Tags: us | europe | euro | cliff

US Is Far From Out of the Woods as ‘Fiscal Cliff,’ Global Woes Loom

By Hans Parisis
Friday, 11 May 2012 01:56 PM Current | Bio | Archive

The OECD’s (the Organization for Economic Cooperation and Development that currently covers the 34 top economies in the world) composite leading indicators (CLIs), designed to anticipate turning points in economic activity relative to trend, point to diverging patterns in economic activity.

Compared to last month’s assessment, the CLIs for the U.S. and Japan show stronger signs of improvements in economic activity, pointing towards an expansion. The CLI for the United Kingdom and major emerging economies, in particular China, where the assessment points to above trend growth, are showing stronger positive signals compared to last month’s assessment. In the eurozone, the CLIs continue to point to sluggish economic activity that is below their long term trend.

These CLIs indicate without any doubt the U.S. is growing “timidly,” but certainly not moving into recession, at least not for now, which is without any doubt a positive for investors and the U.S. as a whole and completely the opposite to Europe, where the CLIs confirm the expectations of Eurostat that sees real GDP for the eurozone to contract negative 0.4 percent in 2012 after growing 1.5 percent last year. Eurostat also expects 11 percent unemployment in the eurozone in 2012.

That said, investors should realize the U.S. isn’t out of the woods yet and I wouldn’t start considering, for now at least, the long-awaited end of the “bubble” in U.S. Treasury prices will arrive very soon.

In this context, Federal Reserve Chairman Ben Bernanke reminded Senate Democrats at a closed-door meeting that failing to address automatic spending cuts and tax increases at the end of the year, known as “the fiscal cliff,” could damage a still fragile U.S. economic recovery.

He said “it is very important to say that if no action were to be taken by the fiscal authorities, the size of the “fiscal cliff” is such that there is, I think, absolutely no chance that the Federal Reserve could or would have any ability whatsoever to offset that effect on the economy.”

In the meantime, unfortunately once again, Europe’s worries continue to dominate the most important world markets in the negative sense. After last weekend elections that were “growth-driven” in France and “austerity-fatigue” driven in Greece, it now becomes clearer by the day that even with or without a eurozone growth pact, the probability of the eurozone not surviving within the structure as we know it today is growing.

With what we know so far, it looks like only Greece is likely to leave the eurozone within more or less a year because of the very simple reason they will not be able whatsoever to comply with the promises they were forced to make to the Troika, which are the IMF, the ECB and the EU.

Yes, Greece is in real danger of becoming a “can’t pay, won’t pay” situation.

Besides, if we don’t have a wonder to occur, Greece could probably not be the only country to leave the eurozone that is dominated by the northern core member states in case those countries stick with their austerity impositions.

Keep in mind that Spain, besides Greece, remains the main problem in Europe and where kicking the can down the road strategy... is running out of road.

In fact, no one really knows if Spain is illiquid or insolvent without gauging the size of the black hole that is the country’s banking sector. Finally, the Spanish government has started to do this: one of the biggest banks Bankia, but also others are set to receive capital injections from the government.

Now, with the Spanish economy in recession and unemployment soaring, the government cannot do anything else than bailing out the banks.

Unfortunately, this only deals with one piece of the monstrous Spanish puzzle. Without growth, the Spanish “sovereign” itself will need a bailout as well. Investors should be prepared for that and it doesn’t matter if it’s called contagion or not.

Investors should also always keep in mind that any eurozone member country can leave the euro or they can default on their debts, which in fact Greece has already done with their so-called voluntary debt restructuring, while staying in the euro if they can manage the requisite internal devaluation.

Alternatively, Germany could agree to transfer sufficient capital to support the periphery's current spending levels, in other words a full transfer union.

The big question would become if the German electorate would agree with that. I’m afraid the answer would be a redundant “no.”

There also were two events that certainly weren’t headlines but nevertheless are, at least in my opinion, of great importance to have a hint what “big” money expects from Europe.

First, there was Norway's $610 billion oil fund, the “Statens pensjonsfond,” which is Europe’s biggest equity investor and the second biggest sovereign wealth fund in the world, has announced it will cut its exposure to eurozone sovereign debt. Yngve Slyngstad, the chief executive of Norges Bank investment management, which administers the Statens pensjonsfond, told Frankfurter Allgemeine Zeitung: “So far we have reduced the proportion of eurozone sovereign debt holdings to 39 percent from almost 50 percent of overall bond holdings, and we are further reducing.” He also added the fund has also cut the proportion of euro-denominated bank bonds almost in half.

Secondly, the eurozone has lost another crucial lifeline as China’s biggest sovereign wealth fund, the China Investment Corporation (CIC), said: “We don’t want to buy any (euro) government bonds,” but added the $440 billion fund was “looking at opportunities in Europe.”

Axel Weber, the former head of the German Bundesbank who is now chairman of UBS, warned that a hard default by Greece was “not off the table.”

Speaking at a conference in London, Mr. Weber warned that rescue measures, including the ECB's 1 trillion euros cheap loan program, had “only bought time.” He added: “Any renewed escalation of the crisis is also likely to come home to roost, even in Germany.”

The weaknesses of the euro “construction” now really start to surface. No one can deny the establishment of the euro was not preceded by an “ever closer (political or constitutional) union” as has been the case with all the monetary unions that have survived and of which the best example is the U.S. dollar. The euro relies too heavily on fiscal redistribution without the benefit of either a coherent monetary or a consistent fiscal area-wide policy.

The euro was also not built to cope either with asymmetrical economic shocks (affecting only some members, but not others), or with the vicissitudes of business cycles.

I’d take with a strong pinch of salt German Finance Minister Wolfgang Schaeuble’s saying that the eurozone could handle Greece’s exit from the currency union because the risk of contagion has waned.

He added: “The risks of contagion for other countries of the eurozone have been reduced and the eurozone as a whole has become more resistant. The notion that we wouldn’t be able to react in a short time to something unforeseen is wrong … We want Greece to stay in the eurozone, but it has to want this and has to accept its commitments. We can’t force anyone. Europe won’t go under that quickly.”

I wish he could be right, but I have my very serious doubts…

Bottom line: Because the geopolitical risks (of which the Iran question is the most important one as Iran reportedly is pursuing work on a nuclear warhead) that remain simmering in the background, we still have the eurozone only setting up for its next crisis.

We are in an environment in which there is an unrelenting uncertainty.

This is one of these times in which investors may be keen to take some cash off the table and take advantage of any periodic recovery in prices accordingly. For the time being I’d prefer the U.S. dollar zone, by far.


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