Marjory Collins Blowing horns on snowfree Bleecker Street on New Year’s Day January 1 1943
I’m not entirely sure that new year’s predictions are interesting enough to write about, certainly when they concern economic systems that are subject to some of the wildest and deepest manipulations in human history, with free markets a distant memory, but I’ll give it a shot, if only to give people the opportunity to vehemently disagree with me, always a barrel of fun.
I thought I’d start out with Nouriel Roubini, an erstwhile Dr Doom, who has mellowed to such an extent I suspect the influence of copious amounts of Xanax. Either that or he’s left behind his court jester role at the parties of the rich in Davos and Aspen, counting his money and waiting to be called up again. He played that role like a Shakespearean actor, making sure that many other people who had much more sensible things to say from 2007 onwards, never got the media attention they arguably might have warranted, and I see no reason to presume he wasn’t generously rewarded for it.
As I said, he’s much more mellow, just shy of bullish, though he smartly injects more bearish points into his message, to the point of seemingly contradicting himself, so at the end of the year, he was right either way. The title already gives away the new Nouriel:
After a year of subpar 2.9% global growth, what does 2014 hold in store for the world economy? The good news is that economic performance will pick up modestly in both advanced economies and emerging markets.
The advanced economies, benefiting from a half-decade of painful private-sector deleveraging (households, banks, and non-financial firms), a smaller fiscal drag (with the exception of Japan), and maintenance of accommodative monetary policies, will grow at an annual pace closer to 1.9%. Moreover, so-called tail risks (low-probability, high-impact shocks) will be less salient in 2014.
The threat, for example, of a eurozone implosion, another government shutdown or debt-ceiling fight in the US, a hard landing in China, or a war between Israel and Iran over nuclear proliferation, will be far more subdued.
Still, most advanced economies (the US, the eurozone, Japan, the UK, Australia, and Canada) will barely reach potential growth, or will remain below it. Households, banks and some non-financial firms in most advanced economies remain saddled with high debt ratios, implying continued deleveraging.
Note: Roubini claims that “ … advanced economies, benefiting from a half-decade of painful private-sector deleveraging (households, banks, and non-financial firms) [..] will grow at an annual pace closer to 1.9%“, but also that “ Households, banks and some non-financial firms in most advanced economies remain saddled with high debt ratios, implying continued deleveraging.”
So economies have benefited from deleveraging, but now they’re going to get hurt by … deleveraging. It apparently wasn’t enough yet, even if they benefited. But now they will no longer benefit. Contradictory? It feels that way, but we can’t be sure. It’s like some spin doctor writes his material these days, or it’s, indeed, Xanax.
In a similar way, Roubini says first that “ … advanced economies [..] will grow at an annual pace closer to 1.9%“, and then that “ … the US, the eurozone, Japan, the UK, Australia, and Canada) will barely reach potential growth … ”
Again, that feels contradictory, but is it? See, I could presume when I read this that his notion of potential growth is much higher than 1.9%. That would take out the contradiction. But he doesn’t day they DON’T reach potential growth, they BARELY reach it, which means they do. What could have happened without deleveraging, he doesn’t say. Would they have gone beyond their potential? Is that even possible? We’ll never know. More predictions:
High budget deficits and public debt burdens will force governments to continue painful fiscal adjustment.
[..] … there is a looming risk of secular stagnation in many advanced economies … owing to the adverse effect on productivity growth of years of underinvestment in human and physical capital.
In the US, economic performance in 2014 will benefit from the shale energy revolution, improvement in the labour and housing markets and the “reshoring” of manufacturing.
The downside risks result from: political gridlock in Congress (particularly given the upcoming midterm election in November), which will continue to limit progress on long-term fiscal consolidation; a lack of clarity about the Federal Reserve’s planned exit from quantitative easing (QE) and zero policy rates; and regulatory uncertainties.
[..] … some emerging markets – namely, India, Indonesia, Brazil, Turkey, South Africa, Hungary, Ukraine, Argentina, and Venezuela – will remain fragile in 2014, owing to large external and fiscal deficits …
The better-performing emerging markets are those with fewer macroeconomic, policy and financial weaknesses: South Korea, the Philippines, Malaysia and other Asian industrial exporters; Poland and the Czech Republic in Europe; Chile, Colombia, Peru and Mexico in Latin America; Kenya, Rwanda and a few other economies in sub-Saharan Africa; and the Gulf oil-exporting countries.
Finally, China will maintain an annual growth rate above 7% in 2014.
As for his belief in shale, he’ll find out. The “revolution” may continue into 2015, but chances are costs will become prohibitive earlier. Making lists of emerging markets is a fun game, perhaps, but the potential downward effect on them from US tapering, and the China Squeeze, is very large. It’s one thing to make predictions based on more of the same conditions as the past few years, but every single country he names at both sides of his self-imposed divide has enormous lurking uncertainties hanging over its head. If and when bond yields and interest rates rise in the west, ugly ghosts may be found hiding in many a closet. Not just in emerging markets either.
Let’s move on to a man who doesn’t need any Xanax, Ambrose Evans-Pritchard, and who’s not afraid to go for a strong headline:
We enter the year of the all-conquering US dollar. As the global security system unravels – with echoes of 1914 – the premium on the world’s safe-haven currency must rise.
[US] growth is near “escape velocity” – at least for now – at a time when half of Europe is still trapped in semi-slump and China is trying to cool the world’s most dangerous credit boom.
As the Fed turns off the spigot of dollar liquidity, it will starve the world’s dysfunctional economy of $1 trillion a year of stimulus. This will occur through the quantity of money effect, hitting in a series of hammer blows, regardless of whether interest rates remain at zero. The Fed denies that this is “tightening”, and I have an ocean-front property to sell you in Sichuan. It is hard to imagine a strategic and economic setting more conducive to a blistering dollar rally, a process that will pick up speed as yields on 10-year US Treasuries break through 3%. [..]
A stronger dollar is something we’ve long talked about at TAE. And while there is no doubt it will come at some point, so far there have been too many too strong parties who didn’t want it. That may sound a bit too conspiratorial to you, but I’m sure it’s only business, and nothing personal. If the Fed raises QE instead of tapering, a move that could come if numbers grow sour, bets are off when it comes to timing.
In case you had forgotten, China has imposed an Air Defence Indentification Zone (ADIC) covering the Japanese-controlled Senkaku islands. [..] While American airlines comply, Japanese airlines fly through defiantly under orders from Japan’s leader Shinzo Abe. Mr Abe has upped the ante by visiting Tokyo’s Yasukuni Shrine – the burial place of war-time leader Tojo – in a gesture aimed at Beijing.
Asia’s two great powers are on a quasi-war footing already, one misjudgement away from a chain of events that would shatter all economic assumptions. It would leave America facing an invidious choice: either back Japan, or stand aloof and let the security structure of East Asia disintegrate. Trade this if you wish. The Dow Aerospace and Defense index (ITA), featuring the likes of Raytheon and Lockheed Martin, has risen 60% over the past year, compared with 29% for Wall Street’s S&P 500. [..]
Obviously, Ambrose likes his war games. Me, I’m weary of all the alleged powder kegs we’ve seen discussed in the past few years. Of course Abe might look to boost his image and ego when-not-if Abenomics falls flat on its face, but I think it’s more likely he’ll just be thrown out of office, and I don’t see 100+year-old hostile and violent sentiments easily return to Tokyo. Being nuked once a century should seem to suffice to make people cool down.
I doubt that we are safely out of the woods, let alone on the start of a fresh boom. How can it be if the global savings rate is still rising, expected to hit a fresh record of 25.5% this year? There is still a chronic lack of consumption.
As the Fed tightens under a hawkish Janet Yellen, a big chunk of the $4 trillion of foreign capital that has flowed into emerging markets since 2009 will come out again. It is fickle money, late to the party. [..]
It is a myth that emerging markets borrow only in their own currencies these days. External debt will reach $7.36 trillion in 2014, double 2006 levels (IMF data), mostly in dollars. Some $2 trillion is short-term. It must be rolled over continuously.
That global savings rate growth has deflation written all over it, as does the ongoing deleveraging. As Treasury yields rise, so will the dollar, and both make rolling over trillions in dollar denominated debt a lot more expensive. But will Yellen really – continue to – tighten when that happens? Is that in the US’ best interest?
Euroland will be hit on two fronts by Fed action. Bond yields will ratchet up, shackled to US Treasuries. Emerging market woes will ricochet into the eurozone. The benefits of US recovery will not leak out as generously as in past cycles. Dario Perkins from Lombard Street Research says the US is now more competitive than at any time since the Second World War. America is poised to meet its own consumption, its industries rebounding on cheap energy. Europe will have to generate its own stimulus this time. Don’t laugh.[..]
The ECB’s Mario Draghi has, of course, eliminated the acute tail-risk of sovereign defaults in Italy and Spain with his bond-buying ruse, though the German constitutional court has yet to rule on the scheme. [..] Credit to firms is still contracting at a rate of 3.7%, or 5.2% in Italy, 5.9% in Portugal and 13.5% in Spain. This is not deleveraging. The effects have been displaced onto public debt, made worse by near deflation across the South. [..]
There is just enough growth on offer this year – the ECB says 1% – to sustain the illusion of recovery. Those in control think they have licked the crisis, citing Club Med current account surpluses. Victims know this feat is mostly the result of crushing internal demand. [..]
The European elections in May will be an inflexion point. A eurosceptic landslide by Marine Le Pen’s Front National, Holland’s Freedom Party, Italy’s Cinque Stelle and Britain’s UKIP, among others, will puncture the sense of historic inevitability that drives the EU Project. [..]
The jobless rate was similar on both sides of the Atlantic in 2009. It is now at a five-year low of 7% in the US, and a near record 12.1% in Euroland. It is becoming harder to disguise this from Europe’s citizens. By the end of 2014 the macro-policy failure in Europe will be manifest.
Shrinking credit and shrinking consumption in Europe. How long will the US be able to pretend it’s doing fine under those conditions? Will Yellen tighten, as Draghi loosens? Can she even?
Nobody votes in EU elections. But they can be used to raise a hell of a racket. I don’t like the inclusion of my friend Beppe Grillo in that list of right wing parties, but I do hope there will be a loud anti-Brussels voice, because the once peacemaking union seriously risks turning into a place for streetfighting men. When you build yourself multi-billion euro new offices while in some member countries two-thirds of young people have been unemployed for years, what exactly would you expect to happen?
Over all else hangs the fate of China. The sino-bubble is galactic. Credit has grown from $9 trillion to $24 trillion since late 2008, as if adding the US and Japanese banking systems combined. The pace of loan growth – 100% of GDP over five years – is unprecedented in any major economy, eclipsing the great boom-bust dramas of the past century. [..]
China may try to cushion any hard-landing by driving down the yuan. The more that Mr Abe forces down the Japanese yen, the more likely that China will counter with its own devaluation to protect the margins of it manufacturing industry. We may be on the brink of another East Asian currency war, a replay of 1998 but this time on a much bigger scale and with China playing a full part.
If so, this will transmit an a further deflationary shock through the global system, catching the West sleeping with its defences against deflation already run down.
AEP again paints it as a China vs Japan, and I don’t think that should have prevalence. China has a major fight on its hands internally, between new money and old politics, a fight wobbly floating on a sea of questionable loans and investments, and that should take up all of its energy the next year and quite possibly beyond.
And Japan has things to do at home as well:
Japanese employers will fail in the next fiscal year to heed Prime Minister Shinzo Abe’s goal of wage increases that outpace inflation, highlighting risks that the nation’s recovery will stall, surveys of economists show.
Labour cash earnings, the benchmark for wages, will increase 0.6% in the year starting April 1, according to the median forecast in a poll of 16 economists by Bloomberg News. Consumer prices will climb five times faster, increasing 3%, as Japan raises a sales tax for the first time since 1997, a separate Bloomberg survey shows.
Hey, I told you last September that sales tax rise was going to come back to haunt him:
If you look through the numbers here, you see that the tax hike from 5% to 8% is supposed to bring in 3 times 2.7 trillion yen, or 8.1 trillion yen, about $81 billion. Abe wants to spend $50 billion of that on more stimulus, so net revenue is $31 billion. This is ostensibly “meant to rein in the government’s massive debt”. However, according to Wikipedia, Japan’s public debt was over 1,000 trillion yen, or $10.46 trillion, for the first time ever on June 30, 2013 (“twice the nation’s annual economic output”).
Which raises the question how on earth $30 billion can “rein in” a debt of $10.46 trillion. If I’m not mistaken, that comes to just 0.28%. Maybe something got lost in the translation of the term “rein in”, but even then. Note: the article calls it “the biggest effort in years by the world’s third-largest economy to contain [the] public debt”.
The sales tax raises prices five times faster than wages, and “reins in the government’s massive debt” by 0.28%. That’s a success story if ever I heard one. Way to go Shinzo. Attaboy Abe.
I want to close off prediction season by looking a bit more in detail in what has become my posterchild for how not to do things: Britain. While it has surprising growth numbers off late, with an exploding housing market, Britain too in fact floats wobbly on questionable credit (with its government adding insult to injury with plans like Funding for Lending). Still, with those growth numbers, artificial as they may be, it becomes very difficult not to let interest rates go up. And then it all will start to wobble for real:
More than a million homeowners will be at risk of defaulting on their mortgages and losing their properties in the wake of even a small rise in interest rates, a bombshell analysis reveals. Borrowers who have failed to pay down their mortgages when interest rates have been at record low levels now face being overwhelmed by “perilous levels of debt” when the inevitable hike comes. [..]
“When rates go up, the number in ‘debt peril’ could increase to anywhere between 1.1 million and two million, depending on the speed at which borrowing costs rise and the nature of the economic recovery.”
The warning comes as a survey carried out by Which? reveals that rather than paying off their debts, around 13 million people (25%) paid for their Christmas by borrowing. Overall, more than four in 10 (42%) used credit cards, loans or overdrafts to fund their spending over the festive period , which suggests that Britons have not shed their addiction to debt. [..]
The markets believe the base rate will increase to 3% by 2018, with what the Resolution Foundation describes as “huge social and human cost”. However, the thinktank warns that a hike of just 1 percentage point more than that, to 4% by 2018, would lead to 1.4 million homeowners facing severe financial pressure.
[.. … the levels of debt built up by families in the pre-crisis years are such that even relatively modest changes in incomes and borrowing cost assumptions produce significantly worse outcomes. [..] … one in six households are currently mortgaged to the hilt, servicing home loans that are at least four times the size of their annual salary, in further evidence of the intense vulnerability of many homeowners to rate hikes.
42% of Britons used credit cards, loans or overdrafts to pay for Christmas. Does that sound like a healthy economy to you? It’s no surprise, therefore, that retail is not doing well. People needed their credit cards to even buy hugely discounted items. The government may claim that the economy is great, but consumers are either MIA or AWOL. How can that make for a great economy? Consumers in Britain don’t account for 70% of GDP, as they do in the US, but still some 65%. And they are maxed out, borrowing, and deep in debt. Yeah, raise rates, and see what happens.
The chief executive of Debenhams has said the high street was a “sea of red” in the run-up to Christmas due to heavy discounting after the department store chain issued a major profits warning.
In an unscheduled trading update that confirms the tumultuous Christmas retail trading environment, Debenhams said profits will now be far lower than expected because its margins were hit by the company offering heavy discounts on clothing in December.
[CEO Michael Sharp] insisted there was not a “fundamental flaw” in Debenhams strategy. He blamed the profits warning on weak consumer confidence and heavy discounting among fashion retailers as they attempted to shift unsold winter clothing that had built-up because of the mild autumn. Mr Sharp also warned that a “final surge” in sales in the week before Christmas had not materialised. Debenhams now plans to cut prices by as much as 70% to sell clothing in January and February.
The profits warning from Debenhams could be the first of a handful from listed retailers given the widespread discounting in the run-up to Christmas. Neil Saunders, retail analyst at Conlumino, said: “It is likely that many will have had a disappointing season in terms of sales, but especially in terms of profitability.”
A “great economy” made up of maxed out consumers. 98 out of 100 of which don’t see a recovery. Well, they can still read about it in the papers, I guess. And they have no-one on their side either, because the unions get it as wrong as the government does.
Only one in 50 voters believes they are benefiting from the economic recovery and most expect the living standards crisis to continue in the new year, a study has found.
Almost half the 1,600 people polled for the TUC wanted services that had been cut to be restored, and one in five of those polled said they expected the gains of an economic recovery to be fairly shared across society. [..]
[TUC general secretary Frances O’Grady said:] “Voters accepted austerity as unpleasant medicine. But now they are realising that what they thought were the unpleasant side-effects are what the chancellor sees as a cure. Recovery seems to mean food banks, zero hours and pay cuts for the many, tax cuts and pay growth for the few at the top.” The union leader added that 2014 would be a crucial year, dominated by a single political question: whose growth?
“Do we want to go back to a business-as-usual version of the pre-crash economy, based on housing bubbles, an overmighty finance sector and increasing inequality as a growing proportion of the workforce fail to share in prosperity? “Or do we want to build a new, genuinely rebalanced economy that through investment, growth and active government aims for a high-skill, high-pay, high-productivity economy that shares out prosperity to all? I know which side unions are on.”
The unions want to talk about divvying up the growth. When I read things like “… a new, genuinely rebalanced economy that through investment, growth and active government aims for a high-skill, high-pay, high-productivity economy that shares out prosperity to all … “, I just want to run and hide and get very hammered.
What these unions should be actively doing, right now, is to talk about what happens to their members in case there is no growth, and/or when the economy shrinks. By ignoring that, they are sure to make things worse for the people who rely on them for support. Secure a minimum, make sure people are fed and warm, and then you can take it from there.
Anyway, so all in all, I do see some interesting elements in predictions, but I see a lot more plain blindness and manipulation as we go gently into this year. Of all I’ve read, I think perhaps Carmen Reinhart and Ken Rogoff come closest to reality in their new IMF (of all sources!) report:
Much of the Western world will require defaults, a savings tax and higher inflation to clear the way for recovery as debt levels reach a 200-year high, according to a new report by the International Monetary Fund.
The IMF working paper said debt burdens in developed nations have become extreme by any historical measure and will require a wave of haircuts, either negotiated 1930s-style write-offs or the standard mix of measures used by the IMF in its “toolkit” for emerging market blow-ups. “The size of the problem suggests that restructurings will be needed, for example, in the periphery of Europe, far beyond anything discussed in public to this point,” said the paper, by Harvard professors Carmen Reinhart and Kenneth Rogoff.
The paper said policy elites in the West are still clinging to the illusion that rich countries are different from poorer regions and can therefore chip away at their debts with a blend of austerity cuts, growth, and tinkering (“forbearance”). The presumption is that advanced economies “do not resort to such gimmicks” such as debt restructuring and repression, which would “give up hard-earned credibility” and throw the economy into a “vicious circle”.
But the paper says this mantra borders on “collective amnesia” of European and US history, and is built on “overly optimistic” assumptions that risk doing far more damage to credibility in the end. It is causing the crisis to drag on, blocking a lasting solution. “This denial has led to policies that in some cases risk exacerbating the final costs,” it said.
While use of debt pooling in the eurozone can reduce the need for restructuring or defaults, it comes at the cost of higher burdens for northern taxpayers. This could drag the EMU core states into a recession and aggravate their own debt and ageing crises. The clear implication of the IMF paper is that Germany and the creditor core would do better to bite the bullet on big write-offs immediately rather than buying time with creeping debt mutualisation.
The paper says the Western debt burden is now so big that rich states will need same tonic of debt haircuts, higher inflation and financial repression – defined as an “opaque tax on savers” – as used in countless IMF rescues for emerging markets. “The magnitude of the overall debt problem facing advanced economies today is difficult to overstate. The current central government debt in advanced economies is approaching a two-century high-water mark,” they said.
Most advanced states wrote off debt in the 1930s, though in different ways. First World War loans from the US were forgiven when the Hoover Moratorium expired in 1934, giving debt relief worth 24% of GDP to France, 22% to Britain and 19% to Italy. This occurred as part of a bigger shake-up following the collapse of the war reparations regime on Germany under the Versailles Treaty. The US itself imposed haircuts on its own creditors worth 16% of GDP in April 1933 when it abandoned the Gold Standard.
My own personal mantra has been for years now that the debt needs to be restructured, and that when a bank or a country ot industry claims it’s doing better, you always need to ask one question first: “What happened to the debt?” It is not happening, we’re still fighting debt with more debt, and hiding the existing (deleveraging hasn’t even really started yet). And when reality threatens to catch up with that, we throw on some more.
It’s not correct to state, as Reinhart and Rogoff do, that “This denial has led to policies that in some cases risk exacerbating the final costs”. That’s not a risk, that’s a certainty. And the costs will be borne by the usual suspects: you and me. The only thing we can do to mitigate the damage from this is to get out of the way, find a remote spot somewhere, and start figuring out ways not to be dependent on the economic system.
Our best and brightest minds should be on this like flies on honey, but they’re neither all that best nor bright: they’re busy making consumer gadgets, and designing high frequency trading systems for a zombified investment model. Looks like we’ll have to become our own best and brightest. Maybe we always were; we just didn’t know it yet.