After covering Japan in-depth so far this week I intend to move onto other economic matters today. Before I do there are some matters to touch on.Looking at the markets Japanese shares have staged something of a recovery overnight with the Nikkei 225 equity index rising over 5% to 9093. However I have to confess concern at two things. Firstly that the Japanese Emperor spoke to his people and secondly that he said that he was “deeply worried”. If you look at Japanese culture that has an ominous tinge to it. Things may have changed a little since the end of the Second World War but the Emperor then managed to avoid saying that they had lost! As Japanese Emperor’s speak very rarely this news makes me concerned that there may be more bad news to come from the four stricken nuclear reactors.
Japan and a problem with how we measure economic growth
The Japanese situation illustrates a clear problem with how economic growth is measured. Ordinarily we use estimates of Gross Domestic Product (GDP) but it does have flaws. Consider this. We have seen a lot of destruction in Japan due to the earthquake and tsunami but this is not recorded as a loss of economic output whereas when such buildings are replaced we see a positive contribution to economic growth as measured by GDP. If you are currently homeless until a new one is built you may wonder as to why there is no measure of your loss and to my mind you would be right. I doubt if anybody will ask if you prefer the new home.
My suggestion would be that for the purposes of measuring economic output we should also have a measure for improvements in the national stock of wealth. For example a new modern building may well be better than the one it replaced and we should try to measure this. Otherwise we run the danger of any destructive national disaster leading to an increase in GDP growth when reconstruction begins without allowing for the losses which take place. For countries unaffected by the disaster the situation is simpler as if they produce something it increases their GDP but for the country affected we need to develop a measure of the loss in my view. Otherwise our estimates for GDP will diverge from the true economic situation and the bias is always likely to be upwards.
The Euro Zone’s new policy for the peripheral nations
Over the weekend Euro zone ministers and officials met to discuss what they can do about the problems afflicting the peripheral nations of Portugal, Ireland and Greece and which looked like they might spread further to say Spain and Italy. Let us look at what they came up with. By ESM they mean European Stability Mechanism and by EFSF they mean European Financial Stability Facility.
The ESM will have an overall effective lending capacity of 500 billion euros. During the transition from EFSF to ESM, the consolidated lending capacity will not exceed this…………. Until the entry into force of the ESM, the agreed lending capacity of 440 billions euros of the EFSF will be made fully effective.
This addresses in theory the main problem of the EFSF which is that whilst it has a theoretical capacity of 440 billion euros because of incompetence in its design it can lend in reality only up to 250 billion Euros. However you may note that there is no description of how they are going to increase its size! We have been told this many times before and it has not happened so readers may be forgiven for an attack of deja vu. Also when the ESM replaces the EFSF in mid-2013 it is going to be larger. This rather contradicts the official view which to quote D Ream is that “Things can only get better” does it not? If so why do they need a larger rescue fund? Also the ESM will require individual nations to raise some of its capital er Greece, Ireland Spain……
However, to maximize the cost efficiency of their support, the ESM and the EFSF may also, as an exception, intervene in the debt primary market in the context of a programme with strict conditionality.
This has led to something of a stir as it suggests that these instruments could for example take up a bond issue or issue from a country in trouble. This is different from the Securities Markets Programme of the European Central Bank which only buys in secondary markets ( However the SMP has recently operated at the same time as debt issues in Portugal which blurs the line a little). However I do not feel we will see debt issues from say Greece taken up by these mechanisms yet as there are many checks and balances in the system as otherwise such purchases would go straight to the German Constitutional Court. Should it begin to operate this is one of the steps towards fiscal union which is probably the real reason it has been proposed. Rather than for use now it is intended for later use in response to a further crisis. Somewhat sneaky I think.
Pricing of the EFSF should be lowered to better take into account debt sustainability of the recipient countries, while remaining above the funding costs of the facility, with an adequate mark up for risk, and in line with the IMF pricing principles. The same principles will apply to the ESM.
Finally a genuinely good idea although yet again the German Constitutional Court is hovering in the wings. It may yet rule such assistance as being illegal.
Some better news for Greece
Against this background and in view of the commitments undertaken by Greece in the context of its adjustment programme, the interest rate on its loans will be adjusted by 100 basis points. Moreover, the maturity for all the programme loans to Greece will be increased to 7.5 years, in line with the IMF.
Essentially in return for promising to continue with its austerity programme and intending to make some 50 billion Euro’s of privatisations Greece gets a cut in the interest-rate applied to it from 5.23% to 4.23% which is good news for her. Also the period of her loans gets extended too. Whilst these are both helpful moves they remind us of the confusion at the heart of Euro Zone policy. When the ” rescue” for Ireland was instituted we were told that Greece’s loans were going to be at 5.8% and for ten years which was an extension of 7 years and a rise in interest -rate of around half a percent. Now they are at 4.23% and are for 7.5 years. No wonder markets have lost faith many may be wondering what the next interest-rate and term will be! It would appear that the concept of planning for the long-term is alien to Euro Zone politicians and officials.
Why not Ireland too?
This is rather simple. Greece had to give up her objection to more privatisations in return for a cut in interest-rates and regular readers may remember the dispute on this point a few weeks ago. But Ireland has stood firm on the issue of raising her Corporation Tax rate which is currently the quid pro quo of a cut in the interest-rate on her bailout package.
The reduction in the interest-rate for Greece is welcome although I wonder how many time s the Euro Zone will announce it has extended its loans to her! Most of the other changes have a heavy element of deja vu and ennui as we have seen them before. But there is a proposed move towards fiscal union with the concept of the EFSF and the ESM potentially purchasing primary government bond issues. This brings the idea of a joint “Eurobond” nearer. It is plain to me that such a Eurobond would need many conditions and with the Euro zones record of sticking to conditions the words of Charlie Brown’s dog Snoopy come to mind “Good luck with that (with the implication that you are going to need it!)”
Portugal is downgraded by Moodys ratings agency
Moody’s Investors Service has today downgraded Portugal’s long-term government bond ratings to A3 from A1 and assigned a negative outlook.
Not entirely as auspicious welcome for the new improved Euro zone support package (which implicitly stands behind Portugal) is it? If we put to one side the fact that the three main ratings agencies as a minimum need major reform let us look at the detail of why Moodys have done this. From the Financial Times we get.
1. Subdued growth prospects and productivity gains over the near to medium term until structural reforms, especially in the labor market and the justice system, begin to bear fruit;
2. Implementation risks for the government’s ambitious fiscal consolidation targets;
3. The government’s balance sheet may need to expand further in the event it has to provide financial support to the banking sector and government-related institutions (GRIs), which are currently unable to access capital markets; and
4. Challenging market conditions that have led to increases in the government’s financing costs, which, if sustained, will cause its debt affordability to weaken, particularly in the context of generally higher European interest rates.
The essential problem at the root of this is a lack of economic competitiveness in Portugal which has led over time to slow economic growth and consistent and somewhat chronic balance of payments deficits. I have put on here several times a chart which shows how slow Portuguese economic growth has been relative to the rest of Europe since 1990 so the problem way predates the credit crunch. Also Portugal has had to call in the International Monetary Fund before to help with balance of payments problems. Accordingly her issues are quite different to Ireland and Greece.
The Portuguese government may feel hard done by after announcing a new range of austerity measures last Friday which mean that she now plans to reduce her fiscal deficit to 4.6% of GDP in 2011 and make further reductions in 2012 and 2013. So in 2011 the pace of austerity is now expected to accelerate which has downward implications for expected economic growth. Portugal now also expects to hit the Euro zone target of a fiscal deficit of 3% of GDP. In total the additional deficit-cutting measures are equal to 4.5 % of GDP over the three years up to and including 2013.This is, of course the flaw in continually asking for more austerity as I explained with the example of Latvia a year ago and that is the danger of a downward spiral before you (hopefully) improve. You need a plan for economic growth too.
Portugal’s opposition oppose the new austerity plan so the brief political consensus has broken and today just to add to her problems she has one billion Euros of twelve month bills to issue. In a way the fact that she is issuing twelve month bills rather tha longer-dated paper highlights her problems and reminds us that yes in a year’s time they too will have to be refinanced in a bond market example of having to run ever faster just to stand still!
The Price of Oil
I understand that recent rises in the price of oil left the price somewhat inflated but am I the only person wondering why it has setback? For example there are continuing problems in North Africa and Arabia as well as Japan which will have to increase oil imports to replace much of her nuclear output.