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Are the UK, US and German safe havens safe at all?

- LIAM HALLIGAN The writer is chief economist at Prosperity Capital Management.

LAST week brought worrying signs, though, that while the eurozone’s woes are not easing, ongoing concerns about monetary union are now having an impact on alternativ­e growth centres, too, imposing real damage on commercial activity in other parts of the globe.

For most of the past year, of course, the eurozone has been on the verge of a full-blown economic collapse.

Investor angst has further intensifie­d in recent weeks, since inconclusi­ve Greek elections on May 6. It is now widely accepted that Greece could be thrown out of the euro if it keeps thumbing its nose at the austerity measures imposed by the member states bank-rolling Athens’s continued sovereign bail-out.

The possibilit­y of a Greek exit, and the related contagion if investors lost faith in the solvency and future membership of other single currency “peripheral­s,” is taking its toll on the region’s real economy. The eurozone’s manufactur­ing purchasing managers’ index plummeted to 45.1 in May, well below the 50point level that indicates growth. After 10 straight months of contractio­n, this marked a three-year low.

The French manufactur­ing PMI slid from 46.9 to 44.7 last month, its Spanish equivalent from 43.5 to 42. Even Germany’s index faded to 45.2 from 46.2 in April, its lowest level since June 2009, the trough of the post-Lehman doldrums.

Little wonder, then, that eurozone unemployme­nt just hit 11%, a euro-era high. Spanish unemployme­nt is an intolerabl­e 24% – the kind of level that could spark not just protests but serious civil unrest.

As the economic and political pressure mounts, financial markets are showing signs of acute strain. Spain’s 10-year sovereign bond yield is once again approachin­g an unsustaina­ble 7%, its Italian equivalent back above 6%.

As the Eurocrats toy with “Grexit,” Spain is trying to plug holes in regional budgets, while defusing the incendiary off-balance sheet liabilitie­s of its rancid banking sector.

For now, Madrid needs a quick 19 billion euros to recapitali­se Spain’s fourth biggest bank. But investors are starting to realise that when it comes to the eurozone’s fourth biggest economy, an economy perhaps “too big to bail,” Bankia is just the tip of the liability iceberg. As such, the euro tumbled below US$1.23 previously, to a 23-month low, with the Stoxx Europe 600 equity index giving up all its 2012 gains.

What also happened recently, though, was that the macro-data alarm bells began ringing so loudly elsewhere – particular­ly in the United States and China – that they can no longer be ignored.

Real economic damage

So global investors are now focusing not just on the potential financial impact of Europe’s troubles – via contagion if there’s another “Minsky moment” – but on the real economic damage already being caused elsewhere by the eurozone’s current paralysis.

The United States is splutterin­g badly. The country’s bellwether “payrolls report” showed only 69,000 new jobs in May, well below market expectatio­ns of 150,000-plus. The figure for April was revised down from 115,000 to 77,000. America’s first-quarter GDP (gross domestic product) growth, meanwhile, having been marked at 2.2%, was downgraded to 1.9%. The Dow Jones Industrial Average, like its eurozone equivalent, is now at its lowest point this year.

So that leaves China, although the People’s Republic is suffering too because the eurozone is its biggest market, buying a fifth of all Chinese goods exports.

In May, China’s manufactur­ing PMI fell from 53.3 to 50.4 – its seventh successive monthly contractio­n. Real estate prices, the store of wealth for much of China’s middle-class, are now at a 16-month low. China grew by 7.9% during the first three months of 2012, but this marked the sixth successive quarterly decel- eration. Full-year GDP growth is on course to hit its lowest level since 1999.

Last month, China’s central bank lowered reserve ratios by 50 basis points, the third cut in six months, in a bid to boost the economy.

But investors have lately been spooked by signs that Beijing is reluctant to really whack the “stimulus button”.

In 2008, the Chinese government rushed to spend its way out of trouble, using reserves rather than more borrowing of course, in stark contrast to the Western world.

The massive four trillion yuan package, then equivalent to US$590bil, did the trick in terms of growth. Yet the lending boom it unleashed has raised fears of a bad-loan crisis, with China, uniquely among the large emerging markets, now seen as a candidate for a subprime crisis of its own.

“Current efforts for stabilisin­g growth will not repeat the old way of three years ago,” boomed the state-run Xinhua newspaper recently. The fact that even China, with its US$1.5 trillion of reserves, is worried about launching another mega bail-out should focus the minds of even the most determined optimists.

Back in the 1970s, the eurozone economies, then among the most dynamic on earth, generated 20% of global growth. Over the past decade, this growth share has fallen to 5%. Yet the single currency area still accounts for more than a fifth of the global economy.


More fundamenta­lly, the region’s banking sector is so distressed, and many of its government­s so close to insolvency, that “eurogeddon” could spark a worldwide shockwave every bit as damaging as Lehman. And this time, of course, there is far less scope for fiscal and monetary bail-outs – not only in Europe, but in the United States and elsewhere, too.

Of course, the United Kingdom, already in recession and reliant on the eurozone to buy more than half its exports, is among the most seriously exposed. In May, Britain’s manufactur­ing PMI index nosedived to 45.9, the weakest reading since May 2009, down from 50.2 the month before. This marked the second biggest one-month drop in 20 years.

Global markets are clearly skittish. The only thing that has stopped asset prices falling further, perhaps, is the belief that escalating market turmoil could push central banks into action – not just the ECB (European Central Bank), but the Bank of England and Federal Reserve, too. That’s why gold prices are firming up once again. It’s also why the dollar index, typically inversely correlated with investor risk appetite, has lately shown signs of reversal.

While the prospect of more QE (quantitati­ve easing) has helped some “risk assets” in recent days, most investors are scrambling for “safety.” So 10-year US sovereign borrowing costs have fallen to a record low and gilt yields are at rock bottom, too. On some two-year German government bonds, yields went negative last week, with investors so desperate for a perceived “haven” that they’re willing to pay for the privilege of lending Berlin money.

We must ask ourselves though, as the global macro data deteriorat­es and the Eurocrats keep squabbling, are the “safe havens” really safe? The United States and Germany, as well as the United Kingdom, have government debt-to-GDP ratios approachin­g 100%, even more including off-balance sheets liabilitie­s.

With the Fed now poised to unleash QE3, more Bank of England money-printing on the cards and even Germany now openly calling for more inflation, real-terms losses, even on relatively short-term “safe” government paper, are practicall­y guaranteed. And that’s assuming that the United States, Germany and the United Kingdom can manage to limit the damage to relatively low-impact “soft default” over the coming months and years, avoiding the horrors of an all-out creditors’ strike.

When the safe havens are no longer seen as safe, that is the moment when genuine panic ensues. A question worth pondering, perhaps, as we approach the pivotal Greek election rerun on June 17. — Telegraph

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