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Politics in Europe, the U.S., and China make 2011 safer than it looks for the global economy–but watch out for 2013
06/14/2011 8:30 am EST
And politics also virtually guarantee another, deeper crisis in 2012 or 2013. I’d bet 2013.
How come? You see just about every politician in the world is trying to kick an economic problem down the road into 2012 or 2013. I think they’ll succeed in 2011 in postponing the day of reckoning using a combination of funny accounting, additional spending, and subsidies. But the price for that postponement will be that problems put off in 2011 will be bigger and harder to truly solve in 2012 or 2013. And that will raise the odds that the the global economy will face a serious crisis again—just five years or so after the last one.
This kick it down the road effort is most obvious in the EuroZone where the effort to put together a new rescue package for Greece really comes down to putting off a Greek default from 2012 to 2013 or 2014. But the effect is also visible in the United States where I think the most likely result of negotiations to raise the debt ceiling will be to kick the problem into the 2012 election campaign with a “solution” postponed to 2013. And in China where the new leadership that takes over in 2012 and 2013 from current President Hu Jintao in 2012 as party leader and in 2013 as president will be extremely reluctant to rock the boat until it’s sitting firmly in the seats of power.
Altogether this politics of delay means that in 2011 the global economy will get enough stimulus to keep growth at the relatively high levels that politicians need to keep folks reasonably happy and that we won’t see politicians even thinking about making the tough choices that might inhibit growth until well into 2012.
You should be familiar with this politics of procrastination from my posts on the Greek debt crisis. The original rescue plan for Greece, cobbled together last year with funding from the European Union, the European Central Bank, and the International Monetary Fund, turned out to be an all-to-hopeful effort to push the problem down the road into 2012. The thinking last year, when the rescue program was put together, was that if Greece could get enough cash from a European Union rescue program to get to 2012 that would be enough time for the country to get its house in order and offer financial markets enough reassurance so that Greece would be able to start to finance its debt from private investors again.
That turns out to have been exceedingly optimistic—so optimistic that I’d label it “just plain wrong.” Greece has not been able to quickly reconstruct its dysfunctional system of tax collection so that the country has continued to collect less tax than it is owed (and than it had promised its rescuers that it would be able to collect) and budget cutting and asset sales—while painful enough to elicit widespread protests in Greece—haven’t lived up to projections either. Add in the effects of the all-to-predictable slowdown in the economy as a result of these measures, and Greece is clearly not ready for the financial markets in 2012 and maybe not in 2013.
Efforts at a new package, held up now by fighting between the German government and the European Central Bank about whether bondholders should be required to extend the maturity of their Greek bonds as part of any deal, are focused on getting enough money from the European Union, the European Central Bank, and the International Monetary Fund to support Greece until 2013 or 2014 when—hope springs eternal—Greece will be able to sell debt in the financial markets again.
The political imperatives driving this thinking are very clear. The only alternative to this deal—if it can be sold to voters in Germany and other Northern European countries and assuming that it works—is a painful re-examination and restructuring of the entire euro project. In the current political climate it’s unlikely that voters in the northern or southern Eurozone would approve a restructuring that actually dealt with the very real problems of running a single currency for economies as different as those of Germany and Greece. Kick the problem down the road and hope seems a pretty good alternative at this point to European politicians.
The situation is totally different in the United States but the result is remarkably similar. With the U.S. Presidential election looming in 2012 and the anemic economic recovery being the issue where the Obama administration is most vulnerable to Republican attack, the Republican opposition certainly doesn’t want to strike any deal over the debt ceiling—the U.S. will run out of room to borrow in August according to the U.S. Treasury—that would remove the shocking state of U.S. financed from the minds of voters. On the other hand, pragmatic Republicans don’t want to force the United States into even a technical default on its debt in August 2011 and risk a) creating a crisis a year too early, and b) potentially getting taking the blame for any crisis. Democrats, for their part, would like some kind of deal this year that doesn’t totally preclude the chance that the economy will pick up speed and look like it’s in better shape in June 2012 than it does now.
That’s why, in my opinion, the likeliest outcome isn’t a crisis this year but some patchwork compromise that gives both sides some potential ammunition for 2012 but that pushes off the hard work on reducing the U.S. deficit into 2012 or into the post-election period.
That would mean that the odds are relatively low that negotiations in Washington will produce budget cuts large enough to make a difference in the U.S. deficit or large enough to turn the current anemic slowdown into a double dip recession. It’s much more likely that U.S. fiscal policy will remain a complete muddle with the Federal Reserve able to hold growth at 2%--and perhaps even better if the Fed is right that the first quarter slowdown was a result of temporary factors stemming from the Japanese earthquake and tsunami.
Until 2013, anyway, when no matter how the election goes the Federal Reserve will be under almost unbearable pressure to reduce its balance sheet and to raise interest rates to something more like a normal range—and when global bond markets will really put the pressure on the United States to come up with a plan—at the least—for reducing its budget deficit over the long term.
China doesn’t hold U.S. style elections to pick its next leaders but the politicking is no less intense just because it’s done behind closed doors and limited to a handful of candidates at the top of the party hierarchy. All the evidence right now points to intense jockeying as candidates for power try to move up the hierarchy as far as they can during the transition. The current revival of Maoist slogans, songs, and work campaigns in some regions in China is one sign of that.
This transition is likely to be especially hard fought since it marks the emergence of the so-called “princelings” onto the stage. The last generation was a transitional one between those who had led the revolution itself and the new generation that is composed of the sons and daughters of revolutionary leaders. For example, Xi Jinping, the almost certain successor to current President Hu Jintao, was born in 1963. His father, Xi Zhongxum, joined the party in 1928 and was deputy prime minister of China from 1959 to 1962. That background presents a generational contrast with current president Hu, who born in 1942, was a student during the cultural revolution, and began his climb up the party hierarchy in the 1980s. There are 19 princelings on the current 204-strong central committee.
There are more princelings than leadership slots, however, and the princelings themselves represent a wide range of ideological positions from economic reformers to cultural hardliners who see the widespread corruption in China’s government as a sign that Chinese capitalism and democracy have gone too far.
You can imagine that no one set on moving toward the upper ranks of power wants to report a slowdown in growth in any region under their responsibility or to rile any of the economic powers that depend on government subsidies or credit. I think you can count on the politics of the 2012-2013 transition to favor a continuation of easy bank credit for the biggest Chinese companies, limited efforts to fight inflation, and economic growth above 8%--no matter what the rhetoric.
After 2012-2013 all bets are off, however.
Nouriel Roubini, famous for his early call on the global financial crisis, has recently pointed to the danger that China faces an economic “hard landing” after 2013. Beijing added massive stimulus to China’s economy in 2008 to head off the damage to the Chinese economy from the global financial crisis. The government has been relatively unsuccessful in slowing the growth of the money supply, bank credit, and fixed investment that formed the basis for that boost to growth even though the crisis is clearly in the rear view mirror of a Chinese economy growing by 10% a year. That has led to a major distortion in the Chinese economy, Roubini says, because economic growth in China increasingly depends on investment in fixed assets that may not be economically productive in themselves but that produce massive profits for well-connected Chinese officials and business people. That has lead to a huge bad loan problem in China, he says, and has produced a massive amount of excess industrial capacity.
No one will challenge current policies during the transition in leadership, but once new leaders are firmly in command, China will have to confront these problems. That will mean, I’d say, not just further attempts to damp bank lending and to raise reserve requirements but truly serious escalation of the battles on these fronts. It will mean new steps to fight inflation. And it might even mean a willingness on the part of the new leadership, if it feels secure and rich enough, to sacrifice some economic growth to achieving these ends. One possible alternative to slower growth would be a shift from growth based on exports and investment in fixed assets to one based on domestic consumption but that would require shifts in the economy—and challenges to powerful interests in that economy-- that could be even more disruptive than a simple slowdown in growth.
If I’m right about the way that the political schedule works, it should provide support in 2011 that’s sufficient to avoid the economic slowdown that the financial markets fear at the moment. The bad news, of course, is that the actions of the politicians that support growth now will have to be paid for in 2013 or so.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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