GS Viewpoint, March 22

Cyprus Never Let a Crisis Go to Waste.

So how can it be that a $22bn economy can be the dominant global topic for conversation for a full week? I am fond of saying that China (at least in 2011) was creating the equivalent of another Greece every 12½ weeks. China creates another Cyprus every week. If Cypriot banks reopen next Monday, in the time they have been shut, China has created another Cypriot economy. Cyprus has now, in my view, become the epicentre of a number of major strategic issues. I can think of at least four (but there are probably more):


First, the European Monetary Union (EMU), in effect, continues to be a union of 17 countries that don’t see their collective shared interests as the same. Second, within this context, much decision making is not actually decided by the EU or euro zone bodies but by key politicians whose main criteria is what they “can get away with” with respect to their parliaments. Can EMU ultimately survive, or indeed, can EMU survive with this system? Third, behind the scenes, who is going to win the battle over the immediate resolution of the Cyprus dilemma – Moscow or Berlin? With it, this has brought a major strategic challenge between those two power centres. And Fourth, is there likely to be sufficient vision and imagination to realise that this crisis can be turned into an opportunity and – while not quite as simple as this, but in essence – that everyone could be a winner?

Russia Seizing the Opportunity.

For several years now, there is not a week going by where I don’t receive at least one email suggesting I should drop the ‘R’ in BRIC. This summer, Russia will take over chairing the G20 and the G20 summit will be held in St Petersburg. The hosts are looking for a theme and, related to that, for an opportunity to improve their image. In fact, they recently hired Goldman Sachs to help on this score – not that I am at all involved in this, given the Chinese Walls. If you look at the attached chart showing the trend of the one-year forward P/E estimates, you can see that Russia trades at a major discount to other BRIC as well as major markets. This hasn’t always been the case but it has been since the 2008 crisis. Early in the last decade, Russia traded at a premium to Brazil, and never quite at the discount it does now. The markets confirm that Russia has a perception problem, at a minimum, which of course may relate to issues of content and policy.
So here is the situation: Russia is priced at a major discount to its BRIC peers, reflective of a general negative view about the country. It is looking for an initiative or opportunity to change this view, and is soon about to host the biggest annual meeting of world leaders. And, a tiny economy of $22bn, Cyprus has banks with a lot of savings from Russian wealth owners. It doesn’t take a genius to figure out that here is a massive opportunity to help itself – and perhaps even the EU.

Germany and the EU.

I have spent much of this week thinking that the Russian policymakers have such a great opportunity, but to most people I discuss it with, the answer is usually: no chance, the EU (or perhaps especially, Germany) wouldn’t like that. What is it that the EU wouldn’t like? One of its member countries being more dependent on a non-EU country than any of them, or that Cyprus won’t ‘suffer’? Or is it that the EU disapproves of certain aspects of Russian life and some of their wealth holders’ activities inside the EU? I have no idea which, if any, of these answers are true but the EU should, like everyone else, ask itself some big questions.
In particular, going back to my earlier four points, is the EU going to lead Europe or simply follow events, especially decisions made in key member countries? And, are the EU and its key members going to look outward and forward instead of inward and backward? Isn’t this also an opportunity for the EU to try and significantly improve its relations with Russia? So many questions. We all await the answers and some are probably urgently needed to stop markets going into a bit of a panic.

There is a Life Beyond Cyprus.

One of the big fascinations of the week is that, despite Cyprus, markets remained remarkably calm. This may reflect the fact that, after all, the Cypriot economy is just $22bn in size, but also probably that, except for Europe, the global economic news continued to improve this past week. This included:

  1. A better-than-expected bounce in the March Philadelphia Fed Survey of business confidence, and an improvement in the new orders component.
  2. Some pick-up in Korean exports judging by the first 20 days of March.
  3. A bigger-than-expected rise in the China HSBC Flash PMI to 51.7, which also included a pick-up in new orders.
  4. The latest Japanese Tankan survey, while weak, improved more than expected, including the implied expectations from the previous survey.

Not all data showed improvements and with reference to the huge importance of the $22bn Cyprus not causing contagion to Europe, the March Flash PMIs in Europe worryingly weakened, suggesting that no early end to the recession is in sight. The euro zone needs something positive, not a fresh crisis. Its weakness is starting to look more isolated. Even the UK managed some positive data surprises this week, with the latest retail sales on the upside.

The UK Budget.

The annual ritual of the UK Budget came and went, and predictably it contained very little of macroeconomic interest in terms of surprise or initiative, except for the renewed request for ‘help’ to the Bank of England.
Some moderately interesting micro steps were announced, including a further cut in the corporate tax rate and measures to help ‘middle England’ by offering needed mortgage subsidies to house buyers and also a cut in tax on beer. How exciting! For me, the more eye-catching part of the Budget is just what an odd ritual it remains, slightly cute in its depiction of eccentric England, and the staggering amount of newsprint that is still given to the proceedings – even though for many years, the November or Autumn Statement has superseded the Budget in terms of importance.

Japan and Expectations.

Mr Kuroda began his life at the helm of the Bank of Japan this past week and he appeared to make all the right noises with his intention to make a crack at their ambitious 2% Inflation Targeting. I notice one or two people starting to suggest that if they succeed, they won’t be able to stop it at 2% and inflation could spiral sharply in Japan. Perhaps, but it would be a better problem to worry about, at least initially. The Yen has clearly lost its straight line weakening trend and without a big surprise initiative from Kuroda and/or until the US bond market sells off sharply in circumstances of another upward revision about the US economy, I suspect it is set to become a bit duller by recent Yen standards.

US Technology Cash.

The FT carried a highly interesting story on Tuesday, 19th March, in which they cited a Moody’s report showing that US technology companies continue to accumulate astonishing amounts of cash. According to the piece, it is now a huge $1.45tr, of which Apple is supposedly some $170bn. The article goes on to suggest that around $840bn of the total is held offshore (hopefully for them not much in the Cypriot banking system!). There are so many interesting angles to this issue, including the question whether it is a bigger deflationary force than US fiscal tightening. Or looked at in a more positive way, can you imagine what happens when it suddenly seems sensible or fashionable to spend it? In the meantime, the pressure to boost dividend payments is likely to rise.

Back to Europe.

So I thought I would end this week where I started, with Europe. I spent Thursday back in Italy for the day where I had been two weeks ago. I was not fulfilling any early plan post-GS role as an economics advisor to Grillo and his Five Star Movement as one person enquired! I conducted an audience survey on three questions: Question one, who voted for my friend Grillo? Hardly anyone answered yes. Question two, how many thought Italy would still be in the Euro by 2020? Virtually everyone said they expected Italy to remain in the Euro. And question three, how many would have voted for Mourinho, had he stood in the elections?
Not a huge number but a few, I assume Inter fans, raised their hands. At a couple of events I was asked many questions about Italy, and what I thought Italy needed to do. I repeated things that I had mentioned a couple of weeks earlier in Cernobbio: Italy needs to pursue policies to boost economic growth, and reforms that boost growth, and to stop policies that are designed to tighten fiscal policy. Italy has the best cyclically adjusted fiscal balance of the G7 countries and, by comparison to some countries, significantly. Indeed. As I only realised answering a specific question, Italy and Finland share the best cyclically adjusted fiscal positions of Euro members. Instead of a “nord” and a ”sud” Euro, it could be a “FinIt”!
We approach Easter with euro zone issues looking very fragile. One hopes that some sort of credible deal can be found to support the Cypriot banking system this weekend, or otherwise we could be in for a challenging next week. Let’s hope many policymakers like the notion of never letting a crisis go to waste.

Good luck!

Jim O’Neill
Chairman, Goldman Sachs Asset Management.

source: gs

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