The EU Recession

Posted on August 29th, 2011

Will the EU and China pull the US down into recession?

A couple of weeks ago the Chancellor of the Exchequer gave a great speech in Parliament (see link: The essence of it was: we cut government spending and the deficit and therefore retained our Triple A credit rating. Left unsaid was the comparison to those that did not cut the deficit and did not retain their Triple A rating.

It took some nerve for the Chancellor to say what he did at a time when there were already riots in the streets of London and other cities, even before the cutbacks became effective. More to the point here, the UK economy is barely growing and tightening fiscal policy can easily tip it into recession (see chart 1).
A recession in the UK is of course of limited significance for the global economy. Unfortunately, however, the UK was only following decisions taken by the EMU for its members. And some governments were forced by the sovereign debt market to take more painful cuts in spending (Italy is the latest, soon to be followed by Spain and France).
As a result of this tightening of fiscal policy, economic growth in the EMU came to a screeching halt (see charts 2-5). Against this background, the leaders of the largest economies in the EMU, Merkel and Sarkozy, had an emergency meeting last week. Their decisions included even more aggressive tightening of fiscal policy in the future and a tax on financial transactions (don’t worry about the latter decision – politicians periodically fall in love with the idea of taxing something they hate because it brings home the bad news. Eventually, they always retreat before causing the damage). What was glaringly absent from their decisions was any measure to boost the economy, even if only by monetary policy means.
This is not the first time Europeans have ignored the need for them to do something when their economy is falling into recession. In 2001, the US economy fell into recession but bounced back after 6 months. The recovery however wasn’t solid enough and Europe remained in a recession so that the Fed had to keep taking Interest Rates lower for the next couple of years. Eventually, rising house prices solidified the recovery in the US and the US in turn through its balance of trade deficit helped Europe out of the recession. This of course was a dangerous gambit in which the housing market in the US had to pull the world economy out of recession. I warned about those risks already in 2003 and the end result is well known. Unfortunately, the world cannot expect the US to pull it out of recession this time. On the contrary, Europe and China with a large and growing trade surplus – which of course means trade deficit for the rest of the world —can easily pull the US down (see charts 6-8). The only hope of avoiding this rests on the dollar continuing to go down sufficiently so the US balance of trade does not worsen significantly. This is also contingent on China continuing to let the yuan appreciate at a faster pace.


A World at Risk

Posted on August 3rd, 2011

♦ The pace of global economic growth started to slow down at the beginning of the year and is now close to zero.

♦ The main cause of this slowdown in growth is an almost universal tightening of economic policy. In the developing world, interest rates were raised to stop inflation. In the developed world, government spending was cut in order to reduce the debt. Thus, irrespective of its motives, tightening of monetary or fiscal policy has caused a slowdown around the world.


The US Stock Market Wants to Go Up: Part II

Posted on March 31st, 2011

Having despaired halfway through listing just the major risks to the stock market (as well as to the US economy, to the world economy, and generally to the world as we know it – – see Part 1) the question arises why own any stocks. Why not get out or go short? The answer, as usual, was given by the market. It has gone up over one percent since I wrote Part 1 two days ago against the background of news that the Japanese found plutonium in the ground near the Fukushima nuclear power plant, house prices went down again in January and February, consumer confidence declined in both the US and Europe, Gaddafi forces advanced again despite NATO action, and Fitch threatened to downgrade both Ireland and Portugal. Bad news it is, but apparently not bad enough to stop the rally.
So why does the market persist in its effort to move higher  and is only 2% off its recent high (basis S&P futures) and a few percent off the all time highs made in 2000 and again in 2007? (See charts 1-3). After all there is no bubble in high tech or housing markets now and if there is a bubble in commodities now it probably has little net effect on the stock market.
The detailed solution to this enigma is somewhat involved but the gist of it is simple: sharply lower interest rates and higher corporate profits.

Lower Interest rates


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