Equity Markets are Trapped in a Repeating Loop whilst Greece needs Reform and a Government which Tells the Truth

One of the features of equity markets recently has been that we have been in a repeating loop since the middle of August. If we look at the pattern we see that after the recent closing peak of 5935 for the UK FTSE 100 on the 22nd of July we then fell to 5068 on the 8th of August for a drop of just under 15%. However since the 8th of August all the bad economic news that has appeared in the UK,US and Euro zone has apparently been matched by optimistic equity forecasts as we have bounced between just over 5000 and around 5400. This is all on a closing basis as during the trading day we have gone below the 5000 level quite a few times (including twice more this morning..) but so far we always recover above it by the end of the day.

However there is the beginning of a sign that this repeating loop may be ending as the highs in this phase are getting lower. So we may soon be able to remove ourselves from a cycle that is like the episode of Star Trek where the starship kept having to repeat the same sequence of events. One warning, however, if history is any guide break-outs from such patterns are usually volatile and often violent in the size of the move.

What has caused this mornings drop?

Even those who have watched the Greece crisis unfold wearing a strong pair of rose-tinted spectacles can see that her situation continues to go from bad to worse. Her government had an emergency cabinet meeting yesterday and it decided to set up what has become called a labour reserve. Under this plan some 30,000 workers in the public-sector would be put in the labour reserve by the end of this year and paid 60 percent of their salaries for a year, after which they would be dismissed.

The problem with this strategy is that Greece has been full of talk of public-sector cuts and yet as I reported on the 19th of September the reality have been very different.

the government had hired between 15,000 and 20,000 people in the public sector in various forms since the start of 2010.

The situation in the private-sector which comments to this blog have pointed out very clearly is one of austerity and hardship but so far the public-sector has talked the talk but walked the walk much less frequently. This leads now to a serious credibility problem for Greece's government. It is easy to look at the new move and think 30,000 workers will get 60% of their pay for doing no work, how is that an improvement? And also to query whether they really will lose their jobs in a years times.

The economy and fiscal deficit have been revised too

The emergency cabinet meeting reduced the forecast for economic growth in Greece in 2011 to -5.5% and the one for 2012 to -2 to 2.5%. This is an area where it has form as it was only on August 22nd we were told this.

The Greek Finance Minister has addressed this matter by lowering the forecast for Greek economic growth from minus 3.8% to minus 4.5% for 2011

Again there is reduced credibility if you keep reducing the numbers in a piecemeal fashion without an actual underlying change.Also there is a danger that they have not yet gone far enough as the last figures for Greek economic output showed a fall of around 7% (seasonally adjusted figures are still not available). The austerity mantra of public-sector cuts and tax rises are likely to make Greece's economic growth trajectory worsen further.

The consequence of the weaker economic figures is that the Greek government also announced that it will miss this years fiscal deficit target of 7.6% of economic output and the number is now likely to be 8.5%. Even the 8.5% forecast came with an omimous accompaniment.

the estimate of 8.5 percent of GDP can be achieved if the state mechanism and citizens respond accordingly

In other words this new forecast is unlikely to be hit either! I pointed out recently that even the European Commission expects the number to be over 9% now.

Is this the surprise we are being told?

Not at all because if we go back to my update of the 9th of March 2011 we saw this.

Compared with the first two months of 2010, revenues declined this year by 9.2 percent…………the shortfall exceeding 870 million euros after the February goal was missed by 595 million.

These numbers were particularly poor because due to increases in the rate at which it is levied the Value Added Tax (sales tax) collection had risen by 7.1% which meant that other taxes must have fallen by more than the 9.2% average. So the pattern was set then or at least it was to everyone outside the Greek Finance Ministry which issued this rebuttal to her ratings downgrade.

Furthermore, Moody's announcement refers to the delay in the rebounding of budget revenues, yet does not take into account the increase in revenues.

The problem with this sort of strategy is that pronouncements by the Greek government now have negative credibility.Whatever the truth is, it is unlikely to be what they are telling us.

Reform is needed as well as a debt haircut

I wrote last week that Greece's situation was now so bad that she would probably now benefit from a combination of default and Euro exit. However this only deals with part of the equation as internally she needs economic reform as her economy is full of closed shops and inefficiencies. She needs to press ahead with such reforms as it is looking ever plainer that this current government has done little in this area.

Will Greece get her next aid tranche?

For all the talk of “conditionality” from the troika it is plain that Greece is nowhere near where she is supposed to be. However I expect them to pay up as they will be unwilling to stomach the alternative. The likely date is the 13th of October when Euro zone finance ministers meet and Greece will then receive her next fix of 8 billion Euros of loans.

It is not only in this area where there has been an utter failure as the “officialese” definiton of conditionality goes the way of its definition of temporary. You see a (conveniently) forgotten objective of the aid was for Greece to be able to borrow again more normally on world financial markets which implied that the costof borrowing would fall, and yet the latest figures pointed out it has risen. From my article on the 23rd of September.

the increased interest expenditures by 2,067 million Euros

More banking problems: Dexia of Belgium

There have been more rumours about this bank over this summer than any other. Its essential problem is that it has a balance sheet that is nearly full of poorly-performing municipal loans and the remaining section has exposure to the sovereign debt of Greece, Portugal and Italy! In the real world it has to be insolvent but in the unreal world it which banks now exist it has been allowed to trade on like a zombie in a horror film.

These rumours built up to a fever pitch over the weekend and French and Belgian ministers are meeting today according to Les Echos to discuss the matter. The problem for Belgium is that Dexia's balance sheet is around one and a half times Belgium's annual economic output which will remind everyone of Ireland's past and present troubles of an over-sized banking sector. The problem for France is that taking part in a bail out of Dexia will imply that similar measures are needed in her other banks such as Societe Genrale and BNP.

As well as the vicious circle that exist between banks and nations there is a further problem for Dexia. The 9% fall in its share price which means that shareholders have lost 57% over the past year means that her potential cpaital resources are shrinking just as her estimated liabilities are rising.

Purchasing Managers Index (PMI) numbers are gloomy too

Today we have received PMI numbers for manufacturing in the Euro zone for September and they are weak. On a scale where a number above 50 indicates expansion only one country has any and surprise,surprise it is Germany but even it only manages 50.3. Greek manufacturing by contrast has continued to contract at a worrying pace with a reading of 43.2. As we are continually being told that her export sector is thriving we can only conclude that the domestic sector is in a shocking state. If these numbers are any guide the it may not be long before the Greek government has to revise its forecasts again.

Operating conditions worsened further, with marked contractions in both production and new orders as demand conditions weakened once more.

The UK had slightly better numbers and whilst they only showed weak growth a figure of 51.1 they were at least positive which is good timing for the Chancellor of the Exchequer at his party's annual conference.

A Week for Central Banks

Both the Bank of England and the European Central Bank have policy meetings this week and we will hear the results of this deliberations on Thursday. There will be rumours of easing by both but I think that the Euro zone inflation figures of 3% last week will mean that many Governing Council members of the ECB will be against an interest-rate cut. However the UK situation is quite different as even a much higher inflation rate may not deter it from further easing. I think that it will be a closely run thing at this meeting and that we could easily see another £50 billion of Quantitative Easing announced. On Wednesday we have the Blue Book announced for the UK which updates our economic statistics and if it were to prove grim then the Bank of England might use it as a rationale for easing. Of course the numbers remain unknown, to us anyway…..

Shaun Richards is a freelance economist who writes the Notayesmanseconomics blog at Mindful Money.