2014 Outlook: Kunghei Fat Choi, Part 5



A great concern for Spain is yet another huge credit bubble caused by low interest rates on debt. The country has more than a trillion USD of debt and the ECB had to bail out Spanish banks with USD 135 billion as recently as summer 2012. In the end the banks ‘only’ needed USD 54 billion.1


Fortunately, none of that bailout money went to the government; its debt may not be anywhere near as high as that of Greece but it has been rising since the economic crisis began and has yet to stop. It has gone from 36.2% in 2007 to 86% in 2012; in 2013 Q3, the rate was at 93.4%.

Chart 1Chart 1

Debt service is using up 30% of tax revenue and the government had to borrow from its social security reserve to honour pension payments.2 Unemployment has shown signs of falling; yet these figures are hardly convincing given that the rate amongst under-25s is still mounting (see chart 1). Added to that, the country is still experiencing the fallout of its housing bubble, with repossessed houses advertised all over Spain, yet 800,000 homes are empty.

An unconvincing recovery, corruption scandals, the unused airport which cost USD 1.4bn3 and Madrid’s will to spend public money on hosting the Olympic Games (the bid failed) has put regional politics back on the front page: Spain’s richest region, Catalonia, will hold a referendum on independence in November this year: the result is difficult to predict.


France’s debt was downgraded one step to AA by S&P in November 2013. Ten months earlier, Minister of Labour Michel Spain remarked, “There is a State but it’s a totally bankrupt State,” explaining that public sector belt-tightening measures have been put in place. “No siren must tempt us off this path,”4 he said. In late December last year, Socialist President François Hollande received the constitutional court’s green light to impose a 75% tax on salaries over €1m (USD 1.37m) – a flight of top earners’ capital has already begun. Former investment banker Richard Marin points out that France has the second biggest pension deficit in Europe.5


Seemingly the economic engine that is keeping large parts of the Eurozone afloat has seen its GDP growth drop between 2004 and 2012 from 1.16% to 0.68%,6 furthermore, the DAX has merely doubled in value since 2004.7

Thanks to propping up other parts of Europe – not forgetting its own reunification – Germany has a deficit to GDP ratio which has hovered around the 80% mark over the last two years. It also has the largest pension deficit in Europe, “Their pensions are less funded than Detroit,” claims Marin.8


With a history of being a political pawn, Cyprus seems to have become the guinea pig for what could happen to larger Eurozone countries. With a mixture of attempts to offset non-performing loans and pressure to bail out Greece by buying Greek debt, the island’s banks have landed in a huge mess.9 So much so, that a strategy called a bail-in has been employed, whereby taxpayers’ deposits are used to ease the impact on… taxpayers!10

The haircut which bank depositors had to endure was said to be 10% – it seemed more like an eisphora. This put the banking system in on red alert; emergency parliamentary sessions were scheduled and then cancelled. Fittingly, the head of the central bank’s first name is Panicos.

The haircut meant that depositors with over €100,000, including many Russian offshore investors, stood to lose up to 60% of their deposits. The oligarchs weren’t happy and London branches of Cypriot banks were kept open to allow an escape route; those who lost more than €3m have been slightly appeased with offers of Cypriot (therefore EU) citizenship.11

This haircut is particularly difficult to swallow for some, as it was applied to all Cypriot bank accounts, regardless of whether the bank had been bailed out or not.

Since all that, Cyprus has shut the door, imposing capital controls to mitigate the outflow. Whilst this is understandable, it’s worth remembering that Cyprus is in the Eurozone. Thus a German, for example, can withdraw euros from his German bank account but may not be able to do the same from his/her Cypriot bank account. Instead of monetary union, then, we now have a euro and a restricted Cypriot euro.

Two of Cyprus’s main banks, the Bank of Cyprus and the Laiki Bank merged and the bank now covers half the island’s lending market. It is back out of administration and the new CEO is the former head of investment banking at RBS. The number-three lender is Hellenic Bank, which avoided a bailout thanks to a New York-based hedge fund, a local investment house and a Belarussian-owned video game developer (if you made this up nobody would believe you). In November of this year, supervision of the Eurozone’s largest banks will be transferred directly to the European Central Bank. This means that Cyprus’s top four banks will come under Frankfurt’s watch, leaving little role for the Central Bank of Cyprus.12

For Cyprus to come back to monetary reality, banks need to reduce the number of branches and staff, get a grip of the non-performing loans and lift those capital restrictions. There have been calls for state guarantees of all deposits in Cypriot banks to help restore confidence. After what has happened, restoring confidence could be quite a task. That said, even though the island’s banking system is now only half its previous size, depositors from Russia and Latin America appear to be coming back, preferring the more stable legal and tax systems to that of their home country.13

United Kingdom

Whilst Northern Ireland was putting up fake shop fronts in the village where a G8 summit was held in June,14 the rest of the UK was undergoing a housing bubble. The Bank of England’s version of QE and government schemes such as Help to Buy are restoring confidence in the credit market. Consequently demand in housing is on the up – an economic forecasting group study measured average 2013 rates up 8.4% this year, set to rise by 7.3% next year  and up by another 5.5% in 2015. This sounds like the shoots of an economic uplift; however, such a rapid rise is sounding alarm bells of another property bubble. Furthermore, much of this trend is caused by foreigners’ interest in luxury homes in London and thus more like an upturn in an investment market, rather than the residential market as a whole.

Pigovian economic theory tells us that subsidies only work in the short term but that governments get addicted to them and use them for much longer than is suitable. Any initial benefit is inevitably outweighed by long term damage. The UK may well have already passed the point of short-term benefit and with its current account deficit, alarming levels of both sovereign and private debt and its unbalanced economy, the UK may be about to cross some kind of fiscal Rubicon.

Next week: Asia & the Rest of the world


1 http://www.spiegel.de/international/europe/end-of-bailout-programs-in-spain-and-ireland-signals-euro-crisis-recovery-a-933650.html

2 http://www.zerohedge.com/news/2013-07-22/insolvent-spain-forced-borrow-social-security-fund-pay-pensions

3 http://www.ibtimes.com/spains-14b-ghost-airport-ciudad-real-sale-just-140m-1501840

4 http://www.lefigaro.fr/conjoncture/2013/01/27/20002-20130127ARTFIG00150-michel-sapin-evoque-un-etat-totalement-en-faillite.php

5 Richard A. Marin, Global Pension Crisis

6 World Bank Databank

7http://finance.yahoo.com/echarts?s=%5EGDAXI+ Interactive#symbol=^gdaxi;range=20000103,20140102; compare=;indicator=volume;charttype=area; crosshair=on;ohlcvalues=0;logscale=off;source=;

8 Richard A. Marin, Global Pension Crisis

9 http://www.ekathimerini.com/4dcgi/_w_articles_wsite2_ 1_30/04/2013_496717

10 http://uk.reuters.com/article/2013/03/16/uk-eurozone-cyprus-idUKBRE92F02P20130316

11 http://www.zerohedge.com/news/2013-03-25/have-russians-already-quietly-withdrawn-all-their-cash-cyprus

12 http://www.cyprusprofile.com/en/sectors/Cyprus-banking

13 http://www.cnbc.com/id/101421968

14 http://www.reuters.com/article/2013/06/03/us-irish-g8-fakeshops-idUSBRE95210520130603

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