Saturday, January 7, 2012
Wednesday, January 4, 2012
2012 could be the year Germany lets the euro die
There will be no Chinese credit explosion this time, no real help from post-bubble India or over-stretched Brazil. It will be a global downturn on all fronts, aborting what remains of recovery even before industrial output in the OECD bloc has regained its pre-Lehman peak.
The second wave will hit with youth unemployment already at 45pc in Greece and 49pc in Spain; and with the US labour participation rate already at depression levels of 64pc.
We will hear more about Italy's Red Brigades, Greece's Sect of Revolutionaries, and America's militia groups, and how democracies respond. Proto-fascism in Hungary is our warning.
China's surgical soft-landing will slip control, like Fed tightening in 1929 and 2007, or Japan's squeeze in 1990. Once construction has run amok, bears will have their way.
Since the purpose of New Year predictions is to stick one's neck out, let me hazard that China will devalue the yuan in 2012. It will export yet more spare capacity into a deflationary world, until the West retaliates and starts to turn its back on globalisation. Capital outflows will accelerate. The idea that China can rescue anybody will seem quaint.
The strong yen has already pushed Japan back into deflation, and fresh recession. Public debt has reached one quadrillion yen, as noted acidly by Tokyo's R&I rating agency when it stripped Japan of its AAA rating last month. That is $12.8 trillion, or Italy plus Spain times four. There is a graveyard full of Gaijin commentators who wrote off Japan too soon. Will the dam break this year at last, with tax covering less than half of spending, public debt at 237pc of GDP, ever fewer workers, and a state pension fund now selling government bonds? Perhaps. As R&I warns, Europe's woes have brought sovereign debt into very sharp focus.
America will look resilient for a few months. The payroll tax deal has averted a fiscal shock, but that is all. Money growth (M3) has sputtered out, and velocity is falling. Politics on Capitol Hill will restrain Ben Bernanke from launching QE3 until the Tea Party can see the eye-whites of deflation. Six-month PCE inflation was 2.9pc in August, 2.4pc in September, 1.6pc in October, and 1.2pc in November. Not there yet. Prepare for a Wall Street squall first. Whether the scare of early 2012 turns seriously ugly depends on the nerve of policy-makers. Shock absorbers are worn thin, but not exhausted. Central banks have the means to prevent a 1930s outcome, even with rates at zero, if willing to deploy Fisher-Friedman monetary stimulus with conviction, buying assets from non-banks and targeting nominal GDP growth of 5pc. But policy defeatism is in the air, and Austro-liquidationists are winning the popular debate.
The second leg of our Kondratieff Winter comes at an awful moment for Euroland, just as the North-South split turns deadly. The European Central Bank has guaranteed trouble by letting M3 money contract. Fiscal tightening into the downward slide will make matters worse. A credit crunch as banks shrink loan books by €1 trillion to meet capital ratios will do the rest. All policy levers are set on deep recession, and deep recession is what Europe will get. Monetary union is too damaged to parry these blows. The ECB's Mario Draghi will cut interest rates to 0.5pc by February, just to keep pace with passive tightening. Half-hearted purchases of Italian and Spanish bonds will drift on, doing more harm than good. By reducing existing bond-holders to junior status, the ECB will ensure a slow exodus. Draghi knows this. His hands are tied.
The Bundesbank will wage guerrilla war against money printing through the pages of Die Welt and Handelsblatt, paralyzing the ECB's Council until Angela Merkel orders Jens Weidmann to desist. By then it will be too late, deliberately so. Contraction will play havoc with budgets in Italy, Spain, Portugal, and France. Austerity alone will seem a Sisyphean task. Club Med leaders will not be able to command popular assent for such 1930s scorched-earth strategies.
Politics will fracture further, splintering to the hard Left and Right. The Front National's Marie Le Pen's will beat Maréchal Sarkozy into the French run-off invoking 'terroir' and the ancient franc. Escalating levels of coercion will be needed to uphold the Project, with EU commissars eating alone in the administered territories of Greece and Italy.
Far from protecting credit ratings, Europe's self-defeating policies will bring a blizzard of downgrades. France's AAA will go, obviously. So will Austria's as banking woes deepen in Hungary, Ukraine, and Croatia. Vigilantes will take a closer look at Holland's household debt, off the charts at 270pc of disposable income. The shrinking AAA core will leave Germany propping up the EFSF bail-out fund, until the weight of contingent liabilities endangers Germany itself. That will concentrate minds. France's President Hollande will "triangulate", playing the pan-Latin card to discomfit Berlin and force a policy change. Portugal's Troika sacrifices will prove as futile as Greek efforts before. Lisbon's second bail-out will come just as Greece graduates from riots to insurrection, and Italy's Silvio Berlusconi will try to snatch power again by whipping up fury against Tedeschi. Bundestag patience will snap at such disorder everywhere.
Germany will not be able to fudge EMU any longer. It must either immolate itself, accepting a debt union and internal inflation to save a currency it never wanted and doesn't love; or opt instead to uphold fiscal sovereignty and the essence of its own democracy, and let the Project die. The shrewd, equivocating, ice-cold Chancellor will quietly oust arch-europhile Wolfgang Schauble and let the Project die, always pretending otherwise. Just an idle hunch. Guten Rutsch.