Archive for December, 2011

Silver Lining

Last month this blog observed that falling inflation by way of lower commodity prices might constitute a rare silver lining to the current crisis.

Since that time, the S&P GSCI index has fallen by a further 5%. Looking at individual commodities, precious metals have been bottom of the class, with gold, silver and platinum all down around 8-10%. Industrial metals did rather better, with copper losing only 3% over the same period. The major soft commodities turned in a mixed performance, with wheat continuing to drift lower (down 3%), rice falling a little more sharply (-6%) and cotton shedding 8% since a month ago. Oil, by far the most significant commodity by traded value and index impact, performed roughly in line with the overall index as one would expect.

This ought to be almost unequivocally good news. As the Chancellor noted in his autumn statement for example, rising prices pushed the UK household sector into recession again in the second half of 2010. Falling inflation, by taking less of a bite out of household incomes, should be a positive for the economy.

On a similar note, lower inflation can mean support for growth via looser monetary policy: in China, for instance, where the reserve requirement for banks was cut two weeks ago for the first time since 2008.

Of course, commodity producers tend not to be so happy with falling prices, which is why their effects cannot be said to be universally benign. And this week’s decision by OPEC to reunite behind an oil production target is an unhappy reminder that this is especially true during a time of civic unrest in the Arab world. From the Wall Street Journal:

A move by members of the Organization of Petroleum-Exporting Countries to put aside major differences means the group may now be able to defend high oil prices by cutting production if needed …

Oil producers on Wednesday closed ranks to defend the high oil price they need to balance their budgets and quell the risk of social unrest. OPEC members, meeting in Vienna, agreed to keep a lid on production at its current level of broadly 30 million barrels a day …

OPEC can afford falling prices less than at any time in its 51-year history. Both Saudi Arabia and Iran have boosted their social spending throughout this year to avoid the kind of unrest seen in Egypt or Yemen. OPEC said in a recent report that many of its members now need oil to be above $85 a barrel to balance their budgets.

Without wishing to outdo the rampaging bear consensus – which this week seized on a single Chinese data point as evidence of an impending east Asian recession – revolution in key Gulf states would most likely turn out not to be a price worth paying for cheaper oil.

As we approach the end of a difficult year it is a reminder of the risks the world still faces that even the silver lining of the ongoing crisis turns out to have another cloud attached.

16/12/2011 at 1:44 pm

Two Futures

Inevitably, all the talk is of Europe – again. The top five worldwide stories on the Bloomberg terminal this morning all concerned the latest summit proposals, pushing a dull tale about the Chinese economy into sixth place. To summarise the headlines:

  • The European Stability Mechanism (the eurozone-only bailout fund originally planned to succeed the current EU-wide European Financial Stability Facility in 2013) will begin operations in tandem with the EFSF subject to a €500bn ceiling next summer.
  • EU Central banks will commit to lending €200bn to the IMF in the event that it needs to be lent back to the eurozone, of which €150bn will come from the eurozone itself.
  • Private sector bondholders will not take losses in future bailouts (i.e. after agreement of the Greek restructuring).
  • Last, and most important: eurozone governments will enact a budgetary agreement which will restrict borrowing and be subject to supranational oversight.

There was a key disappointment in that sizeable government bond purchases by the ECB did not explicitly form part of the package, so market reaction has been muted. European equity markets made a positive start; peripheral bond markets yields are a touch higher, but only a touch and remain kilometres away from their recent highs; and currency markets are unchanged.

Short term developments could transform the picture, of course. The commitment to extend the IMF’s firepower might entice reserve-rich countries (read: “China”) to make similar commitments. On the other hand, the ratings companies are seeking ever more creative ways to compete for credibility while worsening the panic. S&P has threatened to cement its US rating debacle with a raft of eurozone sovereign downgrades. In reply, Moody’s zeroed in on the financial sector and downgraded some French banks this morning. Even Fitch played a clever oblique stroke last week by warning over the solvency of the UK (who’d have thought it?)

Ultimately, however, the only short term variable of real significance remains the bond market. It will determine whether EFSF, ESM or IMF firepower is sufficient. It will determine whether or not ratings companies have the power to upset the apple cart. And it will determine whether or not the eurozone states can muddle through to the key element of the summit: the prospective agreement of a new eurozone treaty by March 2012.

In the words of Daniel Hannan MEP, Conservative eurosceptic and blogger for the eurosceptic Telegraph:

A rival treaty organisation, predicated on common economic government, would become de facto the new forum for integration. One by one, political powers would pass from the EU to the eurozone until the EU became a shell, an amplified free trade area, a kind of EFTA-plus. Which, of course, would suit Britain very well indeed.

The sovereign debt crisis would have transformed the political landscape in Europe – arguably for the better, if you are a Continental believer in the euro (i.e. in the majority) or a British opponent of it (ditto). Economically, the eurozone could come to resemble Germany: a defensive, low-inflationary and low-deficit power with an unexciting trend rate of growth and a high level of regulation. The UK would have the freedom to resemble this picture rather less, for better or for worse.

In the context of the current drama this may seem small beer but at least it would be palatable. Consider a second future: closure of the euro periphery’s bond markets, Italian and Spanish distress, and global panic culminating in a wave of sovereign defaults and an economic contraction that would be especially pronounced in debtor (western) countries. In this case the political consequences could be chilling.

This fifth EU emergency summit will have failed to bring the crisis to a sudden halt. The next few months could be just as interesting as the last. But what it has done – assuming that we get there – is give us a glimpse of what the sunlit uplands will look like.

09/12/2011 at 10:31 am

Moving On

This morning, Angela Merkel likened the eurozone’s struggle to contain its troubles to a marathon:

“Marathon runners often say that a marathon gets especially tough and strenuous after about 35 kilometers,” Merkel told lower-house lawmakers in Berlin today … “But they also say you can last the whole course if you’re aware of the magnitude of the task from the start.”

Nowhere has her analogy proved more apt than in the country which originated the concept: Greece. And while it received negligible attention, the Greeks this week reached another milestone on their long slog towards recovery.

Amid significant popular dissatisfaction, which on Wednesday saw the seventh general strike of the year, the leader of Greece’s main opposition party gave a written commitment to the EU Commission, the Eurogroup, the ECB and the IMF that he would support the budgetary measures sought by caretaker prime minister Papademos. As a result, release of the EU component of the nation’s bailout money – thrown into jeopardy by former PM Papandreou’s referendum call – was agreed on Tuesday night. The IMF is due to approve its €2.2bn share of the €8bn aid tranche by Monday. By January, details of the debt swap with private sector creditors are due to be agreed. The exchange is projected to practically halve Greece’s deficit to 5.4% for 2012.

This amounts to quite a lot of news, but of course the Greeks aren’t the only ones who have been moving on. The bear consensus has moved on too. Concerns over Greece have in the market’s mind long been superseded. The solvency of Italy and Spain has been challenged, as well as that of France. Incredibly, there were even confused reports of a “failed” bund issue in Germany too.

Since then, coordinated action by central banks on Wednesday to improve liquidity in the European banking system has calmed nerves and sent stock markets soaring. And only yesterday, successful bond auctions in France and Spain did the same for government debt. Eurozone bond yields have fallen back substantially over the last couple of days (including, crucially, in Italy.)

Europe’s marathon is far from complete. A disappointing EU summit next week, or any number of left field events could plunge us all back into funk and gloom once again. But it is worth reminding ourselves that despite the pitch of fear and associated confidence effects, disaster has yet to strike. And it is just about possible that while the consensus worries about other things (and indeed everything), an exchange of Greek debt is successfully agreed, Greece and the other bailout countries make further progress towards solvency, other eurozone nations go on happily funding themselves with no outside assistance and the global recovery struggles resolutely on.

Like a marathon, this “muddle-through” scenario could prove protracted and painful. But there’s one thing it still doesn’t appear to be, even after the positive market moves this week: priced in.

02/12/2011 at 4:06 pm 1 comment


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