Wednesday, May 16, 2012

Economic Commentary: A political and possibly a monetary turning point


   The big news of the last few weeks has been out of Europe.   For the past 4 years we've had loose monetary and fiscal policy in the US and relatively tight monetary and fiscal policy in Europe.  I believe that is about to switch.  Now is a good time to identify attractive European equities and European assets that will benefit from increased spending in the near future.
- France just elected the Socialist Francois Hollande; I think he's a moderate at heart but will reverse the relatively extreme austerity that Sarkozy was championing.
- In the past week, Greece roiled markets as voters gave support to parties that are declaring all debt agreements void.
- The unsustainable debt and unemployment situations in Spain and Italy have led to increasing bond yields and growing concern, highlighted by a major bank bailout in Spain announced last week.
- Germany's bundesbank may finally be throwing in the towel on inflation and we may get another major money printing operation from the ECB soon.

  First on Hollande - the markets view him as a big question mark. He's advocating "growth" policies as opposed to Sarkozy's austerity, but no one knows the specifics.  My own take is that Hollande is really a moderate and will not make any radical changes.  Analysts are suggesting that his election and that of Greece mark a political turning point.  Voters are rejecting austerity programs that are ostensibly in the service of foreign debt holders.  However, France has no printing press.  Hollande can increase government spending, but I doubt this will have much of an impact.  French banks have little in the way of excess reserves, so just about every euro that Hollande spends will effectively cause a decrease in private sector spending of a similar amount since banks will have to buy the additional sovereign debt instead of lending; in contrast, banks in the US have lots of cash sitting under the mattress so an increase in government spending would likely increase total consumption.  Hollande might want to be profligate, but in the short-term it won't matter since France's total consumption will change little.  The key is the pressure Hollande is likely to put on the ECB to print Euros.  More on this shortly.
    I don't know what will happen with Greece, but at this point if they leave the Eurozone or default on the bulk of their debt it will be neither shocking nor particularly important to global markets.  Greece's stock market is down 90% from its highs and much of their sovereign debt has already been written off by investors.  The focus is rightly on Spain.
    Last week the Bank of Spain announced a partial nationalization of the large institution "Bankia."  The announcement included a rough outline for a plan requiring all Spanish banks to set aside more reserves, which will further reduce lending to the private sector.  I've said it before and I'll say it again - austerity has never succeeded in getting a country out of a deflationary recession in the history of the world.  Spain will either slide into crisis, or the EU will have to embark on a radical change in direction with a money printing scheme.  With Spanish youth unemployment at 55%, I'll be surprised if we don't see major social turmoil in the next year. 
    The ECB created a trillion euros as part of the ongoing peripheral Eurozone bailout...and it's clear that was no where near enough.  Spain needs more money ASAP and France will likely be demanding easing soon.  Murmurings from Germany's bundesbank suggest they will soon give in and allow further monetization of the sovereign debt.  Back in 2008, the US Federal Reserve doubled the money supply and yet deflationary forces were stronger than the money printing.  I don't know which force will prevail in the coming year in Europe, but the looser monetary policy will likely generate a bid in real assets.  I continue to favor energy commodities and related equities.  

    My positions are unchanged - very small short euro position, short yen, I'm continuing to gradually ease into a long-term short treasury note position, and I'm long energy related equities.  With the exception of the small euro positions, I'm viewing these positions on a 3-10 year time frame.  I want to increase my energy equity investments so if you have any particular ideas or analysis, I'd love to see it.  I also want to invest in European assets - they're incredibly unpopular and the wave of fiscal and monetary easing will provide a tailwind - and would appreciate suggestions.


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