Italy: Roubini Had it Right Five Years Ago

For about two years I have watched the performance of my (mostly American) stock portfolio gyrate, more or less in sync with the news about the PIIGS of Europe.  The latest scary news has been all about Italy: rising bond yields implying an imminent inability to roll over their debt, leading to a possible default.   What surprises me is that the gyrations have been similar in scale to what we saw recently when all the scary news was about Greece.  It strikes me as odd since Italy's economy (and debt) is somewhere on the order of five times the size of Greece's.  I guess you could say the market has been taking the Italian news in stride, or perhaps that the market always knew that the Italian bad news was somehow "baked into" the Greek bad news. Interesting though, that you don't hear much about Spain anymore.  Unemployment there is abysmal, but they seem to be making serious efforts to shore up their banking system, and of course their debt is only around 60% of GDP, as opposed to Italy's 120%.  (see my article and chart: What is Going On in the Eurozone?)

Meanwhile, browsing through Nobel laureate Paul Krugman's economics blog, I was pointed to this very interesting piece written in 2006 by Nouriel Roubini.  Please read it.  At an economic conference at Davos in 2006, Italian finance minister Giulio Tremonti tried to shout down Roubini when he gave an accurate and prescient analysis of the challenges which would be facing Italy if they did not make serious reforms to their economies; basically he compared Italy to Argentina, and said they were going down the same road.  

Of course Roubini turns out to be right, and the entire Berlusconi administration comes out looking like ineffective, corrupt children, who had been placed in charge of a $2 trillion economy.  Nice work, guys.

More to Worry About: Russia Commits to Chernobyl-Style Reactors

Article: Wall Street Journal, Russia to Extend Life of Aging Reactors, by David Crawford and Rebecca Smith

To take my mind off the 400+ drop in the Dow Jones Industrial Average, I was thumbing through the international section of the paper, and found this article about nuclear reactors in Russia.

Despite Western pressure to shut them down, there are still 11 Chernobyl-style reactors, also known RMBK reactors, operating in Russia.  All of them are on the Western edge of Russia, near the cities of St. Petersburg (pop. 4.8 million), Smolensk (pop. 327,000) and Kursk (pop. 415,000).  These reactors originally had a life-span of 30 years; they have now been extended to 45 years.

from www.wsj.com

As per the article: "Many Western nuclear experts believe the RMBK reactors are among the world's most dangerous and still suffer from fundamental design shortcomings."  Such as:

• No containment structure to keep in radiation in case of an accident.  A containment structure is a standard feature on modern nuclear reactors.
• No central crucible to hold fuel rods.  Each fuel rod sits in its own tube, so engineers have to monitor and maintain 1,000 separate tubes, instead of one central crucible.

Although Russia is rich in natural gas, they are reluctant to replace their aging stock of Soviet-era nuclear reactors with natural gas plants, because they prefer to export their natural gas for profit.

I hope that Europe will become less reliant on Russian natural gas soon, and that this will change the equation.  In the meantime, let's all keep our fingers crossed.

The Human Cost of Greece's Debt Crisis

Article: Wall Street Journal, Greek Crisis Exacts Cruelest Toll, by Marcus Walker

This front page article in today's WSJ tells the tragic story of Vaggelis Petrakis, a hard-working family man from Crete who had a company that supplied vegetables to hotels and supermarkets. He was brought low by a “credit economy”, namely clients who paid him with 6-month postdated checks. I won’t paraphrase the story; you’re better off clicking on the link and reading the original.

The article quotes Constantine Michalos, president of the Athens Chamber of Commerce and Industry, who says that the practice of paying with post-dated checks exploded in Greece in the 1990's. "This was a para-banking system of enormous size. It is one of the main reasons for the crisis."

(There was also an interview with Michalos on CNBC today, where he says that about 80,000 small business have gone under in Greece over the last year)

Walker's article notes that the suicide rate in Greece has roughly doubled since the beginning of the crisis.

This morning on CNBC, I saw an interview with Mark Grant, Managing Director of Southwest Securities, who said that total Greek debt, including sovereign, corporate and municipal debt is around $1.1 trillion, roughly 3.5 times their annual GDP -- much larger than the sovereign debt alone, which was reported as $454 billion at the end of 2010 (143% of GDP).

Notwithstanding the outcome of the European debt crisis, it looks like Greece is in for a hell of a de-leveraging, which will weight down their economy for years to come.

What is Going on in the Eurozone?

Fiscal problems in the euro zone have been a primary cause for the gyrations in the U.S. stock market this year and last.  There is an element of panic that a default by one or more countries (ie, Greece) and/ or financial institutions (Societe Generale?) will cause a cascading "contagion" in the markets, similar to what happened with the bankruptcy of Lehman in 2008.  Whenever the euro zone countries step up to do something, often through the efforts of the European Central Bank, or ECB, the market goes up.  When they are seen as hanging back, markets go down.

This week, we have seen markets go up on what seems to be a concerted effort by the ECB along with other major central banks.  Today it was announced that 3-month USD loans will be made available to European banks who have been having problems placing their commercial paper, which has traditionally been an important source of US dollar funding for them (See AP Story, ECB to Provide Banks with Dollar Loans).  And in a CNBC interview yesterday, U.S. Treasury Secretary Tim Geithner was unambiguous in his statement that Europe would not allow its major financial institutions to default a la Lehman -- Europe is by and large less market oriented than the U.S., and not so concerned about "moral hazard".  (See No European Lehman-Like Collapse?)  

There seems to be a growing consensus that Greece will default and probably exit the euro--its bonds are now yielding 25%-- that this will not be the catastrophe some have been fearing, and that Germany will eventually face the inevitable choices that it has to make in order to save the euro experiment--more central planning of fiscal policy, including some kind of central euro treasury.    (See George Soros' article in The New York Review of Books, Does the Euro Have a Future?)

Nothing is decided yet, but markets have been moving up this week on these less-than apocalyptic assumptions.  As of this writing, the Dow is up over 100 points today (1%) and over 350 points since Wednesday (about 3%).

There will surely be more ups and downs on this roller coaster in the future, but as an investor, it is nice to see gains.  Hopefully they will last.

Can Germany Do Without Nuclear Power?

Article: New York Times, Germany Dims Nuclear Plants But Hopes to Keep Lights On, by Elisabeth Rosenthal

Germany's Biblis Nuclear Plant, from www.spiegel.de

An article in today's NY Times notes that Germany has already shut down 8 of its 17 nuclear reactors, and plans to close the rest by 2022.

This was a reaction to the Fukushima disaster in Japan.  That a mishap of this scope could take place in a developed country has really spooked Germans.

Germany has been aggressively pursuing green energy and today gets 17% of its electricity from renewable sources (wind, solar and bio fuels) although the first two are somewhat unpredictable as they are highly dependent on weather conditions.  Skeptics say that Germany's energy plan will lead to higher energy prices, higher emissions, and has already caused it to import more electricity from France and the Czech Republic--countries that use nuclear plants to generate much of their electricity.

The German plan estimates that electricity from renewable sources will double in the next ten years, but also calls for the construction of additional coal and gas-fired plants.

Japan is already backing off its initial pledges to completely phase out nuclear energy.  It will be interesting to see if Germany will follow through with theirs.

Yesterday's Market Excitement

In case, you haven't heard, the U.S. stock market was down big time yesterday.  The Dow Jones Industrial average dropped 634.76 points, or 5.5%.  This had something to do with Standard & Poor's downgrade of the U.S.'s credit rating from AAA to AA+ on Friday evening, but exactly how much is an open question.  The Wall Street Journal's front page headline this morning was: Downgrade Ignites a Global Selloff, but the unavoidable irony is that prices of Treasury bonds were up yesterday (yield on the 10-year note, which moves inversely to price, was down to 2.339%, its lowest rate since January 2009).  And repo markets, the main wholesale funding market by which Wall Street banks lend each other money using U.S. securities as collateral, were largely unaffected.

The sell-off seemed to be caused by a general flight from risky assets into safer ones, such as U.S. treasuries, gold and Swiss Francs, which in the past has been the result of fear of a double-dip recession and default and contagion in Europe.  Perhaps the downgrade just added an extra element of panic to the equation.  Or perhaps large market participants were afraid that the downgrade would cause politicians to do something stupid in reaction to what should be a non-event, what philosophers call an epi-phenomenon, like the smoke from a passing train, or the after-the-fact commentary by a sportscaster.  President Obama's speech certainly did nothing to stem the downturn.

Based on the Wilshire 5000 Total Index, which represents the total value of the U.S. stock market, the market has lost about $2.6 trillion since late July.  Unless you are an S&P sovereign debt analyst, this is quite a chunk of change--about $8,500 for each man, woman and child in the U.S.

data from finance.yahoo.com

Certain stocks were especially hard-hit in yesterday's sell-off: Bank of America and Citi were both down over 15%.  I lost quite a bit on the latter, not to mention Caterpillar, a Germany ETF and others.  Despite stern warnings from CNBC commentators --like lifeguards at Jones Beach--  that it is extremely risky for individuals to trade in such market conditions, I nibbled, and bought a bit more Citi at its new marked-down price.  Of course it dropped as soon as I bought it.  This morning, I saw that Citi was trading at less than half of its book value, and bought some more, using up the bulk of my available cash.   As of this writing, Citi is back up 12% on the day, so maybe I made a good decision -- for now.

Spanish PM Rodríguez Zapatero Calls Early Election

Articles:

Wall Street Journal, Spanish Leader Calls Early Election, Jonathan House

El País (Spain), Final de Ciclo, Editorial 7/17/2011

El País (Spain), Rubalcaba: “Tuvimos ocho años para pinchar la burbuja y no lo hicimos”

Rubalcaba and Zapatero
from Iberosphere.com

The Spanish Prime Minister, José Luís Rodríguez Zapatero, called for early elections on November 20, ahead of scheduled elections in March, 2012.   Spain is suffering from an unemployment rate of over 20%, the highest in the developed world.  Zapatero's socialist PSOE party was handed losses in key regional elections is May.  Left-leaning newspaper, El Pais, has been called for elections "as soon as possible", and said that the leader has not given any reasonable hope for relief to the five million unemployed, and the 300 thousand who have lost their homes in the last 3 years.  They have gone so far as to say that the November date was too late, and that sooner would be better.

Rodriguez Zapatero was elected in March, 2004, just after the terrorist bombing in Madrid commuter trains, which killed 191 people and caused over 2000 injuries, on March 11, 2004.  Zapatero's predecessor, José Maria Áznar, of the conservative Partido Popular (PP) had positioned himself as a leading supporter of George W. Bush, and had sent Spanish troops to Iraq, despite large public opposition in Spain.   When it became clear that the bombs had been set off by al Qaeda (despite early attempts by Áznar to blame Basque separatists), many Spaniards reacted by giving a surprise victory to Zapatero, who had pledged to pull Spanish troops out of Iraq.  Shortly after being elected, Zapatero made good on his pledge.  He was re-elected in early 2008, before the real estate sector, and then the economy, crashed.

It is interesting to see that in today´s El País, it is reported that socialist candidate Alfredo Pérez Rubalcaba said: "We had eight years to pop the bubble, and we didn't do it."  It looks like Spain will have a conservative government by the end of the year.

Natural Gas: Fracking in Europe

Article: Wall Street Journal, Fracking Pioneers Pierce Europe, Guy Chazan

 El Mundo (Spain), The United States' Dirty Energy Revolution, Pablo Pardo

Chesapeake Energy natural gas well in Bradford County, PA
from www.csmonitor.com

One of the biggest stories of the last few years is the growth of unconventional sources of energy.  In the U.S., this mainly means petroleum from the oil sands of Alberta and natural gas from shale, the latter being retrieved via a process known as “hydraulic fracturing”, or “fracking” for short.

The following article from Spain’s El Mundo: The United States’ Dirty Energy Revolution --translated into English on the website WatchingAmerica.com-- gives a good overview of how unconventional energy is transforming the “energy panorama” in the U.S, mainly by making the country much less dependent on world energy markets, and poses the question of whether this “revolution” will spread to Europe.

The WSJ article talks about an early effort to explore fracking in Southern England.  At this time the drilling has been halted, as the result of a minor earthquake, which some say was caused by the drilling.

I have recently become very interested in where the world gets its energy.   This topic is vitally important economically, politically, environmentally, and most importantly, for my investment portfolio.

As far as natural gas and fracking go, I have learned the following:

• Natural gas burns very clean (think of a gas stove), though it does produce carbon dioxide (CO2), the main greenhouse gas.
• It is estimated that the U.S. has at least 100 years supply of unconventional shale-based natural gas.
•  Fracking is a highly controversial practice, as there is evidence that it can lead to polluted aquifers.
• Fracking has been temporarily banned in New York State, but continues in Pennsylvania, Texas, Oklahoma and other areas.
• In Europe, fracking has been banned in France, but is being attempted in Poland, Northern Germany, the UK, and according to the El Mundo article, in Cantabria, Spain.
• One think tank estimates that Europe has at least 60 years of energy reserves in extractable natural gas, though I understand this to be a very preliminary estimate.
• Natural gas can be used to fuel vehicles, but in the U.S. very little infrastructure to provide it (i.e., gas stations) exists at this time.  When I lived in Spain ten years ago I saw buses and taxis that ran on natural gas.
• Natural gas is generally transported via pipelines.  In the absence of such an infrastructure it can be converted into liquid natural gas (LNG), and transported in ships, but the process is currently expensive and difficult.  

Arctic Princess Natural Gas Carrier
Courtesy of  www.ships-info.info

Because of its abundance, cheapness, and the fact that it does not have to be imported, many see natural gas as the solution to the United State's  energy problems, at least in the short-to-medium term.  To the extent that we are concerned about global warming and CO2 emissions, other green energy sources (wind, solar, etc.) may be preferable, but these technologies are not yet economically viable.  Assuming the dangers of fracking can be addressed or mitigated, the use of natural gas to replace sources of energy such as coal and petroleum –and possibly nuclear power—seems highly probable.

$157 Billion Greek Bailout

This morning's Wall Street Journal speaks of a new $157 Billion Greek bailout: Greece Gets New Bailout as U.S. Nears Brink

An admission of defeat by all involved: ECB President Trichet was unable to avoid a "technical default"; German Chancellor Merkel was unable to avoid spending more of her frugal citizens' money.

The Dow went up over 1% yesterday, partly on this news, which at least showed some leadership by Europe, and brought some certainty.

On the other hand, there are a lot of questions:

What about Greece's primary deficit? The country is spending more than it takes in, even before it services its debt. On this basis, they will run through any and all bailout money that they receive (around 100 billion in 2010, over 150 billion in 2011 --quite a bit for a country with a GDP of around $310 billion). I wonder if major political reforms/purges will be needed in order to accomplish the necessary economic restructuring.

Suggestion number 1: stop worrying about Turkey. I understand that a part of the problem has been huge unnecessary military expenditures over the years, which I can only assume have been accepted by the population because of anti-Turkish paranoia. Maybe leadership in some sort of Eastern Mediterranean free trade zone would help Greece's economy.

Suggestion number 2: Sweep out the Greek political class, and put people who are not implicated in the current mess in charge. Dominique Strauss-Kahn should be available soon :)

Will the technical default cause CDS contracts to pay out? WSJ's Steven Fidler says "probably not", because the deal for private sector contributions is voluntary, then follows up by asking "What use is default insurance if there's a default and no payouts?" (see A Guide to the New Deal in Athens: How a 'Selective Default' Works)

If you ask me, Credit Default Swaps (CDS) should not be allowed. I cannot buy insurance against your house burning down, because I have no "insurable interest", and doing so would give me an incentive to set your house ablaze. The word "swap" in the CDS acronym is a fig leaf, just put there to allow lawmakers to pretend that they are not insurance, and can be used by financial institutions in an unregulated fashion. New regs are trying to change this, but the CDS market is still murky and opaque -- its been 8 years since Warren Buffet called these and other derivatives "financial weapons of mass destruction". A large part of what makes a Greek default so scary is that it is impossible to tell what exposures are out there, and what dominos will fall if Greece stops paying off.