Cyprus bail-in revisited: consequences for small economies

1. The news

European Commission draft documents leaked and released on the FT web site are offering a different picture from the previously released details of the bail-in.

First and foremost, in 9 days the bill has spilled over by EUR 6 billion amounting to a EUR 23 billion shortfalls to gap over a 3 years period. The additional burden falls on Cyprus, the total reaching EUR 13 billion.

Second, it will be entirely born by the deposit-equity swap at the new Bank of Cyprus (i.e. post acquisition of Laiki deposits), which nearly doubles to EUR 10.6 billion from EUR 5.8 previously: EUR 5 billion in 9 days (30% of 2012 EUR 17 billion GDP) is quite a number…

Third, Cyprus will sell “excess” gold reserves for a total consideration of up to EUR 400 million: I like the term “excess” in a world of ever devaluing fiat currency and “excess” represents 70% of its 13.9 t of gold! Since the leak, Cyprus has denied they intended to sale gold: what is contained in the report is an hypothesis, of course…

Fourth, bond holders under Cypriot law will be “encouraged” to roll over up to EUR 1 billion that mature until 2016, meaning that the EZ countries and the IMF will only provide EUR 700 million. In 2011 this “encouragement” was deemed by rating agencies (for whatever credibility they have) to lead to a selective default (rating agencies must have learnt from politicians rhetoric: one meets its commitments or one doesn’t; “selective” is bullshit), not talking about a credit event for CDS. Why what was meant to apply to Greece would not for Cyprus?

Fifth, like all assumptions made about Greece by the EU, the ECB and the IMF proved wrong, these will prove wrong for Cyprus: the economic situation will worsen much more than expected the 8.7% real GDP fall in 2013 and 3.9% in 2014. The debt/GDP ratio will go way above 130% in 2015, and not the 126% projected.

2. Cyprus other route

Cyprus lost its independence, like any over indebted country will, France included, not being able to meet its commitments.

To lose its independence, Cyprus had a better course of action: quickly negotiating joining a ruble zone and offering Russia a naval base in Cyprus plus offshore gas rights. Cyprus would have lost its independence but Cypriots would have been better of.

Geopolitically this would have been a coup for Russia: it will loose its naval base in Syria and would have replaced it with an even more strategically positioned one. Russia would also have enjoyed privileged access to Cyprus gas, further surrounding the EU. This also would have open the way for other disappointed countries with the EU to join the fray like Serbia; and eventually why not Greece. The Orthodox church is a powerful cultural and historical link between all these countries.

Cyprus cannot be kicked off the EU (well, European politicians and eurocrats are used to twist and carve treaties and laws to their own advantage), and therefore it would have allowed Russia to have a foothold in the house.

In any case, this would have been a trump card in the hands of Cyprus in its negotiating positions with the troika.

3. The future of small countries

The crisis has demonstrated that all countries in the EU are not equal in rights despite what is claimed (not surprising, it has always been the case: big boys bullying feeble ones). Rules do not apply the same way depending on size: France has hardly ever abided by Maastricht criteria, and always got away unarmed (we are nearing the end of it, since eventually facts are always right over rhetoric). Greece was slammed (they lied, so they got what they deserved), Cyprus walked over and Luxembourg is bullied.

Cyprus and Luxembourg are criticized for over relying on the financial sector. I do not know what makes Germany, France or the US to impose a business model to small countries whose size limits their ability to enjoy a well diversified economy. If they do not like money fleeing, they should offer a fiscal environment where money is happy at home: there is no tax haven if there is not tax hell. With France’s banks over 3 x GDP (more or less Cyprus post bail-in), the financial sector is much too leveraged. In the case of France, the media are increasingly reporting that young educated French national are going abroad to find a job (40-50,000 in 2012 – when one calculates the heavy cost of education and no return from those leaving the country, it will become unbearable at some point). These larges countries should first put their home in order before lecturing others. A few examples: Delaware money laundering machine where the beneficiary owner of a company does not need to be disclosed or the specific local laws that make it very difficult to get rid off an incompetent board or special protections against takeovers; France with its free zones, special tax treatment of Corsica or no income tax in French Polynesia to name a few; and what about the UK with the Channel Islands, The Netherlands with its holding tax efficient regime, etc.

Small to medium size countries where the financial sector allowed them to prosper are increasingly subject to bullying from large ones, the latter specializing in finding scapegoats for their own economic sins.

We are entering a world where democracy is much talked about as never before, but where reality contradicts the words. Small European countries beware, you have been warned.

Source:

European Commission: Assessment of the public debt sustainability of Cyprus

http://blogs.r.ftdata.co.uk/brusselsblog/files/2013/04/DSA-9-April2013.pdf

European Commission: Assessment of the actual or potential financing needs of Cyprus

http://blogs.r.ftdata.co.uk/brusselsblog/files/2013/04/Estimate-of-financing-needs-ESMT-art-13-v09042013-1.pdf

Reuters: Cyprus to sell around 400 million euros worth of gold

http://uk.reuters.com/article/2013/04/10/uk-cyprus-bailout-gold-idUKBRE9390NW20130410

Cyprus bailout: The wrong signal

Cyprus, the eastern Mediterranean island, becomes the fifth country to be rescued: euro zone Finance Ministers agreed on a EUR 10 bn loan; the novelty of the rescue is a tax on deposits with banks in Cyprus to amount to EUR5.8 billions. Mrs Merkel (and nobody contradicted her) found that Cyprus is a centre for money laundering (from Russia and the Middle East) and therefore depositors should be taxed to participate in the bailout; well, if it is the case (and probably it is), the country should not have been admitted within the euro zone in the first place and probably the EU, since these accusations have been running for so many years; by the way, France, the UK, Luxembourg, The Netherlands, Italy, Spain should also be concerned (money laundered via banks and/or real estate). Others explained that a EUR 17 billion loan would overburden the debt/GDP ratio in a way where Cyprus would not be able to repay which is right at 200%. Frankly, EUR 10 billion lending does not change the conclusion anyway, at +/- 150% ratio.

Bank accounts were frozen and the tax will be immediately levied on Tuesday when banks reopen (subject to a positive vote at the Parliament of Cyprus).

The levy is:

6.75% tax on deposits below EUR 100,000

9.9% tax on deposits above EUR 100,000

I would remind the reader that Cyprus banks were meant to go under immediately after the haircut was decided on Greek debt (EUR 4.5 billion loss) and nobody foresaw the problem coming? I do not believe it but since the fiscal situation of Cyprus has deteriorated markedly (oh! Yes, I had forgotten that Presidential elections in Cyprus were held late February 2013…).

Besides the morally disputable action –why punishing the honest citizen who has saved all his life and in addition may have loans on the other side? – It is a very dangerous action sending a clear signal to all European citizens and the rest of the world: Europe is no longer a safe place for depositors; we knew that artificially low rates and rising inflation were in motion to deprive savers, but Saturday’s decision is a leapfrog in the wrong direction. I understand Mrs Merkel who wants to send a tough signal to her public opinion and Parliament. I am not either convinced by the reason given by the Dutch Finance Minister Jeroen Dijsselbloem: “As it is a contribution to the financial stability of Cyprus, it seems just to ask a contribution of all deposit holders”, so what about the Greeks, Portuguese, Irish and Spanish? And what about senior and junior lenders: I would be most interested to see whether they will be hit and if yes, in which magnitude (no details on this-probably banks mainly financed themselves via deposits; I did not look at aggregated Cypriot bank’s balance sheets)?

This is creating a precedent which will hit the confidence in the euro zone institutional environment and safety for depositors. Despites all assurances yesterday and today, particularly in Spain, that Cypus is a special case (it is ALWAYS a special case), residing in a trouble euro zone country, I would be very very worried and would not wait to get most of my saving in a safe place (i.e. outside the euro zone -the nearest is London). No depositor in the euro zone is safe any longer with his savings: each country could impose such a tax for whatever reason, good or bad (remember Roosevelt stealing gold from Americans in April 1933). This would be politically correct: tax all deposits above EUR100.000 in countries receiving EU money, and why not in countries with disastrous public account (France and Italy). Not the way forward for a sustainable fiscal consolidation to create the bedrock of future prosperity.

In the meantime France will not abide by the Maastricht criteria in 2013 (and 2014, I bet), or 8 years over the past 11, without any sanction, despite repeated assurances. Another wrong signal: the rules do not apply the same way to every euro zone country.

Source:

Bloomberg: Europe Braces for Fresh Turmoil With Cyprus Deposit Levy

http://www.bloomberg.com/news/2013-03-17/europe-braces-for-renewed-turmoil-as-cyprus-deposit-levy-at-risk.html

Financial Times: Cypriot bank deposits tapped as part of €10bn eurozone bailout

http://www.ft.com/intl/cms/s/0/33fb34b4-8df8-11e2-9d6b-00144feabdc0.html#axzz2NphVijdj

Current account surplus is a key determinant to bonds market turnaround: Italy’s case

I am reproducing in extenso a market view published bay Horseman Capital which deals with the importance of current account in assessing the ability of a country to return to good fortune, i.e. when the bond market is turning around. In a previous review published in October 2011, Rusell Clark made a good case that returning to a current account surplus is key to the turning point in bond markets.

This espouses my views about France being the real sick man of Europe as exemplified by the graphs below (and see http://marketsandbeyond.blogspot.com/2011/10/who-should-be-single-rated-italy-or.html):

Let’s now read what Russell Clark has to tell us about current accounts, Italy and the bond market.

“Sovereign Debt – Italy

In my last note on Sovereign debt – sent out in October 2011 – I noted that in all the debt crises that I have looked at, the turning point occurs when the troubled country can turn its current account deficit into surplus. I noted that of the distressed peripheral countries in Europe only Ireland had achieved current account surplus, and hence we were buyers of Irish bonds.

Since then Irish bonds have recovered most of their losses of 2011, and the Irish government has been able to return to the bond market. This is during a period of sustained instability in the far bigger bond markets of Spain and Italy.

Italy

Italy has one of the biggest bond markets in the world, and financial commentators quite rightly point out that its size means that it would be difficult if not impossible to implement the same programs that have been used by the European authorities in Portugal, Ireland and Greece. Hence, in my view the future of the Italian bond market is probably a key determinant of the survival of the Euro in its current form.

Like the other troubled nations of Europe, Italy has been running a current account deficit for a prolonged period of time. There have been recent signs of improvement, but not enough to move Italy to a current account surplus. The Economist estimates that Italy will run a 2.4% current account deficit for 2012.

However, beneath the slowly improving current account numbers, Italy’s bilateral trade numbers are showing signs of big improvements. Italy has shown a dramatic improvement in its trade deficit with China, the EU and the US.

If Italy has improved the trade positions with three biggest economic regions of the world, why have we not seen better improvement in the Italian current account? The answer is apparent when we look at the break down of Italian trade by category. As can be seen below, Italy has improved its manufacturing trade balance significantly, but all the gains in this area have been lost due to increasing commodity (mainly energy) trade deficit.

Should we see lower energy costs, I believe we would see a significant fall in the Italian current account, potentially pushing Italy to a current account surplus. For investors looking to play lower commodity prices via a long position in fixed income, Italian bonds look attractive in my view.

Almost all of Italy’s energy needs are priced off the Brent oil price. In 2008, all energy sources were comparably priced, but since then we have seen large divergences, which have put Italy at a disadvantage. Should we see a convergence in energy prices, Italy should be a relative winner, and Italian bonds should also prove to be relative winners.”

Source:

Horseman Capital: Russell Clark – Market Views August 2012

www.horsemancapital.com

Trading Economics

http://www.tradingeconomics.com

Markets & Beyond: Who should be single A rated: Italy or France?

http://marketsandbeyond.blogspot.com/2011/10/who-should-be-single-rated-italy-or.html

 

Greece: August 20 will not be the day of reckoning

After The ECB rejected a proposal by Greece to delay 1 month a EUR 3.2 bn bond repayment, Athens issued EUR 5 bn worth of 13 wk T-Bills August 14, including non-competitive bids, which was bought by local banks on a meager 1.36 x cover ratio (the worst to date) which really shows that even short term financing is becoming difficult. These banks will probably use the T-Bills as collateral with the Greek central bank to access its emergency liquidity assistance (ELA).

Below is the current schedule of T Bills redemption until year end, i.e. EUR 15.2 bn.

The situation remains most precarious. The lack tax collection, in particular due to a continued fall in the GDP y0y and to some extent persistent fraud, does not bold well for the Greek budget. The debt is again on the increase with a sharp EUR 23 bn QoQ: after investors wrote-down EUR 105 bn in March, reducing the debt to EUR 280 bn, end of June it was back above EUR 300 bn at 304 bn.

The budget execution is rather dismay, revenues being 24% behind plan for the period January-July 2012. Looking at it in more details, the PIB item is again manipulated this year in the turn EUR 1.4 bn to present an acceptable bottom line picture.

Despite the debt write-down, interest payments remain as elevated as last year but in line with the budget.

With no GDP improvement in the foreseeable future, and the troika requesting EUR 11.5 bn additional spending cuts in order to provide further financial assistance, the squeeze will continue on the population. This being said, even if Greece does not abide by its commitments, I have no doubt that they will get additional financial aid from the EZ (In my opinion the objective is until the 2013 German elections, but I doubt markets will allow it without the ECB jumping in full gear by buying EZ sovereign debt in the primary and secondary markets with no limit).

Source:

Greek Ministry of Finance: Budget Execution Bulletins

http://www.minfin.gr/portal/en/resource/contentObject/contentTypes/genericContentResourceObject,fileResourceObject,arrayOfFileResourceTypeObject/topicNames/budgetExecutionBulletin/resourceRepresentationTemplate/contentObjectListAlternativeTemplate

Eurozone: This time is different, or is it?

Thursday, Germany lost twice against the Italians: once for the euro 2012 soccer cup semi-final and then, later during the night, when the Italian PM Monti’s (and Spanish PM Rajoy) blitzkrieg won over frau Merkel. He played tough by simply refusing to sign any agreement until Germany agreed that the eurozone must jointly back Spanish banks without Spain having to guarantee the deb.

1. The agreement

• setting up a single European supervisory mechanism for banks under the ECB control

• ESM allowed to directly recapitalize banks

• Possibility for countries which are complying with common rules, recommendations and timetables, to make use of the existing EFSF/ESM instruments to stabilise markets. Financial assistance to Spain will be provided without seniority status for the financing provided by the EFSF/ESM.

• mobilizing around 120 billion euro for growth measures:

• A 10 billion euro increase of the capital of the European Investment Bank implying a lending capacity by 60 billion euro.
• The other 60 billion euro comes (i) from the reallocation of unused structural funds (55 billion), and (ii) from the pilot phase of Project Bonds to be launched this summer and targeted at key initiatives in energy, transport and broad-band infrastructure (4.5 billion).

• Adopting a Financial Transaction Tax by December

2. What’s next?

Ireland must rejoice since they now can lineup to require the same favorable treatment, which cost is put at EUR 64 billion.

European (read mostly EZ) taxpayers are on the hook thanks to the pan-EZ mutualization of the European banking sector rescue. Do not misread me, I strongly believe that for a monetary union to survive (if not thrive) the banking sector MUST have a single supervisory board and the costs must then be shared. However, we are mutualizing liabilities before having had any chance to mutualize benefits (and will probably share none, if any in the future) at nil cost for banks; in a capitalistic environment, the ones who rescue an ailing company take control: nothing near this simple and sensible criteria here… I also notice that no FDIC equivalent is set up to guarantee deposits with no limit on the number of accounts guaranteed one can hold.

The question remains: is this the first step towards the mutualization of sovereign debt? I cannot believe that Germany would carve in; if they do, the credibility of Europe would be jeopardized.

The direction towards fiscal integration is going ahead but many obstacles remain which let me think that the success is far from being certain (I am in fact very doubtful).

Fiscal union without social union will fail as the EZ failed (whatever politicians do to disguise it, it is a failure). The EU loves, and writes in many of its statements, the words “best practice”: ask the French if best practice is 67 years old retirement age, no minimal wage, 40h a week working time, etc.

What last week agreement achieved is reassuring markets for some time by reducing the amount of money Club Med countries will devote to save their ailing banking sector: Spain has gone from 100% down to 12%. Conversely, France is adding EUR 20 billion of liabilities. Remember my words for a rather long time, France is really sick economically and worse than Italy. Today, the French Audit Court is publishing a report that I will carefully read; the first comments are rather straight to the point: EUR 40 billion need to be found until end 2013 to abide by France’s commitments on deficit reduction…

Markets will however go back to the reality of the EZ: a monetary union with a widening competitiveness gap. NOTHING, I repeat nothing, of what was decided last week is addressing this gap; the EUR 120 billion to spur growth via infrastructure investments, particularly in distressed European countries, will take years to bear fruits and 1% of EZ GDP split over 5 or 10 years, with nearly nothing in 2012-2014, is not going to help them drive their way out of recession.

The core of the problem is still pending: lack of competitiveness of Southern Europe versus Northern Europe. As a matter of fact, French will never accept a 25-30% decrease in wages to become competitive again: understandably they will always prefer a currency devaluation than a salary devaluation (and no, the effects are not the same for the population concerned).

Conclusion

Yes, this time is different because Germany bent before blackmailing, but no, it is not different because the roots of the problems remain: lack of competitiveness and structural trade deficits that act as a drag on growth which is the only way out of the crisis. The necessary structural adjustments (lengthening of working hours, postponing the retirement age, reducing the share of the public sector in the economy, etc.) will only be accepted by the population if there is some form of growth. Austerity to bring public finances under control without devaluation is a death spiral – see Greece.

As reported by Bloomberg: “the EU’s two rescue funds may only amount to about 20 percent of the outstanding debt of Italy and Spain, limiting the ability to lower the nations’ borrowing costs.”, not mentioning France.

Source:

European Council 28/29 June 2012 – Conclusions

http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/131388.pdf

Remarks by President Herman von Rompuy following the European Council

http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ec/131390.pdf

Bloomberg: EU Leaders Ease Debt-Crisis Rules on Spain

http://www.bloomberg.com/news/2012-06-29/eu-leaders-ease-debt-crisis-rules-for-spain-as-merkel-retreats.html

Eurozone falling chikens’ choice: internal or external devaluation?

1. An awful political background

Since the financial crisis started in 2007, 8 elections in Europe have driven incumbent parties out of business. Whether justified or not, it shows how the European population is disgruntled by a generation of politicians whose lack of courage led to the current over-indebtedness mess (N.B. voters share the responsibility by voting for the same politicians they despite now).

For a couple of years I have written that Greece could not be saved and I strongly believe that European politicians did not give a damn about Greece to solve the crisis, and were solely interested in insulating their banks from a Greek default: to succeed, (1) time needed to be garnered (hence the succession of costly bailouts) and (2) the ECB involved by buying sovereign debt from banks and extending unlimited liquidities; banks used these liquidities to buy more European sovereign debt (the 3 years EUR 1 trillion LTRO is meant (1) to provide some breezing space for deficit prone Southern European countries –France included- and (2) give a free return to banks to strengthen their balance sheet in the turn of 2-4% i.e. EUR 20-40 bn a year, a disgrace– as a side comment, none of the executives of European banks benefiting from the ECB largess should get any bonus since the profitability of banks has nothing to do with managerial acumen, and should in fact, for many of them, be bankrupt; as I have advocating for so many years banks’ executives and theirs boards should have been fired: what shareholders are waiting for?).

Greece will again go the poll in June and I do not see why results would favor a corrupt and incompetent political arena which has ruled Greece for 30 years, and all poll are giving the extreme left SIRYZA party a large lead. Despite disguised threats to the Greek electorate (80% want to remain within the EZ but with no austerity but an open check book from the Germans – they are living in Cuckoo land) from policy makers about a possible exit from the EZ (if your vote is wrong i.e. you do not abide by our integrationist rules, then it will be a disaster for you and no more money from us), the PASOK and the so-called liberals will be out of business for good, hopefully. The trick is to propose at the same time a referendum about the exit of Greece from the EZ which would end up in a rather strange situation where the majority would vote for an anti-austerity parliament and at the same time vote again the exit from the euro whilst bailouts are linked to austerity; the discussions about adding growth to austerity are fine but will not address the roots of the problem: lack of competitiveness.

After the failure of economic convergence within the EZ, we are witnessing Greece’s standard of living fast converging not with Northern Europe but with its European neighbors, Romania and Bulgaria!

For the time being, Greece got its EUR 4.2 bn rescue payment from Europe last week (add EUR 1.6 bn if the IMF disburses its part of the deal) that will cover its liquidity needs for June and probably until late July since Greece has hardly any repayment due in July.

Parliamentary elections in France, also taking place in June, will see the current Sarkozyst party (UMP) lose a considerable number of seats pending unofficial local agreements with the FN, Mrs. Le Pen populist party. The socialist party will win the elections, the question being by which margin: if their victory is large enough, after gaining control of the Senate in September 2011 for the first time under the V^th Republic, they could hold 2/3 of the congress (Senate + Parliament gathering) to modify the constitution as they wish.

Germany’s Chancellor Angela Merkel registered a strong defeat in North Rhine-Westphalia state election in May, the most populated region. However the increased lead for the SPD (the center left) does not mean that this will end the austerity imposed onto Southern Europe since it is the SPD that enshrined budget balance in the Constitution: Germans will not agree to finance ad vitam aeternam Southern Europe for the sake of “peace and the European construction”, which is the dogmatic and untrue eurocratic motto.

2. An awful economic background

Economic forecasts for 2012 and 2013 are between bad and disastrous for Club Med countries (the IMF is less confident than the EC, and private forecasters are even more pessimistic), and downward revisions will crawl along the year and next.

As the table below exemplifies, GDP will turn negative this year and more deeply so in 2013, with hardly any EU country escaping, the EZ being more affected, and within the EZ, Southern Europe the most

In the case of France, the new President, François Hollande, based his economic program on official, and as usual over-optimistic, growth forecasts of 0.7% in 2012, 1.75% in 2013 and 2% until 2016, whilst the country will be in negative territory in 2012 and 2013 at least. Add a Greek default and you get an asset that becomes a straight loss in the turn of EUR 15 bn from the first bailout already paid plus any recapitalization of the ECB.

France’s deficit will not be reduced back to the 3% Maastricht criteria in 2016 and its debt will continue on its upwards trajectory. Expect 2 notch rating downgrade within 12 months.

 Like other Europeans, the standard of living of French citizens will keep up contracting.

The key issue of low competitiveness is structural, and economic, social and tax reforms are not addressed. Policy makers have focused for too long on what they thought, incompetently or dogmatically, were liquidity issues.

3. The choice

This foolish blindness is leading to one of two tough choices: internal or external devaluation to quickly regain competitiveness.

Let’s come back to my preferred equation:

PIB = Public spending + private spending + commercial balance

The World has huge imbalances which result from demand led economies (USA for example) whose consumption is satisfied by export driven economies (China for example), and these imbalances must be corrected to go back to some economic and financial normality.

Looking at the equation, and taking into account the state of debt and budget deficits in demand driven economies in the West, they MUST shift their focus to improving their trade balance, and export driven countries MUST stimulate domestic demand.

There are two ways to improve the trade and services balance: either increase exports or reduce imports or a combination of the two.

To increase export one needs to propose goods that others want to buy by focusing on added value products (there is no way to be competitive for goods very elastic to prices) or unique goods and improve competitiveness. Wage and social costs are the items a country controls which impact productivity and no Club Med country will escape harsh austerity. Energy is also quite important and must be addressed (the USA is thriving in becoming self sufficient again in the years ahead thank to technology which allows shale oil and gas recovery – this will all also have a substantial positive impact on the US trade balance).

To reduce imports, goods must become too expensive for consumers or find the same ones locally at attractive prices. This can be achieved via custom tariff and/or other tricks or via unfavorable exchange rates.

Therefore, taking the extreme case of Greece (but it is valid for Spain, Italy, France, etc.), to rebalance the economy and improve the terms of trade, the choice is between external or internal devaluation.

External devaluation corresponds to the exit from the fixed exchange rate mechanism (the euro) where the Drachma will loose 50-70% of its new parity with the euro (or DM) leading to much higher imported goods thus lowering consumption and more importantly lowering imports; this assumes that the goods and services needed will be substituted with locally produced ones, otherwise the country will continue impoverishing itself. The terms of trade for exports will also dramatically improve, assuming Greece will produce goods other countries want to buy. For the country not to crumble under debt servicing, this will be accompanied with a debt default (restructuring, straight default, inflating the debt away, you name it). Competitive exchange rate devaluation has always been and still is an economic policy tool (see the US and China manipulating their currencies at will).

Internal devaluation is where countries have chosen austerity without currency devaluation: the only adjustable variable is real wages and social benefits which must be reduced and this must be equivalent to a currency devaluation. The terms of trade will not improve and trade imbalances will remain. Debt servicing becomes unsustainable by eating a rising portion of taxes collected. This can only work with fiscal transfers from other countries if a social collapse is to be avoided, i.e. Germany continuing paying.

Whatever the course of action followed, the standard of living of Europeans will continue to fall for years if not for a decade. However, the internal devaluation route, if followed, would end up very nastily.

I will never sufficiently outline the need for Europe to focus on innovation (strength of the US which also explains why I am more positive on the US economic prospects than the European one) and demographics, an other factor of economic growth: spending money in these areas instead of Greece et al. would have been more beneficial to European growth long term.

Source:

Capital Economics: European Economic Outlook Q2 2012

http://www.capitaleconomics.com/

French Presidential Elections: First round and why it does matter

1. Results

For the first time under the V^th Republic, the incumbent President is behind his main challenger.

The official results are as follows (I do not provide the meaningless result from Jacques Cheminade):

2. Consequences

One of the central conclusions of the campaign is the rejection of the EU as it currently works and calls for increasing protectionism: even Sarkozy demands modifications to the Shengen accord and Hollande a renegotiation of the Lisbon Treaty. A quick analysis of the results show that, in one way or the other, the vast majority campaigned on a platform that will lead to a frontal shock with Germany: budget balance and austerity vs. social welfare and deficits, southern Europe vs. Northern Europe, domestic demand oriented growth vs. export oriented growth.

In addition, both Sarkozy and Hollande built their programs on an over-optimistic GDP growth forecast to cut borrowing at 0.7% in 2012, 1.75% in 2013 and 2% until 2016, well above consensus (most politicians do overstate future growth to buy votes). and neither is addressing the key issues holding back growth. For example, last week the IMF revised down 2013 French growth to 1.0%.

Whoever is elected President on May 6, he will not be able to hold by his promises. This will have a number of consequences:

• Spread between OAT and Bund will widen
• The eurozone will again come under strain and attack from markets (i.e. investors)
• France will loose it AA+ and be downgraded (over a 18 months period, one notch if Sarkozy is elected, two notches if it is Hollande)
• Expect social unrest within 12-18 months, particulalry if Sarkozy is elected

Then, the Parliamentary elections will come in June and there is no chance whatsoever that the current ruling party wins, even if Sarkozy is re-elected. The antagonism with the Front National is too entrenched and the possibility for the Front National candidates to have enough votes to remain in 1/3 of constituencies for the second round.

If Sarkozy is not elected (the likely outcome as of today since over 1/3 of Bayrou and 40% of Le Pen voters will abstain for the second round, the rest will go +/- 50/50 for each remaining candidate), I also expect the current ruling party to fall in shambles with infighting between Coppée (current Head of the ruling party - UMP) and Fillion (current Prime Minister – a senior member of UMP) each preparing for the next Presidential race in 2017 (Fillion will present himself at the mayoral election for Paris).

I then forecast the Front National to try its utmost to organize the opposition to the the socialists around its platform, with some with the right wing of the UMP joining forces with the National Front, and possibly Dupont-Aignan.

Source:

Ministère de l’Intérieur: Presidential elections 2012

http://elections.interieur.gouv.fr/PR2012/FE.html

Ministère des Finances: Stratégie Pluriannuelle de Finances Publiques

http://www.budget.gouv.fr/files/mise-a-jour-rapport-economique-social-financier.pdf

Capital Economics: French election won’t tackle key issues

www.capitaleconomics.com

Stop Press: Markit Eurozone Manufacturing PMI – It’s really bad

I usually do not post this kind of economic data, since there are so many published every week. I am doing so since the numbers are striking, France in particular is a real disaster. As I indicated many time, forget about Portugal, Spain (well not really, do not forget Spain!) and Italy, France is the sick man.

Greece: 3 month high but still in contraction territory @ 41.3

France: 33 month low (yes, you read it right!) @ 46.7 (I heard on the French radio that the 2 French auto-manufacturers – Renault and Peugeot – had sales 30% down in March; the French auto industry, Peugeot in particular, is entering the danger zone for its survival).

The roots of the problem have not been addressed, and politicians are still in denial territory: the construction of Europe for the past 20 years is a failure due to a dogmatic approach.

Source:

Markit:  Markit Eurozone Manufacturing PMI® – final data

http://www.markiteconomics.com/MarkitFiles/Pages/ViewPressRelease.aspx?ID=9330

Greece, Europe and the rule of Law

On 23^rd February 2012, the Greek parliament passed a Law which at the time went mostly unnoticed in one of its provisios: the retroactivity of the CAC (Collective Action Clause) for Greek Law bonds. Greek bonds holders who do not accept the debt swap will be forced to do so.

EUR 205 bn were eligible for the debt swap:

Investors (well, banks) holding EUR 152 bn Greek law bonds accepted the offer (85.9%)

and EUR 20 bn of non-Greek law (69.9%), i.e. 83.7% for the aggregate.

The invitation period (to the public offer) for each series of PSI-eligible foreign-law bonds and of bonds issued by state enterprises and guaranteed by the Hellenic Republic has been extended until 9:00 p.m. (C.E.T.) on March 23, 2012. Note that not only content to renege on past contractual agreements on Greek-Law bonds, Greece is threatening to default on bonds held under foreign (Brtiish) Law if bondholders do not accept the terms of the bond swap agreed (read forced) on March 8.

I thought retroactivity of laws was the benchmark of totalitarian regimes, but no, it is happening in 2012 within Europe, in the birthplace of democracy. All European leaders are applauding to something they should utterly reject, but for futile self-political interest. There is one basic principle of democracies: the non-retroactivity of laws.

I feel that any investor would successfully challenge this before the European Court of Human Rights.

Source:

Hellenic Republic – Ministry of Finance: Press release PSI

http://www.minfin.gr/portal/en/resource/contentObject/id/baba4f3e-da88-491c-9c61-ce1fd030edf6

Eurobank EFG: Greece Macro-Monitor

http://www.eurobank.gr/Uploads/Reports/FOCUS%20GREECEPSI%20March%209%202012.pdf

ISDA: Unofficial translation of the Act of the Governor – Bank of Greece

http://www.isda.org/uploadfiles/_docs/Act_of_the_Bank_of_Greece_9_March_2012.pdf

Greece 2011 Budget execution and the (bleak) future

A year ago, European politicians were hailing the progress made by Greece stating that the nadir of the crisis was behind and difficulties ahead would be dealt with forcefully. As my readers may recollect, I did warn that the plan will fail and the Greek situation would worsen, the country being bankrupt.

Let’s see what happened in 2011 in the Greek Budget:

Note that the last column was the planned 2011 budget as of December 2010, whilst the column (5) contains the budget post-revisions.

A few remarks:

• Compared to the original plan, the budget implementation failed miserably with a EUR 5.5 bn wider borrowing requirement, i.e. a staggering +23%.
• A much larger gap would have been registered (EUR -3.3 bn) without deep cuts in military spending (EUR -1.3 bn.) and the Public Investment Program (EUR -2 bn) during the course of the year compared to the initial budget.
• Revenues were lower than in 2010 and EUR 5.5 bn less than in the initial budget, EUR 6.7 bn if it was not for a new line of revenues that “miraculously” appeared in November and December, registering EUR 1bn (“special revenues from licensing public rights”). Primary expenditures were contained but did not decrease enough to compensate.
• Interest payments were marginally higher than in the initial budget, but EUR 3 bn more compared to 2010.

As I forecasted early 2011 (and also in 2010) the situation has worsened, not improved. Greece is insolvent with a 155% debt/GDP, a 10% budget deficit/GDP (there are rumors that it would finally be closer to the 9.1-9.4% mark thanks to an emergency property tax representing a good EUR 1 bn –looks like a desperate trick to “improve” the picture of a desperate situation) and EUR 350 bn debt (not talking about high unemployment, dismay current accounts and trade balances, insolvent banking system, deposits going abroad, weak productivity, antiquated social welfare state, continued weak tax collection – whilst improving -, etc.). 

As of this Saturday morning, discussions with the financial sector are ongoing regarding the level of write-downs, or more exactly the strength of guarantees on the new bonds to be swapped with the existing ones.

The schedule of T-bills maturing during the next 5 months is:

26wk	09-Aug-11	10-Feb-12	1,000
13wk	15-Nov-11	17-Feb-12	1,600
26wk	06-Sep-11	09-Mar-12	1,455
13wk	20-Dec-11	23-Mar-12	1,600
26wk	11-Oct-11	17-Apr-12	1,600
13wk	20-Jan-12	20-Apr-12	2,000
26wk	08-Nov-11	11-May-12	1,600
26wk	13-Dec-11	11-Jun-12	2,000
26wk	13-Jan-12	13-Jul-12	2,000

In March, add two 5 years bonds due for redemption:

5 yr	07-Feb-09	20-Mar-12	7,000
	05-May-09	20-Mar-12	7,433

Therefore, Greece will need to auction T-Bills next week and the following one to refinance maturing ones (which should go fine if nothing dramatic occurs with the discussions between banks and Greece on existing debt) and find EUR 16.5 bn in March, i.e. EU and IMF money.

To regain solvency, the discussions are centered around how much the financial sector would forgo, and the latest discussions are 70% of their current debt holdings, beyond EU/IMF rescue packages and drastic austerity measures. Would this be sufficient? No: Europe is at best growing flat, debts continue to go north and trade imbalances between countries are not reduced, and these imbalances are one of the reasons of the current crisis, themselves a result of the widening competitiveness gap between countries, with no currency adjustment possible within the euro.

This crisis cannot be solved by only reducing the stock of debt but also by improving cash flows, i.e. growth. Whether the financial sector forgoes 70% of its Greek debt pile (estimated at EUR 200 bn with themajority of it held by Greek banks and, in my view, a substantial chunk of thebalance with the ECB), this is just kicking the can down the road as it has been done for the past 2 years (well, really for the past 10 years). Let’s see the simple equation below:

GDP = private sector consumption + public sector consumption + (exports – imports). This is a very important equation largely overlooked by commentators.

For Greece all of theses items are negative yoy, according to the latest official statistics, and in many countries at least two items are negative: in the current economic environment there is no way that Greece (and others) can get out the over-indebtedness black hole. Greece and Club Med countries (France included) need to improve competitiveness to gain/regain a positive trade balance.

Growth based on retail demand in southern Europe was unsustainable with negative trade balances, and the potion to remedy to this situation will be very bitter indeed: a sharp fall in the standard of living. This is compound by the fact that within a state welfare, redistribution represents a substantial chunk of revenues for individuals, which these countries will drastically reduce to get their finance in order. To regain competitiveness, salaries/social transfers are to decrease by 15-35% - depending on countries - multiplied by the productivity differential with the main exporting countries. The euro is indeed a kind of gold standard where individual countries can no longer devalue their currency to adjust their lack of competitiveness and boost exports.

None of the European political sphere is addressing what is at the core of a flawed eurozone construction.

The table below provides the effort required to get Greece’s finances back under control: this is unsustainable since I do not believe official figures of a EUR 50 bn privatization plan, and will lead to social unrest to a scale not seen so far, the more so that the OCDE announced that the situation is worse in the tune of EUR 15 bn and the EFSF/ESM is not large enough:

“The current EFSF/ESM resources of € 500bn are not enough. Furthermore, the EFSF/ESM has not found it easy to raise funds at low yields even with guarantees.”…

Source:

Hellenic Republic - Ministry of Finance: various publications

http://www.minfin.gr/portal/en

The Telegraph: Eurozone bail-out funds not enough, warns OECD

http://www.telegraph.co.uk/finance/financialcrisis/9057597/Eurozone-bail-out-funds-not-enough-warns-OECD.html

OECD: Solving the Financial and Sovereign Debt Crisis in Europe

http://www.oecd.org/dataoecd/14/25/49481502.pdf
Markets & Beyond: European rescue package: truth and fallacy
http://marketsandbeyond.blogspot.com/2011/11/v-behaviorurldefaultvmlo.html