Monday, May 21, 2012

21/05/2012: Sunday Times 20/5/2012: Euro area crisis - no growth in sight

Here's my Sunday Times article from May 20, 2012. Unedited version, as usual.

Welcome to the terminal stage of the Euro crisis. Only two years ago European press and politicians were consumed with the terrifying prospects of a two-speed Europe. This week, preliminary estimates of the Euro area GDP growth for the first quarter of 2012 have confirmed that the common currency area, instead of bifurcating, has trifurcated into three distinct zones.

In the red corner, we have the pack of the perennially struggling economies of Cyprus, Greece, Italy, Portugal and Spain. The Netherlands, with annual output contraction of -1.3% in Q1 2012, matching that of Italy, has quietly joined their ranks. These countries all have posted negative growth over the last six months if not longer. Cyprus, Italy, and Portugal, alongside the Netherlands, registering negative growth over the last three quarters. Ireland and Malta, two other candidates for this group are yet to report their Q1 2012 results, with the former now officially in a recession since the end of 2011, while the latter having posted its first quarter of negative growth in Q4 2011.

In the blue corner, Belgium, France, and Austria all have narrowly missed declaring a recession in the last quarter, while posting 0.5% annual growth or less.

Lastly, in the green corner, Estonia, Finland, Germany and Slovakia have served as the powerhouse of the common currency area, pushing the quarterly growth envelope by between 0.5% and 1.3%.

The red corner accounts for 40% of euro area entire GDP, the blue corner – for 29%. All in, less than one third of the euro area economy is currently managing to stay above the waterline.

Looking at the picture from a slightly different prospective, out of the Euro 4 largest economies, France has shown not a single quarter of growth in excess of 0.3% since January 2011. In the latest quarter it posted zero growth. Germany – the darling of Europe’s growth strategists – has managed to deliver 0.5% quarterly growth in Q1 2012 on foot of 0.2% contraction in Q4 2011. Annual growth rates came at an even more disappointing 1.2% in Q1 2012, down from 2.0% in Q4 2011. Italy decline accelerated from -0.7% in Q4 2011 to -0.8% in Q1 2012, while Spain has officially re-entered recession with 0.3% contraction in Q4 2011 and Q1 2012.

The Big 4 account for 77% of euro area total economic output. Not surprisingly, overall EA17 growth was zero in Q1 2012 both in quarterly terms and annual terms. The latest leading indicator for euro area growth, Eurocoin, reading for April 2012 shows slight amplification of the downward trend from March. In other words, things are not getting better.

The best countries in terms of overall hope of economic recoveries – net exports generators, such as Austria, Belgium, Ireland, and the Netherlands, are all stuck in either the twilight zone of zero growth or in a years-long recession hell.

Ireland’s exporting sectors have been booming, with total exports rising from the recession period trough of €145.9 billion in 2009 to €165.3 billion in 2011. However, the rate of growth in our exports has been slowing down much faster than projected for 2012. If in 2010 year on year total exports expanded 8.1% in current prices terms, in 2011 the rate of growth was 4.8%. Our overall trade surplus for both goods and services grew 12.8% in 2011 – impressive figure, but down on 19.7% in 2010.

So far this year, the slowdown continues.

The latest PMI data suggests that manufacturing activity is likely to have been flat in Q1 2012. Latest goods exports data, released this week, shows that the sector posted zero growth confirming overall readings from the PMI. The value of trade in goods surplus steadily declined since January 2012 peak of €3,813 million to €3,023 million in March 2012, and in annual terms, Q1 2012 surplus for merchandise trade is now down €99 million on 2011. Although the quarter-on-quarter reduction appears to be small due to relatively shallow trade surplus recorded in January 2011, March seasonally-adjusted trade surplus is down 22% or €850 million on March 2011. With patents expiring, the latest data shows that exports of Medical and pharmaceutical products fell €772 million in Q1 2012 compared to Q1 2011. Overall, comparing first quarter results, 2011 registered seasonally-adjusted annual growth of 7.9% in exports and 15.2% in trade surplus. 2012 Q1 results are virtually flat, with exports rising 0.03% and trade surplus rising 0.8%.

Looking at the geographical composition of our merchandise trade, until recently, our exports and trade surplus were strongly underwritten by re-exportation by the US multi-nationals into North America of goods produced here. This too has changed in Q1 2012, despite the fact that the US has managed to stay outside the economic mess sweeping across Europe. In three months through March 2012, Irish exports to the US have fallen 19.3% and our trade surplus with the US has shrunk 47.1% from €3.33 billion to €1.76 billion.

Services are more elusive and more volatile, with CSO reporting lagging the data releases for goods trade, but so far, indications are that services activity remained on a very shallow growth trend through Q1 2012. As in Manufacturing, Services demand has been driven once again by more robust exports, and as for Manufacturing, this fact exposes us to the potential downside risk both from the on-going euro area crisis and from the clear indication that our domestic economy continues to shrink even after an already massive four years-long depression.

No matter how we spin the data, the reality is that exports generation in Europe overall, and in Ireland in particular, is still largely a matter of trade flows between the slower growth North American and European regions.

In many ways than one, Ireland is a real canary in the mine, because of all Euro area economies excluding the Accession states, Ireland should be in the strongest position to recover and because our exporting sectors continue to perform much better than the European average. Yet the recovery is nowhere to be seen.

Instead, the growth risks manifested in significant slowdown in our external trade activity and in overall manufacturing and services sectors are now coinciding with the euro entering the terminal stage of the crisis.

Since the beginning of this week, Belgian and Cypriot, Austrian and Dutch, virtually all euro area bonds have been taking some beating. In the mean time, credit downgrades came down on Italy and Spain, and the Spanish banking system was exposed, at last, as the very anchor that is likely to drag Europe’s fifth largest economy into EFSF/ESM rescue mechanism. This week, in a regulatory filing, Spain’s second largest bank, BBVA stated that: “The connection between EU sovereign concerns and concerns for the health of the European financial system has intensified, and financial tensions in Europe have reached levels, in many respects, higher than those present after the collapse of Lehman Brothers in October 2008.” Meanwhile, Greek retail banks have lost some 17% of their customers’ deposits since mid-2011 and this week alone have seen the bank runs accelerating from €700 million per day on Monday-Tuesday, to over €1.2 billion on Wednesday.

This is not a new crisis, but the logical outcome of Europe’s proven track record of inability to deal with the smaller sub-component of the balance sheet recession – the Greek debt overhang. Three years into the crisis, European leadership has no meaningful roadmap for either federalization of the debts or for a full fiscal harmonization. There is no growth programme and the likelihood of a credible one emerging any time soon is extremely low. Structural reforms are nowhere to be seen and productivity growth as well as competitiveness gains remain very shallow, despite painful adjustments in private sector employment and wages. Inflation is running well above the targets. Austerity is nothing more than a series of pronouncements that European leaders have absolutely no determination to follow through. EU own budget is rising next year by seven percentage points, while Government expenditure across the EU states is set to increase, not decrease.

In short, three years of wasteful meetings, summits, and compacts have resulted in a rather predictable and extremely unpleasant outcome: aside from the ECB’s long term refinancing operations injecting €1 trillion of funds into the common currency’s failing banking system, Europe has failed to produce a single meaningful response to the crisis.


Box-out:  Speaking at this week’s conference of the Irish economy organized by Bloomberg, Department of Finance Michael Torpey has made it clear that whilst one in ten mortgagees in the country are now failing to cover the full cost of their loans, strategic defaults amount to a negligible percentage of those who declare difficulty in repayments. This statement contradicts the Central Bank of Ireland and the Minister for Finance claims that the risk of strategic defaults is significant and warrants shallow, rather than deep, reforms of the personal bankruptcy code. Furthermore, the actual levels of mortgages that are currently under stress is not 10% as frequently claimed, but a much higher 14.1% - the proportion corresponding to 108,603 mortgages that have either been in arrears of 30 days and longer, or were restructured in recent years and are currently not in arrears due to a temporary reduction in overall burden of repayments, but are at significant risk of lapsing into arrears once again. The data, covering the period through December 2011 is likely to be revised upward once first quarter 2012 numbers are published in the next few weeks. In brief, both the mortgages arrears dynamics and the rise of the overall expected losses in the Irish banking system to exceed the base-line risk projections under the Government stress tests of 2011 suggest that the state must move aggressively to resolve mortgages crisis before it spins out of control.


Robert Lockard said...

This is really scary stuff. Thank you for taking the time to lay it all out in such detail. I've been watching this crisis unfold for some time and I can't help thinking that the entire foundation of the world's monetary systems is inherently flawed. Easy credit and huge amounts of debt are strangling countries and turning people into slaves.

The answer should be to stop giving in to the temptation to think that more debt is the answer, but I worry that politicians and their constituents won't have the willpower to do what is necessary to preserve their freedom.

Brian O' Hanlon said...

I was telling people over two years ago, that the IMF would arrive in Ireland, and that the Euro as a currency system would not last. I was looked at like I was having some strange mental difficulties. Who knows, and maybe I was having some strange mental difficulty. I do not attribute my prediction of either of the above, to any great intellectual faculty or deep insight into currency systems. But the point I wish to make, is that in a short space of time, what seems impossible can become the possible.

The only true observation I have heard about the Eurozone in all of the last few years though - and I can’t claim any credit for this observation - is that, every time we ’solve’ the Eurozone problem, we buy ourselves a little bit of time - and before we know, we are back into another round of ‘what’s going to happen?’ The only thing that is changing is that the period of time between one episode and the next, would appear to be shortening, whilst the severity of the panic on each occasion increases.

It is a bit like one of those medieval movies, where they are ramming the door of the castle with one of those big tree trunk implements. Sure, the door stands up the first, second, third, . . . and after a while, the occupants of the castle begin to feel quite safe . . . and then, they are all shocked. The door is broken. This is what will happen the Eurozone, and we are like those occupants inside the castle at the moment.

Many economists have got it all wrong about ‘mutual insurance mechanisms’, and they get all hung up trying to wrap their heads around how to view how 'Eurobonds' may function.

The only insurances that EU member states will buy from now on, are Euros in hard currency terms. The Euro will end up being the dollar equivalent within the European Union - as the dollar is, on the global stage - the insurance policy. EU member states will end up hoarding trillions worth of these things, which are currency, but not a currency that is circulated within the state which holds the reserve.

Germany, and perhaps France, will end up keeping this currency in circulation within its borders. But the point is, that the amount of Euro currency circulating outside of the borders of Germany or France, will very much dwarf that which is circulating inside. From a global perspective, many Asian and Middle Eastern countries will also hold vast quantities of Euros, along with the dollars they have always had - and that will be good - because it will take some of the role away from the United States of being the issuing nation, of the only global reserve currency. Regards, BOH.