Welcome to 2012 and thanks to the Prince for his great efforts over the Christmas-New Year period, I certainly enjoyed the down time…. Now back to business.
It seems the ECB’s 3-year LTRO was partially successful, at least in the short term. We saw a major decline in Italian shorter-term yields but long-term yields are still very high (Italian 10 year yield reached 7.1 before ECB intervention) and the longer-term auctions struggled to reach their upper limits. In terms of Italy it is likely that these result were helped by the fact that the non-government sector is relatively un-indebted and is willing to take the risk over the short-term.
Longer-term paper is really the domain of larger financials and international institutions and that is where the struggle is, and will continue to be. The ECB’s willingness to lower its interest rates, collateral standards, reserve requirements and actively support sovereigns is holding up the finances of Europe for now, but there is really only so much the ECB can do.
The fundamentals of banking are that loans are a monetisation of non-monetary resources and/or a bringing forward of future potential earnings of a resource or person(s). This monetisation exposes banks to the risk that the monetary value they have estimated of these resources/person(s) may not be the actual value that can be recouped over the time of the loan.
The broad, yet fundamentally important measure of whether banks will be profitable in this enterprise is economic expansion of the underlying economy. That is, growth in economic output of the economies these banks are active in. If this is not occurring then, in aggregate, banking assets will be deteriorating and no amount of central bank operations will help.
The fact that the LTRO reserves have mostly returned to the ECB’s deposit facility shows that there is very limited demand and/or desire for new lending in the European private sector and this is a big problem for the European financial system. (I would note, however, that doesn’t mean that the LTOR funds will stay in the deposit facility forever, but that is a post for another day)
The fact that European M3 growth is falling makes it pretty clear that many parts of Europe are now actively in private sector deflation.
Data released by the European Central Bank shows that M3 money figures tracked by experts as a leading indicator for the economy have turned negative since August, signalling almost certain recession over coming months for the region as a whole.
“The message of these numbers is that the eurozone faces a bleak 2012, with inflation falling rapidly,” said Tim Congdon from International Monetary Research. “There is a desperate need to restore growth to the banking system and boost the quantity of money.”
What I am describing above is that the banking sector issues in many countries are of solvency not liquidity. As I talked about continuously in 2011 the European “solutions” focus on addressing the symptoms (liquidity) but fail to recognise the actual problem (solvency). As far as I am concerned the 3-year LTRO is yet another symptom focussed solution, when the actual problems of ever-growing national competiveness imbalance and the lack of economic growth within European nations remain.
The plan for 2012 appears to be the enactment of the “fiscal compact” with the underlying goal of reducing government balance sheets via spending cuts and tax raises. Apart from the obvious fact that this will further remove wealth from the private sector, recent history has taught us that the usual household response to such policy is to attempt to increase household savings and decrease consumption. At a single-nation level this deflationary effect could possibly be offset by an increase in consumption by export partners, but given this “fiscal compact” is a continent-wide agreement and weaker economies are tied to the currency of the stronger, this outcome seems most unlikely.
And so, it is no surprise that the politicians who are supposedly leading Europe out of its current economic quagmire spent the later parts of 2011 informing Europe’s citizens that the year didn’t really go to plan and therefore 2012 is likely to be even worse.
In her TV address, Chancellor Merkel said that despite Germany’s relatively good economic situation, “next year will no doubt be more difficult than 2011”.
The reduction in government spending may well be the ultimate aim of the policy but, as I have stated previously, it will mean that existing debts are very unlikely to be able to be repaid. Oddly, however, this additional requirement still appears to be an unwavering requirement of the new “fiscal compact”. If the actions of the Italian and French public follow that of other periphery citizens, and I see no real reason why this will not be the case, then I have no doubt that the leaders of Europe will be correct in their assessment of 2012. If we also add in the underlying deflationary economic effects of an ageing population, especially for Italy, then the current situation appears even more perverse.
The year certainly hasn’t started well for Spain
Spain’s new government said this year’s budget deficit would be much larger than expected and announced a slew of surprise tax hikes and wage freezes that could drag the country back to the centre of the eurozone debt crisis.
In its first decrees since sweeping to victory in November, the centre-right government said the public deficit for 2011 would come in at 8% of gross domestic product, well above an official target of 6%.
It announced initial public spending cuts of €8.9 billion and tax hikes aimed at bringing in an additional €6bn a year to tackle the shortfall.
Spain already has 22% unemployment, falling industrial production and continues to run a negative trade balance and current account. Given the large discrepancy in the number I find it hard to believe that 8% is actually the final result but, even if it is, it is very unlikely that Spain will be able to make any significant headway on its current level of government debt to GDP while the rest of Europe also attempts to do the same. This latest news is yet to be reflected in Spain’s yields.
The news isn’t much better from Italy
Long-awaited third quarter Italian national accounts data showed a 0.2% quarter-on-quarter contraction in gross domestic product (GDP). This was the first decline since the final three months of 2010 and stronger than the consensus expectation of a 0.1% fall. Measured on an annual basis, this represented a meagre 0.2% increase in output compared with the same period a year ago, weaker than a downwardly revised 0.7% annual rate of growth in the second quarter.
nor France
French President Nicolas Sarkozy’s re-election hopes have been hit by new figures showing unemployment at a 12-year high amid an austerity drive that leaves him little room to manoeuvre.
The figures issued on Monday showed the number of registered jobseekers in France rising by 29,900 in November to reach 2.84 million, the highest level since November 1999.
Before his election in 2007, Sarkozy vowed to lower joblessness to five percent, but the unemployment level hit 9.3 percent in the third quarter of this year and is on track to surpass 10 percent.
and overall European economic activity continues to slow
Manufacturing activity in the euro zone declined for the fifth straight month in December, although less sharply than earlier in the fourth quarter, according to a survey of purchasing managers released Monday.
The survey is consistent with other indicators of recent activity, and together the numbers suggest the euro-zone economy contracted during the final three months of the year.
Markit Economics said its Purchasing Managers Index for the sector rose to 46.9 from 46.4 in November, in line with expectations and below the 50.0 threshold that distinguishes an expansion from a contraction. Over the fourth quarter, the average PMI for manufacturing was the weakest since the second quarter of 2009.
Markit said that while the fall in output slowed in all of the nations covered by its survey, there were wide disparities. Factories in Germany, France, the Netherlands and Austria reported only mild declines in output, while those in Italy, Spain and Greece reported much larger drops.
The economic uncertainty of 2011 continues with a few elections thrown in, to add to the excitement. Welcome to Europe in 2012.