Mish's Global Economic Trend Analysis

Spanish Implosion Coming Up; Deficit Up, Receipts Down, a Need to Cut 40 Billion in Expenses from 90 Billion; Spain's "Hidden Deficit"
Italy GDP Contracts in Q3, Heads for Harsh Recession; Bizarro World Math; Sarkozy Announces He Will Not Be Sarkozy; LIBOR-OIS Spread Says ECB's 3-Year Financing Scheme Nothing But A "Sugar Rush"
Bernanke Spreads "Happy Dust"; Did the Economy Respond? Will the Economy Respond? Mish 2011 Predictions Review

Spanish Implosion Coming Up; Deficit Up, Receipts Down, a Need to Cut 40 Billion in Expenses from 90 Billion; Spain's "Hidden Deficit"

Posted: 22 Dec 2011 07:46 PM PST

My friend Bran from Spain sent a pair of articles in Spanish that highlight the impossible situation facing Spain. The links below have a target of Google Translations.

Need to Cut 40 Billion Euros from 90 Billion

Spain needs to cut 40 billion euros from its budget to meet its deficit target for 2012. The problem is there is only 90 billion of expenses to 'play with' according to an article in Libre Mercado: The maze of Montoro: save 40,000 million without "social cuts"

To reach the deficit target agreed with Brussels, the new finance minister will have to come to his office with scissors ready.

The key figure is 4.4%. This is the deficit target committed to the EU by 2012. Would overcome a difficult situation in Spain, both to their partners as compared to international investors. In theory, 2011 will end with a deficit of 6% (so say government forecasts), this would leave a hole of 16,500 million for the coming year.

The problem is that almost no one believes any longer in these figures. Funcas predictions published yesterday, which included a deficit of 8% this year. With this figure, the gap would be closed would be about 40,000 million.

To climb this column, Treasury can raise taxes or trust fund to increase the current rates. The first has been ruled out by [Prime Minister] Rajoy, at least in the short term.

The following graph shows the distribution of state revenues by item. As seen, the vast majority, almost 70% comes from direct taxes and social contributions (income tax and companies mainly). Obviously, these items depend very much on the economic activity, any slowdown could even make predictions of the Government go down, which would make the situation even more complicated.

With this background, most of the adjustment will have to come, necessarily, on the expenditure side. At his inauguration, Montoro says he will not come to the Treasury to "make cuts, but to make reforms."

65% of spending is directed to pay the debt, the Ministry of Labour and Social Security (pensions).

The rest (35%) will have to come almost all the adjustment. This is a 91,000 million euros. Imagine the magnitude of the task.

Mission Impossible

The article says debt, pensions, and unemployment are not touchable. Also, Prime Minister Rajoy has ruled out tax hikes (for the short-term) whatever that means.

The entire setup is mathematical nonsense. Should the prime minister resort to tax hikes, it will plunge Spain even deeper into recession.

Spanish unemployment is already 22.8%.

Spain's Hidden Deficit

A second article discusses Spain's Hidden Deficit

One of the foremost experts on national circumstances says "Rajoy has no room to bring out all the hidden deficit and will not." Their main argument is the experience of what happened in Greece, where Papandreou, just come to power deficit brought to light hidden by the previous government and that is the source of the recent seizures in the debt market.

The challenges for 2011 will close with a deficit equivalent to 6% of GDP today seem to me almost insurmountable. Especially considering the revenue performance.

The data announced yesterday by the Tax Office indicated, namely that fiscal consolidation measures have saved up to 8.167 million in November, including the reduction in the VAT rate to 4% on the purchase of new housing, at a cost to the exchequer audience estimated at 115 million euros.

According to the Tax Agency , the comparison between the total amount of regulatory impacts and increased revenues accumulating to November (761 million) it follows that in the absence thereof, the tax revenues would decline recorded in 2011 around -4%, "in line with the fall of the aggregate tax base of taxes in the first three quarters."

This drop in real income-without 'extraordinarios'-explains the suspicion that the real deficit will grow as and when the accounts of the autonomous communities, municipalities and social security itself, which will close this year with a deficit, when expected a surplus of four tenths of GDP, about 4,000 million euros. Especially considering that during the second half of the year the economy has performed worse than the first. And in this context, appear with a deficit of 7% or 8% before the markets seems to be a problem for the new government.

The simple translation is Spain's budget deficit is bigger than they say and revenues are expected to drop next year by 4%.

Bran writes ... "This article tells us that the new government cannot afford to bring out all the debt into the open because when Greece did so, the markets abandoned the country. For each 1% the deficit is off target, another 10 billion must be cut from 2012. People are placing the deficit for 2011 at 7 or 8% as opposed to the planned 6%. FUNCAS gave the 40 billion cut needed mentioned above based on 8% deficit this year."

The Prime Minister apparently thinks if he does not admit the debt and the worsening deficit, the market will ignore the problem. We will soon find out for how long.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Italy GDP Contracts in Q3, Heads for Harsh Recession; Bizarro World Math; Sarkozy Announces He Will Not Be Sarkozy; LIBOR-OIS Spread Says ECB's 3-Year Financing Scheme Nothing But A "Sugar Rush"

Posted: 22 Dec 2011 09:50 AM PST

With 2011 rapidly winding down EuroIntelligence discusses the LIBOR-OIS spread, the ECB's Long Term Refinance Operation (LTRO) and the End of Yet Another Suckers' Rally

There is a depressing regularity about any apparent good news that comes from Europe these days. The markets cheer for a short period, and then revert to normality once they realise that the underlying problems have once again not been addressed. The good news this time was the higher than forecast take-up of the ECB's three-year long-term financing operation [LTRO], which came in at €489bn. The markets rallied strongly on those numbers, hoping that the banks would not come to the rescue of sovereigns and start buying up bonds. In reality, what we are seeing is that banks are dumping their most toxic asset-backed securities, including their own bonds, as ECB collateral.

The FT has the story, quoting one analyst as calling the LTRO a "sugar rush" – which about sums up the overall effect of the ECB's liquidity policies. Also note that the Libor-OIS spread, which measures the stress in inter-banking markets, has not eased up since last week.

The best comment this morning on the impact of this operation came from Mark Schieritz, [Translated From German] who gives a downbeat-realistic assessment. He says the liquidity shower will have a marginally positive impact on the banking sector, in the sense that it reduces the probability of a liquidity squeeze. It probably prevents a massive liquidity crunch, but it is unlikely to lead to more private sector credit. He also dismissed the backdoor theory – that banks would now use the money to buy government bonds. One reason for their caution is that future stress tests might require a corresponding increase of core-tier one capital to back such purchases. Schrieritz concludes that most of the money will end up with the ECB.

LIBOR-OIS Spread

Wikipedia LIBOR-OIS Spread Explanation
St. Louis Fed LIBOR-OIS Spread Explanation

LIBOR-OIS Spread Chart courtesy of Bloomberg

The spread and the direction of the spread suggests underlying stress in credit markets. A healthy spread would be about .1. Although elevated, the spread is nowhere near as bad as during the Lehman collapse in 2008.

LTRO "Sugar Rush"

ZeroHedge comments on the ECB's financing scheme in Here Is The Math: Carry Trade Profits From The LTRO Are Woefully Insufficient To Make Any Impact

Following yesterday's €489 billion LTRO there are few things we know with certainty, primary among them is that the net proceeds from the 3 year refi operation are really €210 billion, due to the rolling of various other duration facilities which are already in use into the LTRO as discussed yesterday.

What we do not know, is whether the net proceeds of €210 billion have been used by banks to purchase sovereign debt or as Peter Tchir suggested, are actually used in a reflexive ponzi whereby banks use the explicit ECB guarantee to buy their own debt.

Perhaps the best evidence that the LTRO was an epic failure when it comes to subsidizing the peripheral bond market is the fact that hours after its completion the ECB was forced to jump into the secondary market and buy up billions in Italian and Spanish bonds: an action that was supposed to be conducted by the banks themselves.

Italy GDP Contracts in Q3, Heads for Harsh Recession

Reuters reports Italy economy shrinks, heads for harsh recession

Italy's economy shrank in the third quarter, setting the country on course for what is expected to be a prolonged recession hampered by a debt burden demanding harsh austerity.

Gross domestic product in the euro zone's third-largest economy sank 0.2 percent from the previous three months, hit by a fall in domestic demand. It was up just 0.2 percent year-on-year, national statistics bureau ISTAT reported on Wednesday.

The data was weaker than expected and points to an economy deeply troubled even before tough austerity measures were adopted in recent months to try to cap soaring borrowing costs.

"A flurry of poor economic data and the intense financial contagion hitting Italy from the euro zone debt crisis point to a painful and prolonged recession which is expected to prevail until the final quarter of 2012," said IHS Global Insight's Raj Badiani, who forecast a 1.5 percent GDP contraction in 2012.

This will make new, technocrat Prime Minister Mario Monti's task even harder.

Earlier this month, he presented 34 billion euros of tax hikes and spending cuts, saying Italy's third austerity package since the summer was needed because of a deteriorating growth outlook.

Bizarro World Math

Check out that last paragraph closely. Only on Bizarro World would one need tax hikes and austerity packages "because of a deteriorating growth outlook".

Sarkozy Promises to Not be Sarkozy

Also straight from Bizarro World please consider this snip from EuroIntelligence

Sarkozy announces there will be a "break" between president and candidate Sarkozy

Speaking to about 100 deputies from his own UMP, Nicolas Sarkozy announced there will be "break" between what he stands for as the current President and what the candidate Sarkozy will stand for, according to Les Echos [In French].

Without going into detail he raised expectations for the job summit he intends to hold on January 18, which may be inspired by his talks with Chancellor Gerhard Schröder past Tuesday when the former German explained how he introduced the far reaching social and labour law reforms with his „Agenda 2010" in the early 2000s. Sarkozy was upbeat regarding his chances to win the presidential elections in May 2010. The president compared his Socialist challenger Francois Hollande to former presidential hopefuls such as Edouard Balladur or Lionel Jospin who were leading the polls in December but who lost in the elections in spring.

The candidate Sarkozy is in essence running against the track record of the current French president Sarkozy. Incredible.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Bernanke Spreads "Happy Dust"; Did the Economy Respond? Will the Economy Respond? Mish 2011 Predictions Review

Posted: 22 Dec 2011 12:02 AM PST

Reader "JB" emailed a link to a Bloomberg article citing a quote by Allen Sinai, co-founder and chief global economist and strategist at Decision Economics in New York that the Fed was spreading "Happy Dust".

Indeed most of the article is about "Happy Dust", that essentially everyone will live happily ever after, and Bernanke merely ran into "Bad Luck" in 2011.

Please consider Bernanke Prods Savers to Become Consumers by Bloomberg columnist Rich Miller.

Federal Reserve Chairman Ben S. Bernanke finally may be catching a break: His easy-money policies are showing signs of speeding up the economic rebound three years after he cut interest rates to zero.

"When the Fed sprinkles happy dust on the economy, we always respond," said Allen Sinai, co-founder and chief global economist and strategist at Decision Economics in New York. "The happy dust has been out there a long, long time, and I think it finally may be settling in some places."

He sees growth accelerating in the range of 2.5 percent to 2.75 percent next year from 1.5 percent to 2 percent this year, when the economy was hit by what Bernanke called "some elements of bad luck" in a Nov. 2 news conference. These include a run- up in oil prices caused by the Arab spring and a sell-off (SPX) in the stock market triggered by Europe's debt crisis.

Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey, is even more optimistic than Sinai. Crandall -- the most-accurate forecaster of the U.S. economy as of Dec. 1, based on Bloomberg calculations -- predicts growth next year of just over 3 percent, as companies become more confident about the outlook and expand their businesses.

The resilience of the economy will lift corporate earnings and stock prices, Sinai said. Operating profits of companies in the Standard & Poor's 500 Index will rise by an average of 8 percent to 10 percent in 2012, and the stock gauge will end the year at 1,400, he forecasts -- up from 1,241.30 at 4 p.m. in New York yesterday.

Happy Dust, Bad Luck, or Wishful Thinking?

Making predictions, especially about the future, is extremely difficult - to paraphrase Yogi Berra.

Apparently no one could have foreseen the "bad luck" that came in 2011.

However, I can't help wondering what Lou Crandall and Allen Sinai were saying in 2007, 2008, and 2011.

Is there any reason to believe their forecasts for 2012? Perhaps there is. So let's see their forecasts for 2007, 2008, and 2011.

Predicting the Future is Extremely Difficult

I did not do so well predicting 2010. Happy Dust (known as QE II) got in my way. I did not think it would matter, but it did, and I was wrong.

However, I did get the turn in housing on the nose in 2005. In 2007-2008 I got the bond market on the nose with a call for record low yields across the entire yield curve. I also called for deflation (defined as a collapse in credit) and also for the rise in gold.

In a major call I took on Doug Kass in 2008 when Kass said "Sell Bonds Short".

When everyone saw inflation, I saw deflation as well as a rise in gold prices.

However, it is easy to point out good calls while ignoring the bad calls. I have had a number of bad calls as had everyone else who dares make predictions about the future.

2011 Predictions Review

Every year before I make my predictions for the next year, I take a look at how I did the past year. Sometimes it is a humiliating experience, sometimes not. However, I will put my 2011 calls up against anyone, in spite of starting off with a huge miss.

Please consider Ten Economic and Investment Themes for 2011 written December 22, 2010. Each of the 10 predictions is immediately followed by a review in retrospect.

1. US Municipal Bankruptcies Head to Center Stage
Look for Detroit and at least one other city in Michigan to go bankrupt. Also look for increasing discussions regarding bankruptcy from Los Angeles, Miami, Oakland, Houston, and San Diego. Those cities are definitely bankrupt, they just have not admitted it yet. The first major city to go bankrupt will cause a huge stir in the municipal bond market. Best to avoid Munis completely.

1 Review: Detroit is in trouble and Harrisburg did declare bankruptcy. Jefferson County Alabama became the biggest US bankruptcy in history. Thus, I could spin this into a neutral call if not a correct call. But I won't. The intent behind my call was a troubled Muni Bond market. I missed the mark. Munis in general did well. I got this wrong.

2. Sovereign Debt Crisis Hits Europe
The ECB and EU are hoping things return to normal and they can deal with things more calmly in 2013. The markets will not wait. Expect a new Parliament in Ireland to want to renegotiate whatever horrendous deal Prime Minister Brian Cowen agrees to. Portugal and Spain will need bailouts. The surprise play in Europe will be Italy, a country not on anyone's front burner. Italy will come under intense credit market pressure, and when it does the whole Eurozone comes unglued. Europe's banks are insolvent and ECB president Jean-Claude Trichet will have a choice, haircuts or massive printing.

2 Review: Emphasis in red added. This was a home run. Few if any eyes were focused on Italy or European banks when I wrote that in December 2010.

3. Cutbacks in US Cities and States
With Republican governors holding a majority of governorships, with Republicans holding a majority in the House, and with a far more conservative Senate, there is going to be little enthusiasm for increasing aid to states. There will be some aid to states of course, but nowhere near as much as needed to prevent cutbacks. Expect to see a huge number of layoffs and/or cutbacks in services. Cutbacks in cities and states will be a good thing, but that will counteract other gains in employment. The unemployment rate will stay stubbornly high.

3 Review: The unemployment rate was stubbornly high until perhaps last month (assuming 8.6% is not stubbornly high, although I think it is). There was undoubtedly cutbacks in state government across the board. This was a solid call.

4. Public Unions Under Intense Attack
Public unions will face increasing hostility, not only in the US but also the Eurozone and UK. Look for Congress to consider legislation to kill collective bargaining. If it passes, the president would veto it. The problem however will not go away. Cities and states in distress will increasingly outsource every contract they can.

4 Review: There was not fireworks at the national level but fireworks in Wisconsin and Ohio exceeded all expectations. Cities and states are indeed in stress. Unions are under attack in the UK, Greece, Spain, Italy, and Portugal.

5. China Overheats, Multiple Rate Hikes Coming
China, everyone's favorite promised land, has a hard landing. China will grow at perhaps 5-6% but that is nowhere near as much as China wants, or the world expects. Tightening in China will crack its property bubble and more importantly pressure commodities. The longer China holds off in tightening, the harder the landing.

5 Review: China did hike multiple times to slow inflation and rein in its property bubble. Growth slowed, but not to the extent I expected, but more than enough to matter. The Shanghai stock index is one of the weakest global markets. I could spin this as a home run, given sentiment on emerging markets and China was extreme to the opposite direction.

6. Property Bubble Bursts Wide Open in Australia and Canada
Australia, having largely avoided the global recession runs out of luck this time around. Look for the Australian economy to fall into outright recession. Look for Canada to slow dramatically as its property bubble pops. The US property bubble is much further progressed, by years, than Australia, Canada, and China. This matters immensely.

6 Review: Half correct. The bubble in Australia burst. The bubble in Canada did not. It will.

7. US Avoids Double Dip
The tax cut extensions and the payroll tax decrease will keep the US out of recession. However, growth estimates are still too high. The tax cut extensions do nothing more than maintain the status quo while the payroll tax deduction is just for a year. Most will use it to pay down bills. Look for GDP at 2.0-2.5%. That is the stall rate.

7 Review: Amusingly, I did better at the beginning of the year than my mid-year forecast of recession in 3rd or 4th quarter. A very good call.

8. Year That Something Matters
For the global equity markets, this will be the year that something matters. Certainly nothing mattered in 2010, and optimism for equities is at extreme levels. I have no targets other than a suggestion this is an extremely poor time to invest in darn near anything.

8 Review: That was a rock-solid call.

9. Decoupling in Reverse
I do not think any countries decouple in 2011, including China. However, on a relative basis, the US could. Europe is a basket case, China is overheating, Australia is headed for recession, the UK is going nowhere, and 2.0-2.5% growth in the US just might look damn good compared to anything else. Bear in mind far more than 2.0-2.5% US growth is priced in, but on a relative basis that is likely to smash the performance of the Eurozone, Australia, and Canada. China may grow 5.0-6.0% but with 10% priced in, overweight China, the emerging markets and the commodity producing countries is a serious mistake. Actually, equities are a mistake in general and so are commodities. Finally, falling commodity prices would be US dollar supportive and supportive of a decreasing US trade deficit as well, especially if grain prices stay high while oil sinks. Should grains stay firm while other commodities sink, it would help boost US GDP.

9 Review: Like my forecast on Italy, I am not aware of anyone else making this exact call. The US outperformed by a mile. European equities, Asian equities, Japanese equities, and Australian equities were hammered. The US was flat. This was another home run.

10. US Dollar to Strengthen
Look for the US dollar to strengthen because of the net effect of all the above issues.

10 Review: Not quite. After a ride in both directions the US dollar is roughly where it was a year ago. Given that most thought the dollar would sink, I will take half credit.

Overall Score

I will rate that 8 out of 10 with 2 home runs and possibly a couple doubles.

Here is the deal. It is very easy to get one year right or one year wrong. I have made numerous wrong calls, but fortunately more in short-term forecasting than long-term thinking.

The problem I have is mainstream media seeks out those with the hottest recent hand, but only from a list of candidates that manage the most amount of money.

People want to hear "Happy Talk", as well as "Home Runs" (but only from big names). Thus we see one-hit wonders like Paulson, coupled with "Happy Talk" in numerous places in 2007, 2008, and 2011 quoted all the time. Those who got it essentially correct for years are ignored.

In a subsequent post I will make some calls for 2012. Don't expect more home runs. This is a tough act to follow.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

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Thursday, December 22, 2011

Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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