This week we look at some mostly bullish analysis from my friends at GaveKal for the Outside the Box. Much of the letter is devoted to looking at why Europe may fare better than many think (which will make uber-European bull David Kotok happy to read!). But be very sure to read the last page as Steve Vannelli analyzes the latest speculation about the Fed and quantitative easing. All those calling for QE2 may not actually do what they think it will. His conclusion?
“Once again, if there is no growth in broad money, no increase in velocity and no increase in Fed credit (hybrid money), then the only source to finance growth in the real economy will remain the sale of risky assets. When confidence seems to be stuck in a low plateau and talk of reigning in fiscal deficits is growing louder, a policy of undermining the value of risky assets couldn’t be more counterproductive to growth.”
I find myself in New York this morning (I once again did Yahoo Tech Ticker) leaving for DC later. Then sadly will have to forego Turks and Caicos, but that does allow for me to go to Baton Rouge for a one day course on the affects of the gulf oil spill on the regional economy, helicopter flyovers, etc. I will report back in this week’s letter what I learn.
Have a great week.
Your wishing he was still fishing in Maine analyst,
John Mauldin, Editor
Outside the Box
GaveKal Five Corners
By Francois-Xavier Chauchat, Pierre Gave, Steve Vannelli
The German Question
Looking at consensus growth forecasts for 2010-12, most believe that Germany’s current export boom will fail to translate into a convincing improvement for the domestic economy. Needless to say, this issue is of crucial importance for the sustainability of growth in Europe, and for its much-needed rebalancing. Simply put, Europe needs Germany to be more than an export power-house.
Fortunately, the inability of most to see beyond Germany’s exporting prowess (see, for example, every other Martin Wolf column) may just reflect the extrapolation of the previous economic upswing of 2003-2008. Indeed, the previous German export boom did not trigger an increase in domestic consumer spending (annual growth of private consumption averaged, over that period, a discouraging +0.25%). But looking forward, things may be different for the following reasons:
• To start with the obvious, domestic growth is not just about consumption; it is also about investment. Fixed capital formation grew very strongly in Germany from late 2005 to 2008, after a decade of sustained weakness, and contributed to no less than 40% of German GDP growth over that period. The same could easily happen from late 2010 to 2012. Interestingly, for the first time since early 2008, German banks are now reporting higher loan demand by companies for investment needs.
• From 2003 onwards, the sustained rise of the Euro and the overall inflexibility of the corporate environment made companies unable, and unwilling, to sacrifice their emerging profitability. Among other things, this resulted in nonexistent wage growth. But today, corporate Germany is competitive and profitable, the Euro has declined by -10% since last year, and unemployment has reached an 18-year low. As such, capping wage growth is no longer useful, nor is it feasible.
• The consolidation of government accounts from 2000 to 2007 hurt households considerably. Social contributions were hiked, social spending and pensions were cut, and the VAT was raised by a significant 3 percentage points in January 2007. For the years 2011-2014, the government plans a series of gradual spending cuts and tax increases on banks and utility companies. This time around, households should be spared. Meanwhile, the Ricardian effect of fiscal consolidation will likely be quite powerful as this could be the last push before Germany finally achieves the solid budgetary stability that it enjoyed before the country’s unification.
• Finally, evidence is increasing that former East Germany is emerging from a twenty year lethargy that cost some 3% of GDP each year in budget transfers from the West (see Green Shoots in the East German Desert). According to the latest IFO survey, companies of all kinds in the New Landers—from industrials to retailers—have the best assessment of the economic situation in the region’s History. Unemployment in DDR is also decreasing fast. Thus, for the first time since reunification, East Germany is no longer a headwind. For the above reasons, and even though the German economy will remain extremely dependent on global trade, the case for a gradual and sustained revival of investment and consumption in the biggest economy of Europe is probably more compelling than what most believe. After a decade of near-deflation comes normalization. And this normalization, coming on the heels of years of stagnation, could well look like a boom.
A US$2,000bn Rebalancing
As we have argued repeatedly in numerous reports, the Western World faces two distinct challenges:
• Over-extended banks that have over-collateralized real estate linked assets.
• Governments with massive unfunded liabilities (pensions, healthcare, etc…)
But needless to say, the picture is not uniform across the OECD and some nations are actually in fine shape (see The Nordic Hedge). Scandinavia or Switzerland, for example, will enjoy very favorable monetary conditions and rapidly recovering economic growth for the foreseeable future. In fact, these economies are already seeing their export boom morph into a strong pick-up in domestic demand, a recovery enhanced by rising consumer confidence and falling unemployment rates. According to the Swiss national bank and to the Swedish Riksbank, the domestic macro-situation justifies a continued normalization of monetary policy. However, with Euro, US$ and Sterling interest rates bound to remain close to zero for the foreseeable future, the SEK or CHF risk going to the roof if monetary policy is tightened significantly.
This constraint upon monetary policy in fiscally-sound countries (see The Riksbank Dilemma) implies that interest rates in these economies will very likely remain well below neutral over the next few years. The flipside is that the boom of domestic growth in Scandinavia and Switzerland thus has much further to go. For the Eurozone, this is significant as Scandinavia and Switzerland are even larger clients (12.7% of Euroland exports) than the US (11.6%) or China (5.8%). Interestingly, and importantly for the debate about Europe, the size of these economies almost exactly matches that of Portugal, Ireland, Greece and Spain (roughly US$2,000bn). So while the deflationary forces in these latter countries will remain a drag on European growth, the dynamism in Scandinavia and Switzerland could very well counter the downside pressures emanating from the PIGS.
The regional rebalancing of growth within continental Europe remains one of our central themes for the area (see Euroland’s Growth Prospects and Europe’s Outperformance and Strong Data). In the coming quarters, monitoring this rebalancing will be of crucial importance to assess the nature and the magnitude of risks attached to European financial assets. In our view, the ability of fiscally healthy countries in Europe to compensate for the very poor economic performance of the PIGS is one, usually underestimated, element of comfort.
Category: Think Tank
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Category: Federal Reserve
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Jeff Matthews: GOP Midterm Victory Will Lift “Wet Blanket” Off Economy, Stocks
Yahoo Tech Ticker, Aug 05, 2010