Before I address the latest developments in the Euro zone crisis I would like to draw your attention to two other factors which are at play in world markets at this time. The first follows on from the issues concerning China that I discussed last week particularly in my article on the 11th of November. The inflation fears I discussed are starting to have an impact on the Chinese stock market as the Shanghai Composite Index has fallen by 3.98% this morning and after the heavy falls on Friday we now have a fall of 8% in three days. We will have to see how European and US equity markets respond to this.
Long-term and government bond yields are rising: not what QE2 was supposed to provide
Also we have seen declines in government bond prices and rises in interest rates/yields in places which are not directly influenced by the Euro zone crisis. For example the ten-year UK gilt or government bond now yields 3.26% which whilst still low in historical terms has risen by one-third of a percentage point recently. In spite of the commencement of US government bond purchases by the US Federal Reserve under the new so-called QE2 programme which started on Friday we have seen US yields rise recently too. For example her ten-year yield is now 2.91% and her long bond or thirty-year now yields 4.37%. This is not what you might read elsewhere as many journalists have reported falls in US government bond yields since QE2 began in spite of the fact that what really took place was a shift in the shape of the yield curve(which I discussed on the 8th of November) and this has now been replaced by rises. On the day of the FOMC meeting I established some benchmarks for future reference and the ten-year yield has since risen by 0.34% and the thirty-year by 0.46%. So if you argue that one of the objectives of QE2 or Ben Bernanke’s Bazooka was to reduce longer-term interest rates you can only look at the numbers and say that at this point the policy is not working.
The Euro zone crisis
The general trend of an increase in longer-term interest rates does not help the Euro zone in its crisis as even its benchmark German government bond market has seen rises in yields. This does matter because in essence this is where any bailouts will be financed! So the rise of around 0.15% in German ten-year bund yields will have an impact on current talks in the Euro zone crisis. Also if I may mention a country whose name will only be whispered at the talks that of Spain her ten-year government bond yields have been steadily moving higher through this phase from around 4% to the current 4.56%. I was doing some research yesterday by reading some Portuguese articles and there was an interesting theme, the Portuguese feel that they are the first line of defence for Spain. This is not quite what you will hear from public pronouncements.
Late last night there was the first sign of a crack in Irish resistance to receiving an aid package from the Euro zone. In an interview with RTE Prime Minister Cowen said this, “We have to discuss these matters with partners as to how best to underpin financial and banking stability within the euro area”. So perhaps there will be some real negotiations today. For the moment markets are giving Ireland the benefit of the doubt but this lull will not last for ever.
There appear to have been discussions which involve the Euro zone rescue fund stepping in directly to bail out Irish banks and I wish to be clear that I feel that this would be a retrograde step. The reason for this is simple, Ireland’s plight is now so bad she may have to cut herself adrift at some point from parts of her banking sector and so EU support for the sector could lead to Ireland’s range of options going forwards being hamstrung.
There have also been some strange goings on at the Irish central Bank to say the least. I was discussing the situation online with Lorcan RK who follows these matters closely and he pointed out that the “other assets” section on the balance sheet of the Irish central bank has recently increased by some 20 billion Euros.This is not the sort of thing you do by mistake is it? Except there has been no explanation at all. Some might think that the Irish central bank feels it can undertake its own version of Quantitative Easing with what is more than ten per cent of Irish economic output.
The thoughts of Bono of U2
When I discussed the tax wheeze used by Google recently where it moves its money through various jurisdictions to avoid tax I have to confess I had forgotten what one of Ireland’s most famous son’s had also done. This was discussed back in 2009 on the Tax Justice Network.
For over 20 years, U2 benefited from Ireland’s non-taxation of creative income. But in 2006, the government had the audacity to cap the tax break at 250,000 euro annually. So U2 promptly incorporated in the Netherlands, where its royalties would only be subject to a 5% tax rate as opposed to Ireland’s 12.5%. Nothing illegal, but it’s a little hypocritical when someone who wants developed country governments to give more money to poor countries doesn’t want to pay his fair share of taxes.
The criticism looks fair enough to me when you consider Bono’s moralising over the years however he did reply in the Irish Times because he did not think it was fair.
I can understand how people outside the country wouldn’t understand how Ireland got to its prosperity but everybody in Ireland knows that there are some very clever people in the Government and in the Revenue who created a financial architecture that prospered the entire nation.
As I am a fan of some of U2’s music I guess the phrase “heroes with feet of clay” seems appropriate and of course Bono does now have the opportunity to pay his taxes again at home to support his own country in its hour of need.
Greece’s fiscal problems continue to increase
Yesterday as discussed in the comments section on here new figures for Greece’s finances were released by Eurostat. The details are that the new revised numbers for 2009 numbers are a fiscal deficit of 15.4% of her Gross Domestic Product and a National Debt of 126.8% of GDP. This affects the expected numbers for 2010 as they start from a worse position and they are now for a fiscal deficit of 9.4% of GDP and a National Debt of 144% of GDP. If you look at my update of October 22nd you can see that I was expecting these numbers so they are not a surprise in themselves but they will one more time lead to a fall in Greek credibility.
It used to be considered frightening that Greece would have a national debt to GDP ratio of 150% in 2013 or 14 and now it will arrive next year. The sad news is that the minute she returns to international bond markets she will immediately be insolvent. For readers who have not followed this situation Greece does from time to time issue short-term bills but does not offer bonds at this time, she did have plans to do so but they look ever more unrealistic.
The aid scheme looks ever more permanent and I hope the countries which provided it took my advice and used finance which lasted longer than the originally intended period of 3 years.Also there will have to be even more austerity measures if Greece is not to break the conditionality for the aid package. The dangers of a downward-spiral are increasing. Perhaps the decline in Greece’s circumstances is a warning to Ireland.
The Portuguese Finance Minister Mr. Santos had this to say yesterday.
The risk is high because we are not facing only a national or country problem. It is the problems of Greece, Portugal and Ireland. This is not a problem of only this country…………This has to do with the euro zone and the stability of the euro zone and that is why contagion in this framework is more likely. It is not because markets consider we have similar situations. They are only similar in what concerns markets, but as I said they are very different.
In this as I have written before there is an element of truth Portugal’s situation is different from Ireland’s and indeed Greece’s. It is also true that it must be difficult being something of a bridesmaid in the current Euro zone negotiations as Ireland has taken the foreground and it appears that Portugal may have to wait. Once the Irish situation comes to a head then the markets and the media will turn their focus to Portugal. However he went onto weaker ground when describing Portugal’s austerity programme which until recently had led to an increase rather than a decrease in public expenditure and this out-turn has been a significant factor in the way markets have become more difficult for her.
The European Central Bank steps up its debt purchases
The Securities Markets Programme has been very active recently and I discussed the issues relating to this on the 9th of November. There is something of an irony here as members of the ECB Governing Council had begun to suggest it would be wound down and one of the opponents of the programme Axel Weber had suggested it should be ended. Instead it is having to be expanded and according to the data just released the SMP has announced purchases of some 1073 million Euro’s of debt in the week up to last Friday. So we now know the actual state of bond markets in Portugal and Ireland last week was even worse than it appeared as their dreadful performances up until bail out rumours gathered force were after support from the ECB.
One other area where the ECB is very active is in that of liquidity provision to Ireland which you could consider a type of backdoor bailout as it now has reached some 130 billion Euros or one years Gross National Product for Ireland. If there is any truth in the rumours that there are the beginnings of a run on some of the Irish banks it may have to provide even more liquidity to them.
This crisis has had various features. Perhaps the strongest has been the way that the politicians of the Euro zone have been proved to be so out of touch with reality. As I look at their shock and awe package I see two vehicles they constructed for this. The first the EFSF I have discussed many times on here seems ill-equipped to deal with the problems it is likely to encounter. For example it was always likely to face a situation of rising interest-rates and hence costs in any situation it was likely to be called on. I believe that one of the reasons for the delay in dealing with Ireland has been exactly this, an instrument created for political bluster needs to be converted into something which actually works and this is proving to be not so easy.
The other route of accessing the 60 billion of funds under the control of the European Commission is starting to trouble me too. We were told that the funds would be provided by the 16 Euro nations but I am starting to wonder if its funds can be disentangled from the other nations in the EU. Should it prove to be the case that the funds will be contributed too by the other nine nations there will be considerable dissent, not only from the UK.