What would happen if some leading European banks were to suspend their payments? Or if other dominoes were to fall?
The answer is that we would have a nightmare. Everyone has forgotten that Greece owes about €350 billion, i.e. a bit more than America’s quarterly deficit. Solidarity among Europeans is a must, whatever the cost, to head off a second banking crisis that would be irreparable this time. Angela Merkel must have realised this, albeit a bit late. 2012 is an electoral year in a number of large countries, and none of the leaders concerned wants to bring on a crisis before facing his or her voters.
Most importantly it will be a presidential election year in the US, which has a budget deficit of $1.4 trillion and a national debt exceeding $14 trillion. Despite this US politicians learned nothing from the 2008 credit crunch: the Democrats continue blindly to advocate social spending and the Republicans continue blindly to advocate tax cuts and smaller government. Two wars and social security with no revenues to back them have combined to create a staggering, unsustainable shortfall. Mainly Republican lobbies, lubricated by millions of dollars, shoot down any initiative designed to do away with tax niches. These lobbies are so effective that they have enabled Wall Street to stop paying taxes on the pretext that its billions in capital gains and bonuses are fair compensation for the tough work the beneficiaries have to put up with. Tough work indeed. So with any rise in taxes ruled out, the Federal Reserve continues to print money that is worth less and less.
By 2013 America’s public debt will reach more than 85% of GDP in a context of sluggish growth. Another sword of Damocles (and not a Greek one) is that any increase in short-term interest rates, being kept at 0% by the Fed, would become a raging financial tidal wave. After QE2 should we expect a QE2½ to continue distorting long-term rates? With no real way to collect on big multinational companies (which keep their profits abroad) and no way to abolish the tax breaks and niches accumulated by the Bush Junior administration, the US deficit is not going to shrink any time soon. Cutting it would not slow the economic recovery, which is jobless and quite moderate for the moment.
With unemployment still soaring and consumer sentiment at an all-time low, a 2% rise in GDP cannot generate enough new jobs to boost confidence and trim the deficit. If the leading ratings agencies were not American, the US would have already lost its triple-A status and the downgrade would have cost it another $100 billion in debt-servicing charges. With professional politicians engrossed in getting re-elected, there can be no brave bipartisan bid to break out of the crisis. With no reforms before next year and no drastic measures forced on them, governments and central banks will go on printing money to dilute the value of their currency and take the sting out of the crisis. Euroland, whose politicians have cheered the stability and efficiency of their currency for the past ten years, has experienced broad-based inflation in commodities, services, healthcare, real estate and energy. A loaf of bread in France has gone up from one franc to one euro! Stagnation and dwindling purchasing power are grinding away at the economy.
The emerging countries in contrast continue to grow rapidly, and their currencies are appreciating. This is helping export industries in Europe and the US, with Japan benefiting less owing to its tsunami-induced slowdown. But rising inflation and initial pressure on China’s banks could start slowing their growth. Moreover developing local industry will not help global sectors that have been protected by their exclusivity. Embraer has already entered the fray in aerospace, and the day of Chinese airliners is not that far away. Boeing, Airbus and their subcontractors can take notice.
The Swiss franc is dizzying high, flying above the whirlwind of counterfeit currencies. It is a commodity that speculators have bid up far beyond its normal realm of circulation. Too bad for the Swiss National Bank, which lost CHF 42 billion trying to hold it down. Speculation has driven our franc up 20% to the great dismay of exporters and hotelkeepers. The mini-Deutsche mark has become a tool for bidding against the euro, since there is no drachma left... The SNB was bitten and is twice shy of the forex market. The deflationary impact will be felt in the second half, unless a miracle on the Acropolis brings some relief.
What investment policy can one imagine amid such poor visibility? Is that gleam in the fog a sunray or the headlight of an express train barrelling towards us? We recommend keeping positions in hard assets for safety’s sake. Gold is still the best bet. With bonds the least lucrative and riskiest of asset classes, only corporate issues offer yields worth considering. Here, in fact, there are still some good opportunities in fixed- and floating-rate paper. Another «hedge» is to buy shares in solid industrial blue chips. These suggestions may not be very original, but they are a way of avoiding volatility with equities these days wont to dive on a single press release. On the other hand there is surprisingly little talk about Zynga’s and Facebook’s IPOs after LinkedIn’s, at astronomical capitalisations that reflect the glut of liquidity.
Original article from Patrick Ségal, Banque Privée Edmond de Rothschild S.A., June 2011