On Growing Tensions, Spreading Global Downturn And A Dead-End Greek Resolution
Just when one thought it was safe to come out of hiding from under the school desk after the latest nuclear bomb drill (because Europe once again plans on recycling the Euro bond gambit - just like it did in 2011 - so all shall be well), here comes David Rosenberg carrying the launch codes, and setting off the mushroom cloud.
From Gluskin Sheff
Anti-austerity demonstrations in Frankurt. Massive emigration out of Spain. Student bombings in Italy. Suicides in Greece, along with a run on the banks. Camp David discord with Germany. Unusual nuclear war talk out of Russia.
The euro area fiscal and banking crisis is taking on a certain destabilizing geopolitical tone. One reason why gold — as a hedge against instability — is starting to stage a comeback. After touching a four-month low last week and moving into official correction mode of a 20% decline from the highs, the yellow metal then went off and enjoyed its best day since January on Thursday and posted a nice follow-through to finish off the week.
Spreading Global Downturn
Italy, Spain, Portugal, Greece, the Netherlands and Brazil are now facing economic contraction (Brazil is the world's seventh largest economy and despite a huge 350 basis point rate cut from the central bank, the country has suffered three straight months of declining economic activity). France is stagnating. China is slowing down rapidly. The only two countries I see that have managed to surprise to the upside are Germany and Japan (the latter just saw the government actually raise its assessment of the economy).
Beyond Greece, two areas of concern are clearly Spain's woefully undercapitalized banking system where bad debt ratios have hit all-time highs (the banks received a Moody's downgrade late last week too), and China's property market which continues to deflate — average prices in 70 major cities fell in April for the second month in a row (-1.2% YoY versus -0.7% in March ... maybe this is one of those events that we're supposed to assume will somehow stay contained). On a MoM sequential basis, prices declined 0.3% and have fallen now for seven consecutive months (Chinese policymakers over the weekend verbally hinted of a coming round of additional monetary stimulus along with a fiscal boost ... and the market bulls desperately needed to hear that).
It's not just the economies, either, but also stock markets. The likes of Greece, Spain, Italy, Russia, Brazil and even Canada have seen corrections of 20% or more from the cycle highs. The U.K. FTSE has corrected more than 10%. As the Financial Times reports, euro area banking stocks are actually lower now than they were at the panic troughs after Lehman collapsed nearly four years ago. The S&P 500 has given up two-thirds of its 2012 gains and is now below its level of a year ago. The VIX index is at a new high for the year and copper touched a four-month low to finish off last week. The FX market is consistent with this downbeat global growth assessment, underscored by the Aussie slipping to its lowest level since November and the NZ kiwi sliding to its lowest level since December. The winners have generally been the more defensive units — like the U.S. dollar, the yen, and sterling as well.
Greece is the Word
Well, look at the bright side. At least we'll know whether Greece decides to stay or go within the next month since the second-round election in June is being widely viewed as a referendum on continued euro area membership. Incredibly, the polls show that 80% of Greek citizens want to stay in. The problem is that they also want more bailout money with fewer stipulations.
What was considered unthinkable just a few months ago is apparently an event that now seems inevitable. The editorial in the current Economist runs with The Greek Run: It is Not a Good Idea for Greece to Leave the Euro, But it is Time to Prepare For its Departure. The weekend WSJ went with this on page All — Europe Weighs Exit Scenario. There's even a new name being bandied about over this departure prospect — a "Grexit". Surreal. All the more so since the Maastricht Treaty contained no provisions on any exit — there are no ground rules!
There are no clear winners from a Greek exit unless you are long confusion, turmoil and uncertainty. The country faces a depression no matter what it does or doesn't do — though reclaiming control over its currency and monetary policy could end up having long-run competitive benefits. The country would likely need a 30-40% devaluation to put its economy on a more competitive footing. The financial disruption, based on many estimates I have seen, would cost Europe something in the order of 2-2.5% of lost output. Greek's total public and private external liabilities amount to $540 billion U.S. dollars — the ECB, the IMF, banks and a swath of other foreign creditors would suffer deep losses.
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