Oil and Frexit: Two Concerns in a Complacent Environment

We cannot deny that we are in an environment where global growth and leading indicators show more positive prospects than expected. We have gone from fear to hope – as we explained here – and the US data once again shows strength after the declines seen before the elections. Add to that an increase in expectations of oil demand and the improvement in manufacturing index in Europe.

However, there are two risks. Inflation is mostly coming from energy import costs, and the risk of default from France is rising in the face of the threat to “leave the Euro”

The report of the IEA (International Energy Agency) published yesterday shows us positive and negative data.

Demand growth revised upwards to +1.6 mb/d

  • OPEC production is down 1 mb/d y/y
  • Non-OPEC output is down 0.4 mb/d y/y
  • OECD stocks fall at a rate of 800 kb/d in 4Q.
  • This is balanced by high absolute level of stocks.
  • and US supply growth revised up by 0.1 mbd, now forecast to grow 520 kb/d Dec ’17 vs Dec ’16

Oil demand has been revised upwards to 1.6 million barrels a day by 2017, which indicates that after years of anaemic economic growth and poor demand, it can be a signal a global of improvement. But we must be cautious, given the high level of inventories and the likely seasonal effect. At the moment, OPEC production cuts may seem like a “success”, but as it happens, US production continues to pick up. In addition, the response from consumers happens faster, with substitution and technology accelerating. The world cannot afford an oil shock because of a short-term policy of producers.

It has always been said that the world goes into crisis when the oil burden – the cost of importing oil over total GDP – exceeds 5%. It is rather the opposite, energy overpricing is triggered by the inflationary effect of stimulus policies, and overcapacity and debt remain, triggering a crisis.

At the moment the rise in oil prices comes because producers cut supply, but the impact of these incorrect decisions always generates a response from consumers that accelerates the substitution and diversification of non-cartel producers.

What is the problem? For consumer economies it will have an impact on growth. Imports soar, competitiveness is eroded… but there is some hope. Just as the 2016 oil price recovery did not reduce Spain or Europe’s growth – in fact, it was better than expected – it should not be a recession-leading factor in 2017 as prices remain low. The fact that oil is below $ 57 a barrel (Brent) and is anchored in a very narrow trading range despite the production cuts, shows us that the marklet is very well supplied.

Frexit. The biggest bankruptcy in history?

A couple of days ago, David Rachline of the National Front in France, decided to go to the manual of unicorns ‘Made In Varoufakis and Podemos‘ and state that “the debt of France is about 2 trillion euros, about 1.7 are issued under French law, which means that they can be re-denominated.” Easy, isn’t it?. Your loans in euros can be returned in French Francs … and he thinks – he says – that nothing will happen.

Nothing. Only the collapse of France’s pension and social security system, which is mostly invested in sovereign debt, the destruction of the savings of millions of citizens, and the bankruptcy domino of the French banks. Let us remember that more than 40% of France’s Government Debt is held by the French savers, pensions and institutions.

No amount of money printing would mitigate the impact of an effective default in France, and the contagion on the rest of the Eurozone.

The magic idea of ​​thinking that sinking the currency and defaulting is going to improve the economy is based on three lies:

  • That a default will not affect new credit and access to future financing. To think that they are going to default and investors will lend France more, and cheaper, is so ridiculous it can only be defended by a politician with a straight face.
  • That defaulting does not affect citizens. Not only are their savings and pensions destroyed, so are their deposits – by devaluation and the inevitable bank run -, but access to credit from SMEs and families disappears, even if they want to invent a thousand public banks printing papers.
  • That they can “contain” the brutal impact (which the National Front themselves expect) with a fictitious second currency that will be “closely pegged” to the euro while the transition takes place. A trainwreck in slow motion. It would collapse the Euro and the “closely pegged” currency as well.

If France were to carry out this atrocity, it would be the biggest credit event seen in recent history and, considering that the assets of the French banking system exceed the country’s GDP by more than three times, it would be an implosion that no serious person would think would go away printing French Francs.

Banks’ outstanding home sovereign and sub-sovereign securities represented 6.4 per cent of total assets in the EU as of February 2016, according to Standard & Poor’s… A credit event of the magnitude of France re-denominating its debt, and the subsequent contagion risk throughout the Eurozone, would lead French and European banks to collapse.

Someone should tell LePen that her plan has already been carried out. By Argentina. And its currency lost 13 zeros in 40 years.

It is terrifying to see that citizens are led to believe in these fake magical proposals to which the totalitarian populists have accustomed us. But it is even scarier to see that the European populists believe these ideas have not worked in the past because they were not implemented by them. The idea that economic imbalances caused by printing money without control is solved by printing even more money with much less control. Brilliant.

The good news is that crisis after crisis, each credit event after another, it becomes increasingly clear that the populists’ technical capacity to destroy the economy and plunge their citizens’ wealth with magical “solutions” is diminishing.

French candidates must warn of the devastating effect of these pyromaniac ideas.

It is sad to see that there is still someone out there who believes that sinking the currency and defaulting will make us richer and borrow at lower costs. It shows us that we did not explain currently our past generations that Santa Claus does not exist.


Daniel Lacalle is PhD in Economics and author of “Life In The Financial Markets”, “The Energy World Is Flat” (Wiley) and forthcoming “Escape from the Central Bank Trap”.


About Daniel Lacalle

Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.

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