Tags: US | Economic | Tragedy | Greek

US Headed Toward Economic Tragedy of Greek Proportions

Monday, 19 March 2012 02:36 PM Current | Bio | Archive

We have seen a lot of growing optimism in the markets as well as among politicians, especially in the EU. There, politicians like French President Nicolas Sarkozy want us to believe the worst in the Greek sovereign debt crisis is over.

It’s interesting to see that complacency is apparently on its way back, once again.

In my opinion, investors should do better to remain realistic and ask themselves how countries like Greece, but also the other “problematic” Mediterranean countries like Portugal, Spain and Italy can under very severe austerity measures come back to growth, which is the essential condition to bring their fiscal houses in order, so that they can comply with the new eurozone fiscal targets.

I can’t see that happening as long as the actual EU monetary union hasn’t become a true political federal union.

Unfortunately, I’m still convinced until we see real tangible and sustainable actions and these Mediterranean countries comply with their promises, for which they don’t have good track records, the worst still lies ahead.

It’s understandable that professionals like Pimco's Andrew Balls is cautious on Spanish and Italian government debt while he continues to avoid Portugal, but also Ireland bonds.

In that context, and after the IMF signed off on its 28 billion euro ($36.9 billion) share of Greek bailout despite Brazilian opposition, the IMF released its latest (sobering and enlightening) staff report on Greece wherein it paints the bleakest picture yet of Greece's outlook stating: “… The program remains subject to notable implementation risks. In general, Greece has little if any margin to absorb adverse shocks or program slippages. In the event that policy implementation takes longer or falls short, the economy takes longer to respond to labor market and supply-side reforms, or fiscal multipliers are higher (reducing the growth path), a deeper recession and a much higher debt trajectory would be the likely result … With debt to remain very high for some time, Greece will remain accident prone…”

Yes, the report doesn’t give any reason whatsoever to become realistically optimistic on Greece.

Speaking in Beijing, IMF Managing Director Christine Lagarde said: “…the global economy may be on a path to recovery, but there is not a great deal of room for maneuver and no room for policy mistakes … the world economy has stepped back from the brink and we have cause to be more optimistic. Still, optimism must not lull us into a false sense of security … financial systems are still fragile and high public and private debt persists in many advanced economies—euro area public sector and bank rollover needs total about 23 percent of GDP during 2012 … the rising price of oil is becoming a threat to global growth … there is a growing risk that activity in emerging economies will slow over the medium term…”

Now, speaking about oil and not withstanding for the moment the markets seem well supplied, it’s an undeniable fact the oil price is heavily skewed to the upside, not at least because the smoldering crisis in the Persian Gulf that could easily push oil prices to new all-time-highs, should it escalate.

Friday, the U.K. daily “Independent” commented on speculation that Israeli Prime Minister Benjamin Netanyahu had made a speech “preparing” the public for war against Iran.

The paper cited Netanyahu as saying that “Israel has never left its fate to others, not even the best of its friends,” and noted a report in Israeli newspaper Maariv that Cabinet ministers had privately commented that the address “sounded like a preparatory speech for an attack.”

At the very least, it can hardly be said that this backdrop is conducive to a sustained easing in oil prices. Besides, from a technical point that includes seasonality and tactical considerations, I think the upward trend to continue at least until midyear, at which point we could see demand destruction setting in.
Bottom line: I still believe that new all-time-highs can be reached this year, which is of course a serious, albeit temporary (hopefully) threat to the global economy.

Finally, recent somewhat “dollar strengthening” that occurred partially on the back of rising U.S. Treasury yields, which for the near future, already seems to have run its course for about three quarters of the way yields can be expected to go, not at least because further dollar strength would require for a great part higher rates to offset the still widening U.S. trade deficit. Please don’t misunderstand me, but here I’m talking about what I see happening this year.

In 2013 it will be another situation. Investors should keep mind that under current legislation, next year, the U.S. will undergo roughly $500 billion, or 3 percent of its GDP in fiscal tightening due to expiration of the Bush tax cuts, a rise in payroll taxes and automatic spending cuts because the congressional budget “super committee’s” failure to agree in November on program-specific cuts.

Fiscal retrenchment of this magnitude would probably guarantee stagnation or even another U.S. recession and dollar strength versus most currencies through deleveraging.

Of course, we can expect Congress scaling back this programmed tightening. The question remains, by how much?

Nevertheless, uncertainty around this issue will damage corporate as well as consumer confidence in late 2012 and will slow U.S. real GDP growth whereby the economy could again decelerate to around 1.5 percent in Q1 2013.

Bottom line: Keeping in mind that the dollar, based on a longer-term structural model regressing the real effective exchange rate on quarterly variables such as debt levels, terms of trade and productivity differentials is about 6 percent undervalued.

It now also seems sure we have the near term setup for the dollar in place that should allow for additional strength following the reversal from the perceived range lows and important support levels as well as the breakout in U.S. Treasury yields through the multi-month range highs.

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Monday, 19 March 2012 02:36 PM
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