|Leverage, leverage ...|
|Saturday, 29 October 2011 00:00|
US savings fall, no clarity on source of EU funding
The combination of higher US GDP growth data (2.5% in Q3 versus 1.3% in Q2) and a European deal to avert a banking crisis (50% haircut on Greek bonds, ¤100 billion recapitalisation of banks and hiking EFSF from ¤440 billion to ¤1 trillion) got global and Indian markets soaring, but it’s not clear what the fuss is all about. In the US, investment growth continues to rise, from 10.3% in Q2 to 16.3% in Q3 for non-residential investment; personal consumption expenditure also rose 2.4% in Q3 as compared to just 0.7% in the last quarter. But it needs to be pointed out that these estimates are ‘advance’ estimates and, as the Bureau of Economic Analysis has pointed out while releasing the data, the difference between the ‘advance’ and ‘latest’ data can be as high as 1.3 percentage points. Two, during this period, the real personal disposable income fell by 1.7% at an annualised rate—so the hike in consumption was made possible by already stretched consumers cutting their savings rate from 5.1% in the previous quarter to 4.1%. With unemployment not even dented—the economy needs to keep growing at 2.5% for this to happen—and home mortgages still in negative territory, it’s hard to see how consumption can keep up.
Europe is equally dicey since, after all the hike in ‘firepower’ of the European Financial Stability Facility, there is no clarity on where the additional ¤560 billion ($780 billion) is going to come from. Some part is to come from China—China is the EU’s biggest trade partner and would need a stable Europe—but it is unclear as to how much China will invest and whether the EU will meet some of its demands such as those on granting market-economy status. Other moves to boost EFSF firepower include leveraging it to provide insurance or first-loss guarantees—so we’re back to financial engineering of the type that caused the 2008 crisis. Even this, it is obvious, is not enough to meet the demands coming out of Italy (its debt is $2.8 trillion), so a credible reform strategy there is critical, but there are no signs of this so far. There is considerable doubt over the ¤100 billion recapitalisation estimate for banks since this is half of what the IMF said was needed—other estimates are still higher. Indeed, the big fear is that instead of raising money from markets—in case there are buyers out there—banks will try and shrink their balance sheets to reach the required capital adequacy norms. In which case, economic activity which is required for all the debt-buildup to be sustainable will quickly disappear. Wait for the next crisis summit.