This morning, Greece introduced capital controls. People can only withdraw €60/day ($65) from their bank accounts. The government has also called a referendum on Sunday, after Eurozone talks on a new bailout package collapsed.
The key issue is that Greece will never be able to repay its debts. These are currently estimated at €322bn ($365bn) – far larger than its economy, which is only $238bn after having shrunk by 25% since 2008. Greece also needs new money to be invested in the country, if it is to make a new start and fund new growth.
If Greece was a company, everyone would know what needed to be done. The business would have to be put into bankruptcy; debt-holders would have to write off some debt and swap the rest for equity; and a new business plan would have to be developed to be funded with new money from existing and new investors.
But Greece isn’t a company, of course. And today’s politicians don’t like to take hard decisions or to deliver difficult messages to their electorates. This is why I feared 2 weeks ago that the “Slow motion Greek train wreck was getting ready to hit another buffer‘. The heart of the problem is very simple:
- Political union in the Eurozone was essential if economic and monetary union was to succeeed
- But although this was rejected by France in the 1990s, the Eurozone project still went ahead in 1999
Politicians instead pretended that political union existed, and banks have since lent vast sums to Greece. And although it has been clear since 2009 that these loans cannot be repaid, they failed to explain this to their electorates. Instead the Greek and Eurozone leaders decided to extend repayment to 2050.This policy of “pretend and extend” means Greece is now bankrupt on an epic scale.
None of us can now know what will happen next. But we can assume Eurozone politicians will continue to try and avoid telling their electorates what has been done in their name. The German part of the bill could easily be €86bn, and in a worst case could be the entire €322bn according to the respected IFO Institute.
But the game of “Pretend and Extend” is clearly complicated by the involvement of the IMF. It is not allowed to lend to countries who cannot repay their loan, and it has powerful members outside the Eurozone in Asia and Latin America, who want it to enforce this rule. Thus Christine Lagarde, the head of the IMF, told CNBC yesterday:
“Our objective is clearly to restore the financial independence, the stability of Greece – to make sure that growth can start again. And that Greece can be sustainable from an economic and financial standpoint. As I’ve said, it is a balancing act. There has to be measures taken by Greece, there has to be support by the Europeans. And they come in sequence. Measures have to be taken, they have to be implemented. And that triggers a different attitude and a willingness to look at both financing and debt sustainability.”
The IMF is thus coming out on the side of those who want realism to be injected into the debate. The Greeks have to develop a functioning tax system, and realistic social policies. In turn, the Eurozone governments have to agree to write off debt and finance the new start. That is the real meaning of Ms Lagarde’s emphasis on the need to look at “both financing and debt sustainability” in sequence.
This is why the concept of political union should have been agreed alongside economic and monetary union. But today, German taxpayers face a different decision – and one that has not yet been explained to them. This is simply that if they don’t refinance Greece, they stand to lose all the money that has been lent to Greece in their name.
Greece’s decision to hold a referendum highlights the impasse that has been reached:
- Greece can only implement one side of the necessary deal – reforming its taxation and spending policies. It cannot come up with the new money needed to reverse the current decline in its economic performance
- The Eurozone is in an equally bad position, as it cannot force Greece to undertake this restructuring. And so it may end up having to write off the Greek debt, and getting nothing in return
This is always the problem with ‘pretend and extend’ policies. In the end, reality has a habit of intruding.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 40%
Naphtha Europe, down 40%. “Values are coming down gradually from recent highs as the product is long and its use in summer gasoline blending is limited”
Benzene Europe, down 39%. “There is still a steady stream of imports moving into the region from the Middle East and India. As a result, some traders believed that this would readjust the current supply/demand dynamic before long”
PTA China, down 29%. “The two major producers Yisheng Petrochemical and Hengli Petrochemical currently have no plans for any run rates reduction in July. This was largely to faciliate cash flow, several market participants added”
HDPE US export, down 19%. “Domestic export prices slipped during the week on oversupply, verified by industry data released on Friday.”
¥:$, down 21%
S&P 500 stock market index, up 8%
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.
Yesterday’s post described how OPEC oil producers are seeing their export sales to the US start to disappear. But this, of course, is only one side of the story. As the chart from the Wall Street Journal shows, Saudi needs a $93/bbl oil price to balance its budget. Most of OPEC needs a higher price. Only Kuwait, UAE and Qatar need less.
Most analysts choose to focus on this question. But important though it is, it is not the key concern. We are in the New Normal – where demand growth may no longer exist, and suppliers have to fight for market share. As the International Energy Agency has warned recently, “the recent slowdown in demand growth is nothing short of remarkable.”
A moment’s thought, after all, reveals that there is no point in having a high price if it becomes purely nominal. OPEC countries will have no income if they cannot sell their oil barrels.
The coal market provides a vivid example of the problem. 50 years ago, it was common to assume the world was running out of coal. Today, however, coal is being left in the ground, as it is no longer needed.
ASIAN OIL DEMAND IS NO LONGER ON A GROWTH PATH
Developments outside the US provide a vivid wake-up call. Already Asia has become unable to accept cargoes of Russia’s highly valuable Sokol oil. The economic slowdown, and increasing African competition, means the market is over-supplied. So it has been forced to travel to California to find a home.
Even worse, from the producer viewpoint, is that Asian governments are being forced to cut back on fuel subsidies.
China has been doing this for some time, and now indexes domestic prices to world levels. India began cutting them last year, and the new Modi government is now increasing them to world levels. Indonesia will have to follow and increase them by 23%, as the end of the commodities boom makes it impossible to fund subsidies.
Already the subsidy cuts have slowed India’s growth in diesel sales to zero, from up to 11%/year growth in the past. Clearly the pattern is now being repeated across Asia.
And one immediate result is that Indian refiners are demanding better terms from Saudi and Iraq. Bloomberg reports payment terms are likely to be extended to 60 days – essentially a price cut by another name.
Global oil consumption growth had already slowed to 1.2%/year before these changes, as the blog discussed back in July. Western oil consumption has been falling for some years, with even US consumption falling 0.6%/year since 2008. And this trend is likely to continue:
- US Dept of Transport data highlights that “as we age, we drive fewer miles“
- Similarly, the world is now entering its “peak car” moment, where sales will start to decline
- High prices have also spurred moves to gas, and to increased fuel efficiency
Thus oil producers are now effectively in a battle for market share. This is not only between themselves, but also against other forms of energy such as gas and renewables. Those who lose, like coal producers in the past, will have to shutdown.
Saudi Arabia knows this. And its reliance on the US for its defence needs means it has to be amongst the winners.
Tomorrow the blog will look at the key question of what these changes in supply and demand balances will likely mean for prices.
Its now nearly 2 years since the head of the European Central Bank (ECB) said he “was ready to do whatever it takes” to save the euro, and brought down interest rates in the weakest PIIGS economies (Portugal, Ireland, Italy, Greece, Spain). As the chart shows, this statement had a remarkable effect in financial markets:
- Interest rates today (green column) for the PIIGS are far lower than at their peak in 2012 (blue)
- And rates in 4 of the 5 PIIGS are lower than before the 2008 financial crisis began (red)
The reason for this remarkable turnaround is not hard to find:
- Investors believe that Germany will be happy to pick up the bills for the problems in the PIIGS
- This, of course, is wishful thinking – Germany will not, and cannot, afford the cost involved
- Thus in reality the potential break-up of the Eurozone has only been delayed by the ECB’s bluff, but not avoided
Even more worrying is that the impact of the lower rates is not not even being felt amongst businesses in the PIIGS. As the blog noted last September, lending in the PIIGS has been sharply reduced. And as the New York Times reported last week, the banks in countries such as Portugal simply don’t want to lend. As a result, interest rates for even a small €100k loan ($138k) are now at an unaffordable 10% level.
Thus although the ECB claims its policies have “worked”, they have not solved the two core problems of the European economy:
- Unemployment in the Eurozone remains at 12%, whilst almost 1 in 5 young people under 25 are unemployed
- Pension age is still around 65, even though life expectancy has now reached 80 in most countries
The end result is that economic growth is far below its potential, slipping back in Q1 to just 0.2%.
Equally disturbing is the failure of the major political parties to address these core issues in this week’s EU-wide elections. As a result, voters are disillusioned, and turning to alternative anti-EU parties in record numbers.
Greece, the initial cause of the Eurozone crisis, presents a particularly worrying example. A year ago, the blog worried that the financial crisis had led to 90% cuts in the supply of pharmaceuticals. Now the Financial Times reports that Greece’s neo-Nazi Golden Dawn party is winning votes and credibility by becoming a major provider of medical services, replacing the collapsed state system.
This is just one example of way in which Europe’s social stability is being undermined by the focus on monetary policy. It is wishful thinking to imagine that today’s lower interest rates in the PIIGS are a sign of economic recovery.
But politicians prefer to hide behind the veil of monetary policy. They refuse to show leadership as this would mean addressing the real questions about jobs, pension promises and medial services that matter to ordinary people.
The result is that fringe parties such as UKIP in the UK, the National Front in France, Golden Dawn in Greece and many others are filling the gap.
The result is that this week’s Euro elections will probably show at least 20%-25% support for the anti-EU parties. It could well be higher. And contrary to consensus opinion, these parties will not then allow ‘business as usual’ to continue in the European Parliament. Why should they, when their purpose is to destroy the EU?
It is not yet too late to change the direction of travel. Europeans are desperate for real political leadership, and for leaders who are prepared to have an honest dialogue about the hard choices that now have to be made.
Hopefully Sunday’s election results will act as a wake-up call to centre politicians. The majority of Europeans do not want to see parties such as Golden Dawn in power.
But desperate times can create desperate outcomes, as we saw in the 1930′s.
The IeC Boom/Gloom Index (blue column) proved its value again last month. It shot to a new record high, and this was then followed by a record high for both the S&P 500 (red line) and the Dow Jones Industrials. But now the Index has fallen sharply. This highlights the major divergence between developments in the real world, and financial markets:
- It was no surprise to see US GDP at just 0.1% in Q1, or that over 800k people left the US workforce in April
- Nor is it a surprise that Abenomics is now going seriously wrong in Japan, with auto sales forecast to fall 15%
Instead, just as forecast in the blog’s New Year Outlook, policymakers’ optimism about an ’inevitable recovery’ has once again disappointed.
The real concern about financial markets, however, is the debt of debt now taken on by traders. Borrowing levels on the New York Stock Exchange remain at record levels at $450bn – higher, even, than during the previous bubbles of 2000 and 2008:
- High levels of borrowing suggest that traders believe that US policymakers will not allow markets to fall
- Thus they are happy to speculate with borrowed money, to increase their ‘winnings’
- If someone borrows $100 to invest alongside their own $100, they double their return if the market goes up
- But, of course, they can lose more than their original $100 if the market starts to fall
This is what has always happened in the past – as at the end of the dot-com bubble in 2000, and the subprime bubble in 2008. Suddenly people realise they have overpaid and rush for the exits. But we are not yet at the equivalent moment to 7 September 2008, and the blog’s now famous warning “The Price of All Assets Will Go Down“.
In the meantime, the speculators simply laugh at warnings and remind everyone of the profits they are making.
But there is no shortage of potential catalysts to cause markets to go into reverse:
- Ukraine’s fighting continues: and the US has sent 600 troops to Poland/Baltic states to support its NATO allies
- Oil markets look perilous, with record high US inventories starting to pressure prices
- China’s leadership is continuing its credit crackdown on the real estate market
- As the blog discusses tomorrow, this means developers’ cash needs are now driving polyethylene imports
And, of course, this month sees the European elections take place. These are likely to provide further warning tremors of the earthquake that threatens today’s seemingly calm market surface:
- It is quite possible that anti-EU parties will top the polls in 2 of the 5 major EU countries – France and the UK
- Across the EU itself, Reuters suggests these parties could well achieve 20% – 25% of the total vote
- Of course, conventional wisdom says they can safely be ignored, and that it will be ‘business as usual’
- But this vote would double the Greens 7.5% in the 1989 election, which made environmentalism a major force
The key issue is that markets and companies have become complacent over the potential impact of geopolitics. They have forgotten the world before the Boomer-led SuperCycle. And as the saying goes, ‘those who cannot remember the past are condemned to repeat it’:
- China’s Communist Party has no interest in anything other than its own survival in power
- It is taking the necessary steps to ensure this survival, as the blog’s Research Note described
- Similarly the Russian leadership does not depend on Wall Street money for its survival
- The anti-EU parties also have their own agenda, which does not include ‘business as usual’
The blog continues to have a bad feeling about the outlook, which won’t go away. It fears an earthquake threatens.
And it remembers its fear through 2007-8 that a hurricane was about to hit Western economies. And also, that on the fateful weekend of 13-14 September 2008, there was not only a real hurricane in Houston, but also the Lehman collapse that triggered the financial crisis.
The blog’s weekly round-up of Benchmark price movements since January 2014 is below, with ICIS pricing comments:
PTA China, down 12%. “Inventories in China remained ample, with several market participants estimating it to be at around 1.6m tonnes, which was above the healthy mark of 1m tonnes”
US$: yen, down 3%
Brent crude oil, down 1%
Benzene, Europe, up 2%. “Many players expect pricing and availability in Europe to remain volatile”
Naphtha Europe, up 3%. “Pricing volatility has contributed to market uncertainty as traders struggle to determine positions amid mixed signals from downstream sectors”
S&P 500 stock market index, up 3%
HDPE US export, up 7%. “Producers waited to see whether global prices rise enough to make US material competitive in the global market”
Markets have been remarkably calm ahead of Crimea’s planned Sunday referendum to leave Ukraine and join Russia. Yet as Associated Press has reported:
“The Group of 7 world leaders say they won’t recognize results of a referendum for the Crimea region to split from Ukraine and join Russia. A statement from the seven nations released from the White House on Wednesday calls on Russia “to cease all efforts to change the status of Crimea contrary to Ukrainian law and in violation of international law.” It says the referendum scheduled for this weekend “would have no legal effect” and the process is deeply flawed.
“The leaders said they would take further action, individually and collectively, if Russia tries to annex Crimea. The statement was from the leaders of Canada, France, Germany, Italy, Japan, Britain and the United States, along with the European Council and the European Commission.”
This calmness is probably because markets have forgotten that geopolitics matter. And as the old saying goes, “those who fail to learn from history, are doomed to repeat it”.
German Chancellor Angela Merkel used to live in East Germany, before German unification, and she hasn’t forgotten. She warned the European Parliament of potential “catastrophe” yesterday:
“We would not only see it, also as neighbours of Russia, as a threat. And it would not only change the European Union’s relationship with Russia. No, this would also cause massive damage to Russia, economically and politically.”
The Ukraine/Crimea dispute is thus just a first sign of the growing distance between the Have’s and the Have-nots. As the above slide from Branko Milanovic of the World Bank shows, there are 7 major global flashpoints today where this divide is already evident (red dots):
- “First to fourth world: Greece to Macedonia/Albania; Spain to Morocco; Malaysia to Indonesia
- “First to third world: US to Mexico
- “Borders mined or walled: N Korea to S Korea; Saudi Arabia to Yemen; Israel to Palestine”
These flashpoints matter because the key issue in income inequality today is not within countries, but between them. Where we are born and live explains 60% of the difference in personal incomes. Our parent’s income only explains 20% of the difference, as class distinction within countries has reduced in importance.
If we add a red line to Milanovic’s map to divide West and East Europe, we can easily see how his argument applies to the Crimea/Ukraine dispute:
- Europeans are relatively wealthy with GDP/capita averaging around $40k
- Russian GDP/capita is just a third of this at $14k
- Ukrainian GDP/capita is a third of Russia’s at $4k
Ukrainians and Crimeans might therefore easily see themselves in different camps:
- Those who live in Crimea and regard themselves as Russian might choose to join Russia
- Non-Russians living in Ukraine might instead choose to stay independent and hope to link up with Europe
Geopolitical issues like these were generally ignored during the economic boom of the SuperCycle. But now we are transitioning to the New Normal and economic growth has slowed. So geopolitical issues like these are therefore resurfacing and will become increasingly important once more. As Lithuania’s president warned last week:
“Russia today is dangerous. After Ukraine will be Moldova, and after Moldova will be different countries. They are trying to rewrite the borders after the Second World War in Europe.”
Today’s confrontations are probably only a taste of those to come. Relationships between the West and Russia are now clearly set to worsen as Merkel warned. Last week, for example, Russia’s President Putin claimed that Lithuania and Poland had helped to organise the unrest in the Ukraine.
In turn, it is likely that China will see today’s dispute as an opportunity to re-establish its former relationship with Russia. Its ambassador to Germany warned Wednesday:
“We don’t see any point in sanctions. Sanctions could lead to retaliatory action, and that would trigger a spiral with unforeseeable consequences. We don’t want this.”
We can have no idea of how the various strands will play out. But one thing is very clear. Many companies will suddenly wake up in shock one morning, having realised too late that their prized foreign plant is now on the ‘wrong side’ of the growing geopolitical divide.