Market Update – June 30 — The EU

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Today, I pulled data from articles about the EU (and member countries).  When the  EU announces the results of their “stress tests” and gives us a “boost of confidence,” here are some things to be thinking about…

Part 1: Greece is Still in Trouble

1. Greece has debt of $371 billion (300 billion euros).


2. In mid-June, Moody’s cut Greece’s credit rating four notches to junk status (from A3 to Ba1).  They cited substantial risks to economic growth from the austerity measures.


3. Many think that Greece will restructure its debt once it gets its house in order.  Their debt will be 150% of GDP and the interest costs will be burdensome.


4. Credit default swaps on $10 million of Greek debt (for five years) reached $1.1 million (per year).  Apparently, these prices imply a 69% chance of default over the next five years.    Greece is now considered the second riskiest sovereign borrower in the world, behind Venezuela.


5. Greece should not have to sell bonds for at least two years due to the EU bailout.  Greece has a $135.6 billion funding package in place which covers their debt needs for the next three years.


6. Greece expects their GDP to shrink 4% this year and 2.6% next year.  This past year, their deficit was 13.6% of GDP.


7. There is fear that tourism will be slow in Greece this summer and that will cause large problems.  It’s odd that tourists wouldn’t want to visit a country that is implementing austerity measures and is constantly striking.


8. This week, Greek unions held their fifth general strike of the year.  They are protesting the government’s plan to cut pension benefits and loosen labor laws.  Companies will be allowed to fire five percent of their workers.


9. Greek pensioners (on average) receive 96% of the salary that they had when they worked!


10. The Greek pension system consumes 12% of national output.


11. A recent poll showed that 64.8% of Greeks believe that their sacrifices will not save their pension system.


12. Juergen Stark (an executive member of the ECB) said that the ratings agencies acted irresponsibly in downgrading Greece while the IMF was negotiating with Greece.  My view is that Stark needs to get a clue.  Ratings shouldn’t be based on potential deals or the disruptive effect of these deals.  A rating can be conditional and a rating can be upgraded if a deal is made.  But, we should have learned from the financial crisis that we want the ratings agencies to be proactive.


13. The IMF’s head of their Greek mission said that Greece will overcome their debt crisis with the austerity plan.




Part 2: Germany Is Doing Well and Supporting the EU

14. Germany is expected to account for 27% of euro-zone GDP.  Industrial production is up 13.9% YOY.  Unemployment is down to 7.7%, the lowest since December 2008.  Annualized growth could hit 5% in Q2.  Germany is being helped by the weak euro.  In addition, companies and individuals are not overleveraged.  They are the only sovereign issuer that has not had their AAA status questioned by investors.


15. Germany contributed approximately $1 trillion to the EU bailout.


16. Paul Krugman criticized Germany’s austerity measures.  He also criticized the head of the German central bank.  Krugman has been a big fan of “spend now, worry about the debt situation later.”


17. George Soros said that Germany’s fiscal tightening could lead to deflation and ultimately endanger the EU.




Part 3: The Rest of the Euro-Zone (Much Of It is In Trouble)

18. A Fitch report said that the euro-zone problems were caused by:

A. economic imbalances

B. skepticism over the ability of economies within the eurozone to adjust in the absence of monetary and exchange rate flexibility

C. concerns about fiscal solvency given large fiscal deficits and wak economic growth prospects

D. doubts over the political commitment to the eurozone in the aftermath of the hesitant and reluctant support given to Greece



19. For years, Europe had a model of high taxes, but a complete safety net (medical care, retirement, housing) for your whole life.  Now, these benefits are being cut.


20. We have the EU implementing austerity measures while China is also trying to slow growth.

21. Loans to private businesses increased .2% (YOY) in May in Europe.  While commentators have been noting the acceleration of credit, this is still a very low rate.  In addition, realize that there wasn’t much lending in the public markets…


22. The volume of bonds sold in Europe in the first half of 2010 fell 29% to $1.2 trillion.  European companies led the decline with a 63% decline from the same period in 2009.  These numbers are a little unfair because the first half of 2009 was particularly strong.  Many countries and companies took advantage of the strong markets last year.  With that said, the drop also reflects investors’ fear about Europe.


23. According to the IMF, the three countries that must raise the most money this year are Italy, Belgium and France which all have to raise more than 25% of GDP.


24. Ireland’s GDP shrank 7.1% last year and is still in recession.  Unemployment is above 13%.  This is what happens when you have austerity measures.  Last year, their deficit was 14.3% of GDP.  This is a country that has a debt-to-GDP ratio of only 77%.


25. Spain is trying to change their labor laws: reducing severance pay to 25 days pay per year worked (from 45 days), making it easier to lay off workers temporarily during bad times and simplifying contracts.  They have 20% unemployment.


26. Spain’s banks took possession of large inventories of homes, building and land two years ago in order to avoid defaults.  They basically made a bet that the market would come back.  Now, they need to get rid of these assets.  So, some of the banks are offering 100% financing.  Keep kicking the can down the road…


27. France is going to raise the legal retirement age from 60 to 62 by 2018 (not a particularly bold move).  They are also going to raise the top income tax rate from 40% to 41% and increase the taxes on capital gains.  They plan on balancing their pension fund by 2018.  But, most people don’t trust this…the fund is supposed to become underfunded again after 2018.  France’s deficit is 8% of GDP this year and their debt-to-GDP is 85%.

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