We Can't Afford To Be Green

Mint – Bill Blain’s Morning Porridge  - March 13 2013

Lowering greenhouse emissions while economic aspirations rise is essentially unsolvable…

This morning.. UK – is anyone doing anything to sort it? Spain auction – smart. Japan about to destroy the planet, and why Italy yields may back up.. and why the Germans aren’t happy…

Another consolidative day in prospect. Eurogroup is meeting on Friday to talk about this “special deposit tax on Cyprus” which might reduce the bailout to €10bn rather than €17bn. Who said fudge? But Germany won’t even think about voting on Cyprus till April. (Which will give plenty of time before bond matures in June..) Meanwhile, Ireland about to come to market with a new sovereign 10-yr deal – wheeee.. that will cause an outbreak of joy and happiness across Europe. Except for the fact Merkel and Hollande are going to have a very public spat about France missing deficit targets by a country mile..

Meanwhile, and despite this morning bright sunshine.. the UK is in deep gloom. If stock markets were really such good predictors of future growth, then we’d have nothing to worry. Numbers say otherwise as UK heads towards triple dip recession. FT points out the uptick in inflationary expectations as linker yields tick up to 3.3% - raising the spectre of Stagflation... dah dah dahhhhhh...

The numbers are shocking. UK economy in freefall... well nothing like a bit of Wednesday morning hyperbole. Manufacturing output down 1.5%, flatline growth thus far in 2013. As the government dithers and fails to present anything that might possibly be called coherent strategy... sterling crashes some more. Buy Osborne a ticket to Tokyo... The weakness in sterling should be an opportunity – instead it's more coalition nonsense.

Meanwhile, I was intrigued by what was going on in Spain yesterday as they announced an extraordinary bond auction yesterday. We suspect the Tresor reacted to dealer demand to cover market shorts. It allows them to further chip away at the 2013 funding totals - selling bonds while the market is open, rather than take the risk it could close later this year. Smart move.

And a moment of deep introspective doom and gloom. The fact Japan is about to start mining ocean methane hydrates is a massive worry. If it goes wrong – the sea floor shifts and we get the mother of all tsunamis.. If it goes well – the result is global warning (methane is about 100% times faster in terms of the greenhouse effect than CO2..) Energy paradigm shift perhaps. Doomed planet? Likely..

And on to Italy… Is it possible I’m wrong it’s a benighted basket case? I'm beginning to wonder if I should reassess Italy despite its debt burden, chronic electoral mishmash, and the corrosive lack of growth. These aren’t the real problem. Sure there is a debt problem, but recent headlines like: "A politically explosive secret - Italians are over twice as wealthy as Germans.." highlight factors like endemic tax-avoidance and a burgeoning black economy which disguise the true hidden wealth of the economy. No Sh*t Sherlock.

If the Italian economy is so wealthy, then you'd think the debt burden is more bearable - which is witnessed by the strong domestic demand for BTPs.

The story - find it here: http://www.testosteronepit.com/home/2013/3/8/a-politically-explosive-secret-italians-are-over-twice-as-we.html  - is a variation on an old theme: "it’s not that Italian (and for that matter French or Spanish) workers earn too much, but Germans earn too little". German policies to repress earnings helped the country turn around quickly after slowdown following unification. Real wages in Germany have hardly risen since the 1990s - and even fell in the early days of the euro. As a result, the whole competition/productivity mismatch and German advantage probably requires a consumption boom in Germany to match austerity in the rest of the eurozone.

Findings from the European "Household Finance and Consumption Survey" since 2010 have highlighted disturbing anomalies in Europe - like chronically imbalanced wealth distribution: 5/50 in Austria (Top 5% of the population own 50% of the wealth) and mean income of €265,000 which greatly exceeds the median income of €76K! The Bundesbank has been sitting on the German number - unwilling to release it - lest it shock the electorate.

Why? Because it reveals just how wealthy Italy is....

Italy's median income under HFCS reveals a median income of €163K while Germany's is thought to be close to Austria's €76K! And that Italian number may be a considerable underestimate. It suggests Italy's private sector is far more wealthy than the rest of Europe! Why? How can that be? Because Italian families have successfully avoided seeing their wealth diminished through taxation. Instead, Italians have enough dosh to lend their government the money it should have raised in taxes.

Any country which operates just on borrowed cash is a variation on the Ponzi scheme. But Italy gets away with paying enough tax to pay the coupons. Which, to my mind, explains why Italian interest rates should, (and historically have been), so much higher than Germany's. Remember - pre euro, Italian lire Interest rates where a step-change higher than Germany.

I remember selling lire bonds with 12.5% coupons while d-mark rates were low single digits! (Wish I was clever enough to get my Bloomberg to show me Italy vs German interest rates since 1950.) Markets worship mean reversion - so I suspect the natural level of Italian yields (even within the single currency) is considerably higher in spread over Germany. Does that make sense?

Can Italy remain wealthy? Under the euro, the wealthy are benefiting from low real taxes and little pressure to increase tax revenues as the government reaps low rates and euro support. If rates rose, they saw an increase in their returns from funding the government! Within the politics of Italy, fine and dandy. Within the politics of Europe - unacceptable.  The pressure on Italy to increase revenue collection will increase as the government struggles with rising debt service costs. And, wealth will fall as the cosy don't-ask/don't-tell tax laissez faire Italian tax understanding breaks down due to Brussels interference, and Italians are forced to pony up their taxes!  

All of which is a massive headache for Germany. Explain to German workers why they are less wealthy than Italians, but are still having to bear the contingent costs of supporting these economies by allowing their central bank to QE Italy?

Watch that space...

So in the medium-term, should we expect some form of mean reversion and Italian rates to rise back towards a more significant spread over Germany until long-term we see the Italian tax-collection paradigm shift towards proper state finances? Perhaps..

As always.. out of time..

Bill Blain

0207 786 3877

[email protected]

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