50 | EUROZONE WORDS | Charles Purdy
DISTRESSED
www.opp.org.uk |MARCH 2011
seemed to “invent” a cycle in which he could justify overspending at certain times on the basis that the money would be recouped at other times when, presumably, tax receipts went up. He also seemed to think that boom and bust would become a thing of the past. We now know this world of perfect economics to be nonsense.
Money for nothing W
hen he was the UK’s Chancellor of the Exchequer, Gordon Brown
But the same thought process clearly applies elsewhere in the western world. The US has both a budget and balance of payments defi cit that continues to dominate the global economy. Given the level of unemployment in the US, politicians have decided to throw the kitchen sink at the problem with a joint stimulus package of tax cuts and quantitative easing.
The size of the package is truly extraordinary and quantitative easing remains untested as way to achieve the desired economic results. It clearly exacerbates the problem for the longer term by putting off the need to deal with the deep-seated structural defects to a future date. But there is one major advantage for the US dollar: because it is effectively the world’s reserve currency its importance stretches beyond its own borders with many
parties keen to see its value maintained. In the UK, the coalition government has identifi ed that spending needs to be brought into line with the country’s ability to pay for it allowing the UK to address its problems in isolation. But what of the Eurozone? The fi rst issuance of a bond by the European Financial Stability Facility has just taken place. This was well received in the markets by investors who saw a bond issued by the Eurozone as more secure than one issued by an individual member country. So a step forward for the euro but, I think, only a small step. The problem is the very large amount that still needs to borrowed by both governments and banks within the Eurozone during the coming year. During 2011 the forecast borrowing requirement for the Eurozone is of the order of €814 billion. Sometimes fi gures get so large you lose all sense of perspective and I think this is one of those occasions. What also interests me is that the way this fi gure is made up. Of the €814 billion, €189 billion is made up of interest payments for existing borrowing rather than being used to pay for vital public services such as hospitals and medical staff. It is a fact of life that when governments borrow more, the interest bill rises, and more and more of future taxes have to
be used to pay for past spending. And another €555 billion is earmarked for refi nancing loans that mature this year. It is such a large amount that my fi rst reaction is that the lenders who are due to get their money back probably won’t want part or all of it back at this moment in time because they will have to fi nd somewhere else to reinvest it. I suspect they will want to see an increased return – a higher interest rate – and to ensure that the loan is suitably secure. The remaining €70 billion will be new funds required to fund governments’ budget defi cits, the difference between their income from tax receipts and their spending. This is
“German politicians are under extreme pressure and will not be allowed to bale out the rest of Europe”
A roadmap | to prosperity in Europe is not going to be easy or smooth says Purdy
an extraordinary fi gure as it is a new amount that has to be enticed from investors. I think we should perhaps dwell for a moment on what levels of refi nancing might be needed next year. Given the likelihood of increased yields and increased borrowings the €189 billion of interest payments for this year is only going one way and that is up. Compounding interest rates are frightening and something that politicians seem blissfully unaware of and/or able to comprehend. The bottom line is that there is a government debt crisis in the Eurozone, which is not going away any time soon. It’s also worth thinking about the extent of the funding required by the banking system. I understand that the regional banks of Spain require €95 billion to restore them to an acceptable level of funding. They are not an isolated case. The problem extends through out the Eurozone and includes the German banks. There are two advantages to the banks’ debts. Firstly once resolved they – hopefully – cease to be an ongoing problem. Second, they can, if the bank in question is profi table,
The “Eurozone” debt crisis caused major problems in distressed property markets of Spain. How did it happen and why do governments allow it. Charles Purdy, director of Smart Currency Exchange, reports.
things can be funded from the banks own cashfl ow. The problem with this is that it reduces the banks ability and/or willingness to lend as they rebuild their balance sheet.
What I always fi nd diffi cult to understand about the Eurozone is how the politicians expect the differing economies to march to the same beat. Who ever thought that the economies of Greece, Spain and Portugal would work in the same way as Germany, still the world’s second greatest exporter? I mentioned earlier the European Financial Stability Facility and the success of the fi rst fund issuance. This is clearly a step in the right direction but it seems that at this moment in time its lending capacity is limited to €255 billion. Not a huge amount when you look at the fi gures I have identifi ed earlier. It also is dwarfed, for example, by Spain’s funding requirement of €467 billion until 2013.
The problem is two fold. Politicians, especially the German politicians, are under extreme pressure not to bail out the rest of Europe. The second problem is that a solution needs to be found to a two or even three speed Eurozone when it comes to economic capabilities. One thing I am sure of is that this Eurozone debt crisis will continue to have a signifi cant and detrimental effect on the countries at the periphery of the Eurozone, especially Portugal, Spain, Ireland and Greece. House prices have already fallen given the problems and the overhang of unsold properties from a house building binge in the good times, but we are likely to see further falls as their economies continue to falter. The one saving grace may be the euro itself losing value because of the debt problems. This could have a two-fold effect as we see the Eurozone exports become more competitive and therefore grow and it could also make homes and the cost of living more affordable to people from outside the Eurozone, such as the UK. And we all know how much the British love the sunshine.
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