Goldman Sachs Global Economics, Commodities and Strategy Research 2010 1

Goldman Sachs Global Economics, Commodities and Strategy Research 2010 1


The Credit Crisis and the Euro

Ben BroadbentManaging Director & Senior European Economist

September 2010


Summary

Europe recovering but sharp divergence within the Euro-zone.

Partly industrial composition: investment-driven cycle so sharpest “V”s in capital-goods-producing countries.

Credit crunch has also blown away a decade of interest-rate convergence between “core” and “periphery”.

Eurozone needs (i) more fiscal discipline ahead in good times &/or (ii) more support in bad times. Will politics allow this?


Estimated banks’ losses, March 2009

Eurozone banks: EUR 920bn (10.1% of GDP)

UK banks: GBP 210bn (14.6%)

Total: USD 1.4tn (15.1%)


Domestic Demand and Growth Contributions, Last Decade

Source: GS Global ECS Research

0

5

10

15

20

25

30

35

40

45

China Russia India Brazil BRICs US Euroland

%

Demand Contribution

Growth Contribution

2000-2009 average contribution in USD terms


Chinese Growth: Not Just Exports

-40

-20

0

20

40

60

05 06 07 08 09 10 11

%yoy, 3MMA

Total Exports Non-Commodity Imports


US not as central as it once was

Source: GS Global ECS Research

-60

-40

-20

0

20

40

60

80

100

Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10

USD Billion Jan 2007

U.S.

China

Change in Real Retail Sales Since Jan 2007


Very aggressive policy response

-5

-4

-3

-2

-1

0

1

2

3

-4 -2 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36

Base Rate (%)

Source: GS Global ECS Calculations

Euroland (Current Cycle)

UK (Current Cycle)

Max

Min

Mean

Months from start of crisis


No comparison with Japan

80

100

120

140

160

180

200

220

240

-24 -12 0 12 24 36 48 60 72 84 96 108 120

Index(0 = 100)

Source: ECB, BoE, Fed, BoJ.

BoJ

Central bank liabilities(as a % of nominal GDP)

Months since start of crisis

Weighted average of ECB, BoE & Fed


Not the Great Depression II for output...

60

65

70

75

80

85

90

95

100

105

0 6 12 18 24 30 36 42 48

Index

June 1929=100

April 2008=100

Source: Almunia et al, with GS updates Months since peak


...or for asset prices

30

40

50

60

70

80

90

100

110

120

0 6 12 18 24 30 36 42 48

Index

June 1929=100

April 2008=100

Source: Almunia et al, with GS updates Months since peak


Bounce in asset prices has helped banks’ balance sheets

0

2

4

6

8

10

12

14

Italy Spain France Germany UK

Tier I Capital, % RWA

Average 2005-07

2008

2009

Source: Bank of England FSR


More like other post-war financial crises

78

83

88

93

98

103

108

-5 -4 -3 -2 -1 0 1 2 3 4 5 6

GDPIndex

Source: OECD, GS Global ECS research

FIN

SWEESPJAPNOR

Years from start of crisis

Current cycle includesGS Forecast

UK(current cycle)

Euro-zone(current cycle)

GS F'cast


Divergence

-6

-4

-2

0

2

4

05 06 07 08 09 10

GDP growth,% yoy

Periphery

Other EMU

Source: National sources, Eurostat


Partly reflects industrial composition

-25

-20

-15

-10

-5

0

5

10

15

20

00 01 02 03 04 05 06 07 08 09 10

% yoy

Private-sector investment

Private consumption


But markets price of sovereign debt has also diverged significantly

0

50

100

150

200

250

300

350

400

450

07 08 09 10

bps

Periphery

Germany

Source: Datastream, GS Global ECS Research


Spill-over impact on banks’ funding costs

0

50

100

150

200

250

Nov-07 May-08 Nov-08 May-09 Nov-09 May-10

5-yr CDS Spread,bps

Weighted ave. of European SovereignsiTraxx Senior European Financials

Source: GS Global ECS Research, Datastream


Divergence follows years of convergence

7

8

9

10

11

12

13

14

15

13

15

17

19

21

23

25

27

80 83 86 89 92 95 98 01 04 07 10

Other EMU

Periphery


Real GDP Level ('000 EUR per capita)


No evidence EMU deepened trade integration

13

14

15

16

17

18

19

20

21

22

23

18

20

22

24

26

28

30

32

34

91 93 95 97 99 01 03 05 07 09

%, GDP

World Exports (lhs)

Intra Euroland (rhs)

Source: Eurostat, IMF, GS Calculations.

(Trade shares)


But it did help compress bond yields

2

4

6

8

10

12

14

16

18

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

%German 10-yr yields

Weighted ave. 10-yr yield (Periphery)



And as income converged, current accounts diverged

-15

-10

-5

0

5

10

95 96 97 98 99 00 01 02 03 04 05 06 07 08

% of GDP

Germany France Italy Spain

Greece Ireland Portugal

Source: Haver Analytics and GS Global ECS Research

Current Account


Low rates encourage domestic demand

0

10

20

30

40

50

60

-4

-3

-2

-1

0

1

2

3

4

5

6

7

Germany France Spain Italy Greece Ireland Portugal

pp of GDP

Change in gov. expenditure (lhs)

Gov. expenditure (2000)

Gov. expenditure (2008)

Source: OECD and GS Global ECS Research

% of GDP


Strong demand raises domestic costs

60

70

80

90

100

110

120

14

15

16

17

18

19

20

21

22

85 87 90 92 95 97 00 02 05 07 10

Index (2005=100)% of GDP

Source: IMF, the Spanish Statistical Office and GS Global ECS Research

Real Effective Exchange Rate (ULC, rhs)

Government Consumption(lagged 4q)


…causing declines in the periphery’s export market shares

70

75

80

85

90

95

100

105

110

00 01 02 03 04 05 06 07 08

Index (2000 =100)

GermanySpainPortugalFranceItalyGreece

Source: IMF

Export Market Shares (Volume Index)


And sharp deteriorations in external positions

-120

-100

-80

-60

-40

-20

0

20

40

Portugal Spain Greece Ireland Italy France Germany

% of GDP

2000 2008

Source: Haver Analytics and GS Global ECS Research

Net International Investment Position


Not a problem for the Eurozone as a whole

0

5

10

15

20

25

30G

erm

an

y

Fra

nc

e

Ita

ly

Sp

ain

Ne

the

rla

nd

s

Be

lgiu

m

Au

str

ia

Gre

ec

e

Fin

lan

d

Ire

lan

d

Po

rtu

ga

l

Slo

vak

ia

Lu

xe

mb

ou

rg

Slo

ven

ia

Cyp

rus

Ma

lta

% Euroland GDP

Country's Share of Euroland GDP (2009)


Hefty adjustments needed to achieve stabilization of debt levels

-10

-8

-6

-4

-2

0

2

4

6

Greece Ireland Italy Portugal Spain

% of GDP

Debt-stabilizing primary balance

Targeted primary balance (2010)

Source: National Budget Offices, GS Global ECS Research


Decline in interest rates not restricted to the Eurozone

0

1

2

3

4

5

6

7

1750 1775 1800 1825 1850 1875 1900 1925 1950 1975 2000

Real ex ante consol rate, %

Source: BoE, GS calculations

Avg. since 1700


Reform: The options

Nothing: let countries restructure (if they have to)

Piecemeal: More support/control ex post (EFSF plus EC intervention); tighter standards ex ante (Van Rompouy)

Wholesale: Full fiscal federalism (note US example: political union precedes monetary union).

Euro break-up


Macro rebalancing

Keynes (Bretton Woods, 1946):

“the process of adjustment is compulsory for the debtor and voluntary for the creditor. If the creditor does not choose to make, or allow, his share of the adjustment, he suffers no inconvenience. For whilst a country’s reserve cannot fall below zero, there is no ceiling which sets an upper limit”.


Disclaimer

I, Ben Broadbent, hereby certify that all of the views expressed in this report accurately reflect personal views, which have not been influenced by considerations of the firm’s business or client relationships.

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Goldman Sachs Global Economics, Commodities and Strategy Research 2010 1