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Key Variables in the Global Outlook

David Malpass | November 27, 2012

This piece was originally written for Encima Global.

We expect superficial positives in coming weeks including deal-talk in Washington, a disbursement to Greece, a Spanish request for European aid, fewer rocket launches from Gaza into Israel, Fed movement toward QE4, and more monetary easing and infrastructure spending in China.

These developments sound good and might lift the market in the short run. It likes can- kicking, is attractively valued relative to 0% interest rates, and was very happy with the December 2010 Obama-Boehner closed-door deal (each side got all their tax cuts and credits for two years without regard to cost.) However, political developments are making the underlying problems worse and won’t stop the economic deterioration.

  • As Europe is finding, weakening growth also means wider fiscal deficits, compounding the debt problem. Periphery governments won’t downsize. We think Germany is falling into recession with France likely to follow early in 2013.
  • Weighing on U.S. investment, we note a bad tax code, higher taxes starting January 1, massive regulatory and litigation burdens, and Fed policy (which channels the limited ration of capital to the government, big business and gold rather than to job creators.) Capital goods orders fell sharply at mid-year and aren’t expected to have recovered in the October data due out tomorrow. We expect the marginal tax rate on capital gains and dividends to rise substantially on January 1, increasing the cost of equity capital and further reducing capital investments.

Some indicators are contributing to a sense of near-term stabilization:

  • We expect U.S. third quarter GDP to be revised well above the initial 2% reading (to 2.5%-3% in the November 29 release). Fourth quarter growth will benefit from consumption, housing and hurricane-related spending, with 2% GDP growth possible despite the weakness in business investment (which will hurt 2013 growth).
  • PMI data from China gave more signs that the economy has bottomed, with the November 21 HSBC reading at 50.4 for November after bottoming at 47.6 in August.
  • PMI data from Europe showed the recession continuing, but suggested that France and Germany, while sluggish, are not yet in freefall.
  • The Nikkei hit a six-month high on November 26 on the expectation that Liberal Democratic Party President Shinzo Abe will retake Japan’s prime ministership in the December 16 election on the theme that “we’ll restore Japan.” He was prime minister for a year in 2006-2007. His platform includes an expansion of government spending programs and asset purchases by the Bank of Japan in 2013. We don’t think these will work, leaving Japan with structural, tax and currency barriers to faster growth. While the yen has weakened and equities strengthened since November 14 due to the prospect of BOJ QE (including initial hopes that it might purchase infrastructure bonds), Japan hasn’t put a clear ceiling on the yen (as the Swiss have done). Japan’s previous QE didn’t stop yen strength in the 2000s, and BOJ Governor Masaaki Shirakawa has vocally opposed QE citing ample evidence that it doesn’t work and is pushing on a string. We think Japan is falling into recession and Abe doesn’t have a program that will stop it.

The growth outlook remains weak under current policies. It is unlikely that the key growth steps listed below will be taken:

  1. Will the fiscal deal lay the groundwork for tax reform, a budget or spending restraint in 2013? Most of the likely lameduck outcomes harm spending restraint by adding substantially to the deficit and harm tax reform by using up important revenue raisers to fund lameduck spending.
  2. Will Europe’s can-kicking for Greece cause a growth-oriented downsizing of any of Europe’s many levels of government? The November 22 New York Times reported on 43,000 bottles of wine stockpiled by the European Union in Brussels for the endless summits. We’ve documented the inability of politicians in Greece, Spain and Italy to downsize their benefits, sell assets or reduce their control over their economies. See my Dec 16, 2011 WSJ article entitled “And the Crisis Winner Is Government” explaining how Europe’s governments are using the opportunity from the debt crisis to expand rapidly and the May 23, 2012 WSJ article entitled “Greece’s False Austerity” explaining how the Greek government hasn’t downsized at all or sold its asset but is instead blocking growth by imposing new taxes and mandates on the private sector to satisfy IMF and German austerity conditions.
  3. When will China accelerate its monetary and credit easing and will it improve the government-dominated capital allocation process?
  4. Will the Fed couple its balance sheet expansion with a policy to encourage private sector credit expansion? Speaking of the pendulum swing in credit standards, Chairman Bernanke’s November 15 speech to the Global Financial Dignity Summit said: “it seems likely at this point that the pendulum has swung too far the other way, and that overly tight lending standards may now be preventing creditworthy borrowers from buying homes...” His November 20 speech to the Economic Club of New York made very clear that he was talking only about mortgages, not lending in general: “While some tightening of the terms of mortgage credit was certainly an appropriate response to the earlier excesses, the pendulum appears to have swung too far, restraining the pace of recovery in the housing sector.”

We think the answer to all these steps is “unlikely”, pointing to a recession in 2013.


David Malpass is President of Encima Global and Chairman of’s Stop the Fed campaign.

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