Thursday, 2 August 2012

The Euro crisis


Darkening skies over Europe
The euro zone may be forced to make a difficult choice soon.


1 August, 2012

You can’t spell Spain without “pain,” and you can’t spell euro zone without nearly breaking down in tears as you contemplate the latest unraveling of the continent.

On some level, it is hard to make room in your mind for how badly the financial condition of Spain has unwound in the past two months, but you need to do that because it is as serious as Greece, but with bigger consequences.

Don’t get tired of all the bad news. You still need to pay attention even though policy makers are trying to cobble together another in a series of rickety, short-term fixes this week with twine and chewing gum. There is a controlled explosion rippling across the continent, and just because it is summer, does not mean it’s not real.

Despite the efforts made toward the 100-billion-euro bailout of its banking system last month, Spain has not yet evaded a banking crisis at all. And it has not evaded its sovereign debt crisis. And its fiscal situation is worsening because the Spanish people are freaking out about the fourth in a series of harsh austerity measures. The regional government system in Spain is also getting worse, with Valencia needing a bailout now and Catalan soon to follow.

And all this time, the euro zone paymasters in Germany are sick and tired of people asking for more money. They’re ready to dump their Greece project, and will try to drop the hammer on Spain as well — the heck with euro zone unity. Which can only lead to one thing, and that is a social and political crisis, as the Spanish and Greek people take to the streets to protest, stepping out on their jobs, cutting output, and, in turn, reducing the taxes that can be collected to solve the fiscal crisis.

The drain in Spain is a classic deflationary spiral lifted out of the history textbooks and dropped into a modern, beautiful country full of hard-working and lovely people with iPhones and vacation house and some of the best food in the world.

The latest plan by the Spanish government to generate more funds calls for an increase in the consumption tax, which is similar to a sales tax (or a VAT) to 21% — up from the already super-high 18%. Policy makers are also demanding a cut in unemployment benefits, an increase in wage cuts, and layoffs of more state workers. The way analyst Gregory Weldon counts it up, it looks like 110 billion euros in austerity measures have been launched at the Spanish people over the next three years. This in a country where youth unemployment is already 52%.

Where has all the money gone? A lot of bad real estate investments that did not pan out, all across the country. Tens of thousands of kids dropped out of school so they could build houses that now sit empty, and the youths have few higher-education skills. Last week, the Spanish government was forced to spend 18 billion euros to create an emergency financing facility for regional governments, who are saddled with their own debt, a great deal of which matures at the end of this year.

Valencia is more than just sunlight and oranges. The semiautonomous region is deeply in hock, with a debt-to-GDP ratio nearly three times that of Italy, according to Weldon data, pegged at 21%.

There is not enough money in the central government to bail out Valencia and Catalan, and there is not enough in the euro zone to bail out Spain. German lawmakers have taken the unexpected step of blocking the recapitalization of Spanish banks directly — an agreement that was the centerpiece of the euro zone summit last month — putting the onus of all new funding on the back of the sovereign.

I hate to sound negative, but this is not going to turn out well unless ECB chief Mario Draghi attacks the crisis with all guns blazing, with German lawmakers staunchly behind him.

Also making investors run a fever lately is the revived specter of a Greek exit from the euro zone. Germany and the IMF were quoted over the weekend stating that the Athens government isn’t moving quickly enough to complete austerity measures required before the next tranche of bailout money will be released.

It’s looking like the IMF and Germany both want out of Greece, where they have already dropped tens of billions. So what are the odds they are going to be willing to drop more on Spain, following the 100-billion-euro bank bailout? You can probably ignore the apparent haste of the announcement last week. Nothing happens too fast in Europe, especially in the summer, but at least you know the direction the financial winds are headed. Skies are darkening.

* * *

Against this backdrop in Spain, the stock market news in the rest of Europe is not much better. Italy introduced a ban on the short-selling of bank and insurance stocks. The measure is to remain in effect through the end of the month.

Meanwhile, Spain banned the creation of negative bets on equities through shares, derivatives and over-the-counter instruments for three months. These efforts never work — and in fact, make matters worse because they prevent legitimate hedging. They are demagoguery and lead to worse financial conditions.

The political instability in Italy is growing to be more of a concern, as Italian President Monti tries to hold his technocratic government together. There was a report in late July that Monti was considering calling early elections for the fall to shore up his support. If he loses a vote of confidence, the already very weak investor confidence could be shot, and just at the worst time.

The problem in Italy is the same as elsewhere on the continent: Cities are under increasing financial strain. The newspaper La Stampa reported that there is a “black list” of 10 major Italian cities with more than 50,000 people at risk of near-term financial problems. Naples and Palermo top the list. This follows last week’s worry that the autonomous region of Sicily was nearing default on its debt.

To top it all off, in Europe came a report over the weekend that the International Monetary Fund could end support for Greece as early as September. Der Spiegel reported that senior officials at the IMF have informed the EU that the fund is no longer willing to fund Greece. Greece’s creditors seem unwilling to be flexible on bailout program terms, as the next tranche is expected to amount to 50 billion euros.

Switching to China, the news doesn’t get much better. The latest independent data shows that China’s growth could slow further. The region’s equities were lower today after a respected professor stated that economic growth for this quarter could be 7.4%. This is in comparison to consensus of 7.8% and last quarter’s 7.6%. You may recall that Premier Wen Jiabao lowered the country’s economic growth target to 7.5% from in 8.0% in March. Stocks have retreated to their lowest level in three years.


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