Thursday, February 24, 2011
MORE FROM BUSINESSWEEK
By Matthew Brown
Nov. 19 (Bloomberg) -- A resolution of the Irish debt crisis may shift the burden of speculation to Portugal.
While officials such as European Central Bank Vice President Vitor Constancio predict a bailout of Ireland will reduce financial pressures in the euro region, analysts from Citigroup Inc. and Nomura International Plc say any relief would be short-lived as investors turn their focus to the next-weakest peripheral nation.
The markets indicate that country is Portugal with 10-year bond yields of 6.88 percent, compared with 8.26 percent in Ireland and 11.62 percent in Greece, which received rescue funds in May from the European Union and International Monetary Fund. Portuguese Finance Minister Fernando Teixeira dos Santos said Nov. 15 that while “there is a risk of contagion,” that doesn’t mean the country will seek financial aid.
“Portugal isn’t in the situation that it is now because of Ireland,” said Steven Mansell, director of interest-rate strategy at Citigroup Global Markets Ltd. in London. “If Ireland reaches an agreement to tap the European Financial Stability Facility or some other mechanism to support its banking sector, I don’t think that will alleviate the pressure on Portugal.”
The government has forecast that economic growth in Portugal will slow to 0.2 percent in 2011 from an estimated 1.3 percent this year. Portugal has made less progress at taming its deficit than some of the other peripheral nations. In the first nine months, the central government’s deficit rose 2.3 percent from a year earlier. That compared with a decline of more than 40 percent in Spain and more than 30 percent in Greece.
While Portugal has no plans to sell more bonds this year, so-called market vigilantes drove up yields on its debt during the past month amid doubts about the country’s efforts to reduce the budget deficit. The 10-year yield reached a euro-era record of 7.25 percent on Nov. 11, 484 basis points higher than benchmark German bunds of similar maturity.
Portuguese 10-year yields are little changed this week, while Irish yields fell 10 basis points. The spread between the 10-year Portuguese bonds and German bunds rose 6 basis points today to 410.
Investors who push up yields to alter government policy are known as vigilantes, a term coined in 1984 by economist Edward Yardeni, president of Yardeni Investments Inc. in New York. They were credited with forcing Bill Clinton to cut the U.S. deficit after he came into office in 1993, helping drive 10-year Treasury yields down to about 4 percent by November 1998 from above 8 percent in 1994.
While Irish and Portuguese bonds probably would rise with a bailout agreement for Ireland, any gains wouldn’t change the underlying problems for peripheral Europe, according to Charles Diebel, head of market strategy at Lloyds TSB Corporate Bank.
Greece Than Ireland
“Wait a few weeks and the markets will just go for someone else, with Portugal at the front of the queue,” London-based Diebel said. “The vigilantes pushed Ireland into the same situation Greece is in. Why would you conclude they won’t do the same to Portugal?”
Ireland’s debt crisis was triggered by the rising cost of bailing out the nation’s banks, including Anglo Irish Bank Corp. and Allied Irish Banks Plc. While Portugal doesn’t face a crisis in its financial industry, it has a larger debt burden and the country has almost 10 billion euros of debt that comes due during the first half of 2011, data compiled by Bloomberg show.
Teixeira dos Santos, the finance minister, said in parliament two days ago that Portugal wants to continue financing itself in the markets.
‘Significantly at Risk’
“Portugal needs more cash than Ireland does because they go to the market on a regular basis,” said Nick Firoozye, head of interest-rate strategy at Nomura in London. “The market may move onto Portugal at some point because it’s significantly at risk.”
While Ireland started to reduce spending in 2008, Portugal has been slower to address its fiscal deficit, the fourth- largest in the euro region, and the government failed to reach an agreement with its biggest opposition party on the 2011 budget plan until the end of last month.
Portugal has proposed to lower its total wage bill for public workers by 5 percent, freeze hiring and raise the so- called value-added tax by 2 percentage points to 23 percent.
The government is counting on exports such as paper and wood products to support expansion. Portugal’s economy unexpectedly grew 0.4 percent in the third quarter from the previous three months, beating economists’ estimates for a contraction, as exports rose and imports grew at a slower pace.
Still, the Organization for Economic Cooperation and Development yesterday forecast the economy will swing to a contraction of 0.2 percent next year.
“Their view on fiscal consolidation is still premised on an excessively-optimistic growth projection,” Citigroup’s Mansell said. “Portugal is hugely reliant on the fortunes of its neighbors and it takes a huge stretch of the imagination to see growth remaining buoyant.”
--With assistance from Joao Lima in Lisbon. Editors: Tim Quinson, Andrew Davis
By EMESE BARTHA And PATRICIA KOWSMANN FOR DOWJONES AND WSJ
FRANKFURT—Some European officials are quietly discussing contingencies for what might be a Portuguese request for financial aid as early as next month, when the highly indebted country begins facing large-scale debt redemptions.
Financial pressure on the country's treasury is increasing, a topic that is likely to come up at the March 11 and March 24 meetings of European Union leaders, according to people familiar with the discussions.
"The feeling is that it can't go without a bailout beyond March or April at the latest and is already under pressure by countries like Germany to ask for help, to get it so the situation in the euro zone becomes more clear," a senior euro-zone government official said. Some Portuguese officials are privately considering the possibility, this official said.
Portugal has raised €4.75 billion ($6.5 billion) via bond sales so far this year. But it now faces redemptions totaling €3.848 billion in maturing Treasury bills in March, according to data from Portugal's Treasury and Government Debt Agency. It then has €4.342 billion in bond redemptions in April, followed by €4.933 billion to be paid out in June.
That borrowing volume will come at a stiff price. Ten-year Portuguese yields Tuesday were hovering near multiyear highs of 7.344%, well above the 7% level at which debt-servicing costs are deemed unsustainable.
The Portuguese debt agency skipped a time window for a bond auction this week, probably because of high costs. At these levels, Portugal is paying a painful 4.18 percentage points more than the German government on equivalent 10-year bonds.
Another senior European official said many around the EU consider it only a matter of time before Portugal asks for a bailout package similar to the deals struck with Greece and Ireland last year.
Portugal's already detailed reform plans mean much of the work needed to put a package together has already been done. That means the European Commission—the EU's executive arm—could move quickly once a request comes in, the official said.
Athanasios Orphanides, a member of the European Central Bank's governing council, said in an interview over the weekend that Portugal's case is "particularly urgent." He warned that failure at next month's summits to come up with convincing changes to fiscal policy and competitiveness in the bloc could destabilize the 17-country euro zone.
Officially, the Portuguese government remains resolute in declining the need for outside help to extricate the country from its fiscal straits.
That could be at least in part due to national politics. Portugal's largest opposition party, the center-right Social Democrats, has raised the possibility it could put forward a censure motion against Prime Minister José Socrates' minority government.
But market watchers are betting otherwise, believing that Portugal is approaching the end game in its struggle with fiscal deficits.
"They will seek help," said Jan von Gerich, a senior analyst at Nordea in Helsinki, adding that the timing is the more uncertain factor than whether or not the country will ask for assistance.
"I don't think they can manage unless the March summits come up with another idea," he said, adding that he expects a decision on Portugal's bailout before its April bond redemption.—Laurence Norman in Brussels contributed to this article
Tuesday, February 22, 2011
By JASON DOUGLAS for Dow Jones for WSJ
LONDON—U.S. Treasury Secretary Timothy Geithner said he doesn't believe a controversial austerity program embarked on by the U.K.'s coalition government will hurt Britain's economic growth.
Critics of Mr. Geithner's U.K. counterpart, Chancellor of the Exchequer George Osborne, have warned that the Conservative-led government's program of tax rises and spending cuts will cripple a fragile economic recovery.
In a radio interview recorded at the weekend and broadcast on British Broadcasting Corp. on Tuesday, Mr. Geithner said he didn't see much risk that Mr. Osborne's strategy would compromise growth.
"I am very impressed, as one man's view looking from a distance, at the basic strategy he has adopted," Mr. Geithner said. "At a time when it was easier to make tough choices quickly, he locked this coalition into a set of reforms that were very good."
While the U.K. and most of Europe have embarked on austerity drives to tackle problematic public finances, the White House has continued with an economic-stimulus program and proposed a slower path of fiscal consolidation.
Mr. Geithner said this difference in strategy between the U.K. and U.S. reflects differing circumstances. The U.S. has a smaller deficit relative to its economy, better underlying growth dynamics and a smaller government, Mr. Geithner said.
"Our fiscal challenges are very different from what you face in the U.K. and Europe as a whole," Mr. Geithner said.
He said the U.S. and Europe share similar challenges in funding "unsustainably expensive" commitments on health care and pensions.
But he added, "Our demographics are better, our growth rates are higher and those commitments are less expensive for us than they are for most of Europe. "That's not a challenge for us of the next three years or five years. That's a challenge for us of the next 50 years."
Mr. Geithner also criticized the light-touch regulation of the financial system that existed in the U.K. prior to the financial crisis, saying it was deliberately designed to lure business away from the U.S. and Europe and ultimately proved "very costly."
Mr. Geithner said international change in the financial sector will be a very complicated long-term challenge. "We have to make sure we act on reform while the memory of the crisis is still acute," he said.
By NICHOLAS WINNING from Dow Jones for WSJ
LONDON—Euro-zone private sector output is growing at the strongest rate for more than four-and-a-half years, but surging inflation suggests the European Central Bank may raise interest rates sooner than expected, the preliminary results of a survey by financial information firm Markit showed Monday.
The euro-zone economy could grow 0.7% in the first quarter, up sharply from the disappointing 0.3% expansion seen in the final three months of 2010 when activity was hit by severe winter weather, according to Chris Williamson, chief economist at Markit.
There are also signs that divergences between strong growth in Germany, Europe's biggest economy, and the smaller states at the heart of the currency area's debt crisis may be starting to narrow, he said.
"Less welcome are the signs of inflationary pressures building up. The jump in rates charged for goods and services was the largest ever recorded by the survey, highlighting the speed with which prices are being driven higher by rising food, oil and other commodity prices," Mr. Williamson said.
The flash reading of the euro zone's Composite Output Index, a gauge of activity based on partial results of a survey of manufacturing and services firms, rose to 58.4 in February from 57 in January, the highest reading since July 2006. A reading above the neutral 50 level indicates an expansion in activity.
The manufacturing Purchasing Managers' Index rose to 59.0 from 57.3 in January, the highest reading since June 2000, while the Services Business Activity Index rose to 57.2 in February from 55.9 the previous month, marking the strongest reading since August 2007.
Economists said the results of the survey increased the risk that the ECB could start tightening monetary policy earlier than expected. The central bank, which aims to keep inflation just below 2% over the medium term, has held rates at a record low of 1% since May 2009.
"Our forecast is for the first rise in rates to materialize in the fourth quarter this year, with various factors holding the ECB back, including a potential logjam in political discussions over bolstering the support mechanisms for countries in difficulty, and weak money and bank lending growth," said Ken Wattret, chief euro-zone market economist at BNP Paribas.
Growth in new orders gathered pace for the fourth month running and at the sharpest rate since June 2007. Manufacturing new orders grew at a rate equal to last March's 10-year high, with exports showing the largest monthly increase since April 2000. Services new business posted the strongest monthly gain since August 2007.
Employment rose for the 10th consecutive month in February as backlogs of work posted the largest monthly increase since July 2006, but job creation remained well below the pre-crisis peak, Markit said. Manufacturers took on staff at the fastest pace since June 2000, but a far more modest increase was registered in the services sector.
"Today's better-than-expected PMI data indicate that the euro-zone recovery is still in full swing, and remains little affected by the lingering sovereign debt problems in the region," said Martin van Vliet, an economist at ING. "This, coupled with signs of inflationary pressures building, reinforces expectations of a first ECB rate hike in the second half of this year."
Tuesday, February 15, 2011
By NICHOLAS WINNING for the WSJ
LONDON—Euro-zone growth was slightly weaker than expected in the final quarter of 2010 as Germany was hit by severe winter weather, France's economy failed to accelerate, and Greece and Portugal contracted, preliminary official data showed Tuesday.
Euro-zone gross domestic product grew 0.3% for the second consecutive quarter in the period from October to the end of December, the European Union's Eurostat agency said. Economists were expecting quarterly growth of 0.4%, according to a Dow Jones Newswires' survey last week.
On a year-to-year basis, GDP was 2% higher than in the fourth quarter of 2009—up from growth of 1.9% in the third quarter but short of market expectations of a 2.1% expansion. For the year as a whole, the euro-zone economy grew 1.7% in 2010, following a record 4.1% contraction seen the previous year when the single currency area was in the grip of a severe recession due to the credit crisis and drop in global trade.
In the currency area's largest economies, German growth slowed to 0.4% in the fourth quarter from 0.7% in the third, France expanded 0.3% for a second consecutive month, while Italian GDP rose just 0.1%.
Among the smaller states at the center of the euro zone's debt crisis, many of which have introduced severe austerity measures, Greece contracted 1.4% on the quarter, Portugal shrunk 0.3% and Spain grew just 0.2%.
In a separate release, Eurostat said the 16 countries that shared the euro at the time had a combined global goods trade deficit of €500,000 million ($677,350) in December following a revised €1.5 billion deficit in November. Economists were, on average, predicting a €1.2 billion surplus.
The breakdown of the data showed euro-zone goods exports totaled €133.6 billion in December, a 20% increase annually, but imports grew 24% to €134.2 billion. However, exports were 5% lower on a monthly basis in December, while imports fell 5.6%. For the year as a whole, the euro zone's trade surplus shrank to €700,000 million in 2010 from €16.6 billion in 2009 as the rise in imports outpaced that of exports.
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► European Parliament, Strasbourg - 24 November 2010
► Speaker: Nigel Farage MEP, UKIP, Co-President of the EFD group;
► Debate: European Council and Commission statements - Conclusions of the European Council meeting on economic governance (28-29 October)
Good morning, Mr van Rompuy,
You've been in office for one year and in that time the whole edifice is beginning to crumble, there's chaos, the money's running out - I should thank you; you should perhaps be the pin-up boy of the Eurosceptic movement.
But just look around this chamber, this morning. Just look at these faces. Look at the fear. Look at the anger. Poor old Barroso here looks like he's seen a ghost.
They're begining to understand that the game is up and yet in their desperation to preserve their dream, they want to remove any remaining traces of democracy from the system. And it's pretty clear that none of you have learnt anything.
When you yourself, Mr van Rompuy, say that the euro has brought us stability. I suppose I could applaud you for having a sense of humour, but isn't this, really, just the bunker mentality?
Your fanaticism is out in the open. You talked about the fact that it was a lie to believe that the nation state could exist in the 21st Century globalised world. Well, that may be true in the case of Belgium, who haven't had a government for six months, but for the rest of us, right across every member state in this Union - and perhaps this is why we see the fear in the faces - increasingly people are saying, 'We don't want that flag. We don't want the anthem. We don't want this political class. We want the whole thing consigned to the dustbin of history.'
And we had the Greek tragedy earlier on this year, and now we have this situation in Ireland. Now I know that the stupidity and greed of Irish politicians has a lot to do with this. They should never ever have joined the euro. They suffered with low interest rates, a false boom and a massive bust.
But look at your response to them. What they're being told, as their government is collapsing, is that it would be inappropriate for them to have a general election. In fact Commissioner Rehn here said they had to agree their budget first before they'd be allowed to have a general election.
Just who the hell do you think you people are?
You are very very dangerous people, indeed. Your obsession with creating this Euro state means that you're happy to destroy democracy. You appear to be happy for millions and millions of people to be unemployed and to be poor. Untold millions must suffer so that your Euro dream can continue.
Well it won't work. Because it's Portugal next, with their debt levels of 325% of GDP, they're the next ones on the list, and after that I suspect it will be Spain. And the bailout for Spain would be seven times the size of Ireland's and at that moment all of the bailout money has gone - there won't be anymore.
But it is even more serious than economics. Because if you rob people of their identity. If you rob them of their emocracy, then all they are left with is nationalism and violence. I can only hope and pray that the Euro project is destroyed by the markets before that really happens.
By PAUL HANNON from DOW JONES
Experience has taught us not to take the labels the European Union chooses to place on its many and various "pacts" at face value.
The Stability and Growth Pact was cooked up in 1996 and singularly failed to meet either of its two goals. Patently, the euro zone has neither been stable nor characterized by strong growth.
So it is with the new Competitiveness Pact, which German Chancellor Angela Merkel and French President Nicolas Sarkozy are trying to foist on their counterparts in the rest of the euro zone, so far without much success.
Few of the measures being proposed under the pact are likely to make the euro zone's members more competitive, either within the currency area or relative to other economies in the rest of the world.
Instead, they are intended to improve the public finances of the "peripheral" members by ensuring that they behave more like Germany. And on one issue—corporate taxation—the pact looks likely to damage rather than enhance competitiveness.
While it may not be what its authors claim it to be, many of the measures included in the pact are of value, such as raising the age at which workers are entitled to start claiming pension payments.
But the German and French governments haven't done a very good job of selling the pact, and that's partly down to the fact that while it involves pain and political risk for other euro-zone members, it ignores most of the problems that confront the bloc's two giants.
Finance ministers from the euro zone are working Monday and Tuesday to find compromises that will make a deal possible by the time European Union leaders meet at the end of March. But even if a deal can be reached, the euro zone may not have done itself many favors. Not for the first time, it has drawn attention to the fact that it needs to improve its long-term growth potential, without doing so.
Agreeing to raise the retirement age makes an awful lot of sense for the euro zone. Standard & Poor's estimates that without further reforms to state-funded pension programs, German government debt will rise to more than 400% of gross domestic product by 2050, French government debt to more than 403%, Italian government debt to over 245%, and Spanish government debt to over 544% of GDP.
And enshrining limits on borrowing and debt levels in national constitutions doesn't seem a bad way of restoring trust in the financial management of euro-zone governments, which don't have a great deal of credibility left.
But it's unclear how either of those two measures would directly boost competitiveness, or the ability of euro-zone businesses to produce world-beating goods and services at low cost.
The steady loss of wage competitiveness relative to Germany has been one of the troubling and underlying causes of economic difficulty for a number of euro-zone members since the launch of the single currency. Putting an end to wage indexation does look like a move that would help the competitiveness of the small number of countries that still indulge in the practice, which ensures that a relatively high inflation rate is inevitably translated into higher wages without any guarantee of increased productivity.
But the clearest sign that the Competitiveness Pact isn't about competitiveness is the proposal to set a minimum corporate tax rate, which would undoubtedly be higher than the lowest rates currently applied by Ireland, Cyprus and Hungary.
In a paper published last week, five economists from the Organization for Economic Cooperation and Development, working with Christopher Heady from the University of Kent in the U.K., examined the impact of tax changes in 21 developed economies over the past 34 years.
Their conclusions aren't ambiguous. If the goal is to boost growth, "corporate taxes appear to be the taxes that should be reduced most."
Ireland's 12.5% corporate tax rate has long rankled with German and French policy makers. Their main objection is that companies looking for access to the EU market set up in Ireland in order to minimize their Europe-wide tax payments.
Ireland gets the jobs, but at the cost of depriving other EU members of corporate tax revenue. And they argue that leaves Ireland with a narrow tax base and makes its public finances vulnerable to the collapse of a single sector—such as construction.
There is an argument to be had, and France and Germany may be right. But this isn't about competitiveness, it's about boosting tax revenue.
The EU did have a competitiveness pact: the so-called Lisbon Agenda, which was launched in 2000, ran until last year, and was intended to raise the bloc's long-term growth potential. It promised a great deal more than it delivered, and any serious attempt to make the euro zone more competitive would revisit the Lisbon goals and make sure they were met at the second time of asking.
The Lisbon Agenda had promise because it tried to compare EU members with other parts of the global economy, identify where they were weak, and where there were better ways of doing things.
Reviewing progress over the 10 years of the Lisbon Agenda, the Centre for European Reform awarded top marks to the Netherlands. And therein may lie a glimmer of hope.
Arriving at the meeting of Euro Group finance ministers Monday, Dutch Finance Minister Jan Kees de Jager made it clear his government has much to contribute.
"It's not a diktat as such, but we can't just accept the ideas of France and Germany," he said of the Franco-German pact. "The Netherlands has ideas about this too. We do need to discuss competitiveness and strengthening it is very important. But …this proposal is just a starting point for discussion."
Monday, February 14, 2011
The Boom, the Bubble, and the Bust Abroad
The housing crisis this country has experienced over the past four years has been the worst since the Great Depression. That comes as no surprise to most Americans; as home prices fell, the country saw a vigorous debate about the crisis, and about the laws and regulations that have emerged to help prevent another one from happening.
What is surprising is how often the debate here characterizes boom-bust cycles in housing prices as though they are uniquely American. They aren't.
Real House Price Growth in Selected Countries 1996-2009
1996 - Peak
Peak - 2009
|Notes: Prices deflated using the standard consumer price index for each country|
n.a. (Prices fell over entire period)
|United Kingdom (NBS)|
As the table above shows, most European countries saw a huge run up in real (inflation-adjusted) home prices followed by sharp declines.
In Europe, where the five-year, fixed-rate mortgage is king, middle-class families surged into the housing market as global interest rates reached historic lows and fast-rising home prices fueled a frenzy. A similar story unfolded in the U.S., especially in states like Nevada and Florida, where borrowers were more likely to eschew conforming conventional (i.e. 30-year fixed rate) mortgages in favor of 2/27's, 3/28's, and other short-term subprime and non-traditional mortgage products. On the other hand, the presence of the 15-30 year mortgage may be one reason the U.S. home price bubble did not reach the same stratospheric levels as in some other countries.
But the key question posed by the table above is this: why didn't German borrowers respond to low interest rates like the borrowers in the U.S., United Kingdom, or Spain? A few reasons suggest themselves.
First, the hurdles to homeownership are higher in Germany. While long-term prepayable mortgages with down payments of 20 percent or less are standard in the U.S., they are virtually unknown in Germany. Borrowers there can expect to make 30 to 35 percent down payments on mortgages with terms of 10 years or less, and also agree to stiff pre-payment penalties equal to the interest they would have paid had the loan amortized to full maturity.1
Second, Germany's mortgage terms also reflect a housing policy that has primarily targeted public support towards middle-class rental housing as opposed to owner-occupied homes. The homeownership rate in Germany is 42 percent versus 67 percent in the U.S. and more than 80 percent in Spain.
Third, Germany did have a housing price bubble. But it took place a decade earlier, following re-unification. German home prices rose much faster than incomes as the country merged, and were coming off their peak at the start of the 21st Century. As a result, they are now back in line with neighboring countries.
Even so, Germany wasn't immune from the financial aftershocks that followed when the housing bubble popped in 2007, according to a recent report from the Congressional Budget Office.
"In some (European) countries, the government bailed out issuers of covered bonds, and in early 2009, the European Central Bank launched a €65 billion ($84.5 billion) program to purchase covered bonds in an effort to restore liquidity to that market," the CBO writes, and "Spain and Germany guaranteed another €300 billion ($390 billion) worth of covered bonds issued by mortgage lenders" to shore up their housing finance systems.2
The bottom line: just as a housing price bubble wasn't unique to the United States, neither was the coincident financial bust that followed.
1 "The American Mortgage in Historical and International Context," Green and Wachter, Journal of Economic Perspective, Fall 2005.
2 "Fannie Mae, Freddie Mac, and the Federal Role in the Secondary Mortgage Market," Congressional Budget Office, December 2010, p. 50.