And Another Debt Crisis

By Spectrum IFA
This article is published on: 1st November 2013

We have been living through the Eurozone sovereign debt crisis and now we have the US debt crisis again. It feels like déjà vu, as it was around this time last year that there was much talk about the US fiscal cliff.

Just hours before the deadline of 17^th October, the US Congress passed a bill to re-open the government and raise the federal debt ceiling – well at least until next year – as new deadline of 7^th February was set. The consequences of not having made this ‘temporary fix’ would have resulted in the US defaulting on its sovereign debt. Default would have been catastrophic for the US and also for the global economy.

The Republicans lost this battle and probably the war against ‘Obamacare’. The reputation of the party is damaged and they will need to work very hard to earn the trust of the American people in time for next year’s mid-term elections.

Naturally, the uncertainty prior to the deadline made the stock markets a little nervous, but there were no big falls. Likewise, when the deal was reached, there was no big rally in markets. Generally, markets only react to the unexpected and I guess that it was unthinkable that the US would default on its debt.

However, the US economy was damaged by the theatrics of the bat and ball game by the politicians. The ratings agency, Standard & Poor’s, estimates that the partial US government shutdown shaved $24bn from the American economy; the US government estimates that this will cost 0.25% of GDP in the fourth quarter of 2013. The US dollar fell and Fitch put the country’s credit rating on negative watch, whilst one of the Chinese ratings agencies downgraded it a notch.

The Fed has since met and has decided that there would be no change to its $85bn per month asset purchasing scheme, a strategy that was put in place in September 2012 in the hope to drive down long-term interest rates and spur growth. The job market remains sluggish and inflation below its 2% target. Most economists think that the uncertainty stemming from the government shutdown will force the Fed to wait until 2014 before beginning its asset purchase tapering. Short-term interest rates were also kept at zero and so no encouragement for savers, a situation that has existed since December 2008.

Turning to the Eurozone, there are slight signs of economic recovery. At the early September press conference of the ECB, President Draghi described the economic recovery as “weak, fragile and uneven”. The benchmark interest rate was kept on hold at 0.5%. Draghi said that rates were likely to remain at this level for an “extended period”. More bad news for savers.

Since that meeting, the unemployment figures for September across the 17 Eurozone countries have been published. Rising by 60,000 to 19.4 million, this is the 29^th consecutive monthly increase in unemployment. At 12.2%, the jobless rate is the highest since monetary union began at the end of the 1990s, according to data from Eurostat, the EU’s statistical agency. Youth unemployment amongst the under-25s is running at 24.1% and alarmingly at over 40% in Italy and 50% in Spain.

The slowdown in inflation is also becoming increasingly concerning. According to Eurostat, the Euro area’s inflation rate has dropped from 1.1% to 0.7%, which is considerably below the ECB’s target of being at or just below 2%. Lower energy bills in the Eurozone is one of the main factors that has pushed down the inflation rate, the complete opposite of what is being experienced in the UK at the moment. The ECB’s prime objective of price stability in the Eurozone is under pressure.

The inflation data has surprised the market and when combined with the strength of the Euro, questions are being asked about the risk of the Eurozone falling into a ‘Japan-like’ deflationary spiral. If the ECB considers that this is a real risk, it may need to act by cutting interest rates again. We will have to wait and see what the ECB does at its November meeting. Whilst it is unlikely that there will be an immediate cut in interest rates, perhaps it may give some signals in its ‘forward guidance policy’.

Closer to home, the French budget – Projet de Loi de Finances 2014 – is progressing through parliament. As expected, amendments have already been proposed and adopted by the National Assembly, including amendments to the government’s proposed reform of the capital gains tax regime relating to property. If the National Assembly’s amendment continues through to the final law, we could see the maximum taper relief applicable to property gains, for the purpose of the social contributions only (currently at the rate of 15.5%), being restricted to 28%, whilst the capital gains tax would be fully tapered out after 22 years of property ownership. The bill is now with the Senate for debate and so maybe they will reject the National Assembly’s proposal for fear that this will continue to stagnate the French property market.

The French footballers have also been in the news, protesting about the proposed total 75% tax rate that their employing clubs will have to pay on their salaries, just as have the farmers protested about the proposed eco-tax. If President Hollande gives in on these policies, the money will have to come from somewhere to balance the books. No doubt savers and people with wealth could be targeted.

With all this short-term ‘disruption’ going on, we have to keep an eye on our long-term goals and objectives. Interest rates are still not going to rise in the near future and could actually fall further at some point. Therefore, the alternative of investing in assets, other than cash, remains viable for income seekers and for those who wish to protect the real value of their capital over the long-term. As we have seen with the US debacle, the markets take these things in their stride.

The mitigation of taxes is also a very important subject that should be planned for and continually reviewed as governments change tax policy and individuals’ situations evolve. Having an adviser that understands how these things work where you live is an essential part of the ability to give professional advice. Sadly, from time to time, I come across a case where the potential client decides to retain their adviser in their former country of residence out of loyalty for past service, even though that adviser does not understand the intricate workings of the French tax personal tax system and the inheritance rules and taxes. Even worse, I come across cases where the adviser fights hard to retain the business, which might be tax-efficient under the country’s rules where the adviser is based, but not in France. Naturally, the client trusts that adviser and only after becoming French resident finds that this is a costly mistake.

If you would like to have a confidential discussion about how the proposed French tax changes may affect you or on any other aspect of financial planning, please contact your local French adviser.

The above outline is provided for information purposes only and does not constitute advice or a recommendation from The Spectrum IFA Group to take any particular action on the subject of investment of financial assets.

 The Spectrum IFA Group advisers do not charge any fees directly to clients for their time or for advice given, as can be seen from our Client Charter

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