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Tags: us | strong | euro | contagion

US Economy Isn't Strong Enough to Ward Off European Contagion

By    |   Wednesday, 06 June 2012 12:34 PM EDT

President Barack Obama was right when he said that the sovereign debt and banking crisis in the eurozone is beginning to seep across the Atlantic and “cast a shadow” on the U.S. economy.

Warren Buffett was also right, at least in my opinion, when he said he was more positive on the U.S. He said he sees little chance the nation will slip back into recession in the near term. He warned that a second recession is unlikely “unless events in Europe develop in some way that spills over in a big way.”

He confirms the positive picture of the May 2012 U.S. Manufacturing ISM report on business that printed 53.50, albeit somewhat down from 54.8 in April (above 50 means expansion), but showing economic activity in the U.S. manufacturing sector still expanding in May for the 34th consecutive month and the overall economy still growing for the 36th consecutive month.

Fed President James Bullard made some interesting remarks at a conference in St. Louis. “The outlook for 2012 has not changed significantly so far," Bullard said. "A change in U.S. monetary policy at this juncture will not alter the situation in Europe … I don't think it's reasonable to say we're going to have a policy reaction every time the situation seems to get a little hotter.”

From his side, Dallas Fed President Richard Fisher stated that Fed policy makers “must keep their heads about them,” noting that “short of an implosion, I cannot support further quantitative easing.”

All that said, at the same time it’s also clear that the U.S. growth pace isn’t strong enough to withstand contagion should the eurozone crisis take a turn for the worst if after the Greek elections on June 17 an anti-austerity led government takes power that finally results with Greece leaving the euro, which should become a major global contagion event. No doubt about that.

Of course, that’s certainly not the only colossal problem the eurozone is facing. Spain (EU’s fifth economy and 12th in the world) is definitively on a “dead end” road where kicking the can down that road will become practically impossible.

Just as an example, the seasonable adjusted industrial production numbers (IPI is the Spanish acronym for ‘Índice General de Producción Industrial’) for Spain show a contraction of -8.3 percent y/y in May, which is much worse than April at -7.5 percent and -6.2 percent for the first 4 months of 2012.

Yes, there is no durable Spanish and at the same time EU solution without growth. And we could go on with Portugal and even Italy. Even the Markit Germany Construction PMI shows contraction coming in at 44.7 for May, down from 49.8 in April.

This comes after the Markit Germany Composite Output Index, which measures the combined output of the manufacturing and service sectors, hit a six-month low in May at 49.3, down from 50.5 in April, which means Q2 is currently tracking a broadly flat German GDP outturn with near-term risks clearly to the downside.

I totally lack confidence in the way the eurozone under the reign of its “decision” makers is moving forward. Believe me, it will take a lot for my confidence in the eurozone to come back.

Investors should keep in mind the ECB is tasked with maintaining price stability and hasn't the broader dual mandate the Fed has of maximum employment and stable prices.

So, investors shouldn't expect too much of the ECB and certainly not expect it to fill the vacuum left by the lack of “real” eurozone governance.

The eurozone crisis that’s now under way for more than 2 years has shattered assumptions about the sustainability of bank capital, government debt together with a worrisome dysfunctional sovereign bond market as well as credit markets — and even the underlying structure of the euro itself.

Anyway, once again many politicians as well as markets all over the “important” places want and expect someone, somewhere in Frankfurt, Washington, Beijing, or London to heed their calls for action and fire up the printing presses and make everything right again, albeit only for a very short time as realistic and therefore long-term sustainable solutions seem to be no more part of the main (sound?) objectives.

I hope their calls fall on deaf ears, but, that’s only my wish and that of some other people, but we are certainly not part of the dominating majority.

Leaders of the G-7 held an emergency meeting (via conference call) hosted by the U.S. Treasury to discuss the financial crisis in the eurozone and its implications for the global economy.

As usual, we learned practically nothing. The hosts said the officials “reviewed developments in the global economy and financial markets and the policy response under consideration, including the progress towards financial and fiscal union in Europe." They agreed to monitor developments closely ahead of the G-20 summit in Los Cabos, Baja California Sur, Mexico on June 18-19, which comes exactly one day after the elections in Greece.

A European diplomat said the G-7 conference call was a general debate that included the financing needs of Spanish banks and Greece’s June 17 general election. Another senior European official briefed on the call said a potential Greek exit from the euro was “not” discussed. “We discussed common challenges in the world economy and especially solutions to them.”

Let’s hope, one day and hopefully very soon, they will come up with sustainable solutions because time is running out.

If things don’t change dramatically, I still expect that within a year there will be a "perfect storm" scenario with:

• a eurozone train wreck;

• The U.S. economy falling back to stall speed because of EU contagion and the “fiscal cliff”;

• A serious oil price spike because of the Iran war, which I still consider as unavoidable;

• China and the emerging markets suffering a hard landing.

As far as the markets are concerned; I’m still waiting and I’m certainly not in a hurry for a capitulation. Of course, I could be wrong … Let’s hope I am.

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Wednesday, 06 June 2012 12:34 PM
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