May 1, 2012 Patrick Oliver-Kelley

Chinese Dragon

The global economies are slowly improving. World GDP is set to rise 3.5% this year and just over 4% for 2013. There are still risks ahead: the euro crisis, fiscal austerity in the rich world, and upheaval in the Middle East and a hard landing in India and China, to name the obvious. Growth will certainly be hurt by deleveraging at the European banks as they boost capital and dispose of unprofitable businesses. A welcome to HSBC’s Yuan denominated bond issue in London which heralds the emergence of a brand new offshore market. Birth of the next euro dollar market?

The economic crisis rumbles on. The Economist constructed a ‘lost time index’ that shows Greece has lost over 11 years, Italy, Spain, Portugal lost over seven. Britain lost eight years and the US has lost ten years as the result of the world economic meltdown. There are seven categories ranging from household wealth to annual output, to real wages, unemployment measured to make the index. Of the G7 group, only Germany has not gone backwards. America’s is already growing. But for some, the lost time to the crisis, will never be recovered. As for stock markets, It took the US 25 years for stocks to regain their 1929 highs, and Japanese stocks have never regained it back to their peaks.

US Economy

The fragile economy is painstakingly coming back with a variety of remedies: zero interest rates, extended tax cuts, the Detroit bailout and the stimulus spending on infrastructure projects. However, soaring energy prices threaten to undo it all. The rise stalls creation of jobs and lays groundwork for spiraling inflation. In the U.S. consumers stepped up their spending in February even as incomes rose only modestly, partly reflecting higher energy costs and lower savings. Personal spending jumped 0.8% last month, the best gain since July, while incomes increased 0.2%, the Commerce.


America has what it takes to bounce back. As hegemons go, it has been exceptional. American style democracy has spread over the planet. No combination of nations has felt the need to come together to counter that power. The world, it can be argued is more stable because of its hegemony. The American system is uniquely one of relative freedom, and is uniquely capable of recovering and adapting. It must wrestle down its debt, steady the financial system, deal with inequality, rebuild its infrastructure, and fix its political gridlock. No small order of events. Can China supplant such a machine? Not likely. America’s power stands on its health at home. If its economy is restored, the world can rest easy.

There are some few pesky autocrats that will test the next US leader:

  • China seriously challenges the US global leadership economically and from its growing military force. As America’s banker there is little room to maneuver.
  • Russia in the person of Putin is talking tough to America. We must engage its leaders as was done during the cold war.
  • Arab World’s incoming governments must be pressed for essential tools of freedom, especially in elections and in a free press and in a free judiciary.
  • Iran- the new leader must head off any military action against Iran. Its race for nuclear capability will test the world.
  • North Korea must prove its sincerity to reset the nuclear clock. Its recent insistence in launching a satellite is not helpful to build that credibility.
  • Pakistan must be helped to turn their failing nation into a thriving one. A little frankness and honesty would be helpful in this relationship.

The Eurozone could breakup and trigger a ‘full blown panic in financial markets and depositor flight’ and a global economic slump to rival the Great Depression, the IMF recently warned. In its World Economic Outlook the IMF said the collapse of the single currency could not be ruled out. It warned that disorderly exit of one member state would have untold knock-on effects.

The euro zone is risking a “prolonged period of deflation” if it doesn’t do more to address the vicious circles that its debt crisis is creating, said the IMF. The ECB has been sustaining the euro but yields on Italian and Spanish debt are too high. The remedy, austerity, is insufficient. It merely makes weak economies, weaker. As yet, there seems no coherent plan for addressing the single currency’s ills. There is no lender of last resort. The euro zone needs a Eurobond. The euro may be recovering, but Europe is flirting dangerously with protectionism. It can hardly argue against ‘buy American’, restrictions while adopting ‘buy European’ ones.

Free trade benefits countries that open their markets by promoting productivity. Everyone benefits from cheaper foreign goods that save money; therefore, it seems perverse for countries to deny themselves a means of controlling spending, by putting producers above those of consumers. It’s all about Politics. If the EU were serious, it would encourage its members to take a page out of Germany’s playbook and encourage its industries to export more. A better form of reciprocity is the mutual opening of markets, not favoring ‘home’ producers.

Europe needs to be bolder and create some form of joint liability for countries’ debts. Having said that, ‘the euro crisis is still far from resolved’ and Germany remains steadfastly opposed to anything that reeks of Eurobonds. Spain’s ten year government bond yield is over 6%; its budget deficit is 8.5%; its economy is in recession. Lots of bank loans have turned sour and over 93% of Spain’s private debt is owed to foreigners. They want repaying. Greece and Portugal have similar foreign debts profiles. Italy is scarcely in less trouble. Look out for France. The Eurozone bail-out fund is not large enough to remedy any of these problems… The clock continues to tick.

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