Morgan Stanley team members Steven Jen and Eric Chaney (joined by Takehiro Sato and David Miles) debate today the interesting question of whether the eurozone economies have entered a liquidity trap (LT). Those who have no idea what one of these would look like could do worse than read Paul Krugman’s classic article on the topic: It’s baaack! Japan’s Slump and the Return of the Liquidity Trap (pdf).
So what is all the fuss about?
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Well French Central Bank Governor Christian Noyer is back in the news again. Today the FT have an interview with him, and some of his points make interesting reading.
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Sorry if I’m belabouring a rather obscure and generally ‘non-sexy’ issue: government debt in the eurozone. If I am doing this it is because I think something important is happening. I missed this point during the week.
Fitch Ratings on Wednesday lowered to negative its credit rating outlooks for Italy and Portugal ? both among the three weakest countries in the eurozone ? amid concerns about their deteriorating public finances.
The negative outlooks could herald future credit rating downgrades, adding to concerns about economic divergence within the eurozone.
That’s the second time in a week (See the S&P post) that a ratings agency has done this to eurozone government debt. There are three economies in the ‘particularly at risk category: Italy, Greece and Portugal. They are ‘at risk’ not simply because they have substantial debt and/or deficits, but becuase they have this *and* important structural economic problems about the kinds of economic activities they engage in, they have a lack of international competitiveness that a drop in euro value of the order of magnitude we are seeing won’t resolve, that they are going to be forced to reduce their deficits during an ongoing economic ‘growth slowdown’, and that given their ageing populations their mid-term fiscal outlook is between poor and not-sustainable. Maybe we aren’t noticing much evidence of it yet, but the landscape beneath our feet is changing, even while we talk.
Incidentally, Italy has found another big one-off:
Italy’s government will raise as much as 4.1 billion euros ($4.9 billion) selling up to 10 percent of Enel SpA, Europe’s fourth-biggest utility, in the world’s largest share sale so far this year, the Finance Ministry said.
Italy will sell Enel shares at 7.18 euros each to institutions, Finance Ministry Director General Vittorio Grilli said at a press conference in Rome today. That’s 0.7 percent below Enel’s closing share price yesterday. Shares will be sold to individual investors at 7.07 euros each.
The thing is, you can try selling-off the furniture when you have problems paying the mortgage, but you can’t keep doing it forever.
The FT this morning discusses the state of the bond markets for the ‘weaker’ eurozone economies: Italy, Greece, Portugal. As expected interest differentials between government debt in these countries and German debt is widening, but only slowly. Italy is being evaluated at present as the weakest member. As the FT points out the temperature of the water will be tested again this week when Portugal issue a new batch of debt:
“The expected launch next week of a new 10-year benchmark bond by Portugal, whose credit rating was recently downgraded by Standard & Poor?s, is set to test investors? appetite for debt issued by weaker eurozone members.
Portugal, which on Friday appointed bankers to manage the syndicated bond sale, will be competing for demand against France, which enjoys the highest credit rating available and plans to auction a new 10-year bond of its own next week.
Bond spreads of Portugal, Italy and Greece – the three weakest countries in the eurozone – widened marginally on the back of this. On the week, the spreads of bonds of Portugal, Italy and Greece, widened by just 1.3bp, 0.5bp, and 0.5bp, to stand at 8.3bp, 21.5bp, and 24.5bp, respectively against Bunds.
But they have been widening for several months. Spreads of Italian 10-year paper, for instance, have doubled from 11bp to 21.5bp against the Bund in the last four months.“
I’m not very happy with the ‘US Trade Figures‘ post I put up last Friday. I think it’s a glorious mess. The key to the problem is that I tried to deal with two – interrelated but disinct – topics at once: the euro and China trade. So today lets ignore the euro (which has once more resumed the downwards drift, even as I write) and take a bit of a closer look at where we are – in trade terms – with China. (Btw: the planet has finally returned to its orbit, and Brad Setser has an analysis of the US trade data here).
The big item in this weekend’s news is, of course, the agreement reached with Beijing on textiles. The EU textile industry will now have three years to adapt, but since textile manufacturers don’t appear to have taken too much advantage of the ten previous years, it is hard to know whether this will serve any useful purpose. Doubly so, since it is not yet clear how the calculations will be made, and I have the distinct impression that much of the recent surge in imports will now, in effect, be consolidated.
Be that as it may, what about the broader issue?
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Interesting to note, following our discussion of the state of play of the Hungarian economy, that Hungary’s finance minister is not a euro pessimist. Janos Veres said in an interview with the Financial Times that he did not foresee a wider crisis for the single currency and that Hungary had ‘no option’ but to continue aiming to join the eurozone in 2010:
“I do not think Hungary has any other playing field,” said Mr Veres. “The Hungarian forint is not the Swiss franc. It cannot be maintained independently for decades.”
But Mr Veres, whose left-liberal government faces elections next spring, rejected calls for deep spending cuts that many economists view as necessary to keep Hungary on track for joining the single currency.
Instead, he outlined a plan for moderate spending cuts and the introduction of a simplified tax system designed to increase revenues next year. “We will not do anything that represents a radical, structural change,” he said.
Obviously the attraction is those nice low interest rates, to help pay for all that extra debt. But seriously, with the economically healthier Czech Republic now questioning whether it will join the euro, isn’t there a danger of the eurozone becoming a club for those structurally incapable of walking alone. “Oh when you walk, through the storm, hold your head up high,……….”
This week Hungary has a new President. The election of Laszlo Solyom as Hungary’s new President was a major setback for the governing Socialist Party (MSZP), at the same time as it was widely lauded as a victory by the right wing opposition Fidesz party. The outcome was largely the result of the behaviour of the MSZP?s junior coalition partner, the liberal leaning Free Democrats, who abstained. Katalin Szili, the MSZP choice, was regarded by Free Democrats as being far too involved with the MSZP. Only 3 votes separated the two candidates, and this reflects the current balance within the Hungarian parliament between Fidesz and MSZP ? a handful of independents and the Free Democrats in fact have the deciding votes.
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The ever readable Martin Wolf has been writing in the FT on Italy:
“Let us think the unthinkable: could the eurozone disintegrate? The answer is yes. Disappearance of the zone as a whole seems hugely unlikely, so long as the commitment to the European project survives. But the exit of one (or more) members, a sovereign default or both is not at all inconceivable.”
Provisional GDP numbers for eurozone countries in the first quarter are out today. The German economy surprisingly bounces back, whilst Italy is now officially in recession after two quarters of contraction. Also worthy of note is that the Dutch economy contracted slightly in the first quarter, which may have some implications for the forthcoming constitution referendum there.
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In a post which appeared earlier this week Tobias asks us whether, given some of the possible consequences of a French “non”, it might not be reasonable to ‘scare’ voters a little by spelling out some of the potential fallout which might follow a French rejection of the Constitution Treaty.
Perhaps the phrasing is unfortunate, but undoubtedly voters in Eurozone countries need to think long and hard about one especially sensitive area of impact: the future of the euro itself.
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