The world appears to be fixated on events in Europe. Speculation as to the probable outcome changes almost hourly, depending on which desperate politician is in front of the camera. The main focus is on Greece. However, Spanish and Italian bond yields are back again at nosebleed levels. As of yesterday's close, they’re up more than 200 basis points on Spanish 10-year notes, 113 basis points on Italian debt, and 138 basis points on Portuguese bonds. By contrast, the yield on 10-year treasury notes has fallen to a record 1.546%, a yield we haven’t seen since 1946. German bunds are also at record lows, dropping to 1.21%.
Source: Bloomberg
There appears to be no price too high to be paid for perceived safety. Experts believe the macroeconomic outlook for the US would least be effected by a Greek exit. U.S. exports to the EU accounted for roughly 17.8% of total US exports in Q1 of this year. This compares to over 32% for North America.
Source: Bloomberg
However, damage control depends on how Greece leaves if that is what transpires. A disorderly exit could ignite a financial contagion (think Lehman) leading to additional bank runs in other countries, a freezing up of interbank lending, and a vacuum in international trade finance. If this scenario plays out everyone would be impacted, and that includes the US.
The Fed may already be contemplating such a move. There have been several Fed governors and Presidents who have hinted that they could resurrect the numerous credit easing programs from the Term Asset Facility, Money Market Investor Funding Facility, the Asset Backed Commercial Facility, to foreign exchange swap arrangements. Having lived through this experience before during the Lehman crisis, hopefully some sort of preventive action will be taken and coordinated by the big boys: the Fed, ECB, BOE, and the IMF.
One likely outcome could be a pan-EU guarantee of bank deposits in euros. This brings the EU one step closer to integration. It lowers the risk of loss through devaluation, and reduces capital flight. Another idea floating around is some form of euro-bond. For that to become a reality the Germans would have to become more accommodative. With close to 50% of their GDP tied to exports they have become the biggest beneficiary of the euro. They enjoy the lowest unemployment rate, the highest economic growth, and the lowest bond yields. Today, we get our first look at the possible outcomes as the Irish vote on the EU “fiscal compact.”
As Bloomberg Businessweek reported this week, an actual exit could actually be more painful for Greece than the present austerity plans. Leaving the euro will be an easy way for Greece to shrink its unsupportable mountain of debt. A exit will come at a cost of hyperinflation, layoffs, capital flight, and possible shortages of essential commodities. Greece imports most of its raw materials for production. The price of those materials would soar as the drachma is devalued. The problem for the Greeks is that their economy is uncompetitive. They import more than they export and pay for the difference with debt—an unsustainable and tenuous economic predicament no matter the choice. Staying in the euro, buys them time, gives them help, and allows for gradual adjustments. They may be what they decide to do in the end. Polls show that most Greeks want to remain in the euro. They all know what comes after they exit which is why Greek deposits have fallen by $33.7 billion EUR since March of last year.
While the world is focused on Europe another set of numbers were released today with the most important releasing tomorrow. Today, we saw US economic growth for the first quarter of this year revised downward. Tomorrow we get the big one: the May unemployment report and the ISM Manufacturing Index. Look for a drop in the ISM, based on weakening regional PMI’s. The jobs number on Friday could also be weaker than anticipated, that is unless the miracle workers at the BLS come up with some magical hypothetical jobs from the birth-death model.
Despite much of the dismal news out there the US still owns the best looking house in a global neighborhood. Our stock market reflects this fact with US stock indexes clearly outperforming many of the global markets. Since the crisis ended in 2009 the best performing markets in the globe have been the US and the UK. Much of this performance can be explained by the ability to pursue quantitative easing, a policy goal I believe will be pursued again if trouble surfaces either in the markets or the economy.
On a more positive note the center of gravity in oil seems to be shifting back to the Americas again. According to recent stats the US is producing more than 1.7 million barrels of liquid fuels per day than in 2005. The US as a result is importing less oil with imports dropping from 60% in 2005 to 45% last year. Production in North Dakota has risen from a few thousand barrels a day to nearly half a million barrels a day.
Horizontal drilling and fracking have revitalized the US energy industry. Companies like Exxon-Mobil are making big bets on this technology as a means of driving production growth in the future. Exxon-Mobil reported sales of $486 billion with profits of $41 billion last year. The company is making a big bet on unconventional oil from oil sands, tight oil, to shale gas. The company will invest $185 billion in its business to explore for and develop new sources of oil and gas. The cost of the “next barrel” is on the rise, says Exxon’s president Tillerson, as the easy-to-access reservoirs are depleted.
Let’s hope they succeed. The world economy runs on oil. It is used to make the food we consume, the goods we manufacture, and how we travel around this planet. No oil, no economic growth. It’s that simple.
