Last week, the New York Mets announced that the fences of its ballpark would be brought in by about 12 feet starting next year. The creation of 100 new seats is what economists might call a positive externality of the primary objective: Boost the number of home runs. Since moving to the new stadium in 2009, the Mets have hit a major league low 331 home runs. By way of comparison, their cross-town rival Yankees have hit more than twice the number of home runs over the same period.
Baseball fields come in a variety of shapes and dimensions and Citi Field did not appear to be the largest and the change will not make it the smallest. The debate over the precise metrics is for baseball enthusiasts, the point is that when the objective, in this case home runs (as a means of more victories and higher attendance) proved too difficult, the Mets, like the Detroit Tigers in 2003, took measures to increase the probability of achieving the objective.
For two years now Europe has been trying to address its debt crisis. It has not been particularly successful. Unable to stabilise the Greek problem, containment has been elusive. Greek 2-year yield hit 107.25% on November 3. It finished last year near 12.25%. 10-year Italian bond yields rose to 6.4% last week, an EMU-era record high. The French 10-year premium to Germany rose to 126 bp, also an EMU-era, and compares with about 40 bp premium at the end of 2010.
The recent string of economic data suggest that the euro zone is either in a recession or entering one
quickly. In the popular press, decoupling has meant the ability of the emerging markets to continue to expand and offer, apparently, lucrative risk-reward opportunities, while the developed countries are mired in poor growth and low returns.
Yet one striking de-coupling now has been the US economic performance relative to Europe’s. Data has pointed to the resilience of the US economy in Q3 (2.5% annualized growth) with momentum has carried into the start of Q4. However, the financial markets still offer a channel of contagion. Three-month dollar Libor illustrates this point, though a number of other market prices would show the same thing. Libor continues to creep up, extending its longest rise in more than half a decade, to stand at the highest in over a year.
As European growth estimates are reduced, there will be pressure for more austerity to ensure reaching fiscal targets. This has been seen in France most recently, where next year’s forecast has been cut to 1% and the government is drawing up plans for an estimated 6 bln euros in new savings. Euro zone countries are seeking to reduce budget deficits to 3% of GDP in 2013. Europe needs to break the trap of pro-cyclical fiscal policy or it risks triggering a dangerous spiral. Perhaps, like the Mets’ home run fences, the targets should be relaxed.
Investors are voting with their pocketbooks. These economic and financial goals do not appear credible. Offsetting the contractionary impulse of structural reforms with some positive growth measures may mean the budget goals are not met until 2014 or 2015. In exchange, though, investors will get a more credible economic and financial strategy.
The Debasement of Voluntary
The start of the modern history of the debasement of the concept “voluntary” may be the dubious honour of Reagan-era officials who secured agreement from Japan to “voluntarily” limit their auto exports to the United States. To say that there were implicit, if not explicit, thrats of harsher action, is to be crass. The consequence is that most of the Japanese cars driven by Americans today are made in North America. The “voluntary” nature of the exercise made it somehow less odorous than traditional forms of protectionism like tariffs and subsidies.
European officials appear to have skirted creation of a default event, by getting private sector holders of Greek sovereign bonds to “voluntarily” accept a 50% haircut. As we noted before this 50% debt forgiveness reduces Greece’s debt by only about 28%, because only about 200 bln euro of its 350 bln debt qualifies. This would still place Greece’s debt at 120% of GDP in 2020, EC figures, about where Italy is today, which is not seen as sustainable.
While the 50% haircut is going to mean less reduction in the sovereign debt burden than it may seem, it may mean a bigger hit on the private investors. A French and Dutch bank claimed a 60% impairment on Greek bond holdings in their recent Q3 earnings reports.
When is a 50% haircut not a 50% haircut? If one factors in the cash flow of a reduced coupon. By some estimates cited in the press, if the coupon of the new bonds is 6% (suggested in the Greek media), the total cost to investors is near 53%. If the coupon matches the average cost of Greek’s existing debt (~5%), than the haircut is estimated at 58%.
The most likely scenario following the weekend developments is a national unity government in Greece, led by the current Finance Minister Venizelos, a rival of Papandreou for PASOK leader in 2004. It does not look like New Democracy, the largest opposition party will participate in the new government. New Democracy, headed by Samaras, a college roommate of Papandreou, is pressing for national elections, under which polls suggest he would become the next prime minister. Elections may not be held until middle of Q1 2012. The new government would seek rapid ratification of last month’s agreement and without Papandreou, it could garner the super majority of 180 votes.
A semi-permanent EU task force has taken up in Greece starting this month. The ostensible goal is to modernize Greece’s civil service and public administration. It is not immediately clear how large a task force is required, but reports indicate that dozens of European officials will be involved. They apparently will be having something to say on a range of government functions, including privatization, tax collection, and small business lending.
As unpleasant as it may be to host the Eurocrats, it incomparable with having to host armies. However, the Eurocrats are understood as representatives of the creditors, to increase the likelihood of repayment. It already appears to be triggering a nationalistic response. At last month’s crisis summit, German Chancellor Merkel warned that if the euro fails, “no one should think that another half century of peace and prosperity is assured. It isn’t.”
One of the few concrete outcomes of the Cannes G20 fractious meeting was that Italy “voluntarily” accepted and IMF team to monitor the implementation of its austerity program. The IMF will look at many of the same issues the Eurocrats will be looking at in Greece: labour market flexibility, pension reforms and privatization. The quarterly monitoring is expected to begin later this month. Italy rejected IMF financial assistance, purportedly in the form of a precautionary line of credit, despite reports of repeated offers.
This may aggravate an already delicate situation. Italy has to raise at least 30.5 bln euros this month and 22.5 bln euros next month to fund maturing obligations (and 300 bln euros next year).Yields are rising even though the ECB appears to have continued to buy Italian bonds (albeit in small size relative to the market). There is increased risk that the clearer will require greater margin to trade Italian bonds. A distressed sovereign leads to pressure on domestic financial institutions. Moreover, if talk of a debt swap that domestic institutions would “voluntarily” accept does in fact materialise, it cannot do any favours for their balance sheets.
It is hard to accuse the Eurocrats of destabilizing Italy’s political situation, but it may be serve as a catharsis. Berlusconi’s support within his own party is weakening, with a couple of defects to the opposition reported last week. Another handful of so of coalition MPs joined those calling for a change in government.
The Chamber of Deputies takes up the 2010 budget report in the coming days. The defeat of the same procedural measure last month, seemingly orchestrated as message to the beleaguered Prime Minister by members of his own government. That is what triggered the last confidence vote, which Berlusconi again survived. There is asymmetrical risk. A defeat this week would likely topple the government and accelerate the downdraft of Italian bonds. A victory by the government prolongs the agony and is also unlikely to stabilise the bond market.
A technocratic government may implement the reforms with a bit more vigor, but the transmission to faster economic growth is far from immediate. The fact that seems to be lost to many observers is that when the overall debt of Italy is calculated, both public and private obligations, its is among the lowest in the OECD. When Italy joined the euro zone, its public debt/GDP was over 100%. Its debt did not cause the crisis, but the crisis makes its government debt unsustainable.
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