Global equity markets continued to advance. Last week’s newsletter noted the importance of clo...
The 3 Big Crises of 2012
12/09/2011 8:00 am EST
To the Eurozone mess…which will spread…add Russian unrest and a budget crunch in India. By midyear, we should know how it will all play out.
Ready for the next crises?
Yep. That’s "crises." Plural. Because 2012 promises to be even more exciting than 2011.
First off, the euro debt crisis isn’t going away. Sorry if you’re bored with it. But it will take a new twist.
As Europe sinks into a self-induced recession created by all that tough talk about the need for austerity and budget cuts, we’ll get treated to the spectacle of chickens coming home to roost, as politicians have to explain to suffering voters why they need to tighten their belts even more to balance budgets thrown out of whack by no-growth economies.
But I do think that we’ll add exciting new crisis venues such as Russia and India in 2012.
And this could be—don’t get too excited—just a run-up to 2013, when the United States and China could get into the act.
Ready? Let me play tour guide to the next stage of the fun.
Eurozone Debt: The Once and Future Crisis
Want to know why this crisis will launch a new season in 2012? Take a look at what’s going on in Ireland.
If there’s a Eurozone debt crisis/budget austerity success story, Ireland’s it. After a $90 billion bailout, the government’s annual budget deficit is projected to fall to 10.1% of gross domestic product in 2011 (from 32% in 2010—yes, that was the annual government budget deficit that year). That would be slightly below the 10.3% target.
And the economy could actually show 1% GDP growth for 2011. That’s quite an improvement from the 7% GDP drop in 2009 and the 0.4% decline last year.
That "progress" comes at considerable pain—tax increases and budget cuts of $34 billion, so far. That’s equal to about 15% of Ireland’s annual GDP, or $2.2 trillion if the Irish economy were the size of the US economy.
Unemployment has climbed to 14.5%. It would be higher, except that, as of the end of November, 40,000 people have left the country in search of jobs. (Ireland has a population of just 4.5 million, so 40,000 people is nearly 1% of the population. That level of emigration is equivalent to 2.8 million people leaving the United States.)
Combining those budget measures with the pain of falling wages, the government figures the country’s austerity plan is the internal equivalent of a 16% currency devaluation. (Roughly as if the euro went from $1.36 in US dollars to $1.16.) No wonder Ireland’s GDP growth this year is built on a 5.4% increase in exports in the first nine months of 2011.
And the progress isn’t guaranteed to continue into 2012.
The slowdown in the European economy because of the Eurozone debt crisis, and the increase in interest rates because of it, have resulted in lower-than-projected tax revenue —about 1.6% below projections in the first 11 months of 2011—and an increase of interest payments of about $1.4 billion over the first 11 months of 2010.
The situation looks worse in 2012. On December 6, Finance Minister Michael Noonan cut his forecast for 2012 GDP growth to 1.3% for 2012, from 1.6%. That was the second cut to growth projections in a month, and Noonan’s forecast is still substantially above forecasts of 1% from economists at the Economic and Social Research Institute in Dublin.
This week, Noonan put forward a program of an additional $4.5 billion in cuts and tax increases designed to keep Ireland on track to hit its target of a 2012 budget deficit of 8.6% of GDP. The package included tax increases such as a 2-percentage-point increase in the sales tax, to 23%.
The plan by the European Central Bank and the International Monetary Fund has been to support Irish borrowing, using bonds issued by the European Financial Stability Facility, until Ireland can start raising money in the financial markets again in 2013. By 2015, the Irish debt-to-GDP ratio is supposed to be down to the Eurozone limit of 3%.
It’s not going to happen if growth in the Eurozone economies sinks below 1% in the next quarter or two, and then heads for 0%. Which is where the next European debt crisis comes in.
If you don’t include the payments Ireland has to make as a result of the government bailout of banks like Anglo-Irish, which collapsed along with the Irish real-estate market, the Irish budget deficit was €1.6 billion lower in the first 11 months of 2011 than in the similar period in 2010.
But, if you include the cost of that rescue, then the deficit was €8 billion higher. The debt-service costs alone ran €1.1 billion higher than in 2010.
So in 2012, Ireland—and Greece and Portugal—are going to face a huge choice. They can either try to grind out more austerity in the midst of a Eurozone recession, or they can try to renegotiate some of that debt.
If you remember, the battle over Greek bank debt almost scuttled the euro this year. Well, we’re going to see the same problem again in 2012, with debtor countries looking for a way to convert some of their current debt into debt of such long duration—how about 30 years?—that it will amount to a write-down for existing debt holders.
The outcome of the crisis will depend on how rigidly Germany sticks to its current demand for no private-sector write-downs. Ireland will probably try to strike a deal that trades some de facto write-down for its political support for German plans to restructure the Eurozone. But I don’t expect those negotiations to go smoothly.
And remember, Ireland is the best-case example of Eurozone austerity. I don’t think Greece or Portugal have enough room to negotiate any deal to reduce their debt that stands a chance of getting past Germany and the other austerity hawks.
NEXT: Something Different: A Very Russian Crisis|pagebreak|
Something Different: A Very Russian Crisis
If you’ve been paying attention to the news from Russia at all lately, I’ll bet your attention has been on the confrontation in the streets of Russia between crowds protesting the fraud in the recent Russian election, supporters of Vladimir Putin, and units of the police and interior ministry troops.
But if you can spare a moment, take a look at the 2012-2014 budget passed by the Duma at the beginning of the month. The assumptions necessary to produce a budget with just a 1.5% deficit for 2012 are extraordinary.
First, the budget assumes 12.8% economic growth in the 2012-2014 period. That’s going to be tough to achieve.
The World Bank projected 2012 Russian GDP growth at 3.8% back in September. Everyone’s projections have come down since then, because of the Eurozone debt crisis and the slowdown in European growth projected for 2012. (Europe is, after all, Russia’s biggest customer for oil and natural gas.)
Second, the budget calculates tax revenue from oil—and oil revenues at 29% are a huge the source of Russian government receipts—based on the assumption that oil will average $100 a barrel in the period.
Urals crude, the benchmark grade for Russian oil, sits near $110 a barrel. But that price includes a huge $21 a barrel run-up since the end of the third quarter, on fears that a boycott of Iranian oil will disrupt oil supplies.
Still, what’s the big deal? If the price of oil fell to $90 a barrel, the Russian budget deficit would rise to just 3%, government economists calculate.
But 2012 is an election year—and so far, elections haven’t been going well for Putin’s United Russia party. The group lost 77 seats in the 450-seat lower house, even after extensive fraud that included stuffing ballot boxes and falsifying voter rolls.
Putin is running for president again in 2012, and if the Russian government follows form, that means big spending on subsidies for food and fuel, increased pension payouts, and more. Forget about a budget that works on $100-a-barrel oil.
If that bread-and-circuses approach should run into a global economic slowdown that depresses the price of Russian oil and cuts Russian GDP growth below the budget’s targets, then forget about a 3% budget deficit in 2012. And it’s not like the Russian government is going to propose an austerity program in an election year.
The danger—the reason we might see a Russian crisis in 2012—isn’t that the short-term shortfall is so dangerous. (Russia does sit on $520 billion in foreign-exchange reserves, remember.)
It’s that a relatively minor current crisis might remind financial markets of Russia’s huge, long-term problem. Russia is one of the most rapidly aging countries in the world, with net retirees set to jump by half a million people in 2012.
And it has a big pension problem. The country had just $38 billion in private-pension savings at the end of 2010, and most Russians will depend on government pensions from a program that is running a huge deficit.
In 2012, the pension deficit will double to $58 billion—that’s about 3% of GDP. That would be equivalent to $420 billion in the US economy.
The long-term trend is so dire that the World Bank’s economist in Moscow, Sergei Ulatov, compared the Russia’s impending financial crisis with that of Greece. "By 2030, the debt level would be unsustainable like Greece," he told Bloomberg.
Standard & Poor’s has said that Russia’s demographics may put its sovereign credit rating under rising pressure after 2015. Government debt could rise to 585% of GDP by 2050, S&P said. I know 2050 is a long way off, but 585% is a staggering number.
Will anyone in Russia’s government try to do anything about the trends this year, and risk setting off more protests in the streets? Will the financial markets decide that Russia, like Greece and Italy, doesn’t have a government capable of tackling the problem—and send Russia’s cost of money climbing, just as the country needs to borrow big to fund the infrastructure required by the 2014 Sochi Winter Olympics?
NEXT: Is India the New Italy?|pagebreak|
Is India the New Italy?
So much of Italy’s financial problem in 2011 stemmed from the financial market’s judgment of the Berlusconi government: Italy’s budget deficit and its lack of economic growth would just keep getting worse, because no one in Rome was interested in or capable of addressing the country’s problems.
Italy, meet India.
The government of Indian Prime Minister Manmohan Singh presides over a house in disarray. Inflation at the wholesale level, the Reserve Bank of India’s preferred inflation measure, was an annualized 9.7% in October. That level would be more shocking if inflation hadn’t run above 9% for the past 11 months.
The Reserve Bank of India has relentlessly tried to stem inflation by raising interest rates—13 times since March 2010. But all that has done is raise interest rates—the yield on India’s ten-year bond was 8.6% on December 6, compared with 2.03% on ten-year US Treasuries—and cut into growth.
India’s economy grew at a 6.9% annual rate in the September 2011 quarter. That would be great if it weren’t the lowest growth since the second quarter of 2009. Citigroup has cut its GDP projection for the fiscal year that ends in March 2012 to 7.1%, from an earlier projection of 7.6%.
Doesn’t sound so bad? Well, these aren’t the worrisome numbers.
In its budget for fiscal 2012, the government had estimated that its budget deficit would be stable at 4.6% of GDP. But with growth slower than expected, economists are now looking for a 5.6% budget deficit. And that’s for the year that ends in March 2012. Nobody expects the global economy to have turned around by then.
And India doesn’t have the luxury of Russia’s big cash cushion. India runs a current account deficit and relies upon capital flows from overseas. In the quarter that ended on June 30, India’s current accounts ran in the red by $14.2 billion, up from $12.1 billion in the same quarter of 2010. Capital flows from overseas more than made up the difference, so that the total balance of payments was a positive $5.44 billion.
But you see the problem, right?
- A government looking at a rising deficit and total government borrowing near the highest levels ever.
- Inflation stubbornly above 9%.
- Economic growth trending down.
- Bond yields near three-year highs.
- A negative current account balance that depends on overseas cash flows.
India isn’t in a good position to confront a slowing global economy.
A Conundrum of Crises
Do any of these crises rise to the level of this year’s European debt crisis? The odds say no.
Mostly because the countries at the center of these potential crises—Ireland, Russia, and India—don’t carry anywhere near the weight in the financial markets as Italy does. Italy’s bond market is the third-largest in the world, and a collapse in that market outweighs the effect of any crisis in Ireland, Russia, and India.
That doesn’t mean, however, that global financial markets would ignore a crisis in any of these countries. These crises would add huge volatility to the financial markets at a time when even shouting "boo" can spook bond traders. The potential for a crisis like any of these is one reason that I think the first half of 2012 will offer investors a very wild ride.
Why only the first half of the year? Not because everything wrong with the global economy will be fixed by July 1, certainly. But by that point, we should have a reasonable handle on how bad the slowdown will be in Europe, on how hard a landing we will see in China and Brazil, and on how slow the global economy will get. Even if the news isn’t great, the certainty will be appreciated by the markets.
The financial markets are good at discounting even bad news. It’s the ability to mark prices up or down because there is no consensus view of the future that drives traders and investors to acts of extraordinary volatility.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund , may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of September, see the fund’s portfolio here.
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