Europe Gives Euro Doomsayers Pause With Dormant Davos Sanatorium
European leaders heading to the home of Thomas Mann’s Magic Mountain sanatorium are surprising credit-ratings companies, and the economists who agree with them, as the consensus predicts another year of trauma for the euro area.
Money market lending rates have eased, economic data from Germany to France are beating analysts’ estimates and Italian and Spanish bonds are rebounding after their yields reached euro-era records in November. The Bloomberg European Financial Conditions Index (BFCIEU) has risen to minus 3.5 percent, its highest since August and up from a low of minus 5.4 percent in September.
That gives German Chancellor Angela Merkel and European Central Bank President Mario Draghi some room for optimism that the worst of their debt turmoil may be over as they head to Davos, Switzerland this week. That prognosis is challenged by billionaire George Soros and Nobel laureate Joseph Stiglitz, who will also be attending the World Economic Forum’s annual meeting and argue that the crisis is still raging.
“European policy makers at Davos will keep doing everything possible to try to calm markets,” said William Browder, founder of London-based Hermitage Capital Management and a Davos attendee for 12 years. “People are still petrified.”
A century after Mann visited his ailing wife in the ski resort and used the trip as inspiration for his 1924 novel, “The Magic Mountain,” Merkel and Draghi will join about 2,600 political, business and financial leaders at the five-day conference. Merkel delivers the opening speech on Jan. 25 and Draghi speaks two days later.
They gather as Europe’s fiscal crisis displays some signs of stabilizing a month after Draghi pumped an unprecedented 489 billion euros ($632 billion) of three-year cash into a financial system that was in danger of seizing up.
The gap between the overnight indexed swap rate and the cost of borrowing for three months in euros has declined 15 basis points to 85 basis points after last month touching the highest since March 2009.
The yield on Italy’s 10-year government bond has dropped more than one percentage point after hitting a record of 7.48 percent on Nov. 9 and was at 6.25 percent on Jan. 20. While academics such as Martin Feldstein and economist Nouriel Roubini have predicted the euro could splinter, an investor who last year put $1 million in a basket of securities mimicking the Bank of America Merrill Lynch index of euro-region sovereigns would have earned a profit of about $33,000, the best since 2009.
In December, euro region government debt returned 4 percent, the most since before the currency was created, and another 0.6 percent this month, the BofA Merrill indexes show.
Economic data is also coming in stronger than forecast by the biggest margin since May, according to Citigroup Inc.’s “surprise index.” Recent reports showed German investor confidence jumping the most on record and French business sentiment also improving.
There may be more grounds for optimism in coming days. Charles Dallara, managing director of the lobby group representing creditors negotiating with Greece, said yesterday he was hopeful of an agreement on a debt-swap needed to lower the country’s borrowings. That would clear the way for a second round of international aid. In Italy, Prime Minister Mario Monti says his government will this week pass a package of measures to cut red tape to lift its economy.
“Europe is trying mightily to solve its problems,” Jamie Dimon, chief executive officer at JPMorgan Chase & Co., told analysts and investors on a Jan. 13 conference call. The ECB’s actions were “very, very powerful” because it means banks will not face liquidity or funding problems for at least next year, said Dimon, who will be at this year’s meeting.
Davos is an apt forum for a debate on Europe’s future given Mann’s classic, which tells the tale of German Hans Castorp’s sojourn in the town during the years leading up to World War I and the international personalities he meets there. The sanatorium perched 300 meters above the town is now the Schatzalp Hotel, which last year hosted events attended by rock star Bono, Google Inc. (GOOG) Chairman Eric Schmidt and HSBC Holdings Plc (HSBA) Chief Executive Officer Stuart Gulliver.
“At 5,000 feet it provides a vantage-point from which to survey the rest of Europe -- what Mann in The Magic Mountain calls the ‘flatland,’” said Ritchie Robertson, a professor of German language and literature at the University of Oxford.
Signs of improvement stack up against the risks that rescue plans get derailed by political bickering or that Greece suffers a banking collapse or default. A recession that may already be under way in the euro region could also be deepened by a credit crunch and crisis-inspired austerity measures.
“You have an ongoing crisis,” Soros said Jan. 9. “We are now in a more dangerous situation than in 2008” when Lehman Brothers Holdings Inc. collapsed, he said.
European leaders have been here before. In the middle of 2010 the turmoil calmed before conflagrating again as Merkel pushed for investors to help cover the cost of future bailouts. The 10-year bond yields of Portugal (GDBR10) and Ireland surged above 7 percent and both countries followed Greece in needing bailouts.
Slowing growth is also making it harder for countries to get their budgets under control. Spain was forced to raise its deficit forecast for 2011 by 2 percentage points to around 8 percent of gross domestic product on Dec. 30 and introduce 15 billion euros in fiscal measures. The yield on Portugal’s 10- year security has doubled to more than 14 percent in the past year.
Europe’s woes are infecting the world economy. Google, owner of the world’s most popular Internet search engine, on Jan. 19 reported fourth-quarter profit that missed analysts’ estimates as the region’s slowdown hurt international sales. The International Monetary Fund is set to cut its forecast for 2012 global growth tomorrow from September’s 4 percent estimate.
“The outlook is going to be shakier than appears to be the case at the moment,” said Stephen Roach, non-executive chairman of Morgan Stanley Asia, who will be in Davos. His colleagues in Europe predict the euro area will contract 0.3 percent this year and that the ECB will cut its benchmark from the current 1 percent and engage in quantitative easing.
Banks looking to cut debt are hoarding cash and restricting lending to the economy as they face regulatory calls to raise an additional 114.7 billion euros of core capital by June. Banks parked a record 528.2 billion euros at the ECB overnight on Jan. 17.
Governments will be forced to test any recovery in investor confidence on a regular basis. Deutsche Bank AG estimates euro- region nations need to raise $1.1 trillion this year with about a third of that in the first quarter. Italy, the region’s third largest economy, needs to repay 25.8 billion euros of bonds next week.
Stiglitz, who teaches at Columbia University, said in Lisbon on Jan. 18 that governments are making a mistake by cutting budgets too fast as “confidence won’t be restored if growth is falling.”
Harvard University Professor Kenneth Rogoff sees a risk a euro member will quit and says more sweeping debt restructurings will be required in Greece and perhaps elsewhere. At the University of California, Berkeley, professor Barry Eichengreen says the ECB must become more activist and the German government has to spend more and eventually sign up to greater fiscal union.
‘No Quick Fix’
“There is no quick fix,” said Eichengreen, author of a 2006 history of the European economy. Policy makers will “do the right thing once they do everything else.”
European leaders are trying to act faster than that. While he acknowledges “a very grave state of affairs,” Draghi said Jan. 12 that there are “tentative signs of stabilization” in the euro region economy and predicted last week it “will be in better shape in 2012.”
Draghi succeeded Jean-Claude Trichet as ECB president on Nov. 1. Trichet, who will also be in Davos, spent the end of his eight-year term refuting sceptics such as Harvard University professor Martin Feldstein, who argued the euro is flawed and may splinter.
Investors may be starting to agree with the more upbeat outlook. Traders ignored Standard & Poor’s Jan. 13 decision to downgrade nine euro-area members and France and Spain last week sold 14.6 billion euros of bonds at lower funding costs.
The BofA Merrill Lynch indexes show government bonds have returned another 0.4 percent this month and the euro last week rose for the first week in seven against the dollar. The yield on Spain’s 10-year government bond has dropped 129 basis point from its euro-era high to 5.49 percent.
Delegates are likely to arrive finding local policy makers with other reasons to celebrate. While Swiss National Bank Chairman Philipp Hildebrand was this month forced to resign amid a controversy over his personal finances, the central bank has managed to get the Swiss franc under control after its record- breaking rally threatened to derail the economy.
Four months after the SNB imposed a limit of 1.20 per euro, the currency is trading at 1.2079 and a survey of managers showed Swiss manufacturing expanded in December for the first time since August.
The franc may get further respite if European policy makers push through measures to ease their crisis in the next two weeks and end a string of failed attempts stretching back to early 2010.
Finance chiefs meet in Brussels today as governments aim to restore fiscal credibility by completing a new budget rulebook before next week’s leaders’ summit. A Jan. 19 draft of a planned treaty obtained by Bloomberg News shows officials are heeding some warnings by the ECB not to water down plans for tougher budget limits.
“We’ve gone through many mood swings regarding Europe and we’ll go through more,” said Gerard Lyons, chief economist at Standard Chartered and another conference participant. The leaders in Davos “will want to get across the message that they are trying to resolve some of the fundamental problems.”
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