Back in April, the blog suggested that capital controls might remain for rather longer in Cyprus than the “few days or weeks” suggested by the central bank. And a month later, the bank was still unrealistically claiming they would be lifted “as soon as possible”.
Today, the blog’s own view that they could be in place “for a decade or more” is looking more and more likely.
As the chart from the Wall Street Journal shows, the decline in GDP is accelerating, contrary to all the official forecasts. GDP fell 4.8% in Q1 and 5.4% in Q2. As the Journal notes:
“Christopher Pissarides, a Nobel laureate and head of the government’s council of economic advisers, acknowledges that the economy is sinking faster than expected.”
Credit has basically stopped on the island, with most transactions now in cash. And the economy’s downward spiral is likely to intensify. Unemployment was 17.3% in June, well above the forecast of 15.5%.
Basic industries are suffering badly. Cement sales are only 25% of those in 2008. And as Mr Pissarides added in an unguarded moment ”disaster is still some way off. But times are getting tougher.”
Clearly this is very bad news for Cypriots. But it is equally ominous for the Eurozone for 3 key reasons:
- Cyprus is in the Eurozone. Its use of capital controls means they could happen in other member countries
- Its bailout was the first one where depositors suffered major losses, also setting a precedent for the future
- The policy prescription has now had 6 months to work, and has clearly failed
This would not matter if the rest of the Eurozone was healthy. But it isn’t. Germany’s finance minister has said Greece may another bailout of perhaps €10bn.
Click here to view the embedded video.
And then there is Portugal, whose economy is also getting worse, not better, as this Financial Times video shows.
So what will happen with Greece and Portugal? Will the German taxpayer be asked to pay the bill all on their own? Or will investors instead be forced to take another ‘haircut’ – to use the phrase popularised with Cyprus?
Neither option looks good. As the blog noted in its 4 Butterflies post last month, we all know that these issues cannot be discussed before the German election on 22 September, for fear of frightening voters. Markets clearly expect Germany to then pick up the bill on 23 September. But the blog is not so sure.
Investors are complacent today, but they are not stupid. If Germany forces them to take a haircut or suffer capital controls in Portugal or Greece, they will immediately worry about what might happen next in Spain and Italy? Both will likely need outside help before too long. Spain is not a small island like Cyprus, but the 13th largest economy in the world. And Italy is not a minor country like Greece, but the world’s 9th largest economy. Combined, their economies are the same size as Germany’s.
Most large companies have some exposure to both Spain and Italy either directly or indirectly. Any CFO who hasn’t already developed a contingency plan for the period after 22 September, clearly has a few sleepless nights ahead.
The risk of global recession continues to rise, with the World Bank last week warning that “the real-side recovery is weak and business sector confidence is low“. Spain, the world’s 12th largest economy, provides a good example of how the problems are spreading.
Financial markets have temporarily decided that it has ‘turned the corner’, due to support from the European Central Bank. But in the real economy, things are getting worse, not better. As the chart shows from Spain’s El Confidencial, freight transport is in a “profound crisis”. Truck movements are a key indicator of economic health:
• They have fallen 33% since the pre-crisis peak (in terms of millions of kilometres driven)
• Q3 saw a 7.7% fall, which has continued into November
Even worse is data from the relatively rich Catalonian region, where the Red Cross says 28% of children now suffer from child poverty. Yet budget cutbacks means only 9% of schoolchildren get free school meals. Many of the rest go hungry.
Consumer products giant Unilever tells the same story. Its European head, Jan Zijderveld, warned back in August that “poverty is returning to Europe” and highlighted how they were successfully introducing business models from “Indonesia (where) we sell single packs shampoo for 2 to 3 cents and still make good money”.
Benchmark price movements since the IeC Downturn Monitor’s 2011 launch, and latest ICIS pricing comments are below:
Naphtha Europe, down 16%. “The current surplus is being sold at heavy discounts, and is being replaced by new volumes originating from Russia, as well as product from local refineries.”
HDPE USA export, down 14%. “Tight supplies helped boost prices in some cases”
PTA China, down 11%. “China’s polyester sales shrank further during the week and the sales-to-output ratio of Chinese polyester yarn producers waned to 30-50%, compared with last week’s 50-80% and 80-120% seen in early January”
Brent crude oil, down 11%
Benzene NWE, up 10%. “Growing buying interest among suppliers ahead of a bullish February helped push current month values up as the week progressed”
S&P 500 stock market index, up 9%
Spain is in the eye of the storm in the Eurozone crisis. Its economy is the 12th largest in the world, with GDP of $1.4tn. If it crashes out of the euro, then we will all feel the impact. And worryingly, the pace of events seems to be speeding up, even whilst the politicians continue in the slow lane.
The key issue is that governments cannot agree on a road-map to achieving political and economic union. Monetary union, in the form of the common currency, was never meant to exist in a vacuum, as the blog discussed in July. Thus today, we are in the worst of all possible worlds, where the euro exists – but without the political and economic backing required to sustain it.
Doing nothing is therefore not an option. The blog was in Spain last week, and it is clear that its monetary crisis is now becoming a political crisis.
Almost unbelievably, it even risks breaking up the centuries-old arrangements between Castille and Aragon that are the basis of the modern Spanish state. Last week, for example, Catalonia’s regional government announced new elections for November, as a prelude to a referendum on independence.
Catalonia, with Barcelona as its capital, is Spain’s richest region. Thus its political crisis is in turn creating an economic crisis. And the underlying reasons for this are shown in the chart above. Demographics drive demand and the ageing of Spain’s BabyBoomers (those born between 1946-70) means its economy has now gone ex-growth:
• The Boomers powered growth as they joined the 25-54 age group (blue column)
• This is recognised as the main wealth creating period
• But today, they are moving into the 55+ age group (green)
• Already, Spain’s median age is 41 years, with 28% in this cohort
Thus it is wishful thinking to imagine that Spain’s vast debts can ever be repaid. Even worse, as most Spaniards recognise, the sad fact is that much of this debt went to build housing, motorways and airports that will never even be used. It is no surprise that this toxic combination is starting to have major political implications.
The blog’s series on the emerging ‘VUCA world’ today looks at how companies have to manage increased levels of Uncertainty. This can be seen in key areas of demand, such as housing.
The above chart shows how US housing starts (blue line) have fallen from 2.1m in 2005 to just 0.6m last year. Housing permits (red line) have followed a similar trend.
Each new home contains ~$15k of chemicals and polymers (paint, furnishings, kitchen/bath fittings, adhesives, appliances etc), according to American Chemistry Council data. So the US market is now worth just $9bn, compared to $32bn then.
Housing markets have been equally key to demand growth in other major regions such as China, Europe and Latin America. So the question of what happen next is critical to anyone in the chemicals business.
The honest answer, is ‘nobody knows’. Instead, Uncertanty abounds:
• In the USA, starts have never been this low since records began. Does this mean housing markets may now rebound strongly, or have rates of household formation changed direction?
• In China, investment in real estate has been 13% of GDP, and also a major source of chemical industry demand. But with 64.5m apartments empty, and prices now falling, will this continue?
• Europe has seen a collapse in housing markets in countries such as Spain and Ireland. Many construction projects are now being cancelled across the continent, as austerity programmes bite. Can demand recover?
• Latin American demand has been supported by an economy boosted by increasing exports to China. If China is slowing, will its growth also slip?
Uncertainty of this intensity in such a key market has a major impact on confidence. Even if a company wants to be bold, and bet on an upturn, it may find its bankers harder to persuade.
On 7 September 2008, in its now famous warning that a financial crisis was imminent, the blog noted that “‘Deleveraging’ is an ugly word, and it has ugly implications“.
The chart above shows just how ugly these implications are becoming for the PIIGS countries (Portugal, Italy, Ireland, Greece, Spain).
It is based on data produced since 2009 by the Bank for International Settlements (the central bankers’ bank), and shows the major EU lending flows to the PIIGS. It includes data just published for December 2011:
• Lending to Italy (a G7 group member) has fallen 37%
• Lending to Spain (the world’s 12th largest economy) has fallen 40%*
• Lending to Greece (now in default) is down 54%
• Lending to Portugal is down 32%, and to Ireland down 41%
Major countries simply cannot continue to operate ‘as normal’ when these vast sums of money are being withdrawn from their banking systems:
• Italy has lost $352bn, equal to 32% of its GDP
• Spain has lost $$313bn, 21% of GDP
• Greece has lost $99bn, 33% of GDP
• Portugal has lost $75bn, 32%: Ireland has lost $203bn, 93%
Overall, $1.04tn has been withdrawn, a 39% reduction since December 2009. This is equal to 23% of the PIIGS’ combined GDP.
These numbers, of course, explain why the European Central Bank (ECB) made its emergency €1tn ($1.4tn) loans at the end of December. It says it was seriously concerned “a dangerous loop involving low economic activity, funding stress for banks and a reduction in lending” might occur. This is central bank-speak for saying that the European banking system might well have collapsed.
But the ECB’s lending under the Long Term Refinancing Obligation was just that, lending. It dealt with the immediate cash-flow problem in December. But it did not deal with the solvency issue. Many of these loans will never be repaid, as the assets behind them are now worthless.
* Netherlands lending to Spain is estimated in line with June 2011 levels, as the data is not yet available
The blog’s IeC Boom/Gloom sentiment indicator (blue column) continues to be neutral on the outlook. As the chart shows, this is quite unlike its performance in early 2009. Then it rose rapidly from February – accurately forecasting the major recovery that was about to start.
The problem, of course, is that the austerity reading (red line) remains too strong for comfort. Central bank lending has masked the issue, as banks have always been able to borrow more money from them. But lending only helps with cash flow, it doesn’t help with solvency problems.
The major problems today are in Europe. The European Central Bank averted near-catastrophe in December with its €1tn ($1.4tn) LTRO, Long-Term Refinancing Operation. This was meant to provide the banks with time to rebuild their balance sheets.
Instead, just as one would expect, they have chosen to play even more games in the hope of boosting short-term profits. Thus in Spain, probably next in line after Portugal for another bailout, they have been busy doing deals with bullfighting companies. As the Wall Street Journal reports:
• Fans can’t afford to go to bullfights, with the economy in recession
• This means loans to the bullfight companies are at risk of default
• So now, the banks are lending season-ticket money to bullfight fans
In the short-term, this means the banks avoid a costly default. But instead, they will probably face bigger losses next year. With Spain suffering rising unemployment, repaying a bullfight loan is unlikely to be high on the priority list for many fans in 2013.