Yesterday was not a day for surges in equity markets highlighted perhaps by the US Dow Jones Industrial Average which closed up some 13 points at 11,372. However even so equity markets have had a very good run as the wider Standard & Poors 500 equity index closed at a two-year closing high of 1228. The UK FTSE 100 is not quite at the highs of early November but closed up 7.5% last night if compared to the beginning of this year. The German Dax index has had the best year of the main European markets as it closed up nearly 18% when compared to its level at the beginning of this year. The Japanese Nikkei 225 equity index has staged something of a recovery of late and rose another 53 points last night to close at 10,286. Its rally was partly driven by an upwards revision to Japanese economic growth in the third quarter of this year from an annualised 3.9% to an annualised 4.5% which itself was caused by an upwards revision to capital spending. However relatively the Nikkei has been an under-performer this year as it is still over 2% below the level it started the year. Perhaps most disturbingly the Chinese Shanghai Composite index has been falling recently for example by just over 1% today and is now down some 466 points or 14% since the start of 2010. I say disturbingly because there are a lot of economic hopes based on the Far East.
This general recovery in equity prices has been matched by other assets for example the oil price has been rising over 2010 and the West Texas Intermediate benchmark has risen by 12%. The price has ebbed and flowed throughout this year with lows in May and late August so that since the beginning of September it has risen by just under 25%. Adding to this inflationary influence has been the rises in the price of commodities that have persisted in 2010. The Commodity Research Bureau spot index has risen to above 500 again as it closed last night at 504. Various components of it have competed this year to drive it higher with corn prices and copper prices perhaps attracting the most media attention. However you break it down this index is up 21.7% on an annual basis. Just to add precious metals into the mix the gold price has retreated over the past day or two after hitting highs for the year but is still up some US $293 per troy ounce or just under 27% since the beginning of the year.
If you looked at the world in terms of equity performance so far in 2010 you would come to some interesting conclusions. You might think that there had been some signs of recovery in the US and UK and that there had been a better performance from Germany. Perhaps this is a little unfair on the recent economic strength in the UK but overall that is a fairly accurate picture. However the substantial decline in China and the continuing struggles of the Japanese equity market pose a more troubling question as many hopes for world economic growth are centered on the Far East. There is some hope for Japan from technical analysts as I gather it has made a golden cross today but that is for the future!
The developments in commodity, oil and precious metals prices add a more troubling aspect to the apparent recovery. There are plainly inflationary influences at work here and these have gathered in the latter part of the year. I am afraid that I do not share the Chairman of the US Federal Reserve’s confidence expressed in his claim that he is “100% sure” that he can deal with inflation. In some ways I am offering a critique here of much of my profession as many remain somewhat entranced by deflationary influences. I am not arguing that these do not exist as in a week where Ireland has announced specific budget plans which are very deflationary would be to ignore events. My point is that there are inflationary trends too in the world and as we stand recovering slowly from an economic shock these inflationary trends are stronger than one might have expected.
These inflationary issues may well have been an influence in the recent rise in longer-term interest rates that I discussed yesterday.
The US Stimulus Programme and its fiscal deficit
After considering the size and impact of the proposed US tax cut/stimulus programme I have been looking at the path forward for the US budget deficit. After hitting a high of some US $1413 billion in 2009 we are now in danger of a deficit of that sort of order in 2011 as well. Even though there will be a wind down of the plan in 2012 the deficit there could still be over US $1000 billion too. So the path forwards will be higher should President Obama’s plan be enacted.
It is not my intention to debate at this point the impact of the stimulus plan in the medium or longer-term where supporters are likely to argue it will raise economic growth and help reduce the deficit. If we just remain with the next two years it is very likely that the US will have to borrow a lot more and that this has also troubled bond markets and led to a rise in yields and a fall in prices. Should this be sustained then this also raises the deficit as the US has to spend more on financing its deficit. It is this “vicious circle” of finance which has so hurt Greece and Ireland this year and can easily in extremis become self-fulfilling.
US Treasury Bond (government debt) prices and yields
We saw rises again in yields on these instruments and falls in prices yesterday. The US ten-year yield rose to 3.27% and the thirty-year rose to 4.45%. Putting this into perspective this took us back to levels last seen in mid-June of this year for the ten-year maturity. This will be troubling to the US Federal Reserve which is engaged in a programme to buy US government debt and is currently finding that not only is it making a loss on what it is buying but is also failing to reduce yields on these bond as planned.
A real cost was paid by the US taxpayer yesterday as the US government issued some US $21 billion of ten-year bonds at a yield of 3.34% which compares with 2.64% on the previous issue. So for each of the next ten years the US taxpayer will be paying an extra US $147 million in coupon payments on these bonds compared with the previous issue.
Also these yields spread across the US economy into mortgage interest rates and the rates at which companies borrow….
Greece and her economy
I make a point of returning regularly to the economic evidence for Greece to see how she stands. In the midst of an austerity programme she is likely to have plenty of troubles combined with optimistic hyperbole from politicians and officials. A recent example of the hyperbole has been the way that whilst the loans to her from the IMF/EU/ECB have been extended from 3 years to definitely 7 and perhaps 11 her government still talks of issuing bonds next year whilst welcoming the extension. Bond markets are unlikely to be as welcoming! I have a suggestion should Greece try some form of national unity bond next year as some are implying, I would make the politicians who issue it put their own money into it.
Returning to the economics of the situation we see that Greece’s inflation rate has dipped below 5% to 4.8% on the European Consumer Price Index measure. So this reduction is welcome although her consumers will be being hit by these price rises as there is little prospect in general of wage rises to compensate and we may indeed see wage cuts. Accordingly real wages are falling and are likely to fall further.
As the Greek consumer gets squeezed by falling real wages we are seeing quite substantial falls in her level of retail sales. The numbers are somewhat delayed but in the year to September 2010 there has been a fall of 11% in them in volume terms. This comes on the back of already weak figures as the numbers for September 2009 were some 10% below those of a year earlier. The index for this has a base level of 100 from 2005 and just to give you a taste of the overall fall it is at 85.4. The worst hit area has been clothing and footwear.
The latest estimate for economic growth was -4.6% for the third quarter of 2010 if compared to a year before which shows an acceleration from the first (-2.7%) and second quarters (-4%) of this year. This is also a slight downwards revision to the previous flash estimate of -4.5%. As the latest figures for industrial production (excluding construction) are -7.1% it is hard to see where any improvement is going to come from.
Unemployment is also rising with the latest figures this morning showing an unemployment rate of 12.6% in September according to EL-STAT. This is up 0.4% on the figure for August and up 3.5% on the number from September 2009. Added to the concerns that this raises is the fact that the number of people who are economically inactive has risen by just under 79,000 over the past year so employment is falling faster than unemployment is rising. Also the young are being disproportionately affected as the 15 to 24 age group has an unemployment rate that has risen from 25.7% to 33.6% over the past year, a rate nearly double any other age group. This has echoes of the situation in Spain.
The situation sadly continues to deteriorate. Some of Greece’s economic statistics are delayed when compared with others but these latest updates are concerning as rising unemployment and economic growth revised down even if only slightly raise yet more concerns. If we project falling employment into lower tax receipts and rising unemployment into higher social security spending this puts even more pressure on the Greek budget deficit. With retail sales falling it is hard to see taxes on consumption helping much either in spite of the rises in the rate of Value Added Tax.
If we look at some of Shakespeare’s works we find the image of fate being represented as a wheel of fortune where you have to fall to the bottom before you can recover. Placing this image on Greece the problem is that she still appears to be falling and accordingly under his logic is still some way from a recovery. If you look at the underlying statistics a very different picture emerges from that presented by her politicians and the IMF/EU/ECB officials observing her. I would be interested to read the thoughts of Greek readers on this subject.