Wall of Worry
Despite multi-trillion dollar monetary policy programs designed to support financial institutions and stimulate economic growth, economists and investors worry that European recession, GDP deceleration in China and the US fiscal cliff will deflate the global economy.
It Shouldn’t Be Able to Fly but It Does
European Central Bank (“ECB”) president Mario Draghi delivered his “Bumblebee Address” on July 26th in which he said that the euro was like the bumblebee. Rather than relying on the laws of nature to continue to be broken, he committed to do whatever it takes to make sure that the euro survives on its merit. He opined that the eurozone as a whole does a better job balancing budgets and managing debt than either the US or Japan. He foresaw a supranational eurozone founded on four building blocks: a fiscal union, a financial union, an economic union and a political union. The ECB now has the resolve, the tools, the political backing and the plan to have its wealthier members share in the support of its more challenged members. The ECB has gained credibility and market confidence.
When Pigs Fly
Portugal, Ireland, Italy, Greece and Spain were collectively known by their acronym as the “PIIGS” when they were deemed destined to cause a global economic domino effect and market panic. Portugal and Ireland are now able to borrow money at multi-year lows. Two years ago, hardly anyone anticipated that Greece would not default or leave the euro by now, but Greek debt is also trading at improved pricing. The cost of borrowing has dropped dramatically for Spain and Italy because they are expected to take advantage of ECB bailouts. Spain is expected to start negotiations with the ECB in November, committing to improve its fiscal controls in exchange for the bailout, a critical step in ECB fiscal union.
Is China Bust or Robust?
The markets have been worrying whether China will have a “hard landing” from its many years of outsized growth. As global economies are slowing down, China’s rapid growth seems like a bubble ready to burst. China’s economy may have a slightly lower growth rate than in the past but it is on a much bigger base. Unlike in the US, the Chinese economy might be better served by slower growth as it faces a chronic labor shortage and high priced housing. The Chinese government’s decennial leadership transition is proceeding on course, and apparently so is its economy.
The biggest US market worry has to do with the Bush tax cuts which will expire at year-end unless Congress intervenes. Federal Reserve Chairman Ben Bernanke coined the term “fiscal cliff” to warn policy makers that the US economy would instantly fall into recession as a result of these tax increases. To the chagrin of investors, Congress still seems unable to forge a bipartisan compromise ahead of the elections. If the deadline comes and goes, as seems likely, it doesn’t necessarily mean that nothing will get done. The “grand bargain” hoped for this year will probably happen in early March, 2013 instead, after the next Congress convenes and the new presidential term begins, by which time the debt ceiling will have exceeded its legal limit of $16.4 trillion.
Is the Private Sector Doing Fine?
Since bottoming out in 2009, the US has had consistent recovery in private job growth and household net worth, while the stock market has more than doubled. Consumers’ ability to handle their monthly nut is, unbelievably, at an all-time record high. This year, the US stock market is beating bonds, commodities, gold, European stocks and Asian stocks. Notwithstanding, the Fed is unsatisfied with the results of the $2.6 trillion it put into the US economy. On September 13th the Fed announced QE III, which is an unlimited and open-ended mandate for it to buy up mortgage-backed securities.
These are unprecedented times. Using monetary policies to intervene in slipping economies while implementing fiscal policies to keep governments solvent defies economic theory. Only time will tell if the right decisions are being made in Europe, China and the United States. For now, the reality seems to be better than the perception.