Euro Zone Economy Declined Even With Mild December Weather, Cold Snap Impact to Show Up In Next Quarter Report

Headlines from Europe are causing losses in financial markets in the U.S. today. According to the European Union's statistics office, output in the 17 countries sharing the euro shrank 0.3 percent in October to December from the third quarter. While the uncertainty over a Greek debt deal may be an even bigger factor in the declines in the financial markets, concerns about the sinking European economy are contributing to the decline.

The monetary stimulus provided by the ECB has kept the European banking sector afloat and held down interest rates for sovereign debt, but has not provided a meaningful boost to economic activity. When reports on January through March economic activity are issued, it seems almost certain that further declines will be reported. The almost month long cold snap the began during the last week of January sapped economic activity in the eastern countries of the Euro zone. In particular, tourism and shipping declined due to the cold and snow. While the western countries of the Euro zone, including France and Germany, escaped the brunt of the cold and snow, they still felt the impact of higher energy costs due to high demand across Europe. The high heating bills during the cold snap were Euro zone wide and the reduced economic activity impacted a significant number of the member countries

The negative impact on economic activity from the cold snap, the higher cost of oil this quarter, and reduced government spending resulting from austerity budgets will combine to weaken first quarter economic activity in the Euro zone. The economic forecasts predicting a mild recession in Europe may be overly optimistic, at least in their predictions for the 1st quarter. Be very wary of the impact of the European recession on U.S. financial markets. So far, the weakness in the Euro zone has not spilled over into the U.S., but continued de-coupling is by no means assured.

Would Greece Suffer From Food Shortages If They Left The Euro?

In previous posts, I have suggested that going back to the Drachma might be the only solution to the Greek debt problem. A devalued Drachma would make Greek exports more competitive and increase revenue from tourists taking advantage of low prices. Numerous other commentators have published posts along a similar vein.

However, there is a monster problem with Greece leaving the Euro, the country is not self sufficient in food production. The cost of imported food might double if the Drachma experienced a 50% devaluation. As reported by Megan Greene,

Greece has few export industries it could rely on to grow its way out of the crisis even if it devalued its currency. There is tourism, but any profits from shipping are kept out of the country and green energy is still but a mere pipe dream as an export industry for Greece. Given that Greece is not self-sustaining in agriculture,  a devaluation accompanied by hyperinflation would result in a starving population, and that the resulting civil unrest would destabilize the entire Balkan region

Thus, while a return to a devalued Drachma would be good for those whose make their livelihood from tourism and related services, the rest of the country would be plunged into even more dire straits. The high cost of imports, including food and energy, would push a significant portion of the population into poverty. 


The current efforts of the Troika are primarily based on avoiding short term damage to the European financial system from fallout that will occur when unsustainable Greek deficits and debt lead to a default on their sovereign debt. However, the austerity measures being forced upon the Greeks are destroying the economy. No real solutions that might potentially solve the problems caused by a government that spends more than it collects in revenue are even on table at this point. Given the downward spiral of the Greek economy, deficits will continue to mount. Eventually, the Greeks will either decide for themselves to leave the Euro zone or they will be forced out by the member countries that are already weary of funding Greek deficit spending. Regardless, of whether Greece voluntarily leaves the Euro zone or if they are forced out, the outcome will likely be years of grinding poverty for the Greek population.


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Leap Day Weather Weirdness Suggests Global Warming Is Not Just A Hoax

A scan of the headlines on Weather.com on Leap Day 2012 illustrates that weather weirdness is striking across the U.S. While weather extremes are normal, today is yet another day when the weather seems to be on steroids.

1. Record heat is being experienced in the South and Midwest, 
2. 17 tornadoes have been reported and damage is widespread in some towns
3. the drought in California is worsening. 

Is seems hard to reconcile Rick Santorum's claim that "global warming is a hoax" with the increasing frequency of extreme weather. While the weather being experienced today across the U.S. does not prove anything in regard to climate change, it certainly seems to be a reason to pay attention to the predictions of those warning about global warming. Of course, with it being a leap day, the high temperature records that will be set today only have 1/4th the usual competition as on others day of the year, so they can be somewhat discounted. However, regardless of the lower hurdle for new records on a leap day, the 80 degree temperatures predicted for southern Texas and Florida are remarkably warm for February.

Hottest Day Records

If global warming theory is valid, the U.S. may be in for a hot summer. It appears that La Nina is winding down and may end in a few months. Thus, the cooling effect of La Nina caused by cold waters rising to the surface in the Pacific is unlikely to influence the summer temperatures in the U.S.  Last year was the coolest La Nina year on record. This summer we will discover if  new records for hot weather will be set without the qualifier of only being compared to other La Nina years.

Tornadoes and Hurricanes

The wild card into whether there is a trend toward an increase in extreme weather in the U.S will be shown by whether there is a change in tornado and hurricane activity.  According to meteorologist Jeff Masters, last year's "incredibly violent tornado season is either a fluke, the start of a new trend, or an early warning symptom that the climate is growing unstable and is transitioning to a new, higher energy state with the potential to create unprecedented weather and climate events. All are reasonable explanations".

It is also impossible to predict the number and potential devastation from hurricanes striking the U.S.  Any of the following the could either be the beginning of a trend or a normal variation in the weather:

1. an increase in tropical storms in 2010 and 2011- suggesting more hurricanes hitting the U.S. 
2. only one hurricane has made landfall in the U.S. since 2008- suggesting no change in hurricanes hitting the U.S.
3. the massive devastation from hurricane Irene - suggesting the hurricanes hitting the U.S. may become more powerful and destructive in the future

Conclusion

The weird weather striking across the U.S. provides evidence that climate change may be having an impact on local weather. However, while the debate about global warming is a source of contentious debate, there is too much evidence of its impact to label it a hoax. Global warming researchers predictions may be faulty, but there is not an organized attempt to perpetuate a giant hoax. 


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U.S. Debt Ceiling Scenarios - When Will The Ceiling Be Hit and Which Party Will Control Congress

The U.S. government is rapidly spending its way toward the debt ceiling. Treasury Secretary Tim Geithner recently told lawmakers that he expects the debt limit to be reached "quite late in the year." The United States will likely hit the $16.4 trillion debt ceiling between late November 2012 and early January 2013.

The Treasury Department can employ a variety of accounting maneuvers to push back the deadline prior to  the U.S. defaulting on its debt. It did so last year, when the debt limit was technically reached in May but Treasury was able to push back the deadline until early August. Thus, it seems unlikely that the debt ceiling debate will have to be broached by Congress until after the November election.

Regardless of what scenario plays out, the solution will be messy. The credit rating of the U.S. is in danger of being slashed again. Here are a couple of critical considerations:

1) Will Congress and the Presidency be unified under one party or remain split between the Democrats and Republicans?
2) Will raising the debt ceiling fall to a lame duck Congress and/or President to vote upon after the November elections but before the winners actually take their seats in January?

If the Democrats take control of all three branches of Federal government, raising the debt ceiling will probably be noisy, particularly if there is a Republican attempt at a filibuster, but should pass fairly easily. If Republicans take control of all three branches, it may take considerable arm twisting to round up the votes to pass the debt ceiling. however, it seems unlikely that they would force a Federal government shutdown by not passing an increase. As pointed out by Norm Ornstein, of the American Enterprise Institute, if President Obama loses the election, he may still have a strong hand to play in the debt ceiling negotiations, since the newly elected Republican President will not want his first task in office to be rounding up votes for a debt ceiling increase.

The most likely outcome seems to be that the U.S. will continue to have a divided Federal government after the 2012 elections. The seems little cause for optimism that the 2012 Congress will be any better at achieving compromises than the current Congress. The debt ceiling debate is likely to be just as contentious as it was last summer, however, the Republicans may not be amenable to any sort of compromise after the failure of the Super Committee to achieve an amenable solution to reducing the deficit.  

If voters send another divided government to D.C. in the 2012 elections, the potential for a bitter stalemate over legislation to raise the debt ceiling may be in the cards. A shutdown of the Federal government seems like an outcome with a reasonably high probability of occurring. Federal employees should probably be prepared for skipped paychecks and investors should probably be prepared for stock and bond prices to take a hit from a continuation of dysfunctional U.S. government.


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Cold Snap and High Oil Prices Will Accelerate European Slow Down

Beware of economic data and surveys from Europe. Any backwards looking reports that are based on results prior to January 26 incorporate the boost to economic activity provided by the mild winter and stable oil prices up to that point. The cold snap and higher oil price will serve as a one-two punch that will lead to a dip in economic activity that will show up when reports on February results are released.

An example of using backward looking data to suggest that the European economic situation is muddling through is provided by EU Economic and Monetary Affairs Commissioner Olli Rehn who stated ""recent developments in survey data suggest that the expected slowdown will be rather mild and temporary" at a news conference the other day.

Europe is in danger of an economic slowdown that is much worse than just "mild and temporary". European December Industrial Output declined by 1.1%, led by a 2.7% drop by Germany, compared to November (which in turn was a 0.3% decline). The slide in industrial production most likely will show another big drop when February results are published.

The cold snap led to blocked transportation, reduced shopping and tourism, and higher energy costs. Just one  aspect of the cold snap, the freezing of the Danube, led to millions of dollars (actually Euros) in reduced economic activity. As shown in the map from NOAA, the temperatures in most of Europe were 4-6 degrees below normal for 30 day period from January 22 - February 20.

The European economy (as well as the U.S.) is being propped up by the $2 trillion liquidity injection in the past 4-6 months by global central banks, however, this massive money printing is starting to be reflected in higher prices for oil. Continued money printing (or if your prefer, quantitative easing) seems likely to lead to further increases in the price of oil. Combine the dangers of money printing with fact that the Greek debt deal is likely to unravel in the very near future, and it is challenging to come to any other conclusion than that the financial  markets are behaving with irrational exuberance. The recession in Europe is likely to be both severe and lengthy. At the very least, the results for February economic activity are likely to be depressed and come in lower than currently projected.


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Will Rising Oil Prices Burst the Money Printing Bubble?

The debt crisis has remained reasonably well contained over the last few months. The impact of planned austerity measures has not hit the northern tier of the Euro zone countries. Japan, the U.K., Canada, the U.S. and most of the world's other developed economies have blissfully proceeded along with continued profligate government spending. The reason that interest rates required to finance the burgeoning government debts has not gone through the roof is that central banks have been printing money by buying up the supply up government debt. Central banks have pumped nearly $7 trillion into buying government debt in the past 4 years.

So far, the gold bugs that have been warning that this money printing will lead to hyper inflation have been wrong. However, funding trillions of dollars in new debt simply by having central banks buy up the debt is unsustainable. There is a time limit on how many more years that U.S. can continue to add a trillion dollar to the national debt. Japan may already be at the edge of an economic abyss.

The inflationary effect of higher oil prices may hasten the bursting of the money printing bubble. If the opinion of some economists that proclaim that oil prices have a bigger impact on inflation than federal deficit spending is correct, then we may be in for a bout of inflation. The cost of oil impacts the price of almost every product sold in the U.S. in addition to its huge impact on food and transportation costs, as detailed in Do 2012 Economic Forecasts for U.S. Foolishly Discount High Cost of Oil?

There is a real danger that higher oil costs will function synergistically with the massive money printing to reignite inflation. And if interest rates go up due to inflation, government deficits will grow even larger as interest expense will grow. The whole process could turn into a vicious cycle of increasing inflation.

The irony of higher oil prices is that the effort of the U.S. to impose oil sanctions on Iran is backfiring. The higher prices of oil hurts the economies of the U.S. its oil importing allies, while increasing the compensation to Iran for their oil sales. The concept that an embargo on Iranian oil can be effective is incredibly foolish. Oil is too fungible to be effectively embargoed simply via economic sanctions.

Conclusion
The central bank money printing is creating a bubble that is sure to burst at some point during the next few years. Given the saber rattling by Iran, Israel, and the U.S., the price of oil seems unlikely to be headed anywhere but up. The higher price of oil could reignite an inflationary spiral and burst the money printing bubble before the November U.S. election. The rally in the price of gold over the past two days seems likely to continue. The gold bugs are starting to seem a lot smarter than they did when the price of WTI oil temporarily dropped below $100 a barrel.

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Japan - Will The Economic Powerhouse of the Eighties Become The Next Greece?

During the 1980's Japan was a manufacturing dynamo that many feared would decimate the American industrial base. However, the country has lost its status as an exporting powerhouse. During 2011 it ran its first annual trade deficit since 1980.  The country also experienced a  2.3% contraction in the  GDP in the fourth quarter. It is stunning to contemplate the downward spiral that the Japanese economy has undergone within the last few decades. Japan may be approaching a tipping point that could lead the country into a depression. 

As reported by the New York Times in 2010, 

Japan rode one of the great speculative stock and property bubbles of all time in the 1980s to become the first Asian country to challenge the long dominance of the West. But the bubbles popped in the late 1980s and early 1990s, and Japan fell into a slow but relentless decline that neither enormous budget deficits nor a flood of easy money has reversed. For nearly a generation now, the nation has been trapped in low growth and a corrosive downward spiral of prices, known as deflation, in the process shriveling from an economic Godzilla to little more than an afterthought in the global economy.  

The economic outlook for Japan had gotten even worse over the last couple of years due to: 

1. the March 2011 Tsunami 
2. the increased cost of energy due to shutting down of nuclear plants
3. the country's ageing and declining population
4. the largest debt to GDP ratio of any country in the world at 235% 
5. a government budget that will fund half off all spending via borrowing in 2012

The tipping point for Japan may be the countries high cost of energy. A powerful anti-nuclear movement has prevented Japan's nuclear reactors from being brought back online after they are shut for routine maintenance, and only three of 54 are now operating. Without approval for restarts, all of them could be shut by the end of April, boosting fossil fuel use and adding over $30 billion a year to the nation's energy costs. The elimination of this source of electricity has led to frequent brownouts, leading to increased manufacturing costs..

Tepco, the struggling operator of the tsunami-hit Fukushima nuclear complex, plans to raise electricity prices for commercial customers by an average 17 percent, citing a higher import bill as it shifts to fossil fuel-fired power generation. Concerns over the unstable supply and high cost of electricity have led to industrial production being shifted overseas, making it even more difficult to reverse the downward spiral of the economy.

The multiple problems facing Japan's economy make addressing the enormous budget deficit extremely challenging. The huge debt is only sustainable for now due to the low rate of interest on the government issued debt. However, if buyers start demanding higher yields for government debt, the size of the Japanese deficit will start increasing almost exponentially. 


Japanese Prime Minister Yoshihiko Noda's Cabinet is set to endorse his plan to double the sales tax in three years. With outstanding public debt that is over twice the size of the economy-- and higher than in Greece--Noda wants to raise the current 5% sales tax to 8% in April 2014 and then to 10% by October 2015 to fund growing social welfare spending. 

If the doubling of the sales tax passes, it may be as disastrous for the Japanese economy as austerity measures have been for the Greek economy. The downward spiral of the Japanese economy may pick up momentum and lead it to become the next Greece. 

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