Key Trends in the World Economy

Eurozone rescue packages will continue to fail until they deal with the central issue in Europe's recession

The international financial system is passing through the agony of a new round of the Eurozone debt crisis for the simple reason that European governments, like that in the US, refuse to deal with the core of the economic recession in Europe for reasons of economic dogma.

Anyone who looks at the economic data for the Eurozone without wearing ideological blinkers can see the situation at once – it is charted in Figure 1. The Eurozone recession is due to a collapse in fixed investment. Taking OECD data, at inflation adjusted prices and fixed parity purchasing powers (PPPs), then between the last quarter before the recession, the 1st quarter of 2008, and the 2nd quarter of 2011 Eurozone GDP fell by $204bn. But private consumption declined by only $29bn while the net trade balance increased by $32bn and government consumption rose by $91bn. However fixed investment fell by $290bn – i.e. the recession in the Eurozone was wholly due to the fixed investment decline

Figure 1

 

Equally evidently, due to its scale, until this fall in investment is reversed it will take a prolonged period for the recession to be overcome. Therefore to restore growth, which by now is generally realised is the core to turning round the budget deficit problem, the fixed investment decline must be overcome.

Nor is there anything mysterious about how to do this – the state has entirely adequate means. To take the most decisive international case China made the core of its stimulus package direct state investment particularly aimed at infrastructure and housing – the result being that China’s economy has grown by over thirty per cent in three years.

Europe and the US clearly do not have the scale of state sector, nor the political willingness, to act on the scale China did. But US history shows that even without proceeding to a socialist scale of measures direct state intervention on investment is entirely possible.

Roosevelt expanded US state investment from 3.4% of GDP to 5.0% between 1933 and 1936 (data from US Bureau of Economic Analysis Table 1.5.5). Jason Scott Smith, in his study of New Deal public spending, summarises such investment as including 480 airports, 78,000 bridges, 572,000 miles of highway - which, in addition to its immediate effect in stimulating demand, reinforced the productive position of the US economy. Roosevelt, it is superfluous to point out, was neither a socialist nor a communist (despite claims to the contrary by the US right!).

Quarterly, up to date, data is regrettably not available on what is occurring across the Eurozone for state investment, but it is available for the US and there is no reason to suppose, with  current policies, that the situation in Europe is any better. Between the peak of the previous US business cycle, in the 4th quarter of 2007, and the 2nd quarter of 2011 US private fixed investment fell from 15.8% of GDP to 12.2% - i.e. a decline of 3.6% of GDP. Yet in the same period US state investment did not compensate but also fell marginally – from 3.3% of GDP to 3.2% of GDP. Therefore while Roosevelt expanded the weight of US state investment current US administrations have been letting it fall.

Instead of directly addressing the core issue of the investment fall European administrations are either attempting to stimulate it indirectly – which, as it is ineffective, has led to fiscal/sovereign debt crises, or are acting via expansion of the money supply – which, in a situation whereby companies and households are paying down debt, is merely the famous ‘pushing on a piece of string’. 

The most favourable outcome of such a situation is that eventually the debt will be paid down, but only after several years of stagnation. The less favourable variant, of course, is that the banking system breaks under the strain and renewed recession is further propelled by fiscal cutbacks. All these problems simply arise from the fact that, under the rubric of the dogma ‘private equals good, state equals bad’, European governments refuse to use the state tools available to deal with the investment fall which is at the core of the Eurozone recession.

Some European politicians are now beginning to call for state measures to increase investment, UK Business Secretary Vince Cable being one. But the action they envisage so far is inadequate to deal with the scale of the investment fall.

China's economy, which does not have such ideological inhibitions, will continue to expand while the Eurozone remains relatively stagnant for a significant period - and as long as economic stagnation continues there will be no resolving of the Eurozone debt crisis.

 

Acknowledgement

Some of the data in this article regarding the US was worked up in an exchange with Gavyn Davies on his blog. Readers may therefore want to look at it there, where further points are developed, and some of the issues also become clearer in the context of an exchange with Gavyn Davies own analysis

A 2nd wave of bank share price Armageddons?

The current falls in the prices of bank shares are widely covered in the financial media. However the overall pattern and scale of the decline in market evaluation of banking shares is still not sufficiently frequently drawn together. The aim of this note is therefore to show this pattern in clear terms. It reveals market estimations of a second wave of major bank share price collapses. This is particularly significant as it follows a lack of recovery of the first wave - i.e. there is a clear pattern of a spreading pool of 'collapsed' share prices of major banks. The cases of Barclays, Bank of America and Société Générale in this wave will be looked at in particular in comparison with the earlier cases of Citigroup, RBS and Lloyd's Banking Group.

The 1^st wave of bank share price collapses

The overall features of the wave of bank collapses in 2008 is too well known to need rehearsing here. Attention is simply drawn to the fact that, in addition to the formal bankruptcy or takeover of investment banks (Lehman Brothers, Bear Stearns, Merrill Lynch), a series of very large retail banks were left in a state which, from the point of view of their share prices, means they may be regarded as ‘collapsed banks’ – ‘collapsed’ for present purposes being defined as having suffered a fall of more than 90% in share price. These share prices may also be regarded as 'collapsed' in the sense that no significant recovery has taken place.

Attention is drawn to these features as there is sometimes an implicit assumption that share prices in these banks may have recovered at least to some degree in line with the overall recovery in share prices. This is clearly not the case.

Figure 1

 

Figure 1 therefore shows the share prices for three of the largest such banks – Citigroup, RBS and Lloyd’s Banking Group. The share prices in all these banks rapidly fell by around 90% during the financial crisis – the falls beginning, as a leading indicator of the coming crisis, in all cases between December 2006 (Citigroup) and February 2007 (RBS and Lloyd’s Banking Group). To make possible international comparisons, as with other banks considered here, share prices have been converted into dollars using daily exchange rates.

Figure 1 shows clearly the 1^st wave of collapses in bank share prices and that no recovery has taken place from it. On 9 September 2011 the shares of Citigroup had fallen by 94.8% from their peak, the shares of Lloyd’s Banking Group had fallen 95.9% and the shares of RBS had fallen 97.6%

The 2nd wave of bank share price collapses

The significance of the new current wave of severe bank share price falls is illustrated in Figure 2. This shows that the share prices of a further series of very large banks – Barclays, Bank of America and Société Générale are analysed – had initially suffered falls in share prices during the financial crisis which were as large as the first group of ‘collapsed’ bank share prices. However unlike the first group this second set of institutions had undergone a genuine recovery in share price. What is now significant, therefore, is that the recent share prices of this second group are now falling sharply downwards towards the level of ‘collapsed’ banks – i.e. a second wave of very large banks are being pulled into a maelstrom of  share price collapses.

Figure 2

 

Specifically, for the banks considered above:

• Barclays share price, after peaking in February 2007, by 23 January 2009 had fallen by 95.5%. By 17 September 2009, however, Barclays share price had recovered to to 59.3% below its peak. By 9 September 2011 Barclays share price had again fallen to 85.3% below its peak level – i.e. a second wave of severe share price falls had set in.
• Bank of America’s share price, having peaked in October 2007, by 6 March 2009 had dropped by 93.4%. It then recovered to 61.1% below its peak by 14 October 2009. By 9 September 2011 however its share price had again fallen to 85.3% below its peak.
• Société Générale’s shares, having peaked in May 2007, by 9 March 2009 had fallen by 88.3%. They then recovered to 58.8% below their peak by 29 September 2009. By 9 September 2011 they had fallen to 87.9% below their peak.

The share price pattern of these banks is therefore common. They reached low points early in 2009 before recovering by autumn 2009. Since then at first a slow, and now rapid, renewed decline in their share price has taken place. In other words the market judgement is that a new wave of severe share drops of major banks – including Barclays, Bank of America and Société Générale – is taking place down towards the level of the 1st wave of ‘collapsed’ (in terms of share prices) banks, that is Citigroup, RBS and Lloyd’s.

In order to show this pattern Figure 3 shows the share prices of both the 1st and 2nd wave of share price falls in the banks considered.

Figure 3

 

Severe price falls, by normal standards, are of course taking place for most other banks – including Goldman Sachs, Deutsche Bank, HSBC etc – but these cannot be said to be approaching the level of near 90% falls for the banks analysed above.

Conclusion

The conclusion of the above trends is evident. Bank share prices show a clear pattern of two waves of ‘collapse’ among large retail, or retail/investment, banks.

• The 1st wave saw falls of 90% plus in the shares of banks such as Citigroup, Lloyd’s and RBS. No significant recovery in their share prices has taken place since – which is why they may, in terms of share prices, be characterised as ‘collapsed’ banks.
• A number of other large banks – of which Barclays, Bank of America and Société Générale may be taken as examples - initially suffered very severe share price falls during the international financial crisis but then saw a significant recovery. Their share prices are, however, now again falling towards the level of the 1st group of banks. It, of course, remains to be seen whether this trend will continue, but a current tendency of a 2nd wave of banks being drawn into crises which essentially destroys share prices is clear.

The market therefore clearly judges that the pool of ‘collapsed’ banks, in terms of share prices, is threating to spread in a second wave.