Friday, 16 December 2011

Hoping for a White Christmas


The new austerity packages agreed at the European summit conference on Friday, December 9th means different things to different people.

To Nikolas Sarkozy and Angela Merkel, it was an attempt to convince markets and voters that constitutionally-required austerity and an oversight role on national budgets would be enough to stave off an impending financial disaster. To David Cameron, it was a step too far: a surrender of national sovereignty, ostensibly due to the spectre of overbearing regulation of the City by Brussels.

To the average European voter, it is yet another confusing European summit, during which important decisions are made which he or she can barely understand, but which promise a fundamental and lasting change over his or her future. In these decisions, the European voter has no vote.

To a financial markets economist, it is yet another legalistic attempt to solve the problem which, while perhaps inevitable given the practical constructs of the Eurozone and the European Union, nevertheless does almost nothing to bring about a solution to the current debt crisis.

It is this last issue which we should be focusing on, not the pseudo-nationalistic conflict between Sarkozy and Cameron or lurid editorials about a German takeover of Europe which make for such amusing headlines. Germany is as exposed to the crisis as France.

The fundamentals of the European (and global) debt crisis remain the same:

·       European governments need to finance over EUR 1 trillion in 2012.

·       European banks need to raise capital by at least EUR 120 billion while taking a write-down of Greek debt by another EUR 100 billion. My own estimates for European bank refinancing needs is far higher, on the order of EUR 300-500 billion, based on a balance sheet analysis and over-optimistic NPL provisions.

·       European banks need to deal with urgent problems of non-performing loans, hedge fund and property melt-downs, and a host of other problems on the asset side of their balance sheets.

·       The global economic is grinding to a halt and will decelerate further as austerity programmes take effect.

·       Political paralysis is increasing ahead of US and French elections in 2012 and fragility in a range of other coalition governments.

In January-February 2012, two or more European economies are going to lose their triple-A rating, and yields on sovereign refinancing issues will hit emergency levels. Whether or not this results in a financial panic or substantial action by European institutions and the IMF remains to be seen. Indications are that the IMF support loan by European governments and central banks will proceed; the EFSF is trying to raise capital: it remains to be seen whether this is enough.


It is also not impossible that Japan is hit by the first signs of a financial crisis. Debt to GDP will probably reach 250% in 2012. Political stability is increasingly difficult and certainly not prepared for any kind of austerity programme. The Fukushima clean-up costs are mounting. Whether the Japanese consumer will continue to fund the system is open to question, particularly given the scandals surrounding Olympus and other companies. 

To this unsavoury financial situation, we can add the fact that global political risk is hitting unprecedented levels, and 2012 will almost certainly see the outbreak of military or civil conflict in the Middle East/Persian Gulf that will affect Europe and the United States.

There is elevated risk on a number of fronts:

·       Iran continues its search of a nuclear weapon
·       Syria is in the beginning stages of a full-scale civil war, where external powers may intervene, and where a Russian-US fleet stand-off may occur
·       Egypt risks uncontrolled civil-religious conflict and an intensification of a Hamas-led intifada against Israel
·       Lebanon, where Hezbollah remains ascendant, and may be forced into action depending on the situation in Syria

The US has ostensibly left Iraq, although sizable military forces remain; Iran is expected to intensify its presence there. In Afghanistan, troop withdrawals start at the end of 2012. Relations with and in Pakistan continue to deteriorate. Turkey continues to follow a dangerous economic and political policy in certain areas.

There is a real chance that shipping through either the Straits of Hormuz or Suez will be interrupted, either temporarily, or as a strategic objective. In the case of a wider conflict in the Gulf, Saudi petroleum pumping stations and refineries in Dhahran and other eastern cities will be targeted, as will the other Gulf states. Such a conflict is likely to emerge either as a result of the Iranian programme; the Syrian civil war; or a potential Egyptian implosion. In each case, these events will create massive economic and political uncertainty, and may lead to unrestricted warfare.

The prevailing hope right now is for a quiet Christmas and New Year. It is unknown whether this will be possible.


© Philip Ammerman, 2011
Navigator Consulting Group

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