Slim Pickings in the Eurozone?
In a week when the Greek leadership declares it a historic moment for the European Union that the ailing country has agreed to swallow an additional austerity plan which, so far, seems to have calmed markets it would almost be too much to continue picking on the Eurozone. Yet pick I am going to nonetheless even if I should add my support, and scepticism, to the road Greece currently appears destined and determined to travel.
A Greek Plan and a Believing ECB
On the plan itself Macro Man pretty well sums up my reading of the situation too but more concretely, it is difficult to point a finger on the measures themselves. Consequently, George Papandreou’s government approved this week of an additional 4.8 billion euros ($6.6 billion) of deficit cuts which include raising value-added tax to 21 percent from 19 percent, further increasing taxes on tobacco alcohol as well as of course further scything the public sector wage bill. All this is of course exactly what Greece needs to quell international investors of the worry that Greece will ultimately throw in the towel and default. However, at 2% of GDP (according to Bloomberg) it is almost but a drop in the ocean for an economy running a public deficit well in excess of 10% (which is pledged to be reduced from 12.7% to 8.7% of GDP this year).
Moreover, it was interesting to observe the manner in which Mr. Papandreou resoundingly used this week's additional deficit cuts as a way to articulate over to you then pointing towards coming bilateral talks with Germany and France in which the implicit message was that now that Greece was honing up to its side of the bargain France and Germany should give something the other way. Alas both German chancellor Angela Merkel and her finance minister Wolfgang Schaeuble explicitly pointing out that aside from a friendly tête-à-tête over a bottle of Metaxa future bilateral talks would deal with no such thing as aid commitments. In any case, as Wolfgang Schaeuble noted; the recent measures taken by Greece will probably convince international investors. Let us hope our good Wolfgang is right here and while this in itself may turn out to be a tight call, Germany (and France) have so far dodged the bullet in terms of engaging in direct bilateral aid talks with Greece (let alone Spain).
So far it also seems that EU has dodged the bullet of whether the Greek affair will end up in the arms of IMF which, one assumes, would pave the way for other parts of the Eurozone periphery seeking out the aid of the fund. Moreover, the ECB moved at its monthly conference strongly backing the measures by the Greek government while also noting that it would be inappropriate for Greece to seek help from the IMF.
Yet, all is not well.
As Edward noted earlier this week, recent PMI data from the Eurozone confirms what we already knows in the sense that the recovery is moving very slowly and is essentially non-existing in key economies.
In the first place we have the latest batch of Eurozone PMI data, which suggest that the process of economic recovery is going to be neither so rapid, nor so straight forward, as was initially thought. And even more to the point, exit from the recession is being more characterised for its unevenness than it is for its uniformity. Growth in February was heavily weighted to the manufacturing rather than the services sector, and in manufacturing there was more dynamic in demand from the ex-Eurozone export area, than from internal orders, suggesting that the 6% drop in the Euro is having a positive impact on external competitiveness, while domestic demand remains weak and lacklustre.
Turning to the issue of monetary policy I have to admit that I did not look forward to Thursday's session of ECB newspeak with the same eager as did Edward, but it was interesting to scrutinize the announcement by the ECB that it intends to continue withdrawing liquidity from the system despite the obvious travails of Greece and Spain. It appears then that the ECB is currently playing by the book believing that EU and Greece may sort out the problems without further aid from either the IMF or extraordinary ECB funding. Yet, as Edward shows with a very telling graph Spanish graphs are completely dependent for ECB financing at the current juncture which raises the question of what happens as we move forward towards the summer. Especially the expiration in July of the 1 year bn 442 € bumper tender could mark a turning point.
Reverse Decoupling in the Eurozone?
(click on picture for better viewing)
The steady build up of problems in the Eurozone and the consistent divergence in bond spreads among Eurozone economies have had a notable effect on the Euro. In a post Lehman world the EUR/USD peaked so far in the autumn of 2009 at around 1.44 to 1.45 with some analysts at the time hailing the return of a EUR/USD poised to move into the 1.50s and perhaps even to break the, so far, "magic" 1.60 sticker. Alas, this was not what happened.
Since the autumn of 2009 the Euro has consequently lost some 6% against the USD and is currently trading in the range of 1.35 to 1.36. This value will hardly scare anyone either side of the neutral fence and actually, in my humble opinion, still signifies a grossly over valued Euro based on economic fundamentals. Yet, the recent slide of the Euro (as tepid as it may be) actually represents a double edged sword. In the first instance it is naturally a direct function of the growing problems in Greece, Spain, Ireland etc and thus a sign of weakness. Yet, its real economic effect is decidedly positive as it helps support Eurozone exports which is now, more than ever, instrumental as a driving force of aggregate Eurozone economic growth. In the jargon of Alpha.Sources market lingo, the Eurozone seems to be passing on old maid to the US which of course itself needs a weaker currency. This of course, as debated before, is exactly the rub in a world where would be exporters are a plenty while importers are not.
In this context, it was with some fascination that I recently read the following Bloomberg headline implying that the Eurozone might be subject to reverse decoupling.
Europe’s economy may be coming unstuck from the global recovery as governments to the south of the region struggle to reverse budget deficits and consumers in the north pull back spending.
After the 16-nation euro economy almost stagnated in the fourth quarter, data this week showed the weakness reaching into 2010. Confidence among households and companies worsened unexpectedly, French consumer spending fell and bank loans to the private sector slid for a fifth month. At the same time, Standard & Poor’s said it may soon downgrade Greece again as the country grapples with the region’s largest budget shortfall.
Signs of a flagging recovery risk extending the euro’s slide against the dollar. They are also prompting Citigroup Inc. to advise investors to favor German government bonds and UBS AG to recommend European stocks with links to the faster-growing U.S., such as Daimler AG. As they cut their growth forecasts, economists predict slower interest-rate increases from the European Central Bank, whose governing council meets next week.
Astute readers will notice immediately that it is not the first time that decoupling has been used in a Eurozone context, but this time of course it means something else entirely. The last time was back in the heaty days of 2006 when Bernanke slashed rates and where Japan and Europe were pinned as the economies who were to take over the baton from the US in a new Bretton Woods II(I). I shall not belabour here just how misplaced that was, but merely note how this alternative idea of Eurozone decoupling from global growth might be equally misplaced; at least if using a falling Euro as a premise. I emphasize might here since the irony is that the extent to which the Euro takes a beating on the back of the travails of the problems in the periphery it should actually help the Eurozone lock on to whatever global growth there is in the pipeline in the coming years. The main qualifier here is naturally that the homegrown problems themselves may still lead to an implosion in the form of a sovereign debt crisis as well as the real difficulties in terms of actually sticking to the code of an internal devaluation lies ahead of us, in this respect the following point by Edward is very important I think;
Ironically, market concerns will in all probability now shift to worries that Athens has gone too far in slashing budgets and raising taxes, and that the fiscal measures announced will simply act as a massive brake on economic activity. The risk is that Greece is now in a vicious circle in which fiscal austerity sends the country ever deeper into recession - and Athens has to react even more aggressively to bring down the public sector deficit as a share of GDP.
No easy way out here at all it seems and this more than anything signifies the current position in the Eurozone.
Another week, another show of good will by the Greek government and another indication that the ECB means business in terms of withdrawing excess liquidity provisions. In this sense there is not much new under the sun. However, this comes on the backdrop of a growing realization among market participants and analysts that the recovery, despite policy makers' most ardent efforts, just isn't coming. In fact, the real preoccupation now is what happens on the backdrop of an increasingly hawkish stance towards what is deemed excessively loose fiscal and monetary positions since if we could not foster a recovery with such impressive stimulus measures, what happens next?
The best thing we can hope for at the current juncture is to muddle through and specifically that we manage to prevent some of the more scarier and all together realistic scenarios from materializing. Here I would like to see a little more team spirit from Germany in terms of supporting Greece in her endeavors even though of course, what Merkel probably really wants is for Greece to move to the IMF and thus one step closer to a break with EMU.
Overall, growth prospects in the Eurozone remain weak and with this also the uncertainty. Greece should take whatever comfort it can in Thursday's nod of approvement from the ECB as well as take whatever direct support it gets from the EU. On the latter, this week's message is, not unlike above I hope, that it will be slim pickings indeed.