There are five problems that need to be resolved within the European crisis and Credit Suisse provides a scorecard for the progress towards these 'risk factors'. The key issues are: growth, peripheral current account balances, solvency of the insolvent, ring-fencing the insolvent, and mutualization of government debt; but what is more worrisome is that while they have raised the average score to 2.0 out of 5 (from 0.6 out of 5 in Nov' 2011), it has not budged now in four months. The lack of growth, fiscal tightening, continuing insolvency concerns and excess leverage in the private sector, and de minimus deleveraging in Spain, Greece, Portugal, and Ireland leaves the vicious circle of progress on the European scorecard much harder from here.
Credit Suisse: These are the five problems that need to be resolved and we still score only 2 out of 5 on our scorecard tracking the progress on each factor.
We believe there are five factors that needed to be addressed to resolve the European crisis:
- A return to growth. To some extent this is the most important issue. With growth, fiscal arithmetic becomes more sustainable and the political willingness to accept the pain of restructuring becomes more bearable (though clearly some pain is needed to force restructuring).
- A current account balance in the periphery. The net borrowing of the economy as a whole is more important, we believe, than the net borrowing of the government sector. On current exchange rates we fear a 3% to 12% fall in wages will be needed to restore competitiveness and reduce the current account deficit, but with wages being half of nominal GDP that in turn makes the growth outlook worse.
- Questions over solvency need to be addressed (Greece and Portugal)
- Build a ring fence for the solvent. Being achieved slowly.
- Mutualisation of debt. Mutualisation works because in aggregate Europe has lower government debt and fiscal deficits than the US; the problem is the distribution of debt, not the amount of debt.
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The two most significant problems are:
1) Lack Of Growth
Euro-are PMIs are consistent with -0.5% GDP growth (at best)...
[8]
But PMI's New Orders (whole economy) has a better fit and suggests worst growth...
[9]
But fiscal tightening may lead to weaker growth stil and will be a significant headwind...
[10]
And 2) The Solvency of the Insolvent
Spain, Ireland, and Portugal have overleverage private sectors...
[11]
and so far there has been relatively little de-leveraging...in Spain, Greece, Portugal, and Ireland...
Spanish private sector deleveraging has lagged that in the US and the UK...
[12]
as declines in private sector leverage have been small compared to the aftermath of previous banking crises...
[13]
which will inevitably lead to a total-government-debt-to-GDP rising to levels associated with insolvency in Ireland, Portugal, and now Spain.
So in a nutshell Credit Suisse sees Europe 40% through the resolution of the European crisis but we suspect that the next 60% is highly convex and binary and givebn our previous note on the divergences of opinion [14], also unlikely.