February 4, 2011 Patrick Oliver-Kelley

The American economic Recovery is subdued by historical standards. Banks and households are working off excessive debt. Real bipartisan budgeting must involve increases in taxes and cuts in entitlements.

American companies make a third of their profits outside of the country. The underlying American economy is stronger than pessimists imagined: consumer spending, business investment and job creation are all up lately. GDP could exceed 4%! In 2011, but over the longer term, US GDP growth will likely average around 2% as the economy struggles to deal with its debt burden. An investment strategy would be to own long-dated Treasury bonds.

Eurozone Crisis continues.

Euro Breakup, the unthinkable, is unthinkable no longer, but would leavers be better off outside the euro than inside?

Bond yields are increasing in an ever broadening group of Eurozone countries. Portugal paid an unsustainable 6.7% for ten year money. Belgian debt yields leapt. Spain, without China investment, is just hanging on. Europe’s bail out strategy is making investors more, not less, nervous. What is called for is an immediate strategy to restructure debt in the problematic countries. European economies are improving and their banks have built up capital. All creditors: private investors, governments, and the ECB, need to chip in. Belgium, Italy, Spain are beckoning. The dilatory pace of fiscal consolidation is unlikely to assuage investors.

The ’Putanization’- a noxious trend in Eastern Europe towards cronyism, and authoritarianism in government, is a worrying element all over the periphery of the Eurozone. In Latvia and Estonia, but most dramatically, in Hungary, reforms are stalled. The whole idea of using the Western model has taken a hit, partly from the economic crisis and partly from the perceived diminishing of American prestige.

Of late, Chinese leaders have visited the entirety of the Eurozone. They are spreading goodwill, political support, and euros- few questions asked. China has bought bonds wherever it helped most. The message: China supports European integration, wants the euro to survive and will buy bonds to help the most indebted states. Besides, it provides China a logical diversification away from the dollar. Europe is China’s largest export market and is an important source of technology and know-how. Buying European bonds shores up China’s vital market.

The Dragon in everyone’s parlor.

Nothing big has changed in China. The rise of nationalism in increasingly powerful China, worries many foreigners. China has lurched from quarrel to quarrel with all its most important partners. It sees itself as the victim of Western conspiracies. But, this new Chinese assertiveness should be matched with reassurances and explanations. It rather forcefully asserted sovereignty over great swathes of the South China Sea. America is certainly losing clout but it will remain the world’s most fearsome military power for a very long time. Should China seek competition and confrontation, it may note that America has redoubled its commitment to policing the South China Sea. Japan and South Korea just announced closer defense cooperation.

Awarding the Nobel Peace Prize to Liu Xiaobo was turned into an ‘us or them’ contest. China’s Prime Minister Wen Jiabao, visited India mid-December, hoping to smooth its frayed relationship. Border disputes headed the list. India still resents China’s invasion in 1962. China sent several thousand soldiers to parts of Pakistani controlled Kashmir this year, to build roads for its ‘all weather ‘ ally. India responded by suspending regular bilateral defense meetings. India ships to China mostly unrefined minerals and primary goods which results in a $20B China trade surplus. China has begun construction of huge dams in Tibet that divert water from rivers flowing over the border into India. India has found evidence of cyber-attacks coming from China. India shudders when reading the hawkish commentary in the Chinese press, and sees China as seeking a foothold in South Asia. India has straightened its spine. It is seeking closer relations with friendly democracies, especially with the US, but also with Japan and South Korea. Recently, a Chinese newspaper Global Times, published an essay by a member of China’s Academy of Military Science, stating that ‘we have not recovered the land looted by our neighbors (India?), so how can we boast of being a strong nation?’ Smoothed over frayed relations?

The only positive thing out of China was the announcement that they would file a Yuan denominated share offering in Hong Kong. This is the first stage of internationalization of the Chinese currency. Let’s see if they can control its value.

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