Who would pay the bill, if Greece defaulted on its current €320bn debt ($340bn)?
This is no longer just a theoretical question. Of course, we have all known since 2012 that Greece would never be able to repay its debt. But the EU covered up this hard truth by a ‘pretend and extend’ policy:
- The default deal deferred repayment over many years, in some cases out to 2050
- Interest payments were also reduced and deferred in some cases for up to 10 years
- But not all the repayments have been postponed: €20bn is due to the IMF, EU and ECB over the next 6 months
- Yesterday, the Greek government suggested it might not be able to repay $1bn due next month
The 2012 deal also involved one very critical element. The debt had been lent by German and other banks, who clearly couldn’t afford to ‘pretend and extend’ the loans. So governments, led by the European Central Bank, repaid these loans and effectively took responsibility for Greece’s debt.
Thus around 75% of Greece’s debt is now owed to governments – only €34bn is now owed to private lenders. This, of course, is the reason why Greece’s unemployment rate is still at 25% – very little ‘new money’ has actually gone into support for the Greek economy itself.
In turn, this is why the left-wing Syriza government won power in January. No country is going to put up with 50% of its young people being unemployed forever. And Syriza’s stance on the debt issue is also far more aggressive, tabling a €279bn reparations bill to Germany for a forced loan taken during World War 2.
So now the question arises – what would happen if Greece and the Troika (IMF, ECB, EU) fail to agree on another ‘pretend and extend’ default deal? The answer seems clear – the ECB countries would have to pick up the bill.
This is where the chart above begins to matter, as it shows the ownership of the ECB itself, based on official ECB data. Germany has the largest share at 18%, and so it would face the biggest bill, which could reach €86bn on some calculations, given related losses which would likely occur in the ECB’s Target 2 payments system.
This figure has not been mentioned to the German electorate. Nor have they been told that the bill might well be higher if countries such as Italy (12%) and Spain (9%) decided they couldn’t afford to pay their share. This seems highly likely, given the poor financial state of both economies.
And this is not just my view. Germany’s highly respected Ifo Institute analyses the risk as follows:
“If Greece leaves the euro and defaults, Germany’s maximum loss from foregone Target claims would be €24bn. Germany’s maximum loss in the case of a Greek exit would amount to 86.2 billion euros. Should all crisis countries (Greece, Ireland, Portugal, Spain, Italy and Cyprus) default and exit the euro, Germany’s … overall loss from all rescue operations would amount to €322bn.”
A bill for €322bn, or even €86bn, would create a political firestorm in Germany. Electorates in other northern EU states would also be shocked by what had been done in their name. It would also probably create a major political crisis in non-Eurozone members such as the UK, which owns 14% of the ECB’s capital.
Of course, the EU may still come up with another version of the ‘pretend and extend’ policy. Experienced observers such as Commerzbank suggest there is at least a 50% chance of this happening.
But positions are clearly hardening on both sides. In turn, the fault lines around the global debt-fuelled ‘Ring of Fire’ could well widen still further, if reality overtakes the ‘pretend and extend’ policy.
Nobody can guess the outcome of the UK’s general election on 7 May. This is astonishing, as it is only 4 months away.
Currently, it seems most unlikely that either of the main parties, Conservative or Labour, will be able to form a government on their own. Indeed, 7 different outcomes have been identified as possible by the civil servants preparing for a new government to take power.
Equally astonishing, given the 2-party history of British politics, is that the combined vote of the minor parties is now more than either the Conservative or Labour vote, as the Financial Times chart shows.
Opinion polls are not elections, of course. But so far they suggest that it will take a 3-party coalition to form a government – normally something only seen in wartime. In turn, this means it is quite possible that key policies could be dictated by minority parties as their price for votes.
The position of the Liberal Democrats position highlights the uncertainty. They are currently the minority party in the Coalition government, but are likely to lose at least half of their seats – and could lose many more. And so they would be most unlikely to support the Conservatives again, and would probably support Labour.
Instead, the Conservatives might well have to look for support from the UK Independence Party. Their main policy, as the name suggests, is for the UK to leave the European Union. They would drive a hard bargain for their votes, and a referendum on the subject would become almost inevitable.
Another remarkable development is underway in Scotland, long a Labour heartland. Polls suggest the Scottish National Party will win a majority of seats, despite having lost the independence referendum. They are unlikely to support the Conservatives, and might well demand a second referendum as their price for supporting Labour.
Other minority parties may also be critical to forming a government. The Democratic Unionists from N Ireland might support the Conservatives, whilst the Greens might support Labour if it accepted their key policies.
The problem is simple to explain. Voters no longer believe that the major parties are listening to their concerns, and are instead merely exchanging meaningless sound-bites. Thus Labour’s leader, Ed Milliband, famously forgot to talk about the UK’s problems with the budget deficit and immigration in his keynote Party Conference speech last year.
Unsurprisingly, therefore, alienation is rising amongst the electorate. As a result, populist rhetoric and narrow single-interest policies start to appear more attractive. And instead of returning to the centre ground, the major parties are increasingly focusing on these minority concerns, fearing the loss of votes, and so losing even more credibility.
Thus nobody knows how the voting will go in May or what policies might be pursued by a new government. Horse-trading for coalition votes could easily lead to outcomes that today seem most unlikely. And some seasoned observers even suggest it may prove impossible to form a stable government, leading to new elections later in the year.
The Cycle of Deflation has taken another lurch forward. The reason was India’s decision to veto last year’s Bali deal to streamline customs procedures. Almost certainly, this will prove the dying effort of the World Trade Organisation, which sponsored the proposal.
The blog is particularly sad at this outcome. It has always believed that free trade provides the best possible basis for improving global living standards.
The problem, of course, is that compromise becomes increasingly difficult as the economic outlook worsens:
Thus WTO’s ‘Doha Round’ began in 2001 in Doha, and has since gone nowhere.
It was hoped in Bali that a small deal, allowing everyone to benefit from easier customs procedures, might restore momentum. But India refused to agree this without guarantees that it could continue with its food subsidies.
This of course, is an unrelated issue. But it is very important to the new Modi government, anxious to be seen as champions of the poor. Thus India’s Trade Minister argued:
“We cannot wait endlessly in a state of uncertainty while the WTO engages in an academic debate on the subject of food security. Issues of development and food security are critical to a vast swath of humanity and cannot be sacrificed to mercantilist considerations”.
Other major global trade deals look equally unlikely to deliver real progress:
The reason is simple – politicians are failing to spell out potential benefits and are instead leading from behind.
Thus as the blog warned back in February, protectionism is gaining ground around the world. As the chart suggests, we have moved through the period of devaluation and have now arrived at the period of competitive devaluation, where everyone tries to out-compete their rivals.
This process began more than a decade ago, when companies and policymakers failed to recognise that demand would inevitably slow as global populations aged, and the Boomers joined the New Old 55+ generation. Even today, major expansions are underway in many industries, regardless of the fact that demand growth is already very weak.
Once the money is spent, countries will close their borders to protect jobs. Only then, when too late, will we all look back and wonder what we could have done differently.
A political earthquake hit Europe in the European Union elections on Sunday night:
- For the first time since the War, mainstream parties were beaten in major countries
- In France, the National Front won 25% of the vote, with conservatives 21% and ruling socialist party only 14%
- In the UK, the Independence Party (UKIP) won 28%, with Labour 25%, and ruling Conservatives on 24%
- In Greece, origin of the Eurozone crisis, the far-left Syriza party won 26%, with the ruling party on 23% – and the neo-Nazi Golden Dawn on 9%
France’s Prime Minister rightly called it a “ shock, an earthquake that all responsible leaders must respond to“.
In the UK, coalition partners Liberal Democrats saw their vote slump to 7%, and they lost all but one of their MEPs. This may well herald a potential second earthquake, where the ruling Conservative party form an electoral alliance with UKIP for next year’s general election. This would create a clear threat that the UK would vote to leave the EU in the Conservative party’s planned 2017 referendum – by when Scotland may have voted for independence from the UK.
One cause of the earthquake is shown in the above chart, highlighting how youth unemployment now averages 25% across the EU. Very clearly, the supposed Recovery programmes put in place since the Crisis began have not worked.
The key issue now is whether policymakers will listen to the voters and change their approach. It is clear from the votes in Italy and Spain, where the ruling parties held their position, that voters do not really want the EU to disappear. But they want their leaders to connect with them on the real issues.
Hard messages have to be given about the choices ahead:
- Europe is an ageing society, and will not return to the constant growth seen in the BabyBoomer-led SuperCycle
- It is impossible for pension ages to remain at levels of a century ago, when life expectancy has risen 50% or more
- Education systems must be radically overhauled to give young people the skills required for today’s economy
- Energy costs must be reduced to affordable levels, with subsidies for wasteful vanity projects scrapped
Europe does not have long to make these choices. Voters will not continue to give the mainstream parties ‘one more chance’ forever.
The blog is by nature an optimist. And so it hopes that today’s leaders will rise to the challenge before it is too late. But it fears they will instead hide behind the illusion that monetary policy can somehow solve the real issues.
There is a great risk that the European Central Bank will unleash a major new stimulus programme next month. Yet as the blog argued recently in the Financial Times, deflation is inevitable with ageing populations. More stimulus would therefore solve nothing, and simply increase debt levels to even-more unaffordable levels.
The plain truth, seemingly obvious to everyone but policymakers, is that the voters want real dialogue and real change – not more money-printing designed to boost financial markets.
The risk for the future is obvious, with Germany’s anti-EU party gaining 7% of the vote. Germany not only cannot, but will not, pay the bills to bail out today’s failed policies.
Sunday’s results have caused a political earthquake. It is now up to EU leaders to make the hard choices necessary to set the economy on a new and more sustainable path. Doing nothing is no longer an option, if they want the EU to survive in its present form.
Government bonds in the larger, wealthy countries of the West have traditionally been regarded as being “risk-free”. Most countries have failed to pay their debts at some time in the past, but it hasn’t happened in the post-War period for the major economies, and so investors have forgotten this can happen.
This situation may well change in the future, however, as the population ages. The reason for this risk is that governments keep on piling up large amounts of debt, whilst economic growth remains slow. And whilst the problem will not appear next week, pension funds have to think long-term, looking ahead up to 50 years.
Quite a lot could change over this period, as the blog highlights in a new analysis for Allianz Bank’s ‘Project M’ (click here for free download). The key issue is that the proportion of New Old 55+ in the adult population is rising rapidly, due to the combination of increasing life expectancy and falling fertility rates:
- Policy-makers continuing to believe they can somehow kick-start growth by adding yet more debt
- Yet rising proportions of New Old inevitably create a deflationary rather than inflationary environment
- This combination, if policymakers don’t change course, will eventually mean the debt cannot be repaid
As the chart above highlights, the ageing BabyBoomers are all now becoming New Olders. In Japan, the New Old are nearly half of the adult population today, whilst they are 43% in Germany and Italy.
CYPRUS HIGHLIGHTS THE RISKS AHEAD
The example of Cyprus, and its default last year, is a small, but extremely important indication that it could be dangerous to be too complacent over this type of issue.
Just a year ago, Cyprus defaulted on its debt, causing major losses for domestic and foreign borrowers. Cyprus is and was an EU member and a member of the Eurozone. So it was supposed to be protected by the European Central Bank (ECB) – the second most important central bank in the world. But this made no difference.
The result of the default was that Cyprus then had to impost capital controls, to stop remaining money flooding out of the country. This was totally contrary to all the EU rules, but still took place. It was said at the time that these controls would merely be temporary, perhaps lasting for just a week or two. But the blog was more cautious, arguing:
“The eurozone’s bungled rescue of Cyprus’ banks last week has led to capital controls being introduced on the island. These are meant to be temporary, whilst things ‘normalise’. But ‘temporary’ can mean different things to different people. The UK, for example, introduced “temporary capital controls” as World War 2 began in 1939. They were only abolished in 1979.”
Unsurprisingly, the blog’s analysis has proved correct. Every few months, there have been ‘promises’ that the controls will be lifted in a week or two. But now the Foreign Minister has admitted they will remain for at least the rest of this year, as the economy is forecast to decline 4.8% this year, after a 6% fall in 2013.
The blog will therefore stick to its original forecast, that the controls could easily last for a decade or more.
The critical point is that it is foolish to rely on the promises of policymakers, when the policies that should support the promises are bound to fail:
- As suggested back in September, if one EU member can introduce capital controls, then so can others
- And if policies can fail in a small economy like Cyprus, then they can also fail to work in larger countries
- Cyprus demonstrates that promises made by the ECB, IMF and EU have not proved deliverable
GEOPOLITICAL RISKS ARE RISING ALL THE TIME
The EU now has a growing geopolitical crisis on its doorstep with the Ukraine issue. Whilst next month may also see major gains by the anti-EU parties in next month’s European Parliament elections. Reuters, for example, reports there are now “some projections suggesting around a quarter of the 751 seats in the parliament could go to non-mainstream parties“.
The EU have made promises to Ukraine which it clearly cannot keep. And with anti-EU politicians becoming more numerous, who knows what promises will be next to be broken.
None of this will be new to those who lived through the Cold War, and other geopolitical crises, before the Boomer-led SuperCycle led to the illusion that constant growth was now inevitable. ‘Trust but verify’ was then the best advice for ordinary citizens and companies, as well as governments.
Those not around in those days now need to go up the learning curve on these issues as fast as possible. Otherwise they will find out, like the citizens of Cyprus, that policymakers’ wishful thinking has a habit of disappearing into thin air when faced with hard reality.
Autos remain the world’s largest manufacturing industry, and the single biggest source of demand for chemicals and plastics. According to detailed analysis by the American Chemistry Council, each new US auto is worth $3,539 in terms of sales – and involves a wide range of products including antifreeze, plastic dashboards, bumpers and windows, as well as upholstery fibres, tyres and coatings.
So the chart above, which summarises sales in the world’s 7 largest markets since 2007, is cause for concern. These markets account for over 80% of all auto sales:
- Including China (yellow), sales have increased 18% from 47m to 55m
- But excluding China, they have fallen 2% from 41m to 40m
Equally of concern is the detailed picture:
- US sales (green) have fallen 4% over the period, EU sales (red) are down 18%
- The smaller markets have done well until recently, but have now slowed
- Brazil is up 42%, but fell 1% in 2013 (pink) despite the boost from soccer World Cup and Olympics activity
- Russia is up 4% (orange), but fell 6% in 2013: India is up 77%, but fell 7% in 2013 (blue)
- Japan is up only 4%, and was flat in 2013 (dark blue) despite the Abenomics stimulus
So a lot depends on China to power future growth. This, however, looks most unlikely to happen, for reasons discussed in the blog’s detailed analysis last week. The new leadership are already cutting back lending in the shadow banking sector, which has been the main source of finance for auto sales.
Supporting evidence for this analysis comes from developments in those countries who had been major suppliers of raw materials to China. Brazil and others have all seen their economies go into reverse as China cools.
Equally, the blog is quite doubtful about the bullish forecasts for US sales this year. It continues to believe these have been largely driven by financing deals – which made new cars more attractive than used cars. Only 42m used cars were sold in 2013, as the average price has risen 18% since 2007, due to relatively few new cars being sold in 2008-11. But now more cars are now coming on the market, and dealers expect prices to fall again.
Globally, analysts WardsAuto also report that manufacturers’ inventory in the major markets in December was 9% higher than in 2012 in both the US and Asia-Pacific, and 4% higher in Europe.
Of course, policymakers’ optimism over a sustained recovery may still turn out to be well-founded. But behind the hype, the detail of current auto industry performance suggests that any company without a Plan B risks finding themselves in a difficult position by the middle of the year.