Tag Archives: Deficit

Credits: PIGs Gone Wild

On Wednesday Greece was the major troublemaker in the credit markets, a role that investors appeared to believe the country had left behind. Greek CDS spreads were relatively stable Thursday, but its fellow peripherals, Portugal and Ireland, compensated with further volatility.

“However, investors were happy to overlook sovereign debt problems and focus on earnings and economic releases.”

Gavan Nolan


Portugal’s spreads started widening Wednesday after budget talks between the minority Socialist government and the opposition Social Democrats broke down. The passing of the budget, which is proposing relatively severe austerity measures, is essential for the country in reducing its deficit. Thursday the Irish CDS spread made another jump.

“A nervy sovereign debt market wasn’t enough to stop risky assets recovering some of the ground lost yesterday. Another day of strong corporate earnings and an upward surprise on US weekly jobless claims figures provided ballast to a market still uneasy from revised QE expectations,” credit analyst Gavan Nolan at Markit Credit Research writes in his daily update.

Wednesday Greece was disturbing the peace in the market, a role that investors appeared to believe the country had left behind.

Greece’s spreads widened by over 70bp today, the largest move since the turmoil of June. The credit deterioration was prompted by the Eurostat revising Greece’s 2009 budget deficit to above 15%.

This is over five times the initial estimate of 3%.

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“I always believed that pigs go the slaughterhouse”.
(Walter Annenberg)

The Greek CDS spreads were relatively stable Thursday, but its fellow peripherals Portugal and Ireland compensated with further volatility.

Portugal’s spreads started widening yesterday after budget talks between the minority Socialist government and the opposition Social Democrats broke down.

The passing of the budget, which is proposing relatively severe austerity measures, is essential for the country in reducing its deficit.

“It seems improbable that the two parties aren’t aware of the delicate fiscal situation and it is likely that a compromise will be reached over the mix of tax and spend. But until then the sovereign will be vulnerable to spread volatility,” Nolan writes.

Ireland, a country that has embraced austerity with little opposition from the general public, also widened Thursday.

Unlike Portugal, its recent credit deterioration has in large part been caused by its broken banking sector.

Ireland’s budget deficit has spiralled upwards to 32% of GDP as a consequence of its support for banks, particularly Anglo Irish Bank.

“Investors received another reminder of the state’s painful exposure with the news that a group of subordinated
bondholders are planning to block the proposed debt exchange,” Gavan Nolan points out.

The bondholders are unhappy about the terms of the exchange, which they view as unfair.

But the Irish government has already stated that the terms are non-negotiable and has intimated that it will turn to legislation if it faces opposition.

“Nonetheless, Ireland’s sovereign spreads widened significantly amid doubts about the validity of burden sharing,” Nolan notes.

In contrast to the day before, however, investors were happy to overlook sovereign debt problems and focus on earnings and economic releases.

The earnings season has so far proved to be a strong one, with companies that beat expectations easily outnumbering those that missed.

The trend continued today, with oil majors Royal Dutch Shell and Exxon Mobil gaining from higher oil prices. France Telecom, Potash Corp, Visa and Dow Chemical were among the other companies to beat consensus estimates.

In an otherwise quiet day for economic releases US initial jobless claims were always likely to stand out. The figures
dropped by 21,000 to 434,000, their lowest level in three months,

“The data surpassed expectations and helped markets rally in the afternoon. But the gains were modest, with investors no doubt wary of the news heavy days lying ahead,” Gavan Nolan at Markit concludes.

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Why Club-Med Cuts Won’t Work; 3 Possible Euro Zone Scenarios

It is conventionally assumed that the euro zone crisis arose because Club-Med governments have been too profligate. If only they had been as cautious as northern European countries, the argument runs, they would have retained their export competitiveness. A recent carefully researched paper, popularly known as the RMF Report and compiled by academics at the University of London, SOAS, shows this view to be entirely without foundation, professor George Irvin writes in a recent blog post.

“In effect, we face three possible euro zone scenarios.”

George Irvin


“Inter alia, the Report investigates the relationship between Club-Med current account (external) deficits, government deficits and the countries’ total stock of debt. Club-Med governments have not been wildly profligate: Greece, Spain and Portugal all have government deficits lower than the UK, and with the exception of Greece, their net public debt-GDP ratios are running at 60% or less,” professor Irvin points out.

The key point, however, is that much of Club-Med debt is held by the private sector: nearly 90% of all debt in Spain, 85% in Portugal and over 50% in Greece.

Moreover, less than half of all Spanish debt has been contracted abroad (in contrast to Portugal and Spain where the overseas proportion is much higher).

Secondly, a far higher proportion of private debt is relatively short-term, meaning it will need to be refinanced sooner than much of the public debt.

In Spain, private profligacy has mainly to do with a sharp rise in private investment resulting from the housing boom.

In Portugal and Greece, by contrast, private investment growth was much less important; in essence, private savings have contracted to finance rising consumer demand. Nor is there anything surprising in these patterns—until 2008, the UK experienced both a private housing boom and a private savings collapse to sustain consumer demand.

All-round austerity starting with government deficit reduction has become the official answer to the problems of the euro zone.

But as the case of Ireland demonstrates, severe cuts reduce aggregate demand and induce further economic contraction, thus lowering government revenue faster than expenditure.

The main argument used by euro zone deficit hawks—since devaluation is no longer possible—is that public cuts will restore the competitiveness of Club-Med countries.

Once again, the problem is that where everyone practices fiscal retrenchment, aggregate demand throughout the euro zone contracts. Because so much of the euro zone’s trade takes place within it (ie, is ‘intra-trade’), what may benefit one country taken singly cannot benefit all simultaneously.

Competitive wage-cutting has much the same effect as beggar-thy-neighbor devaluation did in the 1930s. And with the poor performance of the US economy increasing competitive pressures in the rest of the world, Club-Med countries cannot easily increase net exports outside the euro zone.

In effect, we face three possible euro zone scenarios.

The first is a decade of very low growth and high unemployment all ’round. The danger is that in a decade’s time, Europeans will be so thoroughly disillusioned with the European project that it will fall apart politically.

The second scenario is default—whether partial or full. A partial default or debt restructuring exercise will, minimally, involve losses for creditor banks in Germany and France and necessitate further bailouts. Maximally, debtor-led full default would lead some Club-Med countries to leave the euro zone, entailing the possible demise of the single currency.

Alternatively, growing German resistance to ‘bailouts’ and a serious falling out with Paris over its export-led growth model might lead Germany to quit the euro and revert to its beloved DM.

 

George Irvin is a retired professor of economics. He is now honorary Professorial Research Fellow in Development Studies at the University of London, SOAS.

 

The third scenario is fundamental reform of the euro zone: the establishment of a genuine European Treasury with a substantial budget and fiscal powers and reform of the ECB, starting with the emission of federal euro-bonds.

It is becoming increasingly clear that if the euro is to be saved, this is the path Europeans will need to adopt.

By contrast, universal fiscal retrenchment enforced by levying fines on ‘profligate countries’ fails to address the real issues.

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But will European political leaders listen?

By George Irvin

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