The great recession is turning 6. In September, 2008, I was in Brasilia celebrating the 200 years of the Finance Ministry, when we learned that the republican government of the USA had intervened to avoid the bankruptcy of Fannie Mae and Freddie Mac. The great recession would come to question old dogmas: who could imagine a republican administration intervening in the market to avoid bankruptcy?
Few days later, amongst an inundation of problems with other financial institutions, the same government let Lehmann Brothers file for bankruptcy. On September, 15th 2008, the Dow Jones fell 504 points, or 4.4% and the S&P 500 fell 4.7%. On September, 17th, the Dow Jones fell another 4% after a failed attempt by the FED to receive approval from the American Congress to buy bad debt. I could continue on and on recalling the horrible fall of 2008, where we all thought we were on the verge of another great depression. On March 2009, however, the recovery of the stock market began and a bull market is still in place, almost 6 years later. The world is very different and when one looks to Brazil, USA and Europe, there are valuable lessons to be learned.
Europe had several crises in the meantime, and the problems in Greece, Portugal, Spain, Italy and Ireland were the graver. Not so long ago the very existence and viability of the Euro currency was questioned. It took a change in leadership for the ECB to start promoting liquidity and addressing the problems. On the fiscal side, the austerity policy has prevailed and after 6 years, the European recovery - which looked certain in the spring of 2013 - is at risk. The German and Italian GDP, representing the 2 biggest economies of the region, contracted in the second quarter of 2014 and the GDP of France, the third biggest economy, stagnated.
On the other side of the Atlantic, the British economy showed better results due to the easy monetary policy implemented by the Bank of England combined with a fiscal stimulus. Angela Merkel’s insistence on austerity had not worked and the Keynesians should be happy to prove once more that appropriate fiscal policy is a good response in time of crisis.
Brazil went from a position of favoritism among the emerging countries to a black sheep. For this new role, we have President Dilma to thank for her (bad) interventionist policy. To be sure, nowadays more than 30% of the prices in the economy are controlled, as well as the exchange rate. Petrobras holds the most debt in the sector (debt/equity=84.89). The government spends more, and does so inefficiently. Let’s not confuse the fiscal leniency of this government with the stimulus her antecessor gave to weather the crises in 2008.
The state of the economy in the USA is proof of how monetary and fiscal policy can be combined, in a free market, to promote growth. Having strong and innovative businessmen helps a lot. While the other countries are facing contraction or very slow growth, plus increasing unemployment, the USA has had small but continuous growth and falling unemployment rates. Inflation is low while in Europe there is fear of deflation and in Brazil inflation is increasing. At this point, we should have learned that not all liquidity are equal and necessarily produces inflation; the same applies for public debt.
Within a month, politics will show more clearly what to expect in 2015 in the USA and Brazil. The latter will have presidential elections and once more, fate plays an important role in the country: the sudden and tragic death of Eduardo Campos, leading to Marina Silva’s candidacy for president, has changed the political picture. A month ago, Dilma was seen as the virtual winner, which is not true anymore. Now, Marina seems close to invincible. This is going to be a very competitive election but let’s not forget the advantage the incumbent always have. As I said before, whoever wins will have a difficult task and will have to promote a readjustment of prices and the exchange rate, meaning that the situation will get worse before it gets better. I was not expecting anything good for Brazil in 2014 and I am not expecting much in 2015.
Investors however are piling up Brazilian assets: they were undervalued and at this point the risk of a downside is much smaller than the risk of an upside, because they believe that anything is better than Dilma. I don’t share this view and I will keep my distance from Brazilian assets.
In the USA, there will be congressional elections and if the republicans take control of the Senate, Obama’s final year will be even more difficult than it has been so far. Fortunately for us, the role of the President in determining the direction of the economy in the USA is overrated. More important is what the FED will do and how the markers will react to its actions. To be sure, we all know the bond buying program will end in October. What is now up for question is when will interest rates go up, and how will the market react to the announcement. Once more, close monitoring is the best way to go.
In Europe the decisive factor will be whether there is a change in fiscal policy. In a strong speech at the Jackson Hole meeting Mario Dragui defended more flexible fiscal policies. Will Angela Merkel continue to insist on austerity?
Last week the ECB reduced even more the interest rate from 0.15% to 0.05%, causing further deterioration of the Euro and a positive impact on the financial markets. He also announced an asset backed security purchase program and is now one step away from QE. Here we have another topic that needs a follow-up, meaning the divergent policies of FED and ECB, and the divergence in the two economies.
After the cease-fire between Israelis and Palestinians, as well as the potential cease-fire between Russia and Ukraine, the geo political risks were reduced. The ISIS, however, is a growing threat. The financial market had ignored the political risks so far, which in a way is consistent with the fact that those conflicts are too far away and have no immediate impact in the USA economy. In Europe, however, the situation is different; the conflict is too close to home and there are economic consequences. Russia has responded to the Euro zone sanctions banning imports of beef, pork, vegetables and fruits form the Eurozone. Even if in the short run such bans do not have a big impact, the continuation of sanctions will eventually affect business confidence and decision-making with a negative effect in the euro zone economy that, as of now, is to grow only 1% in 2014.
Once again, the USA is the best place to put your money.