Austerity Programs Fail

rduvall      austerity programs, Europe, Greece

Earlier this month the IMF updated its world economic outlook, with a very modest increase in growth projections for this year. However, it warned of continued economic risks in Europe and emerging industrialized economies in Asia and Latin America. The IMF forecast is consistent with our own forecasts of the last six months and we remain less optimistic about world growth because of our continued expectations of recession in Europe which are being confirmed by the economic contractions in an increasing number of EU economies in the fourth quarter of 2011 and the first calendar quarter of 2012.

However, of more importance to us is the language in the IMF forecast that for the first time calls on European nations to curtail its emphasis on austerity programs in favor of policies that stimulate economic growth. It appears that the IMF is the latest in a number of private and official economic organs to recognize the fallacy of stringent austerity programs as the solution to the Europe’s sovereign debt crisis. Indeed, the relapse of an increasing number of European economies into recession and the failure of an increasing number of European countries to meet debt/GNP targets for 2012-13 are showing the destructive impact of the EU austerity programs on the economic, financial, social and political fabrics of Europe and its concomitant impact on the rest of the world.

We hate to say we told you so, but we forecasted this in our SPG Trend website articles of December 17, 2010 and March 15, 2011. Those articles, plus others on our SPG Trend blog, warned of the dire consequences of “squeezing” economic growth to zero as a result of the draconian austerity programs dictated by the EU onits members. Almost two years later, some of the very institutions demanding these austerity programs are recognizing their failure. Unfortunately, it is too late to save the EU from recession this year and in many cases within the EU, next and the wheels of political change we also warned about in our articles is already underway. Elections in France, Greece, Italy, the Netherlands and Spain could result in new governments that have vowed to repudiate or ignore the EU austerity measures. Such developments would unravel the EU and create panic in international financial markets. We have always felt the “Achilles heel” of the EU was the unwillingness of the populations within its members to endure increasing economic hardship to appease international creditors.
The upcoming elections with the EU this year and next will determine the Union’s fate and future. An increasing euro-skeptic mood among the Union’s body politic is ominous and should be a source of concern for all of us.

Morris R. Segall

Geopolitics: Why its so important

Morris Segall      Capital Markets, Emerging markets economic growth, European debt crisis, Global financial and banking systems, International economic growth, U.S economic growth, Worldwide recession

Since the spring of 2010 events outside the U.S. have been dominating our financial news and influencing our economy and capital markets. That spring the European debt difficulties moved to crisis stage with the imminent debt default of Greece. The financial crisis that began that spring has continued virtually unabated with a series of financial “band aids” that have staved off world financial disaster but done nothing to provide a permanent solution to Europe’s financial distress. In the meantime, the ratings agencies have downgraded both sovereign and bank credit through much of Europe and the ill advised austerity programs (See our website articles of March 15, 2011 and December 17, 2010), adopted by the members of the European Union have “choked off” economic growth in much of the continent, threatening the region with existing and imminent recession. During this period, world financial markets have been in turmoil and capital markets have been depressed.

Without a firm solution to the spreading sovereign debt woes, panic spread to the continent’s banking system that forced world central banks to add liquidity to the European banking system. This new calamity necessitated a summit of European leaders to fashion a long awaited permanent solution to Europe’s debt crisis. The summit was held last week and as we expected, failed to produce a bona fide solution to the debt crisis. Once again, a summit of European political and financial leaders was long on rhetoric and short on tangible solutions. After a reflex rally in the world capital markets last Friday on the news of increased unity and collaboration of EU members, the absence of substance in the summit became evident on examination over last weekend and the capital markets reacted accordingly on Monday.

We have been pessimistic about the future of the European union since its financial woes became unmanageable in 2010 and the sequence of events since then have only borne out our concerns. The fact is there is no machinery within the European Union framework that will accomplish what is needed to alleviate Europe’s financial distress and satisfy world financial markets that Europe is creditworthy. The principal entity that should be able to provide a conduit for Europe’s sovereign debt financing and shore up its banking system, the European Central Bank, is not empowered nor does it have the resources to do both. Therefore, the members of the EU face totally revamping their union with new treaties, subordinating their sovereignty to the European Commission, or creating some ersatz organ to provide the financial resources to do so. Again, there is not enough consensus among EU members to do what is necessary and not enough resources within the European Community to fully engineer a financial solution to both the sovereign debt and under-capitalized banking system. So the angst over Europe’s financial future continues as does the continuing threat of credit downgrades by the credit rating agencies, exacerbating an already tense situation. At this point, the austerity programs have created a negative economic situation for Europe, both Western and Eastern, that is threatening world economic growth for 2012-13. Europe represents approximately 20% of world trade and is a major market for U.S. and emerging market exports. Its economic stagnation has negative implications for GDP growth here and abroad. If Europe’s financial woes degenerate into a world financial crisis threatening the banking systems globally, it could precipitate a worldwide recession. This is the principal reason why forecasting world economic growth for the next 2-3 years has become so difficult.

That difficulty has been compounded by the current significant economic growth slowdown in the emerging market leaders in Asia and Latin America, notably China, India and Brazil. Emerging markets have been the locomotive of world economic growth before the recession and have led the world economic recovery since the recession ended. Economic deceleration in this key segment of the world economy coupled with economic stagnation in Europe cannot help but depress prospects for economic growth in the U.S. The impact of overseas events on our economy, our financial system and capital markets has never been greater and is unprecedented in the post war era. Unfortunately it is part of a secular change in the world economic order where global interdependence has replaced economic independence and where global economic growth leadership has passed to the newly industrialized economies of Asia and Latin America.

Morris R. Segall

Is Egypt slipping away?

Morris Segall      "Arab Spring", American antagonist, closer relations with Iran, Geopolitical threats, Islamic fundamentalism, loss of Egypt, Middle East unrest, new threat to Israel, power vacuum

In our October 19, video blog, we warned about the power vacuums being created in Middle East countries where existing governments have been overthrown by populist movements. Our concern has been particularly acute in regards to Egypt because of its large size, strategic location and its geopolitical importance to the U.S. and stability in the Middle East. In our October 19th blog, we enumerated a series of distinct actions on the part of the interim Egytian government and the Egyptian body politic that have resulted in adverse developments in Egypt’s various ethnic and religious communities and its previous coexistence policy with the State of Israel.
New sectarian violence between Muslims and Christians broke out last month breaking a long standing policy of tolerace within the country. This was followed by savage attacks on the Israeli Embassy by mobs in Cairo, which were allowed to get out of hand by passive police action. Also within the past 30 days, the Egyptian interim government and its population gave a warm welcome to the Prime Minister of Turkey who gave a series of inlfammatory anti-Israel diatribes. During this period, it became apparent the Egyptian authorities were “looking the other way” to increased arms shipments in Gaza from Egypt to aid anti-Israel military activities on the part of Hamas.
And now at the time of this writing, violent, popular demonstrations to remove the caretaker military government are underway and threaten to create a further vacuum in the governance of Egypt until new elections can be held. Parliamentary elections are scheduled to be held next week but presidential elections are not scheduled until next year. How can representative elections be held in the middle of mob violence that has unraveled civil order?
In the middle of this chaos and upheaval, the development we most feared is occurring. The highly organized, trained and well funded Islamic fundamentalist parties are assuming leadership of the popular demonstrations and increased support within the electorate itself. They are now favored to win a majority in the Parliamentary elections.
If this occurs, we can expect a radical shift in Egyptian domestic and foreign policy. The more extreme elements of the Islamic political movement wants an Islamic state governed by the Islamic law of Sharia. If this were to become law, Egypt would revert from a largely secular state to a theocracy along the lines of Iran. Indeed,
a more militant Muslim Egypt might be expected to forge closer diplomatic relations with Iran. Egypt would become an American antagonist in the region instead of a dependable ally.
Of more concern is the shift in Egyptian foreign policy towards Israel. There is a clear shift towards an anti-Israel attitude in the street and in leadership and political elements within Egypt and it portends ill for the maintenance of peaceful relations between the two countries and the region. If Islamic fundamentalists take control of the Parliament, we could expect the peace treaty with Israel to be “scrapped” and Egypt would take a more mililtant, pro-Palestinian stand on issues between Israelis and Palestinians. While Egypt might become an antagonist to America it would become an enemy to Israel. This would upset the balance of power in the Middle East, isolating Israel further in the region and presenting a new potential military threat to that country on its western flank. A more militant Egypt would embolden Hamas and Hezbollah to engage in more overt military actions. Israel may decide it needs to pre-emptively protect itself from increasing threats.
All of this bodes ill for U.S. foreign policy, economic and security interests. We will face new, uncomfortable challenges in dealing with this important region in the face of a new, unfriendly Egypt. Unfortunately, our ability to control events in Egypt are virtually nil and the rapidity of events in the Middle East have left us unprepared in dealing concretely with the aftermaths of this year’s Arab Spring. Our unpreparedness will cost us economically, militarily and politically as we find ourselves dealing with new leaders with whom we have cultivated little influence.

Morris R. Segall

Osama Bin Laden is Killed and Risk Tolerance Rises For the Moment

Morris Segall      Al Queda, Capital Markets, consumer spending, debt ceiling deliberations, economic realities, Fed's QE 2 program, geopolitical changes, inflation, kudos to U.S. intelligence and military, obama, Osama Bin Laden, President's reelection, risk aversion, stock market

Last night’s news that U.S. military forces killed Osam Bin Laden is another unexpected geopolitical development in a year that is already seeing huge changes in the world’s political landscape. The news of Bin Laden’s death is causing an immediate reaction of relief and exultation which is seeing large gains in U.S. equity futures which will translate into large gains in U.S. stocks at today’s open. The very short term reaction in U.S. stocks will see a reversal in recent surges in safe haven investments led by gold and oil which are already trading down in Asian and futures markets. This reversal of risk avoidance will last in the very short term but economic and geopolitical realities will reassert themselves in fairly short order.

First, the U.S. markets will still have to deal with U.S. budget contentions that threaten to stall a rise in the U,S. debt ceiling that must be done to avoid a potential U.S. debt default. We continue to believe an eleventh hour agreement on raising the debt ceiling will occur but the cost in the form of higher taxes and decreased federal spending will be significant.

Second, the rise in inflation through the first quarter and extending into the current quarter threatens the growth of personal consumption and business profitability. Already more companies are announcing price increases necessary to pass along higher commodity, manufacturing and distribution costs. Unless, commodity prices collapse on an extended basis through the second half of this year, inflation will continue to be an economic headwind, not just for the U.S. but more importantly, for most economies overseas.

Third, the Fed’s QE 2 program will end at the end of June. What will the effect on the U.S. Treasury market be once the Fed stops absorbing the continuing large issuance of Treasury debt to finance this year’s large deficit.

Fourth, while the killing of Osama Bin Laden is a huge psychological victory over Al Queda, the reality is Al Queda has been operating independently of Osam Bin Laden for some time as witnessed by the vibrancy of the Al Queda operations in Yemen and Africa. The killing of Osama Bin Laden will not change that fact or the threats from local Al Queda chapters. In fact, these factions may intensify their threats in order to offset the psychological loss of Bin Laden.

So after a near term robust rally in U.S. and overseas equity markets, we expect euphoria to be tempered with economic realities. The impact of Bin Laden’s loss may have more mileage in the Arab world where people may feel a sense of relief and increased security that will empower them to further their fight for economic and political change in North Africa and the Middle East. In the dizzying pace of international events, it is difficult to forecast with clarity how political and economic developments will be shaped but major changes in both are underway and the status quo around the world is being altered.

Finally, we have been critical of President Obama in his handling of foreign policy including our recent website article on the Middle East. Despite critical diplomatic setbacks, we must congratulate the President and the counterintelligence agencies and the military for what appears to be first rate work in intelligence and military operations and decisive action on the part of the President to secure the prize. This will undoubtedly be a huge boost to the President’s reelection chances and deservedly so.

What if Moammar Gadhafi Turns into Saddam Hussein?

Morris Segall      inflation, Iran, Libyan air force, Libyan civil war, Middle East unrest, oil infrastructure, reduced economic growth, rising oil prices, Saddam Hussein, weak foreign policy

In the fluid sequence of events in the Libyan civil war, it appears the forces of Moammar Gadhafi are solidifying and mounting a more cohesive counter-offensive to the rebellion that has challenged the Libyan dictator. First, pro-government ground forces are conducting more concerted and organized offensive attacks on targets that have been selected for their strategic and pyschological importance. Second, the government is utilizing its air force more cohesively and effectively in supporting the ground offensives and inflicting significant damage to rebel positions and material. Today, the Gadhafi government bombed key oil installations in rebel controlled territory for the first time.

This raises the question-suppose Moammar Gadhafi is prepared to destroy his oil infrastructure, as did Saddam Hussein, to challenge the West in exerting further pressure on him and getting involved in the civil war, knowing they are reluctant to do so. In doing so, Gadhafi is challenging the West to stop him and their failure so far to do so is empowering him to use more force that could overwhelm the rebel forces.  The increased use of air power is the deciding factor in government forces defeating the rebels. By bombing oil installations, Gadhafi is also punishing the West by continuing to scare the oil markets and potentially drive up oil prices further. Furthermore, destruction of oil pumping and distribution facilities would lead to protracted elevation in oil prices which would harm worldwide economic growth and lead to increased inflation. We do not think this strategy is far fetched given the erratic behavior of Moammar Gadhafi, his obsession with staying in power and his anger at the West for trying to force him out.  

The failure of the West to “ground” Libyan air power is turning the tide of the civil war from what two weeks ago looked like a successful rebellion leading to the ouster of Mr. Gadhafi. If the rebellion in Libya is crushed, it will have long lasting and far reaching negative implications for the U.S. and its NATO allies. First, it will have demonstrated again to the world how impotent U.S. and Western foreign policy is in the post Iraq/Afghanistan war period. We have commented in several geo-political posts, on the blog and website,  the danger to U.S. and Western security and economic interests weak and failed foreign policy initiatives present. Second, the failure to tangibly support the Libyan rebels, to the point of their success, will reverberate throughout the Arab world as another failure of the U.S. and its allies to support democratic movements in that part of the world. Third, in their anger and frustration, the unrest we have seen so far in North Africa and the Middle East could spread and become more violent, threatening friendly governments in Jordan and Saudi Arabia and those of the Gulf Emirates. Our failure to support democratic movements will strengthen the reactionary and antagonistic actions of Iran and its allies in Syria, Iraq, Lebanon and Gaza.  The failure of the U.S. and its NATO allies to commit military assets to protect their national interests send a signal to our more strategic adversaries in Moscow and Beijing that we are not prepared to confront them in military and economic expansionism.  

The price of this foreign policy failure will be higher prices for oil for an extended period of time, suppressed economic growth in the oil consuming, industrialized economies and increased worldwide political tensions. None of these are good for worldwide public capital markets. In view of the new developments in Libya, we must now be more vigilant to economic impacts here and abroad and the reaction of the capital markets.

Morris R. Segall