Tags: Eurozone | Dangerous | Circle | Recession

Eurozone Caught in Dangerous, Vicious Circle of Recession

By    |   Tuesday, 17 Jan 2012 07:57 AM

Ma Jiantang, the head of China's statistics agency, said China's growth was likely to slow further as Beijing tries to restructure the economy away from exports and toward domestic consumption.

His comments came after Chinese GDP came in at 8.9 percent year over year in Q4 of 2011, which is the weakest pace of growth in 10 quarters.

Elsewhere, the Baltic Dry Index, which tracks worldwide international shipping prices of various dry bulk cargoes fell today in London to 974, its lowest level since Jan. 23, 2009, when we saw bottom Baltic Dry prices that went as low as 733 on Nov. 27 when the 2008 crisis impacted the world economy and shipping industry most.

By the way, the Baltic Dry Index reached a top of 11067 on May 15, 2008. The index has lost about 40 percent so far this year.

Meanwhile, the OECD’s ( The Organization for Economic Cooperation) composite leading indicators (CLIs), designed to anticipate turning points in economic activity relative to trend, continued pointing to a slowdown in activity in China as well as in most OECD countries and major non-member economies.

The Chinese CLI lost 2.9 points from 102.9 in December 2010 to 100 in November 2011. Interestingly, over the same time span, the U.S. CLI barely changed and was at 101.4 in November 2011 against 101.6 in December 2010, herewith remaining above its long-term trend (100) and even “recently” showing some timid signs of a encouraging positive change in momentum, which should be considered as a positive for the time being, but that could be abruptly derailed by an EU upset.

During the same period, the eurozone (17 countries) CLI came down from 104.2 to 98.3, which confirms a developing recession in the eurozone. Noteworthy is also the negative performance of Brazil that saw its CLI fall from 102.9 to 94 over the same period.

In my opinion, for long-term investors, the OECD LCIs are good indicators were we are heading.

Fed Governor Elizabeth Duke made an interesting comment by saying: “If having an explicit numerical target for inflation helps anchor inflation expectations over the longer run, then monetary policy will have greater flexibility to pursue the goal of maximum employment in the shorter term.”

She added it is “hard to see where the inflationary pressure is going to come from because inflation and inflation expectations are pretty well contained.”

Keep in mind that Fed Chairman Ben Bernanke has long advocated the adoption of an inflation target as a way to keep self-feeding inflation expectations in check.

Critics worry it could impede the Fed’s policymaking flexibility and could lead the central bank to focus more on stabilizing prices at the expense of promoting employment.

Meanwhile, it is downgrade time in Europe. While it may not have been a surprise, it is important because it reminds us of the mechanism of the eurozone’s unraveling process that could have started definitively, but that still needs confirmation.

There is no doubt in my mind that fiscal austerity will worsen the developing eurozone recession, which will cause more downgrades, to which the European policy response will probably more recession.

We are on the brink of an extremely dangerous, vicious circle that could be triggered by a “disorderly” Greek default when it can’t comply with its 14.4 billion euro Greek bond maturing on March 20, which could then “oblige” Greece to quit the eurozone, which in turn would then endanger Portugal, etc. Yes, full contagion...

I’ve thought it could be of help to investors to quote the reasoning of Standard & Poor’s for its EU downgrade actions that were triggered because the EU December summit failed to address the actual crisis: “… We also believe that the agreement is predicated on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the eurozone. In our view, however, the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the eurozone's core and the so-called ‘periphery.’ As such, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers' rising concerns about job security and disposable incomes, eroding national tax revenues…”

Under the circumstances as they are today, if Greece can’t pay for its maturing bonds on March 20 and as the ECB remains adamantly opposed to breaching its mandate by becoming a direct lender of last resort to sovereign nations I don’t think it’s an overstatement to assume that the last line of defense for Greece would be nothing else than the other eurozone member states should agree to another increase in the size of the continuously expanding Greek bailout. Adding to the problem and according to BlackRock, Greek banks are now also in worse shape than estimated; there is a shortfall of about 15 billion euros or $19 billion dollars.

The big question after the recent downgrades avalanche is now if an increase of the bailout is “politically” do-able. We should not forget we have presidential elections in France within 100 days, now it just has lost its triple A rating.

Indeed, François Hollande, the socialist candidate who is currently leading in the polls portrayed the downgrade as: “It’s not France that has been degraded; it’s a set of policies, a strategy, a government, a president.”

I’d like to add, although French banks are heavily exposed to eurozone sovereign debt and economies, it is difficult to see the current French government being particularly keen agree to an increase in the size of the Greek bailout.

All that said, Moritz Kraemer, the head of Standard & Poor's European sovereign ratings unit told Bloomberg Television: “Greece will default very shortly. Whether there will be a solution at the end of the current rocky negotiations I cannot say … There is a lot of brinksmanship on and a disorderly default will have ramifications on other countries but I believe policymakers will want to avoid that ... The game is still on.”

As a long-term investor, it seems reasonable to me to start planning for the possibility of a Greek default in March and even to start considering the “unthinkable” of Greece exiting from the single currency.

Fitch Rating Agency’s Director of Sovereign International and Public Finance Parker said Greece is unlikely to honor its March 20 bond payment. He also added a Greece default will not be a surprise and it will happen quite soon.

In my opinion, we are very close to the point where the situation having moved beyond that point where a technical fix could work, but unfortunately, it looks like the tool kit is exhausted and the Pandora box could open very soon.

Of course, I could be wrong. Nevertheless, I remain completely “risk off.”

Yes, I prefer being patient.

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Tuesday, 17 Jan 2012 07:57 AM
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