26 November 2010

Ireland, PIGS and the Eurozone: Here we are…

1. Bailout, bailout and bailout
A few numbers on loans provided by the IMF and the EU:
Greece: EUR 29 billion (+ EUR 9 billion to be paid in January)
Ireland: EUR85 billion (will see during the WE what the final number is)
In January, Greece will get EUR 9 billion for its third installment (I have no doubt that even if they are dissent countries, arm-twisting will do the job), representing a total of EUR 38 billion i.e. 35% of the EUR 110 rescue package dedicated to Greece. Ireland will get EUR 85 billion i.e. 11% of the 750 billion EU and IMF backstop line.
The EU/IMF bailout will take total debt to GDP of Ireland to well in excess of 100%, and, realistically, it is most probable that the total burden of debt will be shared with creditors.
The cost of a bailout on the Irish scale for Portugal would cost EUR 100 billion, based on a package of 60% of GDP. According to Bloomberg, for Spain a bailout of 60% of GDP would cost EUR 632 billion. For Italy, the region’s second-most indebted nation after Greece, the figure would be EUR 820 billion, but I am not so worried about Italy, for reasons I will explain later, I am more worried about France
The EUR 860 billion double barreled package looks rather thin when the uphill task is contemplated. Even based on 30% of GDP, there is a shortfall, and don’t forget that a number of banks would not be able to sustain the shock.
Wednesday in Paris, European Central Bank council member Axel Weber said governments can increase the size of the European Union-led bailout fund if necessary to restore confidence in the euro. “If not [the EUR 750 billion recue], it will have to be increased.” In a worst-case scenario, the fund would need an additional EUR 140 billion, an amount that would not jeopardize the survival of the euro, Weber said Thursday in Berlin. EUR 140 billion? Why not 250 or 300 or 100? And which worst-case scenario is he talking about? And can governments that are already over-indebted increase their commitment? I doubt it, and in any case not in the current format.
2. The Eurozone is a (sad) farce
I note that all the Irish banks successfully passed the EU regulators’ tests in July; as discussed in this blog at the time, these tests had no credibility being designed to defuse the risk of a EUR collapsing even faster at the beginning of the summer: fact have stayed, waffle has gone. Likewise, ongoing declaration from European leaders have no credibility at all went they explain that the crisis is under control and that Spain will not need a bailout: why Spain should be much different from Ireland when they also had a real estate bubble of the same magnitude (true there are difference regarding the solidity of the banking sector, but in essence the situation is similar)…
On November 18, the Irish Finance Minister said, as reported by the FT:
“...Brian Lenihan, Ireland’s finance minister, told Irish radio early on Wednesday the banks had “no funding difficulties.”
On November 25, asked in an interview on Punto Radio in Madrid if Spain risked having to seek a rescue like Ireland or Greece, Salgado said “absolutely not.
” The euro faces “speculative attacks”. [Ah! The speculators are back, the usual scapegoat for politicians]
“I should warn those investors who are short-selling Spain that they are going to be wrong and will go against their own interests,” 
Zapatero said in an interview with Barcelona-based broadcaster RAC1 today.
Bloomberg continues reporting:
“Merkel and Sarkozy are “impressed” by government’s budget cutting plans, today’s statement said.”
Really? I am also impressed by their consistent denial of reality. Anyway, during a financial crisis do not trust banks and politicians the least.
Let’s carry on with some spice from Portugal’s Prime Minister latest declaration: 
“There are those who think that the best way to preserve the stability of the euro is to push and force the countries that at this moment have been more under the floodlight to that aid…But that is not the vision or the political option of the countries that are involved”
Add Austria Finance Minister Josef Proell who mid-November said the EU was postponing the payment to January to wait for a final estimate of Greece's fiscal numbers, since denied. However, the IMF added:
"So far the government has been able to offset these [revenue] shortfalls by underspending at a state level, that's why the overall targets are still being met. That's clearly not a sustainable strategy going forward…The sustainability of achievements to date will only be maintained if there is a very determined effort to move on structural reform".
Whatever, it shows that dissenting is getting more voiceful, after the Slovak parliament refused to participate in the bailout for Greece on 11th of August.
This crisis is moving towards a fully blown political crisis.
This is a farce, a sad screen play written by incompetent and dogmatic politicians who are driving Europe to the wall and its citizen to poverty. Nobody listened when I claimed numerous times to some European elites that the over-indebtedness of Europe will drive to lower standard of living unless tough and unpopular measures were implemented quickly: just watch Ireland, Greece, Spain, France et al. And this is only the beginning since countries have no longer money available to soften the effect of the crisis, to the contrary. The chart below gives you a flavor:

3. The foundations of the Eurozone are flawed
As written several times, the one-fits-all does not work. A union that was meant to foster economic convergence has fueled divergence. I can only agree with David Fuller:
“The Euro is based on the assumption that one monetary policy would be appropriate for 16 different fiscal policies. The peripheral Eurozone debt crisis highlighted how incorrect that hypothesis is and policy initiatives are currently being put in place to improve fiscal cohesion. However, this does not heal the very real debt problems that were allowed to develop over the last decade.
Without currency union, countries such as Ireland, Portugal, Greece, Spain or Italy would have recourse to a significantly weaker currency to help defuse their debt problems and improve competitiveness. On the other hand, today's Euro is probably considered by many at the Bundesbank to be too weak to contain nascent inflationary pressures in Germany. This is another contradiction that will eventually have to be dealt with.
German, French and UK banks are most exposed to bank and sovereign debt in the periphery. Greek and Portuguese sovereign debt, Irish banks and Spanish banks and Cajas pose a serious threat to already weakened financials in the rest of Europe. It is for this reason that governments have been forced to absorb private sector debts. The core Eurozone quite rightly expects those who borrowed to pay their debts. Bailouts on the periphery are seen as preferable to defaults and bailouts in the core. It remains to be seen whether voters in high deficit countries will be willing to accept the amount of economic hardship required to bring debt levels back into line with Eurozone requirements.

Over the medium-term, the big question is about competitiveness. The last decade saw countries such as Ireland, Greece, Spain and Portugal substitute a focus on exports and balanced budgets for spending and higher wages and inflation. The contraction in labour and other costs, if allowed to run its course, will improve competitiveness and set the stage for a medium-term recovery. Longer-term, it is to be hoped that voters display the fortitude and integrity necessary to make sure politicians with a focus on fiscal responsibility are put in power, lest the boom to bust pattern of development prove interminable. “ [emphasis mine]
It is time for weak European countries to sit down with creditors and agree on an organized debt restructuring and an haircut; I have advocated this since the beginning of this year as I do not see any other proper way out.
4. Who is really at risk?
The data provided by the Bank for International Settlements provide some useful information which I tabulated in the following table with some added flavor.

France, Germany and the UK are by far the most exposed to PIGS countries with EUR 1 trillion. Portugal is rather over-exposed considering the size of its banking sector. One big surprise is the very low exposure of Italy, particularly when compared to France.
When the net number is calculated (even if netting does not really work this way, but at least it provides a better idea of the real exposure and the arm twisting that can be used – remember Iceland), Italy and the UK are in an enviable position, being net negative.
This is the first reason why I am more negative on France than Italy.
The next table, borrowed from Morgan Stanly, confirms that French banks are the most exposed (besides the usual winner: RBS).

The second reason is derived from the following table:
Whilst France is less indebted than Italy, the sovereign debt growth is 4 times quicker in France than in Italy, and France will catch up Italy in absolute terms next year.
In addition, Italy has a trade balance in equilibrium whilst France is heavily in deficit, showing that Italy is more competitive, an important ingredient for a recovery and eventually the reduction of the sovereign debt.
A last word, this morning, I was hearing on the French radio that residential real estate in Paris was up by 13% so far this yearwith the average square meter above EUR 7,000, , a record high, thank to low interest rates and revolving credits again available: Central banks low interest rate and liquidity creation policy is again fuelling asset bubbles (including the mother of all bubbles: government debt).
Have a nice week-end!
FT: Dublin fails to dispel eurozone debt fears
Bloomberg: Portugal Says EU Can't Force Governments to Accept Rescue Aid
Bloomberg: Salgado Dismisses Bailout Risk as Borrowing Costs Surge to Euro-Era Record
Moneynews: Greece Cleared to Get Next Bailout Installmenthttp://www.moneynews.com/Economy/EU-Greece-Financial-Crisis/2010/11/23/id/377895
BIS: Locational Banking Statistics
Eurostat: European Economic Forecast - spring 2010