Posts tagged ‘governments’
Think “political risk in Europe” this year and you would most likely have thought about the Brexit vote. It is of course true that Britain faces an uncertain future, and that Brexit will have consequences for the EU too. But it is far from the only game in town.
On Sunday week the electors of Hungary will cast their votes in a referendum on the issue of migrants. Specifically, they are being asked if they accept the EU’s allocation of a migrant quota to Hungary without the consent of their national parliament. The most recent opinion polls suggest that anywhere from three to four percent of citizens are inclined to vote, “yes”. Barring a miracle, Hungary is about to throw down the gauntlet to Brussels in a few days. This has already appalled one or two other EU members: Luxembourg’s most senior diplomat has called for Hungary to be expelled from the Union altogether. In response the Hungarian government is calling for treaty change (specifically reform of the constitutional Treaty of Lisbon).
The question for investors, of course, is: will markets care about this? Even if Hungary were to leave the EU it isn’t in the euro and is a smallish country, so the answer, in isolation, is almost certainly “no”.
It is equally obvious, however, that the Hungarian vote is not an isolated incident. Portugal was talking about a Greek-style referendum on bailout terms over the summer, though this has yet to amount to an actual plan (and didn’t do Greece herself any good in the event either). And next week the Italian cabinet is to fix a date for a referendum on constitutional reform. The detail here is extremely boring but Prime Minister Renzi staked his political future on the outcome. He has tried backsliding on his promise this week but by turning the referendum into an effective vote of confidence in his government it is being seen as a conduit for Italian euroscepticism. This has gained sufficient strength for the Five Star Movement – an anti-establishment party founded by a comedian which sits in the same group as UKIP in the EU parliament – to be leading the polls. “M5S” does not actually want Italy to leave the EU – but it does want a referendum on the euro. In the meantime opinion polling suggests that the constitutional referendum is balanced on a knife edge.
Will rising Italian euroscepticism, or at least anti-euro feeling, present a challenge to the markets’ confidence? Not in isolation perhaps . . .
The Italian situation might well be complicated further should neighbouring Austria elect Norbert Hofer of the Freedom Party to be her president this December. Mr Hofer, who is currently in a dead heat with his Green Party opponent, once called for the border with Italy to be changed and the province of South Tyrol to be incorporated into his own country. Be that as it may he certainly wants to close the Italian border to migrants. And there is more: the last time the Freedom Party came into power (as part of a coalition in 2000) the EU imposed sanctions. Would they do so again?
Looking to the new year, the Netherlands will hold elections in March. There, another party with “freedom” in its name is topping the polls and its leader, Geert Wilders, once banned from entering the UK for his views on Islam, could end up as premier. He and his party want out of the EU.
Soon after the Dutch it is the turn of the French to vote for their president. Marine Le Pen, leader of the National Front, is almost certain to wind up in the second round vote, probably against a centre-right opponent. Like her father in 2002 she will almost certainly go on to lose, but her share of the vote will be interesting. The National Front is, as its name suggests, a nationalist party and has always opposed the existence of the EU.
Then, at around this time next year, we will have the Germans. The migrant crisis has propelled support for a new eurosceptic party, the Alternative for Germany (AfD) to 16% in the polls. It has been winning seats in regional elections. It looks set to establish itself firmly as Germany’s third party come next autumn. Some of its members have an enthusiasm for Nazi memorabilia and have defended some of the actions of Hitler’s government. The party has not yet advocated EU withdrawal, but it was founded to bring back the Deutschmark and stop Germans having to bail out other member states. It is also implacably opposed to immigration, effectively opposed to the idea of the Schengen area and overtly anti-Islamic.
Again, it is possible that the EU and the euro will muddle through all this. France and Germany are not going to elect eurosceptic governments, yet. Wilders’ lead in Holland is not unassailable – and the collaboration of his main opponents could, in theory, keep his party out of power anyway. It is impossible to predict these things but it does seem unlikely that the single currency will be seen to be facing as much of a threat over the next twelve months as it was seen to be facing at the nadir of the sovereign debt crisis in 2011.
The risk, however, is there.
Apart from the voting calendar there are simmering tensions to consider within the EU bloc. Perhaps most serious among these is the stress caused by the migrant crisis. The “Visegrad Group” comprising Czechia, Hungary, Poland and Slovakia submitted a list of
demands proposals at the Bratislava summit last week which included flat opposition to mandatory migrant quotas. The EU is at loggerheads with Hungary and Poland over constitutional issues; meanwhile the Polish and Hungarian leaders are extremely close allies who hold frequent bilateral meetings. This is a barrier to sanctions which some in the EU would like to impose on Poland. (It is seen as a lesser problem that the current Polish government swept to power last year with the first absolute parliamentary majority since the restoration of democracy in 1989.)
Of course there are external issues to consider too, most notably relations with Russia and Turkey. Even more widely, the Brexit vote, support for Donald Trump in the US and the threat of the Philippines to pull out of the UN among other things might suggest that supranationalism as a concept is struggling at this point in history.
But we don’t need to worry about that. There is quite evidently enough within the EU to worry us already.
In isolation, none of these risks appears to pose much of a threat to the bloc or its currency. Importantly, the result of this is that such risks are no longer remotely priced in. Given what we know about the political calendar over the next twelve months it is hard not to conclude that this represents too high a level of complacency.
A while ago, we looked at the re-entry of Greece into the bond market and noted that it could mark the beginning of the end of the sovereign debt crisis. This week, new borrowing figures for the UK reminded us how big a millstone borrowing can be around a country’s neck
The government is borrowing more this fiscal year than it did last time. This was not supposed to happen: the economy is growing at a fair lick, unemployment is falling, welfare spending and public sector pay has been capped and so on. Reasons for the disappointing outcome include weak earnings growth, a slower-than-expected housing market and the lower oil price. (It is worth observing that real wage compression in particular has been a persistent affliction here in Britain, with inflation-adjusted wages at the whole economy level almost 10% lower today than they were five years ago.)
It is still likely that our debt to GDP will peak in the next three years or so and gradually climb down below 90% again (on a Maastricht basis). But even at this level, and with very low rates, interest payments for 2015-16 are forecast at £59bn – more than the education budget and about 8% of total government spending.
Of course Britain is not alone in this position. Look around the developed world and sovereign balance sheets are, as a rule, stretched. The increase in US debt to GDP, which saw it rise from 63% in 2007 to over 100% five years later, has levelled off, but in money terms the country owes the staggering sum of $17.9trn. For the American fiscal year just ended, interest on this debt amounted to just under $431bn. That is getting on for an eighth of the Federal budget.
Eurozone debt was 90.9% of GDP last year and it still likely to rise with growth in the economy as anaemic as it is. In Japan, debt to GDP stands at over 210%, and last year the Japanese were still running a massive budget deficit (over 9%). Controlling this has consequences, as we saw earlier in the year when the sales tax increase came in and shrank the economy.
Japan is an interesting case for another reason, however. It is one of the world’s largest holders of reserve assets, with some $1.2trn in the bank. Only China has more (almost $4trn). Another country with huge reserves relative to GDP is Saudi Arabia, with $735bn worth against total output last year of $745bn. Neither China nor Saudi have a material level of sovereign debt (22% and 12% of GDP respectively).
Some of the results of this situation are obvious. On the one hand, highly indebted nations will spend many years paying huge amounts of interest and struggling to grow their way to more manageable debt positions. On the other, those nations with little debt and healthy reserves will profit from the interest payments. China owns about $1.3trn of US government debt. If this reflected the market as a whole the average coupon would be around 2.5%, so Uncle Sam would be paying the Chinese $32.5bn per year.
More interesting, perhaps, are the less obvious effects. It might come as a surprise but Saudi Arabia increased production of oil by 50,000 barrels a day last month. The IMF estimates that the Kingdom requires a price of $83.60 per barrel to balance its budget, which is about where oil is at the moment, but with no debt to speak of and huge reserves the Saudis can manage a few years of low prices. After all, their oil is still very profitable to extract at this level. And if it hurts the competition in Russia, poses a distant threat to shale exploitation in the US and possibly destabilizes Iran, it seems unlikely that Saudi Arabia will mind very much.
The global debt position has changed the balance of economic power. In addition to political consequences there have been and inevitably will be consequences for markets, not all of which will be intuitive. Finally, it is rather gloomy to reflect that the UK is not among the stronger nations on any measure now: our high debt ratio is accompanied by lower reserve assets than Poland and less gold than Venezuela.
The United States has been a source of much consternation this year. First of all the Federal Reserve accidentally triggered a mild panic over one of its least efficacious policy programmes. Then Congress deliberately threatened to push the nation towards default to force the government’s hand over legislation passed by itself in 2010. It is almost as if elected representatives in Washington have become so disappointed with the failure of their European counterparts to provoke another global financial meltdown that they have decided to do the job themselves. This is an unusual attitude to American exceptionalism. And it is hardly intuitive to wave the cudgel of a selective default on US debt while claiming to do so in an attempt to bring US debt under control.
However, what Warren Buffett has rightly called the “extreme idiocy” of the present position has not had that much of an effect. This seems incredible given what might technically be at stake. Already, 70% of intelligence staff have been placed on unpaid leave; just enough employees at the Department of Energy have been left in post to discharge their responsibilities to supervise the nation’s nuclear stockpile; diplomacy has already been affected, though troops are still to be paid (and the postal service remains in operation). And yet the S&P 500 is only 2% off its record high of a couple of weeks ago. The trade weighted dollar has tumbled all of 1% over the same period. Credit default swaps – which are priced specifically to insure against the risk of sovereign default – have admittedly ticked up a bit, but only to 42bp. That isn’t even the high for the year. According to Bloomberg the US still prices in this market as the sixth safest debtor in the world (between Britain and New Zealand).
Compare and contrast this picture with the down-to-the-wire debt ceiling negotiations of July and August 2011. Back then there was pandemonium. President Obama and Congress between them hammered out a complex package of fiscal arrangements and at the eleventh hour managed to avoid the shutdown we’re now seeing – and markets collapsed. The meltdown which accompanied the events of that summer was truly savage (see this blog’s coverage here and here).
Something has clearly changed.
As was apparent from the start in 2011, the real trigger for the crash was not the political turmoil: it was downward revisions to US GDP, raising fears of a double dip recession. This occurred against the background of looming default for Greece, revolution across the Arab world, the obliteration of part of Japan’s east coast – in short, a climate of absolute fear.
And let us not forget that at that time, the US federal budget deficit was running at 8% of GDP.
Today the situation is very different. Markets are behaving with relative equanimity because the infighting on Capitol Hill really isn’t as important as the economic fundamentals – unless Buffet’s point of extreme idiocy is breached, of course. Today, the federal deficit is 4%, and falling. US GDP growth has been increasing (and the last set of backdated revisions saw the numbers go up this time). Unemployment is 2% lower, bank balance sheets are cleaner, the housing market has picked up, manufacturing is stronger – and Europe, too, seems considerably further from the brink of catastrophe than it was two years ago.
A particularly gifted politician might be expected to assimilate all these things without even thinking, adapting instinctively to the changed national mood. It certainly appears that the President has done so. In 2011 he conceded ground to avoid a shutdown which was posing an additional threat to confidence. This time round there have been no concessions. In fact, Mr Obama has ruled out negotiating with his opponents at all until the government is reopened and the debt ceiling raised. “I’ll negotiate with you only after you give me what I want.” It’s an insouciant stance to say the least, and so far, the damp squib shutdown appears to justify it.
We ought not to be one-sided. The healthcare reform so vehemently opposed by many Republicans has been controversial from the start and unwieldy to implement. And without their intransigence back in 2011 that budget deficit would likely not have been repaired to the extent that it has. The US debt burden is huge, and such a position brings with it expense and vulnerability.
Nonetheless, the President is on the right side of the markets’ mood and the economic undercurrents this time – so long as he can avoid a sovereign default. At that point, CDS at 42bp would begin to look like something of a bargain …
The big economic news in the US of late has concerned jobs. Last Friday it was announced that the unemployment rate dropped to 7.8% in September from 8.1% the month before, the lowest level since January 2009. Some thought this was too good to be true. Jack Welch, legendary former chairman of GE, was suspicious that such positive news should come two days after a presidential debate which the incumbent was widely seen to have lost, accusing “the Chicago boys” of having “changed the numbers”.
Inevitably, Mr Welch was accused of cracking up. But it is true that governments do fiddle the figures, or perhaps just as worryingly, have to fight hard to make sure they’re not being exaggerated.
In Argentina for example, inflation was running at an uncomfortably high level a few years ago. The former president took decisive action.
In January 2007, key staff in the statistics office started to be replaced.
A year later, inflation had fallen from 9.7% to 8.2% – proof that the strategy worked. Except, that is, according to those who kept an unofficial eye on consumer prices and whispered that the true rate was nearer to 20%.
Sometimes it’s the statisticians who need policing. At around the same time as the former President Kirchner was improving the quality of Argentine price measurement, the Chinese government set about toughening the laws on falsifying data:
Data falsification has long been a problem among Chinese officials, who seek to meet government targets to qualify for promotions. In 2007, nearly 20,000 violations “were uncovered,” China Daily reported in April. In one case, the NPC [National People’s Congress] reportedly discovered that officials in Chongqing municipality added a zero to the production figure of an enterprise to boost its output data tenfold. In 2004, the NBS found that local economic reports exceeded the national GDP total by 3.9 percent …
Of course, in the West we have the rule of law, and self-advancement is not so dependent on flattering the targets of the state. Nonetheless, it is amusing to note that British officials are currently looking at ways to reduce the quoted rate of inflation here, something which would coincidentally cut the government’s cost of borrowing: it was the cost of servicing Argentina’s inflation-linked bonds that so irked the late President Kirchner half a decade ago.
But we must not be too cynical. Mr Welch – if not cracked, exactly – is very likely to be wrong.
US unemployment has stayed high for an unusually long time since the end of the recession. In the early 1980s it took less than two years for the peak in unemployment to fall back down to its pre-recessionary level. In the 1990s it took a little longer, as it did following the collapse of the stock market ten years later. Today we are exactly three years from the 10% high of October 2009 – and yet the rate has only fallen back to 7.8%. That’s still a long way from the 4.6% average seen in 2007. If anything, we should be surprised that the rate of job creation has taken so long to increase.
There has also been some corroborating evidence to support the release of the unemployment data since last week. Only yesterday, the number of weekly initial jobless claims was reported at 339,000 – the lowest level since January 2008. (And this is an actual number, unlike the labour market data which is based on business and household surveys.)
It is right to be sceptical of data, and folly to impart too much significance to an individual release. And it is an indisputable matter of record that politicians with the necessary degree of motivation and cojones (as they say in Argentina) can corrupt economic numbers if they so choose. Jack Welch’s incredulity is understandable, up to a point. But the best advice is surely to follow patterns of behaviour over time; to build up a big picture. Once we have that in mind, it becomes easier to spot what might genuinely be out of place.
As some commentators have pointed out, this year’s Budget took place in the context of a threat to the UK’s AAA credit rating. Only last week, ratings company Fitch put the country on “negative outlook”, meaning that it sees a slightly greater than 50% chance of a downgrade over a two year horizon.
It was accordingly fortunate that some improvements in his economic forecasts meant that Chancellor Osborne was able to announce a slight fall in the projected peak of the UK’s national debt, revised down to 76.3% of GDP in fiscal 2014-15. He made specific mention of the figure in his statement. Fitch has since gone on the record to say that the reduction is modest and that their stance is unchanged: should the Chancellor deliver on his targets the AAA is likely to be affirmed, but in the meantime it remains vulnerable to shocks.
The number they cite, however, is a peak of 92.7% of GDP in 2014-15. At first glance this might appear confusing, or even incorrect. But in fact both numbers are right.
The government’s preferred measure of borrowing is “net debt” – the value of its liabilities less the value of its liquid assets (e.g. the cash it keeps in the bank to cover spending). This is where the 76.3% comes from. The 92.7% reflects the country’s “gross debt”: liabilities only.
That the difference is so large – 16.4% of GDP, or some £293bn in future cash terms – is interesting in itself. What is also interesting is that the UK reports the 92.7% figure (on p. 109 of the full Budget document for those interested) as the “Treaty debt ratio”: the treaty concerned being the Maastricht Treaty of 1992, under which the calculation of government borrowing statistics is governed across the EU.
In fact it is gross debt to GDP which is generally quoted in respect of Europe’s indebted economies. Italy’s fabled 120% debt-to-GDP ratio, for instance, falls to 100% on a net basis according to data from the IMF. In the case of Japan the difference is even more astonishing: the IMF projects a whopping 238% debt ratio for 2012, but on a net basis the figure is only 139%.
The real point, however, is that we must be careful to compare apples with apples. A casual listener on Wednesday might well have thought that the highlighted figure of 76% was directly comparable with the 120% for Italy, for instance. The truth is a little less flattering.
Nevertheless, progress is being made in Britain. This is underlined by yet more excitement from page 109: the figures for “Total managed expenditure” (government spending) as a % of GDP. On current policy this is projected to fall from 45.8% this year to 39% in five years’ time, at which time the budget is broadly expected to balance.
One final international comparison: 39% of GDP is about what Greece has been raising in revenue over the last few years. This may come as a surprise to those who believe the country somehow went broke through tax evasion. The problem for the Greeks was that while raising 40% of GDP, their government was consistently spending even more. Such evasion as undoubtedly takes place might be regarded as evidence of the Laffer curve: the economic theory stating that once tax rates reach a certain level, revenues stop increasing (and begin to decline if rates keep going up). Here in the UK, the disappointing results from the 50% rate of income tax provide a parallel illustration.
If there is one lesson for governments to draw from the recent crisis it is that spending must have its limits. Europe has been forced to acknowledge this in the most brutal manner. In Britain we have had an easier ride from the markets but the arithmetic points to the same conclusion.
There are still plenty of commentators who see fiscal consolidation – “austerity” – as some kind of demand-dampening mistake. The fact is that there is a limit to what states can raise in tax and borrowing. Sometimes spending cuts are all that is left. Sometimes there is, to coin a phrase, no alternative.
There has been a lot of talk lately about restructuring Greek sovereign debt. Greece failed to meet its deficit reduction target for 2010; its debt on a Maastricht basis stands at 143% of GDP; its austerity programme saw the national economy shrink by more than 6% over the course of 2010; unemployment has risen to 15%. The country’s credit ratings are low and still sinking. Most alarmingly, Greek bonds have sold off to the point where two year yields have reached 24% – 10% higher than where they were a month ago. Some kind of sovereign default must be round the corner.
And yet … Greece’s underlying problems would not be solved by debt restructuring – problems it has already begun to address. Yes, a budget deficit of 10.5% is abysmal, but that’s down by almost 5% on the year: a fiscal consolidation not even close to being matched by any other country in Europe. The Greek government has also embraced a programme of privatisation and land sales to bring down its debt burden. All this is being accomplished in the teeth of fierce opposition from trades unions and large swathes of the public.
Beyond Greece too, what would a restructuring accomplish? Nobody knows for certain what the effect would be on the balance sheet of the financial system, including the ECB, and on Greece’s existing sovereign creditors, but it would be far from benign. And once the precedent of a restructuring was set, surely Ireland would be next in line to be pushed over the cliff (2010 deficit: 32.4% of GDP). Perhaps Portugal might follow.
At that point, the harbingers of Euro-doom could be proved right: we might witness the collapse of the single currency zone. The global fallout from that would likely make Lehman Bros look like a picnic. Which is why – to take one example – China has been piling into European investments, including government bonds. The world does not want another crisis, and a sovereign collapse in the eurozone could be just the catalyst to make it happen.
These remain uncertain times. The recent election in Finland serves as a reminder of the unpopularity of bailing out bankrupt states. And Greece has serious problems.
We should be careful, however, not to write off the possibility that Greece, and the other countries in crisis, find time and support enough to muddle through without resorting to default. It is also possible to envisage a “minor” restructuring of Greece’s debt – such as an extension of maturities and / or capitalisation of interest for a few years, arranged so as to have a neutral effect on the value of the instruments concerned – that could be helpful to the Greeks without sparking serious contagion (though the risks would be high).
In other words, the bears may have their day again soon: but on the other hand, Greek debt could present the bond market opportunity of the decade.