A few years ago, the federal government proposed changes to the Canada Pension Plan. The changes were in response to our aging population and the dramatic shift of population – the baby boomers – into retirement. These factors combined with declining fertility rates and increased claims for disability pensions meant changes had to be made to maintain the sustainability of the program and ensure it is a viable pension plan for future generations. If you remember there was changes made in regards to the management of the CPP earlier this decade with an increase to employee and employer contributions to the plan and more latitude to the CPP Board on the management of the assets – ability to take on more global exposure, etc. These recent changes to CPP will not be the last as future governments will be tasked to maintaining these programs.
The Canada Pension Plan was created by legislation in 1965 as a national social insurance system providing retirement, disability and survivor benefits. The CPP and QPP went into effect in 1966, are closely coordinated and contributions to the CPP/QPP are portable from one province to the other.
The majority of the most recent changes came into effect January 1, 2012. These new rules are impacting Canadians between the ages of 60 and 70 who have either started collecting CPP benefits or will have to soon decide when to start collecting benefits. Prior to January 1st, if you were between the ages of 60 and 70 and had started receiving your CPP benefits you were no longer required to pay CPP premiums (neither was your employer). In order to have started receiving benefits you would have had to stop working either the month before or the month that you CPP benefits would have started. If you began to collect your benefits early (between age 60 and 65), the amount of CPP benefits would have been reduced up to a maximum of 30%. If you delayed collecting benefits after your 65th birthday (up to age 70), your benefits would have increased by a maximum of 30%.
What are the New Rules?
1. Work Cessation Test and Requirement to Remit Premiums
· If you are 60 years of age or older you will no longer be required to stop work for a 2 month period in order to receive CPP benefits. If you are under age 65, you will be subject to CPP premiums on your employment and self employment income even if you are already collecting benefits. If you are between the ages of 65 and 70, you’ll be subject to CPP on your employment and self-employment income by default, but if you are already collecting CPP benefits you’ll be able to opt out of the requirement to pay premiums. If you continue contributing to CPP while already collecting benefits you’ll receive a post-retirement benefit which will be effective the calendar year following the premium payment, so that your CPP benefits will increase each year you continue your CPP contributions
2. Increase or Decrease in Benefits
· If you commence to receive CPP benefits before age 65, the reduction in your benefit entitlement will gradually increase from 0.5% to 0.6% per month by 2016, so that the maximum reduction in benefits will be 36% if you start to collect benefits at age 60. Likewise, if you delay initial receipt of your benefits to past age 65, your benefit entitlement will gradually increase from 0.5% to 0.7% per month over a three-year period (from 2011 to 2013). Therefore, the maximum increase in your benefits will be 42% if you wait until age 70 instead of age 65 before beginning to collect benefits.
These changes mean determining when to begin CPP benefits has become a more complex planning issue than in the past. If you are working past 64 and receiving CPP benefits you need to decide whether you will continue to pay your CPP premiums. These changes make it more important today to work closely with your advisor in the development and monitoring of your Retirement Income Strategy.
What about OAS?
A few weeks ago Prime Minister Harper delivered a speech at an economic summit in Geneva, where he mentioned that Canada’s other pension program, Old Age Security, was under review and considerations were made to increase the eligibility age from the current age 65. In the following weeks the finance minister, Jim Flaherty, has come out to say that any changes would not come on line until at least 2020. These comments by the government are again in response to the increasing sustainability pressures on our public pension system. This is a debate that needs to be had and will be a similar debate that will be happening in other developed nations. When looking specifically at Old Age Security we have to look at the history of the program and the many changes that have been made to in fact increase the amount that has been paid out under the program.
The Old Age Security Act came into force in 1952, replacing legislation from 1927 requiring the federal government to share the cost of provincially-run, means-tested old age benefits. The Act has been amended many times. Among the most important changes have been: the drop in age of eligibility from 70 to 65 (1965), the establishment of the Guaranteed Income Supplement (1967), the introduction of full annual cost-of-living indexation (1972), the establishment of the Spouse’s Allowance (1975), payment of partial pensions based on years of residence in Canada (1977), maximum of 1 year retroactive benefits (1995), etc. As you can see all these changes have increased the cost of the program and with the current shift in demographics the sustainability of the program is in question.
I think we would all agree that changes have to be made to these programs so they will be around for future generations and no doubt the debate will be a lively one. It is a debate that we need to have and in the end will be a worthwhile one. I encourage everyone to get involved and voice their opinion through their elected officials and directly participate in the public consultation process.
Sources: Grant Thornton LLP November 2011 Newsletter
Friday, February 24, 2012
Friday, July 22, 2011
Just the Facts - Closer Look at the US Debt Situation and Problems in Europe
Many of you have no doubt seen the doom and gloom that is being professed on the evening news, newspapers and on the internet almost every day. The old adage is “bad news sells”, and boy, is it selling these days. So far, in 2011 the world stock markets have been volatile to say the least. With the Japanese earthquake, the debt crisis in Europe and the debt ceiling in the US, one would think the markets have plummeted this year according to the media. In fact, the S&P 500 is slightly up year to date and the TSX is down approximately 1%.
The objective of my blog today is to provide you with some facts around the situation in the US and in Europe. First, in the US the second round of quantitative easing (QE2 which is an increase in the money supply so public debt can be serviced by the government) ended at the end of June. The current debt ceiling in the US is $14.3 trillion. The US has reached this and requires this be raised on order to service upcoming maturing government bonds. The deadline to raise this ceiling is August 2. Currently, the US is in a presidential election cycle so there is a tremendous amount of political posturing going on between the Democrats and Republicans. Both are trying to increase their favor with the voting public. The Democrats are suggesting a combination of modest tax increases and cuts to government spending while the Republicans do not want to consider any tax increases. While both parties negotiate a deal, I am of the opinion there is very little chance that a compromise deal will not get done. The alternative to the US not increasing the debt ceiling is not in anyone’s best interest. If the world’s largest economy defaults on its debt this will result in a downgrade to their debt rating (the rating institutions have threatened this to hopefully motivate the decision makers) which will increase their cost of borrowing and reduce the value of all the US debt currently being held around the world – the largest holder being the Chinese.
The Republicans passed a motion through Congress that will most likely be defeated in the Senate and President Obama has promised a veto which called for a cut and cap in government spending. It would allow the debt ceiling to be raised by $2.4 trillion as long as Congress approves a balanced budget amendment to the Constitution. As recently as yesterday, a bi-partisan Senate proposal has been circulated with a $3.7 trillion debt reduction plan. At the end of the day a deal will be struck.
The US is currently attempting to grow themselves out of their deficit by keeping their dollar artificially low (helps manufacturers export their products) and keeping interest rates low so consumers can continue to service their debt and get their balance sheets in order as well as encourage spending with homes, etc. Once a new president is elected and during the first year of office in 2013, this will be the opportune time to begin increasing taxes – perhaps a Value Added Tax, etc as currently the political will is not there to increase taxes.
If we focus on some of the economic statistics that have come out over the recent weeks, it is clear that recovery continues albeit at a slow pace. In the second quarter the US experienced a normal mid-cycle slowdown. The balance sheets of the banks are in a lot better position than they were 2-3 years ago (same with corporations and individuals). The expectation for hiring is good and credit is available. Loan charge offs and delinquency rates are down indicating improved consumer health. The unemployment rate in the US continues to go down albeit at a slow pace. If we look back 50 years on previous recessions, employment has taken longer to improve in each successive recession due to technology and continued increase productivity. If we expand our view globally, we saw 4.3% in annualized GDP growth in the second quarter of 2011 (World Economic Outlook, April 2010).
THE EUROPEAN SITUATION
Now turning our attention to Greece. Early in 2010, Greece’s inability to service their debt became evident to the rest of the world and the threat of the country defaulting on their debt was a real possibility. Thanks to the intervention of the International Monetary Fund and the European Central Bank a “line of credit” was established called the European Financial Stability Facility. As long as countries introduce measures to address the public debt problems than this facility is available to them. Greece, Ireland and Portugal have already accessed this facility. What it does is allow these countries refinance their debt in controlled, transparent way. To put things in context, the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) represent only 4% of world GDP (International Monetary Fund Estimate 2010 and CIA Fact Book 2010) and so long as Germany and France remain strong economic powers (as they are today), the threat of one or more of these countries defaulting and pulling the world into a global recession is remote. The other positive point is that the EU has taken ownership over the issue and convened various meetings and summits (one this week) to ensure there is a clear consensus among all policy makers. European leaders negotiated a Greek aid package yesterday during an emergency summit in Brussels. Banks will voluntarily agree to write down the value of their Greek securities by 21% as part of a bond buyback and exchange program. Europe’s 90 biggest banks hold about 98 billion Euros of Greek debt. This package will require the banks to contribute 54 billion Euros. (Bloomberg)
The most recent source of market volatility was the passing of austerity measures in Greece to ensure they would receive funding from the IMF and European Union. While these measures were met with public protests and political brinksmanship, they were passed in the end. While this is the first on many measures, I am sure there will be protests again at a later date. A summary of the Greek austerity measures include:
Tax Increases
· Solidarity Levy – applied to all citizens – amount dependent on income
· Lower Income Tax Free Threshold
· Sales Tax – VAT increased from 13% to 23%
· Wealth Taxes – yachts, pools, property
Spending Cuts
· Public Sector Wages decreased by 15%
· Public Sector Wage Bill – cut 150,000 public sector jobs
· Social Benefits Reforms – raise retirement age to 65
· Spending Cuts
· Social Contribution – cut down on evasion
· Public Investment – decrease spending on infrastructure
Privatization of Government Companies
They say that the biggest issues contributing to Greece’s debt problems is corruption resulting in poor tax enforcement (it was estimated that around 25% taxes are not being paid in Greece), corruption does not go along with transparency. What is important to keep in mind that with both the situation in Europe and the US, is that all the information is known and priced into the markets. It is the unknown or unforeseen events that trigger short term market volatility. It is important to ensure your portfolio continues to remain well diversified and actively managed. As well, maintaining an asset mix that matches your time horizon, risk tolerance and stage of life.
Cheers,
Chris
The objective of my blog today is to provide you with some facts around the situation in the US and in Europe. First, in the US the second round of quantitative easing (QE2 which is an increase in the money supply so public debt can be serviced by the government) ended at the end of June. The current debt ceiling in the US is $14.3 trillion. The US has reached this and requires this be raised on order to service upcoming maturing government bonds. The deadline to raise this ceiling is August 2. Currently, the US is in a presidential election cycle so there is a tremendous amount of political posturing going on between the Democrats and Republicans. Both are trying to increase their favor with the voting public. The Democrats are suggesting a combination of modest tax increases and cuts to government spending while the Republicans do not want to consider any tax increases. While both parties negotiate a deal, I am of the opinion there is very little chance that a compromise deal will not get done. The alternative to the US not increasing the debt ceiling is not in anyone’s best interest. If the world’s largest economy defaults on its debt this will result in a downgrade to their debt rating (the rating institutions have threatened this to hopefully motivate the decision makers) which will increase their cost of borrowing and reduce the value of all the US debt currently being held around the world – the largest holder being the Chinese.
The Republicans passed a motion through Congress that will most likely be defeated in the Senate and President Obama has promised a veto which called for a cut and cap in government spending. It would allow the debt ceiling to be raised by $2.4 trillion as long as Congress approves a balanced budget amendment to the Constitution. As recently as yesterday, a bi-partisan Senate proposal has been circulated with a $3.7 trillion debt reduction plan. At the end of the day a deal will be struck.
The US is currently attempting to grow themselves out of their deficit by keeping their dollar artificially low (helps manufacturers export their products) and keeping interest rates low so consumers can continue to service their debt and get their balance sheets in order as well as encourage spending with homes, etc. Once a new president is elected and during the first year of office in 2013, this will be the opportune time to begin increasing taxes – perhaps a Value Added Tax, etc as currently the political will is not there to increase taxes.
If we focus on some of the economic statistics that have come out over the recent weeks, it is clear that recovery continues albeit at a slow pace. In the second quarter the US experienced a normal mid-cycle slowdown. The balance sheets of the banks are in a lot better position than they were 2-3 years ago (same with corporations and individuals). The expectation for hiring is good and credit is available. Loan charge offs and delinquency rates are down indicating improved consumer health. The unemployment rate in the US continues to go down albeit at a slow pace. If we look back 50 years on previous recessions, employment has taken longer to improve in each successive recession due to technology and continued increase productivity. If we expand our view globally, we saw 4.3% in annualized GDP growth in the second quarter of 2011 (World Economic Outlook, April 2010).
THE EUROPEAN SITUATION
Now turning our attention to Greece. Early in 2010, Greece’s inability to service their debt became evident to the rest of the world and the threat of the country defaulting on their debt was a real possibility. Thanks to the intervention of the International Monetary Fund and the European Central Bank a “line of credit” was established called the European Financial Stability Facility. As long as countries introduce measures to address the public debt problems than this facility is available to them. Greece, Ireland and Portugal have already accessed this facility. What it does is allow these countries refinance their debt in controlled, transparent way. To put things in context, the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) represent only 4% of world GDP (International Monetary Fund Estimate 2010 and CIA Fact Book 2010) and so long as Germany and France remain strong economic powers (as they are today), the threat of one or more of these countries defaulting and pulling the world into a global recession is remote. The other positive point is that the EU has taken ownership over the issue and convened various meetings and summits (one this week) to ensure there is a clear consensus among all policy makers. European leaders negotiated a Greek aid package yesterday during an emergency summit in Brussels. Banks will voluntarily agree to write down the value of their Greek securities by 21% as part of a bond buyback and exchange program. Europe’s 90 biggest banks hold about 98 billion Euros of Greek debt. This package will require the banks to contribute 54 billion Euros. (Bloomberg)
The most recent source of market volatility was the passing of austerity measures in Greece to ensure they would receive funding from the IMF and European Union. While these measures were met with public protests and political brinksmanship, they were passed in the end. While this is the first on many measures, I am sure there will be protests again at a later date. A summary of the Greek austerity measures include:
Tax Increases
· Solidarity Levy – applied to all citizens – amount dependent on income
· Lower Income Tax Free Threshold
· Sales Tax – VAT increased from 13% to 23%
· Wealth Taxes – yachts, pools, property
Spending Cuts
· Public Sector Wages decreased by 15%
· Public Sector Wage Bill – cut 150,000 public sector jobs
· Social Benefits Reforms – raise retirement age to 65
· Spending Cuts
· Social Contribution – cut down on evasion
· Public Investment – decrease spending on infrastructure
Privatization of Government Companies
They say that the biggest issues contributing to Greece’s debt problems is corruption resulting in poor tax enforcement (it was estimated that around 25% taxes are not being paid in Greece), corruption does not go along with transparency. What is important to keep in mind that with both the situation in Europe and the US, is that all the information is known and priced into the markets. It is the unknown or unforeseen events that trigger short term market volatility. It is important to ensure your portfolio continues to remain well diversified and actively managed. As well, maintaining an asset mix that matches your time horizon, risk tolerance and stage of life.
Cheers,
Chris
Tuesday, March 15, 2011
Commentary on the Situation in Japan
The recent earthquake and subsequent tsunami in Japan has naturally caught the world’s attention. Our thoughts are with the people of Japan during this time of great human suffering.
One of our management teams, Signature Global Advisors, has provided me with their view on how this natural disaster will impact the Japanese economy. Below is a brief commentary from Drummond Brodeur, Portfolio Manager from our Signature team who specializes in Asian securities. Drummond also discusses their funds’ exposure to Japanese securities.
At this time, many uncertainties remain and the key risks of further aftershocks and nuclear accidents are impossible to quantify.
In terms of our portfolio exposure, all of our funds were significantly underweight in Japan compared to their respective benchmarks. Beyond our global and international funds, no fund has a direct exposure greater than 1%.
We do expect there to be several short-term implications as markets asses the scale of damage and policy responses. From a macro perspective, there will clearly be a near-term hit to Japan’s fledging economic recovery, as many factories and facilities close for varying lengths of time to asses and repair any damage. In the medium-term, there will be an offset as significant disaster recovery and infrastructure rebuilding commences. The earthquake and tsunami hit to the north of Tokyo while the core of Japan’s industrial heartland is to the south. Overall, most of Japan’s key global industries and international trade infrastructure remains operational. The region covered by the disaster is estimated to account for about 6% of Japan’s GDP.
The Japanese government will be required to fund significant rebuild programs and given their massive debt and deficit, how these get funded is unclear. Certainly, some will come from various reserves designed for such purposes, but it will also likely require additional borrowing, which could potentially be funded through further easing by the Bank of Japan (BOJ) or quantitative easing as the U.S. calls it. I have argued for many years that with structural deflation and a strong Yen, the BOJ should be printing more money regardless and such a tragedy may be a catalyst for more aggressive policy. While the Japanese government may have a massive debt, we cannot forget that Japan as a nation has massive net savings and continues to run a current account surplus, so policy options do exist. As for the currency, initial strength is expected as funds are repatriated by companies and financial institutions. Think of insurance companies facing significant claims needing to sell and repatriate some of their overseas holdings. By later in the year, I would expect any Yen strength to reverse as weaker economic numbers and low rates weigh on the currency, particularly if the U.S. recovery continues to gain traction. The ultimate pace and direction for the currency will be dependent on Japan’s policy decisions over the coming months, which we will continue to monitor.
One area of particular concern is the damage to nuclear facilities. While the extent of damage and radiation leakage remains unclear, at the very least, one and possibly two plants have been rendered permanently inoperable while several more have been shut down to asses any potential damage and will be offline for months. In the near-term, Japan will have to rely on a significant increase in gas, oil and coal fired power generation, thereby increasing demand for oil, gas and coal imports. One likely consequence of the unfolding nuclear plant accidents will also be an increased aversion globally to expanding nuclear power generation, particularly in the West.
Several refineries have also been closed, so we can expect a decline in crude imports and an increase in refined product demand, leading to an overall tightening in these markets. For the electronic components and auto industries, there will be some specific disruptions in supply chains, but for the most part, these industries are globally diversified and supply will be sourced from alternative sources and existing inventories, thereby also tightening up several of these markets as well.
We were lucky to have a very limited exposure to the areas directly impacted by this disaster. All of our portfolio managers and analysts continue to look into the potential implications in their sectors and holdings, and will interpret information as it becomes available. In short, the unpredictable nature of such events only underscores the need for well diversified portfolios, across regions, sectors and asset classes, where appropriate, such as those managed by the Signature Team.
Drummond Brodeur, Signature Global Advisors
One of our management teams, Signature Global Advisors, has provided me with their view on how this natural disaster will impact the Japanese economy. Below is a brief commentary from Drummond Brodeur, Portfolio Manager from our Signature team who specializes in Asian securities. Drummond also discusses their funds’ exposure to Japanese securities.
At this time, many uncertainties remain and the key risks of further aftershocks and nuclear accidents are impossible to quantify.
In terms of our portfolio exposure, all of our funds were significantly underweight in Japan compared to their respective benchmarks. Beyond our global and international funds, no fund has a direct exposure greater than 1%.
We do expect there to be several short-term implications as markets asses the scale of damage and policy responses. From a macro perspective, there will clearly be a near-term hit to Japan’s fledging economic recovery, as many factories and facilities close for varying lengths of time to asses and repair any damage. In the medium-term, there will be an offset as significant disaster recovery and infrastructure rebuilding commences. The earthquake and tsunami hit to the north of Tokyo while the core of Japan’s industrial heartland is to the south. Overall, most of Japan’s key global industries and international trade infrastructure remains operational. The region covered by the disaster is estimated to account for about 6% of Japan’s GDP.
The Japanese government will be required to fund significant rebuild programs and given their massive debt and deficit, how these get funded is unclear. Certainly, some will come from various reserves designed for such purposes, but it will also likely require additional borrowing, which could potentially be funded through further easing by the Bank of Japan (BOJ) or quantitative easing as the U.S. calls it. I have argued for many years that with structural deflation and a strong Yen, the BOJ should be printing more money regardless and such a tragedy may be a catalyst for more aggressive policy. While the Japanese government may have a massive debt, we cannot forget that Japan as a nation has massive net savings and continues to run a current account surplus, so policy options do exist. As for the currency, initial strength is expected as funds are repatriated by companies and financial institutions. Think of insurance companies facing significant claims needing to sell and repatriate some of their overseas holdings. By later in the year, I would expect any Yen strength to reverse as weaker economic numbers and low rates weigh on the currency, particularly if the U.S. recovery continues to gain traction. The ultimate pace and direction for the currency will be dependent on Japan’s policy decisions over the coming months, which we will continue to monitor.
One area of particular concern is the damage to nuclear facilities. While the extent of damage and radiation leakage remains unclear, at the very least, one and possibly two plants have been rendered permanently inoperable while several more have been shut down to asses any potential damage and will be offline for months. In the near-term, Japan will have to rely on a significant increase in gas, oil and coal fired power generation, thereby increasing demand for oil, gas and coal imports. One likely consequence of the unfolding nuclear plant accidents will also be an increased aversion globally to expanding nuclear power generation, particularly in the West.
Several refineries have also been closed, so we can expect a decline in crude imports and an increase in refined product demand, leading to an overall tightening in these markets. For the electronic components and auto industries, there will be some specific disruptions in supply chains, but for the most part, these industries are globally diversified and supply will be sourced from alternative sources and existing inventories, thereby also tightening up several of these markets as well.
We were lucky to have a very limited exposure to the areas directly impacted by this disaster. All of our portfolio managers and analysts continue to look into the potential implications in their sectors and holdings, and will interpret information as it becomes available. In short, the unpredictable nature of such events only underscores the need for well diversified portfolios, across regions, sectors and asset classes, where appropriate, such as those managed by the Signature Team.
Drummond Brodeur, Signature Global Advisors
Thursday, March 3, 2011
A Glass Half Full
Please see below some excerpts from a commentary on the situation in Europe by Richard J Wylie, Vice President Investment Strategy for Assante Wealth Management. In his comments he highlights the reforms that have taken place by the European Union to help Greece, Ireland, Portugal and Spain restructure their debt in an orderly manner.
Recent European history seems to be full of financial crises. In the fall of 2008, Iceland’s three major commercial banks collapsed, and that was followed by more turmoil on the continent. However, even though Europe has seen plenty of shocks, signs of improvement have appeared. As with most industrialized nations, the major European economies have found that global growth, driven by the developing world, has translated into stronger exports. In addition, the region-leading German economy has seen considerable improvement since the end of the recession.
Debt and deficit
Most of the headline-grabbing news in Europe has been with respect to what is now being called the “sovereign debt crisis.” As the original creation of the Eurozone raised the interconnectivity of those countries that use the euro, so too did it increase the risk of contagion spreading if financial problems were to emerge. Greece’s borrowing problems became a headline issue in early 2010. Worries quickly spread to include nations that would eventually be branded the “PIIGS” – Portugal, Ireland, Italy, Greece and Spain. After the introduction of the euro in Greece in 2001, the country was able to borrow at lower interest rates than had previously been possible under the nation’s former currency, the drachma. However, new
borrowing at lower interest rates was not used to retire higher interest rate debt: Greece’s overallindebtedness continued to climb, along with heavy social spending.
Debts and deficits among the so-called PIIGS were significant economic issues in 2010. The global financial crisis that began in 2008 and the subsequent widespread recession had a particularly large effect on Greece. Real gross domestic product (GDP) declined by 2.0% in 2009 and the International Monetary Fund expects the Greek economy will have contracted by an additional 4.0% during 2010. Eventually, government austerity measures and a European Union loan arrangement helped to restore some stability to the Greek government’s finances. Similarly, Ireland was on the receiving end of a €67.5 billion bailout later in 2010. As worries over the plight of Portugal arose in the wake of the Irish crisis, a framework for assisting member nations emerged. To shore up longer-term confidence in the euro, European Union finance ministers also agreed on a permanent mechanism that from 2013 onward would allow a country to restructure its debts once it has been deemed insolvent.
Currency implications
Interestingly, if the PIIGS were applying today to enter the Eurozone and use the euro as their common currency, they would not meet the Maastricht criteria, which are the requirements for membership:
1. The ratio of government deficit to GDP must not exceed 3% and the ratio of government debt to GDP must not exceed 60%.
2. There must be a sustainable degree of price stability and an average inflation rate, observed over a period of one year before the examination, which does not exceed by more than one and a half percentage points that of the three best performing member states in terms of price stability.
3. There must be a long-term nominal interest rate which does not exceed by more than two percentage points that of the three best performing member states in terms of price stability.
4. The normal fluctuation margins provided for by the exchange-rate mechanism must be respected without severe tensions for at least the last two years before the examination.
Source: European Central Bank
However, today’s practical realities of maintaining the Eurozone have allowed for flexibility. Debt and deficit targets as opposed to unbending requirements have become part of the bailout packages. As well, because these nations are members of the Eurozone, they cannot unilaterally stimulate their respective economies with monetary policy. They are not free to independently pursue policies like lowering interest rates or using quantitative easing if they desire – options that are available to nations like Canada and the U.S., for example, which do not have linked currencies. Eurozone countries face the catch-22 of wanting to stimulate their economies but having to adopt austerity measures to qualify for the bailout packages.
Germany generates robust growth
While much recent market attention has been focused on the travails of the PIIGS, significant improvements have been seen in Europe, particularly in Germany. By the close of 2010, Germany recorded a new 18-year low in unemployment, declining to 6.8% – and itsemployment level exceeded the pre-recession peak. In line with the employment gains, wages and salaries rose 3.8% during 2010. However, consumption edged up only 0.5% over the year.
Despite the relatively soft growth in Germany's domestic spending, the economy recovered surprisingly quickly from the economic crisis, revealing some disparity between it and other European nations. German gross domestic product (GDP) advanced at roughly twice the pace of the Eurozone economy as a whole for 2010. In fact, Germany's overall economy grew at its strongest rate since the country's reunification in 1990. Significantly, trade was key to the nation’s improving circumstances. Exports in 2010 surged 14.2% in inflation-adjusted terms, while imports rose 13.0%. This followed on the heels of declines of 14.3% and 9.4%, respectively, in 2009. Not surprisingly, developing nations where economic growth has been strongest were providing growing demand for German exports. In particular, well-recognized luxury brands experienced strong export growth. Chinese demand for luxury autos has been especially robust. According to marketing research firm J.D. Power and Associates, China’s
luxury car segment expanded by more than 40% in 2010 and nine of the top-selling luxury models in China are German, led by Audi.
Elsewhere
While China is not the only destination for European exports, it does stand out as one of the fastest growing. Global management consulting firm Bain & Company estimated that the Chinese luxury market grew by more than 23% in 2010. As this suggests, one of the paradoxes of this communist country is that luxury exports from Europe are in very high demand. Italy’s Ferrari announced its 999th Chinese customer in January 2010, something that would have been impossible before China began its economic reformation. Also, retail outlets for other well-known European luxury goods providers, from clothing to jewelry, are becoming more commonplace within the country. The United Kingdom, France and the other nations that
export these goods will derive increasing benefit from this trend. Avoiding protectionism and fostering improved trade ties should eventually benefit all of Europe.
Conclusions
• The European sovereign debt issue will continue to take time to play out. Additional bailout funds and austerity measures may yet be required, but in the end the fiscal and monetary lessons learned will provide a firmer base for the region’s economic expansion.
• Germany stands as an example of how good economic and financial market news can be drowned out by other events within the region. Good prospects for continued expansion in trade will further bolster overall economic growth for Europe.
• Looking beyond the headlines for investment opportunities can bear fruit.
• Investors can capture opportunities if they use a disciplined approach, professional advice and welldiversified portfolios.
Recent European history seems to be full of financial crises. In the fall of 2008, Iceland’s three major commercial banks collapsed, and that was followed by more turmoil on the continent. However, even though Europe has seen plenty of shocks, signs of improvement have appeared. As with most industrialized nations, the major European economies have found that global growth, driven by the developing world, has translated into stronger exports. In addition, the region-leading German economy has seen considerable improvement since the end of the recession.
Debt and deficit
Most of the headline-grabbing news in Europe has been with respect to what is now being called the “sovereign debt crisis.” As the original creation of the Eurozone raised the interconnectivity of those countries that use the euro, so too did it increase the risk of contagion spreading if financial problems were to emerge. Greece’s borrowing problems became a headline issue in early 2010. Worries quickly spread to include nations that would eventually be branded the “PIIGS” – Portugal, Ireland, Italy, Greece and Spain. After the introduction of the euro in Greece in 2001, the country was able to borrow at lower interest rates than had previously been possible under the nation’s former currency, the drachma. However, new
borrowing at lower interest rates was not used to retire higher interest rate debt: Greece’s overallindebtedness continued to climb, along with heavy social spending.
Debts and deficits among the so-called PIIGS were significant economic issues in 2010. The global financial crisis that began in 2008 and the subsequent widespread recession had a particularly large effect on Greece. Real gross domestic product (GDP) declined by 2.0% in 2009 and the International Monetary Fund expects the Greek economy will have contracted by an additional 4.0% during 2010. Eventually, government austerity measures and a European Union loan arrangement helped to restore some stability to the Greek government’s finances. Similarly, Ireland was on the receiving end of a €67.5 billion bailout later in 2010. As worries over the plight of Portugal arose in the wake of the Irish crisis, a framework for assisting member nations emerged. To shore up longer-term confidence in the euro, European Union finance ministers also agreed on a permanent mechanism that from 2013 onward would allow a country to restructure its debts once it has been deemed insolvent.
Currency implications
Interestingly, if the PIIGS were applying today to enter the Eurozone and use the euro as their common currency, they would not meet the Maastricht criteria, which are the requirements for membership:
1. The ratio of government deficit to GDP must not exceed 3% and the ratio of government debt to GDP must not exceed 60%.
2. There must be a sustainable degree of price stability and an average inflation rate, observed over a period of one year before the examination, which does not exceed by more than one and a half percentage points that of the three best performing member states in terms of price stability.
3. There must be a long-term nominal interest rate which does not exceed by more than two percentage points that of the three best performing member states in terms of price stability.
4. The normal fluctuation margins provided for by the exchange-rate mechanism must be respected without severe tensions for at least the last two years before the examination.
Source: European Central Bank
However, today’s practical realities of maintaining the Eurozone have allowed for flexibility. Debt and deficit targets as opposed to unbending requirements have become part of the bailout packages. As well, because these nations are members of the Eurozone, they cannot unilaterally stimulate their respective economies with monetary policy. They are not free to independently pursue policies like lowering interest rates or using quantitative easing if they desire – options that are available to nations like Canada and the U.S., for example, which do not have linked currencies. Eurozone countries face the catch-22 of wanting to stimulate their economies but having to adopt austerity measures to qualify for the bailout packages.
Germany generates robust growth
While much recent market attention has been focused on the travails of the PIIGS, significant improvements have been seen in Europe, particularly in Germany. By the close of 2010, Germany recorded a new 18-year low in unemployment, declining to 6.8% – and itsemployment level exceeded the pre-recession peak. In line with the employment gains, wages and salaries rose 3.8% during 2010. However, consumption edged up only 0.5% over the year.
Despite the relatively soft growth in Germany's domestic spending, the economy recovered surprisingly quickly from the economic crisis, revealing some disparity between it and other European nations. German gross domestic product (GDP) advanced at roughly twice the pace of the Eurozone economy as a whole for 2010. In fact, Germany's overall economy grew at its strongest rate since the country's reunification in 1990. Significantly, trade was key to the nation’s improving circumstances. Exports in 2010 surged 14.2% in inflation-adjusted terms, while imports rose 13.0%. This followed on the heels of declines of 14.3% and 9.4%, respectively, in 2009. Not surprisingly, developing nations where economic growth has been strongest were providing growing demand for German exports. In particular, well-recognized luxury brands experienced strong export growth. Chinese demand for luxury autos has been especially robust. According to marketing research firm J.D. Power and Associates, China’s
luxury car segment expanded by more than 40% in 2010 and nine of the top-selling luxury models in China are German, led by Audi.
Elsewhere
While China is not the only destination for European exports, it does stand out as one of the fastest growing. Global management consulting firm Bain & Company estimated that the Chinese luxury market grew by more than 23% in 2010. As this suggests, one of the paradoxes of this communist country is that luxury exports from Europe are in very high demand. Italy’s Ferrari announced its 999th Chinese customer in January 2010, something that would have been impossible before China began its economic reformation. Also, retail outlets for other well-known European luxury goods providers, from clothing to jewelry, are becoming more commonplace within the country. The United Kingdom, France and the other nations that
export these goods will derive increasing benefit from this trend. Avoiding protectionism and fostering improved trade ties should eventually benefit all of Europe.
Conclusions
• The European sovereign debt issue will continue to take time to play out. Additional bailout funds and austerity measures may yet be required, but in the end the fiscal and monetary lessons learned will provide a firmer base for the region’s economic expansion.
• Germany stands as an example of how good economic and financial market news can be drowned out by other events within the region. Good prospects for continued expansion in trade will further bolster overall economic growth for Europe.
• Looking beyond the headlines for investment opportunities can bear fruit.
• Investors can capture opportunities if they use a disciplined approach, professional advice and welldiversified portfolios.
Wednesday, September 1, 2010
Time to Take Advantage of Gloomy US Markets
Good Morning,
I came across this article from Larry Sarbit which really caught my eye. What is interesting is this money manager has been the eternal pessimist over the past decade. For the past decade most of his portfolios have been invested in cash....at one point at AIC he was holding 3 stocks with Waste Management being his largest and the rest was on cash at over 70%. His fund is now 15% cash and 85% stocks -the eternal pessimist is jumping in with both feet. Larry Sarbit is the CEO and Chief Investment Officer for Sarbit Advisory Services and sub-advisor to IA Clarington Sarbit US Equity Fund. Here are some excerpts:
Time to take advantage of gloomy U.S. equity markets
You should be buying American now: The sale won't last forever
I remember John Templeton on the PBS show, Wall Street Week in the summer of 1982 when the U.S. markets were trading at ridiculous bargain prices. The gloom at the time was so thick you couldn’t help but feel it.
Mr. Templeton’s advice cut through it all: Stocks are at fire-sale prices – they won’t be this low again for a generation. And he was right.
Moments like that are rare but we are living in one now.
They tend to happen when the available evidence looks so lopsided that you simply have to cut through it all if you are going to figure out what to do. And right now the task is cutting through the fear and loathing around the idea of investing in anything American. To put it bluntly: You should be buying American now.
'Clients won’t buy anything in the U.S. – period.'
Why do I say that? Well, clients usually give you a range of opinions about what they like or don’t like. A consensus view might rise up from time to time, but generally the outlook is mixed or divided. Not now.
I just got off the road talking to advisers, planners and brokers. Every single visit the exact same message was delivered: “Clients won’t buy anything in the U.S. – period. If it has any U.S. content, they won’t touch it!" Meanwhile, U.S investors, according to the Investment Company Institute, have withdrawn a staggering $33.12-billion (U.S.) from domestic stock market mutual funds in the first seven months of the year.
The sort of unanimity of opinion of the masses that the U.S. markets are radioactive, is exceptional, to say the least. I’ve been in the investment business for 31 years and I’ve seen a few such circumstances – the market bottom of 1982, the gold and precious metals buying panic in the late 1970s and early 80s, the tech madness at the beginning of this century, to name a few.
Now, we have seen some dire circumstances strike fear into the hearts of investors – the financial crisis did start in the U.S. after all; there is a lot of debt is piling up at all levels of government; the stimulus package seems to not quite be doing enough; unemployment remains stubbornly high; and on and on it goes.
It’s worse in a way for Canadian investors since anyone holding unhedged U.S. investments has been clobbered by the loonie’s rise against the greenback. There have been terrific returns here at home as well. From the sound of things, it seems that a lot more Canadians intend to keep their loonies here at home. Wrong move.
Before we relegate America to the trash heap of other fallen economic and military empires, remember that they have been through worse. It will undoubtedly take time and cost to get over the current mess. But America is a vibrant nation, composed of an entrepreneurial, adaptable people who don’t easily accept being second rate.
As usual, people mistakenly conclude that what has happened in the past is indicative of what the future will look like.
Warren Buffett, referring to pension fund managers, said back in a 1979 article, that they “continue to make investment decisions with their eyes firmly fixed on the rearview mirror. This generals-fighting-the-last-war approach has proved costly in the past and will likely prove equally costly this time around."
Canadian Stocks
Ten years ago, all clients wanted were U.S. and global investments, after they had achieved a fantastic appreciation over the previous 18 years. Canada? You couldn’t give Canadian investments away a decade ago. Fixed income, balanced funds, and dividend funds – at the time, all out of favour.
And which categories outperformed over the next 10 years? We all know the answer. Canadian equities have comfortably outperformed U.S. and global stocks.
In August, 1999, I wrote an article in this paper in which I said, “The only predictive statement I feel comfortable in making is that I’d be shocked if the next 20 years’ worth of returns even slightly resemble the past 15 to 20 years."
I went to large cash positions in our U.S. investment vehicle because I couldn’t find what I was looking for – wonderful businesses at bargain prices. Many investors didn’t appreciate this stance but I’ll let my track record speak for itself. We protected our clients from losses and actually made money over the decade. That was not too bad, especially compared with the no-return world of the average U.S. business during the same period.
There are rare occasions when the evidence is so overwhelming, that you can make such broad pronouncements. So, here’s my prediction: I’d be shocked if you don’t make a lot of money in U.S. stocks over the next decade.
Bargain Prices
As usual, I can’t begin to forecast what will happen in the short term. What I do know is that for the first time in years, I’m finding fantastic businesses for sale at what I know are bargain prices. Are you all sitting down? I’m over 70 per cent invested (in the early 2000s I reached peak cash at about 90 per cent), and buying more U.S. equities almost every day.
Mr. Buffett brilliantly summed up our current situation from his perch in 1979: “There may well be some period in the near future when financial markets are demoralized and much better buys are available in equities; that possibility exists at all times. But you can be sure that at such a time the future will seem neither predictable nor pleasant. Those now awaiting a ‘better time’ for equity investing are highly likely to maintain that posture until well into the next bull market."
In my opinion, there currently exists an exceptional opportunity for investors to pick up some real bargains in the U.S. equity markets. When economic conditions are this dismal, at some point, the environment will begin to turn positive and a lot of money will be made. But remember: The opportunity won’t last forever.
Our investment philosophy remains committed to well diversified portfolio that includes exposure to US companies. We must be careful not to confuse exposure to the US Economy with exposure to US companies. We all agree the US economy has a long way to recover and most liekly will do so at a slow pace. It is important that we expose our portfolios to good US companies which are multi national in scope but just happened to be headquartered in the US. Our managers focus on strong companies who derive a significant amount of thieir revenue outside the US ie. the emerging markets. These companies have a lot of free cash on their balance sheets, little or no debt, have the ability to buyback shares, pay dividends and have been increasing their dividends each year. Some examples of companies we are investing in the US are: American Express, IBM, Coca Cola, Walmart, etc
Please forward any questions or comments
I came across this article from Larry Sarbit which really caught my eye. What is interesting is this money manager has been the eternal pessimist over the past decade. For the past decade most of his portfolios have been invested in cash....at one point at AIC he was holding 3 stocks with Waste Management being his largest and the rest was on cash at over 70%. His fund is now 15% cash and 85% stocks -the eternal pessimist is jumping in with both feet. Larry Sarbit is the CEO and Chief Investment Officer for Sarbit Advisory Services and sub-advisor to IA Clarington Sarbit US Equity Fund. Here are some excerpts:
Time to take advantage of gloomy U.S. equity markets
You should be buying American now: The sale won't last forever
I remember John Templeton on the PBS show, Wall Street Week in the summer of 1982 when the U.S. markets were trading at ridiculous bargain prices. The gloom at the time was so thick you couldn’t help but feel it.
Mr. Templeton’s advice cut through it all: Stocks are at fire-sale prices – they won’t be this low again for a generation. And he was right.
Moments like that are rare but we are living in one now.
They tend to happen when the available evidence looks so lopsided that you simply have to cut through it all if you are going to figure out what to do. And right now the task is cutting through the fear and loathing around the idea of investing in anything American. To put it bluntly: You should be buying American now.
'Clients won’t buy anything in the U.S. – period.'
Why do I say that? Well, clients usually give you a range of opinions about what they like or don’t like. A consensus view might rise up from time to time, but generally the outlook is mixed or divided. Not now.
I just got off the road talking to advisers, planners and brokers. Every single visit the exact same message was delivered: “Clients won’t buy anything in the U.S. – period. If it has any U.S. content, they won’t touch it!" Meanwhile, U.S investors, according to the Investment Company Institute, have withdrawn a staggering $33.12-billion (U.S.) from domestic stock market mutual funds in the first seven months of the year.
The sort of unanimity of opinion of the masses that the U.S. markets are radioactive, is exceptional, to say the least. I’ve been in the investment business for 31 years and I’ve seen a few such circumstances – the market bottom of 1982, the gold and precious metals buying panic in the late 1970s and early 80s, the tech madness at the beginning of this century, to name a few.
Now, we have seen some dire circumstances strike fear into the hearts of investors – the financial crisis did start in the U.S. after all; there is a lot of debt is piling up at all levels of government; the stimulus package seems to not quite be doing enough; unemployment remains stubbornly high; and on and on it goes.
It’s worse in a way for Canadian investors since anyone holding unhedged U.S. investments has been clobbered by the loonie’s rise against the greenback. There have been terrific returns here at home as well. From the sound of things, it seems that a lot more Canadians intend to keep their loonies here at home. Wrong move.
Before we relegate America to the trash heap of other fallen economic and military empires, remember that they have been through worse. It will undoubtedly take time and cost to get over the current mess. But America is a vibrant nation, composed of an entrepreneurial, adaptable people who don’t easily accept being second rate.
As usual, people mistakenly conclude that what has happened in the past is indicative of what the future will look like.
Warren Buffett, referring to pension fund managers, said back in a 1979 article, that they “continue to make investment decisions with their eyes firmly fixed on the rearview mirror. This generals-fighting-the-last-war approach has proved costly in the past and will likely prove equally costly this time around."
Canadian Stocks
Ten years ago, all clients wanted were U.S. and global investments, after they had achieved a fantastic appreciation over the previous 18 years. Canada? You couldn’t give Canadian investments away a decade ago. Fixed income, balanced funds, and dividend funds – at the time, all out of favour.
And which categories outperformed over the next 10 years? We all know the answer. Canadian equities have comfortably outperformed U.S. and global stocks.
In August, 1999, I wrote an article in this paper in which I said, “The only predictive statement I feel comfortable in making is that I’d be shocked if the next 20 years’ worth of returns even slightly resemble the past 15 to 20 years."
I went to large cash positions in our U.S. investment vehicle because I couldn’t find what I was looking for – wonderful businesses at bargain prices. Many investors didn’t appreciate this stance but I’ll let my track record speak for itself. We protected our clients from losses and actually made money over the decade. That was not too bad, especially compared with the no-return world of the average U.S. business during the same period.
There are rare occasions when the evidence is so overwhelming, that you can make such broad pronouncements. So, here’s my prediction: I’d be shocked if you don’t make a lot of money in U.S. stocks over the next decade.
Bargain Prices
As usual, I can’t begin to forecast what will happen in the short term. What I do know is that for the first time in years, I’m finding fantastic businesses for sale at what I know are bargain prices. Are you all sitting down? I’m over 70 per cent invested (in the early 2000s I reached peak cash at about 90 per cent), and buying more U.S. equities almost every day.
Mr. Buffett brilliantly summed up our current situation from his perch in 1979: “There may well be some period in the near future when financial markets are demoralized and much better buys are available in equities; that possibility exists at all times. But you can be sure that at such a time the future will seem neither predictable nor pleasant. Those now awaiting a ‘better time’ for equity investing are highly likely to maintain that posture until well into the next bull market."
In my opinion, there currently exists an exceptional opportunity for investors to pick up some real bargains in the U.S. equity markets. When economic conditions are this dismal, at some point, the environment will begin to turn positive and a lot of money will be made. But remember: The opportunity won’t last forever.
Our investment philosophy remains committed to well diversified portfolio that includes exposure to US companies. We must be careful not to confuse exposure to the US Economy with exposure to US companies. We all agree the US economy has a long way to recover and most liekly will do so at a slow pace. It is important that we expose our portfolios to good US companies which are multi national in scope but just happened to be headquartered in the US. Our managers focus on strong companies who derive a significant amount of thieir revenue outside the US ie. the emerging markets. These companies have a lot of free cash on their balance sheets, little or no debt, have the ability to buyback shares, pay dividends and have been increasing their dividends each year. Some examples of companies we are investing in the US are: American Express, IBM, Coca Cola, Walmart, etc
Please forward any questions or comments
Friday, May 7, 2010
Potential Error on NASDAQ Causes Market Selloff
On Thursday, the Dow Jone plunged nearly 1000 points in mid afternoon trading. Going into yesterday's trading session, global markets were already jittery due tot he Sovereign Debt situation in Greece (see previous post). Shares we trading lower during the early afternoon due to these concerns, but without any apparent trigger at approximately 2:45pm EST Proctor and Gamble's stock fell 10% to $56 on the New York Stock Exchange (the NYSE sets prices on which all other stock markets work from). This triggered a "circuit breaker" which slowed the trading of the stock for less than a minute. During that time other stock exchanges were allowed to trade the stock on their own without getting the price from the NYSE. According to Proctor and Gamble and the NYSE, the NASDAQ stock exchange may have may have misprinted a quote of $39.37 per share. It is also possible that the electronic trades actually occurred (trader may have incorrectly entered an inflated sell number - 1 billion instead of 1 million) but were made in error.
Other companies like Apple and Accenture were also affected as automated trading took over. Due to the irregular stock prices and trading patterns, the NASDAQ said all trades executed between 2:00 and 3:00 p.m. ET greater than or less than 60% of the stock price as of 2:40 p.m. ET or immediately prior to that time will be cancelled. The SEC said they "are working closely with the other financial regulators, as well as the exchanges, to review the unusual trading activity that took place briefly this afternoon. We are also working with the exchanges to take appropriate steps to protect investors pursuant to market rules."
By the end of the day the market returned to levels before the sharp sell off began. While many retail investors were not aware of this activity it underscores the importance of maintaining a disciplined approach to your investment strategy and the need to focus on the fundamentals in the market and the economy where the indicators have been pointing in the direction of continued recovery. This morning Canada announced 108,000 jobs were created in April (4 times more than expected) and the unemployment rate fell to 8.1%. The issues that happened yesterday will be investigated and corrected like in the past.
Source: The Globe and Mail, CNN Money
Other companies like Apple and Accenture were also affected as automated trading took over. Due to the irregular stock prices and trading patterns, the NASDAQ said all trades executed between 2:00 and 3:00 p.m. ET greater than or less than 60% of the stock price as of 2:40 p.m. ET or immediately prior to that time will be cancelled. The SEC said they "are working closely with the other financial regulators, as well as the exchanges, to review the unusual trading activity that took place briefly this afternoon. We are also working with the exchanges to take appropriate steps to protect investors pursuant to market rules."
By the end of the day the market returned to levels before the sharp sell off began. While many retail investors were not aware of this activity it underscores the importance of maintaining a disciplined approach to your investment strategy and the need to focus on the fundamentals in the market and the economy where the indicators have been pointing in the direction of continued recovery. This morning Canada announced 108,000 jobs were created in April (4 times more than expected) and the unemployment rate fell to 8.1%. The issues that happened yesterday will be investigated and corrected like in the past.
Source: The Globe and Mail, CNN Money
Monday, May 3, 2010
The Credit Crisis in Greece Explained
During the past few months, there has been concern in the global economy that some countries in the European Union will not be able to honor their debt obligations due to their rapidly increasing budgetary deficits. In the case of Greece, in December 2009 they announced a budget deficit of 12.7% of GDP which was a result of existing budget deficits, election year spending and a stimulus plan created in response to the financial crisis. European Union member nations are supposed to keep their annual budget deficits to no more than 3% of GDP. Other countries that also may have issues with their budget deficits are Portugal and Ireland.
In response to this budget deficit, the yields (interest rate) on Greek bonds increased from 3.5% to 8% within months. Even though the the Greek government has wisely financed this debt over the long term, it still has to roll over US $30 billion in debt maturities and finance a US $30 billion deficit - for a total US $60 billion in annual funding requirements.
Last week, stock markets around the world moved lower after ratings agency Standard and Poors downgraded it's sovereign credit rating for Greece to "junk" status and also lowered Portugal by two notches. The downgrades reflected growing fears that the southern European governments will prove unable to implement promised reform measures in the face of determined domestic opposition, raising the danger of the sovereign debt crisis spreading to the world’s major economies.
With the adoption of the Euro, Europe's weaker countries like Greece, Spain, Portugal, Ireland and Italy saw their interest rates converge with the rest of the Eurozone falling from double to single digits. This interest rate decline triggered housing booms, leading to rising employment, growth, wage inflation, bigger government and more generous pensions and entitlements. This debt-financed growth was funded by financial institutions in the core countries of France and Germany, which enjoyed strong exports.
Germany and France ran current account surpluses (exports more than imports) while the countries on the periphery of the Eurpzone ran deficits. The surplus countries funded the property booms in the periphery. These imbalances were masked by the single currency, because the Eurozone as a whole was running current account surpluses. The access to funds for the borrowers is being cut off and these countries need to re-establish its competitiveness compared to Germany, but they lack the option of currency devaluation. As a result, wages and asset values in these countries need to fall, and this will be accompanied by government cutbacks and lower growth.
This past weekend Greece was able to secure a US $150 billion bailout that will help protect the country from debt speculators and restore confidence in the ailing Euro. The EU is contributing $80 billion of the total at an interest rate of 5% while the IMF is supplying the rest. These lenders have demanded sweeping reforms in Greece that will most likely cause the recession in Greece to last longer and cause a social backlash. This will include tough spending cuts and tax increases. The measures will include the extension of a public sector wage freeze until 2014, the elimination of a bonus equivalent to two months salary for many civil servants, a sin tax and a boost in the value added tax (similar to GST in Canada) from 21% to 23%.
Many critics would argue that there is no need to bailout a country which has brought on a lot of it's current difficulties itself. However, saving Greece from bankruptcy may be necessary for preserving the European economic union, countries have an even more compelling reason to prop up the debt-ridden state. Foreign banks are exposed to $236.2-billion (U.S.) of public and private debt in Greece, nearly a third of it ($75.2-billion) held by French banks. A Greek collapse would ripple throughout the EU and beyond.
When looking at the situation in Greece one must keep these events in context. A US $150 billion dollar aid package for the country is still smaller than the US $173 billion bailout of AIG - much of which went to Bear Stearns and a number of European banks.
WHAT ARE THE GLOBAL IMPLICATIONS
The Greek crisis highlights several important global trends. First, investors are now more attuned to sovereign credit risk, especially for countries with more generous social welfare schemes. The financial crisis resulted in a double hit to government finances through lower revenues and costly stimulus schemes, with the result that debt-to-GDP ratios have soared by 20% across the board.
In the same vein, differentials in the credit risk between countries are now becoming more pronounced. For example, Canada is perceived to have kept its fiscal house in relatively good order, so Canadian government bond yields are 30 basis points less than their U.S. equivalents. These shifts will continue. "(higher yields are attached to more risky bond issues)
The recovery has a structural weakness that poses a potential risk for investors. Government authorities have fired both fiscal and monetary bullets at the financial crisis. They appeared to have hit their mark, but there are no bullets left.
Source: Signature Global Advisor, World Socialist Website, Globe and Mail, Bloomberg News
In response to this budget deficit, the yields (interest rate) on Greek bonds increased from 3.5% to 8% within months. Even though the the Greek government has wisely financed this debt over the long term, it still has to roll over US $30 billion in debt maturities and finance a US $30 billion deficit - for a total US $60 billion in annual funding requirements.
Last week, stock markets around the world moved lower after ratings agency Standard and Poors downgraded it's sovereign credit rating for Greece to "junk" status and also lowered Portugal by two notches. The downgrades reflected growing fears that the southern European governments will prove unable to implement promised reform measures in the face of determined domestic opposition, raising the danger of the sovereign debt crisis spreading to the world’s major economies.
With the adoption of the Euro, Europe's weaker countries like Greece, Spain, Portugal, Ireland and Italy saw their interest rates converge with the rest of the Eurozone falling from double to single digits. This interest rate decline triggered housing booms, leading to rising employment, growth, wage inflation, bigger government and more generous pensions and entitlements. This debt-financed growth was funded by financial institutions in the core countries of France and Germany, which enjoyed strong exports.
Germany and France ran current account surpluses (exports more than imports) while the countries on the periphery of the Eurpzone ran deficits. The surplus countries funded the property booms in the periphery. These imbalances were masked by the single currency, because the Eurozone as a whole was running current account surpluses. The access to funds for the borrowers is being cut off and these countries need to re-establish its competitiveness compared to Germany, but they lack the option of currency devaluation. As a result, wages and asset values in these countries need to fall, and this will be accompanied by government cutbacks and lower growth.
This past weekend Greece was able to secure a US $150 billion bailout that will help protect the country from debt speculators and restore confidence in the ailing Euro. The EU is contributing $80 billion of the total at an interest rate of 5% while the IMF is supplying the rest. These lenders have demanded sweeping reforms in Greece that will most likely cause the recession in Greece to last longer and cause a social backlash. This will include tough spending cuts and tax increases. The measures will include the extension of a public sector wage freeze until 2014, the elimination of a bonus equivalent to two months salary for many civil servants, a sin tax and a boost in the value added tax (similar to GST in Canada) from 21% to 23%.
Many critics would argue that there is no need to bailout a country which has brought on a lot of it's current difficulties itself. However, saving Greece from bankruptcy may be necessary for preserving the European economic union, countries have an even more compelling reason to prop up the debt-ridden state. Foreign banks are exposed to $236.2-billion (U.S.) of public and private debt in Greece, nearly a third of it ($75.2-billion) held by French banks. A Greek collapse would ripple throughout the EU and beyond.
When looking at the situation in Greece one must keep these events in context. A US $150 billion dollar aid package for the country is still smaller than the US $173 billion bailout of AIG - much of which went to Bear Stearns and a number of European banks.
WHAT ARE THE GLOBAL IMPLICATIONS
The Greek crisis highlights several important global trends. First, investors are now more attuned to sovereign credit risk, especially for countries with more generous social welfare schemes. The financial crisis resulted in a double hit to government finances through lower revenues and costly stimulus schemes, with the result that debt-to-GDP ratios have soared by 20% across the board.
In the same vein, differentials in the credit risk between countries are now becoming more pronounced. For example, Canada is perceived to have kept its fiscal house in relatively good order, so Canadian government bond yields are 30 basis points less than their U.S. equivalents. These shifts will continue. "(higher yields are attached to more risky bond issues)
The recovery has a structural weakness that poses a potential risk for investors. Government authorities have fired both fiscal and monetary bullets at the financial crisis. They appeared to have hit their mark, but there are no bullets left.
Source: Signature Global Advisor, World Socialist Website, Globe and Mail, Bloomberg News
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