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Europe Is Drowning in Debt
12/21/2009 9:43 am EST
Huge and growing budget deficits threaten to tear apart the European monetary union, just as the global equity rally begins to unravel, writes Greg Weldon in Weldon's Money Monitor.
European Union member states are increasingly [facing] ratings downgrades, interest rate spikes, credit default swap widening, and general [pressure] on their debt instruments.
In fact, of the 27 European Union member states, only five maintain a budget deficit within the limits set by the Maastricht Treaty, which imposes a "hard" ceiling of 3%, as measured by the budget-deficit-to-GDP ratio.
Yes, hard as it is to believe, only Luxembourg, Finland, Denmark, Sweden, and Bulgaria—yes, Bulgaria—boast a budget-deficit-to-GDP ratio below 3%. Worse yet, of the 22 that do not comply, 14 have a ratio that is more than twice the alleged limit.
Note the worst offenders in 2009:
These three are all into double digits, and thus under an acute attack. Then we spotlight the next three worst offenders:
Latvia… 9.0% (expected 12.3% in 2010)
Huh? Latvia, Lithuania, and France? Indeed, and when we note Portugal at 8.0%, the Czech Republic at 6.6%, and Italy at 5.3%, we observe the breadth of the problem geographically within Europe itself. The EU-27 as a whole posts a huge 6.9% budget deficit-to-GDP ratio, which is expected to worsen in 2010, to 7.5%!
Moreover, when we contemplate the Maastricht Treaty's limit on gross external debt to GDP, set at 60%, we note that the majority of EU member states fails to comply. Indeed, according to a recent study by the IMF, of the top 20 offenders when it comes to gross external debt to GDP globally, 15 were European Union members.
The number-one offender globally is Ireland at 1,267% of GDP. Third on the list, at a whopping 408.3%, is the UK. The worst offender out of the core-EU countries is France, pegged at eighth globally with an egregiously non-compliant 236% debt-to-GDP ratio. Greece comes in 16th, pegged at 161.1%, which puts it behind Spain, 15th globally at 171.7%, and Germany, 14th with a 178.5% gross external debt-to-GDP ratio.
For reference, we note that the USA ranks 20th, at a (seemingly) small 95.3% ratio, which would still put the US into the noncompliant category, in terms of the European Maastricht ceiling.
For sure, the European Central Bank is talking tough, as evidenced by comments on the offer from Governing Council member Axel Weber, who said to the press:
"We will see consolidation. Officials are facing a clear necessity to implement concrete budget measures. I expect the countries of Europe to meet their responsibilities.”
That is akin to an Achtung coming from the Central Bank. More important will be the ECB's reaction to the utter failure of Maastricht, as the Union begins to pull apart at the seams, on the back [the downgrade of] Greece, and [the] addition of Spain to the list of countries on Negative Watch, in line with Ireland's position.
Indeed, Christopher Pryce, the analyst at Fitch who downgraded [Greece] to BBB+ this week and, worse still, maintained a negative outlook on the country, told the press that he is “not convinced” that the ECB is willing to do whatever it takes to avoid a debt default by a member state. “Their intention is not to let a euro-area country default. Whether they are prepared to do what might be necessary to save Greece, I cannot be sure,” Pryce said.
We note intensified macro-turbulence emanating from the underlying Greek economy, with weakening in [third-quarter] GDP led by a plunge in business investment. Exports have now contracted at a pace exceeding 20% for three consecutive quarters. Worse yet is the decline in domestic retail demand in Greece, which is broad-based.
As we turn to Ireland, we note [a recent] budget speech by Finance Minister Brian Lenihan, within which he [announced] spending cuts that will result in a 6% pay cut for government workers. Indeed, labor unions are threatening to facilitate "industrial unrest" in response, as the government desperately attempts to keep the budget deficit below 12% of GDP.
Frankly, with a gross external debt-to-GDP ratio of 1,267% and a 12.5% 2009 budget deficit-to-GDP Ratio, we might be surprised that the credit default swap [on Ireland's sovereign debt] is not higher than the current 150 basis points. Goldman Sachs attributes the fact that the CDS is not higher already to Ireland's "self-awareness" relative to other EU countries that remain deeply embedded in denial.
We recently stated, in the wake of the Dubai debt revelations, that other countries will come under intensified scrutiny, as per their gross debt issuance and budget deficits. We have long stated that such a development could be the catalyst to cause an end to the wealth/asset-price reflation trend, and spark a return to a debt-deflation-driven decline in global equity indexes.
That time has come. As unthinkable as it may be to some, the risk of a complete unraveling of the European Union is intensifying, dramatically and rapidly.
The timing of this dynamic implies an end to the asset-reflation trend of 2009, and a renewal in the long-term, fundamental, secular down trend in global equity indexes.
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