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Euro Zone GDP Contracts Further

The 17-nation euro zone output shrank by 0.2 percent in the first quarter 2013 creating the longest recession in the bloc’s history. Projections for the future are not promising. Analysts project slight growth in late 2013 but no significant upturn until 2015. The first quarter contraction marks the sixth consecutive quarter that euro zone GDP has contracted.

France which has been teetering on the edge of a recession finally crossed the line and suffered a 0.2 percent downturn, equaling its output in the fourth quarter 2012. Unemployment in France is at record levels.

France joined the list of euro zone economies in recessions. Finland, Cyprus, Italy, The Netherlands, Portugal, Greece and Spain are solidly entrenched in recessions. Italy and Spain, the euro zone’s third and fourth largest euro zone economies, have endured seven consecutive quarters of negative growth.

The new data pushed the euro below the 1.29USD mark. The currency fell to six-week lows and shows little hope for recovery. The trend of the euro and the anemic growth in the bloc may prompt the ECB to engage in more aggressive monetary easing initiatives.

Last week, the ECB cut interest rates to historic lows. However, Mario Draghi, ECB president, has said that he is not opposed to another rate cut.

Austerity vs. Growth

To a degree, German led calls for austerity have stabilized the euro zone treaty. But, most of the nations want to shift the focus to growth. Euro zone unemployment is estimated to include more than 19 million workers.

The consensus is that the natives of the euro zone have been pushed about as far as they can go. France has been an advocate for growth and has marked the formation of a Europe-wide banking supervisor as an important step in the region’s recovery. German finance minister Wolfgang Schaeuble and Chancellor Angela Merkel have opposed this new initiative fearing that Germany would have to bear the heavy load.

On Tuesday, Schaeuble appeared to soften his position, suggesting that the new, broader banking union could be structured by June. A second aspect of this initiative would call for identification of banks that need to be closed. Schaeuble told French finance minister Pierre Moscovici that the new banking union was a “priority object.”

Germany, always the pillar of the euro zone, is facing its own manufacturing, export and GDP problems. GDP was revised from negative 0.6 percent in the fourth quarter 2012 to 0.7 percent. Germany narrowly avoided falling into recession by posting a 0.1 percent gain in the first quarter 2013. Despite its tempered growth, Germany enjoys the lowest unemployment rate in years.

Liquidity Driving Equity Markets

The euro is off 2.3 percent in May, hitting 1.2883USD in overnight trading. The dollar rests comfortably in the 102 range against the yen. The ECB is likely to consider another rate cut before the end of the year. The dollar reached 102.63 yen overnight.

Meanwhile, the Federal Reserve and the Bank of Japan continue to pour money into easing programs. The weak yen is very liable to cause more export stress in Europe.

The UK has been damaged by the weaker euro and the stronger pound. UK exports have lowered to Europe but have increased to other markets like Southeast Asia and Africa. Outgoing Bank of England head, Mervyn King hinted that the BoE may be softening its easing program shortly. King put forth the first positive outlook for the UK since the outset of the financial crisis. Britain has been successful encouraging small business growth but still fights high unemployment and a slumping housing market.

All eyes will be on Italy’s upcoming 30-year bond auction after Spain had a successful 10 billion euro sale of its 10-year bonds on Tuesday. After Fitch Ratings upgraded the nation’s sovereign debt, a positive accomplishment, Greece’s 10-year bonds surged in Wednesday’s auction. Greece is no longer viewed as a country about to leave the euro zone, a credit to the tough love imposed by Germany.

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Spain – A Heavier Greece

The question is no longer whether Spain can avoid default.  Rather, the question is when will Spain default or be forced to pursue a bailout package that will make Greece look like a toddler cousin.  Euro zone financial ministers have said all along that there was not enough support to keep Spain above water.

The Spanish unemployment rate dwarfs unemployment in Greece.  By all accounts, Spain has had no bounce since the recession began.  Until today, yields on Spain’s bonds were unsustainable.  ECB bond activity may have temporarily eased Spain and Italy but private investors are remarkably disinterested.  Spain’s problems are inherent, systemic and there is no realistic remedy on the table.  Whatever is out there is nothing more than a wing and a prayer.

Like Greece, the natives are restless, angry and discouraged. Unemployment for youthful workers exceeds 50 percent.  The national unemployment exceeds 27 percent.  True unemployment cannot be tabulated.  One of the core components of Spain’s demise is the housing market.  Banks are literally giving away properties as quickly as possible.

The harsh real estate reality is that housing prices have already fallen as much as 50 percent and are expected to hit bottom after another 20 – 30 percent fall.  Banks are holding their own auctions.  Some are offering apartments at 70 percent below 2007 values, just a hair less than Greece’s private investors recouped.  Many have resorted to 100 percent financing.  The number of housing transactions is 50 percent less than in 2007 and 26 percent last month.

Many of Spain’s banks are operating at negative cash flow.  As the unemployed withdraw from their savings, banks are hard-pressed to meet their obligations.  For the majority of banks, the wholesale window is closed.  Credit rating firm, Fitch, has “blacklisted” Spanish debt right alongside Greece, Portugal and Ireland.  Not exactly the company that the euro zone’s fourth largest economy likes to keep.

Spain’s banks hold an estimated 176 billion euros of distressed real estate.  The government has forced the banking sector to write down a mere 50 billion euros.  In efforts to bring stability, the government has directed the merger of a number of banks.  The merger will reduce the country’s banking institutions to just 10 banks.

However, Bankia was created from the merger of seven regional banks.  The bank is writing down 3.4 billion euros in distressed loans.  That write-off is 11 times the bank’s net profit in 2011.  The bank has placed 1400 homes in the real estate market with prices 50% below their value.

The best description of the quandary in Spain was offered by a London analyst who said, “The way banks are raising capital, through accounting, merging and amortizing losses over two years is a kind of capital-less raising.”  Neither the euro zone, nor the global marketplaces need anymore, creative accounting from the region.

Spain has two choices.  The country must find private investors or ask the euro zone for a substantial bailout that will dwarf the Greek bailout. Then, the ECB will have to provide bridge financing.  Sound familiar?

Private investors are not buying.  Last week’s auction was embarrassingly under subscribed.  Through aggressive lending and purchasing strategies, the ECB has already pumped more than 1 trillion euros into the euro zone’s failing economies and banks.  As a result of the housing crash, Spanish banks are laden with bad debt. 

Prime Minister, Mariano Rajoy, has said that a bailout package was not an option.  However, he is implementing the most stringent austerity cuts in Spanish history. The cuts are modeled after recommendations by the euro zone. Looks like Rajoy is paving the way for assistance, but talking a brave game in the meantime.

Spain, like every euro zone entity, is practicing positive rhetoric instead of offering tangible solutions.  According to Raja, the spending cuts will solve a myriad of problems, unless the economy recedes more than 1.7 percent GDP in 2012.  Apparently, negative 1.7 GDP is a good thing.  However, even negative 1.7 percent GDP is an overly optimistic projection.  The euro zone media circus is prey to these strategically timed releases, but private lenders see handwriting on the tombstone.  The only good bets in Spain are short.  If Spain goes, Italy may also go.  If Italy goes, the euro zone will dismantle.

The euro zone appears to be leaning on additional funding from the IMF.  China said earlier in the month that they “could not buy Europe.”  China appears to be supporting the euro zone by staying invested.  China is facing a slower GDP growth than projected and the country is attempting to stabilize the ascending inflation rate.

The US has said it would not increase contributions to the IMF.  In an election year, such a move would be disastrous.  The euro zone will have their hands out to the IMF when the finance ministers arrive in Washington next week.

Despite all this negativism, the euro caught a wave on Wednesday and came off weekly lows of $1.30.  Even that bit of encouraging news is farcical.  Had the ECB not intervened, the bond sales in Italy and Spain would likely have failed.

Amidst this news, troubling political developments that could well end the single currency alliance are taking shape.  In Greece, new elections will take place at the end of the month.  There is a strong possibility that the change in leadership will result in relaxation of the severe austerity program that was a condition of the euro bailout package.

The biggest political problem may be taking place in France.  With elections scheduled for May 6, presiding president Nicolas Sarkozy faces a stiff challenge from Socialist Francois Hollande.  The challenger has lost a little ground but is still favored to derail Sarkozy.  Hollande’s platform includes a review of France’s alliance to the single currency.  If France reneges on its neighbors, kiss the euro zone goodbye.

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