Greece: Loose-Loose agreement is now place, additional pain for all parties enduring

The never ending Greek saga is now adding a new chapter to its drama. And dramatic indeed is going to be the situation of the Greek citizen that after yet another round of bailout funds are bracing themselves for yet more of the same failed medicine: austerity measures, cuts to public services, forced privatization, etc.

7 years of austerity measures that didn't work and nobody is thinking about perhaps changing the medicine. It is fascinating to see how an irrational behavior gets perpetrated over and over in spite of the evidence just to be able to preserve special interests, banks and the needs of the powerful Germany industrial apparatus.

So let's analyze the high-level outcome to see how whatever has been agreed so far; mind much more needs to be agreed in the terms of the bailout that needs to come.

1. the current government of Greece had to swallow an agreement that it didn't believe in. Selve preservation? perhaps... needless to say Mr. Tsipras agreed on punishing measures that are worse than the one offered before the referendum he called. Defeat? Yes. As much as this can be promoted otherwise, his strategy didn't yield any advantage. The only person coming out as a hero out of this is the ex Greek Finance Minister Yanis Varoufakis that called himself out of the deal as soon as the referendum outcome was clear.
2. The Troika forced terms onto Greece and the general feeling across Europe is that they were forced from the powerful and intransigent Germany, an abuse of power. This is bound to increase an anti European and anti German sentiment across Mediterranean Europe that will be used by anti Euro parties to gain vote at first opportunity. 
3. The Troika came short of offering any haircut on the debt with the exception of vague allegation of the need of considering one from the IMF. 

So... 1, 2, 3... more of the same bailout in exchange for higher taxes, less social state, rampant cuts to education and health care, privatization of state assets to the benefit of foreign corporation. Mind that this recipe has failed over and over again over the next 7 years, it is therefore ludicrous to think how the new 80B EUR added to the overall Greek debt are even going to be repaid.

In the meantime, a weaker EUR is bound to help German export just for a little bit longer. With the US heading towards a rate increase in fall it is likely to see parity between EUR and USD in a short while.

This last round of negotiation represents a lost opportunity for both parties:

• For Greece: an opportunity to start re-gaining sovereignty in the face of difficulties. It is clear that difficulties would lie down the road in case of a GrExit but with some proper policing there could also be a light at the end of the tunnel; I am sure that in case of a GreExit there would be new partners in the BRICS very interested in gaining access to the middle of the Mediterranean;
• For the European leaders: the opportunity to re-evaluate the problem of the Mediterranean countries with a new set of measures. An alternative to austerity will require some debt haircut but it would also give confidence again in the European dream.

As pointed out before: there is no solution to the Euro problems without considering two fundamental steps:

A.  Issuing EuroBonds that would make the debt of European members: EUROPEAN;

B.  A system of significant transfers from richer states to poorer and less competitive states; this has been going on in the USA consistently;

C. A process leading towards a stronger political integration to limit fiscal discrepancies across all countries.

It is essential to point out that the differential in the interest rates applied in each country lies flooded certain less competitive countries with cheaper money from the most competitive one. These transfers in the private sector lead to a dysfunctional situation ONLY when during the fall out of the 2008 crisis we decided to bailout the banks with public money.

Since as it seems A-B-C remain something that is so far removed from the political elites in power in Europe we believe that the whole EURO experiment has failed already and it is just going to impoverish further not only Greece but also Italy, Spain & Portugal to begin with. Eventually the losers will outweigh the "winners" in the EURO game and the experiment will come to an end.

The ownership of DEBT in Europe: shifting from private debt of French & German banks to public debt on the shoulder of European Union citizen, saving the banks & the death of the European dream

Debt to be dealt as a main topic all over the news outlet. Although the general rhetoric seems to be rather simplistically dealt with.

It is therefore important for me to speak up against the general statement of: Greeks don't want to repay their debt and therefore they deserve the cuts and austerity?

Mind that the same goes for Italians, Spanish, Portuguese, and let us not forget Islanders and Irish too... 

The only difference with the Islanders has been the recipe applied to solve the debt problem. But we will get to it just a bit later.

Therefore, let's get into a bit of detail to get something straight. Debt comes in many shapes and forms for now we distinguish between Private Debt and Public Debt. (for a definition follow this link)

Credit (& therefore Debt) have been the cornerstone of modern economics, the capitalist version of global development is based upon CREDIT & DEBT.

Simply acknowledge that the most developed countries run a balance deficit and most countries run a positive Debt/GDP ratio: here is a link to a site that calculates it for most countries REAL TIME: http://www.nationaldebtclocks.org

The competitiveness of the credit rate therefore moves capital from one country to another. When in Europe countries started first to run a fixed rate with their local currencies and the EURO and later adopted the EUROs credit opportunities were created by making French & German money available at a cheaper rate in the countries of the south. That is because while the EURO was common the competitiveness of each country was different, the interest rate applied to national bonds were different and therefore Italian, Spanish and Greek bonds were more lucrative thank French & German, that is why money moved from French & German banks to Greece, and Italy, and Spain, etc. etc.

Banks, consumers and individuals in the receiving countries were therefore presented with cheaper money and therefore when presented with a choice they choose the cheaper option. The same natural behavior that takes place EVERYWHERE in the world, not any different than USA, Canada, Korea or Russia. When presented with a more convenient option for similar service people choose the less costly option. 

PRIVATE LENDERS therefore flooded Southern European countries with their money (and also their goods, but that is another story!). Higher yields were convenient to the German and French banks. Nobody complained even if the risk became higher and higher as the competitiveness of the borrowers (southern European countries) was deteriorating. 

At the bursting of the 2008 global crisis the whole game came to an end.

Private money dried up instantly, and the reckless lenders: German, French and Dutch banks for the most part had to be rescued quickly from the toxic waste that they created, and so they were rescued... BUT with public money.

It is ONLY at this point that the PUBLIC debt started to pile up very quickly on the country of Southern Europe, not before. A private debt became a PUBLIC debt issue because Greece and so the other countries started receiving bail-out money that was used to cover the toxic waste of large European Banks. In fact the money of the bailout went directly from the ECB, IMF, etc. directly into the private banks they were saving. 

The rhetoric then became: Greek (or Italians, or Spaniards) don't work hard, over borrowed, etc. 

This argument is simply not credible. The reality is far too complex to believe such an oversimplification.

Southern countries were allowed into the EURO in spite of the fact that they didn't meet the Maastricht requirements (arbitrary requirements nonetheless) because they were useful to keep the value of the EURO low, to allow more competitive countries to develop a new mercantilist strategy and be able to export their goods (and funds and services) to the near shore markets of the south and gain competitiveness abroad.

The imbalances of this strategies have now wrecked any solidarity around the European Union and killed the European dream. Barriers are rising, local nationalist movements are on the rise... sacrificed all in the names of the financial markets, banks and special interests.

I wonder if there will be time for adjusting the system or we have forever deprived the next generation of a united strong and united Europe.

Data: below is a graph (unfortunately in Italian) that shows the debt divided into Bank related Debt in blue (private debt) and State related debt (public debt), you can see the development of the debt from Dec 2009 to Sept 2014, shifting from a private debt into a mostly PUBLIC debt, at that point banks were already saved and the burden of the debt shifted onto European citizen.

EURO DOOM: The Greek vote, another significant step towards scrapping or rethinking the EURO as it is

The time has come to shake the fundamental construction of the EURO ZONE.

The Greek government has gambled its existence and won. The technocrats in Europe had stepped up a strong rhetoric in Greece availing themselves of some good connections in the press industry but it wasn't enough.

As we reported before back in 2011 (http://emerging-markets-investment-news.blogspot.com/2011/07/critical-juncture-euro-usd.html): the EURO project as it is has failed, and the latest is just the apex of this failure so far but we believe that more is coming, and depending on the tactics used now to handle the Greek situation an anti EURO domino effect could be in play.

Austerity measures have had an adverse effect across the entire set of the southern countries of the Euro zone: Greece, Spain, Portugal and the big elephant in the room: ITALY.
Anti EURO sentiments have been flaring in all countries together with some separatist movements.

In Spain the Podemos movement, in Italy the Lega Nord and the "Movimento 5 Stelle" (M5S) embody the anti euro sentiment growing in the south of Europe.

Austerity measures have brought unemployment, they have NOT reduced the debt/gdp ratio, have impoverished the poor and created further distance from the cast of technocrats and "main" street (Point 6 & 7 below for proof).

It has now come the time to reconsider some of the common well advertised misconception that have been used to ride the austerity measures till now and for simplicity we will use Greece as a base for our discussion, please note that the same reasoning have been applied to Spain, Portugal and Italy.

1.  Greek people retire too early!

Following is a graph visually representing the impact of pension reforms on the average effective retirement age from the labor force:

The graph shows in blue the long term (2060) pensionable age before the pension reform and in red AFTER the pension reforms enacted by the various governments. Pre-Austerity Greece (indicated with the two letters EL) had an average pensionable age set at 61.9 years for male, in line with the rest of Europe.

After the reforms Greek citizen will retire gradually later than Italians and all other Europeans, excluding Cypriots, Danish and Dutch citizen.
IF there are certain privileged segments of the populations that retire earlier (called baby-pensioners) this is true across the entire Western countries and not only for Greece.

2.  In Greece there are too many public servants: FALSE!

The following graph shows the ratio of public servants employed against the total employed population.




The data shows the ration between 1999 and 2007.
In Greece the public servants represent less than 8% of the total employed population. In Germany it is 8%! Greece is right on par with the rest of Europe, bar right from Greece marked as EZ.
In France as a term of comparison public servants almost represent 10% of the total employed population.
As a very important note: with austerity measures no European country has decreased the number of public servants as much as Greece has done to-date. In 2009 public servants were 907,351 and in 2014 they were 651,717. That is 255,634 units less for a total of 25% less! Greece post austerity would find itself at the very right of the graph above.

3.  Public spending is too high: FALSE



In the graph you can appreciate the average public spending value against the total GDP between 1999 and 207. Italy has been put in red as a point of reference. Greece is below the Eurozone average (EZ12 - EU27) and it is distant from the 50% of public spending against total GDP surpassed by France for example. This value has gone from 47% in the year 2000 to 43% in the year 2006.

4.  Greece hasn't implemented any structural reforms: FALSE
Cuts in the public sector and in the pension systems have been rather dramatic. Collective negotiations via trade unions have been overall eliminated all together, although the Tsipras government would like to reinstate them. Furthermore, Greece was in 2010 at the 109th place in the standings of the countries most convenient to open a new company and do business. In 2015 in the same standings Greece is now at the 61th place and has climbed tenths of positions getting close to Italy and all other "advanced" economies. Assuming that a flexible workforce is one of the most sought after criteria for development as per the "ease of doing business" criteria, Greece has made significant relative improvements, most than any other European "partners".



5.  Greek people work little: FALSE



Please don't confuse work time with productivity. It is clear that in spite of the longer hours the productivity of the hours is not at the same level let's say with Germany given the different type of infrastructure and industrial development between the two countries.

6.  Greece's crisis is determined by the high public debt: FALSE
The graph below shows the relationship between Public and Private debt leading to the 2008 world crisis.



Greece public debt remains constant during the entire period at around 115%, lower than the Italian one for example. It is the private debt that starts to run away after the fixed exchange rate is introduced and then the country adopts the EURO.
That is because Greece all of a sudden becomes the target of foreign creditors (mostly French and German) because the interest rates with the EURO become lower and Greece can't devalue its currency to bring the trade balance back to zero. Since export weren't enough, Greece finds itself financing its import with credits to the State and to foreign private institutions. At the unfolding of the world crisis of 2008 foreign credits suddenly stop and Greece is forced to austerity to pay its debt.
THEREFORE: it is a crisis of the PRIVATE debt favored by the EURO set up that strangles Greece and not a crisis generated by the PUBLIC debt as hailed by most.
IF later there is an explosion of the public debt/GDP ratio that now has reached approximately 180% from 125% in 2010 it is because AUSTERITY measures greatly increased unemployment from 7% to 25% and they have greatly reduced tax and vat revenues together with the GDP (-25%).


7.  Greece deserves austerity because doesn't pay back its debits: FALSE
As per the previous point the main debit comes from foreign banks, mostly French and German. These banks have inundated families, companies and Greek banks with money from the establishing of the fixed rate between Dracma and Euro, and even more at full establishment of the EURO till 2007. It is more convenient for Greece (companies, individuals and banks) to borrow from abroad since Greece cannot devalue its currency (and together with it its debts) and interest rates start becoming lower and lower because of the EURO. With the Lehman Brothers crisis of 2008, French and German banks stop any lending and start pretending their debts to paid off. Austerity and European loans to save "Greece" are used to save the credits of French and German banks, not to help the Greek people to stand back on their feet.

The loans of the ESM (European Stability Mechanism) end up for 90% of their value in French and German banks to save them. In parallel the debts of all countries that have participated to the "saving" of a country go UP (In Italy it accounts for 40B EUR) and the Greek public debt reaches 240B EUR of ESM loans. But the debt could be considered not legitimate as it is bore by European and Greek citizen to save private banks that to exploit the EUR lent money without paying attention to the fundamentals of the economies financed.



From 2010 the exposure of French, Dutch and German banks to the Greek debt diminish greatly. The banks have been saved! Now Greece could exit the EURO but the Troika is afraid of the domino effect for the other countries with similar problems and bigger economies, see Spain and Italy.

8. Greece has cheated the numbers to enter the EURO: true, but...
With the help of Goldman Sachs and the supervision of the EU, with governments favored by the European technocrats: Neo Demokratia and Pasok. That is because Greece in the EURO was useful to Northern Europe, especially Germany to keep the value of the EURO low against the Mark. All analysts were aware of the accounting tricks of Greek/Goldman Sachs.
A similar set up has been used for Italy which didn't respect the debt/gdp ratio of the Maastricht Treaty (60%) but that has been welcomed in the EURO zone nonetheless. In fact Italy outside of the EURO zone with its currency and the ability to have its monetary policy would have proven a formidable adversary to the mercantilist policy of Germany.
Please note that even Germany and France didn't keep the 3% deficit/gdp ratio during the first years of 2000 but they have never been sanctioned for it.


Data collected:

• Infodata: http://www.infodata.ilsole24ore.com/2015/02/18/lesposizione-di-banche-e-stati-europei-verso-la-grecia/
• Goofynomics: http://goofynomics.blogspot.gr/2015/01/cosa-sapete-della-grecia-fact-checking.html
• Parts translated from posting: Beppe Grillo Blog

Country review: the most cost effective access into the Schengen Zone and its vast market - Invest in Latvia

When we read economic news we are bombarded by events from the usual suspects: US, China, Russia, EU. The truth of the matter is that there are key geographical areas in the world that, although sometimes made up by small economies, offer instead very good attractive environments for investors that aspire to access a large markets in a very cost effective way.

One of these key countries is Latvia. Very interesting location among the Baltic countries I will provide a series of key competitive advantages that position this country as the natural gateway into Europe on one side and into Russia on the other side.

ACCESSIBILITY TO LARGE MARKETS: EU & Russia (and CIS Countries)

Latvia is uniquely positions in Norther Europe with equally good access to Europe as well as Russia and CIS countries.

Latvia in spite of his moderate dimensions has 3 large ice-free international ports: Riga, Leipaja and Ventspils. All the ports are closely linked to the country transportation infrastructure including: railway, pipeline system & highways.

Since Latvia is part of the European Union and a Schengen Zone member all custom regulation are based on free trade principles and are uniformed with the rest of Europe, although custom procedures have been standardised and simplified to make the movement of goods and cargo as effective as possible.

Further Latvian railway uses the same standards as Russia and CIS countries making it very easy to transport goods into Russia and Central Asia. As an example: NATO used Latvian ports to transport non-military goods to Afghanistan using the Russian railway systems. 

DEVELOPED INFRASTRUCTURE

Transportation & Logistics

All the global logistics and shipping companies are present and operate in Latvia (Schenker, BTL, Kuehne and Nagel, Maersk, etc.) and make wide use of the available intermodal infrastructure.

• Roads: Latvia is one of the only three EU countries with direct access to Russia making quite easy to move goods along an east-west route. The Russian highway M9 also known as the Baltic Highway connects Moscow directly with Riga (Capital of Latvia), this highway also crosses another important traffic artery for goods and people which is the Via Baltica highway which runs north to south and connects seamlessly Helsinki with Prague.
• Ports: Latvia is famous for its maritime routes and infrastructure, it features three international ice-free ports: Riga, Leipaja and Ventspils. All ports feature intermodal connections and Ventspils also features a free trade zone.
• Rail: the rail system is well developed and quite reliable with standards matching the typical one of Northern European countries. One important aspect of this system is that it matches the Russian rail track standards and therefore it is very suitable to move goods into Russia and other ex CIS countries adhering to the same technical standard. The system has been used by NATO for example to move non-military goods from the Latvian ports into Afghanistan to support the military effort in the country.
• Air: Riga airport (RIX) is the largest airport in the Baltic and offers direct flight to 80+ destinations and it is conveniently situated at the cross road between Via Baltica and the Baltic Highway.

Information & communication technologies

Latvia has one of the fasted telecommunication network in the world and this has favoured the development of the information system industry as well as contributed to one of the highest Internet literacy in Europe and the World.

• Latvia is 5th globally for the average measured internet connection speed (7 Mbps)
• 7th globally for broadband connectivity above 5 Mbps.

Source: State of the Internet 2011 Q4 Report, Akamai.

MACROECONOMIC STABILITY

Latvia is a member of major economic and political global organisations including but not limited to: WTO (World Trade Organization), NATO and the European Union (Schengen Zone).

As opposed to many European countries Latvia upon the 2008 economic crises has significantly reduced government expenses and immediately put in place a series of investor friendly laws that accelerated the quick economic recovery that is currently still in place.

Data shows that post crisis a healthy de-leveraging process truly took place in Latvia, as opposed to many countries in Europe such as Spain, Greece and Italy for example, and while painful at that very moment it gave way to the recovery and a new cycle of economic expansion.

Latvia has bilateral trade and tax agreements with more than 40 countries for the promotion and mutual respect of investments.

The country joined the EURO area on January 2014.

Intellectual Property Laws are well developed in full compliance with EU standards and the country is not part of the Special 301 Report maintained by Office of the United States Trade Representatives including all countries without adequate IP protection laws and IP enforcement. 

Heritage Foundation Survey 2013 results - Index Economic Freedom: Latvia 

COST EFFECTIVENESS

Latvia is one European country that allows for high productivity at low resource cost, especially what concerns human resources.

The main parameters that make Latvia a very investor friendly country are:

• very competitive and skilled workforce at low price;

• competitive tax rate.

Riga, the capital of Latvia, was ranked 7th best European City for Cost Effectiveness by FDI Magazine (European Cities and Regions of the Future 2012/2013), while Jelgava and Ventspils were ranked 6th and 9th respectively as Best Micro European Cities for Cost Effectiveness.

Latvian Labor productivity

Please note that Latvian workforce in addition to be very productive is also very versatile as the average Latvian speaks at least 2 languages and for the new generation it is common to speak 3 languages: Latvian, English and Russian making it an ideal place from which to conduct international business.

Labor expenses are also very reasonable as compared to the rest of Europe and the employment laws exceptionally liberal for a European country.

For example: Germany’s labor costs are approximately 4-5 times higher than Latvia.

Eurostat data available HERE

Latvian Tax rates

Latvia has one of the lowest corporate rates in Europe and one of the lowest in the world: flat rate 15%.

Personal income tax is also at a low flat rate of 25% according to a government decision such rate will be reduced by 5% in 2015. Dividends to EU citizen are not taxed.

Further note though that for re-export companies or manufacturing companies operating in the designated free zones there are significant tax benefits in place.

Latvia has 4 free economic zones (quite an anomaly in the European Union and something that the existing government negotiated hard to keep in spite of the entrance in the EURO zone this Jan 2014): Ventspils which has been ranked as 7th best free zone of the Future by fDi Intelligence. Riga and Rezekne - 49th and 50th respectively. Please note that Ventspils has also been named second best world port zone in the world.

Residence Program for Investors

Further to the various advantages above the country like few others countries in Europe has set up a residence program for investors with the exception that the entry costs are quite lower than respective programs in Cyprus, Spain or Greece for example.

Investors these days are choosing to buy a real estate property in Latvia that they can easily rent if necessary to be able to acquire a Schengen Area residency and unlock several privileges: unrestricted travel across the EU, access to resident only educational program at the European level, be eligible for European grants for business projects and so forth.

Many Russian and Chinese nationals have availed themselves of this program although recently we started noticing an increasing interest from Arab nationals, especially from the Arabian/Persian Gulf area. 

For additional information about the Schengen residence program please visit HERE.

Please inquire with me if you require additional data about Latvia, for reason of conciseness we avoided entering data about:

• Labor related incentives granted by the government to investors hiring Latvian personnel;

• Macroeconomic data about the different industrial sectors;

• List of investment opportunities in renewable energy and high value added sectors

• Quality of life data

All topics above are bound to be material for additional postings on this blog to further uncover opportunities in Latvia and neighbouring countries.

Economic Outlook for 2014

Dear friends, following are some of the important economic themes for this 2014.

As always we welcome any feedback, I have mode detailed information about each of the topic discussed below but I have summarised the content to fulfil the purpose of this blog which is meant to be informative but not the place where to analyse in depth each subject. If anybody is interested in additional information please connect with me directly using the contact form at www.affinitasconsulting.ae or info@affinitasconsulting.ae.

Overview

We recommend a cautious investment approach to 2014. While at the turning of the year many media outlets run big optimistic titles for 2014 we remain instead very prudent and skeptical about the health of the global economy. We see several reasons for weakness especially in the equity sector. Clearly, as always even weaknesses or a downturn uncover opportunities for successful money making but we leave those strategies to the people in the field and we would rather concentrate the following analysis on long term trends likely to affect economic growth instead.

The tapering of the US QE exercise is bound to have ripple effects globally, especially across the emerging market economies.

We reckon the US economy is not as healthy as mainstream media believes and we expect the Feds to evaluate tapering sometimes after Summer when additional signs of weaknesses are going to appear. Now that the elections in Germany are over and done with, and the upcoming banking stress test from the ECB looming we expect the Eurozone to create some waves again. Spain and Italy are bound to catch the spotlight: the first because of weaker than expected banking system and the latter because we expect the government to be challenged in the coming months.

Bottom line: it may be time to cash out on the equity gains accrued over the last few months and wait for bargains during the volatility that is bound to take place due to the tightening moves of the next few months. Some institutional investors or asset allocators may look into specific infrastructure projects which have demonstrated a low correlation with equity markets oscillations.

Investors or asset allocators may also explore and evaluate financial instruments that have as objective the isolation of the interest rate differentials.

A STRONGER DOLLAR

The tapering program announced by the Federal Reserve is going to be one of the key elements behind a likely appreciation of the USD against the other G10 currencies.

I believe we will see an even appreciation of the currency throughout 2014. While portfolio flows in 2013 definitely favoured Europe we believe that strong equity valuation discounts eliminated any chance for further growth hinderances. 

In addition US Banks are decreasing their exposure against foreign borrowers and we see this as a clear sign that the USD is no longer used as a funding currency but rather as a destination for investment.

With specific regard to the USD/EUR rate we simply believe that in spite of the PR coming from the EU there are significant unresolved problems in the Eurozone that are bound to flare again at any time (more below on this topic - EU problems all over again).

We are forecasting the following key rate: 1.20 $/EUR 

USD Investment Destination (Graph)

PRESSURE ON CORPORATE PROFITS

This topic is directly linked to a phenomenon that many economists have been discussing for more than a decade: the decoupling of productivity and wage growth, the so called Jaw of the Snake.

The decoupling between productivity and wage started to appear around the beginning of the 80s, we believe that the spread of the personal computer and the adoption of information technology greatly favoured this trend. 

Fundamentally: since 1990 German labor productivity increased by 25% with no appreciable difference in wage growth; in the US labour productivity has increased to-date 85% versus only 35% of the hourly wage. In a study published in 2012 & 2013 by the International Labour Organisation we learned that the share of labor as part of the gross national income has declined since 1975 by more than 10% across the 16 high-income economies.

This allows for a redistribution of the national income away from labor and in favour of capital owners.

ILO (International Labour Organisation) research goes therefore at the core of the problem: the decline in the labor share of the national income hinders aggregate demand; that is because the consumption propensity from labour income is much higher than the propensity to consume out of capital income.

We therefore believe that pressure on corporate profit will come directly from the spreading income inequality that is accelerating in many of the G10 economies. In fact, lower aggregate demand lowers government tax collection, and further hinders the ability and willingness of companies to invest.

Adjusted Labor Income Shares (Graphs)

Increasing Income Inequality (Graph)

EU PROBLEMS ALL OVER AGAIN

While the marketing machine hails the Banking Accord of 2013 we believe that its positive effects will take very long time to take effect, and during this time a lot can and will happen. Be aware that the resolution fund part of the accord will not reach its target till 2026! 

Throughout 2014 there are going to be several junctures testing the solidity of the union and especially its banking system. We expect the upcoming banking stress test by the ECB to be one of such tests. It is likely that the test is going to uncover the requirement for additional capital especially in Spain, Greece and Italy. The stress test is promised to be more stringent than the previous one, especially since the previous one proved to be inconclusive since after passing it with flying colors the Spanish Bankia, the Cyprus Laiki and the Franco-Belgium Dexia went belly up just months later.

We also believe that the Spanish economy hasn’t sufficiently deleveraged, especially in its real estate sector.

The figure below shows that notwithstanding the collapse of property prices, Spanish mortgage debt has adjusted by only half the magnitude of the US adjustment. 

Any alarm in the banking sector would have repercussion on the valuation of the sovereign debt. The vast amount of Spanish government debt is in fact held internally by domestic banks.

IMF projections give the Spain structural deficit as one of the worst globally over the next five years. It is likely that additional fiscal tightening is going to be required in the upcoming future to meet the required targets.

We remain quite pessimistic in the future of the Euro zone in spite of the victory speeches of some of its leaders. 

Since the local governments are going to be forced to fund their own bank bailouts till the European fund gets up-to-speed we expect a continuing shortage of credit. With a chronic shortage of credit given to the private sector we expect growth to remain weak or non existent for most of the EU countries and deflationary forces will remain at play during the entire year.

Reality will seep through in 2014 and equity returns should start to be driven by corporate earnings instead than Quantitative Easing operations by the central bank. 

It is clear that Eurozone leaders have addressed some of the issues on hand and made significant steps forward, especially steps that have been blessed by the German leadership. Nevertheless these steps remain insufficient to resolve the disparity between the different countries in the zone and time may be running out before additional shocks are going to rock the system.

Reverse globalisation

Global trade hasn’t recovered to the same levels prior of the 2008 crisis and its growth remains below trend since 2011. Further note that additional data leads us to believe that there is an underlying trend of re-shoring currently in place.

The Manufacturing Advisory Services survey show that among 500 UK small and medium size companies interviewed a significant percentage of them was in the process of reshoring or thinking about it.

15% of the manufacturing business in the South East was already reshoring and an additional 25% of the companies was considering reshoring activities over the following 12 months.

Shipping Remains Subdued (Graph)

Similar trends are not exclusive to the UK manufacturing industries but also in the USA where industrial reshoring has been a key theme of 2013. In the USA the trend is predicated on the falling energy prices (“fracking revolution). 

Over the next decade as labor cost rise in China and other Asian exporters we predict this trend to gain pace.

Shipping Indexes (Graph)

Reasons for Re-Shoring (UK)

DEBT SERVICE BURDENS

As the monetary stimulus keeps on being retracted the lid that was put on government bond yields is going to be lifted little by little. It is therefore normal that interest rates sooner or later are expected to be raised.

Our point is that as this happens we expect service burdens for household to rise and therefore depress consumption expenditures.

Debt Servicing Costs

We indicate few countries that are likely to hit particular consumption degradation at the rising of interest rates: Canada, Netherlands and Sweden. These countries experienced a fair amount of household leverage during the last 10 years with no sign of decrease since 2008.

A study from the Canadian Chartered Accountants found that 29% of the respondents would struggle to keep up with payments if interest rate rose by 2% and further 29% would consider challenging more than 3%.

Canada, the USA and Sweden have a high proportion of non mortgage variable debt outstanding that is used for consumption. As monetary policy keeps on tightening over the course of 2014 investors are best to avoid any consumer centric type of equities.

Interest Rate Vulnerability (Graph)

Please contact the Affinitas Consulting team (www.affinitasconsulting.ae) for any additional query or information.

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

The Long Sunset of Europe

As we are witnessing a consistent stream of bad economic news from the Eurozone, I am a bit puzzled at the relatively shortsightedness of the analysis of the experts broadcasted across most of TV networks.

The main highlights surrounding Greece, Spain, Portugal and eventually Italy tend to focus around problems of fiscal nature.
In reality, fiscal problems are only an effect and rather not the cause of the matter.
In my modest opinion, the fundamental problem that is shared by many economies in the Eurozone is a fundamental lack of competitiveness. Cost of labor have soared, cost of welfare with it, productivity has decreased and the long term demographic trends, as shared in previous posts, are negative with no possibility of reversal.

The resolution of this matter is further complicated by the limited range of monetary policy options at the country level now that the EURO is in effect.

While in the old days each country made ample use of the monetary policy to boost competitiveness of goods and services, today the government of these countries need to come to terms with the fact that this option is no longer available. The ECB is working on a set of monetary policies that are to address the needs of a wide area of countries at times radically different from each other (look at the spread on the 10 years notes to witness the differences first hand). The end result is in fact a bit of an improbable exercise of equilibrium that tends to lack effectiveness.

Now it is the time in which the Eurozone needs to come to terms with a fundamental dilemma: one central bank setting monetary policies for all members but no strong political centre with the necessary powers and support to make difficult choices. The problem is therefore one of political nature just as much of economic one.

While Germany has been working very hard over the past 10 years to increase productivity without increasing the cost of labor (successful exercise, data shows), other countries have grappled with a consistent decrease in competitiveness and soaring costs. Moving forward given the fundamentals the differences between the central and periphery of Europe are going to unravel with: Germany/France on one side, the Mediterranean and Eastern Europe on the other.

I guess the concern that I would like to share is with regards to the remedy currently implemented.
From a birds-eye view, the liquidity offered in the forms of various loans by the ECB/IMF to Greece has a cost of 5%, hardly favorable terms. The loans can be activated in various forms upon implementation of structural reforms which are bound to further decrease internal consumption, which are going to drive down production and increase employment as well as decrease money velocity. (internal devaluation)

Aren't we running the risk of prolonging the agony, destabilize a country (people unrest is a real side effect) and arrive again at a point in which new injections of money is required?

It is indeed hard to evaluate other solutions given the existing exposure of German banks for example to both the Greek and Spanish debt. A potential return to the dracma for Greece would signify the failure of the EURO experiment. Nonetheless, sooner or later German & French voters are going to call for a better understanding of what is in it for them to bail out Greece now and who knows tomorrow.

Jean-Claude Trichet, President of the ECB, rightly said: "there is a need for a quantum leap in the governance of the Euro area". The real question is whether there is the political might and willingness of the single countries to make this necessary quantum leap. If I have to give odds to the Euro today, I would bet against its existence over the next five years, but let it be clear: as a European myself, I hope to be proved wrong.