Week in Review Part I: Europe, Washington and Wall Street

No doubt there has been decoupling when it comes to the U.S. and Europe, though in terms of the equity markets, on both sides of the pond stocks are rallying. But on the economic front, the U.S. has avoided a double-dip recession while the jury is still out in Europe with most believing a double-dip is what the continent will see, with a few exceptions.

But in the past week, the news for much of the eurozone and EU, including non-euro Britain, was a little better. A eurozone manufacturing index, the PMI, came in at 48.8 in January from 46.9 in December, while a combined reading that adds in the service sector was above 50 at 50.4. This is a little confusing because these figures are exactly as first estimated a few weeks earlier and not necessarily new but most news services were treating it that way. Britain actually had two good readings of its own; the PMI reading hit 52.1, ahead of December’s 49.7 (50 being the dividing line between growth and contraction, remember), while the U.K.’s service sector in January registered a 56, also up from December. This is good. Perhaps Prime Minister David Cameron’s austerity moves are now bearing fruit. Certainly business confidence there is up smartly.

But the news wasn’t all hunky-dory. The unemployment rate in the eurozone hit 10.4% in December, though here you have the contrasts. Germany’s jobless rate is down to 6.7% (a January reading), while Italy’s is up to 8.9% and you still have Spain’s record 22.8%, as it was announced there that the Spanish economy contracted 0.3% as the IMF projects Spain’s GDP to fall 1.7% for 2012.

[It’s interesting to note that in 2005, Germany’s unemployment rate was over 12% while Spain’s was just 8.5%. But Germany didn’t have a housing bubble and Spain did.]

Back to Italy, Mario Monti’s technocrat government has a 52% approval rating as the next election isn’t until 2013.
So that’s some of the good and bad. Here now the solely bad.

The Greek government has still not reached an agreement on a debt restructuring with its private creditors, with the government looking for bondholders to take a 70% loss, and accept a 3.6% coupon on a new 30-year bond with a GDP kicker if the economy ever starts growing again. Way back creditors were only supposed to take a 50% haircut.

Recall that Greece must wrap up this negotiation in time to put the final touches on its latest austerity plan before it faces a March 20 bond payment of $19 billion. Greece needs another round of bailout cash to meet this and future obligations, pay salaries, pensions and such.

Now the European Central Bank has profits on massive amounts of Greek paper that it’s holding but it doesn’t want to take losses as part of a public-private partnership so this all remains to be worked out…or not.

The thing is the Greek government has proved to be totally incompetent when it comes to implementing its austerity program and collecting revenue so it’s understandable that the likes of Germany are skeptical when it comes to granting further aid.

And so with this as backdrop, Greece’s political leaders on Friday rejected a new round of austerity cuts demanded by the IMF, ECB and EU as part of a new bailout package. So we’ll find out Monday just how bad this late development is.

Separately, at the 16th EU summit in two years, German Chancellor Angela Merkel got her new fiscal union treaty with the tougher budget rules, though the Czech Republic announced it would join the U.K. in not agreeing to it. Nonetheless, the agreement will be formally signed in March, even as Berlin was warned there were limits to how much sovereignty each government was poised to surrender for the sake of fiscal discipline. It was French President Nicolas Sarkozy who had to tell Merkel to back off the leaked German proposal to control Greece’s budget decision-making, telling her it “would not be reasonable, not be democratic nor would it be effective.” Sarkozy said Merkel agreed.

“The recovery process in Greece can only be enacted by the Greeks themselves, democratically,” Sarkozy added. [Financial Times]

Meanwhile, forgive me for being a bit confused. The 25 members sign the treaty in March, but Sarkozy said he would not ask the French parliament to sign off on it until after the April presidential election; this as the likely winner in the voting, Socialist candidate Francoise Hollande, has already said he would seek to renegotiate the pact. What am I missing? I thought every parliament had to sign off on it first, which was supposed to be a formality, and that the only issue was if Ireland needed a referendum first, which doesn’t seem likely.

Oh, and not for nothing but we were told this week not to worry about Portugal, even though at one point the yield on its 10-year bond was over 18%. Whatever.

Editorial / Financial Times: Lex column

“This must be what they mean by Disziplin, Germany’s reading of the debt crisis is that it is the fault of profligate governments. Monday’s ‘fiscal compact,’ with its coercive imposition of budgetary orthodoxy, debt sustainability and economic convergence, is meant finally to bring them to heel. That should provide Angela Merkel, the Chancellor, with the political cover she needs to increase Berlin’s commitment to addressing the crisis. The question now is whether Germany is ready to repay the favor to the eurozone.

“The compact is a reworking of the discredited Maastricht treaty. Among other things, this stipulated that budget deficits could not exceed 3 percent of gross domestic product and that a nation’s debt should ideally be no more than 60 percent of GDP. Germany itself undermined that agreement. The compact will be more securely enshrined in law, assuming that it will be ratified by the 25 countries that are subscribing to it. It encourages governments to aim for structural budget deficits of no more than 0.5 percent of GDP. This is a blueprint for economic stagnation….

“Having imposed coercive austerity on her fellows, Ms. Merkel now needs to don the armor they handed her and to look the sovereign debt crisis in the eye. The fiscal compact makes it more likely that indebted countries will need more emergency funding while markets remain closed to them. Berlin must be ready to underwrite that funding, through reinforced bailout mechanisms or joint Eurobonds. Germany should allow the European Central Bank greater leeway to intervene in the secondary bond markets. And it must reconcile austerity with the need for reviving the eurozone. The compact is a big ‘take’ for Germany. Now it’s time for some ‘give.’”

So there is much work to do. The European Financial Stability Facility and European Stability Mechanism still need to be reinforced to backstop Italy and Spain. China, though, is now said to be sincerely interested as of this past week in helping out on this front. Before, it was just a lot of talk but now Premier Wen Jiabao said China “is investigating and evaluating concrete ways in which it can, via the IMF, get more deeply involved in solving the European debt problem through [the EFSF and ESM.]”

Washington and Wall Street

What a week. What a start to the year. By the close on Friday, the Dow Jones and S&P 500 were at levels not seen since 2008, while the Nasdaq is at levels not reached since December 2000, the year it began to crash. Nasdaq is off to its best start for a year since 1991, up nearly 12%, while the S&P’s 6.9% gain thus far represents its best start since 1987. For yours truly, who for the time being is wrongly focused on debt levels and geopolitics, as Lloyd Bridges would have said, “Looks like I picked the wrong year to be bearish.”

Then again, the year is young, though I could just rehash what I wrote last time when talking about President Obama’s re-election chances, except this week they got stronger as the January employment report showed the economy adding 243,000 jobs and the unemployment rate falling to 8.3%. Good no matter how you slice it. Sure, we have a long ways to go to reach full employment of around 5%, and the jobless rate is still above the 8% level the president said he’d have us under years ago, but, again, it’s about trends and sentiment and both are working strongly in his favor. Barring an outside interference, some of the next polls will likely show Obama’s approval rating back over 50% for the first time in ages. Yes, as discussed down below, the election is likely to be decided in twelve battleground states and the latest figures have Mitt Romney tied with the president in these, but as long as the economy continues to show progress, even haltingly, I like the president’s odds.

A few more economic items of note: Auto sales, as noted below in detail, were strong for the month, but the S&P/Case-Shiller housing data showed further price declines for their 20-city index, down 1.3% in November over October, 3.7% year over year, and 32.9% from the July 2006 peak. There are few signs of a true price bottom in most parts of the country (Atlanta really taking it on the chin the past year, down 11.8%, 11/2010-11/2011) and there is still a mountain of foreclosures to work off. By the reading of the data, 1 in 5 also remain in negative equity.

Separately, readings on manufacturing were strong, though less than expected, with the Chicago Purchasing Managers Index coming in at a very solid 60.2, 63.0 being forecast, while the ISM for manufacturing was 54.1 vs. a projection of 54.5.

December construction spending was up 1.5%, better; while factory orders for the month, up 1.1%, were a little shy of expectations.

As for December readings on personal income and consumption, the former was up 0.5%, but the latter was unchanged, not a great sign (though part of an increase in the savings rate).

Then you had Federal Reserve Chairman Ben Bernanke speaking before a House committee and he tried to reassure a skeptical Republican chair, Paul Ryan, that the Fed is not seeking higher inflation at the expense of more jobs. In fact Congressman Ryan totally agrees with my own last take on the topic; that the Fed’s zero interest rate policy was appropriate for the crisis in 2008-09, but afterwards it should have normalized rates to give savers a break, adding that normalizing policy would still have left the Fed with an accommodative stance.

But there was another news item this week that got buried with the good news that followed; that being the Congressional Budget Office’s forecast of a fourth straight $1 trillion deficit for the fiscal year; which was an increase in the CBO’s earlier forecast. $5 trillion in debt will have been tacked on in the president’s first term. It was in February 2009 that Obama pledged to cut the then $1.3 trillion deficit in half by the end of his first four years. Not quite. And the $1.1 trillion the CBO is forecasting would rise to $1.2 trillion in fiscal 2012 if the payroll tax cut is extended thru year end, which, by the way, is this month’s mini-crisis du jour…the deadline is fast approaching on both this and the extension of unemployment benefits.

The CBO also expects the government will spend $1.6 trillion on Social Security, Medicare and Medicaid in 2012, 44% of the federal budget. In 2022, the triad could represent 54% of federal spending.

Michael Tanner of the Cato Institute had a piece in the New York Post last weekend in which he says if you include the unfunded liabilities on items such as Social Security and Medicare, the total U.S. debt is 885% of GDP. Greece is more like 875% and France is at 570%. Granted, everyone has different figures when it comes to this category, but here’s some advice to Republicans.

Quick! Pivot from the economy and just focus on the debt issue and foreign policy.

Along these lines, former Republican Senator Alan Simpson of Simpson-Bowles fame told Bloomberg Television’s Al Hunt that President Obama “walked away” from his bipartisan deficit-cutting commission’s plan “because he knew he’d be torn to bits.” Simpson said Obama is “terrified” of the deficit issue. “He didn’t deal with it” in his State of the Union address. Simpson added that the Republican presidential candidates are “almost like robots” in their aversion to any taxes as a way to help shrink the deficit.

For his part, President Obama said he will press Congress on the Buffett rule. He told Democratic members of the House on retreat last weekend that he’s seeking to raise taxes on wealthy Americans “not out of envy, but out of a sense of fairness, a sense of mutual responsibility.” Mr. Obama would fit in very nicely with France’s Socialist Party, I can’t help but add.