EU pain persists
Six years on and the European Union’s post-GFC hangover is becoming more of a chronic migraine. Ahead of a key European Central Bank meeting on Thursday night, the media was awash with commentary about the intensifying risk of deflation.
While the 18-member Eurozone’s economy stopped contracting last year, it has continued to wrestle with feeble growth rates (0.2 per cent in the first quarter), stubbornly high unemployment rates (11.7 per cent), weak bank lending, and stalling inflation rates (0.5 per cent).
And underlying it all, unhappy voters are switching to extremist parties, making the political and economic decisions of their leaders ever more fraught. (Nouriel Roubini was the latest high-profile economist this week to voice concerns about how economic insecurity was sending some Europeans into the embrace of populist parties.)
If today’s disinflation descends into Japanese-style deflation, it will make it harder for governments and individuals alike to pay their debts as the asset values fall. (One newspaper quoted a Greek hairdresser explaining she used to charge 30 euros for a haircut, but after competitors dropped their rates and clients started losing their jobs or getting pay cuts, her prices have fallen to just five euros.)
The European Central Bank (ECB) is aiming to push inflation back towards its target band. A week ahead of the meeting, influential global bonds giant Pimco noted: “The big question is whether the ECB will engage in QE [quantitative easing], following the Fed, the BoE [Bank of England] and the Bank of Japan, given the macro-economic headwinds and the very real deflation risk in the Eurozone. Headline inflation in the Eurozone has been below 1 per cent for more than six months and the market’s, and indeed the ECB’s, forecasts for medium-term inflation are well below the target 2 per cent.”
The different regulations governing the ECB meant it avoided the style of quantitative easing pursued in the US during the global financial crisis (whereby the government bought debt from US banks and car manufacturers that could no longer service it, and were` then paid back over the following years).
Instead the bank engaged in a “Long-Term Refinancing Operation” in which it loaned money cheaply to financially stressed banks – normally in the most indebted nations – which in turn borrowed from their own national governments. But “this was like asking two drowning men to save each other rather than throwing them a lifeline”, says Saul Eslake, chief economist at Bank of America Merrill Lynch.
Eslake believes that, unlike in the US where the economic recovery seems to be more solid, the EU has merely papered over the problems in its banking system, and much more work has to be done to return it to health. (This will come into focus when the ECB releases its results of stress testing the financial sector.)
While dwarfed now by the Chinese-Australian relationship, the EU’s financial health still matters to Australia, particularly indirectly. Europe remains the world’s second-largest economy and accounts for 13.1 per cent of Australia’s two-way trade, although European imports far outweigh local exports.
“The impact (any further weakening in Europe) is not so much in the ‘real economy’ but in the financial markets. Aussie banks still raise money in Europe, so it could impact on borrowing costs. And all else being equal, it would make the Australian dollar stronger,” Eslake says.
Commonsense on bankers’ salaries
Meanwhile, in an altogether different income stratosphere, a Financial Times-commissioned global analysis of banking salaries showed that the heads of 15 of the world’s largest banks got a 10.1 per cent pay rise last year, each taking home an average of $US13 million in 2013.
“The [US and European] pay rises came in a year when [overseas] banks paid record fines in the US for wrongdoing ranging from mis-selling mortgages to violating US sanctions. The 15 banks paid $US48 billion in fines last year, up from $US30 billion in 2012,” the paper said.
In Australia, their counterparts undershot the overseas averages (the ANZ’s Mike Smith reportedly earned $10.4 million as a salary after a 3.2 per cent pay rise and bonuses in 2013).
But a long-time critic of excessive executive salaries, chief investment officer at Clime Investment Management John Abernethy, says that just because local executives earn less than the “astronomical” salaries earned by their overseas counterparts does not suggest that they, too, are not “grossly overpaid”.
“The remuneration of executives of public companies tends to get mixed up with the returns of entrepreneurs, who are people that take a risk and get well remunerated when they are successful in creating a new business.
“However, bank executives are merely custodians of their businesses. They did not create the bank and rarely do they build them ... these people don’t have to be entrepreneurs, but they have to have a fair dose of commonsense, humility and integrity. None of these characteristics are found by offering excessive salaries.
“It’s now ridiculous that executives can make tens of millions of dollars in a five-year stint. Indeed the executive with commonsense would say that is more than enough for me and I am out of here!”
Join the crowd
Crowdfunding advocates in Australia have had a breakthrough with the federal government releasing a much-anticipated review into the web-based funding model.
The report recommends loosening the rules, which currently limit crowd funding largely to charitable or “in kind” style donations, or equity investments by professional investors.
The new rules, should they be adopted, would allow all (adult) investors to become shareholders in small start-ups, but limit their investment to $10,000 over a 12-month period, with no more than $2500 per company, and with cooling-off rights.
Such changes would bring Australia closer to British and US systems, and has been championed by many politicians as a means of encouraging innovation in small business. It could herald a significant expansion of crowd-sourced funding.
A sorry footnote is that it will be the last report to come from the widely respected Corporations and Markets Advisory Committee, another casualty of the federal budget, with its responsibilities transferred to Treasury.
A bit of sunlight
While deflation is the talk in Europe, Australia had some good news this week when economic growth rates surpassed expectations, with an yearly growth rate of 3.5 per cent for the 12 months to March.
Powered by a leap in mining exports, the economy expanded by 1.1 per cent in the first three months of the year. However economists note that a recent precipitous fall in iron ore prices may dampen the results over coming months.
Other growth sectors included financial services and construction – driven in part by the pick-up in residential housing.
However, nervousness over Australian consumer confidence levels continues to dampen expectations about the strength of Australia’s economic recovery, and Deutsche Bank economist Adam Boyton described the GDP figures as “five minutes of economic sunlight”.
This article was first published in the print edition of The Saturday Paper on Jun 7, 2014 as "EU pain persists ". Subscribe here.