The Argentine government’s expropriation of YPF from the Repsol YPF joint venture with the Spain’s Repsol YPF SA is unprecedented for a G20 country member. Several G20 members have stated their disagreement with the action of the government. It is important to take a look as to the rationale for the government’s actions.
The Argentina economy has several significant headwinds. Argentina cannot access financials markets except at exorbitant rates due to the default history of the country. The very high inflation level of the country roughly 25% exacerbates this difficult financing environment. The response of the government has been to control the import and export of goods and currency transactions associated with those trades. The squeeze is on between the access to cash and credit and the cost of goods. Currently wages are indexed to offset the inflationary environment, this is not sustainable if the economy continues to contract.
The answer from the government on inflation in Argentina is to control costs by taking over the largest energy provider and control the price of energy. The government’s chief economist, the man behind this strategy, is taking a page from Keynesian economics. Argentina’s economy will suffer as credit is further closed off to those who wish to trade with Argentina. The government’s attempts to control costs and reduce inflation without a real ability to impact monetary supply are insufficient. Argentina needs to create a business friendly environment for GDP growth, not price growth. Argentina’s best hope for that growth is focusing on its core export businesses. At the end of the day, the YPF situation is all about politics. Banks, credit insurers and political risk markets are closing off capacity in this country as result.
Egypt continues to lurch toward a new government, but this week the economic environment took a surprising turn. Egypt’s interim military government has annulled a gas contract with Israel. The Egyptian Natural Gas Holding Company (EGAS) has stopped transmission to Ampal-American Israel Corporation. It remains to be seen the outcome of this decision. The Egyptian side states this is a contract dispute due to payment issues, the Israeli side reports that the action was taken in bad faith. Either way, it is a surprising move for an interim government to disrupt a long-standing agreement even if that agreement had many ongoing ‘disputes.’ All clients trading with state owned entities should pay heed, the political winds are beginning to blow and the outcome may not always be clear.
In my last update, I wrote about Spain’s ability to borrow at still reasonable levels (under 7%). Today, Spain received a two-notch downgrade from S&P. The markets did not even take it as blip, no movement. Why should we worry?
Spain is a massive economy, this is not Greece, this is one of the largest economies in the European Union. Spanish companies and banks are core to the economy of the EU and the world. Furthermore, this downgrade came after the ECB’s LTRO was implemented, implying the safety net is not big enough. Spain has several large global banks that support the growth in other Spanish speaking regions across Latin America.
Spain has an unemployment rate of roughly 25%, if you look at those under 25 years of age the rate is astronomically higher. The Spanish government has approved an austerity plan to address things. Here is the problem; you cannot cut your way to growth, not in business or in governments. Spain’s plan is reasonable, but it cannot generate the GDP growth and revenue income (taxes) to help the country in the near term avoid the abyss. People without jobs don’t usually generate tax income for their government.
What will happen remains to be seen. The EU partners and central bank will likely step in again but this round of liquidity will be tougher to generate. Germany cannot politically or economically bail this country out on its own. In fact, none of the EU members can bear this weight. France is facing a new Socialist government who is not that enthused about helping the rest of Europe. The key question is how much more will the German people, economy or government bear? If the contagion spreads to France, the world feel the impacts globally as French banks that provide credit all over the world are impacted.
So is the it the end of the world, as we know it? Probably not, it will be a period for much of Europe to digest the over rich meal, pump in more liquidity and languish for another 12-36 months. Given the political environment, France may not be there for support and other key partners like the Netherlands are facing new governments. It makes the US political gridlock seem like smooth sailing. Hang on it is going to be a bumpy ride.