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One Pothole Can Still Derail Shaky Global Recovery

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Thursday, 30 Dec 2010 10:39 AM Current | Bio | Archive

Looking to 2011, I don’t think we will see the U.S. dollar's collapse despite that in 2010 we saw that the United States still isn’t ready to seriously start bringing its fiscal house in order.

The U.S. budget deficit for fiscal 2010, which ended on Sept. 30, was $1.29 trillion, which was down from a record $1.42 trillion in fiscal 2009. The nonpartisan Congressional Budget Office in August projected a $1.07 trillion deficit for fiscal 2011. We will have to wait until mid-February before we will finally know the official U.S. fiscal 2012 budget.

We all know that unreasonable and unsustainable deficits can’t go on forever and it’s a fact that the “bond vigilantes” won’t wait forever, despite that the Treasury Department found a healthy number of buyers for its final note auction of the year with $29 billion worth of seven-year notes after a poorly received five-year note auction earlier this week.

Yes, higher U.S. Treasury yields are possible in 2011. In the meantime, we still see U.S. Treasury Credit Default Swaps (CDS) at 42, which is better than Germany, which stands at 58; Japan and the U.K. at 72; France at 108 and Italy at 237.

But please don’t misunderstand me; I haven’t become an optimist on a “good” U.S. recovery even while the world economy remains broadly on track for recovery. After growing an estimated 4.1 percent in 2010, global growth is expected to moderate to 3.7 percent in 2011 and 3.8 percent in 2012.

Investors should keep in mind that one solid pothole in 2011 could be sufficient to derail the still-fragile global recovery.

It’s a fact that continued slack in labor and product markets should only gradually recede in 2011, and that means continued dis-inflationary forces, or to put it somewhat more mildly, continuous low inflationary pressures in the Big Three economies (the U.S., the EU and Japan.)

Unfortunately, we will see a disturbing divergence in inflation trends with substantial pockets of inflationary pressure in several important emerging markets developing. Because of super-easy monetary policy and large budget deficits in the Big Three, I expect continued strong capital flows into emerging markets and that implies bubbles that will emerge and eventually pop in some of these strong emerging economies.

The permanently unbalanced global economy is creating a number of risks, including commodity and asset-market bubbles, premature policy exit, and trade and currency tensions.

If you ask me, there are a lot of deep potholes out there, be it the political, financial, economical and certainly not overlooking, of course, the geopolitical ones. Yes, 2011 is literally booby trapped on a global scale.

I’m still risk-averse and therefore one of my favorite store values at this moment is the Norwegian krone (NOK), which I still consider as one of the world’s safest currencies.

Investors should keep in mind the Norges Bank recently left its key interest rate unchanged but spoke of the coming summer as the most likely point for the tightening cycle to begin.

“The consideration of guarding against the risk of future financial imbalances that may disturb activity and inflation somewhat further ahead suggests that the key policy rate should not be kept low for too long,” it said.

When asked if a further increase in housing prices may lead to an earlier rate rise, Deputy Governor Qvigstad said the board would assess this in March. Yet, even if a capacity-conscious Norges Bank is unable to abide by its recent statement to delay rate hikes until the summer, the fact remains that Norwegian yields aren’t unattractive right now and rising.

Tuesday, the Norges Bank (Norway’s Central Bank) bonds yielded 2.57 percent (three-year); 3.06 percent (five-year) and 3.71 percent for the 10-year.

Yes, the Norwegian krone is, at least in my opinion, my new haven of choice for 2011. Norway’s fiscal surplus is projected at 10.3 percent of GDP in 2011 while its net creditor position is particularly healthy, thanks to the country’s $505 billion sovereign-wealth fund that, yes, far outstrips China’s forex reserves when seen as a proportion of GDP, which is 116 percent compared with 52 percent.

As a result, Norway also has one of the best sovereign credit ratings in the world, with a five-year credit default swap (CDS) that costs 22 basis points (bp) and is much better than the U.S. at 42 bp, Germany (57 bp), and even Sweden (34 bp), which underlines Norway’s financial solidity and its incongruousness on the European continent and sets the krone far apart from the vast majority of its competitors. (One basis point is equivalent to 0.01 percent, or one-hundredth of a percentage point.)

Bottom line, every solid long-term portfolio needs some Norwegian krone.

Small, compared to the U.S. and China, it is really beautiful and makes a lot of sense. Keep it in mind.

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HansParisis
Looking to 2011, I don t think we will see the U.S. dollar's collapse despite that in 2010 we saw that the United States still isn t ready to seriously start bringing its fiscal house in order. The U.S. budget deficit for fiscal 2010, which ended on Sept. 30, was $1.29...
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Thursday, 30 Dec 2010 10:39 AM
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