Everyone hopes balancing austerity with growth can save the Eurozone. What if that would be true?
Greece may be just a first example of the chaos to come
Just to be clear, the people in Greece can riot a bit more and seek a violent outlet for their austerity anguish, because they know that leaders in Europe’s largest economies will do anything in their power to keep the Eurozone in tact. German cancellor Merkel’s meeting with newly elected French President Hollande last Tuesday moved the focus from austerity to sustainable growth as the direction to go. Eurozone President Barroso declared today: “We are doing a root-and-branch reform of our budgetary and economic policies,” he said. “And, beyond the so-called ‘sound and fury’, we are making good progress in laying firm foundations for strong economic recovery and sustainable growth.”
And the G8 meeting this weekend at Camp David is looking to sugarcoat realities with softer stances and words. And Tiny Tim Geithner is applauding the whole charade as if economic recovery were a matter of goodwill, decency and government sponsored public works projects.
All the while Obama is sitting between a rock and a hard place in this election year. If the Eurozone tanks, the US economy will face a severe setback, even before voters cast their preference in November.
But for argument’s sake let’s assume for a minute that Europe will avoid the meltdown and actually move towards a slow recovery. Then what?
Well, since none of the fundamentals of why the global economy almost imploded in 2008 have really been tackled or corrected, let’s play along with the economic scenario many market participants are hoping for: a calmer Europe.
A Calmer Europe?
If the “old country”” does recover, will we be able to put on the party hats and celebrate? Well, not really. Sure, the pressure on equities would ease up, causing a brief rise in the market. But then what? Are we really out of the woods, entering a rose garden?
If Europe escapes this mess without a major crisis, it’s only because leaders are just kicking an already deflated ball yet a bit further down the road. Besides it should also be clear that those PIIGS countries won’t come back at a promising pace. The path to economic recovery will still be a long slow crawl. Too long for constituents to be happy about.
Also, China continues to have growing pains of its own. What started as talk of a Chinese slowdown is now turning into real – and worrisome numbers. Sure, China isn’t doing horribly, but it’s hardly the hot market of a few years ago. It’s also clear that economically the country has now entered fascism as its economic model, while still trying to hold on to the communist principles. It’s clear however, the promise of never-ending growth with minimal risk just isn’t materializing.
Then there are other top tier players with mixed performances. With commodity prices cooling a bit, Brazil’s GDP growth is projected at 3.2% in 2012, just a slight improvement from last year’s 2.7% growth. However, only a few years ago, predicting double-digit growth rates would have drawn no laughter, based on Brazil’s impressive 7.5% growth rate in 2010.
And yes, then there’s the US story. The job market is “recovering” at a snail’s pace. If the euro crisis ends, it won’t mean a burst of growth for the US – instead it could mean some additional headwinds. US Treasuries will no longer be shielded by buyers protecting themselves from the worst-case scenario. As soon as the storm clouds over Europe clear even a bit to a drizzle, Treasury investors will leave in droves, either flooding back into equity markets or higher-yielding euro countries.
And then Fed Chairman Bernanke will once again find the ball in his court, resulting in two barriers for the US economy. First, US interest rates will feel strong upward pressure and The Fed will have to pump yet more money into the system to keep the rates low as promised. And second, the US dollar will tank again. The EUR/USD exchange rate has essentially been a risk-on/risk-off trade for the past six months. Like a jojo in heat we have witnessed the games that are played and at the slightest bad news in Europe, the US dollar gets a little stronger. Then over the next few days, as nothing critical happens, the euro starts to creep back up. If Europe turns into a real recovery, the dollar will slide from the current $1.30 EUR/USD to last summer’s $1.45 EUR/USD in no time at all.
Remember, the dollar isn’t strong. After the Federal Reserve’s monetary policy of the last few years, the USD has been ravaged. It has only managed to stay afloat as a result of Europe’s underperformance and other problems. If those pressures let up and the Eurozone again shows promise, the dollar is going straight down. Believe it or not, the European Central Bank is still more responsible than the Federal Reserve… and if investors have an equivalently safe option between the two, many will choose Europe.
So, even if you believe the story of parting clouds ahead, don’t get too excited; this isn’t the end of it. In the best-case scenario, we can stop worrying about Greece and can start worrying instead about a weakening dollar and a sluggish economy. Perhaps that’s better than expecting a crash just around the corner, but all the elements of kicking the can way further down the road are still in full play. It’s certainly no picnic either.
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How can increased austerity in US policy work for anyone but the top 5% (in the short run)? Isn’t it true, that ultimately putting people back to work requires increased dollars and some creative planning? or, would you prefer the status quo?