Archive for November, 2012

Quiet Emergency

Beginning with Hurricane Sandy and the elections in the US, this has been an eventful a month as ever. We saw how markets started to fall over fears of the “fiscal cliff”. These fears were not new, exactly – just forgotten. Incredibly, one of the biggest fears of recent times seems to have become largely forgotten in their place.

The Greek crisis is alive and well. It hasn’t been making the same sorts of headlines; but there has been a two-day general strike, a knife-edge budget vote, and a new round of negotiations with and infighting between the country’s major creditors. It is still unclear exactly what the outcome of all this will be, but it is obvious that Greece’s emergency – while it may be in hiding – has not gone away.

So far, however, the world is taking all this in its stride. In fact, Greek bond prices have climbed since the beginning of the month, as has the Athens stock market, which has now risen by almost 25% since the start of the year.

As negotiations continue, what opinion there remains on the situation is divided. One Greek paper yesterday carried the headline, “Greece And Lenders Edge Towards Compromise On Debt“. The piece saw the remaining obstacles and adjustments as being relatively immaterial. On the other hand, the Wall Street Journal maintains that “Greece’s Only Option Is Default“. Here the view is that the economy is irrevocably shattered, society has plunged into savagery and despair, and that only another debt write off can salvage things.

It is impossible to decide with any confidence which of these views is correct as the facts of the situation are unchanged. Nonetheless: local markets are clearly much more sanguine than they have been at any time for a year or more, and that is not something which should be dismissed out of hand. And improvements to projections for the Greek budget over the next couple of years were a material bright spot in an otherwise gloomy EU Commission autumn forecast.

It was Aesop who gave us the phrase “familiarity breeds contempt” in one of his fables. It does seem applicable to the reaction which has been displayed to recent events in Greece so far. The fable is a short one and worth quoting:

When first the Fox saw the Lion he was terribly frightened, and ran away and hid himself in the wood. Next time however he came near the King of Beasts he stopped at a safe distance and watched him pass by. The third time they came near one another the Fox went straight up to the Lion and passed the time of day with him, asking him how his family were, and when he should have the pleasure of seeing him again; then turning his tail, he parted from the Lion without much ceremony. FAMILIARITY BREEDS CONTEMPT.

In the tale the fox gets away with it, which is of course not always the case with Aesop. We must hope for the same outcome with respect to his modern-day countrymen. It would be a pity for the world to have conquered its fear only to be eaten by the lion after all.

23/11/2012 at 4:08 pm

Cliff Edge

Fiscal cliff.

It doesn’t sound pleasant. But what does it actually mean?

What it meant on Wednesday in the aftermath of the US elections was the biggest one-day fall in the S&P 500 for five months, the biggest rise in Treasury futures since April and global risk contagion through equity, debt and commodity markets.

What it means for the US economy is that an automatic programme of tax increases and government spending cuts will kick in at the end of the year. The programme was the result of the debt ceiling crisis reached in 2011: Congress has the constitutional “power of the purse”, Republicans had taken control of the House in the November 2010 elections, and they refused to allow the Treasury to borrow any more money unless agreement was reached to reduce the budget deficit at some point. The automatic programme is clumsy, politically unsatisfactory to all concerned, and relative to the colossal government borrowing involved not as hugely material as some coverage might lead one to believe. But Congress hasn’t managed to agree anything better since a year ago, so for the time being America is stuck with it.

It is understandable that rather less attention was paid to news from Europe on the same day. The EU Commission published its autumn economic forecast, and there was some comment on the fact that expected growth for the eurozone next year has been revised down since the spring from sluggish (+1.0%) to flat (+0.1%). European stock markets had already fallen on the back of this information before descending further as the US took its little bath.

At the same time, however, the zone’s 2013 budget deficit is looking to be in better shape. Originally projected at 2.9% of GDP it is now forecast at 2.6%; bearing in mind the reduced growth forecast this just shows how much progress has been made in bringing budgets under control. Gross government debt to GDP is forecast to peak at 94.5% next year.

Let’s compare this to figures in the US.

According to the Congressional Budget Office (p. 22 here), the assorted terrors of the Fiscal Cliff would see a deficit of 7.3% of GDP this year fall to 4.0% in 2013 and draw level with the eurozone at 2.4% a year later. In this scenario, debt to GDP would peak in 2014. Growth should be expected to suffer. However, the CBO also publishes an “alternative fiscal scenario” (a.k.a. do nothing). While salvaging near term growth, this scenario would see the deficit crawl down to 4.2% of GDP over the next five years before deteriorating again as debt service costs rose. The level of debt to GDP wouldn’t peak at all – it would just keep rising indefinitely.

It is painfully ironic that eurozone governments have been accused of “kicking the can down the road” in addressing the burden of sovereign debt. These states have been taking serious action to improve their books for some time. One can of course argue the rights and wrongs of the trade-offs involved, and observe that they have been acting out of necessity. But it has always been an obtuse criticism.

In contrast, the US government in 2011 kicked the can all the way to 2013. With New Year around the corner the can is in sight once again – and there are plenty of pundits arguing that what’s required for the time being is another kicking. At the same time most politicians seem to recognise that budgeting for an eternal increase in the ratio of debt to GDP is insane.

We have long argued that fears over the US economy have outpaced reality. Budgetary worries are not baseless and it is understandable that markets are concerned. And yet as of this week jobless claims continued to fall, consumer confidence reached a new five-year high, and third quarter earnings for the S&P 500 reported so far are on average 4.7% up on a year ago (above initial expectations and higher than the 4.0% increase in nominal GDP over the same period). We observed recently that Britain’s status as a safe haven was questionable on fundamental grounds but should survive if the world economy continues to muddle through. In budgetary terms the same goes for the United States.

Still, it is worth taking this week’s market movements seriously and thinking a little about the alternative. What we experienced on Wednesday was the tiniest taste of what would begin to happen if markets were ever to decide that it isn’t the European model, or the single currency, but western social democracy as a whole which is no longer economically viable.

09/11/2012 at 5:00 pm


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