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Nowhere else to go
April 30, 2013

Untitled Document

When someone tries to assess the economic situation and decide where to invest, a few things are notable. In Europe for instance, countries that we used to think of as being resistant to crisis (e.g. Sweden, Denmark, Finland, England and Germany) are now showing very low economic growth and unemployment above their historical rates. The same applies to the USA and Japan. in Southern Europe unemployment has surpassed the great depression levels. Until last year, hopes for growth were concentrated on the emerging countries. But weak results in Brazil and Russia, and the slowdown in China, has led to some pessimism. All over the world different policies have been used to try to restore prosperity; some lessons should have been learned. The first, as the situation in Europe clearly demonstrates, is that austerity is not a solution. To be sure, the United States economy has been in better shape than others. We should thank Ben Bernanke and the stimulus policy, so criticized by the advocates of austerity. The economy could even be showing a stronger recovery if the “sequester” was not in place. There is more to it: the regulation in the USA is one that gives companies more flexibility to adjust in times of crisis. Another lesson pertains to leadership and the ability to give quick responses to problems and crises. In 2010 and 2011, as a result of the inaction of the ECB, Europe caused nightmares all over the world. It was a change in leadership that allowed a change in policy: the problems were not solved but at least the threat of Armageddon subsided. On the same note, clear signs and directions are necessary to allow the market to function well and the business community to make right decisions. A more important lesson, frequently ignored, is that replacing traditional financing will certainly cause another financial crisis, similar to the one seen in the USA in 2008.

The question is, are our leaders learning from the recent events? I‘d hope so, but I don’t think that is the case. In Europe, years of economic austerity have failed,; the situation simply got worse. Only recently, leaders -mainly in the most affected economies like Spain, Italy and Portugal –have begun to express their doubts. In the USA, the so called sequester, although small as a percentage of the economy, could be considered a deterrent of stronger growth. Still, Congress will not act to change it.

In Brazil, there is a perception that the Government has abandoned the principles that provided growth and price stabilization in the last two decades. This has led to a loss of credibility: the “market” doesn’t believe there is a real commitment to fight inflation. Nobody really knows what the fiscal surplus will be as the government is engaged in a spending spree. The exchange rate is not free anymore and the presidential elections have taken the driver’s seat.

The 2008 crisis has been associated with the burst of the real estate bubble. Bubbles are not a new concept but the way this particular bubble was financed is relatively new. The crisis came more from the fact that all sorts of non-traditional financing instruments were used, and these instruments were not subject to regulation. This so called shadow banking is now responsible- according to estimates – for $67 trillion dollars in financial assets outside the banking system. The shadow banking system’s share of total financial intermediation has decreased since 2007 but is still around 25%, representing arbout half the size of the assets in the banking system. According to the Financial Stability Board, the USA has the largest share of the shadow banking, with assets of $23 trillion in 2011, followed by the euro area ($22 trillion) and the UK ($9 trillion). The USA share has declined since 2005, but other countries are increasing their participation, amongst them Brazil and China. Brazil only holds a small share but the same is not true for China where it has been growing fast. According to Soros, “The rapid growth of shadow banking has some disturbing similarities with the subprime-mortgage market in the U.S. that caused the financial crisis of 2007-2008.” UBS estimates that about $3.35 trillion financing is done by shadow banking in China. Here resides a potential threat to global financial stability.

As an investor, one has to work with different scenarios and consider the different possibilities of those scenarios. One third of global commerce comes from the Euro zone, so recovery would have a positive impact in many countries. If sales to Europe increase, China will need more raw materials, commodities will rise and Brazil will benefit. In Brazil, while first quarter of 2012 showed a surplus in the trade balance of US 2.4 bi, there was a deficit of US$5.2 billion in the first quarter of 2013. In the United States, the first quarter results are showing a growth in earnings but a weak result in revenues for those companies dependent on foreign sales. Consequently, without a change of policy in Europe, recovery in other parts of the world will continue to present moderate growth. There are also other components specific to each country, but the key is the following: moderate growth is different from recession. The US stock market, thanks to the adjustments made by companies and the monetary easing provided by the FED, has gained since 2009. There is volatility of course, but all in all the result is positive, and nothing is telling me that there will be a change of course. Unless (and until) another bubble bursts, it is better to enjoy the ride.

 

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