Tuesday, 23 February 2010

Testing times for the euro and euroland

Surely we live in interesting times, especially if you are residing in euroland. George Soros, famous investor opined the following in an article appearing in the Financial Times:
"...the euro was meant to be a monetary union but not a political one. Participating states established a common central bank but refused to surrender the right to tax their citizens to a common authority. This principle was enshrined in the Maastricht treaty and has since been rigorously interpreted by the German constitutional court. The euro was a unique and unusual construction whose viability is now being tested.

The construction is patently flawed. A fully fledged currency requires both a central bank and a Treasury. The Treasury need not be used to tax citizens on an everyday basis but it needs to be available in times of crisis. When the financial system is in danger of collapsing, the central bank can provide liquidity, but only a Treasury can deal with problems of solvency. This is a well-known fact that should have been clear to everyone involved in the creation of the euro.
The European Union was brought into existence by putting the cart before the horse: setting limited but politically attainable targets and timetables, knowing full well that they would not be sufficient and require further steps in due course. But for various reasons the process gradually ground to a halt. The EU is now largely frozen in its present shape.
The same applies to the euro. The crash of 2008 revealed the flaw in its construction when members had to rescue their banking systems independently. The Greek debt crisis brought matters to a climax. If member countries cannot take the next steps forward, the euro may fall apart.
The European authorities accepted a plan that would reduce the deficit gradually with a first instalment of 4 per cent, but markets were not reassured. The risk premium on Greek government bonds continues to hover around 3 per cent, depriving Greece of much of the benefit of euro membership. If this continues, there is a real danger that Greece may not be able to extricate itself from its predicament whatever it does. Further budget cuts would further depress economic activity, reducing tax revenues and worsening the debt-to-GNP ratio. Given that danger, the risk premium will not revert to its previous level in the absence of outside assistance.
The situation is aggravated by the market in credit default swaps, which is biased in favour of those who speculate on failure. Being long CDS, the risk automatically declines if they are wrong. This is the opposite of selling short stocks, where being wrong the risk automatically increases. Speculation in CDS may drive the risk premium higher.
So makeshift assistance should be enough for Greece, but that leaves Spain, Italy, Portugal and Ireland. Together they constitute too large a portion of euroland to be helped in this way. The survival of Greece would still leave the future of the euro in question. Even if it handles the current crisis, what about the next one? It is clear what is needed: more intrusive monitoring and institutional arrangements for conditional assistance. The question is whether the political will for these steps can be generated.

Friday, 12 February 2010

Global trade recovering, but is it going back to the glory days?

Roubini Global Economics (RGE) recently reported on global trade prospects. Here are some excerpts from their latest report on global trade:

After slowing to 3.0% in 2008, global trade volumes contracted by an estimated 13% in 2009—the first contraction since 1982 and the sharpest in the post-war period. The decline came as global demand and large inventory destocking hit the global supply chain; the credit market turmoil caused a severe crunch in trade finance; and oil and commodity prices corrected following a boom in early 2008. After plunging during Q4 2008 and Q1 2009, world trade bottomed in Q2 2009 and started growing in Q3 2009. Fiscal stimulus and slower inventory destocking boosted domestic demand, infrastructure spending and global manufacturing activity, and drove global trade in capital and consumer goods, auto parts and commodities.
By the end of 2009, exports of major trading countries were far below their 2008 peak levels, with the exports of Japan and especially the EU lagging those of the US, Asia and Latin America. Imports of major trading countries, especially the U.S. and EU, stood far below their peak levels in 2008. Emerging Asia was the only major trading region in which imports reached 2008 peak levels.
RGE forecasts world trade will grow by 4.5%-5.0% in 2010, led by fiscal stimulus spending, inventory restocking and a small improvement in global demand. Chinese commidity stockpiling, despite slowing from 2009 and a slow pick up in the OECD’s commodity demand, will support bulk trade in 2010. After aggressive inventory cutbacks in 2009, inventory restocking by importers and exporters during H1 2010 will modestly boost global trade in intermediate and final goods. But with economic growth, consumption and investment below their 2007-08 peaks in most advanced and developing economies, the pace of inventory restocking will be weak and will end by mid-2010 in most countries. As a result, the boost to global trade from the inventory cycle will be small and short-lived.
During H1 2010, fiscal stimulus will continue to boost infrastructure spending, domestic demand and industrial activity. This will boost global trade in intermediate, capital and consumer goods, infrastructure-related commodities and auto parts and components. But the impact will wane in H2 2010 as most countries withdraw stimulus measures due to reviving domestic demand and fiscal concerns.
The Baltic Dry Index rose 200% in 2009, led by Chinese commodity demand and a pickup in commodity prices, but the index remains far below the record levels of 2008. While Chinese commodity stockpiling might have peaked, strong emerging market commodity demand, high global commodity prices and factors driving global trade (inventory restocking and fiscal stimulus) will support the Baltic Dry Index in 2010.
The impact of inventory restocking and fiscal stimulus on global trade will fade in H2 2010. Advanced economies' imports will slow as private demand remains sluggish, keeping emerging economies' exports weaker than in the pre-crisis years, notwithstanding improving exports to other emerging markets. Emerging market imports will pick up from 2009, but imports meant for export to the U.S. and EU will recover slowly. Trade growth in the coming years is unlikely to reach the highs of 8.0% witnessed during 2003-07, since imports and exports in the East-West trade might take a few years to return to their high growth rates. In fact, global trade itself might witness structural changes going forward as consumption grows sluggishly in the U.S. and EU.
Going forward, emerging markets will increasingly trade amongst each other for final demand, rather than re-exporting goods to the U.S. and EU, driving global trade flows and changing its direction and composition.

Monday, 8 February 2010

Where have all the money gone?

How did South African collective fund investors invest their monies in 2009? Gareth Stocks, editor of FA News Online, investigated:
The Collective Investment Schemes (CIS) industry achieved record net capital inflows in 2009. Investors affirmed their confidence in the industry by pouring R96bn into the available unit trust fund categories. We attended the Association of Savings and Investments SA (ASISA) CIS statistics presentation. ASISA chief executive Leon Campher addressed the media on 3 February 2010.
Assets under management in the CIS industry topped R786bn at 31 December 2009 in some 904 funds. As part of the ongoing refinement of CIS statistics future reports will eliminate double counting by stripping out Fund of Funds and Hybrid funds. The new methodology reduces the assets under management in the industry to R750bn.

Money market funds account for the bulk of domestic assets (33%), followed by equity (24%), prudential (21%) and fixed interest varied specialist (12%). “Money market, although declining, on a relative basis remains a large portion of the assets in the CIS industry,” said Campher. He noted that the prudential category included asset allocation unit trusts which have grown in popularity in recent years.
There were some significant changes in the per-category capital flows. This was the first year since 2005 that equities experienced a net inflow for the calendar year. Investors backed equity unit trusts to the tune of R10.8bn. “It’s quite encouraging to see equity positive again,” said Campher. Even so, equity inflows were dwarfed by the R47.6bn that poured into money market and fixed income funds. The prudential category attracted R31bn! “Investors are leaving the asset allocation decisions to fund managers,” said Campher.

Positions one, two and three were occupied by money market funds Absa Money Market (R55.298bn), Standard Bank Money Market (R37.594bn) and Prudential Money Market (R34.644bn). One of the country’s most popular management companies, Allan Gray, had three funds in the top 10 with R84bn under management! Campher noted that Allan Gray – with only eight funds – proved that success in the CIS industry wasn’t linked to a multitude of different product offerings. “You don’t have to launch a new fund every two weeks to try and make money,” he said, adding that the industry was working to address the proliferation of funds.
South Africa’s 10 largest management companies (Stanlib, Alan Gray, Absa, Investec, Prudential, Old Mutual, Sanlam, NedGroup Investments, RMB and Coronation) held 80.1% of total CIS assets under management. The rest (some 30 companies) share 19.9% of industry assets!
Campher observed: “In the institutional space we have quite a large percentage in bond funds. The big institutional managers often consolidate the pension funds they are managing into a single bond fund.” Institutional money is heavily invested in equity funds while money market unit trusts are preferred by retail investors who account for 72% of category assets.

Whereto Greece?

Nouriel Roubini and Arnab Das of RGE opined in a recent article in Financial Times that the resolution of Greece's problems is crucial for the fate of its neighbours, Euorozone and even the European Union. Here are some excerpts from the article:

Greece has long been an accident waiting to happen due to heavy public debt and lack of competitiveness. Fiscal incontinence and uncompetitiveness are interlinked across southern Europe. Euro accession and bull-market “convergence trades” pushed the bond yields of Portugal, Italy, Greece and Spain towards German bunds. The ensuing credit boom supported consumption but papered over wage inflation that outstripped productivity growth and priced Greece out of traditional export markets.

Excessive bureaucracy and rigidities in labour, product and service markets, meanwhile, discouraged investment in high value added sectors, despite wages well below the EU average. The resulting noxious mix of large current account and budget deficits led to rising foreign debt. Dramatic euro appreciation in 2008-09 compounded these problems.
As bond yields rise, Greece and its peers face difficult choices. The best course would be to follow Ireland, Hungary and Latvia with a credible fiscal plan heavy on spending cuts that government can control, rather than tax hikes and loophole closures that depend on historically weak compliance. This could achieve an internal devaluation with deep real wage cuts and structural reforms to boost competitiveness, as Germany has since unification.
The easy option would be to resort to financial engineering and fiscal fudges, delaying adjustment. Greece would then have to turn to other member states for direct loans (denied – at least so far); to the IMF (ruled out – so far); or to non-traditional creditors, say China (denied). Alternatively, it could devalue, default and re-denominate liabilities into a “new drachma,” √† la Argentina (unthinkable).
A credible plan would restore solidarity with EU countries that are adjusting, improve the rhetoric of the European Central Bank and key member states, and bring Greek bond spreads back to earth. This approach is working in Ireland – spreads exploded as public debt ballooned to save its banks, but came back in as public spending was cut by 20 per cent. But it is no cakewalk: Portugal has been deflating to boost competitiveness for a decade. Harsh medicine is best ingested quickly.
Failure to take the tough decisions necessary would draw attention to an uncomfortable historical truth: that no currency union has survived without a fiscal and political union.
The story of the other eurozone stragglers is different in degree but not principle. All are highly leveraged – the fundamental source of financial contagion. Spain, like Ireland, has a massive contingent public liability in its banking sector, arising from mortgage debt. Its growth model – residential construction driven by a house price boom – is defunct. Spain, too, needs fiscal consolidation and structural reform to restore debt sustainability, reinvigorate growth and reduce its 20 per cent unemployment rate. Italy’s government is highly leveraged so it too must cut spending and regain competitiveness. Portugal urgently needs structural reform to restore economic dynamism and fiscal health.

Thursday, 4 February 2010

Risky bonds

The financial troubles of Greece has had a detrimental effect on the rest of peripheral eurozone countries. Financial Times reported as follows:
There were further signs of contagion across the eurozone on Thursday as investors sold government bonds of many peripheral eurozone countries, sending yields higher.
Fears of default by companies in the eurozone periphery also rose sharply, indicating that the contagion was spreading to the corporate sector.

“The latest catalyst was [Wednesday’s] bond auction in Portugal which was scaled back and which has re-ignited fears that the likes of Portugal and Greece will not be able to fund their deficits without a bail out,” said Gavan Nolan, credit analyst at Markit.

These concerns have started to spread to corporates in peripheral eurozone countries with CDS spreads on companies such as Portugal Telecom, Telefónica and Hellenic Telecom rising significantly in strong trading volumes. CDS spreads on Portugal Telecom jumped 30 basis points in early trade to 150 basis points, their highest levels since April last year.
Portugal’s 10-year bonds jumped 5 basis points to yield 4.71 per cent. Ten-year Spanish sovereign yields levelled at out 4.1 per cent having climbed 2 basis points earlier in the session. Greek 10-year bond yields rose 6 basis points in early trade to 6.76 per cent but later recovered with yields narrowing to 6.68 per cent, a fall of 2 basis points on the previous close.