Tag Archives: Portugal

The Global Economy is about to Crash

As stated in the EconoTwist’s New Years Eve comment; we are in for a long period of economic stagnation and financial turmoil – perhaps as long as two more decades. Well, now the prominent analyst Satyajit Das with the eurointelligence.com has arrived at the same conclusion.  In his latest article he compares the state of the global economy with the one of an airplane that is about to stall and crash.

“The eerie sound of the stick shaker can sometime be heard on cockpit voice recordings of doomed flights just before they crash. The global economy’s control stick is shaking violently.”

Satyajit Daz

“Powered flight requires air to flow smoothly over the wing at a certain speed. Erratic or slow air flow can cause a plane to stall. Most modern aircraft are fitted with a “stick shaker” – a mechanical device that rapidly and noisily vibrates the control yoke or “stick” of an aircraft to warn the pilot of an imminent stall. The global economy too needs air flow -smooth, steady and strong growth. Unfortunately, the global economy’s stick shaker is vibrating violently,” Mr. Daz writes.

The proximate cause of recent volatility is the down grading of the credit rating US (irrelevant) and the continuation of Europe’s debt problems (relevant). The deeper cause is the realization that future growth will be low and the lack of policy options.

Satyajit Das

In 2008, panicked governments and central banks injected massive amounts of money into the economy, in the form of government spending, tax concessions, ultra low interest rates and “non-conventional” monetary strategies – code for printing money. The actions did stave off the Great Depression 2.0 temporarily, converting it into a deep recession –the US economy shrank by 8.9% in 2008.

As individuals and companies reduced debt as banks cut off the supply of credit, governments increased their borrowing propping up demand to keep the game going for a little longer. The actions bought time. But policy makers did not use the time to prepare the global economy for an orderly reduction of debt. There was little attempt to address structural problems, such as persistent trade imbalances between China and the US or within Europe or the role of the US dollar as the global reserve currency.

Governments gambled on a return to growth and inflation, solving all the problems. That bet has failed.

(Source: Societe Generale)

Patient Zero…

Greece was always going to be Patient Zero in the global sovereign crisis, highlighting deep-seated problems in public finances of developed nations. While the deep economic contraction was a factor, government financial problems were structural. Much of the build-up in government debt had taken place before the crisis as a result of spending financed by increased borrowing.

Like individuals and companies, governments did not always use borrowed money for productive purposes, fuelling consumption and making poor investments. Realising that many European governments had too much debt that couldn’t be repaid, investors pushed up the cost of borrowing and then cut of access to funding.

Instead of treating the situation as a solvency problem and reducing the debt to sustainable levels, stronger countries within the European Union banded together to lend the distressed countries the money they needed. Within a period of about 12 months, Greece, Ireland and Portugal needed bailouts totaling just under Euro 400 billion. Many European banks, exposed to these borrowers, also lost access to commercial funding becoming reliant on European Central Bank (“ECB”) loans. The need to guarantee the weaker countries inevitably increased the liabilities of the stronger countries, weakening them.

Greece, Ireland and Portugal will need debt restructuring. Spain and Italy are now firmly in the sights of markets. The bailout strategy cannot continue without affecting the creditworthiness of France and Germany. In the absence of continuing bailout, the European banking system, including the ECB itself, is vulnerable and will need capital from governments – economic catch 22!

Going Viral…

The sovereign debt problem is global. The US. Japan and others also owe more than they can repay.

The recent rating downgrade of the US should not distract from the real issue – the quantum of US government debt and the ongoing ability to finance America. US government debt currently totals over $14 trillion.

Commentator David Rosenberg passionately described the problem: “In the past three years…we had the U.S. public debt explode by $5 trillion— the country is 244 years old and over one-third of the national debt has been created in just the past three years. Incredible. The U.S. government now spends $1.60 in goods and services for every dollar it is taking in with respect to revenues which is unheard of — this ratio never got much above $1.20, not even during the previous severe economic setbacks in the early 1980s and early 1990s.

America has been able to run large budget and balance of payments deficits because it had no problems in finding investors in US treasury securities because of the special status of the US dollar are a global reserve currency. In recent years, the Federal Reserve itself also purchased around 70% of issues, under its quantitative easing programs. As foreign investors, especially China, become increasingly skeptical about the ability of the US to get its economy into order, the ability of America to finance itself is not assured.

Japan’s government debt to Gross Domestic Product (“GDP”) is over 200%. Tax revenues are less than half its outgoings, the remainder must be borrowed. The world’s largest saving pool has allowed Japan to manage till now. An ageing population and a related slowing in its saving pool will make it increasingly difficult for Japan to finance itself in the future.

China’s headline debt to GDP ratio of 17% (around $1 trillion) is misleading. If local governments, its state controlled banks, state owned enterprise, and other government supported debt are included, then debt levels increase to 60% ($3.5 trillion), compared to America’s 93% of GDP. Some commentators argue that China’s real level of debt is far higher in reality, well above 100%.

At best, governments will cut spending or raise taxes to stabilize government debt as public-sector solvency becomes the priority. Reduction in government spending will slow growth, making the task of regaining control of government finances more difficult. This may require deeper cuts in governments spending and ever higher taxes, miring the developed world in low growth for a protracted period.

At worst, some governments overwhelmed by their debts will default, causing a major disruption in financial markets, perhaps setting off a deep global recession.

Unreal economies…

Government actions affected the financial economy far more than the real economy. Low interest rates boosted financial asset prices, while underlying economic activity remained weak.

Having shrunk by over 12% in 2008 and 2009, American output has yet to re-attain its 2007 peak. On a per-person basis, inflation-adjusted basis, output stands at virtually the same level as in the second quarter of 2005 – in effect America has stood still for six years. The same is true of many countries.

Given consumption is 60-70% of individual developed economies, unemployment, under employment and lack on income growth will reduce growth.

In the four years since the recession began, the US civilian working-age population has grown by about 3% but the economy has 5% fewer jobs — 6.8 million jobs. The real unemployment rate – people without work, people involuntarily working part time, people not looking for work because there is none to be found – is around 15-20% in the US. Long-term unemployment has left millions of people out of work with poor prospects of finding jobs.

Americans in work are generally working less and, adjusted for inflation, personal income is down, not counting payments from the government like unemployment benefits. American household income has declined since the recession began in December 2007, falling to $49,445 in 2010, a total 6.4% decline.

According to latest figures, the number of American families living in poverty rose 2.6 million to 46.2 million, the largest increase since Census began keeping records 52 years ago. Income falls were particularly large for the less well off.

In 2010, the bottom fifth of households that make $20,000 or less saw their incomes decline 3.8% after inflation.

Poor people, minorities were hit hardest. According to the National Women’s Law Center, the poverty rate for women climbed to 14.5% in 2010 from 13.9% in 2009, the highest level in 17 years. The extreme poverty rate for women jumped to an all-time high of 6.3% in 2010 from 5.9% in 2009. The poverty levels have reached the highest levels in over 15 years.

The same is true in Europe where the average official unemployment is above 10%. In many countries like Greece, Ireland, Portugal and Spain, unemployment is around 20%, youth unemployment is around 40-50%, as the economies have shrunk by 10-20%. Understandably, consumer spending is weak.

Key sectors, which employ workers, such as housing are frozen. In the US, housing starts are running around 400,000 to 600,000 units annually well below the level of the 1960s, down a staggering 70%+ from the peak and 50%+ from more normal levels.

With home prices down 35% from the peak and predicted to fall further, the Americans do not have a wealth buffer in housing equity to fall back on. Low interest rates and indifferent returns from investments mean that the ability of retirees to consume is also low. The same is true of many developed economies.

Emerging Problems….

After a sharp decline in economic activity in 2008, emerging nations – China, India, Brazil and Russia– recovered through massive domestic investment, aggressive expansion of domestic credit and, in some cases, strong commodity prices. They benefited from the stimulus packages of developed nations, which helped fuel exports. Money fleeing the developed world looking for higher returns and elusive growth provided cheap and easy capital. That cycle is coming to an end.

China provides an example of the problems. Over-investment in infrastructure produced short term growth but many of the projects are not economically viable and will drag down future growth. Many are funded by debt that is already creating bad debts within the banking system, requiring diversion of funds to bail out troubled institutions.

Tepid growth in the US and Europe, its two largest trading partners, will slow Chinese exports. China’s foreign exchange reserves, invested in US and European government bonds and denominated in dollars and Euros, are increasingly worthless, as they cannot be sold and, if held, will be paid back in sharply devalued currency with lower purchasing power.

Printing money as the US has done, devalues the dollar creates additional pressure on China. Strong capital flows overwhelm smaller markets creating destabilizing asset price bubbles.

Commodities traded in dollars increase in price creating inflation. Domestic inflation forces higher interest rates, slowing down the economy. The high proportion of spending on food and energy in emerging countries means a higher proportion of income is needed for essentials, reducing disposable income and creates wage pressures. These factors all choke off growth.

While improving American competitiveness and reducing its outstanding debt, a policy of devaluation of the US dollar may trigger trade and currency wars. There are already accusations of protectionism, currency manipulation and unfair competition. Many emerging markets have already implemented capital controls. These will be strengthened and supplemented by other measures such as trade sanctions. Even the Swiss National Bank recently announced moves to stop the flow of money into Swiss Francs seeking a safe haven, crimping growth and Switzerland’s exporter’s ability to compete.

Currency intervention may trigger tit-for-tat retaliation, reminiscent of the trade wars of the 1930s and will retard global growth.

Exit Via The Japanese Door …

Current concerns, most readily observable in wild gyrations of equity prices, are driven by the identified concerns but also the lack of credible policy options.

The most likely outcome is a protracted period of low, slow growth, analogous to Japan’s Ushinawareta Jūnen – the lost decade – or two. The best case is a slow decline in living standards and wealth as the excesses of the past are paid for.

The risk of instability is very high; a more violent correction and a breakdown in markets like 2008 or worse are possible. Frequent bouts of panic and volatility as the global economy deleverages –reduces debt- are likely. Problems created gradually over more than the last three decades can only be corrected slowly and painfully.

The eerie sound of the stick shaker can sometime be heard on cockpit voice recordings of doomed flights just before they crash. The global economy’s control stick is shaking violently. It remains to be seen whether the economic pilots can regain control and land the flight safely or whether it ends in a crash.

By Satyajit Das

Former Wall Street trader Satyajit Das is author of Extreme Money: The Masters of the Universe and the Cult of Risk (August 2011).

This post is syndicated by www.eurointelligence.com

Other post’s by Satyajit Das:

Related by the EconoTwist’s:

Advertisements

6 Comments

Filed under International Econnomic Politics, Laws and Regulations, National Economic Politics

European Credit Market: Close To Panic (Update)

While investors in the European credit market more or less capitulated last week, the situation is now more like a total panic. ECB President Jean-Claude Trichet says that the risk to the financial system is as high as it possible can be, putting the mark in RED zone on the new colorized risk meter.

“This did little to boost confidence in a market that already had concerns over the Greek government’s ability to get its austerity measures through parliament.”

Gavan Nolan

The Markit iTraxx SovX Western Europe breached the level  of 240 basis points for only the second time on record. Greek spreads blew up 213 bp’s, to 2100. Portugal gained 50 and are now trading at at record wide levels – 825 points. Other peripherals also widened sharply.

Contagion watchers will have been concerned by the significant moves in Spain (305bp, +22) and Italy (200bp, +20).

The latter sovereign went above 200 basis points  for the first time since January.

See also:

After ECB president Jean-Claude Trichet said that the risk to the financial system is as high as its gets. Trichet also said that the newly created European Systemic Risk Board was planning a “risk dashboard” with a color-coded warning system. And when asked what the current color would be, he answered; “on a personal basis, I would say it is red”.

“Unsurprisingly, this did little to boost confidence in a market that already had concerns over the Greek government’s ability to get its austerity measures through parliament. The conservative opposition declared that it would vote against the bill. This was to be expected and was consistent with its recent position. But there are signs that members of the ruling socialist PASOK party could also vote against the bill, placing its passage in doubt. Even if the government gets the measures through parliament it faces a considerable challenge in implementing them,” analyst Gavan Nolan at Markit Credit Research writes in today’s Intraday Alert.

Adding: “Talk of a “black hole” in the austerity plans added to negative sentiment.”

But the peripherals didn’t have just Greece to contend with, Nolan continues.

“The markets were already in a bearish mood after Ben Bernanke’s cheerless assessment of the US economy, and yet more disappointing economic data was unlikely to be shrugged off. So it proved with the release of Markit PMIs this morning.”

Recession Is Back?

Overnight the Markit/HSBC Flash China Manufacturing PMI came in at 50,1 –  a significant drop from the previous month,  and an 11-month low.

“A hard landing for the Chinese economy is one of the main fears of investors, and sentiment hasn’t been helped by the Sino-Forest scandal,” Gavan Nolan explain.

Growth momentum also appears to be slowing in the euro zone.

The Markit Flash Euro zone PMI fell to 53.6 in June, the lowest level since October 2009.

The core-periphery dichotomy is still evident, but worryingly the rate of growth in German manufacturing slowed sharply.

Output in the euro zone, excluding Germany and France, contracted for the first time since September 2009.

The data underlined just how difficult it will be for the peripheral countries to reduce their debt burdens through growth.

Volatility in the commodity world added to the tension.

Brent crude was down by over $6 a barrel to $107 after the International Energy Agency announced that its members were releasing 60 million barrels of oil from their emergency stocks.

Glencore – 302 bp’s, +36 – the world’s biggest commodity trader was the day’s worst corporate performer.

Here are copies of the latest Markit PMI survey:

Markit Economic Research: Eurozone PMI. 23062011.

Markit Economic Research: PMI and CBI surveys compared. 23062011.

Markit Economic Research: HSBC Flash China Manufacturing PMI. 23062011.

Markit Economic Research. China PMI Flash Comment. 23062011.

MORE@Scribd

Related by the EconoTwist’s:

2 Comments

Filed under International Econnomic Politics, Laws and Regulations, National Economic Politics

Italy And Spain Damage Investor Sentiment

Appetite for risk dissolved today in the face of yet more sovereign debt concerns and worrying economic signals. It was the two countries regarded as the safest of the “PIIGS” – Italy and Spain – that damaged sentiment, according to Markit Credit Research.

“With a general election in Portugal next month and local elections in Italy, political instability could yet create more spread volatility over the course of the year.”

Gavan Nolan


With Europe in a total financial chaos, without someone to lead the economic rescue operations, it’s no wonder investors are a bit sceptical. Another round of bad news sort of nailed the day in credits, Monday.

Late on Friday S&P placed Italy’s “A+” rating on negative outlook, citing the “heightened downside risks” in the government’s debt reduction programme.

Specifically, the agency highlighted the country’s weak growth prospects and the lack of political commitment to reducing the public debt burden (about 120% of GDP).

S&P did acknowledge that Italy’s budget deficit was smaller than the other peripheral euro zone countries, and that its banks have better quality balance sheets.

“These two factors help explain the relative stability in Italy’s spreads compared to the other peripherals,” credit analyst Gavan Nolan at Markit Credit Research writes in his Intraday Alert.

Adding: “Spain is not fortunate enough to be able to claim the same, and its economic problems are causing problems for the government.”

Over the weekend, the incumbent Socialist Party suffered a major defeat in regional and local elections, including the loss of strongholds such as Barcelona and Castilla La Mancha.

While a resounding defeat was expected, the result showed just how difficult it will be to maintain social unity in a time of austerity, Nolan points out.

There is talk of bringing forward the general election to this year, though this has been dismissed by prime minister Zapatero.

“With a general election in Portugal next month and local elections in Italy, political instability could yet create more spread volatility over the course of the year.”


The events in Italy and Spain temporarily took attention away from Greece.

“But the fate of the Hellenic Republic is central to how the debt crisis will unfold, and the uncertainty surrounding the country is set to shape sentiment until the denouement, whenever that may be,” Gavan Nolan writes.

The government met today to approve a fifth austerity plan, and there are reports that the EU and IMF will require them to quicken the pace of state assets sales in order to receive bailout funds.

“The country’s capacity to withstand yet more austerity is questionable and is only likely to heighten speculation around debt restructuring,” the Markit analyst states.

Away from the travails of the periphery, markets were also troubled by disappointing economic leading indicators.

The preliminary estimate of the Markit/HSBC China Manufacturing PMI showed that the world’s second-biggest economy is continuing to cool.

“The index dropped to 51.1 in May, a 10-month low, and added to fears that monetary tightening could lead to sharp slowdown,” Nolan comments.

Germany, another of the world’s growth engines, also saw its rate of expansion slow.

The Markit Flash Composite PMI came in at 56.4, still indicating growth but the lowest reading since October 2010.

“Signals that China and Germany are running out of steam will put even more emphasis on the US and the ISM number at the beginning of next month,” Gavan Nolan concludes.

Click to enlarge

4 Comments

Filed under International Econnomic Politics, National Economic Politics