Risks for the global economy

The Republicans were out in force this past weekend, beginning the 2012 election charge by promising to cut discretionary spending and saying they won’t vote for an extension to the current debt ceiling until the Democrats agree to more harsh spending cuts. IF, and only IF, lawmakers give the perception that some of the longer-term structural changes—like a rapidly aging workforce—will somehow not bankrupt the government with costs from Medicare, Medicaid, and Social Security, then the public will be confident that they have a legitimate plan to tackle the deficit. 

According to Robert Fisher the Dallas Federal Reserve (in a year old study): “According to our calculations at the Dallas Fed, that unfunded debt of Social Security and Medicare combined has now reached $104 trillion US— trillion with a “T” — in discounted present value.” The outlook for the US debt forecast is so toxic it’s depressing to think about.

In fact the can is so damn big, they can’t kick it down the road anymore. But few (though growing) really want to hear how bad the fiscal position of the U.S. really is because of what it means to living standards.

The largest economy in the world has problems that are massive and need a massive overhaul, which this government or any other in the coming years, will  likely not be bold enough to make. Many recognize the problem, but it just might be “too big not to fail.”

Then there is China, now the second largest economy in the world, perhaps having pulled economic growth forward many years and creating their own bubble. Readers should watch the following documentary on the overbuilding going on in China and decide for themselves.

Personally, I find it hard to believe and I hope to visit China and India this summer to see for myself. That said, it makes one wonder and adds a dose of concern when blindly believing emerging markets will grow ad infinitum, without much natural cyclical correction that we see in other economies.

And poor Japan, the recent tragedy is really heart wrenching to think about. The toll on human life is a real wakeup call that we should be more aggressive in addressing impacts of a warming planet.

But Japan’s problems are only complicated by this latest tragedy—that is, they are fiscally bankrupt and have been for a while. Population growth peaked a few years ago and economic growth has been anaemic for years, despite their repeated QE intervention and mounting government debt.

And last, but not least, the world’s biggest economic bloc, the euro, led by the fourth biggest economy in Germany, is a house of cards—with several counties in the bloc already bankrupt and Germany and France being forced to carry the load. The worker in Germany will simply not tolerate a higher burden so that the worker in Greece can retire ten years earlier. Chancellor Angela Merkel said so on Monday at her party's election defeat in the prosperous state of Baden-Wuerttemberg—after 58 straight years of rule.

We think several PIIGS countries will ultimately break from the euro and another global banking crisis is likely when defaults hit. Sadly, we do not see it any other way, but we hope we are wrong. We are not fear mongering, we are simply analyzing the economic risks, and they are not good in our view.

That said, we are full weight equity exposure in our investment accounts for clients and we think for now markets will focus on earnings, which look positive for another quarter or two. We do not want to see the March lows broken over the next few months. If they break, it could be a warning that the markets are pricing in an economic contraction again. HELLO QE3...QE4...QE5...HELLO JAPAN