You can't turn on the news, read the morning paper, or peruse the Internet without running into some handwringing piece on the troubles in Europe or perhaps a chest-puffing diatribe saying, "Here's how to solve it all, you buffoons." So just how bad is Europe? Well, the smoke has pretty much cleared from the past few months of smoldering hope followed by flames of despair. The euro zone has just two options: break up or print money. At this point, it really is just that simple. The distinct scent of eau-de-contagion weighs heavy in the air.
For a welcome change of pace (note the wry grin), Greece is no longer Public Enemy No. 1 as Italy takes center stage, with Spain and France elbowing their way into the spotlight and Hungary waving from the wings. With the long-anticipated demise of the Papandreou government in Greece and the fall of Berlusconi in Italy, events in Europe are likely to pick up speed.
Italian and Spanish borrowing rates are reaching levels the countries cannot afford, meaning the ECB or the IMF must lower rates or provide additional debt at below-market rates. Spain's first debt sale since the weekend elections to replace its government resulted in an average yield of 5.11% on the three-month T-bill, up from 2.292% for similar issuance October 25. Apparently, the market isn't in love quite yet with the new government.
French 10-year bond yields have also risen dramatically from 2.6% to more than 3.6% in less than two months. That's a 38.5% increase! France may still be AAA rated officially, but the markets aren't pricing the debt as AAA. (Recall that when the US lost its AAA rating, Treasury bond yields fell!) If France officially loses its rating, the EFSF (European Financial Stability Facility) will be seriously impaired, further dimming the prospects for any sort of bailout.
Third-quarter German GDP growth came in at a meager 0.5%. France had 0.4% growth after a second-quarter contraction of 1%. Spain and Italy were flat. Euro zone factory output fell 2% in September. Exceptionally high debt levels, rising borrowing rates, and stagnating economies make for a dangerous brew.
Italy and Greece are now led by appointees, rather than duly elected officials. For the time being, there is no reason to believe these appointees will have any more success than their elected predecessors.
Hungary has asked the IMF for help. Contagion strikes again as Eastern Europe desperately needs external financing for its banking system, with about 80% of the financing coming from European lenders and their subsidiaries. A banking crisis in Europe will leave Eastern Europe vulnerable to an enormous credit crunch.
The pullback in lending by highly stressed European banks is being felt by companies around the world, making borrowing harder and more expensive. This is a headwind to global growth.
Basel 2.5 implementation, with its more stringent capital requirements for banks, is due on December 31 for European Union countries. As if things weren't tough enough!
Why do rising interest rates matter so much for sovereign debt? Imagine a country that has $100 of annual GDP (its income), debt of $100, and a government that is spending 10% more of its GDP a year than it takes in from taxes. If its GDP were expected to grow at, say, 2% while it had to pay 6% on its debt, it would be in a downward spiral and would quickly become insolvent, because the debt would grow faster than the income at an ever accelerating rate. Ouch! (US debt is about equal to our GDP, and we are running large deficits.)
Year 1: GDP = $100*(1+2%) = $102. Debt = $100*(1+6%)+(10%*100) = $116.
Year 2: GDP = $102*(1+2%) = $104. Debt = $116*(1+6%)+(10%*102) = $133.
Year 3: GDP = $104*(1+2%) = $106. Debt = $133*(1+6%)+(10%*104) = $151.
(You get the point.)
Bottom Line: The fundamentals have not changed. The market is just now beginning to appreciate the reality of the situation. What makes this even more startling is that, even though all these yields are rising dramatically, the ECB is furiously buying up buckets full of all these bonds. Imagine what yields would be without this ECB wingman! There is a clear flight to safety into the German Bund and US Treasuries.
The most important question is not if the European leaders can muster the collective will to solve this crisis, but whether they have the financial ability to solve it. I believe it is unlikely they can solve it in any meaningful way, regardless of what agreements arise. Political will cannot make 2+2 = 5, despite what bureaucrats may claim!
Back home, things don't look too rosy, either.
Tuesday's US auction on five-year Treasuries had the lowest yield in history. This indicated that the markets have a negative outlook on future economic growth.
Unemployment is still exceptionally high at 9%, with the adult male unemployment level at a near-record 8.8%, a level previously seen only in the very deepest recessions.
The youth unemployment rate is 24%.
A quarter of homeowners are under water on their debt.
The fiscal deficit (the amount the government spends in excess of tax receipts) is 9% of GDP, with interest rates at record lows and our national debt about equal to the annual GDP. Remember the earlier math exercise?
Since 20% of our exports land in Europe, a slowdown there affects growth prospects here.
Our "super committee" turned out to be not very super. Is anyone really surprised?
If that didn't get your attention, ponder this. These types of conditions are what you see coming OUT of a recession. And, as I'm sure frequent visitors of this Website are well aware, we are likely heading INTO one. That's like heading into an all-nighter at work after spending a three-day weekend in Vegas without seeing your hotel room once.
The US and the global economy as a whole are heading into some exceptionally challenging times. But before you head to the hills with that 50-gallon bucket of dehydrated food, remember that the worst of times often can serve as a catalyst for meaningful and powerful change.
Thats the problem with Politicians everywhere(even in America);they thrive in sucking the taxpayer dry.
Unless you figure out a way to make politicians completely accountable to the electorate they are supposed to serve(and make them accountable in real-time) and not only at election times;I don't see much change happening.
Hey,Here's a novel thought-Lets say the public in a constituency is unhappy with their elected representative.They can vote to cut his salary(by 25%.50% and 100%).Wont that improve their behaviour and performance???
The video you've linked does a great job of exposing legal corruption in the European Parliment. Each member of the Parliment has a salary that exceeds that of the German Chancellor -
7,339 € - Basic monthly salary (attendance not required!)
3,980 € - Non-taxable expense compensation
3,408 € - Daily compensation at 284 € per day times 12 (average) sessions per month
14,727 € per month!
Apparently, even the daily compensation is not so generous that they need to work for it, as the MEP members have a practice of showing on Friday mornings with their bags packed. They register their names on the attendance sheet to "earn" their 284 € for the day and then skip town before the work day actually starts.
The camera crew showed up on a Friday and filmed the members darting away like roaches running for the dark. It's great fun to watch, as long as you're not paying EU taxes.
Thank you for this great article. I read it again tonight and still impressed that you could explain the whole situation in such as a simple way.
Specifically, you pointed out the danger in Central and Easter Europe. They were among the worst performing market regions in 2009 (over 5% GDP decline) and have had a relatively weak recovery in 2011 and 2011. With the euro zone crisis spreading and deepen, how will the region e affected? Would the problem getting bigger and eventually drag the whole euro and world down with it? I guess we will find out soon.
A look at the numbers tells us that an attempt to grow our way out of this period of difficulty is a move in the wrong direction. Energy production, especially in the case of natural gas, requires an unprecedented ramping up of controversial extraction techniques, just to keep supply at today's levels. Where will the relatively high amounts of investment needed for this come from, when the make-up of mainstay currencies is sloshing with spiralling debt and hedge paper--whose value in some cases is impossible to determine?
A crash-landing for this economy does seem inevitable. In fact, those with antipathy to republican governments couldn't exercise their ill will better than by forcing those governments to assume the burden of a system where toxic assets predominate.
In this case we should look to the restructuring of the unprofitable European Union, not a dissolution. A union of the best and the brightest on the continent, while a threat to some, is one positive thing that could come out of this mess.
Great video. Good piece of journalism. Pretty amazing.
I've always wondered what kind of value and entirely new political infrastructure such as the EU adds to member states... apparently not much beyond the additional overhead, and the capacity to blow up the entire world financial markets.
The economy has grown less strongly this year than we forecast in March, primarily because higher-than-expected inflation has squeezed household incomes and consumer spending. On the assumption that the euro area struggles through its current difficulties, we expect the underlying momentum of the economy to pick up through next year, but with the headline measure of GDP broadly flat until the second half. Our central forecast is for 0.7 per cent growth in GDP in 2012, compared to the average external forecast of 1.2 per cent.
Asish, you are right. The same is happening with Chinese currency Yuan. Once in 6 months the central bank of China, review its position with Dollar and they refix its value at par with dollar to make sure that they have a better currency power.
I agree with you that those politicians are hopeless. In my opinion, there are three forces can help us out of this mess: entrepreneur spirit, innovation and leadership. Now I gave up leadership completely, because all of those politicians are hopeless. But I still bet on entrepreneur spirit and innovation. Why? because I think people need to survive and will survive from this mess. We are heading dark and turbulent period, people will struggle to survive. Because they need survive, they will find ways, new ways to get us out of this mess. It's not a easy task, sometimes maybe painful. But I believe we will survive and get better. I believe we will see lots of changes, changes to make this world better.
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Forget about business growth as long as the future of tax rates remains unclear, regulation continues to expand in unpredictable ways, and legislation keeps creating increasingly onerous burdens.
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