More Austerity Measures are Likely in 2011

As we start a new year, I thought it would be interesting to assess the performance of the leading countries in addressing their public deficits. After a 2010 characterized by a European sovereign debt crisis, it is time to think about whether 2011 holds similar prospects.

In summary, I think there are significant issues ahead for Sovereign Debt in 2011. In particular, Spain appears set to follow the path of Greece, Ireland and Portugal. Similarly, I think that the next in line of the major countries is the US and UK. However, those countries are likely to benefit more from a cyclical pick up because their Governments were purchasing assets in the crisis. If growth is stronger than expected than these assets could perform well (or be sold back to the private sector) and their financial situation could be improved.

However, on trend, the US and UK will have to implement more austerity measures. Italy and France will also have to take measures. I am particularly worried about Italy, but I will start by looking at Spain.

Spain Set for a Bail Out?

According to reports, the ECB has not yet been buying Spanish debt but it has been buying Portuguese and Irish. This is why after the recent ECB action, Portuguese 10 year bond yields are below their November highs…

…but the Spanish 10 year yield is not…

This is a clear indication that the Portuguese bond market is being held by European Stabilization Fund (ESF) buying. It should be noted that, according to the BIS, Spanish banks hold over $108bn worth of Portuguese sovereign debt. Moreover, the market doesn’t seem too keen to insure Spanish debt. See 5 year CDS pricing here…

So what is in store for 2011?

Stabilizing European Deficits?

Not for nothing is Trichet insisting that any usage of the European Stabilisation Fund should be accompanied by implementation of budgetary austerity measures. I wanted to see how this plays out by trying to estimate how much Governments will have to cut back in order to try and stabilise their deficits.


 Firstly I've compared current 10 year yields with nominal GDP forecasts and included gross debt as a percentage of GDP. The last two columns are for Government Financial Balances as a share of GDP.

		Nominal GDP Growth		Gross Debt % GDP		Gov Fin Balances
	10 Yr Yld	2011	2012	2011	2012	2011	2012
Belgium	3.43%	3.30%	3.50%	104.30%	105.20%	-4.50%	-3.60%
France	3.36%	2.60%	3.10%	97.10%	100.20%	-6.10%	-4.80%
Germany	2.96%	3.60%	3.40%	81.30%	82.00%	-2.90%	-2.10%
Greece	12.47%	-0.30%	1.50%	136.80%	142.20%	-7.60%	-6.50%
Ireland	9.06%	2.20%	3.70%	112.70%	115.60%	-9.50%	-7.40%
Italy	4.82%	2.50%	2.70%	132.70%	133.00%	-3.90%	-3.10%
Japan	1.00%	0.90%	0.50%	204.20%	210.20%	-7.50%	-7.30%
Portugal	6.60%	1.10%	3.00%	98.70%	100.60%	-5.00%	-4.40%
Spain	5.45%	1.10%	2.10%	78.20%	79.60%	-6.30%	-4.40%
UK	3.40%	3.70%	3.20%	88.60%	94.50%	-8.10%	-6.50%
USA	3.29%	3.40%	4.10%	98.50%	101.40%	-8.80%	-6.80%

source: OECD Forecasts

The next step is to calculate what these Governments need to do in order to stabilise their debt. I can do this by calculating this number from the following equation


Stabilising deficit= (Debt % GDP *(i-g))/(1+g)


This gives the following results in the second and third columns.

	Stabilising Deficit		Adjustment
	2011	2012	2011	2012
Belgium	0.13%	-0.07%	-4.63%	-3.53%
France	0.72%	0.25%	-6.82%	-5.05%
Germany	-0.50%	-0.35%	-2.40%	-1.75%
Greece	17.52%	15.37%	-25.12%	-21.87%
Ireland	7.56%	5.97%	-17.06%	-13.37%
Italy	3.00%	2.74%	-6.90%	-5.84%
Japan	0.20%	1.05%	-7.70%	-8.35%
Portugal	5.37%	3.52%	-10.37%	-7.92%
Spain	3.37%	2.61%	-9.67%	-7.01%
UK	-0.26%	0.18%	-7.84%	-6.68%
USA	-0.10%	-0.79%	-8.70%	-6.01%

source: Markets and Culture ,OECD Forecasts

The last two columns (adjustment) are the key to this exercise. So for example, the UK has to cutback 7.84% and 6.68% in 2011 & 2012 respectively from their proposed spending, just in order to stsabilise the debt/GDP ratio. They illustrate how much these Governments need to do in order to stabilize their deficits at the levels they are at now. Of course, they do not necessarily need to do this, but I would hope that they would realize the importance of reducing their overall debt burdens.

Incredibly, given current bond yields, the US, UK and Germany could run slight deficits and still eat away at debt in 2011. However, I would caution that this relationship exists as long as the bond markets have confidence in them.

Frankly, Spain and Portugal are going to have to make more cutbacks. This will be very hard for Spain given that their economy looks weak and their housing market remains a drag on growth. I would expect downwards pressure on their GDP growth numbers. Moreover, if the market continues to doubt them then their debt servicing costs will only increase.

US and UK Debt Positions Helped By Asset Purchases

Turning to the UK and US, they too look like they are going to have to make more cutbacks. However, there is a mitigating circumstance. Going into the financial crisis these two economies had a higher share of GDP in financial services than the others. They ended up buying assets, therefore their net financial position is liable to be positively impacted by growth.

		% of 2011 & 2012 GDP
	Gross Financial Liabilities		Net Financial Liabilities
Belgium	104.3	105.2	84.2	85.0
France	97.1	100.2	61.8	64.7
Germany	81.3	82.0	51.6	52.0
Greece	136.8	142.2	105.1	110.1
Ireland	112.7	115.6	69.7	74.6
Italy	132.7	133.0	104.7	105.0
Japan	204.2	210.2	120.4	127.1
Portugal	66.7	67.4	67.6	70.0
Spain	78.2	79.6	49.3	52.8
UK	88.6	94.5	57.6	62.3
USA	98.5	101.4	74.3	78.2

 source: OECD Forecasts

Clearly, Italy’s overall debt burden is a cause for concern and I feel that ECB buying of Spanish debt is highly likely. Moreover, the Spanish are likely to have to deal with a failing housing market, which will further exacerbate their banking sector difficulties. I think fears over Italy will be next after Spain. The interesting thing about Spain is that their net financial deficit is relatively low and they have Government assets that they can sell off. However, it is their lack of growth and fears over their housing market which is causing all the problems.

The Political and Economic Will for More Bail Outs?

Whether the political and economic will exists for this is another question. The ECB seems keen to talk of defending the Euro and its members’ sovereign debt, but this is likely to be politicking in order to hold up peripheral bond yields. Unfortunately, it’s not working. Moreover the knock on effects of falling Spanish and Portuguese debt (not to mention Italian) could be significant upon the European banking sector.

I’m not long European Banks.



Source:
OECD Forecasts

Richard Dawkins The Selfish Gene: A Book Review

Book Review: The Selfish Gene by Richard Dawkins

Richard Dawkins’ ‘The Selfish Gene’ is a well written and enjoyable book. As the title suggests, it is an exploration of the role of genes in evolutionary theory. Dawkin’s asks us to accept the genes are programmed to survive and that we or any other organism are merely ‘survival machines’, within which evolution plays out the outcomes of gene mutations.

This asks us to reframe our assumptions about the world and accept it as a huge battleground for genes fighting for survival. This can be a liberating thought for a scientist because it then allows him to apply scientific method and rationalize behavior using this initial assumption. Indeed, Dawkins goes on to explain a collection of interpersonal, societal and biological relationships by applying game theory to the behavior of the ‘survival machines’ within these relationships.

The Selfish Gene

Pivotal to this idea is the notion of ‘selfishness’ in the title. In fact, to Dawkins, the genes are just trying to ensure their survival (and promulgation), in other words, they are not so much immoral as amoral. However, the term ‘selfish’ is probably used to highlight this amorality, and he spends ample time explaining how apparently altruistic behavior is, in fact, selfish behavior.

He adds succor to this conclusion by pointing out that he is not advocating the case for selfishness as an evolutionary moral code. This would make his argument weaker. On the contrary, he is arguing that this is how it actually is.

On the whole it is an interesting read and I would advise it as a thought provoking tome. However, it would have been preferable if Dawkins extended the scientific rationale to his exploration of religion. He touches-unsatisfactorily-upon religion in the book, but never manages to reach what I think is the inexorable conclusion of his this theory.

Dawkins, Genes and God

It is entirely feasible that a gene that causes the brain to accept submission to a higher authority (an idea which characterizes all religious thought) as the ultimate creator exists. If such a gene is successful then the ‘survival machines’ (us) that it occupies might see continued promulgation. Those that do not possess it might seek immortality by treating to recreate this creation process and dying out with their failure. In this sense, religion can be seen as an entirely necessary part of evolutionary development. I happen to believe that history shows us that all men ultimately submit. Even as established religions seem to be on the decline in, say Europe, they are being replaced with no end of new age nonsense. Dawkins’ irrational belief is his faith in ‘science’ and science killed many more men than religion did in the last century.

Whilst the idea of this gene seems obscure enough, it is entirely consistent with Dawkins’ approach. Animals do not seem to trouble themselves with notions of Gods or question their ultimate reality or creation. We do. Why Dawkins seeks to isolate this one area of evolution and then subject it to the onslaught of ‘reason’ in his later works is a real mystery.

Source:

Dawkins, Richard 'The Selfish Gene' Oxford University Press, 1989