By Delusional Economics, who is unhappy with the current dumbed-down vested interest economic reporting the Australian public is force fed on a daily basis, and takes pleasure in re-reporting the news with “bad” parts removed, and a bit of contrarian balance thrown in. Cross posted from MacroBusiness
The big news from Europe last night was the “surprising” PMI numbers. But as usual the news also goes behind the headline.
The PMI again highlighted the underlying issues and delusion in Europe. As I have spoken about many times before, the European model is based on the fact that Germany is an industrial powerhouse which has suppressed its wages in comparison to its production compared to its neighbours. This has made it a large net exporter into Europe and therefore appear to be running a sustainable economy. But for that to be the case then other European nations needed to be net importers. Given the common currency, countries within Europe with differing productive capacity had a choice between labour markets or debt markets as their response mechanism. Given the liberalisation of the banking system and the illusion of credit risk symmetry across Europe many nations took the path of least resistance. Debt. By doing so they allowed Germany to continue to export into Europe under the illusion of sustainability, but as we have now seen this was a fool’s game. Weak political will in fiscal policy, the loss of national monetary control, de-regulated cross-boader banking and the single currency created an environment of massive imbalance.
We have now reached the point where that imbalance has lead to a crisis. The debt that accumulated in the periphery based on this model has now reached a point where it is unserviceable. But this has been a symbiotic relationship. The net exporters need the net importers to continually take on debt or they cannot finance the purchasing of their manufactures or maintain their banking systems that are based on loans to the indebted nations to continually fund those purchases. Demand that the periphery stop spending and down goes the whole ship. That is what we are now seeing.
Anyone making assumptions that there will be a recovery based on anything but a bailout or a write-off simply doesn’t understand the macroeconomic environment of Europe. That is why I have been stating for some time that this is an issue of leadership. Europe must choose its poison, it simply has no other choice.
Yet, even members of the ECB seemed to be completely confused about this point:
European Central Bank Vice President Vitor Constancio said sustained bond purchases by the central bank would only delay the fiscal adjustments that governments need to make.
“The secondary market purchases are not, and cannot be used to circumvent the principle of budgetary discipline as a pillar of Economic and Monetary Union,” Constancio said at an event in Frankfurt tonight, according to a text of his speech published by the ECB. “Sustained buying of government paper by the central bank would only postpone problems and delay the necessary fiscal adjustments, ultimately resulting in a build-up of inflationary pressures.”
The comments underscore the ECB’s reluctance to continue buying the bonds of distressed euro-area governments to contain a sovereign debt crisis that’s now threatening to engulf Italy and Spain. It was forced to re-start the purchases last month after governments failed to convince investors they can solve the crisis which, according to a research paper published by the ECB today, is putting the survival of the euro at risk. ECB Executive Board member Juergen Stark, a co-author of that paper, resigned this month to protest the bond purchases.
Constancio said an intensification of turbulence in financial markets “is leading to very high interest rates in some countries, to potentially damaging volatility, and to very low trading volumes in some government bond markets that at times cease to function appropriately.”
The ECB has no choice. It is the funder of last resort, there is no “fiscal adjustment” that any of these nations can make outside of defaulting if they do not continue to receive bailouts somewhere in the region of their external sector deficits while they are de-leveraging the government sector.
Over the past week we have seen more and more evidence that the rest of the debt laden periphery are lining up behind Greece in the default congo-line. From Portugal:
The budget deficit narrowed to €6.687bn in the first seven months of the year, a €2.243bn decrease against the same period last year, benefiting of an increase in revenue and a decrease in expenditure, the government declared Monday in its monthly budget report. This year’s budget target stands at 5.9% of GDP, as agreed under the bailout programme, from more than 9% in 2010.
The budget deficit narrowed to €6.687bn in the first seven months of the year, €2.243bn less than the same period last year, benefiting from an increase in revenue and a decrease in expenditure, but both at a slower pace when compared with the same numbers published last month, said the government Monday in its monthly budget report.
It sounds positive, but it is not. The government has enacted changes to the tax system in order to increase government income. But Portugal has a deficit in the external sector, high private sector debt and a stressed banking system. Under these conditions the inevitable outcome is that the private sector will deflate and this will lead to a fall in government income. This is exactly the situation we saw in Greece.
That is why, in light of the fact that government revenues are now slowing, the Portuguese PM admitted to national broadcaster RTP1 that a new request for help will be needed if the situation in Greece doesn’t receive a new bailout:
Portugal’s prime minister said late Tuesday that should Greece default, it is possible Portugal could need a second round of aid from its European peers and the International Monetary Fund.
“If something really negative happens in Europe, particularly in Greece, it is necessary that [Portugal] is fulfilling and even surpassing all the demands made by the troika,” Prime Minister Pedro Passos Coelho said in a televised interview.
“If something happens, it is important that those able to help us can do so convinced that what happened in Greece won’t happen here,” he added.
Italy and Spain are in exactly the same situation; it has just manifested in different ways:
Italy has leapfrogged Spain on the euro zone worry list but Madrid is still a long way from convincing investors it is on the mend as its regions fight high debt and its banks struggle with still-sliding property values.
Spain has something of a headstart on Italy.
It has been under market attack since May 2010 after Greece asked for its first bailout and Prime Minister Jose Luis Rodriguez Zapatero’s government was forced to recognize the crisis was at its door.
Austerity measures, which have helped save public coffers around 60 billion euros ($82 billion) since last year, structural reforms and a bank recapitalizing plan, have shown investors it is serious in turning its economy around.
And earlier this month, Spanish politicians agreed to set constitutional limits on public deficits and debt which will provide long-term certainty though they will not come into force until 2020.
On Tuesday, the International Monetary Fund said Spain may meet its 2011 deficit target of 6 percent of gross domestic product after 9.2 percent of GDP last year and 11.1 percent a year before that.
Italy by comparison has found itself under siege since July, just as bitter political infighting and a number of scandals besetting Prime Minister Silvio Berlusconi cast doubt on the government’s ability to implement meaningful austerity measures.
Italy has had to pay a higher yield on its 10-year paper than Spain for over six weeks as investors become increasingly concerned Rome is stuck in a trap of high debt and anemic growth.
“Italy’s bond spread is being driven by a liquidity rather than solvency risk. Italy has huge amount of public debt to refinance every year and, given the liquidity conditions in the secondary bond market, the refinancing risk of that debt increases proportionally,” rate strategist at Lombard Street Stefano Di Domizio said.
Spain, while it has one of the highest levels of household and corporate debt levels in the euro zone, has a relatively low debt-to-GDP ratio of an expected 67.3 percent this year. Italy meanwhile faces public debt levels of 120 percent of output.
Nonetheless, Spain’s economy is expected to remain stagnant into next year due to fragile consumer spending and slowing export growth, its 17 autonomous regions are making painful cuts to rein in deficits and its banking system is laden with bad debt from a construction bust.
It will take 17 billion euros to completely recapitalize, the Bank of Spain says, but critics say this figure is unrealistic and could soar higher.
Ironically the IMF knows that the current situation is unsustainable which is why they are being very vocal about Europe’s need to recapitalise its banking system:
Christine Lagarde, the managing director of the International Monetary Fund, urged Europe’s leaders to bail out their fragile banks, as the boss of the eurozone’s biggest bank, BNP Paribas, rejected fears that the financial sector is “in peril”.
Addressing journalists in Washington at the opening of the IMF’s annual meeting, Lagarde said that Europe must tackle “this twin problem of sovereign debt and the need to strengthen capital buffers”.
She said: “It is critical that to fuel growth banks be in a position to finance the economy, to finance enterprises, to finance households, to finance local governments. To do that they need to have the balance sheet that will actually support credit to the economy.”
Despite the recent stress tests carried out by the European Banking Authority, which suggested that most of the banks were well-placed to cope with the sovereign debt crisis, the IMF estimates that banks have taken a €300bn (£260bn) hit in the past year as a result of the growing risk of default by Greece and other vulnerable eurozone countries.
Europe needs to make a choice. Bail or default, time is up.
Update: Moody’s downgrades 8 Greek banks and maintains a negative outlook.
Moody’s said the outlooks for all the ratings remained negative. The downgrade concluded a review begun on July 25.
The agency cut National Bank of Greece SA (NBG), EFG Eurobank Ergasias SA (Eurobank), Alpha Bank AE (Alpha), Piraeus Bank SA (Piraeus), Agricultural Bank of Greece (ATE) and Attica Bank SA downgraded to Caa2 from B3.
Emporiki Bank of Greece (Emporiki) and General Bank of Greece (Geniki) were downgraded to B3 from B1.