I know the euro crisis isn’t exactly over. But doesn’t it feel so 2011? Aren’t you ready to move on?
Ready for the next crises? Yep. That’s “crises.” Plural.
2012 promises to be even more exciting than 2011.
The euro debt crisis isn’t going away. Sorry if you’re bored with it. But it will take a new twist. As Europe sinks into its self-induced recession created by all that tough talk about the need for austerity and budget cuts, we’ll get treated to the spectacle of chickens coming home to roost as politicians have to explain to suffering voters why they need to tighten their belts even more to balance budgets thrown out of whack by no growth economies.
But I do think that in 2012 we’ll get to add exciting new crisis venues such as Russia and India.
And this could be, don’t get too excited, just a run up to 2013 when the United States and China could get into the act.
Ready. Let me play tour guide to the next stage of the fun.
The euro debt crisis, the once and future crisis.
Want to know why this crisis will launch a new season in 2012? Take a look at what’s going on now in Ireland.
If there’s a euro debt crisis/budget austerity success story, Ireland’s it. After a $90 billion bailout, the government’s annual budget deficit is projected to fall to 10.1% of GDP in 2011 (from 32% in 2010—yes, that was the annual government budget deficit that year.) That would be slightly below the 10.3% target. And the economy could actually show 1% GDP growth for 2011. Quite an improvement from the 7% drop in GDP in 2009 and the 0.4% decline last year.
That “progress” comes at considerable pain—tax increases and budget cuts of $34 billion—so far. That’s equal to about 15% of Ireland’s annual GDP. (Or $2.2 trillion if the Irish economy were the size of the U.S. economy.) Unemployment has climbed to 14.5% and would be higher except that 40,000 people have left the country in search of jobs through the end of November. (Ireland has a population of just 4.5 million. 40,000 people is about 0.9% of the population. That level of emigration is equal to 2.8 million people leaving the United States.)
Combining those budget measures with the pain of falling wages, the government figures the country’s austerity plan is the internal equivalent of a16% currency devaluation. (Roughly as if the euro went from $1.36 to $1.16.) No wonder that Ireland’s GDP growth this year is built on a 5.4% increase in exports in the first nine months of 2011.
But the progress isn’t guaranteed to continue into 2012 even if the pain is.
The slowdown in the European economy–because of the euro debt crisis–and the increase in interest rates—because of the euro debt crisis—have resulted in lower than projected tax revenue—about 1.6% below projections in the first 11 months of 2011—and an increase of interest payments of about $1.4 billion over payments in the first 11 months of 2010.
The situation looks worse in 2012. On December 6 Finance Minister Michael Noonan cut his forecast for 2012 GDP growth to 1.3% for 2012 from 1.6%. That was the second cut to growth projections in a month and Noonan’s forecast is still substantially above the forecast of 1% growth from economists at the Economic and Social Research Institute in Dublin. This week Noonan put forward a program of another $4.5 billion in cuts and tax increases designed to keep Ireland on track to hitting its target of a 2012 budget deficit of 8.6% of GDP. The package included tax increases such as another two-percentage point increase in the sales tax to 23%.
The plan by the European Central Bank and the International Monetary Fund has been to support Irish borrowing using bonds issued by the European Financial Stability Facility until Ireland can start raising money in the financial markets again in 2013. By 2015 the Irish debt to GDP ratio is supposed to be down to the EuroZone limit of 3% of GDP.
Not going to happen if growth in the EuroZone economies sinks below 1% in the next quarter or two and then heads for 0%. Which is where the next euro debt crisis comes in.
If you don’t include the payments Ireland has to make as a result of the government bailout of banks like Anglo-Irish that collapsed along with the Irish real estate market, then the Irish budget deficit was 1.6 billion euros lower in the first 11 months of 2011 than in the similar period in 2010. But, if you include the cost of that rescue, then the deficit was 8 billion euros higher. The debt service costs alone ran 1.1 billion euros higher than in 2010.
So in 2012 Ireland—and Greece and Portugal—are going to face a huge choice. They can either try to grind out more austerity in the midst of a EuroZone recession or they can try to renegotiate some of that debt. If you remember, the battle over Greek bank debt almost scuttled the euro this year. Well, we’re going to see the same problem again in 2012 with debtor countries looking for a way to convert some of their current debt into debt of such long duration—how about 30 years—that it will amount to a write down for existing debt holders.
The outcome of the crisis will depend on how rigidly Germany will stick to its current demand for no private sector write downs. Ireland will probably try to strike a deal that trades some de facto write down for its political support for German plans to restructure the EuroZone. But I don’t expect those negotiations to go smoothly.
And remember Ireland is the best-case example of EuroZone austerity. I don’t think Greece or Portugal have enough room to negotiate a deal to reduce their debt that stands a chance of getting past Germany and the other austerity hawks.
Something different–a very Russian crisis.
If you’ve been paying attention to the news from Russia at all lately, I’ll bet your attention has been on the confrontation in the streets of Russia between crowds protesting the fraud in the recent Russian election, supporters of Vladimir Putin, and units of the police and interior ministry troops.
But if you can spare a moment, take a look at the 2012-2014 budget recently passed by the Duma at the beginning of the month. The assumptions necessary to produce a budget with just a 1.5% deficit for 2012 are extraordinary.
First, the budget assumes 12.8% economic growth in the 2012-2014 period. That’s going to be tough to achieve. The World Bank projected Russian GDP growth at 3.8% in 2012 back in September. Everyone’s projections have come down since then because of the euro debt crisis and the slowdown in European growth projected for 2012. Europe is, after all, Russia’s biggest customer for oil and natural gas.
Second, the budget calculates tax revenue from oil—and oil revenues at 29% are a huge source of Russian government receipts—assuming that oil will average $100 a barrel in the period. Urals crude, the benchmark grade for Russian oil, sits near $110 a barrel currently. But that price includes a huge $21 a barrel run up since the end of the third quarter on fears that a boycott of Iranian oil will disrupt oil supplies.
Still what’s the big deal? If the price of oil fell to just $90 a barrel, the Russian budget deficit would rise to just 3%, government economists calculate.
But 2012 is an election year—and so far elections haven’t been going too well for Putin’s United Russia party. The group lost 77 seats in the 450-seat lower house even after extensive fraud that included stuffing ballot boxes and falsified voter rolls. (For some extraordinary video of an election official falsifying ballots see this video by election observer Yegor Duda http://www.youtube.com/watch?v=-64YM3y0Y5g .) Putin himself is running for president again in 2012 and if the Russian government follows form in an election year that means big spending on subsidies for food and fuel, increased pension payouts, and more. Forget about a budget that works on $100 a barrel oil.
If that bread and circuses approach should run into a global economic slowdown that depresses the price of Russian oil and cuts Russian GDP growth below the budget’s targets, then forget about a 3% budget deficit in 2012. And it’s not like the Russian government is going to propose an austerity program in an election year.
The danger—the reason to think we might see a Russian crisis in 2012—isn’t that the short-term shortfall is so dangerous (Russia does sit on $520 billion in foreign exchange reserves, remember), but that a relatively minor current crisis might remind financial markets of Russia’s huge long-term problem. Russia is one of the most rapidly aging countries in the world with net retirees set to jump by half a million people in 2012; and it has a major pension problem. The country had just $38 billion in private pension savings at the end of 2010 and most Russians will depend on a government pension from a program that is running a huge deficit. In 2012 the pension deficit will double to $58 billion—that’s about 3% of GDP. (That would be equivalent to $420 billion in the U.S. economy.)
The long-term trend is so dire that the World Bank’s economist in Moscow, Sergei Ulatov, compared Russia’s impending financial crisis to that of Greece. “By 2030 the debt level would be unsustainable like Greece,” he told Bloomberg. Standard & Poor’s, everybody’s favorite credit rating company these days, has said that Russia’s demographics may put its sovereign credit rating under rising pressure after 2015. Government debt could rise to 585% of GDP by 2050, S&P said. I know 2050 is a long way off but 585% is a staggering number.
Will anyone in Russia’s government try to do anything about the trends this year and set off more protests in the streets? Will the financial markets decide that Russia, like Greece and Italy, doesn’t have a government capable of tackling the problem and send Russia’s cost of money climbing just as the country needs to borrow big to fund the infrastructure required by the 2014 Sochi winter Olympics? Stay tuned.
Is India the new Italy for 2012?
So much of Italy’s financial problem in 2011 stemmed from the financial market’s judgment of the Berlusconi government: Italy’s budget deficit and its lack of economic growth would just keep getting worse and worse because no one in Rome was interested or capable of addressing the country’s problems.
Italy meet India. The government of Indian Prime Minister Manmohan Singh presides over a house in disarray. Inflation at the wholesale level, the Reserve Bank of India’s preferred inflation measure, was an annualized 9.7% in October. That level would be more shocking if inflation hadn’t run above 9% for the last 11 months. The Reserve Bank of India has relentlessly tried to stem inflation by raising interest rates—13 times since March 2010—but all that has done is raise interest rates—the yield on India’s 10-year bond was 8.6% on December 6 compared to 2.03% on 10-year U.S. Treasuries—and cut into growth. India’s economy grew at a 6.9% annual rate in the September 2011 quarter. Which would be great if it weren’t the lowest growth since the second quarter of 2009. Citigroup has cut its GDP growth projection for the fiscal year that ends in March 2012 to 7.1% from an earlier projection of 7.6%.
Doesn’t sound so bad? Well, these aren’t the worrying numbers. In its budget for the fiscal 2012 the government had estimated that its budget deficit would be stable at 4.6% of GDP. But with growth slower than expected economists are now looking for a 5.6% budget deficit. And that’s for the year that ends in March 2012. Nobody expects that the global economy will have turned around by then.
India doesn’t have the luxury of Russia’s big cash cushion. India runs a current account deficit now and relies upon capital flows from overseas. In the quarter that ended on June 30 India’s current account ran in the red by $14.2 billion, up from $12.10 billion in the same quarter of 2010. Capital flows from overseas more than made up the difference so that the total balance of payments was a positive $5.44 billion.
But you see the problem, right? A government looking at a rising deficit and total government borrowing near the highest ever. Inflation stubbornly above 9%. Economic growth trending downward. Bond yields near their 3-year highs. A negative current account balance that depends on overseas cash flows. India isn’t in a good position for confronting a slowing global economy.
Do any of these crises rise to the level of this year’s euro debt crisis? The odds say, No. Mostly because the countries at the center of these potential crises—Ireland, Russia, and India—don’t carry anywhere near the weight in the financial markets as Italy does. Italy’s bond market is the third largest in the world and a collapse in that market outweighs the effect of any crisis in Ireland, Russia, and India.
That doesn’t mean, however, that global financial markets would ignore a crisis in any of these countries. These crises would add huge volatility to the financial markets at a time when even shouting, “Boo” can spook bond traders. The potential for a crisis like any of these is one reason that I think the first half of 2012 will offer investors a very wild ride.
Why only the first half of the year? Not because everything wrong with the global economy will be fixed by July 1 certainly. But by that point in the year we should have a reasonable handle on how bad the slowdown will be in Europe, on how hard a landing we will see in China and Brazil, and on how slow the global economy will get.
Even if the news isn’t great, the certainly will be appreciated by the markets. The financial markets are good at discounting even bad news. It’s the inability to mark prices up or down because there is no consensus view of the future that drives traders and investors to acts of extraordinary volatility of the kind that investors are suffering through just about every day.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of September. For a full list of the stocks in the fund as of the end of September see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
No related posts.