I’d like to wish everybody “good luck” to start 2012 because, honestly, we all will need it.
Continuous deleveraging in 2012 will hurt in many places all over the world as the U.S. recovery will most likely remain extremely fragile. This was confirmed by what we read in the minutes of the FOMC’s Dec. 13 meeting. “A number of members indicated that current and prospective economic conditions could well warrant additional policy accommodation.”
On the other side of the Atlantic, the ongoing eurozone crisis will be made worse because of the imposed austerity measures at a moment the eurozone shows clearer signs of relapsing into recession.
Jean-Claude Juncker, current president of Eurogroup, said Europe is on the brink of recession.
And if that wasn’t enough by itself, those hoping the ECB becoming the rescuer of last resort of the eurozone got another blow by Senior German Bundesbank official Andreas Dombret, who just reiterated that it is the bank’s position the ECB should not become the lender of last resort. Yes, Germany and most of the other eurozone member states really live in “different” worlds and that doesn’t look to change anytime soon.
The eurozone is literally stuck in a severe balance-of-payments imbalance of a nature similar to the one that destroyed the Bretton Woods System (the Bretton Woods system was the first system used to control the value of money between different countries. It meant that each country had to have a monetary policy that kept the exchange rate of its currency within a fixed value, plus or minus one percent, in terms of gold.)
Greece, Ireland, Portugal, Spain and Italy have suffered from balance-of-payments deficits whose accumulated value, as measured by the target balances in the national central banks’ balance sheets. By September 2011, the accumulated payment imbalance between Germany and the rest of the eurozone had grown to 450 billion euros (US$525 billion).
The national central banks of these countries covered the deficits by creating and lending out additional central bank money that flowed to the euro core countries, Germany in particular, and crowded out the central bank money resulting from local refinancing operations. The ECB forced a public capital export from the core countries that partly compensated for the now reluctant private capital flows to, and the capital flight from, the periphery countries.
While France and Germany continue to push for tighter fiscal restraints, this in itself will not secure stability given that it is the misalignment itself that must be addressed. Ironically, this process ensues right now in the most brutal fashion: Just as German economic growth has seen its pool of unemployed fall to its lowest level since unification, the likes of Greece and Spain continue to deflate in a process that will afford them some competitive potential. However, whether this “adjustment,” or economic contrition, can ever yield an economic “periphery” that could live with the northern eurozone states is far from certain.
Whether certain member states would therefore be prepared to stick it out for the long run should they ride out the liquidity crisis “unscathed” remains to be seen.
Today, the eurozone faces a twin crisis, combining a banking crisis with a sovereign debt crisis. The emerging economies’ crises of 1990s were also twin-crises, which combined banking crises with currency crises.
Long-term investors should keep in mind that deleveraging by European banks will impact not only the eurozone, but also the U.S. shadow banking system as well as “capital flows” to the emerging economies. That’s not a pretty picture…
In my opinion, there is no doubt the 40-year expansion of (easy) credit, which we could call “the debt super cycle,” is definitively over now there is more debt in the world than there are real assets to back that debt. It’s a fact we will no longer be able to rely on more debt to pull us out of a slump the world worked itself in.
We are at the dawn of a new world that will be defined by just how we go about deleveraging from a 40-year credit bubble. We’re really entering a new area that will be interesting to follow and for many, an unpleasant experience.
By the way, in its just released “Financial Report of the United States Government,” the U.S. Treasury estimates the government’s total indebtedness at $51.3 trillion, which represents five times the size of the national debt.
Of course, all of this will also be paid for by future generations out of future output. Interestingly, the Treasury also projects that within a generation the federal debt will rise to 100 percent of GDP as future commitments become part of annual spending over and above projected revenues.
According to Bloomberg, governments of the Group of Seven nations together with Brazil, Russia, India and China have this year more than $7.6 trillion of debt maturing, which is up from $7.4 trillion a year ago. Japan with $3 trillion and the U.S. with $2.8 trillion lead the pack. Yes, there is really no other option than continue all efforts of further deleveraging.
All this comes after Standard & Poor’s cut in 2011 the U.S.’s rating to AA-plus from AAA and put 15 European nations on notice for possible downgrades. Long-term investors should be prepared for the unavoidable fact we’ll see further a number of important downgrades this year. Of course, the rating agencies will be once more the “bad” boys.
In this context, Chinese Premier Wen Jiabao made just some interesting comments, saying China will fine-tune monetary policy for 2012 as economic slowdown concerns intensify. Notwithstanding Wen said that big projects and ongoing construction sites will receive continuous funding, he also hinted the government is not ready to carry out another massive fiscal stimulus program: “We can't repeat the practices of excessive capacity building or blind expansion … We can't talk in general whether bank loans are too many or too few, whether liquidity is too much or too little … The key is to ensure that money is spent in the right place.”
Remember China launched at the end of 2008 a 4 trillion yuan (at today’s exchange rate, about US$635 billion) stimulus package to bolster growth, and spending by Beijing and local Chinese governments has also left China with piles of debt.
Taking all this into account, I’m convinced it won’t take much to downgrade 2012 to 2011. I still can’t detect any reason whatsoever to change my preference for “risk off.”
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