21/11/2016

More Economic Change Is In The Air - by Jeff Fitchett

Change is in the air.  Over the past handful of years, many mainstream political parties have been removed from office. “Fringe” politicians and new political parties are resonating with disenfranchised voters.   Donald Trump is an example of this as is Alexis Tsipras (The Prime Minister of Greece).

Discontent is spreading. People want a new direction to travel.  Many people who are living comfortably are unaware of the hard times that billions of people are experiencing. Each continent is experiencing upheaval in some manner. 

Too much debt and stretched budgets are negatively impacting many nations. Peripheral countries often experience economic & political hardship before G20 nations experience hardship. Our globalized economy allows for vast sums of money to flow in and out of nation states with relative ease.  During good times investors shower money in developing countries and this boosts the economies of these countries.  When times get tough the same money flows out and leaves behind economic carnage and political upheaval.  

For example, Greece was a major benefactor of cheap money prior to the 2008 Financial Crisis.  They were able to borrow money at the same rate of interest as Germany.  However, fiscally speaking, Germany and Greece could not be more different.  Germany’s government and citizens tend to be more prudent as it pertains to fiscal responsibility. Greece on the other hand is much more socialist in nature and this has lead the country into serious financial difficulties. 

In my opinion, the European Union is like a noose around Greece’s neck.  The majority of independent countries outside of the EU have currencies that float up and down depending on how well the said country is doing.  

If Greece were out of the EU their currency would drop significantly in price when compared to the Euro, US dollar, Chinese Yuan, etc.  If Greece left the EU they could take advantage of their low valued currency.  Exports would pick up because the cost of production would be lower given the decline in the value of their currency.  Tourism would increase because of the lower costs.

However, Greece’s debt has reached the point where government sponsored social benefits such as pension plans are no longer affordable.  Austerity measures are negatively impacting society.   I think everyone is aware of the troubles that Greece is experiencing.  They have already passed the point of being able to maintain the status quo.  In turn, the Greek population voted out of power mainstream political parties and chose a party that many (incorrectly) believed would be able to bring about positive change.  

In Italy, the Five Star Movement (anti-establishment and populist party), lead by Beppe Grillo (who happens to be a comedian that many liken to George Carlin), is gaining significant traction and will likely garner enough support to lead the Italian government after the next general election.  In the meantime, a constitutional referendum will be held on December 4th, 2016.  It appears the current Prime Minister, Matteo Renzi, will resign if he loses the referendum. He is blaming the Five Star Movement for the lack of support for the constitutional changes he wants to make. 

In France, Marine Le Pen leads the National Front Party (NFP).  The NFP is considered socially conservative, nationalist and against the EU and the EU’s immigration policies.  Over the past number of years the National Front has been gaining major wins in municipal, regional, EU and national elections.  

From a global perspective

Eventually a crisis will occur that engulfs the world as it did during the Tech Bubble in 2000 and the Great Recession in 2008.  I have felt that we have been sitting close to the edge of a cliff for quite a few years.   Debt and budget deficits are now problematic.  Political policies that maintain the status quo are beginning to fail.  As the problems deepen so to will the discontent.  

For every action, there is an equal and opposite reaction - Newton’s Third Law 

Check out the number of major elections, referendums and meetings that will be occurring over the next year and a bit. 

The Brexit vote and the election victory of Donald Trump are both major examples of the sea change that is occurring around the world.  I suspect ‘surprise’ victories will continue unabated over the coming months and years.  

Final Thoughts - near term observations

Volatility will continue to increase as political change occurs.  Financial market pundits will prognosticate that the polices Donald Trump intends to initiate will spur economic growth and cause inflationary conditions.  ‘Infrastructure spending’ has been a common theme anytime there is a recession or economic crisis.  The fact of the matter is that increased government spending leads to an increase in budget deficits and government debt.  

More often than not, politicians and central banks are able to use words to move the financial markets.  The equity market frenzy we have witnessed since the election is a prime example of this.  Nothing has changed fundamentally yet the financial markets have pushed to new highs.  

I think that financial market exuberance has given the Federal Reserve the cover to increase interest rates in December.  As I have stated repeatedly in past missives, economic fundamentals do not support an interest rate increase at this point in time.  Over the past several weeks bond prices have undergone a revaluation given the increased likelihood of interest rates going up by 25 bps.  As well, the US dollar has strengthened.  

In my opinion, the dichotomy of the situation is that the financial markets are reacting positively to proposed monetary and political policy changes where as economic fundamentals and societal issues are in stark contrast to these policy changes.  The danger for the average person is that these new policy changes will likely spark the next crisis and cause further hardship for the average person.  

Debt issues cannot be solved by issuing more debt.  For the past 20 years debt has fuelled economic growth globally.  Now that we have reached an unsustainable level of debt the idea that a country can grow their economy out of the debt issues they face is a fallacy.  As is the meme ‘Making America Great Again’.  

Stagflation will likely ensue as was the case in the 1970’s.  Stagflation is a period of time where persistent high inflation combined with high unemployment and stagnant demand in a country's economy.  


Interesting times to say the least!

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