Weaknesses in Developed Economies Will Continue to Cause Global Economic Woes

Thursday, 27 Dec 2012 10:47 AM

By Hans Parisis

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The fiscal cliff situation in the United States got additional stress this week when Treasury Secretary Timothy Geithner sent a letter to Congress wherein he states the statutory debt ceiling of $16.4 trillion will be reached on Dec. 31.

Because of reaching the limit, the Treasury Department will begin taking measures from now on, which is intended to make some headroom under the debt limit for an amount of about $200 billion for a period of more or less two months in order to temporarily postpone the date that the United States would otherwise default on its legal obligations.

Please keep in mind that if the legally planned tax hikes and spending cuts come into effect on Jan. 1, this could give Treasury more time.

I don't think it’s an overstatement to say we could see policymakers in Washington at loggerheads for some time to come before they finally come to some kind of a compromise on the fiscal cliff and that any deal would be interlinked to the coming debt ceiling debate, which is now on the agenda within the next few months.

Beware, this would not necessarily result in a good deal for the country. In the meantime there will be substantial risk the United States would slip back into slower or even negative growth (recession) and downgrade(s) by the major rating agencies. If that occurs, all the major economies in the world would be negatively affected.

Anyway, whatever comes out, I have no doubt at all we will see higher taxes alongside (some?) spending cuts in 2013. No, we aren’t there yet but, just in case, as a long-term investor I would prepare my parachute!

I wouldn’t be surprised if we see a large “risk-off” move in the markets because investors’ confidence will be shocked and disillusioned once again by political dysfunctionality in Washington.

Contrary to the majority, I still expect, in the context of a larger U.S. bear market, a “topping” process taking hold, and I expect substantially lower prices down the road in most market sectors. Even gold could move down to its resistance zone to around $1,525, where, once we are there, further bearishness shouldn’t be discarded, which should create interesting accumulation opportunities.

The U.S. dollar should do very well if all that were to occur.

As always, time will tell if I’m right or wrong.

One thing’s for sure — higher taxes don’t stimulate growth or business capital investment or hiring.

In its World Economic Situation and Prospects 2013 report, the United Nations warns of the risk of a synchronized global downturn and echoes what the International Monetary Fund and the World Bank have stated before. The UN expects world gross domestic product to be 2.2 percent in 2012, 2.4 percent in 2013 and 3.2 percent in 2014, which is below potential.

Under these circumstances, many economies will be unable to recover the job losses of the Great Recession. Worst of all important economies in the world is the euro area, which is dragged into a downward vicious circle where slow or even negative growth, high unemployment, continued deleveraging by businesses and households, continued banking fragility, heightened sovereign risks and fiscal tightening relentlessly continue to feed on each other.

The eurozone has chosen, so far at least, to maintain building the structure of the euro under the present conditions and because of that it has no remedy at hand to alleviate the process of “internal devaluation” other than abandonment of the euro itself, which is of course out of the question. This process will cause, in my opinion, the eurozone to continue stumbling from one crisis into another for the foreseeable future.

Growth in the United States is expected to slow down in 2013, with significant downside risks.

In short, weaknesses in the major developed economies will continue to cause global economic woes.

I think that “politics” everywhere will play an increasing role on how markets will perform in the future. Also, do not think big central banks, which include the Federal Reserve, the European Central Bank, the Bank of Japan, the Bank of China, etc., are omnipotent institutions that are able to solve all the world's problems. Because they simply can’t.

So, maybe not such a weird question: “Quo vadis, 2013?” Will 2013 be a half-full or a half-empty year?

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