Euro zone may struggle with its own Lost Decade
Additional Reporting by Andy Bruce and polling by Rahul Karunakar and Sumanta Dey.
As Europe’s crisis drags on, the prospect of a Japanese-style lost decade of economic malaise is becoming increasingly real, according to a new poll. Half of the bond strategists and economists surveyed by Reuters are now expecting just such an outcome.
Many market participants have dismissed the fall of two-year German bond yields below their Japanese counterparts as being merely a result of a crisis-fueled flight to quality bid. Two-year German yields are now close to zero, offering returns of only 0.02 percent. By contrast, equivalent Japanese bonds are yielding 0.11 percent.
But a significant portion of analysts in a Reuters poll see something more sinister in the rapid narrowing of the premium investors require to hold German debt over Japanese bonds. One half of those polled – 12 out of 24 – said it is likely the euro zone is close to entering a period of prolonged low or no growth and inflation and low interest rates, with the other half saying it was unlikely.
According to Stephen Lewis, chief economist at Monument Securities:
I don’t really see an early end to the financial crisis in the euro zone. I think it’s very unlikely that Germany and the other countries will see eye to eye in the course of this year. That’s going to keep the euro zone economy looking very weak for the next several quarters.
Europe’s economy stagnated in the first quarter of 2012 and is expected to shrink 0.4 percent this year, according to another recent Reuters poll. Data on Thursday certainly pointed in that direction, suggesting even wealthier countries like France and Germany are also starting to feel the pinch.
Manifest currency? U.S. dollar’s global dominance not set in stone
Incumbency, it is often said, confers many advantages.
Sitting U.S. presidents certainly have reaped its benefits – in the past 80 years, only three have been unseated.
Most economists believe the same benefits apply to reserve currencies. Yes, the U.S. dollar may one day be supplanted as the leading international currency, the thinking goes, but that day is many decades away.
Then again, maybe not.
A new working paper from the National Bureau of Economic Research that looks more closely at the dollar’s own rise to the top in the 20th century suggests, among other things, that “the advantages of incumbency are not all they are cracked up to be.”
By looking at the currency denomination of foreign public debt issued by 33 countries from 1914 to 1946, the authors – University of California-Berkeley professor Barry Eichengreen and Livia Chitu and Arnaud Mehl of the European Central Bank – find that dollar-denominated bonds were nearly equal to those priced in sterling by the late 1920s. That’s about two decades earlier than the date assumed by previous scholars.
When stripping out Commonwealth countries that had strong commercial and political links with Britain, the dollar overtook sterling in 1929.
It seems unlikely any other nation of the world would want to have it’s currency and people abused as much as the dollar is, in our current status as reserve currency. Name one country that could withstand that kind of abuse, and survive, or benefit? None.
Risk of contagion if Greece exits euro: WestLB
What happens if Greece leaves the euro? No one can say for sure. But John Davies at WestLB, finds it difficult to envision a benign outcome.
Greece’s economy, at around $300 billion, is very small compared to the euro zone as a whole. The problem is if other countries follow suit – or are pressured in that direction by stubborn financial markets.
Such a scenario doesn’t bear thinking about because it is so horrible.
There is a good chance that the market would immediately trade Portugal towards pre-debt swap Greece levels. The next in line would certainly be Ireland and Spain.
Initially you have got to assume that spreads would become even more dislocated. As you are moving out and down the credit curve the ones with the weakest credit ratings will likely suffer worst, at least initially, because we are moving clearly into the world of the unknown and that’s precisely what the market doesn’t like.
The Greek elections have left a political vacuum that is raising speculation that the country may eventually exit the euro. Last Sunday, Greek voters punished mainstream parties that supported harsh austerity in exchange for international bailout cash. That left the Greek parliament with a jumble of minority parties that have been unable to form a government.
The leaders of Greece’s once-dominant conservative and socialist parties made a push on Friday to avert new elections and prevent a victory by a radical leftist who has promised to tear up its international bailout deal.
Inability to implement the reforms set out by international lenders amid this political void could compromise the country’s life-support bailout money and lead to a default. This could make the country’s membership of the euro increasingly unsustainable, even though those very reforms risked choking growth further in an economy suffering its fifth year of recession.
Even Germany, the key driver of growth in the euro zone, might eventually be threatened by worsening financial and economic conditions around it. And what of the bullish German Bund market which seems to know no bounds? Davies again:
debt relief by more debt added faster…faster..faster.faster…
the math is compelling.
the greeks must default…default..default.default…
printing is the world’s only current option. if, and only if, the major currencies agree to unified manipulation of currencies, and stick to it, can the pain inflicted by fiat foolishness be gentled enough to allow the real people to be ok.
p.s. the printers must agree to a fixed ‘flow’, but that’s another story.
NYC Mayor Bloomberg: Highly-indebted U.S. could go the way of Europe
New York City Mayor Michael Bloomberg slammed the federal government for following the same fiscal path that has cost European governments so dearly, perhaps offering Democratic President Barack Obama and Republican challenger Mitt Romney hints about what policies he would like to see from them to win his endorsement as a moderate independent. Bloomberg’s seal of approval carries added weight because he is a billionaire businessman with close ties to Wall Street, a source of donations as well as a powerful force in the economy.
I think it is clear that we have a deficit problem that is going to hurt this country dramatically and unless we do something about it is a cloud on the horizon. It doesn’t mean America is going to go to zero… But I think if you take a look at Europe and other places and it shows you when you live above your means – It’s different than the city, the deficits we project are aspirational deficits, in the end we balance our budgets, the federal government does not.
The city by law must close any deficits. In contrast, the U.S. government can borrow to fund its operations – and at very low rates in recent years.
The mayor, now in his third and final term, was presenting an update to his $68.7 billion budget plan. One reason private employment in New York City has broken the 1969 record high is the city’s budget discipline, he said.
“We have to give people the clarity and confidence that we are going to face fiscal realities,” he said. The country’s failure to wrestle its deficit under control is curbing businesses from growing, he said. “Nationwide, there are some real questions in people’s minds and they are not willing to do that.”
New York City has regained about 180 percent of the private sector jobs lost during the Great Recession; the nation has only won back about 40 percent, he said. Private employment has climbed to 3.291 million, topping the decades-old high of 3.275 million. “We’re part of America; we want America to grow,” Bloomberg said.
Disappointing profits on Wall Street – the city’s economic motor – forced the mayor to slice his forecast for tax revenue by $352 million in the current budget and the new one that starts on July 1. The city is home to some of the world’s wealthiest individuals – including the billionaire mayor himself. Added Bloomberg:
Bloomberg doesn’t know we have a fiat currency. And the author of the article thinks we “borrow” money.
“There are human beings involved” in austerity debate
The inventors of democracy and its greatest 18th century champions both go to the polls this weekend. Greek and French voters will try to elect governments they hope will help release their economies from the grips of the euro zone debt crisis.
While exercising their democratic vote, Europeans will also be contemplating another key issue: their basic economic survival.
That is why the debate about austerity versus growth has become so important.
Financial markets see fiscal discipline as crucial to get the euro zone’s debt burden back to sustainable levels. They are going into the Greek elections favoring triple-A rated bonds over peripheral counterparts.
The premium investors require to hold French debt over German Bunds has also risen in the run-up to the French vote as Francois Hollande became the favourite to win.
But as economies fall deeper into recession and double-digit unemployment hurts prospects for growth, the view that austerity alone will not solve the euro zone debt crisis, seems to be gradually winning over some investors in the bond market – the heart of the crisis.
Sanjay Joshi, head of fixed income at London and Capital, says:
Europe in recession – an interactive map
Spain has become the latest European country to slip into recession joining the Belgium, Cyprus, The Czech Republic, Denmark, Greece, Italy, The Netherlands, Ireland, Portugal, Slovenia and the United Kingdom.
Click here to view an interactive map.
*Updated to include Romania and Bulgaria
Thanks for comments – Will update with Romania and Bulgaria
High inequality makes it tougher to reform economies: Swedish Finance Minister
Americans are all too acquainted with the shouting-match politics that tends to accompany any debate over economic policy: everyone is yelling and nobody is listening. The toxic political discord in Washington has become so familiar it is almost a cliché.
It turns out high levels of income inequality, which the United States is also famous for, could be to blame. According to Anders Borg, the Finance Minister of Sweden, a large wealth gap makes it harder to achieve political consensus because the debate is poisoned by mistrust. Speaking at the Peterson Institute this week, Borg said high inequality in Southern Europe was a factor preventing those countries from achieving agreement as they struggle with a deep financial crisis:
You need to deal with the social cohesion issue. You cannot have a society where the conflicts that are built in become so strong that you undermine the political ability to deal with problems. If I compared Sweden with Spain or Italy or Greece, one of the reasons we have been able to these reforms is that our income differences are substantially lower which also means that the political tension is on a completely different level.
Eurobonds key to financial stability: Nobel economist
There’s no other way. In order for Europe to hold together as a monetary union it must be able to issue a currency region-wide bond. That’s according to Christopher Sims, Nobel-prize winning economist and Princeton University professor, speaking on a panel at the IMF over the weekend:
My view is that the only way to preserve the usual manner of operation of monetary policy in Europe, and the usual operation of financial institutions is to deliver on the Eurobond, and not after years but soon. A Eurobond that could be used as the main instrument of monetary policy in Europe would go a long way to stabilizing the financial system.
This explains why Europe is in trouble while other industrialized nations that also face high debt levels are not seeing anywhere near the same market pressures, Sims said:
There is a very important distinction between inflation risk and default risk. There is a kind of a default premium. An entity that issues debt that only promises to pay paper that it can print for free, is free of any risk that the entity will be unable to deliver on the contract terms. It’s one thing for markets to worry about unpredictable inflation reducing the value of a bond. Another thing is for the markets to be uncertain whether at the next rollover this issue of debt is going to not be fully paid or whether there might be a general haircut on debt.
The risks to holders of debt of an unspecified form of default is much more disruptive than the risk of losing some of the value of the debt through unpredictable inflation. And I think that’s why even though on fundamentals the UK and the U.S. and Japan look like they’re in as much trouble as European countries, nonetheless those countries can print what they promised to pay. So there’s no short-term risk of a sudden, unpredictable allocation of losses across different bondholders.
It makes sense. Yet given the complicated political challenges posed by the issuance of a common bond across separate nations, Europe better hope Sims has it wrong.
A recovery in Europe? Really?
There’s a sense of relief among European policymakers that the worst of the euro zone’s crisis appears to have passed. Olli Rehn, the EU’s top economic officials, talked this week of a “turning of the tide in the coming months”. Mario Draghi, the president of the European Central Bank, speaks of “sizeable progress” and “a reassuring picture”.
At last week’s spring summit, EU leaders couldn’t say it enough: “This meeting is not a crisis meeting … it’s not crisis management,” according to Finnish Prime Minister Jyrki Katainen. All the talk is of how the euro zone’s economy will recover in the second half of this year.
But for the 330 million Europeans who make up the euro zone, the outlook has, if anything, darkened. As euro zone governments deepen their commitment to deficit-cutting, and rising oil prices mean higher-than-expected inflation, households can’t be counted on to drive growth. Not only did housing spending fall 0.4 percent in the October to December period from the third quarter, but unemployment rose to its highest since late 1997 in January.
Joblessness is reaching shameful levels in southern Europe. In Greece, unemployment rose to a new record high of 21 percent in December and to 23 percent in Spain in January. Even in wealthy, northern Europe, the number of people out of work has started to rise in France, the Netherlands and Germany.
Just over half of the euro zone‘s economic output is generated by domestic consumer spending, but demand for goods looks chronically weak and fiscal austerity is aggravating the situation. Euro zone governments, desperate to distinguish themselves from debt-stricken Greece, are completely unwilling to step in and spend. The European Commission, persuaded mainly by Germany that fiscal discipline will lift economic growth, is on their backs to get their deficits within the 3 percent level of GDP by the end of 2013.
“The case against Europe’s growth strategy is that it is all supply and no demand,” said Philip Whyte, a senior research fellow at the Centre for European Reform. “Fiscal policy is being tightened too rapidly. The more certain EU countries do to balance their budgets, the more output contracts,” he said in a recent paper.
So where will growth come from? The ECB’s Draghi said this week he is counting on foreign demand. Emerging Asia and a stronger recovery in the United States might help pull the euro zone out of its slump. But with Germany responsible for almost 40 percent of the euro zone’s exports, a wider tide of prosperity across the currency area looks unlikely.
Europe’s wobbly economy
Things are looking a bit unsteady in the euro zone’s economy. Just ask Olli Rehn, the EU’s top economic official, who warned this week of “risky imbalances” in 12 of the European Union’s 27 members. And that’s doesn’t include Greece, which is too wobbly for words.
Rehn is looking longer term, trying to prevent the next crisis. But the here-and-now is just as wobbly. The euro zone’s economy, which generates 16 percent of world output, shrunk at the end of 2011 and most economists expect the 17-nation currency area to wallow in recession this year and contract around 0.4 percent overall. Few would have been able to see it coming at the start of last year, when Europe’s factories were driving a recovery from the 2008-2009 Great Recession. And it shows just how poisonous the sovereign debt saga has become.
Not everyone thinks things are so shaky. Unicredit’s chief euro zone economist, Marco Valli, is among the few who believe the euro zone will skirt a recession — defined by two consecutive quarters of contraction — in 2012. This year is “bound to witness a gradual but steady improvement in underlying growth momentum,” Valli said, saying the fourth quarter was the low point in the euro zone business cycle.
That could still happen. Business surveys support the idea that the worst is behind us, while European Central Bank President Mario Draghi agrees that last year’s collapse in confidence has now steadied, albeit at low levels. So far, the ECB has not given a strong signal on whether it will take interest rates below the 1 percent level for the first time, but the bigger risk is whether a disorderly Greek default or the threat of a severe credit freeze — which the ECB’s nearly 500 billion euros in loans has so far helped avoid – come back to crush the green shoots of growth.
The ECB’s latest lending survey showed for the last three months of 2011 reinforces the concerns of a credit crunch, as banks are still not passing the money on to the real economy. Thirty-five percent of banks reported they had tightened the standards they apply to loans to businesses, compared to only 16 percent in the third quarter. The ECB is set to make its second offer of three-year loans at the end of the month and that could ease credit risks, but may also discourage banks with bad loans on their books to reform.
So, in economist-speak, the risks are still on the downside and uncertainty remains high. Basically, things are still looking wobbly.
