Europe's economy would become 1/3 of the global economy in the next 3-years. Spending cut would be a huge drag on the economy. US companies would suffer most....Threat to Euro
By Shan Saeed
Its like a train coming at you and you are not going to stop it by standing in its way…..The series of events in Euro zone were nerve shivering. Just when the market seemed to have got over its sovereign debt jitters, the Irish crisis has come back to haunt us all. Thanks to its €750 billion stabilization fund, Europe is better equipped to deal with the situation than it was earlier this year.
However, Euro zone’s economy will become weak going forward with series of bail outs and sovereign debt risk going out of the roof. Euro economy would become 1/3 of the global economy for sure.
The Greek bailout did nothing for the country's bond yields, however, which are still 9.09% higher than their German equivalents. Ireland's sovereign spread is not all that much lower, at 6.83%. Bond yields are going up, prices are down. Moody’s is cutting Spanish Sovereign rating. Investors are nervous at this topsy-turvy situation. E.U. officials had hoped the
Irish rescue, and greater clarity on future rescues, would quell
market fears of contagion spreading to other heavily indebted euro
countries, like Spain and Portugal. Spain bail out would cost $617 billion to the European Monetary Union and sleepless nights for economic managers.
Unlike Iceland, which pulled out of its own debt crisis in part by
devaluing its currency to increase exports, euro countries like
Greece, Portugal and Ireland cannot use devaluation as a way to
stimulate growth. That makes their prospects for escaping a debt
crisis look bleak because the cuts needed to control budget deficits
also depress growth. Austerity plans, belt tightening and fiscal authority have never worked because governments need to spend more , come out with stimulus to keep the economy moving .
“It’s very hard for any economy to flourish in the teeth of fiscal
austerity of this magnitude — let alone those that can’t devalue. These levels suggest a high probability that debt will not be repaid in full. So is restructuring on the cards? This is the only solution to send positive signal to the market. Bail out is not working to calm the markets or the investors.
US & EUROPEAN MARKETS. Key lessons.
Contagion from the European debt crisis could infect U.S. markets, and
if it does, it will happen fast. Most of the US companies drive their profits around 53% from Europe. The U.S. stock market is recovering although not in a stellar fashion,
with earnings growing in line with overall economic growth. I don’t see anything that’s rapidly going to increase the rate of U.S. growth and world growth.
The Americans borrowed an amount equal to 6 percent of G.D.P. in an
attempt to stimulate growth. The Germans spent about 1.5 percent of
G.D.P. on their stimulus.
The early returns suggest the Germans were. The American stimulus
package was supposed to create a “summer of recovery,” according to
Obama administration officials. Job growth was supposed to be surging
at up to 500,000 a month. Instead, the U.S. economy is scuffling
along. The German economy, on the other hand, is growing at a sizzling (and
obviously unsustainable) 9 percent annual rate. Unemployment in
Germany has come down to pre-crisis levels.
But the results do underline one essential truth: Stimulus size is not
the key factor in determining how quickly a country emerges from
recession. The U.S. tried big, but is emerging slowly. The Germans
tried small, and are recovering nicely.
The economy can’t be played like a piano — press a fiscal key here and
the right job creation notes come out over there. Instead, economic
management is more like parenting. If you instill good values and
create a secure climate then, through some mysterious process you will
never understand, things will probably end well.
Over the past few years, the Germans have built on their advantages.
They effectively support basic research and worker training. They have
also taken brave measures to minimize their disadvantages.
The Germans have recently reduced labor market regulation, increased wage
flexibility and taken strong measures to balance budgets.
In the U.S., policy makers inherited a different economic model, one
that also has certain advantages. It fosters disruptive innovation (of
the sort useful in Silicon Valley). It also has certain disadvantages
— a penchant for over-consumption and short term thinking.
STRESS TEST ---AN ILLUSION
Banking stress tests were not stringent enough to sustain this pressure. Classic case studies of 2 banks in Ireland that succumbed to the pressure of sovereign debt risk. Bank of Ireland and Allied Irish Bank were asked to raise capital to remain safe and secure in the financial market. Although they did clear the stress test.
Markets, meanwhile, continue to suffer from fears that Europe won't contain its debt woes. Europe’s economy will become 1/3rd of the global economy and getting into the sluggish mode.
European markets have taken a beating lately due to concerns that
economic crises in Ireland will spread to countries such as Spain and
Portugal. Spain crisis would be the real stress for the policy makers taking into account the size of its economy i.e. GDP size $1.47 trillion twice the size of Greece, Portugal and Ireland. In other words, close to half of Germany’s GDP $3.35 trillion
And what is Spain’s fiscal deficit? Last year, it was officially 7.9% of GDP—twice the EU limit. Not Irish or Portuguese or much less Greek numbers, but still up there—officially. Why do I say “officially”? And now put “officially” in scare quotes? Because of a very disturbing anonymous paper, released last September on 30 2009.
It basically said that the Spanish GDP numbers for 2009 were cooked—and then went ahead and showed the whys and hows of this analysis. FT originally ran the piece—and it was picked up by everybody, freaking everyone out. But then FT retracted under political pressure, excusing their cowardice by saying “life is too short”. Let’s look at Greece and Ireland:
Originally it was thought that €45 billion would be enough to bail out Greece—but the final tally for that looked to be something like €90 billion [about $122 billion]. At this time, bailing out Ireland is going to come to something similar over the next 3 years—€90 billion—assuming, of course, there aren’t any hidden nightmares in the Irish banking sector, which is the reason Ireland is going under. In both these cases, essentially three times the yearly deficit was the ballpark figure for the European bailouts.
Therefore, to bail out Spain, and plug up its fiscal balance sheet hole over the next three years would cost €450 billion—minimum. That’s about $600 billion.
Look at that number again—look at it closely, and take your time: €450 billion.
That’s twice the size of Ireland’s total GDP for 2009. In order to figure out how much each party would have to shoulder of this €450 billion price tag.
According to Paul Krugman, it was essentially advocating war as a fiscal stimulus solution...But figures are fudged. Taking into account, the considerable bad things about Greece, regarding faked GDP data[ Courtesy Goldman Sachs ] —and knowing the Spanish—I wouldn’t be a bit surprised that Spanish GDP figures have been faked in Madrid, in order to keep everything copacetic. Compare Spain and USA. What’s striking about Spain, from an American perspective, is how much its economic story resembles liKe US. Like America, Spain experienced a huge property bubble, accompanied by a huge rise in private-sector debt. Like America, Spain fell into recession when that bubble burst, and has experienced a surge in unemployment. And like America, Spain has seen its budget deficit balloon thanks to plunging revenues and recession-related costs.
But unlike America, Spain is now going deep into debt crisis. The U.S. government is having no trouble financing its deficit, with interest rates on long-term federal debt under 3 percent. Spain, by contrast, has seen its borrowing cost shoot up in recent weeks, reflecting growing fears of a possible future default. Why is Spain in so much trouble? In a word, it’s the euro.
Spain was among the most enthusiastic adopters of the euro back in 1999, when the currency was introduced. And for a while things seemed to go swimmingly: European funds poured into Spain, powering private-sector spending, and the Spanish economy experienced rapid growth.
Through the good years, by the way, the Spanish government appeared to be a model of both fiscal and financial responsibility: unlike Greece, it ran budget surpluses, and unlike Ireland, it tried hard (though with only partial success) to regulate its banks. At the end of 2007 Spain’s public debt, as a share of the economy, was only about half as high as Germany’s, and even now its banks are in nowhere near as bad shape as Ireland’s.
But problems were developing under the surface. During the boom, prices and wages rose more rapidly in Spain than in the rest of Europe, helping to feed a large trade deficit. And when the bubble burst, Spanish industry was left with costs that made it uncompetitive with other nations.
Now what? If Spain still had its own currency, like the United States — or like Britain, which shares some of the same characteristics — it could have let that currency fall, making its industry competitive again. But with Spain on the euro, that option isn’t available. Instead, Spain must achieve “internal devaluation”: it must cut wages and prices until its costs are back in line with its neighbors.
And internal devaluation is an ugly affair. For one thing, it’s slow: it normally take years of high unemployment to push wages down. Beyond that, falling wages mean falling incomes, while debt stays the same. So internal devaluation worsens the private sector’s debt problems. What all this means for Spain is very poor economic prospects over the next few years. America’s recovery has been disappointing, especially in terms of jobs — but at least we’ve seen some growth, with real G.D.P. more or less back to its pre-crisis peak, and we can reasonably expect future growth to help bring our deficit under control. Spain, on the other hand, hasn’t recovered at all. And the lack of recovery translates into fears about Spain’s fiscal future.
Should Spain try to break out of this trap by leaving the euro, and re-establishing its own currency? Will it? The answer to both questions is, probably not. Spain would be better off now if it had never adopted the euro — but trying to leave would create a huge banking crisis, as depositors raced to move their money elsewhere. Unless there’s a catastrophic bank crisis anyway — which seems plausible for Greece and increasingly possible in Ireland, but unlikely though not impossible for Spain — it’s hard to see any Spanish government taking the risk of “de-euroizing.”
But even if they haven’t been, it’s not as if the official numbers are painting a rosy picture: Spain has nearly 20% unemployment, near 10% yearly fiscal deficit to GDP, and no clear way how to get out of this hole that it is in. So much of Spanish growth over the last decade was fueled by real estate development and over-leveraging, that there’s no clear way forward for the Spanish economy.
Ireland has accepted a bailout package to rescue its banking sector,
but the problem with European bailouts is that
those countries aiding their neighbors are dealing with their own
economic problems as well.
I look to Europe, and I’m wondering who’s supporting who over there.
These are not wealthy nations, any of them, and they are supporting
their weakest members. I don't see how it could help but
be contagion. Whether we like it or not we live in a global world and any kind of
contagion is going to spread very quickly.
BRADY’S PLAN IS REQUIRED IN EUROPE IN THE NEAR FUTURE.
Another idea that has gained some ground recently is a Brady plan for
indebted European economies. The plan was recently put forward by a
former Treasury secretary, Nicholas F. Brady, who led an effort in
1989 to help Mexico and other Latin American economies restructure
their debt — requiring bondholders to take a loss of 30 percent in
exchange for new, longer dated debt instruments that had lower rates
and were backed by 30-year United States zero-coupon bonds. Much
criticized at the time, the plan is now seen as the first step of
Latin America’s recovery.
FUTURE OUTLOOK FOR EUROPE.
The worry is that Ireland won't mark the end of the eurozone crisis
and with the economies of Portugal and Spain looking less than robust,
markets are worried that we could be talking about potential bailouts
once again in the not-too-distant future. European officials concede that, for euro-zone nations unable to
devalue, the process of adjustment may be long and painful. Internal devaluation would be a drag on the economies opting out of Euro Single Currency. Their
strategy is to push structural changes and new rules based on the
lessons of the crisis, in hopes of preventing such divergences in the
European Central Bank policymaker are increasing their efforts to bolster
market confidence in the eurozone's rescue for Ireland, informing the cagey
investors they should have faith in the plan's success. They are goading the investors as they are dealing with Ireland to bring down Dublin's borrowing costs to more normal levels. "There is no reason to doubt the recovery plans of the two countries. But market reaction showed investors thought the crisis that started with Greece's budget blow-out more than a year ago was far from over.
I don't think this is going to be a silver bullet. I think there are
still going to be some question marks on Portugal and Spain. Moody’s is cutting the AA rating on Spanish sovereign bonds, thus sending ripples in the financial market. One of the questions that has been dogging markets for weeks and
helped drive Ireland off the cliff was whether and under what
circumstances private bondholders could be made to take losses, or
"haircuts," on eurozone government debt. Overall economic growth in the euro zone is expected to be 1.51 percent in 2011, slightly lower than the projection for 2010. .
Even as the yields on the 10-year bonds of Greece, Ireland, Portugal
and Spain are going higher and bond holders are looking elsewhere to diversify their risk and get of the market, EU officials haave been lackluster in their approach to solve this pressing issue. Rising
yields reflect increased risk in the eyes of investors as well as
inflationary expectations. Not that anyone expects Germany, by far
Europe’s most powerful economy, to come close to defaulting on its
debt. And neither Italy nor Belgium is considered in the same boat as
Greece, Ireland and Portugal, since their deficits are lower and they
borrow primarily from domestic lenders. Instead, the fear is that
Europe’s strategy so far — painfully drawn out step-by-step bailouts
of Greece and Ireland — has failed to impress the markets and that the
burden to finance even larger rescues for Spain and perhaps even Italy, Belgium or Portugal would be too much for Germany to bear, both financially and
Current cycle of soaring bond yields among European economies to the
series of competitive devaluations that led to the collapse in the
early 1990s of the European Exchange Rate Mechanism, the precursor to
today’s monetary union that binds the 16 nations in the euro zone.
We can clue from someone [ De Grauwe] who proposed transforming Europe’s rescue facility into a
European equivalent of the I.M.F., but other specialists advocate that
Europe is not prepared to undertake the long and political challenging
treaty revisions that would be required to bring it to life. Still
others acknowledge that some form of restructuring is crucial.
just as investors of Dubai World were required to
share the pain in return for a rescue by Abu Dhabi, so should
bondholders in Irish banks. It was not easy, but in the end all the creditors accepted it.
This is just a research piece and not an investment advice. Investors are encouraged to execute their own due diligence before making an investment decision or strategy implementation.