Who Dealt This Mess Anyway?

November 19, 2014

In this second decade of the 21st century, it is increasingly difficult to pull together a cogent market story.  Part of the problem is the senseless path that world geopolitics seems to be taking.  History documents crises that were more costly than present-day disturbances, but there is a global element to present day dangers that make the label apocalypse fit better than ever before.  Climate change challenges life as we know it in way that man has never encountered before, and the past propensity is absent for exceptional political leaders to arise when history most required such. 

Depending on one’s point of view, human emotion has been either removed largely from currency value determination, or amplified greatly in this digital age.  A bulk of currency trading decisions are now relegated to machines.  When unexpected news happens, there’s less scope for a nuanced human reaction taking into account a range of interpretations about most likely implications.  The currency market-rigging scandal suggests a different kind of disconnection between how currency values ought to move and how they in fact are behaving.

Japan, Germany, the United States, Russia and China are in profound transitions with elements of irony and disbelief.  Much like former French President Sarkozy, Japanese Prime Minister Abe has been compulsively provocative in just about every phase of what he does, catching allies and opponents offguard.  In his two-year stewardship, Japan’s fiscal deficit swelled to 240% of GDP, growth remained on a boom-bust treadmill, and progress has now stalled toward eradicating deflation.  The trade balance remains in deficit despite a plunge of around 35% in the yen.  Abe has irritated China and the United States.  He has been too timid about implementing crucial reforms of the labor market and other areas that need deregulation, and now differences have emerged between his vision and that of his hand-picked monetary policy team over matters concerning fiscal policy.  Nonetheless, Abe should emerge from next month’s elections with a new mandate because his political opposition is even more discombobulated than the LDP.

German officials and businessmen preach smugly to fellow Europeans the truth as they see it.  It’s a recipe to enslave the rest of the euro area to a much weaker standard of living than they deserve or would now enjoy if they had retained their own currencies and independent monetary policies.  If the European Currency Union is to survive, German policy thinking will need an epiphany not unlike that of Ebenezer Scrooge, and I doubt that such will ever happen.  A break-up of the euro remains a substantial threat, but it’s timing is deeply unknown.  The point has long ago been passed when the only thing holding the union together is the feared cost of breaking it apart.

The apparatus of democracy in the United States is broken.  Politicians needs to work to solve problems that must be addressed, one way or another.  The fault lines between red and blue states are hardly new.  Irreconcilable differences in the 19th century were settled by the nation’s costliest war.  The legacy of that conflict’s beaten side now has momentum on its side in dictating the direction in American values, priorities, and misguided notions about what works and what doesn’t.  Infrastructure is being neglected, and most of the citizenry is being left behind.  A parade of sexy apps continues to march briskly by, but productivity has been growing more slowly since an initial post-recession spurt.  The United States has a history of bouncing back strongly from developmental lulls, but these turns for the better didn’t just happen.  Decisions being implemented now are making the a return to grander times  less plausible.

Russia is led by popular yet delusional leader.  Countries in similar situations invariably experience an unhappy ending.  Regrettably, the pain is rarely limited to the country most affected.  Russia’s in a position to inflict a lot of damage in a world that has enough problems without this one, too.

From so many vantage points, China is too big to fail safely.  The autocratic path favored in the world’s second largest economy has not succeeded in earlier centuries, which doesn’t mean that such a strategy will not prove optimal in the future.  So much else has changed.  China’s swaggering competitiveness in foreign and economic policy reveals resentment over its treatment by other countries in the past and little empathy for the rest of the world as it now endeavors to increase its worldly influence.  China faces slower economic growth that may be hard to manage and could prove dangerously combustible.

Traditional economic fundamentals continue to favor an appreciating dollar.  Economic growth remains stronger in the United States than in much of Europe and Japan.  Emerging economies, which bailed out the global economy in 2009, have fallen on harder times in many cases.  Interest rate differentials will be making U.S. assets more attractive.  The first oil price shock in 1973-74 coincided with the shift from fixed dollar exchange rates to flexible ones, and with a few notable exceptions, the dollar trended lower and oil prices became more expensive in the new global monetary environment.  In one departure from that pattern in the latter 1990s, however, oil prices slumped to a monthly average of $10.87 per barrel of WTI crude in December 1998, and the dollar was well-bid over a multiple of years.  Current excess supply of fossil fuel suggest that energy will become even cheaper.  Intuitively, that also supports a period of prolonged dollar good fortune.  But so what?  The broader context of a world stumbling from crisis to crisis makes the resulting implications on the dollar outlook appear rather inconsequential.

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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