Dubai, as I said when the specter of default loomed large, was symptomatic of a bigger global problem of a sovereign debt crisis. Greece is symptomatic of the problem that the Eurozone (and, by default the Euro) currently faces. Success of Eurozone depended on strict internal discipline by the members. Problem was the different stages of economic growth in different countries. Fact is, many of those nations who aspired to be a member of the much avowed group of countries, did not really care for the discipline expected out of them. The problem was exacerbated by the fact that there was a uniform monetary policy across members as was the uniform deficit target. Sure France and Germany sent out wrong message by violating the deficit targets without inviting sanctions, thanks to the clout they enjoyed. The smaller economies thought that they would continue to enjoy the benefits of being a member without being disciplined. The credit fuelled growth enjoyed by them without the adequate checks and balances meant that, when the global environment turned around for the worst, they paid a heavy price for their lack of discipline. And they did not have ammunition to fight given the centralized policies.
Make no mistake, the PIGS (Portugal, Ireland, Greece and Spain) economies are in real danger of sovereign default and the only way that can be averted is by forcing all of them to drastically reduce the deficit, meaning to say that the government should cease to play the role of propping up the economy. In the current environment, this would lead most of these economies into another bout of recession. And this will pull the others alongwith. Also, as the risk perception increases, it can lead to an increase in risk premium in the interest rates, which can also slowdown the recovery process.
Essentially what this means is that Euro will continue to be weak. And, by default, the US dollar will strengthen, more so given the likely flight to safety. Since its December low, the dollar has already gained more than 10% vis-à-vis Euro and as a result, the trade weighted dollar index is also moving up. My feeling is that, the dollar will generally remain strong, although it will continue to be volatile, given that the US economy itself is on a weak wicket. However, sustained weakness of the dollar is not on the cards now.
With Ireland being forced to mend its profligate ways and Greece having no other alternative but to follow suit, some questions are being raised as to whether UK would have been better off by being part of the Eurozone, which would also have ensured more fiscal discipline.
However, I am not sure that joining the Eurozone would act as a panacea. Greece fudged its data to join and did nothing to bring their finance in order. Neither has Portugal. It’s all about internal discipline. Spain's growth was more about being credit driven (via the housing market route) and there was nothing much fundamental about it. Unemployment at 25% is the result as the bubble pricked.
Fact is, if one looks at the history, things are not very encouraging. The biggest proponents of the Stability & Growth Pact (SGP) viz France & Germany continued to flout 3% deficit cap with impunity. Yet, the Council of Ministers failed to apply sanctions against them although punitive proceedings were started when dealing with Portugal (2002) and Greece (2005), though fines were never applied. The reasons that larger countries have not been punished include their influence and large number of votes on the Council of Ministers, which must approve sanctions. It is unlikely UK would have been much different. Agreed, UK needs to do mend its ways. But it is also important to realise that the extent of deficit reduction Greece and Ireland needs to do would, in all likelihood, plunge these economies into recession. A big economy like UK plunging into recession has its own implication.
Actually there’s no right or wrong action. There are both pros and cons of being part of the Eurozone. A bigger question though is can UK afford not to have an independent monetary and fiscal policy? In this regard, Krugman’s views (link pasted below) does sound logical. (http://www.nytimes.com/2010/02/15/opinion/15krugman.html?em)
Despite the bad weather, the number of Americans filing first-time claims for unemployment insurance rose last week. Initial jobless claims rose (as against a general expectation of a fall) by 31,000 to 473,000 in the week ended Feb. 13, as per the Labor Department figures released today. More importantly, while the total number of people receiving unemployment insurance was unchanged, those receiving extended benefits increased. The number of people who’ve used up their traditional benefits and are now collecting extended payments rose by about 274,500 to 6 million in the week ended Jan. 30. This point to the fact that by the time the next set of unemployment data is released, the average duration of unemployment will be even higher.
Clearly, the labor market continues to be very weak and this is going to be a major impediment against rising sales. And only evidence of rising sales can result is hiring.
According to the US Census Bureau data released yesterday, the Housing starts rose by 2.8% MoM (or 21.1% YoY) in January’10 to a seasonally adjusted annualised rate (SAAR) of 591,000, while the December data was revised to a decline of 0.7%. While the multi-family segment recorded a robust growth of 17.6% MoM (as against a growth of 8.9% in December) to 100,000, the single-family housing starts growth was muted, rising by a mere 1.5% MoM to reach 484,000 SAAR, following a 3.0% MoM decline in December. Building permits, an indicator of future construction, slowed down in January, falling 4.9% MoM. In comparison, it jumped by 10.9% in December, while single-family permits rose a mere 0.4% MoM to 507,000 SAAR following a 7.7% gain in December.
Fact is, by February’09, single-family starts slumped to a record low of 357,000 SAAR. Although there was robust recovery (by a more than 40%) by September’09, it started to retreat again. Single-family starts recovered by 42% from the low of February’09. However, toward late 2009, starts fell back again. As I have been maintaining, the movement of housing starts has a lot to do with the stimulus package which entailed a US$8,000 homebuyer tax credit. Fact is, housing demand continued to wax and wane depending on the expiration (initially proposed to expire by November’09) and extension of the credit. Meaning, a part of the increase was driven by the anticipated boost in demand for housing due to the homebuyer tax credit. With the recent extension of the homebuyer tax credit through April’10 and the expansion to include higher-income and step-up buyers, demand for new homes are likely to see some support. On the other hand, in the multifamily segment, starts have shown no signs of stabilization, due to the existence of excess inventories.
The fact that Greece has bluffed its way (namely fudging data to show strong balance sheet) to join the Eurozone is well known. However, as new skeletons tumbled out of the cupboard, it seemed that Goldman Sachs was its partner in crime. It helped Greece raise $1 billion of off-balance-sheet funding in 2002 through swap deals, something that the European Union regulators claim that they were absolutely unaware of. While corruption in the Greek public sector is well known (which, we Indians, can fully understand), their messy financial situation landed them in even greater trouble being part of the Eurozone, given the lack of independence of their monetary and, to a great extent, their fiscal policy.
Fact is, the extent of debt that has been run by (among others) the PIGS economies have made their countries highly vulnerable. Not that all the others are in a good shape, but the PIGS economies epitomizes the problems the profligate economies (that cannot self correct) face.
Surely, Greece, as a nation is in clear need for a bailout. Default (even a technical one) would be catastrophic. CDS spread of Greece has skyrocketed to 400 basis points plus. As a rough estimate, about €300 bn worth of Greek bonds are outstanding in the global market. Overall, as the sovereign rating of the vulnerable countries (Portugal and Spain are also facing increasing pressure) take a beating, the interests rates would start to rise. And the problem will not be restricted to the few countries only. Even the biggies would be affected. In case of Germany, for example, in the past about 6 months, the CDS spread more than doubled. As per the BIS data, total exposure of the German banks in the PIGS economy (Ireland, instead of Italy) is close to a quarter of their total exposure in developed Europe and nearly 15% of their total global exposure. Meaning, the impact of the vulnerable economies would be increased interest rates, something that the entire region can ill afford at this point in time, when recovery is of paramount importance.
On the other hand, bringing the deficits down (which should be the prime focus) substantially in a shorter period of time (as is expected of Greece or, for that matter, already implemented by Ireland) to enable these economies to meet the requirements to be part of the Eurozone, can lead these economies straight into recession as the Government has to stop supporting the economies fairly soon.
Not surprisingly, there is now increased clamour about a dual currency in the Eurozone (a strong Euro or the existing one and a weak Euro to be adopted by the weaker economies). Not that the Eurozone policy is to be solely blamed. A significant body of academic research shows that since euro’s introduction in 1999, not only have the periphery countries of the Eurozone not achieve real convergence towards the union’s core countries, they have actually diverged further. Euro-participation provided periphery countries with a false sense of financial security preventing them from pursuing unpopular yet necessary fiscal and structural reforms. And they are paying the price for it.
Picking up from where I left yesterday on similar issue of unemploment (http://kunalsthoughts.weebly.com/1/post/2010/02/us-initial-claims-economy-on-sticky-wicket.html), the malaise seems to be deeper than what the bulls of the Q4’10 GDP number might want us to believe. First things first. Employers cut as much as 20,000 jobs, when the median market expectation was some positive job creation. It is also important to note that while the gain in November employment was revised up from 4,000 to 64,000, the revised December number showed the job loss plummeting from 85,000 to as much as 150,000 – more than erasing the gains in the previous month.As per the data leased by the Labor department, the fall in employment last month was mostly driven by a plunge in construction jobs and a drop in state and local government hiring. Although manufacturing employment increased, employers squeezed more out of existing workers by making them work more as is reflected by the increasing average work week (average workweek for all employees on private nonfarm payrolls was up by 0.1 hour to 33.9 hours in January, with the manufacturing work week rising by 0.3 hrs to 39.9 hrs). In fact, since June, the manufacturing workweek has increased by 1.2 hours. The factory overtime increased by 0.1 hour over the month. Not surprisingly the productivity has been rising.The extent of the problem can be gauged from the fact that the number of long-term unemployed (those jobless for 27 weeks and over) continued to rise in January, reaching 6.3 million. Since the start of the recession in December 2007, the number of long-term unemployed has risen by 5.0 million. Getting job has become so difficult now that the average duration of unemployment has crossed 30 weeks for the first time, meaning people who lose job, remain unemployed for an average of seven months plus, and that’s big. Not surprisingly, the number of discouraged workers (as part of what is called marginally attached) increased to 1.1 million in Jan’10 as against 0.7 million in Jan’09 and the remaining 1.5 million people marginally attached to the labor force had not searched for work in the 4 weeks preceding the survey for reasons such as school attendance or family responsibilities.Hence the drop in unemployment rate, despite the rise in unemployment number is more technical in nature as some section of the unemployed (who were surveyed) have not looked out for jobs during the past 4 weeks (the period on the survey) and hence did not qualify as unemployed.While this anomaly might be rectified next month, unemployment rate might not increase much next week given the firms have now become so lean (by cutting headcounts and increasing productivity of the remaining), they would need to add some workers as inventory restocking starts. However, unless the demand picks up to sustain rising production from mere restocking to meeting rising demand (which is quite unlikely), the economy is shaping up for rising levels of unemployment a few months down the line.In any case, the actual level of unemployment is much higher, if we take a more logical gauge of unemployment, which is reflected in the U6 (U-6 Total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force) numbers and not simply U3 (Total unemployed, as a percent of the civilian labor force (official unemployment rate). The U6 rate is now as high as 16.5%.
The US economy is in a very sticky wicket indeed, notwithstanding the above expected growth recorded during Q4’09. The recovery is mainly technical as inventory draw down is coming to a close and the inventories have gone to such levels that some restocking is essential. Question is, will the inventory stocking finally lead to production cranking up and economy starting to move up? No, because the consumer sentiments are terribly scythed.
Make no mistake, the consumers are in deep waters and unemployment rates are not going to go down very soon. If anything, there is every likelihood that the unemployment rate will inch up for some more time to come.
The data released by the US Labor Department today shows that Initial jobless claims increased to 480,000 (as against the market expectation of around 450,000) in the week ended Jan. 30, which is the highest in the last seven weeks and up from 472,000 the week before. More importantly, the number of people receiving unemployment insurance hardly changed and those receiving extended benefits actually increased, thereby signaling the difficulty of people landing up with jobs. It is also important to note that, the number of people who’ve used up their traditional benefits and are now collecting extended payments increased by about 242,000 to 5.86 million in the week ended Jan. 16.
However, as restocking slowly starts, capacity utilization has started moving wee bit up, having hit its low by the middle of 2009. Not surprisingly, productivity has started increasing. As per another report of the Labor Department, worker productivity, as measured by output per hour, rose at a rate of 6.2% (annualized) during Q4’09, resulting in an overall increase of 2.9% during 2009, which incidentally is the biggest one-year increase since 2003. Labor costs dropped by 4.4% last quarter and fell by 0.9% during the whole of 2009, which incidentally is the biggest drop in seven years.
Source: Fed, BLS
On the upside, the large jump in productivity does hint that some employment generation will take place soon. However, the overall scenario is unlikely to change much and the overall unemployment rate will not come down anytime soon. As the initial claims number suggest, there is a clear lack of confidence that the economic recovery will be sustained. There is every likelihood that the inventory restocking based recovery will run out of steam soon.