With a population equivalent to just 3% of the eurozone total, and with public debt equivalent to just 3% of eurozone GDP, the concern regarding the ongoing financial crisis in Greece in recent weeks perhaps seems out of proportion.
The collapse of Lehman Brothers in 2008 and the events that followed are still very much fresh in investors’ minds. Back then, prices of almost all assets collapsed as the global financial crisis played out. Fear took hold. Business activity ground to a halt as worries about counterparty risk and credit worthiness surged. Investors withdrew their money into “safe havens” i.e. largely cash and government bonds.
Turning our attention to the impact that the crisis had on commodities markets, we can see that steel prices duly crumbled. From highs of over €800/tonne during mid-2008 for instance, average prices of hot-rolled coil in Europe fell as low as €360/tonne by the end of March 2009. This was part of a wider sell-off – oil prices fell by some 60% for example, while US stock markets lost roughly half of their value during the same time period.
So, what chances of a Greek default setting off another wave of fearful investment behaviour? Will investors now worry about Greece’s creditors not being able to pay off some of their debts? Will one default set off a chain reaction?
Certainly there are concerns. Despite being some seven years on from the global financial crisis, many eurozone countries still remain vulnerable. Governments still hold large debts and are running large budget deficits, thus only adding further to their debt piles each year. The usual suspects pop up – Portugal, Ireland, Italy, Spain, and even France.
Political risk also seems to have increased. Upcoming elections in Portugal and Spain over the next 6-12 months may bring changes in government similar to that seen in Greece earlier this year. Eurosceptic and/or anti-austerity parties across the region appear to have made gains.
Furthermore, if Greece does drop out of the eurozone then it will have shown that entry into the single-currency area is not irreversible. If Greece were to then prosper and eventually improve economically outside of it, other countries may decide that it wouldn’t be such a bad path to head down after all. Greek default, or debt restructuring, may be just the beginning.
But while some variables are undoubtedly concerning, there are reasons to hope that this need not set off another wider crisis this time. Perhaps the contagion can be contained.
For one, Europe seems more prepared. Following earlier bailouts, additional funds have been raised to deal with such crises, in the shape of the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM). The European Central Bank (ECB) meanwhile has pledged to do “whatever it takes” to save the euro. It has also, as part of its strategy, begun quantitative easing this year, effectively lowering the cost of government debt in the eurozone.
Indeed, the cost of borrowing for most eurozone governments is now below that for the US government. Even Portugal has seen its cost of borrowing fall below that of the USA this year.
So what about the steel market?
Turning our attention to the steel market, one thing is immediately obvious. Europe’s steel industry has done a good enough job of getting itself into a mess over the past few years. It has certainly not needed any help from the “Grexit” problem.
Over the past three years, European steel prices have fallen by around 30%. And this has not been part of a wider retrench in business activity.
Indeed, during the same timeframe, global stock markets have gone on to notch a number of record highs, while eurozone GDP has also begun to improve.
Instead, the European steel industry probably has bigger worries at present than the unfolding drama in Greece.
Rising imports, particularly from China, are one. A rash of trade investigations has been the response so far. But this is like a global game of whack-a-mole. When imports from one region get hit, imports from other countries simply pop up to fill the gap.
Increased energy costs are another problem faced by Europe’s steel industry. The EU’s renewable energy targets are likely to see taxes rise on more traditional, and carbon-intensive, energy sources. Large users of energy such as steel companies will be the ones to bear such increased costs.
Finally, there is the structural overcapacity that burdens the global steel industry. This in itself is linked to the growing import numbers in Europe. Producers elsewhere are simply looking for a home for their excess production. This will put steel prices under pressure for a number of years yet, particularly in Europe where the outlook for demand growth looks weak.
This is not to downplay the issue of the crisis in Greece. Certainly if the crisis was not contained to Greece then further falls in steel prices would be expected as business activity took a hit.
As mentioned earlier, however, Europe does appear to be better prepared this time to deal with a default. The key metrics to watch will be the yields on government bonds in the eurozone. Should these begin to move higher, the ECB’s stance to do “whatever it takes” will be put to the test.
But in the end, even though such contagion would initially cause turmoil it would in the end be overcome, as happened following 2008/09. Instead, Europe’s steel industry should be focusing on the more fundamental issues particular to its industry.
This article was also published for Steel First in July 2015