November 16, 2011
Greeks wary of fellow Europeans bearing gifts
Chief Economist, CanaData
The economy is taking so many twists and turns these days, the leaders we’ve chosen to drive our finances are in danger of succumbing to vertigo.
Lawyers specializing in whiplash cases no longer have to chase ambulances. They need only stand at the side of the road.
One good turn of events will cause a burst of enthusiasm about future prospects, only to be dashed soon afterwards when there’s an unexpected spin-out and loss of steering control.
The Greek debt problem was apparently resolved and then Prime Minister George Papandreou decided to hold a referendum on the bailout package.
Some in the international financial community thought this might be a political maneuver designed to wring better terms out of Germany and France.
German Chancellor Angela Merkel and French President Nicolas Sarkozy nixed the notion and unequivocally stated that Greece was being offered the best terms it could possibly hope for.
Polls have indicated that seven out of ten voters in Greece do want the country to stay under the Euro’s umbrella.
Still, there’s no denying the possibility Greece may eventually choose to take its chances on the outside.
Or (and perhaps equally as likely) the other members of the currency union, in ultimate frustration, may decide to kick Greece out.
That would mean a return to the drachma for Athens and a currency devaluation of at least 60%.
Banks outside Greece would take a huge hit on their Greek debt and banks within Greece would be challenged to stay afloat.
The threat of contagion is the biggest problem. Italy is already being placed under increasing scrutiny by speculators as they make wager on whether or not it will be the next domino to fall.
The interest rate Italy must pay on its new borrowing is currently three times what Germany faces.
To ease the suffering a bit, the European Central Bank (ECB), under its new President, Mario Draghi — who maybe not so coincidentally was formerly Governor of the Bank of Italy — has just lowered its key policy-setting interest rate by 25 basis points to 1.25%. (100 basis points equals 1.00%.)
To guarantee early passage of Rome’s next budget — which will include emergency measures (e.g., asset sales and more spending cuts) to straighten out state finances — Silvio Berlusconi has agreed to resign as Prime Minister.
That will put an end, at least temporarily, to his nearly 20-year stint at the top of Italian politics.
These developments aren’t the only recent shocking news. Iran is now judged to be much closer to nuclear weapons capability than previously thought.
The timetable for Iran to achieve such “success” — although that hardly seems the right word under such circumstances — is now judged to be six months to a year.
Of course, ever since the “weapons of mass destruction” label was found to be untrue in Iraq, the credibility of outside intelligence reports has been called into question.
Nevertheless, it appears pressure will be mounting for Israel and the U.S. to do something to halt Iran in its tracks. More stringent sanctions may be applied, especially with regard to the export and import of radioactive materials.
The international dealings of Iran’s central bank may also be a target for more intervention in order to cut off payment and funding flows.
Cool heads would prefer that matters not deteriorate to the point where there is a first-strike military response to take out research and production facilities.
These latest developments threaten to add a great deal more instability to a region already under duress as a result of the Arab Spring.
Finally, in the U.S., the most recent meeting of the Federal Open Market Committee (FOMC) of the Federal Reserve was more bearish about the outlook than in the past.
The Fed previously estimated U.S. “real” (i.e., inflation-adjusted) gross domestic product (GDP) growth would be close to +3.0% this year. 2011’s newly revised figure is only +1.7%.
Furthermore, 2012 has also been scaled back. The latest projection is for growth of +2.9% next year, versus June’s forecast of +3.5%.
Prior to the meeting there had been speculation that a Q3 round of quantitative easing (i.e., increase to the money supply) might be in the cards.
But apparently bank governors, with few exceptions, don’t want to go that far. Other measures to provide monetary stimulus will continue to be tried first.
What’s frustrating for the Fed is that its attempts to stimulate the economy are being offset on the fiscal side by government downsizing, particularly through layoffs at the state level, and the imminent expiry of some tax cuts.
One reason given by the U.S. Federal Reserve for the current slower growth scenario may turn out to be a positive longer term. American households and businesses have been more aggressive in reducing their debt than most would have thought either likely or possible.
This will provide a more solid foundation for expansion once the U.S. economy is back on its feet.
The fed expects the national unemployment rate to ease on down only gradually, declining from slightly over 9.0% this year to 8.5% on average next year.
Perhaps that’s being too pessimistic. Initial jobless claims for the latest week (ending October 29) were 397,000, a decline of 9,000 versus the period before.
The number of first-time unemployment insurance seekers has been much healthier for the past three months. During the recession the figure climbed as high as 650,000.
A number of 400,000 or less on an ongoing basis will mean eventual significant success in reducing the persistently high jobless rate.
For more articles by Alex Carrick on the Canadian and U.S. economies, please see his market insights. Mr. Carrick also has an economics blog. His lifestyle blog is at www.alexcarrick.com
