Mark Lister

On Investing

Mark Lister: Euro market doing job, forcing political response

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During a trip to the United States in 2009 I quickly learned that admitting I was a sharebroker in New Zealand was a sure-fire conversation stopper.

The anger from main street Americans towards anything that resembled Wall St was overwhelming and the protest marches across the country last week suggest not much has changed. Their bitterness is understandable, as they blame corporate greed and fiscal carelessness for a weak economy, persistent unemployment and various taxpayer-funded bailouts.

Europe looks to be heading in the same direction, with the division between the stronger northern countries and the troubled southern ones growing. Greek butchers and hairdressers may soon face a similar reception when visiting Munich.

It's not difficult to find examples of the inefficient Greek public service to gain an insight into just where their problems began. As in many European countries, one of the most obvious is the pension system.

In Greece, the official state pension age is 65 years for men and 60 for women - not too different from here in New Zealand. Both countries also have similar per capita income levels.

But when you look at retirement trends the similarities end. In New Zealand, OECD figures suggest that over 70 per cent of our 50- to 64-year-olds are working, while in Greece the corresponding figure is below 50 per cent (as it also is in Spain and Italy).

This leaves Greece with an average retirement age of 60, which is low even by European standards. Where our system is clean and simple with few exceptions, the Greek pension system is complicated with a host of archaic exceptions.

Decades of union activity in Greece have led to a range of situations where early retirement is allowed, as young as 50 for women and 55 for men in some cases. Greece has promised early retirement to 10 to 15 per cent of its workers.

OECD data shows 11.6 per cent of Greece's public expenditure last year was spent on pensions, compared with 4.7 per cent in New Zealand.

By 2050 that number is projected to jump to 24 per cent and 8 per cent for both countries respectively.

One of the more extreme examples of how the pension system has been open to abuse is the Greek Government's list of "arduous or unhealthy professions". Under a system enacted in the early 1950s, these are jobs that it has historically considered to be dangerous enough to justify letting the workers who engage in them retire in their 50s, at the expense of the state.

The 500-plus categories of unhealthy jobs include coal mining, bomb disposal and other genuine high-risk professions.

But numerous other vocations make the grade, including hairdressers (because of the chemicals and dyes used), television presenters (because of the bacteria from microphones), trombone players (risks of potential breathing problems later in life) as well as cheese factory workers and butchers.

These bizarre examples of archaic policy are in the minority, but they do highlight why there is such resentment towards Greece from the more prudent members of the European Community, namely the northern members such as Germany and the Nordic countries.

The Greek Government announced a range of reforms to its pension system last year in an effort to reduce its deficit and closing some of these early retirement loopholes was one of the aims. But it clearly hasn't moved fast enough and recently admitted that it will miss its deficit target, which means that it won't get the financial aid package it had hoped for this month.

The issues in Greece, Ireland and Portugal are nothing new, and with hope of them fully paying back what they have borrowed fading, an eventual debt restructuring seems inevitable. This would mean substantial "haircuts" for holders of these countries' sovereign debt.

Debt restructuring is a process where a company (or in this case a country) facing financial distress renegotiates and reduces its debts.

Taking a "haircut" on debt holdings simply means that a creditor has lent money to a poor credit risk, that they can't pay it back and some of the debt will need to be written off.

Taking a 50 per cent haircut would mean that for every $1 the borrower owes them, after the "debt restructure" they get only 50c back.

It was expected that this inevitable debt restructuring would occur in two to three years. It was also hoped that by this point the European banks that have lent money to Greece would have had time to prepare themselves and accumulate further capital, so that when they were forced to take large haircuts on their debt, they would survive the losses.

At the same time, the more financially challenged countries were expected to have had time to implement some austerity measures (raising taxes and cutting spending), conduct some asset sales to raise funds and put themselves on a more sustainable fiscal track.

But looking at Europe's growth prospects, it is hard to see a scenario where the banks build up enough capital to withstand the write-downs.

Second, market pressure is increasing and the strategy of buying time may serve only to reduce confidence further and worsen the problems.

It is beginning to look as though the sovereign debt restructuring for distressed countries could occur much earlier, maybe even before the end of this year.

Regardless of how it all ends, it will ultimately come at the expense of future economic growth, which is part of the reason the world's sharemarkets are reacting the way they are. Markets look forward, anticipate future growth and earnings and then discount it back to a present-day value.

If this was the only thing driving markets at the moment they would probably be higher than they are, because they seem to be factoring in an overly pessimistic growth outlook.

However, markets also despise uncertainty, which is what they are facing at the moment thanks to the circus that is global politics.

The New Zealand sharemarket is, believe it or not, actually in positive territory so far this year. It's only up 0.3 per cent, but it's still up. Comparatively, the US market is down 8.7 per cent and Italian shares are down 23.9 per cent, which is not surprising, given that Europe is the epicentre of the problems.

While we will not be immune from any financial aftershocks, we can take comfort that we may be more insulated than most.

My personal view is that we will see an orderly resolution which will involve Greece at least partially defaulting on its debts. I don't believe we will see a break-up of the euro area, even a partial one, which makes it hard to see the wealthier members escaping responsibility for some element of taxpayer-funded bailout.

Some of the European banks will face significant haircuts on their loans, and their shareholders will be required to inject more cash as part of a recapitalisation process, which will no doubt include some government involvement.

The largest of the world's central banks will play a supportive role along the way, proving liquidity and acting as lenders of last resort.

Governments will have to deliver and enhance their adjustment plans. Tougher fiscal and economic governance rules will be required as will some demonstration of the political will to move towards a greater fiscal union in Europe.

However, market pressure will be needed to ensure some advancement on the political front, so financial market volatility is likely to remain high.

Ironically, as painful as it is to watch financial markets react to these issues, the pressure that is building on Europe's political leadership shows that the market is doing its job and forcing a response.

Mark Lister is head of private wealth research at Craigs Investment Partners. His disclosure statement is available free under his profile on www.craigsip.com. This column is general in nature and should not be regarded as personalised investment advice.

- NZ Herald

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