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Extend-and-pretend policies expected in 2013
January 21, 2013
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NEW YORK: The year of 2012 ended on highs in sentiment, complacency and stock market valuations and with a firm belief in the miracles of extend-and-pretend policies.

The final bill from the US fiscal cliff still needs to be finalised in March 2013, but as we write in the macro section, much of the damage has already been done as companies have been holding back on investments while they await the outcome of the ugly political wrangling.

The outlook for businesses and the middle class remains uncertain at the best and very worrisome at the worst. Sure, stock markets being up 15-20 per cent is good for the 10 per cent of the population with stocks in their portfolios, but the sad truth is that the remaining 90 per cent of the population have seen little or no net wealth impact from the big rise in equity prices in 2012 and since the low in March 2009.

Remember that unemployment in Europe is at a record high, and has been stubbornly slow to come down in the US as well.

The reason, of course, is that 2012 was mostly about stopping the European Union Club Med and the European banking system from collapsing.

The EU and the European central bank have clearly succeeded in this regard, but very little has been done to address legacy debt and rising social tensions, which are worsening every month at the EU periphery.

Short-term stabilisation does not mean we have a long-term solution on our hands.

On the contrary, when a mere increase in liquidity is presented as a solution to the risk of de facto insolvency, it is only a temporary brake on the undeniable force of economic gravity, which dictates that the price must ultimately be paid.

Even as perceived risk has fallen, the real systemic risk has actually risen as the co-dependency between local banks and their governments has never been higher. In another day and age, having underfi- nanced governments guaranteeing undercapitalised banks would have been called a Ponzi Scheme, but these days it is celebrated as good policy or the success of Mario Draghi and Ben Bernanke. 2013 will be about bridging the huge reality gap between improving conditions of the financial system with the still stumbling real economy.

That job is far bigger than consensus seems willing to admit. This is best seen by the lack of confidence among small businesses in the US - a segment that represents 65 percent of all jobs and growth in the US. This is why we are below consensus on Q1 growth for the US but also the world. The consensus for 2013-Q1 GDP is +1.6 per cent - we see it closer to +0.8 per cent. The wealth effect from higher stock markets that all central banks are betting on is only impacting the 10 per cent, not the 90 per cent. The reality remains that the average wage earner and especially the lower income earner is seeing serious erosion of their disposable income.

The IBIS World Business environment report Per Capita Disposable Income, provides clear numbers: In the US, for example, 2008 disposable income was $33,229, and now five years later it is $32,529 (minus 0.9 per cent). Over the same period (March 2009- December 2012), the S&P500 is up 100 percent. This is what extend-and-pretend is about: Savings banks and governments by letting taxpayers and creditors pay. It is capitalism without capital or accountability.

Lower income can be dealt with through dissaving, taking money from your account over a shorter period, but now five years into the crisis this patience is running on empty and despite the us federal Reserve’s explicit focus on unemployment, the fact remains that in 2011 the average Nonfarm Payroll’s number was +153K per month and in 2012 it was also +153K. Both way short of the desired 225K- 250k per month to make the us grow at long-term trend. we also have a second serious concern: the total debt build-up is nothing short of spectacular.

The US Fed promised in December to take its balance sheet from $3 trillion to close to $4 trillion in 2013, a rise of some 30+ per cent, but companies surveyed see little or no impact on their businesses from this massive stimulus. If US small businesses do not want   to hire - and surveys indicate they do not - then the economy lacks 65 per cent of its capacity to create jobs. This is exactly why the US Fed’s new policy thresholds are a major risk. There is no academic or practical study that proves any correlation between monetary policy and employment levels.

In other words, the fed’s new initiative appears economically and socially well intentioned, but there is no reason to celebrate it as a game changer when the results will be hard to see in the real economy, just as the previous trillions of money printing have failed to do the trick.

In Europe we see 2013 as a critical test for Germany’s attitude toward the EU project.

The Germans are being forced, step by step, to accept debt mutualisation and this will have a huge impact on not only Germany’s credit rating, but also its export numbers. In 2013, Angela Merkel will be busy making fiscal gifts to her voters ahead of the September election, but as 2013 progresses, Europe will get closer to sharing its debt, meaning Germany will be on the hook for more.

There is an almost naive sense in Germany that they control this EU political process, but for the objective observer, Germany is always giving concessions as it is dragged closer to fiscal union and Euro bonds.

In 2013 there will be no hiding for Germany as most of its formal demands are now in place, principally the much needed ECB oversight function and the economic examinations detailed first in the six-pack agreement and later in the two-pack.

The painfully high unemployment rate and waning growth will make Club Med more forcefully call for all-in measures from the ECB similar to what the US Fed is doing. And make no mistake - the ECB board has a majority for printing money, which will leave the German Bundesbank contingent very isolated. Violations of the EU Treaty will be once again ignored when europe-wide unemployment keeps rising - at least that is the history so far of this crisis. In Asia we remain very aware of the need for China to change its business model. China’s economic experiment is now one generation old, having been born in 1979. China’s next step is to move through the eye of the needle - at the cusp of evolving from the world’s largest “emerging” economy to a fully developed superpower. This entails three key changes: increasing competition to reduce corruption, deeper and more developed domestic capital markets to cater for increased wealth and its storage, and most importantly, an extension of social welfare programmes, particularly healthcare.

All of these will help secure the hand-over from an economy over-reliant on infrastructure building and exports to one that is balanced with domestic consumption demand.

This will only happen if the propensity to save is reduced through a more comprehensive social safety net, otherwise the average Chinese will keep his 40-50 percent savings rate forever.

We think it will happen, but mostly in the second half of the 10- year period of the new Politburo leadership. Things take time, particularly in China. The result for world growth and the market will be a China that contributes less to growth and more to inflation. Let’s not be too pessimistic on the prospects for 2013.

The downside for risk and the economy in 2013 comes down to this being a year of transition, where first we will try more of the same, but we will increasingly see the admission that time is running out and that something new must be tried - and that is a good thing.

What we need are measures that see us dealing with structural problems and encouraging investment rather than merely lining the pockets of bank executives. Our old theme of supporting the micro economy is still our main message for 2013, as it was in 2012. With all the focus on saving banks and governments, very little attention has been paid to business conditions.

Measured by PMIs and sentiment overall, these are sub-50, or in recessionary mode - this could be good news as it leaves room for an upside surprise, but we doubt that printing money or announcing an EU banking union will do the necessary heavy lifting.  the real concern in 2013 is that we need to see something “break” before we are able to move to a real mandate for change.


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