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How to restore prosperity
April 30, 2012

Untitled Document

2008 was the beginning of a series of economic events – the financial crisis in the US, the Irish crisis in 2009, followed by Greece, Portugal, Spain and Italy – that introduced the question of how to restore prosperity. Until recently, the European leaders thought that they had the answer to the problem: austerity. Austerity, prescribed by the IMF and EU, would restore confidence, thus economic growth would follow. Austerity was a requirement to receive emergency funds from the IMF.

Four years later, it has been proved that austerity hasn’t worked: far from restoring prosperity, it undermined economic growth and contributed to further deteriorating the fiscal situation of the several countries that implemented the IMF recipe. The unemployment rate is one of several indicators that prove my point: in Ireland the unemployment in 2009 was 13%, and now is 15%. In Greece, unemployment grew from 17.3% to 21.8%, in Italy it raised from 7.0% to 9.3%, and in Spain it is now almost 24%, meaning 1/4 of the population. This list could increase. Interestingly enough, two countries that didn’t quite follow the austerity recipe saw decreasing unemployment rates; Brazil and the USA. In the US, despite the political gridlock, austerity was not implemented. The measures approved by President Obama in the beginning of his term, when the democrats had the majority in the House, lessened the recession, and maybe even avoided a depression. The stimulus, however small it may have been, contributed toward the decrease of the unemployment rate from 9.9% to 8.2%. In Brazil, unemployment fell from 6.85% to 6.2%.

Suddenly, the conversation changed over the last few weeks. There are now talks of changing strategies and it seems urgent to revert the vicious cycle of unemployment and recession. The Dutch Prime Minister had to resign after failing to pass more austerity measures and it is quite possible that next week, the French will elect a socialist as their President. We don’t know what Hollande is going to do as President, which reminds me of when President Lula was about to win the election in Brazil and the “market” panicked. After Lula took office, however, his views and posture altered. That might also happen to Hollande, but I still do not believe that he will endorse austerity.

The change on the “mantra” of austerity coincided with the deterioration of the economy in Spain, which now occupies center stage. Greece is already history and the Spanish economy is four times bigger than Greece’s. We can see a divergence between the views of the IMF and the EU leaders (meaning the Germans). Despite Mario Draghi’s worried statements about the situation, the ECB is paralyzed once more. Now would be the time to decrease interest rates, and to inject money into the Spanish banks. We have a repeat of 2011 – a lot of talk and very little action. In the meantime, the circumstances only worsen.

Last week in the USA there was fight called the battle of the beards, involving Ben Bernanke and Paul Krugman. While Bernanke keeps repeating that the FED is and will remain on standby mode, Krugman advocates for more QE, even if that means more inflation, in order to further stimulate the economy.

In the US, the presidential election looks like a dead tie. The messages of the candidates are vague. Obama‘s message is “let’s do what we have being doing and everything will be fine”. Romney says, “l will do something else better and everything will be fine”. Fuzzy…. Romney has a couple of tasks ahead such as presenting a more detailed plan and choosing his running mate. After the release of the HBO movie Game Change, which showed how Sarah Palin was picked to run for VP and what a mistake it was, this decision will be even harder. Many things will happen until November but regardless of who wins the election, there will be a fiscal drag in 2013. The vote to increase the debt ceiling carried a provision that will cut expenses automatically starting in January, less than 8 months away. Last week, the GDP numbers reminded us of the importance of government expenses: the American economy growth rate slowed from 3% to 2.2% in the last quarter, mainly due to the decrease on the participation of the government.

The truth is, the political uncertainty in Europe and the USA will impact the financial market. Since February, there was a return of volatility to the markets. The Dow Jones, which was having a great ride since the beginning of the year, is now stalled. The economic data in the US is mixed, with some positive and some negative news. The jobless claims numbers are lower but the pending home sales are higher, reaching a peak in the last 2 years. We started the earnings season with fears and concerns that bad news would add to the European problems and would lead to a fall in the Dow Jones. That didn’t happen. Though it is still early in the season, the results are 7.3% greater than those of the last trimester. There are too many uncertainties in the air, however, to avoid volatility. As I said earlier, risk management is crucial.

We are in May and are now having unexpected cold weather that made me retrieve my coats from the storage. In the market, we are having a pull back – not so unexpected, but rather a gentle reminder that problems have not been solved in Europe, and God knows what the elections will bring in the US. More importantly, I don’t see a clear path to restoring economic growth.

 

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