I saw a very interesting article in this weekend’s Financial Times discussing the London property market. Ed Hammond cited data showing that Greek and Italian citizens have accounted for more than 10% of London property purchases so far in 2011. In fact, Greeks and Italians have so far this year spent more than £400m on prime London property, up from £245m in 2010. Much of this has been into the most exclusive parts of London such as Mayfair and Knightsbridge. It looks like there is a real urgency amongst rich southern European citizens to protect their wealth in this environment of soaring government bond yields.
It struck me that it was, though, a strange situation. Two countries that are on their knees, unable to finance at sustainable rates, that at the same time find themselves very high up the global wealth league tables. Italy, for instance, in 2010, sat in the top 10 of countries with the highest average wealth per adult (according to Credit Suisse). In another study, the Human Development Report 2011, Italy comes out as the 24th wealthiest country in the world while Greece sits at 29th. The UK came just above Greece, at 28th, for purposes of context. Norway and Australia come first and second, respectively.
In these markets that are being totally dominated by what we call the sovereign debt crisis, the market has become fixated on debt to GDP ratios, as corporate bond investors have always paid close attention to companies’ net debt to EBITDA ratios (an income statement approximation to cash earnings). Both ratios very simply look at the level of debt relative to earnings, and thus give some indication of how easily a country or company can service their debts.
Going into this crisis, countries (not companies) were paying out more in spending than they were taking in tax revenues. And as the bond markets have become not just concerned, but obsessed with starting to reduce debt levels relative to GDP, we have seen austerity budgets passed all over Europe (not the US, but that is something we will all worry about at a-not-that-much later date). These are a direct attempt to bring primary budgets back into balance, where spending is financed through tax revenues rather than increased borrowings. A secondary aim of this is to start to bring down the all-important debt to GDP ratio.
But governments are finding it very difficult to bring in the necessary budgetary reforms due to political unrest. And now, the few reforms that have been brought in to cut spending have met with what looks like being a global slowdown. Perhaps even a global recession. So governments are not only struggling to bring the primary budget back into balance, but are now seeing GDP growth fall, whether by coincidence, or by actually contributing to the decline in growth (more likely). And if GDP starts to fall, then debt to GDP ratios deteriorate unless total debt levels are being reduced by a faster amount. You won’t find many, if any, examples of states that are actually cutting their total debt levels in Europe yet.
It is worth observing, in passing, that there are several countries that have pretty terrible debt to GDP ratios that also have historically low interest rates (witness the US, the UK and Germany, amongst others). The implicit message here is that debt to GDP is not the be-all and end-all in terms of the cost of that debt.
So what is needed, if growth continues to slow and the threat of renewed recession spreads across these over-indebted nations?
The evidence of the Greeks and the Italians coming and spending such large sums of money on prime London property suggests that these people fear a new wave of fiscal approach to this crisis. As growth in both these states continues to plummet, thereby worsening traditional debt to GDP ratios (bar a haircut or default, both synonymous as far as we’re concerned) a new approach by policymakers may start to take hold. Austerity isn’t going to help in this environment. Perhaps even the opposite. What is needed is an ability to stimulate the economy, so as to generate jobs and growth. And what is all too clear from the last couple of years is that the bond markets will no longer lend to finance these budgets aimed at growth. So the resource needs to come from somewhere else. Is it time for Robin Hood to come to the rescue in the form of a wealth tax? It appears that many citizens of peripheral Europe are starting to fear exactly that.