to “sovereign debt” but also excesses in the financial sector, real estate etc.

We must do everything to avoid recession. … We need a fiscal strategy that is “growth friendly”

Fiscal consolidation will not tell us to say “no” to all or which is cut everywhere. We must “prioritize”

We ask each member state to establish a “job plan”, we make commitments we can evaluate

The next meeting of the Eurozone member is the end of this month where a tax on financial transactions will be considered and, hopefully, they will discuss job creation and debt reduction.

I’m no expert on the bond market but I do know that when a bond interest rates rise, it is more expensive for the holder of those bonds to borrow money. That’s an over simplification as it pertains to the situation that has been developing with the Eurozone that is possibly on the verge of collapse due to the economic instability of Greece and, now, Italy. Of course, it is affecting market around the world. On Tuesday there was a massive sell off of all Eurozone bonds that is threatening the stability of the Eurozone. David Dayen explains:

Under current arrangements, the Eurozone doesn’t even have the money to save Italy. If the core countries start to lose their credit ratings and cannot afford to borrow, we’re really just done here. Spanish debt is also above the level where they would need a bailout, another troublesome sign.

About the only country on somewhat solid footing is Germany, and this has sowed resentment, particularly because of their domineering response to the crisis. Austerity for thee and not for me is bound to create a backlash.

This is all happening because the European Central Bank refuses to honor the “central bank” part of its name. This is dragging down all of Europe. Edward Harrison works through the issues in Italy, which is ground zero here.

   Italy needs to run a primary budget surplus (excluding interest payments) of about 5 percent of GDP, merely to keep its debt ratio constant at present yields. It won’t ever be able to do so.

   Therefore, yields for Italian bonds must come down or Italy is insolvent as it must roll over 300 billion euros of debt in the next year alone.

   Austerity is not going to bring Italian yields back down. First, Italian solvency is now in question and weak hands will sell. Moreover, investors in all sovereign debt now fear that they are unhedged due to the Greek non-default plan worked out in Brussels last month. As Marshall Auerback told me, any money manager with fiduciary responsibility cannot buy Italian debt or any other euro member sovereign debt after this plan.

   Conclusion: Italy will face a liquidity-induced insolvency without central bank intervention. Investors will sell Italian bonds and yields will rise as the liquidity crisis becomes a self-fulfilling spiral: higher yields begetting worsening macro fundamentals leading to higher default risk and therefore even higher yields.

Nobel Prize winning economist, Paul Krugman, mostly agrees with Harrison’s assessment of how the euro will end if the ECB doesn’t step in with a massive bail out and adds his thoughts:

I might place greater emphasis on the immediate channel through which falling sovereign bond prices force bank deleveraging, but we’re picking nits here.

And this is totally right:

   If the ECB writes the check, the economic and market outcomes are vastly different than if they do not. Your personal outlook as an investor, business person or worker will change dramatically for decades to come based upon this one policy choice and how well-prepared for it you are.

Crunch time. If prejudice and false notions of prudence prevail, the world is about to take a major change for the worse.

There are a number of factors here. Without the backing of Germany, the only Eurozone country with money, the ECB doesn’t have enough money to cover Italy’s debt and Germany’s participation hinges on their demand for austerity measures. The the elephant of a question then becomes what happens if the ECB doesn’t write the check? What if the ECB let’s Italy default, what then?

Harrison’s article at naked capitalism on the Italian default scenarios is long but well worth reading for the suggestions for investors on how they can protect themselves in either event.

Never mind dreaming of Jeannie, trader Alessio Rastani tells the BBC host that he goes to bed dreaming of the next recession and doesn’t care what happens to the economy because people like him will make a fortune from the crash. He almost makes an ambulance chasing lawyer sound like a humanitarian but he’s not wrong just painfully realistic.

“This is not a time right now for wishful thinking that governments are going to sort things out,” Rastani told the BBC. “The governments don’t rule the world, Goldman Sachs rules the world.”

In a candid interview about the Eurozone rescue plan, Rastani said the market is ruled by fear and cannot be saved by the rescue plan.

“They know the stock market is toast,” he said. “They know the stock market is finished.”

Rastani said most investors are moving their money to places it would be more safe, like U.S. treasuries and the dollar, as they simply do not care about the state of the economy but rather about their own pockets.

“Personally it doesn’t matter,” he said. “See I’m a trader. I don’t really care about that kind of stuff. If I see an opportunity to make money, I go with that.”

snip

“For most traders…we don’t really care that much about how they’re going to fix the economy, how they’re going to fix the whole situation,” Rastani said. “Our job is to make money from it.”

h/t Yves Smith @ naked capitalism