Portugal (the P in ‘PIIGS’ for Portugal, Ireland, Italy, Greece and Spain) has been out of the media in the last few months, not least because its government has made a serious effort to comply with the conditions that accompanied its 78b. euro bail-out package in May 2011. The budget deficit in 2011 was indeed sharply lower than in 2010, although that owed much to the one-off effect of the re-classification of pension liabilities. As the following note by Mr. John Petley shows, so far this year the deficit is running above the 2011 level. However, the deficit is not radically higher than in 2011. It is still early days, but the deficit may end up in the 6% - 8% of GDP area, down from the 2010 figure of almost 10% of GDP, but not as good as 2011’s outturn of under 4 ½% of GDP. Portugal’s public debt is over 100% of GDP and, all being well, the debt/GDP ratio is expected by the International Monetary Fund to peak at under 120% of GDP in 2013. Also relevant to debt sustainability are the external borrowings of Portugal’s banks. Portugal’s banks have borrowings from the ECB of over 60b. euros, about a quarter of GDP. As no doubt much of this debt takes the form of the ECB’s ‘long-term refinancing operations’, the banks ought to be comfortable with their funding arrangements for a year or two yet. The right verdict for Portugal seems to be ‘much better than Greece, but its return to fiscal probity has been slower than Ireland’s’.
Greece’s financial plight is intensifying, despite the promises made to international creditors and, more specifically, to the Troika of the International Monetary Fund, the European Commission and the European Central Bank. Fiscal austerity had become essential after the budget deficit reached 15% of GDP in 2009, but – because Greece is a member of the Eurozone and does not have its own currency – fiscal austerity could not be offset by monetary expansionism. Because of the wider Eurozone malaise, the attempt to reduce the budget deficit has had to be made while demand in Greece’s main trade partners has been weak. The data show that the attempt has failed. According to the IMF’s latest database (prepared in April), Greece’s gross domestic product was 230b. euros in 2010, but will fall to about 205b. euros in 2012 and 2013. The IMF also gives the ‘net borrowing’ of Greek general government as 15.6% of GDP in 2009, falling to 10.6% in 2010, 9.2% in 2011 and 7.2% in 2012. Well, that isn’t the message from the Greek government itself, which helpfully publishes a website with the data. The data show that the government deficit was 23.3b. euros in 2010 and 27.3b. euros in 2011, and is running at a somewhat higher level (although not dramatically higher) in 2012. The detail of the figures shows that serious efforts at fiscal restraint have been imposed, but the slump, and the resulting fall in tax revenues and increase in welfare spending, have overwhelmed the Roughly speaking, the Greek budget deficit is stuck at about 15% of GDP despite all the efforts of international and local officialdom.
This week’s e-mail note is by my colleague, John Petley, and compares Spain with Greece. As the note points out, the situations are very different. No doubt the Spanish banking system has its problems, but there is no certainty that future real estate losses will wipe out its capital. Indeed, if the Eurozone (and hence Eurozone asset prices) were to return to growth as European politicians promise, such losses might be easily manageable. Further, so far Spain’s money supply has not suffered severe contraction, as in the Greek case. The yield spread between German and Spanish government bonds in the one- year area has recently been about 500 basis points. If the banking situation were normal, with readily available inter-bank lines, and 100% certainty about the contractual stability of banks and sovereigns, this would be a fantastic profit opportunity. (Assume internal management capital allocation to the trade of 5% [whatever the Basle rules say], then the return on capital – from an inter-bank borrowing costing 50 basis points with the proceeds invested in Spanish government debt – would be almost 100%.) The reluctance of German banks, and of other banks, to sell one-year bunds and to buy one-year Spanish government paper speaks volumes about the lack of confidence in the permanence of the Eurozone. Even if the Spanish banks were over-capitalized relative to other EU banks, the uncertainty about the Eurozone’s survival would limit their ability to maintain their inter-bank funding. Ditto., as regards sovereign risk. Even if Spain has low government debt (as a % of GDP) relative to other EU nations, the uncertainty about the Eurozone’s survival undermines the Spanish government’s credit-worthiness. That is the Eurozone’s real problem. In this sense the Eurozone is inherently dysfunctional.
A weekly e-mail note with the same title" How worrying are Eurozone money growth trends" as the present one was sent out on 11th May. It pointed out that – because Eurozone banks seem to have drawn nearly all of the 1,000b. euros available to them under the ‘long-term refinancing operations’ – the European Central Bank had only limited ability to lend them more. A figure of 300b. euros therefore seemed – reasonably, plausibly – to be the most that banks could receive in extra central bank credit unless the ECB and the related EU authorities embarked on a new initiative of some sort. As Spain has now stated, without equivocation, that it is shut out of financial markets, an update to the 11th May note is needed. More specifically, Spain cannot issue new government debt except at an unacceptable interest rate (of nearly 7% or even more), while its banks cannot obtain new lines in the inter-bank market or even roll over existing lines. The trouble in the inter-bank market is linked with that in government debt issuance, because Spain’s banks would normally be the principal buyers of new short-dated Spanish government debt. However, the Spanish government has insisted that it will not seek a large-scale international financial bail-out, not least because it has already implemented fiscal austerity measures. Obviously, something has to give. Academics have made proposals that the ECB should let the markets know that it will act as a buyer (‘of last resort’) of Eurozone government bonds, if their yield differential relative to the best sovereign risk (i.e., bunds) exceeds some figure (say, 300 or 400 basis points). But the guardian of the best sovereign risk (i.e., Germany) would then need an enforceable promise of good fiscal behaviour from those with a weaker reputation (i.e., Spain and others). Meanwhile Eurozone M3 fell in April, largely because banks are still under pressure to recapitalize their businesses.
A key condition for easing the balance-sheet strains in the Eurozone banking system is a stabilization of commercial and residential real estate values in the PIIGS countries (i.e., Portugal, Ireland, Italy, Greece and Spain). Further, real estate values are influenced by the growth rate of the quantity of money. So it is important to check the latest money growth statistics. The following note briefly surveys some recent developments. Eurozone M3 has in fact been rising in the last few months, despite the return of intense anxiety about possible Greek departure from the Eurozone and the nervousness over the situation in Spain. The rise is to be explained largely by banks’ response to the two rounds of “long-term refinancing operations” (in December 2011 and February 2012) which, together, imply an increase of about 1,000b. euros in European Central Bank loans to the Eurozone’s banks. As expected, some banks have used the loans to increase their holdings of government securities. That has added to bank deposits, even as banks have been reducing their loans to the private sector. Also to counter the extreme doomsters, the Conference Board’s leading indicator index for the Eurozone had healthy rises in January and February, ahead of a (smaller) fall in March. Future money trends are less than clear-cut. Inspection of the ECB’s balance sheet – which is published every week – shows that the total of “long-term refinancing facilities” now approaches 1,100b. euros, implying that the amounts arranged in December and February have been fully drawn. However, “main refinancing operations” stand at only 34b. euros. In the last few years of crisis, they have at times exceeded 300b. euros, which suggests that the ECB could offer another – say – 250b. - 300b. euros of loans to banks, if collateral were satisfactory. But a really big crisis – say after Greece’s departure from the Eurozone this summer – could lead to adverse deposit flows for the Spanish or Italian banking systems which might be much larger than this. I cannot see how the ECB could respond comfortably to that, as its balance sheet would have to exceed 3,000b. euros, perhaps by a wide margin.
The European Central Bank’s two long-term repurchase operation exercises had a hugely positive effect on the Eurozone’s peripheral sovereign bond markets, but that effect seems now to be largely played out. That does not mean that yields will return to their highs in November 2011, when the “Draghi bazooka” would indeed have failed. (The high last November for 10-year Spanish government bonds was 6.7%. That yield dipped briefly to under 5% in early March, but has since surged back to about 6%.) The purpose of this week’s note is to set out some of the key facts and figures, in order to get a better feel for the risk that the yields jump back towards 7% or higher in the next few months. Markets and commentators are jumpy, which by itself is one reason for fearing that the LTRO exercises will fail. Spanish banks’ borrowings from the ECB/the Eurosystem (which in fact are identified from the Bank of Spain’s balance sheet) increased sharply in February and March, provoking much adverse comment. (Average net borrowings by Spanish banks climbed to 227.6 billion euros from 152.4 billion euros in February, according to the Bank of Spain website. The figure was well under 100b. euros as recently as last summer. Spanish lenders took 29 percent of the total LTRO facilities.) But there was nothing surprising at all about these large increases. The meaning and purpose of the LTROs was that commercial banks in such countries as Spain, with serious difficulties in funding their assets, would take up lines from their national central banks (i.e., the national central banks that together constitute the Eurosystem) in order to replace inter-bank lines. It seems entirely plausible that – when fully drawn down – the Spanish banks’ borrowings from the ECB will reach or even exceed 500b. euros. How significant would that be relative to Spain’s GDP and its total banking system balance sheet?
In a note on 29th September last year (see the Appendix) I called the turn on US monetary trends. I accepted that banks were still being hampered by the regulatory assault on their industry. Nevertheless, my view was that most American banks had sufficient capital to be able, once again, to expand their balance sheets and hence their deposit liabilities (i.e., the quantity of money). I argued that 2012 could see trend or even above-trend growth in the American economy, given that the helpful effect of positive money growth on balance- sheet strength and asset prices would be reinforced by virtually zero interest rates. That was a long way from the consensus at the time, but the 29th September note now looks prescient. (As I am inordinately proud of it, the Appendix version is in the loveliest gold frame allowed by Microsoft software.) But what about the future? A continuing problem is intellectual. In the USA as elsewhere, officialdom believes the private sector deleveraging (i.e., shrinkage of banks’ risk assets relative to their capital) is benign, regardless of the resulting destruction of bank deposits. All the same, the signs are that US banks are growing again and, despite the usual ifs and buts, a positive rate of broad money growth is to be expected in the rest of 2012. The annual rate of money growth will be positive, but probably in the low or mid- single digits, not in the high single digits or double digits seen in some cyclical recoveries. Given that the USA appears to be on the threshold of a dramatic transformation in its energy supply capability, and is now far advanced in the application of the new telecom and computer technologies, several good years lie ahead for the American economy. A widening contrast between American economic success and European economic failure is to be envisaged.