Austerity Programs Fail

rduvall      austerity programs, Europe, Greece

Earlier this month the IMF updated its world economic outlook, with a very modest increase in growth projections for this year. However, it warned of continued economic risks in Europe and emerging industrialized economies in Asia and Latin America. The IMF forecast is consistent with our own forecasts of the last six months and we remain less optimistic about world growth because of our continued expectations of recession in Europe which are being confirmed by the economic contractions in an increasing number of EU economies in the fourth quarter of 2011 and the first calendar quarter of 2012.

However, of more importance to us is the language in the IMF forecast that for the first time calls on European nations to curtail its emphasis on austerity programs in favor of policies that stimulate economic growth. It appears that the IMF is the latest in a number of private and official economic organs to recognize the fallacy of stringent austerity programs as the solution to the Europe’s sovereign debt crisis. Indeed, the relapse of an increasing number of European economies into recession and the failure of an increasing number of European countries to meet debt/GNP targets for 2012-13 are showing the destructive impact of the EU austerity programs on the economic, financial, social and political fabrics of Europe and its concomitant impact on the rest of the world.

We hate to say we told you so, but we forecasted this in our SPG Trend website articles of December 17, 2010 and March 15, 2011. Those articles, plus others on our SPG Trend blog, warned of the dire consequences of “squeezing” economic growth to zero as a result of the draconian austerity programs dictated by the EU onits members. Almost two years later, some of the very institutions demanding these austerity programs are recognizing their failure. Unfortunately, it is too late to save the EU from recession this year and in many cases within the EU, next and the wheels of political change we also warned about in our articles is already underway. Elections in France, Greece, Italy, the Netherlands and Spain could result in new governments that have vowed to repudiate or ignore the EU austerity measures. Such developments would unravel the EU and create panic in international financial markets. We have always felt the “Achilles heel” of the EU was the unwillingness of the populations within its members to endure increasing economic hardship to appease international creditors.
The upcoming elections with the EU this year and next will determine the Union’s fate and future. An increasing euro-skeptic mood among the Union’s body politic is ominous and should be a source of concern for all of us.

Morris R. Segall

Geopolitics: Why its so important

Morris Segall      Capital Markets, Emerging markets economic growth, European debt crisis, Global financial and banking systems, International economic growth, U.S economic growth, Worldwide recession

Since the spring of 2010 events outside the U.S. have been dominating our financial news and influencing our economy and capital markets. That spring the European debt difficulties moved to crisis stage with the imminent debt default of Greece. The financial crisis that began that spring has continued virtually unabated with a series of financial “band aids” that have staved off world financial disaster but done nothing to provide a permanent solution to Europe’s financial distress. In the meantime, the ratings agencies have downgraded both sovereign and bank credit through much of Europe and the ill advised austerity programs (See our website articles of March 15, 2011 and December 17, 2010), adopted by the members of the European Union have “choked off” economic growth in much of the continent, threatening the region with existing and imminent recession. During this period, world financial markets have been in turmoil and capital markets have been depressed.

Without a firm solution to the spreading sovereign debt woes, panic spread to the continent’s banking system that forced world central banks to add liquidity to the European banking system. This new calamity necessitated a summit of European leaders to fashion a long awaited permanent solution to Europe’s debt crisis. The summit was held last week and as we expected, failed to produce a bona fide solution to the debt crisis. Once again, a summit of European political and financial leaders was long on rhetoric and short on tangible solutions. After a reflex rally in the world capital markets last Friday on the news of increased unity and collaboration of EU members, the absence of substance in the summit became evident on examination over last weekend and the capital markets reacted accordingly on Monday.

We have been pessimistic about the future of the European union since its financial woes became unmanageable in 2010 and the sequence of events since then have only borne out our concerns. The fact is there is no machinery within the European Union framework that will accomplish what is needed to alleviate Europe’s financial distress and satisfy world financial markets that Europe is creditworthy. The principal entity that should be able to provide a conduit for Europe’s sovereign debt financing and shore up its banking system, the European Central Bank, is not empowered nor does it have the resources to do both. Therefore, the members of the EU face totally revamping their union with new treaties, subordinating their sovereignty to the European Commission, or creating some ersatz organ to provide the financial resources to do so. Again, there is not enough consensus among EU members to do what is necessary and not enough resources within the European Community to fully engineer a financial solution to both the sovereign debt and under-capitalized banking system. So the angst over Europe’s financial future continues as does the continuing threat of credit downgrades by the credit rating agencies, exacerbating an already tense situation. At this point, the austerity programs have created a negative economic situation for Europe, both Western and Eastern, that is threatening world economic growth for 2012-13. Europe represents approximately 20% of world trade and is a major market for U.S. and emerging market exports. Its economic stagnation has negative implications for GDP growth here and abroad. If Europe’s financial woes degenerate into a world financial crisis threatening the banking systems globally, it could precipitate a worldwide recession. This is the principal reason why forecasting world economic growth for the next 2-3 years has become so difficult.

That difficulty has been compounded by the current significant economic growth slowdown in the emerging market leaders in Asia and Latin America, notably China, India and Brazil. Emerging markets have been the locomotive of world economic growth before the recession and have led the world economic recovery since the recession ended. Economic deceleration in this key segment of the world economy coupled with economic stagnation in Europe cannot help but depress prospects for economic growth in the U.S. The impact of overseas events on our economy, our financial system and capital markets has never been greater and is unprecedented in the post war era. Unfortunately it is part of a secular change in the world economic order where global interdependence has replaced economic independence and where global economic growth leadership has passed to the newly industrialized economies of Asia and Latin America.

Morris R. Segall

The EU gets serious about its sovereign debt crisis

Morris Segall      European banking systems, European debt restructuring, European Financial Stability Facility, European sovereign debt, European Union, Greek debt crisis

European leaders today agreed to a plan brokered by French President Sarkozy and German Chancellor Merkel to provide a second and more comprehensive “bailout” of Greece and avoid that country’s imminent debt default. The new agreement is noteworthy in that for the first time, it calls on private debt holders to be part of the solution.

In addition, the EU is not just giving Greece a new tranche of money from its European Financial Stability Facility (EFSF), it is restructuring the Greek debt by extending maturities and lowering interest rates and expanding the scope of the Facility to provide for financing stabilization for other EU countries in distress. In effect, the EFSF will fulfill the role the Federal Reserve System played in stabilizing the U.S. banking system in 2008 by becoming the lender of last resort.

We have long argued (See our blog article of July 1 and our website article of March 15), that this approach was long overdue by the European Union leadership if a continuum of sovereign debt defaults by its weaker members was to be avoided. The concession to Germany to include private debt holders in debt restructuring is a major and necessary development. These moves will avoid an imminent Greek default on its debt (although the debt restructuring will likely create a technical default of its credit terms) and will also alleviate the increasing pressure on Italian and Spanish finances for the time being.

Notwithstanding these new and bold moves by the EU, today’s agreement will need further expansion. First,  the EFSF must recapitalize the various EU banking systems for the losses incurred in the debt restructuring to keep them financially strong.  Second. the private creditors of Greek debt must all agree to the principal loss involved in the restructuring. Third, the EFSF must be greatly expanded if it is to effectively “backstop” Irish, Portuguese, Italian and Spanish debt. Third, private creditors must be convinced to go along with similar restructuring of the debt of those countries if a comprehensive solution is to be achieved. Fourth and most important, the voters of the other EU countries, whose credit is underwriting the EFSF facility, must continue to go along with this scheme. This has been the most difficult hurdle to overcome in the ongoing European debt crisis.

Until all of these factors are accomplished, we are of the opinion that substantive steps have been taken to avoid the crisis du jour in Europe for the time being. Until further and more expansive steps are taken to truly restructure more of Europe’s sovereign debt, we remain skeptical the EU has fully solved it sovereign debt issues. We will watch further developments unfold to see if the current crisis has been deferred once again or if long term solutions are truly being implemented.

Morris R. Segall