2010-06-18 09:00
Strategy Team, Saxo Capital Markets
SINGAPORE, June 18 /PRNewswire-Asia/
--
We have reached the stage where almost every
bank in the western world is trading on the strength of the public
finances of the country that back-stop the banks' liabilities. This
means that everyone should now focus on public finances... which
they are.
No doubt we have some problems in the PIIGS
(Portugal, Italy, Ireland, Greece and Spain) countries and some
Eastern European (EE) countries like Romania and Hungary. Barring
any meaningful and "hard choice" reforms in these countries, we
should fear default in the not so distant future. But even if one
or more of these countries would fail and restructure debt, we will
still be okay if the majority of the G10 countries have sustainable
finances. The problem is that they don't.
The "extend and pretend" game has continued
for too long and the total leverage of the Western economies has
increased during the crisis. And yet nothing has been resolved:
-- Consumers have only moderately reduced
their spending. The consumption/GDP ratio of the US economy is
still hovering at around 70%, which is way too high to ensure
long-term growth.
-- Banks are still lying about their balance
sheets and we suspect that majority of the banks are still
insolvent either due to the massive defaults on mortgages (US and
European banks), or irresponsible exposure to Southern Europe
(European banks). As a result, banks are unlikely to start the
securitization/lending machine anytime in the next decade.
-- Government spending continues almost
unabated with very little attempt to reduce it. The lavish
entitlement programs are left untouched in most European countries
and as a result budget deficits are likely to continue over the
next 3-5 years, if not longer.
In a recent BIS Working Paper # 300,
researchers attempted to forecast the government debt / GDP ratios
of several developed economies under three different scenarios. The
ratios are predicted on a 30-year horizon and we end up with a
completely impossible scenario in most cases.
In the baseline scenario, where no change on
government entitlement programs and age-related spending is made,
the UK is expected to reach a government debt / GDP ratio of 540%
in 2040. For the US and Japan, the numbers are 450% and 600%
respectively.
Naturally, this will not happen. Either
governments will make small or gradual adjustments (scenario 2) or
they will make small and gradual adjustments and keep age-related
spending constant (scenario 3). If we assume scenario 2, the
"middle-scenario", and use this to predict the government debt /
GDP ratio with the assumption that household and corporate debt to
GDP remains constant at the 2010 level, we reach the situation in
below graph.
(PHOTO:
http://www.prnasia.com/sa/2010/06/17/20100617373484.html )
The total Debt / GDP is set to surpass 500
percent in 8 out 14 of the economies in question, including the US,
the UK, Japan, Spain and France. From 1997 to 2040, the ratios will
increase by 66% on average. This works out to more than 200
percentage points of GDP. In short, everybody will look like Japan
in 30 years time.
But this will not happen. The only reason why
Japan managed to stay afloat until now is because their household
savings were so large. However, this is no longer the case and
Japan is now entering the extreme danger zone where it would be
foolish to assume that domestic investors will continue to roll the
ever-greater debt at ever-lower yields.
But none of the other countries in question
have domestic savings sufficient to finance such public sector
profligacy. The idea that governments will make "small and gradual
changes" is a harsh assumption and we have only very few examples
in history where hell-bent administrations actually succeeded in
reducing government expenditure. Margaret Thatcher is about the
only politician who achieved a significant adjustment of government
spending to GDP through her rule.
European voters and policy makers are
seemingly still ignorant of the size of the problem and have so far
focused on outlawing "speculation" rather than facing the real
problem: budget deficits and debt burdens.
Safe Havens in Northern Europe
We therefore expect Europe to do "business as
usual" until bond markets clearly refuse to finance more government
consumption. Interest rate spread versus Germany will move higher
and fiscal sustainability will be centre-stage for the bond market.
Germany, Denmark, Norway and Sweden will continue to benefit from
their safe haven status and strong public finances. At the same
time, PIIGS spreads versus Northern Europe will continue to edge
higher as they have been doing lately.
This development sends out an important
message: If we assume that the inflation/deflation outlook for
Europe is roughly the same and with spread on 2-year notes
(PIIGS-Germany) moving higher and with Germany et al verbally
committing to a bail-out of the PIIGS; this can only mean that the
bond market is ignoring cheap talk and actually believes that
Germany et al will ultimately NOT be liable for the PIIGS debt
problem.
Investors could in other words count on some
sort of restructuring within the Euro-zone. This may make a lot of
sense and could be the only way out of the debt trap Greece is
caught in.
Crisis Continues to Drift East?
We believe that the focus of the market will
continue its gradual move to the East. This began in 2008 with the
subprime crisis, then the UK with the big financial sector and now
Europe with the PIIGS debt problem. The debt crisis has since
spread to the Eastern European countries and we are already seeing
concerns about Romania and Hungary. With the International Monetary
Fund (IMF) cash-strapped, the market will increasingly expect EE
restructuring to take place in the near future. Since IMF is the
determining factor, one should also worry about the Baltic
countries again. We expect this to be an on-going topic over the
next three months.
But Can Asia Lift The Global Economy?
The next phase in the "focus-shift" will be
China, the global growth engine which consumes between a fifth and
a seventh of all global commodity production. With China being the
marginal buyer par excellence, it is not difficult to imagine what
will happen to the commodity complex if the China recovery runs out
of steam. Is that likely? Recent data is pointing to a slowdown in
China commodity imports and hence a slump in demand. However, as
you look deeper into the trend, it seems that China has been
delving into their personal reserves of copper, iron ore and
various basic materials and we expect the uptrend in consumption to
continue.
Asia ex-Japan has been performing well and
exports have been growing, despite Asian currencies appreciating
against the US and Euro-zone. In addition, Asian banks have come
out relatively insulated due to the lack of toxic exposure to US
subprime and Euro-zone debt. We continue to see favourable
operating conditions here as growth continues to surprise to the
upside.
What will it take?
Policy makers are moving slowly to reduce the
deficits everywhere, but it actually doesn't require that much to
calm down markets. Hiking the retirement age by 2-3 years, cutting
public employee wages by 5-10% and social transfers by 5% would
generally be enough balance the budgets in many
countries.
Yes, GDP figures would look awful in one or
two quarters and real disposable income would for many groups be
slashed to 2001 levels or so, but in hindsight 2001 was not that
disastrous. Try to imagine the market if such measures where
implemented... stocks and bond markets would immediately stabilize
and so would the interbank markets, since the guarantees on bank
liabilities would no longer be drawn in doubt.
All in all, there appears to be only two
viable solutions to this crisis: Either restructure debt (like
Greece will have to) or cut the deficits now. On that note, it is
encouraging to see that Germany will implement a cut that amounts
to 3.5% of GDP. This is a good start, but not enough.
Mid-term elections in the US will probably mean that we will
see more austerity measures and less bail-outs. Let's hope that
Germany will provide the good example for the rest of the European
countries, despite history showing that no political leader has yet
to provide the vision and guts to demand it.
About Saxo Capital Markets
Saxo Capital Markets Pte Ltd is a
wholly-owned subsidiary of Saxo Bank A/S, an online trading and
investment specialist. It serves as the Asia headquarters and holds
a capital markets services license under the Monetary Authority of
Singapore. Clients can trade Forex, CFDs, Stocks, Futures, Options
and other derivatives via SaxoWebTrader and SaxoTrader, the leading
multi-asset online trading platforms. SaxoTrader is available
directly through Saxo Capital Markets or through one of its global
partners. White Labelling is a significant business area for Saxo
Capital Markets, and involves the online trading platform being
customised and branded for other financial institutions and
brokers. The Saxo Bank Group has more than 120 white-label partners
and thousands of clients in over 180 countries. It is headquartered
in Copenhagen with offices in the UK, France, Italy, Switzerland,
Singapore, Spain, Australia and Japan.
For more information, please visit
http://www.saxomarkets.com.sg
Disclaimer:
Saxo Capital Markets Pte. Ltd. ("Saxo Capital
Markets") is licensed as a Capital Market Services provider and an
Exempt Financial Advisor, and is supervised by the Monetary
Authority of Singapore.
At the time of writing neither the author(s)
nor Saxo Capital Markets holds any shares in securities mentioned
in this Article.
The author(s) and Saxo Capital Markets are
not responsible for any loss arising from any investment based on
any recommendation, forecast or any other information contained
herein. The contents of this publication should not be construed as
an express or implied promise, guarantee or implication by Saxo
Capital Markets that clients will profit from the strategies herein
or that losses in connection therewith can or will be limited.
Trades in accordance with the recommendations in an analysis,
especially in leveraged investments such as foreign exchange
trading and investment in derivatives, can be very speculative and
may result in losses as well as profits, in particular if the
conditions mentioned in the analysis do not occur as anticipated.
Investors should carefully consider their financial situation and
consult their financial advisors as to the suitability of their
situation prior to making any investments.
For further information, please see:
http://sg.saxobank.com/en/about-us/pages/general-disclaimer.aspx
Media contacts:
Saxo Capital Markets Pte Ltd
Celeste Fong
Tel: +65-6303-7713
Email: [email protected]
SOURCE Saxo Capital Markets Pte. Ltd.