Tuesday, 11 December 2012

Iceland: Coming in from the cold


Authors: Andrew Whitehead and Thomas Viegas

In 2008 Iceland became the first country to be hit by the ugly aftermath of the global financial crisis; the now infamous sovereign debt crisis that has now engulfed the rest of Europe. In the now familiar story the years prior to this were characterised by the embracement of unfettered capitalism and financial liberalisation that lead the newly privatised Icelandic banking industry to grow to a monstrous 1000% of GDP, economic policy described by the Chief Economist at Citigroup as “collective madness”. Although, by no means alone in the pursuit of such policies, the relative size the banking industry to a country of only 300,000 people made it unique.    

When the crash did happen it was spectacular: the stock market plummeted 90%, unemployment shot up to an all-time high and inflation rose to 18%. All the ingredients for at best, a prolonged depression and at worst the complete collapse of the economy. The situation was so dire that around 2-3% of the population immediately fled the country! This remarkable implosion not only left their economy in tatters but also resulted in the country being widely mocked. In particular the SNP leader Alex Salmond was roundly sniggered at for his previous quote that an independent Scotland could join some small nations such as Iceland to form an “arc of prosperity”, while across the water with the Irish banking system collapsing the Irish media consoled themselves by joking “at least we’re not Iceland!”

However the mockery has now quickly receded. Employment levels in Iceland have fared far better than in many other European nations, even in the depths of the crisis unemployment never reached double figures while in Greece and Spain it remains above 20%. While their employment rate is the second highest in Europe, in the latest figures (78.5%) this compares favourably against economic powerhouses Germany (72.5%) and the UK (69.5%) and even more so when compared with other small nations hit by the crisis such as Latvia (61.5%) and Ireland (59.2%)

But how has Iceland fared so well despite such an economic catastrophe? The reason is part dumb-luck and part excellent management from the Icelandic Government and, for once, the International Monetary Fund (IMF). I say dumb luck because it is the very nature of the “collective madness” described earlier that makes Iceland such an excellent test of economic doctrine accepted (or forced) on the rest of us. Due to the huge magnitude of their banking crisis (the largest ever relative to GDP), they were forced to use unorthodox measures to save their economy. In the words of economist Paul Krugman “Iceland zigged when all the conventional wisdom was that it should zag”. The rest of the developed world has followed the path of huge bailouts, resulting in the shift of private debt to public balance sheets, and the slashing of public sector spending with the hope that this would restore the much needed confidence in markets to stimulate private sector spending.

These hugely unpopular policies were sold to the public on the basis that there was no other alternative. The case of Iceland however proves that this is not true. While everyone else rushed to give taxpayers money to the banks, Iceland let them fail. While the bankers at the heart of the crisis were protected and in some cases rewarded in the US and Europe, in Iceland they were jailed and while the rest of Europe embarked on a social spending slashing binge, Iceland expanded its social safety net.  At the time, the consequences of these unconventional policies were warned against by many economists, who predicted punishment from global credit markets leading to bankruptcy and economic Armageddon. This has not been the case. Compared to Ireland, which took full responsibility for its banks debt, both suffered similar drops in GDP (14 and 15% respectively from peak to trough) but credit default swaps in Iceland are now much lower than in Ireland, indicating increased confidence in the ability of the Icelandic government to service its debt. Furthermore this year has seen the Iceland successfully return to the international credit markets for the first time in five year.

A crucial part of the recovery was the relationship between the country’s government and the International Monetary Fund, who provided a $2.1 billion loan package. Just as Iceland’s economic catastrophe and road to recovery has been unique so has its co-operation with the IMF. While in the past the IMF has been severely criticised for its role in worsening crisis, most notably in Asia in the 90’s (in South Korea what we know as the “Asian Financial Crisis” they know as the “IMF crisis”), the IMF’s response in Iceland was different. They allowed the Government freedom to maintain fiscal control, altering spending and revenues how they saw fit. More surprisingly they allowed capital controls, a move normally regarded as heresy by the Fund’s free market priests. These capital controls, although controversial, prevented the collapse of the Icelandic currency as it prevented large amounts of funds leaving the country. The measures are still in place and are based not on time but on prevailing economic conditions (a lesson the US may which to observe as they approach their fiscal cliff). Another different approach used by the IMF was allowing the maintenance and even strengthening of the Icelandic welfare system. They allowed automatic stabilisers to do their job in protecting the citizens of the country from the depths of the crisis, as inflation rose and wages fell, delaying fiscal adjustment for a more stable time. A key factor in this economic salvation was the helping out of heavily indebted households, a policy recently recommended to the US by the former chair of the Federal Deposit Insurance Corporation. This freed up consumers to spend their money on other things, no surprise then that domestic demand has been a powerful aspect in the recovery. The extension of social security resulted in inequality actually falling during the crisis as the bond and shareholders as well as foreign creditors bore the brunt of the fallout from the banking collapse.

So although Iceland did experience severe economic damage and a substantial drop in living standards, the effects on its people were contained and the economy has been able to launch its own moderate recovery.  Although comparisons between a small island of 300,000 people and large dynamic economies such as the UK may seem far-fetched it is clear lessons can be learnt from the country that ‘zigged’. The case has clearly taught the IMF a lesson, explicitly shown in the recent conference set up by the fund “Iceland’s Recovery: Lessons and Challenges” in the countries capital Reykjavik. One such noteworthy lesson , outlined by the Funds managing director, is the importance of a wide range of tools for dealing with the crisis, even if such tools go against what is being practiced elsewhere. Another is the importance of the role of the welfare system in any economy’s recovery. It has long been an accepted view that more equal societies perform better on a variety of social indicators from crime to mental health but it has been extensively believed that a trade-off exists between equity and growth. But this conception is being gradually eroded and recent research undertaken by the IMF has shown that countries grow faster and more consistently when income is shared more equally. This coupled with their recent paper stepping away from the use of austerity shows a clear change of direction for the IMF, one that will hopefully see them become an increasing effective in achieving their main goal: the safeguarding of the global economy.

The message to take from Iceland’s experience is that contrary to what the majority of policy makers keep preaching to the public about austerity being the only way forward, there is a clear and credible alternative. While Iceland’s road to recovery will not necessarily be repeated to the same extent in other economies, due to the uniqueness of its crisis, its stance on several key policy decisions can be adhered to. Iceland’s policies centred on protecting its people, assisting indebted households and holding those responsible for the crisis to account and this has rescued its country from economic disaster. Hopefully Europe’s leaders will sit up and take notice of what has been achieved in the country that zigged as currently zagging has not only resulted in increased social unrests but also shows no clear signs of short to medium term improvement in growth.

Monday, 10 September 2012

Election Stick Or Twist

As the general election draws ever closer in the US, It is evident that economics will dominate. The stance of both candidates on this issue will be vital in deciding who will be become the President for the 57th term in its history. But what is the actual state of the world’s largest economy? Growth had been on an upward trend in 2011, peaking at 3% in the fourth quarter. However with the worsening of the Eurozone debt crisis, coupled with the slowdown of the emerging economies across the world, growth slowed to 1.5% in the second quarter of 2012 with now signs of improvement in the short term. Vast amounts of deleveraging by both firms and consumers have also contributed greatly to lacklustre growth. While Keynesian theory would promote the government stepping in to replace the spending that is not forthcoming from the private sector, gridlock in congress and the upcoming elections have made further fiscal stimulus close to impossible.

Unemployment had been falling at a more than expected rate throughout 2011, a sign some believed signalled a quick recovery for the economy. Yet 2012 has brought about increased difficulty for a large proportion of economically active Americans. With the joblessness rate hovering above the 8% mark, the latest figure being 8.3% in July, and increased problems the creation of new jobs throughout the country, the sign of a quick recovery has all but evaporated.

Despite countless forecasts of high and dangerous inflation from some commentators, who Paul Krugman refers to as ‘Very Serious People’, as a result of large amounts of bond buying from the Fed. The rise in the general price level in the US has slowed greatly over the past year, falling below the target of 2% set in early 2012. This has led to increased calls for the Fed to do more in order to revive growth given it has larger scope in which to do this.

Several economists though have advocated for a long time that US economy is in a position (i.e. a ‘liquidity trap’) in which monetary policy is, to a large extent, an ineffective tool to boost growth Despite an all-time low interest rate of 0.25% for over a year and several rounds of Quantitative Easing (QE) implemented by the Federal Reserve, substantial and sustainable growth has not materialised. With the Fed also seeming to rule out any new action to kick start the economy until after election and Congress not blinking, the short term health and future direction of the US economy increasingly hinges on the outcome on November the 6th.

Running for a second consecutive term in office is President Barack Obama. He will be campaigning partly on the basis that while in office his economic policies prevented a repeat of the type of financial conditions seen in The Great Depression and now under his guidance the US is on a path to recovery, all be it a very slow one . Many would claim that the incumbent has not gone far enough with his economic policies to restore the US to the growth it saw before the financial crisis hit.

An example being his largest economic policy to date, the $787 billion 2009 ‘American Recovery and Reinvestmentstimulus package. While the total size of the package might sound like a lot, when comparing it to the size of the US economy at the time, it is minuscule. The package only accounted for around 2.6% of total GDP over the period of 2009/2010. Furthermore the central problem of a total loss of spending in the economy (estimated at around $2.9 trillion) was not properly addressed as the stimulus plan consisted of only about $600 billion of actual spending. This was clearly not enough to deal with the dramatic slump of consumption as it didn’t even cover over a third of the total spending lost.

The overall failure to restore substantial growth was clear to see. Despite the package pumping $241.9 billion into the economy, stirring growth to a robust 3.9% by early 2010. Growth, consumption and investment fell thereafter, resulting in the unemployment rate rising to 9%, as it became obvious that the package had not been large enough. Moreover the ineffectiveness of the package gave ammunition to the Republicans, who were reluctant in ratifying the plan in the first place, to prevent any additional spending by the government to help support the economy.

In the aftermath of the crisis Obama has attempted, the degree to which can be debated, to try and prevent another repeat of the implosion of the financial system. The most significant being the Dodd-Frank Wall Street Reform Act, which is the most comprehensive financial reform since the Glass-Steagall Act of 1933, with the intention to improve the overall regulation of the banking sector. But the way in which his administration approached reform in the financial sector drew anger from sections who claimed that it didn’t go far enough in reining in and punishing those responsible for the crisis in the first place.

Another major policy implementation by the President has been the Patient Protection and Affordable Care Act (PPACA) of 2010, referred to generally as Obamacare. The act, which has provoked much controversy in the county and had substantial opposition from the GOP, is aimed at decreasing the number of uninsured Americans and reducing the overall costs of the healthcare system (the US has the most expensive but inefficient system in the western world). The impact of this act is still to be seen due to the constant Republican opposition which has led it to be referred to the Supreme Court in 2012 (the court upheld the constitutionality of most of PPACA). Further improvement of the US healthcare system is one of the main pledges given by Obama should he be re-elected.

Some of the other economic policies that have been instigated by Obama include: The raising of the federal minimum wage from $5.15 an hour to $7.25, favouring an increase in capital gains tax above the present 15% rate to 20% for families whose income is above $250,000 and attempts to implement the so called ‘Buffet Rule’ which would apply a minimum tax rate of 30% on individuals making more than a million dollars a year. No doubt the biggest challenge facing Obama in his campaign will  be re-elected is to regain the trust and confidence of the American people that he is the man that can once again restore growth in the US to the level it once was, despite failing to do so first time around. It remains to be seen whether the electorate are willing to give the man, who campaigned firmly behind the slogan ‘Yes We Can!’ in 2008, another chance to revive the country’s economic fortunes or whether the US people have finally decided that ‘No He Can’t!’.

Opposing him will be Republican Mitt Romney, who recently compounded the shift to the right in US politics by appointing uber conservative Paul Ryan as his running mate. Much of the media has focused on Ryan’s and not Romney plan for the economy, perhaps a sign of the lack of direction the formers campaign is at risk of being characterised by. Romney endorses the so called Ryan Budget, the now well-known and controversial deficit reduction plan. The main victims of the cuts will be the poorest Americans, 62% of cuts are aimed at programs targeted at aiding those on low or moderately low incomes. Medicaid, a program that provides health care to those on low incomes or with disabilities, will be hit with $1.4 trillion cuts thus withdrawing health care from 11 million people. A voucher system is planned to be introduced alongside Medicaid, in the name of increasing consumer choice and competition. These buzz words translate to giving more power to insurance companies, who have it in their interests to try and reduce care and shift the focus away from pre-emptive care.

Even with these harsh cuts to social programs the budget will (if the numbers add up, and many believe they do not) take 18 years to balance. This is because of the plans to further increase military spending, which under Obama has increased to its highest level since World War II. This illustrates the hypocrisy that lies within the Republican Party’s ideology. While championing freer markets with minimal government intervention, they virulently defend an increased military budget which is ironically the least competitive US industry. 

The main reason for the focus on the Ryan Budget is that there is no clear path being proposed by Romney himself. He has released his own 59 point plan for the economy, described by some as “50 shades of Grey without the sex”, light on detail and avoiding difficult or interesting questions. This non-committal stance may be tactical, it is easy to see his opponent struggling with a weak economy while not offering an alternative that may itself be criticised, but with so much focus this election on the economy it will be risky to give it the silent treatment for too long.

A key component of the plan is Romney’s commitment to lowering taxes. With this he seeks to be seen as the candidate for the middle class. His tax cuts would represent roughly a $1000 saving for the moderately well-off family, while those earning over $1m will benefit by $250,000. The tax cuts will be paid for by making the system simpler, first by the notoriously hard task of removing  loop-holes and secondly by reducing tax breaks. These breaks include mortgage reductions, local tax deductions and pension and tax benefits, measures that all aid the middle class. Give with one hand, take away with the other.

While tax remains a divisive issue, the economic impact of Romney’s foreign policy is often forgot about amidst his pandering to Israel and approaching on racist rhetoric towards Arabs. Perhaps the most important relationship America now has is with China. Relations between the world’s two biggest economies have long been strained by the latter’s trade practises and Romney has already ruffled feathers in the Far East by labelling the Chinese “currency manipulators” and describing their currency policy as “cheating”, as well as criticising Obama’s supposed weak stance with the Chinese. What these statements will lead to if he becomes President is unclear but any trade war and rush to protectionism will be disastrous for the recovering US economy.
  
So while Mr Romney describes the levels of poverty in America as “tragic” it is undoubted that his policies will further increase inequality in the most unequal advanced economy. Even ignoring the social context of this shift, it has a wider toxic impact for the economy as a whole. With the population desperate for the economy to accelerate forward all growth is being made at the very top of the pyramid (in 2009-2010 the top 1% captured 93% of the income growth). While the majority of income growth for those at lower incomes is immediately spent, going back into economy, those at the top have a much lower propensity to spend. More importantly the richest, who have sought to buy political influence, do not require as many public services as the 99% and make a habit of avoiding taxes, so use this influence to block any attempt by Government to tax them and invest in infrastructure, education and technology. This means that many potential innovators and entrepreneurs coming from lower incomes may never have the opportunities afforded to their wealthy peers.

What must be remembered is that this is not only a divisive election for the US economy but globally. The time in which it takes for the World’s richest nation to find its feet again, will significantly impact on the prosperity of the rest of us. For the electorate it is a choice between the man that has prevented a repeat of the harsh conditions of 1930’s but has failed on his promise to return America to the path of sound and sustainable growth. While on the other side is a Republican who seeks to return the nation to its Conservative roots both fiscally and socially. Though many believe his ideal America is based on fantasy and that his policies will drive it further away from a return to prosperity.

Authors: Thomas Viegas and Andrew Whitehead

Thursday, 24 May 2012

The Inevitable Option

With the people of Greece going to the polls for a second time, after pro-austerity parties were not supported as much as needed (Funny that!), the possibility of a Greek exit from the Eurozone has become increasingly real. The The fall out this could have for the rest of the zone and the world would be massive. However a state in which Greece would keep the single currency could potentially do even more damage in the longer term. Let’s have a look at what could happen next if Greece decided to leave the zone and return to the Drachma.

First off the Drachma would plummet in value against all other currencies, and fast. This would then make imports, which include a lot of food and medicine for Greece, much more expensive and exports extremely cheap. There would almost certainly be a run on Greek Banks which would leave them on the brink of collapse. Greeks would not be able to easily access their own savings, many businesses would go bust due to lack of funds. This would also impact on other European Banks, particularly French ones, which have lent heavily to southern Europe. These banks would become nervous and slash their lending. Thus forcing many firms and consumers to cut back on their own spending. Events that all strongly point to a potential Eurozone recession. Furthermore all this would increase investor’s nervousness across the world, thus leading to the value of stocks falling and the selling off of many risk assets while the fight over safe assets would begin. Moreover let us not forget the immediate impact this would have on other zone states such as Spain especially and Italy. Access to market funds will become even harder as bond yields rise, leaving bailouts as the most viable option. In all, the worst case scenario is that the global economy falls to its knees once more.

However if Greece decided to keep the euro, which basically depends on the results of the second election in June, what would happen then? Well first off it would have to devalue to become more competitive in order to reduce its debt in the long term. The only way it could do this is through internal devaluation, reducing the unit costs of the goods and services it produces to increase its total exports. However with the unions in uproar already due to the savage public sector reductions already in force, anymore action towards reducing the public sector and its costs in further will face increased opposition. Secondly it is likely that the Greek Government would have receive further funds into to keep up with its debt repayments, something that seems increasingly unlikely due to both increased resistance by the German taxpayers and the lack of belief from other zone countries that Greece can actually pay back its debts. The pressure by investors on other southern states such as Spain and Italy would also mean that more bailout funds could be needed. In all it would be a costly and painful process for not only the Greek people but the majority of Europe.

Regarding the longer term existence of the euro, two main ideas have been put forward by both politicians and commentators. The first, which is being advocated by the new French government and is supported by Greece, is the creation of Eurobonds. These are bonds, probably 10 year bonds, which would be released by the zone states together which would allow them all to borrow money from the markets, in all it would be collective debt for the Eurozone. With Greece, Spain, Italy and Portugal facing increasing difficulties and costs from borrow money by releasing separate bonds; Eurobonds would allow these countries to borrow at a cheaper rate thus increasing the possibility of these countries repaying their debts. The main opposition to this is from Germany, who argues that it goes against the EU treaty and could lead to a large increase in costs for their country who can currently borrow around zero, or even negative, rates.

The other suggestion is increased integration of the Eurozone countries, both politically and economically. Some analysts have stated, rightly in my opinion, that creation of the euro was flawed from the beginning due to its failure to have both fiscal and monetary integration of member states. A need for a ‘United States of Europe’ or something to that effect would be needed for the zone such that if problems, like that in Greece, arose again then a transfer union and central fiscal authority would greatly help troubled zone states. This is similar to the way some poorer states, such as New Mexico and Mississippi, in the US are compensated by richer states, such as New Jersey and New York. While the future of the Eurozone and its type of existence still has some time to be decided, the current existence of Greece in the zone has not got time and even multiple options. The inevitable has finally come. The Greek exit will, for the sake of its people and the future of the euro project, and needs to happen.

Author: Thomas Viegas

Sunday, 12 February 2012

The spread of Redundantitus

There is currently a deadly disease running rampant across Europe. It has affected millions of people and left them feeling hurt, isolated and worthless. We do know its origins however; it in fact began across the Atlantic by a few groups of self interested men but let us remember that its development and advancement has occurred due to several other man made errors along the way. It is only now that we seem to be deeply concerned and are striving to find a cure to stop it before it gets even worse. The disease that I am describing is unemployment.

The old continent is currently been ravaged by the disease that has been partly caused due to the experimental cure. Austerity. The results thus far are frightful. The rate of people unemployed has now reads at 9.3% with a staggering 26.8 million out of work. It is even worse when we just observe the euro zone by itself. The unemployment amongst the 17 member state is still at the record high of 10.3%, a rate at which 16.4 million are jobless. The decision by the powers at be in Europe to implement fiscal constraint to try and achieve growth has failed on several economic growth markers i.e. GDP growth, total exports. Unemployment is just another which demonstrates that Europe needs to change fiscal paths and quickly.

The most severely infected country in Europe so far is Spain. The total number has now gone above 5 million and the unemployment rate is a towering 22.9%, a rate which many did not think was possible to witness for a developed country to ever have again. The youth are even more vulnerable to the infection with an unthinkable 51.4%, which is more than double the European Union average. Another country that has been badly contaminated is that of Greece. With the debt crisis still raging on and the squeeze on the government’s coffers getting even tighter, the public sector is suffering and suffering bad. The deal currently being thrashed out in Athens would lead to a further 150,000 people in the sector being made redundant along with a 20% in the minimum wage. With all this on top of an unemployment rate of 19.2%, the prospect for the country looks even bleaker then before (if that is even possible).

Why you may ask I am saying unemployment is like a disease? Well they are ways in which they are in fact similar; let me talk you through what I mean. Say if country X has a large amount of people unemployed (i.e. Spain) then it isn’t utilising one of its factors of production (the others being capital, land and entrepreneurship) thus it is producing less goods and services than it possibly could. This in turn would lead to less demand for goods and services by country X from country Y as the former is not producing as much as it once was*. With less demand for its goods, country Y would reduce production thus reducing the amount of people needed to work. So the unemployment rate in country Y would rise due to forced redundancies and the process would continue so on and so forth. While I accept that this is a quite simple explanation for ‘spread’ of unemployment, I do believe it can explain certain countries predicaments, with some in the euro zone being some of them. However I am not claiming that this is the only reason for Europe’s mass working decline, as it is not.

The costs of unemployment are not only economical but also social and these potential costs are very dangerous to society. Social unrest throughout the single currency zone has already been warned by the IMF and many other analysts. Rioting, striking and civil disobedience could all become seen as the norm across several countries and this needs to be prevented at all costs. However as I have said the outlook does look bleak due to the path that has been chosen by the leaders in Europe. To kill this disease, we need to find a suitable cure and from the facts so far austerity is not that cure.



*Note: The dependency of the two countries would have to be taken into account. In the euro zone the countries are very dependent on each other as they share the same currency.

Author: Thomas Viegas

Thursday, 19 January 2012

The fallacy of the 'free market'

When taught economics, one of the first things you are told to accept is that there are so called ‘free markets’. These being ‘free’ in the sense that if untouched by state intervention they will produce efficient outcomes due to the laws of demand and supply and should not fail, most of the time anyway. However this is false. ‘Free markets’ do not actually exist.  Every market has some rules and boundaries that restrict the freedom of choice for consumers and suppliers. The term ‘free market’ is actually not an economic one but in fact a political one. It is used by politicians/organisations who want to introduce market liberalization (normally not on some countries but others i.e the IMF in Asia) and strip back, in many cases, much needed government intervention into certain markets.

Markets develop and change with time and so has the term ‘free market’ also been altered. Even though the actual definition of a ‘free market’ hasn’t changed from that of a market with no government interference whatsoever. Let’s take the example of the 1819 Cotton Factories Regulation  Act in Britain of regulating child labour. At the time the proposal cause massive controversy with opponents seeing it as undermining freedom of contracts and thus the very foundations of the free market. However today it is unimaginable to think that any promoter of the ‘free market’ would advocate for a return to child labour, even though a true believer in such a market would see it as right and just.  Another example is the stock market, one of the most thought ‘free market’ markets where anyone can buy and sell shares as they please. But even the stock market has a degree of government regulation. A person cannot just go to the steps of the stock exchanges in the City of London with shares and sell them. They would have to go through a round of checks and meet certain requirements to begin trading, which is natural practice around the world.

It is well known that the Conservative Party in Britain, and throughout the most of its history, has been an advocate of a small state and letting the markets be relatively ‘free’. With David Cameron saying only today that “I believe that open markets and free enterprise are the best imaginable force for improving human wealth and happiness". However it is also widely known that the Conservative party believes in tighter immigration laws. Both of these ideas however go completely against each other. To believe in a ‘free market’ is to believe in the free movement of labour as firms would demand the lowest cost of labour possible and at the present time this would come from overseas countries such as China, India and many Eastern European states, this would also lead to cheaper goods for consumers (which they would demand) thus leading to market efficiency. However then the Conservative pledge to limit immigration in Britain while also advocating for “open markets and free enterprise” doesn’t go hand in hand. Hypocrisy many would cry.

The belief that markets, if left to their own devices, produce efficiency would suggest that capital (money or assets) would flow to places where success of investment is greater. But as Joseph Stiglitz, Nobel Prize winner in Economics pointed out, that instead of capital flowing from Western Countries to the more prosperous economies such as the BRIC’s (Brazil, Russia, India and China) where the prospect of large profits was greater in the last decade or so. Capital in fact flowed in the opposite direction and the prosperous economies actually fuelled to the Western Countries, creating a culture of people living beyond their means and thus fuelling debt problems, which is now the big problem facing the West and the World. So as some economists and politicians claim that they are trying to defend the market from political interference by the government. They are lying. The government is always involved, in some way or another, in markets and those proclaimed as ‘defenders’ are as politically motivated as anyone else.

Author: Thomas Viegas

Tuesday, 3 January 2012

After the storm: The 2011 Stock Market

As the clock finally ticked down to the dawn of a new year, trading on the world stock markets had finished for 2011. And in a year that saw the USA lose its coveted triple A credit rating after nearly defaulting in early August, Greece effectively defaulting, the euro almost disintegrate, a revolution in Libya, the slowing of the rapid growing economies and the global growth turning anaemic. These events had shaken global markets throughout 2011; the year had been wild, difficult and an ominous sign of things to come.

The year was mostly dominated by the crisis in the euro zone, and markets showed this. With the France’s Cac 40 and Germany’s Dax down 17.5% and 14.7% respectively for the year. Now considering that Germany was the euro zone’s best performer in 2010, this year has marked a dramatic change in its fortunes. Not surprisingly Greek stocks fell by more than half (52%) in 2011 showing that devastating lack of belief by global investors in its future. Another noticeable decline was in the Cypriot market with it falling by a massive 72% in the year, mostly due to the decline of Greece. The UK, where growth had stalled throughout the year as Austerity started to take place, also performed badly on the stock market. The FTSE was down 5.6% for the year but the UK managed to hold on to its triple A credit rating due to its ‘credible’ deficit reduction plan, a view that I do not particularly agree with mainly because of the future prospect of growth looks unlikely.

Across the Atlantic, the US performed better than expected with its stocks actually up for the year. This is despite the reality of defaulting at the end of summer and the clear lack of credibility between both political parties to come to an agreement over deficit reduction. And while this was recognised by credit agency Standard and Poor’s, which reduced the world’s largest economy’s credit rating from triple A (which it had always been since credit agencies had been introduced), it wasn’t by the global investors. The reason being for this was due to events across other parts of the world. With fast growing economies slowing and the euro zone on the brink, the US was seen as a safe haven for investors, especially toward the end of the year. The best performing country of 2011 was also found across the Atlantic but in the southern America. Venezuela’s √ćndice Burs√°til Caracas (IBC) was up a considerable 79% for the year. This has been put down to increased government spending as the country emerged from recession. In addition to it being one of the world’s major exporters of natural gas and oil.
In Asia the year’s picture was relatively bleak on the stock markets. Despite its high growth rates, relative to the rest of the world, China’s SSE Composite Index was lost 22% of its value in 2011. Investors seemed to question the Dragon’s short term growth prospects as global demand slumped thus impacting on China’s exports. Its historical rival, Japan also endured a bad year, in fact a horrific one. With the Tohoku earthquake in the early part of the year, it was always going to be hard for the country in 2011, and investors did not ease the pain on Japanese stocks. The results were that the Nikkei ended at its lowest level since 1982, losing a fifth of its value throughout the year.

As the year ushers in 2012 the prospects for the global economy already look bleak. With Angela Merkel, Chancellor of Germany, warning that this year will be worse than 2011. Furthermore a recent survey of prominent economists done by the BBC in the UK has shown that a euro zone recession looks an almost certainty. And that the euro zone would not remain in its current form by the end of the year, with around 40% of those surveyed predicting a breakup of the single European market. So while the fireworks and partying continue around the world the message is if you thought last year was bad, this year is going to be even worse. Happy New Year!

Author: Thomas Viegas