Financial markets have become increasingly nervous in recent weeks, since the blog last reviewed developments in global bond markets.
Its conclusion then was that investors are worrying more about return of capital, than return on capital, as we transition to the New Normal. This is because 272 million westerners are now over 55 years old, and they need security of income as they prepare for retirement.
The chart above updates market moves in the JUUGS (Japan, UK, USA, Germany, Switzerland) and the PIIGS (Portugal, Ireland, Italy, Greece, Spain). Since August (blue column), the 2 groups have seen very different interest rate trends for 10-year government bonds (red line):
• Rates in the JUUGS have been extremely stable. UK and Swiss rates have edged down 0.1%, whilst German rates moved up 0.1%. US and Japanese rates are unchanged.
• The PIIGS have been much more volatile. Greece is now paying 34% vs 22% in August: Portugal’s rate is 12% vs 11%: Italy’s is 6.4% vs 5.7%: Spain’s is 5.5% vs 5.3%: only Ireland’s reduced, from 8.8% to 8.3%.
This suggests Portugal will also need to default on its debts, alongside Greece. Otherwise the burden of interest payments will simply become too large, particularly as austerity programmes lead to recession.
Italy, of course, is the real problem child. It is a rich and large G7 country. But its interest rate is now also close to being unaffordable. Two key questions are looming on the horizon:
• Will it really now allow the IMF to dictate its economic policy?
• What will happen to French and German banks if investors start to question Italy’s ability to repay its debt?
Italy currently owes $416bn to French banks, and $162bn to German banks. It owes a total of $788bn to European lenders. This is the concept of ‘contagion’:
• If Italy’s rates move into the 6.5%-7% area, and remain there, then its default becomes almost certain.
• France, another G7 member, would then be in the firing line.
• Its 3.3% interest rate is already 50%+ higher than those of the JUUGS. This suggests underlying nervousness amongst investors.
The blog will continue to monitor the situation closely.
Stock markets soared after the eurozone meeting this week. But the head of the German central bank warned “The envisaged leverage instruments are similar to those which were among the origins of the crisis, because they temporarily masked the risks.”
It is clearly far too early to assume that EU leaders have really decided to take the difficult decisons necessary to restore long-term financial health. The key issue remains Italy, where major doubts remain over the government’s willingness, as well as ability, to make the major cuts necessary to reduce its borrowing to manageable levels.
Unsurprisingly, international lending to Greek banks has dropped quite sharply over the past 12 months, according to latest data from the BIS (Bank for International Settlements). As the chart shows, it was $111bn at the end of June, compared to $174bn in June 2010, and $182bn in December 2009, when the blog first discussed the problem.
Greece of course continues to borrow the same amounts. Instead, it now borrows from the European Central Bank. This means Eurozone taxpayers are standing directly behind the loans, rather than indirectly when the loans were made by the big commercial banks.
This seems to confirm June’s analysis of how the issue will play out:
• Greece will remain in “can’t pay, won’t pay” mode
• Germany will get even more upset about paying Greece’s bills
• Private investors will continue to pass their Greek debt to governments
• The ECB will worry about default, and its own stability if this occurs
The politicians’ habit of ‘kicking the can down the road’ is not solving the key issues. Rather, it is increasing the overall economic cost, and the political risk associated with this.
Meanwhile, European commercial bank loans to the 2 major economies under pressure – Italy and Spain – were $1388bn. This is lower than December 2009’s $1753bn, but an increase since December 2010’s $1326bn. This perhaps explains investors’ underlying nervousness about what happens when the politicians finally have to confront reality.
TUESDAY UPDATE. Greece’s decision to hold a referendum on its austerity plan highlights the fragility of the political consensus behind the current eurozone plans.
Most of us have now heard of the PIIGS countries (Portugal, Ireland, Italy, Greece, Spain). They are the ones causing the Eurozone debt crisis.
Today, the blog introduces the JUUGS (Japan, UK, USA, Germany, Switzerland). These are the major countries that investors now love.
If you are worried about return of capital, rather than return on capital, these are the countries for you. They have deep and liquid debt markets, are politically stable and highly likely to pay their bills. Importantly, they are not reliant on flows of foreign money to fund government spending. 85% of US Treasuries, for example, are owned by Americans.
This is becoming mission critical for many investors.
The chart above shows the difference between interest rates for 10 year government bonds in the PIIGS countries (left) and the JUUGS (right). It also shows how rates have moved between August 2010 (blue column) and today (red line):
• Rates have shot up in the PIIGS
• Greece is now paying 16%. Even Spain and Italy are paying 5%
• But rates have dropped to historic lows in the JUUGS
• Japan/Switzerland are paying just 1%, and the others only ~2%
This is another clear sign that we are indeed entering the New Normal. It also supports the blog’s argument that changing demographics, particularly the ageing of the Western BabyBoomers, are leading to major changes in global demand patterns.
We explore this argument in more detail in Chapter 2 of our new free eBook, ‘Boom, Gloom and the New Normal’. We believe its argument needs to be better understood and debated, if the chemical industry is to reposition itself successfully for future growth.
Please click here if you would like to download a copy.