I had some visitors over the weekend, therefore I decided to take a longer than usual break from my keyboard and writing of my Latest Letter. In the meantime I've done a lot more reading and it would appear there are so many opinions and experts and gurus out there, that at times I simply don't know what I should think or believe or trust or even incorporate into my analysis. So, in the end, I always do the same thing: I trust my own analysis and look at the markets through my own blend of experience, intuition and evidence. I came across the concluding paragraph in Stephen Roach's article entitled "Sputtering" where he talks of the world economy wearing thin (sputtering) and looking like it's tailing off rather quickly. To quote:
"An unbalanced global economy is a vulnerable global economy. As the world's imbalances have continued to mount - underscored by the sharp recent widening of the US current account deficit - those perils have only grown larger. A serious pitfall was averted in 2003 when the authorities opted for a major reflationary policy gambit. But the impacts of those efforts have now worn off. That leaves an unbalanced world with little choice other than to face up to the imperatives of global rebalancing. A slower US growth dynamic is an integral part of that rebalancing. It is up to the rest of the world as to whether there are any compensating offsets. For the time being, that does not appear to be the case. And so an unbalanced global economy is now beginning to sputter."
In all fairness, I think Mr. Roach has excellent thoughts and analysis, but I am often lacking follow through from him, i.e. Ok, the world is sputtering, but how or where do we go from here and what might be the outcome?
Let me try and give a short answer to that.
His "global headwinds" are listed as rising energy prices and a normalisation of real interest rates. This I concur with. The US consumer having had it "too good for too long", may start to feel the consumption pinch as soon as these headwinds start to pick up considerable speed and strength. Here I am thinking of the US oil dependent economy and its asset-driven consumption, e.g. housing, which has been a source of contrived wealth or a cash extraction mechanism fuelling the consumption, to a large degree. Equally he is right in pointing out that Europe does not, at this moment, provide any positive data signalling an imminent robustness within the Eurozone, and hence acting as a global driver in the absence of the US.
My eyes are focussed beyond the present. The Euro nations are currently in a massive "realisation campaign" that business cannot go on as usual, ie. before the EU was formed and before the recent expansion of the EU. This has been a slow and grinding psychological and way-of-doing-business process for the member nation states. But the reforms that most nations have now embarked upon are certainly the seeds from which a strengthened EU will emerge and which are slowly beginning to bear fruit. Likewise, the EU citizenry is one more prone to saving than pure consumption, regardless of real interest rates. It seems ingrained in them, maybe even too much, at least from the institutional side, i.e. that required for capital investment and risk capital.
The US, is seemingly the exact opposite. Having ridden the 90s high tech gone berserk dot.com bubble, everyone thought it would never end. It did of course. And since then the US Fed has been pumping money into the system to keep things floating. This spilled over into all sorts of things, but mostly it drifted into the housing complex as witnessed by the current median home prices relative to income. With interest rates dropped to near zero and hence real interest rates gone negative, this encouraged consumers even further, and it encouraged institutions to play the bond spreads. But what has not seemingly happened at all is an accompanying psychological adjustment that "this state of financial affairs cannot go on forever". Neither the Fed nor the Federal government nor the indidviual citizen has embarked upon a tightening or fiscal restraint policy required in order to start the process of rebalancing the national debt and current account deficits. It is still a relative fiscal mess facing the US economy mid to long term.
This fiscal tightening may be forced upon the US as it seems no less intent than on continuing with current policy no matter the end it must surely perceive as being ugly and ruthless, hence the psychological response is to avoid it altogether. Although short term foreign Central Banks may be supportive of the US dollar out of pure "stability" considerations, I am relatively certain that longer term the EU and its Euro may present the lesser of two evils for foreign investors looking to diversify their (large USD) holdings.
That is why when looking beyond the edge of the current fiscal plate, I see the seeds for recovery in Europe being planted while in the US I see them hacking down all the fruit bearing trees, instead of just pruning them back a bit and waiting for a new generation to blossom. In short, it amounts to destroying all your future seed for a short term bumper harvest.
In conclusion, let me remind you:
There are two irrevocable laws on this earth : You cannot drink yourself sober and, you cannot borrow your way to solvency. The longer either continues, the more terrible the hangover.
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