Cyprus: a dangerous precedent. Another step forward toward the end of the EURO.

Dear all, after reading the latest news arriving from Cyprus I couldn't help but getting onto the blog and share these few lines.

In spite of the relative quiet stand taken by the European media the bailout news is HUGE and deserves to be absorbed in all its frightening details.

If approved by the Cyprus government tomorrow this is going to be first time that the European authorities are going to apply a levy on account holders regardless of income but purely on the amount of deposits held: 6.75% for all account holders with up to 100,000 EURO in deposits an 9.99% for all account holders with deposits above 100,000 EURO.

It is hard to say whether this measure was passed onto Cyprus citizen because the European authorities wanted to collect as much money as possible out of the deposits of Russian citizen holding cash in the country. Regardless, the implementation of such measures are bound to have significant ripple effects in other countries of the periphery. Nonetheless it will be interesting to see the Russian reaction to these measures after they contributed more than 5B EURO in previous bailout money to preserve a special status with Cyprus (please note that Cyprus and Russia have a taxation treaty and Cyprus has been the not too hidden destination of much of the money taken offshore by Russian oligarchs). Perhaps the real reaction we will see only next Winter when Russian gas will need to flow into Europe.

In consideration of the following:

• current record bottom interest rates'
• real risk of government appropriation of funds, whether mandated by the European Union or the IMF truly doesn't matter;

Most people in Greece, Spain and Italy are better off rushing to their bank and pick up as much cash as possible to keep it under the pillow or in the mattress. Better yet convert it into gold or buy diamonds with it....

As our reader generally know when have always been bearish against the EURO and we keep on holding our ground. The lack of proper planning and proper imagination is pushing all periphery countries into the same deflationary spiral that is currently in place. Bailout like Cyprus is nothing but another stepping stone of the same policy: austerity -- contraction -- austerity -- contraction and so on.

As we repeated in other occasions the reaction to this will be political and will not be of conciliatory nature. It doesn't matter how many EUROs the ECB will keep on printing.
This is a deck of cards destined to failure.

Critical juncture - Euro & USD

Dear all, I was preparing the new blog article on a completely separate topic when I started to pick up from the press the convergence of a series of issues that require immediate attention.
I will therefore leave on this occasion the general analysis of the emerging market economies to focus on the impending "perfect storm" that is brewing across Europe and the USA.

We are in fact fast approaching a series of events that if not carefully thread could have a profound impact on the global economy the way we know it, more specifically:

1. the Euro crisis is spreading and it has INEVITABLY included Italy;
2. the USA is about to vote on a structural piece of their economic system and its timing is indicative of a very fragile system; 

Let's briefly analyze each item separately and then try to make sense of what is happening.

The Eurozone debt crisis

In talks with friends and clients we have sustained for the past 2 years two fundamental claims: the Euro was an experiment that unless strong political changes supported couldn't be supported long term.

We also claimed that the critical moments in which the crisis would have accelerated was the moment in which Italy was going to become the focal point of the crisis, or the tipping point. The issue is a matter of size: while Greece barely represents the GDP of a German Land, the Italian economy is the 4th largest economy in Europe and the 8th largest economy in the World. An Italian bailout is bound to create significant ripple effects both politically and financially.

Please note how the debate on the global media with regards to the Eurozone crisis has started to include Italy no more than a month ago. Nowadays all newscast globally, other than the one in Italy of course, seem to have recognized the size of the problem looming.

For the first time I have noticed going "mainstream" some of the "what-if" scenarios that we have been kicking around for quite some time now: the idea of multiple euro currencies: a "core euro" and a "peripheric" euro. I think that the fact that these scenarios are reaching mainstream talk is a sign that time is maturing for some bigger event. For additional information about scenarios like the one mentioned above please follow this posting by Izabella Kaminska of July 15.

As predicted earlier the list of "endangered" countries now comprises:

- Greece

- Spain

- Portugal

- Ireland

- Italy

Long before than the media investors have started moving, please look at the latest spreads.

From Bloomberg:

"Italian two-year note yields surged the most in over a year, as the nation’s borrowing costs rose at a debt sale and contagion from Greece’s debt crisis spread across the 17-nation euro region.

Yields on notes from Ireland, Portugal and Greece soared to euro-era records, while German bunds advanced for the fifth time in six weeks as Europe’s politicians clashed over how to craft a new rescue plan for Greece involving private bondholders. Spanish and Italian 10-year bonds slumped, sending yields to the most since the euro’s inception in 1999, as borrowing costs rose to a three-year high at a sale of five-year Italian securities. France, Spain and Germany plan to sell debt next week."

Italy’s two-year yield climbed 75 basis points over the week to 4.26 percent as of 4:40 p.m. in London yesterday. That’s the biggest weekly increase since the five trading days ending May 7, 2010, the week before Europe’s leaders announced a $1 trillion backstop for the euro. Yields on 10-year notes advanced 48 basis points to 5.75 percent. They reached 6.02 percent on July 12, the most since 1997.

Ireland’s two-year bonds plunged after Moody’s Investors Service cut the nation to Ba1 from Baa3 on June 12, saying it is likely to need a second bailout. The country’s two-year yields climbed 6.9 percentage points to a record 23.12 percent, while its 10-year bond yields advanced 1.13 percentage points.

Greek 10-year yields climbed 71 basis points over the week, while the nation’s two-year bond yields soared 2.69 percentage points. Fitch Ratings slashed Greece’s credit rating on July 13 to CCC, its lowest grade, and said that a default is a “real possibility.”

Spain’s 10-year bonds dropped, pushing the yield up 39 basis points to 6.06 percent. Spanish debt may continue to fall next week as the nation prepares to auction 5.5 percent securities maturing in 2021 and 2026 on July 21. It will also sell 12- and 18-month bills on July 19.

What does it mean the trending of the spreads for Italians? It means that the 40B Euro in economic cuts and additional taxes will be all but wiped out by higher borrowing costs that the country will need to face in the future. More corrections will be required. 

Let's take additional data from Italy: the money supply over the past 6 months has fallen drastically. M1 and cash deposits over the last 6 months has contracted at an annual rate of 7%. To put this in perspective: this is faster than the build up leading to the great recession of 2008. Such dramatic figures typically indicate an economic contraction approximately 6 to 10 months away. What is also important to report is that the numbers in the core eurozone has started to deteriorate as well, and in spite of this ECB has recently increased interest rate. It does seem that the leadership of the ECB is battling political and financial issues but the end result is that there is still a fundamental denial about the gravity of the situation that is building up.

Remember: once the situation will be mature, we will require a small event to unravel the euro and send shockwaves across the global economy. Will China commit to save the Euro? Please remember that China has been one of the supporters of the Euro note over the past year.

My prediction is that the "endangered" countries of the Euro will turn the issue political sooner rather than later and that economic matters may take a backseat.

Now let's briefly take a look at what is happening on the other side of the Atlantic.

US debt ceiling debate

Raging right now in the US is the debate to change the debt amendment and raise the current deficit ceiling. In essence Congress must raise the $14.3 trillion limit on US borrowing by Aug. 2nd. If that doesn't happen the US may face a downgrade in his credit rating and send significant shockwaves across the the financial system, or at least many believe so. 

President Obama and the Republican opposition have been fiercely fighting over two fundamentally different approaches towards this matter.

I personally believe that like the ex chairman of the Federal Reserve Paul Volker: "reason will prevail" and the politicians will find a compromise. In fact history leads us to believe that it will be so: in the past 30 years the limit has been raised already a significant amount of times.

The real important issue for me is timing and the fact that uncertainty at this time in the global economy, and especially uncertainty surrounding its largest economy, is adding onto very negative investor sentiments. The message here is economical as much as political: the transition between a world dominated by the G7++ economies into a world led by China & India is fast in the making. While the trends are undeniable the transition is froth of peril for such an interconnected world and the aftershocks of a new order may excerpt sacrifice on many parties.

Again, pragmatically: what does it mean for the investors right now?

My advice in the short term is to stay liquid, please look at currencies like the Swiss Franc and the UK Pound. Leave the equity market to its woes and play out some of the uncertainty unless you are a good trader. 

In the long run evaluate different type of investments altogether: food commodities are a sure bet in the long run but you need to brace yourself for a bit of a roller coaster ride. In some of the most uncertain countries or where financial instruments are limited, focus on building business ventures that satisfy local needs.

Related posts on this blog that explained the fundamentals of what is happening:
- Geopolitical & economic shift eastbound: underlying trends fueling long term growth in an economy - December 19, 2009
- emerging markets: by choice or mandatory evolution? - December 27, 2009


Related posts from other sources:
- Italy money supply plunge flashes red warning signals - The Telegraph, July 14, 2011
- U.K. Pound Approaches One-Month High Versus Euro Before Bank Stress Tests - Bloomberg, July 15, 2011
- Barack Obama’s extravagant Ancien Régime tells the American people: let them eat taxes - The Telegraph, July 15, 2011
- Moody's: U.S. faces default on debt payments not 'technical', - Reuters Video
- Volcker: Common sense must prevail in U.S. debt debate - Reuters Video

Middle East & North Africa unrest - a perspective

Over the recent weeks many friends, mostly Europeans and North Americans called me to get an opinion about what has been happening in the Middle East and North Africa.

I have refrained from publicly sharing any of my views since events were unfolding very fast and needed some time to analyze them and formulate an opinion.

The following is a summary of my thoughts and humble opinions hoping to be nothing more than a perspective from someone that has been operating in these markets for years and that has a first-hand appreciation for the commonalities and the differences that these diverse cultures share.

Let's get out of the way few important notions:

• Origins of conflict: first and foremost with the exception of Bahrain the events in Tunisia, Libya, Egypt, Saudi Arabia and Oman have been driven by socio economic factors and not religious ones.
• Oman: secondly, Omani protesters haven't requested for a change of the ruling family but rather a set of changes that improve the ability of employment and changes in some of the government posts.
• Bahrain: remains an exception because we have a Sunni government in country that is vastly Shi'ites and some of protests took a religious connotation especially after the clashes that took place about 10 days ago.

The risk of simplifying an analysis and group all these countries together, while useful for some reasons and to certain people, does not represent reflect the truth about the profound diversities among these countries.

AT FIRST GLANCE

Tunisia, Libya and Egypt saw a long deterioration of the conditions of the masses leading up social unrest that took many years in the making. Take Egypt as an example: the economy has been growing fast over the past few years in spite of the global recession: 5.3% in 2010, 4.6% i 2009 & 7.2% in 2008, unfortunately such growth didn't benefit the fast growing population: 20% of the population remains below poverty line, and this looks like a rather conservative estimate. It is not by chance that the majority went to the streets asking for radical changes and that the protests turned violent.

While regime changes were long in the making in Tunisia and Egypt, the unrest in some of the other Middle Eastern countries may have taken some of their governments by surprise. 

Unemployment rates among the local population breeds unrest, especially youth unemployment. At sign of first trouble the answer given by the ruling families in Saudi Arabia, Oman, Bahrain has been to prepare a package of handouts in form of government salaries increases, and to create new government jobs (Bahrain: 20,000 new jobs promised - http://www.reuters.com/article/2011/03/06/bahrain-jobs-idUSLDE72505C20110306, in a country of 1,000,000 approximately it is a significant increase). King Abdullah of Saudi Arabia returned home and immediately implemented a $37 billion social welfare package: pay rises, unemployment benefits and affordable housing.

Notably out of the lot during these troubled times have been the United Arab Emirates, Kuwait and Qatar where there was little to no sign of discontent. 

These countries have been able to share in a relatively less inequitable way the wealth of the country and last but not least the population is differently composed: a majority of expatriates workers at every level of society together with a 15-20% of passport holders.

Without getting deeper in the analysis of each single case I would like to highlight some of the risks on hand and some of the opportunities:

RISKS

• Egypt controls the Suez canal and therefore the traffic of oil derivatives and container into the Mediterranean. It is essential to have a stable Egypt to guarantee free flowing of the goods. Further Egypt is one of the most populous countries of the Arab League and presents phenomenal opportunities for growth: large and young population, need for infrastructure and good combination of agriculture and services industries;
• Saudi Arabia: any unrest in this country would send oil skyrocketing to levels never seen before. Saudi Arabia has acted as additional supplier in times of need for the West. Since the second oil shock Saudi Arabia has intervened with additional oil supply any time there was necessity to stabilize the market.
• Some forces in the West could characterize the current situation along religious lines further exacerbating the contrapposition between Islam and Christianity that seems so useful to some lobbies.
• Gulf countries: some of the measures that have been put in place to quell the unrest may prove harmful in the long run. Government jobs and subsidies hardly seem the way to create long term competencies much needed in these countries. Government jobs may prove a way to employ the youngsters short term and a way to redistribute the wealth coming from natural resources (oil & gas) but it breeds inefficiencies and promote bureaucratic tendencies. It is known in the UAE for example that many Emirati passport holders don't like to work in private enterprises and hold out of the work force to be employed by the government which provides a secure job, indexed salaries and easy advancements.
• Since the USA and many European allies actively sustained many of the families ousted during this last round of discontent it is possible that the new forces shaping up to take control in these countries may be less friendly than their predecessors towards the West. (Remember: US 6th fleet is anchored in Bahrain, Saudi Arabia is a key ally of the US, Egypt received armaments and economic support from the US and allies: Italian Prime Minister Mr. Berlusconi called him one of the wisest leaders in the world just two weeks prior of him leaving Egypt for good).

OPPORTUNITIES

• Increased internal development: this unrest is a stepping stone in the development of a country. This could be seen as an alarm bell for many ruling families in the region that could put additional resources in the development of the country and in the creation of a better leveled field for its citizen. This in turn can create a virtual circle of business opportunities for all: locals and foreign investors alike;
• SME sector: a more balance redistribution of wealth in certain countries could mean an accelerated development of economic sectors other than the one of the natural resources which in fact has been on the agenda of many Gulf countries for many years. The next step is promoting the development of a strong private sector independent from the government owned conglomerates that have been fueling the development already for many years.
• UAE as the most stable country in the region: what may be an issue for some it can be an opportunity for others. Capitals as well as tourist require stability. Since Egypt has proved unstable all tourists have been redirected to the UAE resorts: try booking a room in Ras Al Khaimah these days… Let's look at relative advantages to uncover opportunities.

Useful marco-economic data:

Country	Ranking GDP per capita	GDP per capita (PPP)	GDP Ranking	Nominal GDP	Population
Tunisia	82	9,488	76	43,863	10,549,100
Egypt	103	6,367	40	216,800	79,890,000
Saudi Arabia	39	23,742	23	434,440	27,136,977
Oman	34	26,197	68	53,782	2,694,094
Bahrain	33	26,807	96	21,733	807,000

Macroeconomic Data from:

• CIA World Factbook;
• International Monetary Fund;