The Sustainability of Global Recovery
Now that I am back in the saddle, I am going to start doing my week in review narratives again with links to the most newsworthy posts from the past week or so. On second thought, let me actually cover the ground back to the beginning of September for this review since I haven’t done one in a while.
What’s the overall theme? I would say it’s recovery sustainability. And that takes us principally down three tracks: The US, Europe and Asia.
The Risk Trade
Marc Chandler started things off by noting the slump in equity markets in August in his post Will the Risk Appetite be Sustained In North America? He asks an important question because, as I see it, US policy in particular has been geared toward trashing cash in order to get people into risk assets – Lever up, if you will. And the equity market carnage and soaring bond prices in August suggested that the risk trade is starting to be less appealing. I, for one, have actually become cautious on bonds because of the risk/reward as many are piling into them and out of the risk trade – more on this in another post. But, on the whole I think this correction was overdue. And the risk off trade has been driven by some rather dodgy economic data coming out of the U.S. in particular.
The U.S. Recovery
Right now, it seems like the U.S recovery is coming off the boil. If you recall, last December I wrote Double dip recession and the perverse math of GDP reporting as a warning that this was where we were headed given the wind down of stimulus. My conclusion was this:
If the recent spectacle of government handouts to big Pharma and the banks via GSE mortgage market intervention give you that warm and fuzzy feeling about the efficacy of stimulus, then you’ll want to see some serious additional stimulus to prevent this coming train wreck. Otherwise, brace yourself for serious economic problems in the U.S. starting in the second-half of 2010 – just in time for the mid-term elections. And given already high levels of unemployment and fragile asset markets, expect serious carnage in both the real and financial economies.
My hope, of course, is that the carnage is done – that August was the worst of it and we are having a rather early mid-cycle downswing in economic fortunes. The jobs data were anti-climatic in that the numbers were poor but not catastrophic – better than expected actually. My sense is that we could be headed for worse despite the two posts I wrote on jobless claims being benign. See today’s post Anticipating the End of a Weak Recovery for my discussion of this issue. How we got here is certainly of interest because it will give us a read on where this is headed politically. See On critiquing Obama’s economic policy and other links with some quality links to analyses on what happened to the Obama Administration’s economic agenda.
My take is this: Obama was facing an economic environment like the days of Herbert Hoover more than like the days of FDR or Reagan or Clinton or any of the other Presidents his people were comparing him to. As Martin Wolf says, the President was too cautious at the outset, making fewer waves, looking for more consensus and making less change than he should have done. My sense is his people really did not grasp the enormity of the problem until they had already over-promised things like 8.0% unemployment. I can legitimately say he should have seen this because this is what I was saying at the time. In truth, Obama is no economic guru any more than his predecessor Bush was a foreign policy expert. So, given how much the economy was front and center, it has meant that Obama has literally bet his Presidency on the counsel of Tim Geithner and Larry Summers much as George Bush bet his on Dick Cheney and Donald Rumsfeld.
The long and short of this is that the while banks have been recapitalized, the auto companies have sprung back to life and many large companies are flush with cash, the economy has not prospered. Clearly, voters are going to take their frustration out come November. And since the Democrats are the party in power, they will be handed a crushing defeat. All very predictable, by the way. The irony in all of this is that Obama is being attacked as anti-business despite this juxtaposition and voters actually believe he is.
What I think this means, as it has in the UK, is that stimulus is out. The US is going into a more austere form of governance. The President is looking for some tax credits and the like. But none of these are major programs compared to what he has done in the past. Marshall wrote One Small Step for Recovery, One Giant Leap Still Needed saying so. He urges urges job guarantees over jobless benefits as a means of bolstering employment. That’s not going to happen until a severe recession hits. As for taxes, I do understand future house speaker John Boehner has said he would accept a tax cut deal without mandating cuts for the wealthy, so some income tax relief may be forthcoming. But that’s about the most we are going to get.
Given the economic headwinds the U.S. faces, a double dip is actually my baseline for 2011. Some are expecting worse. That’s why you see Michael Burry discussing investing in farmland, real estate and gold. That’s sort of the full report on the U.S. except for a piece from Fred Sheehan on munis I recommend.
The European Recovery
In Europe, it looks very uneven. Ireland is dreadful these days. The sovereign debt crisis has moved on there as a result. I devoted a links post to Ireland here. Simon Johnson and Peter Boone think Ireland is essentially insolvent. I wrote a piece about the sovereign debt crisis called On Creators of Currency and the Sovereign Debt Crisis recently that I recommend for general context. For Ireland, the problem is basically that austerity has not been working because the Irish economy is still in a state. The banks are still losing lots of money. And property prices are still dropping, forcing some to extend and pretend. This from the former austerity star.
Germany has done the best. But not all of their numbers have been great and they are still heavily export dependent which makes the Germans more vulnerable to another downturn. Ed Hugh went on a bit of tear dissecting this. See his pieces One Swallow Doesn’t Make A Summer, But… on Germany, Not Content With France, Now It’s Poland Too! on extrapolating German growth to France and Poland in an unbelievable way, and Wolfgang Munchau Has It (More or Less) Right for yet more on Germany. The other Edward does a spectacular job on Spain as well. See here for example.
In my view, the Europeans have some of the same problems that the US has as I discussed this morning. Government threw a lot of money at the banks without really tackling any systemic issues, hoping the problem would go away. Afterwards, they tried the U.S. con of bogus stress tests to give the whole charade a professional veneer. But, the economic weakness in many countries has made this tactic less effective and most observers recognize the fragility of Europe’s banking system and their economies. And just in case you thought this was a Eurozone phenomenon, read Marc Chandler’s Political Risk Rises In Romania, Stay Short RON.
What comes next? For the crisis-ridden countries like Ireland or Greece, a long stagnation is in store. For the UK, double dip could be coming as austerity has not boosted business confidence and investment. For countries like Germany or even Sweden who are trying to export their way to prosperity, they will soon find their ship is tied to their European brethren and de-coupling will prove illusory. I anticipate the Germanys and the Swedens of the world will do relatively well though as long as we are in global recovery mode.
The Chinese Economy
The Asian situation is a bit more tricky. I’ll start right up front with Marshall’s provocative piece China is Still a Renegade Nation. This piece points to the downside risks in China going forward and the trade tensions that will result from their current mercantilist economic policy. Marshall takes the Krugman line of threatening China to get them to stop manipulating their currency.
My take is different. I see China has having a huge amount of excess capital investment. Who takes the losses on this and when is the question. It is not necessarily the case that it will all end in a massive bust. I do think the property market will bust. When and with what effects on the real economy is the question. As for trade, the U.S. is always looking to blame others for its own problems, pointing the finger at China when it should be concentrated on getting its own house in order instead of starting trade wars. But realistically the trade wars may be coming as Michael Pettis keeps pointing out. Read his piece What do the “good” trade numbers tell us? for more on this.
Tying the threads
So, tying these threads together are the two Danes Niels Jensen and Claus Vistesen. Niels’ piece Beggar thy Neighbour and Claus’ piece The Global Economy – Old Maids Who Won’t Play Anymore are must reads.
I like Claus’ analogy of the old maid or what Germans call der Schwarze Peter. The global economy had a great shock and is now recovering in fits and starts. Some are doing better than others. In particular, the Germans, along with the Japanese and the Chinese and a handful of smaller countries have an external surplus. They are doing the best as they are trying to inoculate themselves from the weaknesses in places like Spain by ginning up the export machine.
This sets up a natural tension with the external deficit countries which are the ones with the weakest economies. Ireland and the U.S. would like to be export kings too but not everyone can have an external surplus. Ireland does, the U.S. does not. The only way out for the likes of Spain or Greece is via internal devaluation (wage and price cuts). The U.S. and the U.K. can try to depreciate their currencies. Ireland, a good exporter in its own right is trying austerity.
But, in the final analysis, it is beggar thy neighbour which is the logical strategy for all international players. Everybody wants a cheaper currency and an export machine to overcome the malaise and everyone is pointing the finger at everyone else for trying this. What’s the solution?
Is there a solution? Politicians are not interested in sacrificing the economic fortunes of voters at home to appease foreigners abroad. Therefore, I don’t see international coordination as a solution. The holy grail of macro will be increasing demand domestically without increasing private (and in some cases, public) sector debt loads. How we get there is the question. It seems unlikely that we can accomplish the deleveraging and the growth at the same time in a world beset by external imbalances. Somewhere, something has to give. Some nation or nations are going to be left holding the Old Maid. Which will it be?