Lighthouse - Euro-Zone Monitor - 2013-04
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Transcript of Lighthouse - Euro-Zone Monitor - 2013-04
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Lighthouse Investment Management
Euro-Zone Monitor - April 2013 Page 1
Euro-Zone Monitor
April 2013
ContentsEuropean Equity Markets Diverge as Crisis Resumes ............................................................................... 2
A Walk Through the Euro-zone ................................................................................................................. 3
Nominal GDP: G6+1 .................................................................................................................................. 4
Nominal GDP: Europe ............................................................................................................................... 5
Real GDP.................................................................................................................................................... 6
Governments' Share of GDP ..................................................................................................................... 7
Government Revenue and Spending ........................................................................................................ 8
Cuts in Government Revenue and Spending ............................................................................................ 9
Trade Balances / Average Cost of Debt .................................................................................................. 10
Unemployment ....................................................................................................................................... 11
Debt-to-GDP, Primary Balance................................................................................................................ 12
House Prices, Unit Labor Costs ............................................................................................................... 13
Retail Sales, Industrial Production .......................................................................................................... 14
Deposits, Loans ....................................................................................................................................... 15
Summary ................................................................................................................................................. 16
Conclusions ............................................................................................................................................. 16
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European Equity Markets Diverge as Crisis Resumes
As I was recently dining at a restaurant, the couple at the neighboring table kept complaining about
their food. The server tried to make things right, but eventually the manager had to intervene. Later, I
overheard the manager lecturing the server, explaining that "perception is reality".
And it's true. What does it matter if your bank deposits are safe as long as most customers believe they
are safe? The worst thing that can happen to a bank is pictures of long lines of customers trying to
withdraw money. Or, as in Cyprus, banks being closed, limited account access and "haircuts" to those
who believed their money to be safe.
Only then reality pierces perception, and depositors are suddenly reminded they are merely creditors.
From the bank's perspective, deposits are a liability, a source of funding for their assets. The bank
customer, of course, has no idea what kind of assets the bank acquires, and the risks taken. And he
shouldn't have to.
However, after the Troika (EU, ECB and IMF) seemingly didn't mind haircutting small depositors in
Cyprus, every depositor should be aware that the EU-wide deposit guarantee does not exist.
By confiscating deposits of those depositors, who had little to do with the demise of their bank, a new
frontier in the Euro-zone crisis has been reached. EuroGroup president Dijsselbloem made it clear theCypriot bail-in was a template for future bank rescues. Depositors in the Euro-zone periphery are on
high alert, and will likely not think twice before starting a bank run. Just as the Euro-zone crisis subsided,
politicians have succeeded in setting it on fire once more. A strong divergence of returns in European
equity markets since February (see chart) is a sign of increased trouble ahead.
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A Walk Through the Euro-zone
Why has the Euro-zone fallen back into recession, and why can't it shake of its seemingly never-ending
crisis? Is there light at the end of the tunnel?It has been a while (Letter to Investors, March 2011) since we last looked into macro-economic
developments inside the Euro-zone.
A picture says more than a hundred words, so here are a few charts, with comments.
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Nominal GDP: G6+1
Nominal GDP, with the year2000 set at 100.
You see that Spain was one of
the strongest performers
among the G6+1 (I took the
liberty to replace Canada with
Spain), while Germany was
one of the weakest.
This is an example how little
GDP actually says about thehealth of an economy.
Zooming in on the time
period since the 'great
recession' shows how
Germany fared better than
Italy and Spain (both never
reached their pre-crisis level
of nominal GDP).
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Nominal GDP: Europe
Focusing on Europe, Cyprus
comes out on top in terms ofnominal GDP growth.
GDP is a flow value, meaning
each year it starts at zero. GDP
completely ignores level of
debt, and is therefore pretty
much useless.
If I ran a kingdom I could
double GDP by deficit spending
(but this wouldn't last verylong).
Here we zoom in on nominal
GDP since the 'great' recession,
showing dramatic declines in
Ireland and Greece.
If your GDP falls 15% (and
unemployment skyrockets)
your fiscal deficit is going to
get worse, not better. Also, a
falling GDP makes the debt-to-
GDP ratio worse than it already
is.
Harsh austerity is the medicine
that kills the patient.
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Real GDP
Moving on to real GDP, or
eliminating the effect of
inflation in order to get
changes in volume.
Look at Italy - worse off than
Japan. Yes, deflation actually
helps your real GDP, since it
makes real GDP higher than
nominal GDP.
However, I don't think Japanfeels really good about
deflation.
Zooming in on the past six
years, we observe that all
countries except Ireland and
Switzerland have dropped
back into recession.
Eurostat has apparently given
up on publishing numbers for
Greece, or is too
embarrassed to show how
Troika-prescribed severe
austerity destroyed the
economy.
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Governments' Share of GDP
Which government is best at
'milking' its taxpayers? TheFrench!
More than 50% of GDP is
siphoned off by the French
government.
You also notice recent
attempts by Portugal and
Greece to extract more
money for the government.
Switzerland stands out aspositive example.
Government know one thing
best, and that is to spend all
available money (and then
some).
Not surprisingly, the Frenchgovernment is leading the
charts, followed by Greece.
Switzerland again stands out
by far.
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Government Revenue and Spending
Compared with the level in
2000, the German
government had the lowest
increase in revenues,
followed by Switzerland.
Meanwhile in Cyprus,
working for the government
was great.
If governments only
remembered not to spend
more than they have!
Ireland is a special case, since
they had to bear the cost of
bailing out banks
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Cuts in Government Revenue and Spending
Recessions rip holes into
government revenue, as tax
receipts decline.
Some countries quickly
recovered, while Ireland and
Spain clearly have problems.
How are those countries
coping with their loss of
revenues?
Ireland, Greece and, to lesser
extent Portugal, have
significantly cut spending (as
condition for receiving bail-
outs).
In Spain, however, little
attempts are seen at cutting
spending, a clear mismatch to
the decline in revenues.
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Trade Balances / Average Cost of Debt
A negative trade balance
(more imports than exports)must be financed, usually
leading to external
indebtedness.
Recent improvements among
peripheral countries are
encouraging. However, not
every country can have a
positive trade balance; it's a
zero-sum game. Since neither
Germany or Netherlands
seem to give up any surplus,
imbalances must be popping
up elsewhere (Japan, USA,
other emerging markets).
An important chart, showing
the average cost of debt by
country. Everybody is
between 3% and 4% (even
Greece), despite huge
differences in debt
sustainability.
Many countries are
benefitting from the implicit
subsidy of being a member of
the Euro-zone.
While this is good for highly-
indebted countries, it doesnot impose fiscal discipline as
few countries have to pay the 'true' cost of their debt.
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Unemployment
Now some ugly charts:
unemployment rates.
Germany is enjoying its time
in the sun, while other
economies are struggling.
Is this how an economically
unified zone looks like?
Language seems to be a
bigger barrier to free labor
movement than thought.
Youth unemployment is the
real drama, with rates of over
50% in Greece and Spain, and
rising sharply in other
countries (except Germany).
France saw social unrest with
"just" 25% youth
unemployment; I am
surprised how 'patient' young
unemployed Spaniards seem
to be.
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Debt-to-GDP, Primary Balance
Finally coming to one of the
key areas of Euro-zone crisis:unsustainably high debt
levels.
The Greek 'haircut' brought
little relief, and Greece still
heads the ranking.
Eurocrats try to remedy a
debt problem by throwing
more debt at it. "Official"
(ECB/EU/IMF) creditors arecrowding out private ones,
and lead to higher haircuts in
the end.
The primary balance excludes
interest on debt.
Even if all debt was forgiven,
many countries would still
not have sustainable budgets.
The adjustment needed in
Spain is worryingly high,
probably too high (especially
given high unemployment).
At some point, social stability
becomes a factor (and the
potential for political
extremism).
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House Prices, Unit Labor Costs
Housing markets are booming
in Scandinavia, while Spainlooks dreadful. This will rip
more holes in the balance
sheets of Spanish banks.
The Netherlands is also
showing some signs of
deterioration.
German employees showed
wage restraint while workers
in other countries enjoyed
salary increases. Used to fight
regular currency devaluations
of its European tradepartners, German companies
are constantly improving
productivity.
While the price of labor
(salaries) is only flexible in
one direction (up),
adjustments in the other
direction usually fall onto the
number of workers
(unemployment).
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Retail Sales, Industrial Production
While retail sales are
stagnating in Germany, theyare shrinking dramatically in
countries that had to be
bailed out.
The Netherlands are again a
surprise, with similar
development as in Hungary.
In Germany and France,
industrial production peaked
in early 2011. Other countries
(Greece, Spain, Portugal)
never really recovered.
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Deposits, Loans
Finally, a look at the banking
sector. Deposits in Spain and
Portugal are bleeding with
annual rates of 10%.
This, together with rising non-
performing loans and
increased capital
requirements will make banks
reduce their lending, choking
small and medium-sizedcompanies.
This is reflected in declining
loans by financial institutions
in the PIIGS (with the
exception of Italy - for now).
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Summary
1. GDP is pretty useless as indicator of economic strength, as it ignores debt accumulated by the
largest contributor to GDP (governments).2. If one thing can be gained from looking at real GDP it is the fact that, over the past 12 years, Italy's
growth has been inferior to that of Japan. Without any grow, even otherwise (borderline)
sustainable debt levels become too much of a burden on the economy.
3. Even in times of rapidly declining revenue, governments are unwilling or unable to cut spending
unless forced to do so by EU/ECB/IMF. This is the reason why most countries try to resist any
bailouts until it is too late (usually when the capital market refuses to further finance its debt).
4. Governments do not have any cash reserves; insolvency is only a failed debt auction away and can
happen at any time.
5. Trade imbalances of the PIIGS are on the mend (but without the major beneficiaries, Germany and
Netherlands, giving up any of their surpluses).6. The average interest paid on government debt is surprisingly uniform (3-4%); the subsidy of being
member in the Euro zone does not enforce fiscal discipline.
7. Unemployment, and especially youth unemployment provides for potentially explosive social
tensions and/or radical political movements, making governing more difficult.
8. Debt-to-GDP ratios continue to rise as required fiscal adjustments are too large and recessionary
trends take their toll on government finances.
9. Despite recent improvements, Germany has still a large advantage in unit labor costs.
10.Declining house prices in Spain and Portugal will continue to weigh on banks.
11.Collapsing retail sales and industrial production in the PIIGS continue to erode the tax base.
12. In Spain and Portugal, trends in deposits look to undermine the banking system and choking smalland medium-sized companies.
Conclusions
Developments in Spain and Italy will lead to further deficits and increase in debt levels.
At some point, capital markets will refuse to absorb new debt.
ECB/EU/IMF will be forced to step in, as local banking systems are loaded with government bonds.
Any government bond restructuring would also impair the banking system.
Rumors regarding the solvency of banking systems could trigger bank runs, as depositors are warned
by the Cypriot example.
Many years of further austerity seem to be the inevitable result, with potential political and social
instability sprinkled in.
Central banks might be able to paper over (literally) a collapse of the Euro-zone, but still won't be
able to prevent stock markets from reacting negatively to recurring crises.
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Disclaimer: It should be self-evident this is for informational and educational purposes only and shall not be
taken as investment advice. Nothing posted here shall constitute a solicitation, recommendation or
endorsement to buy or sell any security or other financial instrument. You shouldn't be surprised that
accounts managed by Lighthouse Investment Management or the author may have financial interests in any
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we might not necessarily disclose updated information should we discover a fault with our analysis. The
author has no obligation to update any information posted here. We reserve the right to make investment
decisions inconsistent with the views expressed here. We can't make any representations or warranties as to
the accuracy, completeness or timeliness of the information posted. All liability for errors, omissions,
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