Volume 63, Number 4
A global move away from austerity appears underway as voters and economies react to the policies of the past several quarters. In the US, we see a slightly better tilt to the data – particularly on consumer lending – which should sustain growth in our economy moderately stronger than a year ago despite weaker performances around the world. Moreover, a steady drumbeat of concern about the fiscal cliff is at least pricing the risk of that catastrophe into markets and stimulating some thought on how to avoid its full brunt. So far my view on US political moves remains damning with faint praise, but a new round of stop gap extensions is more likely than disaster on January 1st. In China, the much weaker than expected round of just released April data has spurred another 50 basis point reduction in the reserve requirement. We expect several more to come as the Chinese stimulate credit to small and medium businesses and perhaps let off the brake a touch on real estate development in response to soft growth. But it is in Europe that the biggest developments are brewing as the political map is being redrawn leading to reassessments of existing policies and promises by key players in the North and South.
Politicians rarely listen to each other anymore, but they do still listen to the voters. A series of elections across Europe has sent the clear message that austerity is not working for the majority of voters. In four elections held this past week – in Greece, France, Germany and the UK – power shifted away from the conservative/right led governments to the left. In France, Francois Hollande became the first Socialist Prime Minister elected since Francois Mitterrand ruled from 1981 to 1995. In Greece, a coalition of radical left parties, Syriza, unexpectedly finished second. In Germany, Merkel’s Christian Democrats had their worst showing in Schleswig-Holstein in over 50 years and her coalition partner, the Free Democrats, was routed in local elections costing the conservatives the majority. In the UK, Labor had a strong showing in local elections. And, as the commercials say, that’s not all. Earlier, in Romania, a conservative government lost a no confidence vote and was replaced, while in the Czech Republic a conservative government barely survived a similar vote.
It is not just the shift to the left that is weighing on politicians minds. Angry voters tended to polarize as they moved to throw the bums out everywhere. In Greece and France far right groups like the Golden Dawn and National Front gained power. In the UK, the anti-Euro Independence party picked up votes. However, the greatest losses were among the center-right coalition partners. Greece’s ruling New Democrat Party only defeated Syriza by 2% with their former Socialist coalition partner PASOK dropping to third. No party polled over 20%, but the New Democrats benefitted from a Greek rule which gives the winning party 50 additional seats in the 300 seat parliament. Polls suggest Syriza would come in first in new elections – which are likely next month if the President fails in his last ditch efforts to form a unity government. In Germany and the UK, it was not the ruling right wing parties (Tories and CDU) that suffered as much as their more left leaning coalition partners (Liberal Democrats and FDP). One can think of what happened as an increased polarization in both directions from a conservative base. Nor is the US immune to this process, as seen in the loss of Indiana Senator Luger to the Tea Party backed candidate, Mourdock.
For the Euro zone, our most immediate conclusion is diametrically opposed to what we see in the press. Rather than increasing the risk that Greece or any other country leaves the Euro, we see the backlash of the voters as a greater assurance that policy will be adjusted such that no one leaves the Euro – though many will wish some had. In Greece, which is closest to the fire, even the leftist coalition Syriza is dedicated to remaining in the Euro – they just want the austerity to stop. Germany (and others) are already talking tough, but the reality is Greece is in the better bargaining position. They need less European aid now because they have already received so much. If they don’t receive enough aid (most of which foes to pay interest on the debt) and can’t pay their workers it may mean more immediate pain, but the outlook is pretty grim under austerity anyway. A default while remaining inside the Euro is a reasonable option, and one they can hold over the head of their lenders. The European Constitution does not have a procedure for kicking anyone out of the Euro. Clearly that was bad planning, but it makes Greece’s desire to remain within the protected economic zone while reducing its interest payments and debts easier to achieve.
The votes of no confidence in Romania (passed) and the Czech Republic (failed) are also illustrative of the continental support for the Euro. Both countries were following strict austerity programs specifically so that they could qualify for entry into the Euro. Both could have followed the consensus prescription for Greece and simply devalued by 25% after defaulting on Euro based debts, clearing the decks like Sweden did years ago (twice) and the UK tried in 2008. Rather, the Czech’s stuck with their austerity government, although there is a Presidential election coming next year which may alter the political picture. The new Romanian government has already secured IMF approval to hike wages after earlier strong austerity put them ahead of schedule on deficit reduction. Bottom line, being further left politically does not mean anti-Euro, indeed it may be more pro-Euro as these groups embrace the subsidies and supports implicit in the European government system. It is specifically the ability of small countries to impose these costs on the narrow base of winners – Germany and Finland – that so distresses those nation’s politicians. Bottom line, the disgruntled winners are more likely than the losers to seek an exit – and not likely once they consider the repercussions on their exports from significantly strengthening currencies.
For those still in positions of policy making power, the voice of the voters is likely to lead to a reassessment of how fast deficits need to be reduced and who should bear the burden of the adjustment. Hollande will surely challenge some of the earlier commitments of Sarkozy, but not until after he consolidates his victory in parliamentary elections next month. With France and Greece both back in the election cycle, expect lots more anti-austerity talk. Merkel faces another test this weekend in North Rhineland-Westphalia. While she and Finance Minister Schauble are talking tough, the Bundesbank has already offered that inflation should be higher in Germany if one is looking at the European average as the guidance goal. Spain and Italy – regardless of who is in charge — are likely to want to tone down austerity as well. Politics is a trend business and it is unlikely the recent tide will be turned in just one month. Ultimately, the purpose of democracy – however sloppy – is to reveal a consensus on which way the public wants to march and then politicians design policies to achieve those goals. In Europe, the new direction is toward less austerity – and whatever else that brings along with it.
China’s Switches Back On
We have often compared Chinese monetary policy to a child driving an electric golf cart. There are only two speeds – on and off – and the driver lurches from one potential calamity to another due to overcorrection. Over the past year, China has been attempting to dampen the consequences of the massive stimulus unleashed in early 2009. That policy saved China from the global Lehman collapse, but unleashed high general inflation – led by very high inflation in real estate and food. The backlash against property development has crushed the construction markets and many related businesses, while the solution to food inflation has been to drive more of income growth down to the common man, exacerbating the demand for agricultural products. New policies are being adopted to address these overcorrections, with increased corn imports likely this year to help settle food issues and the easing of credit restrictions designed to generate growth in new areas to offset the development bust. We do not think the policies are simply designed to return to the good, old days. China realizes it must stimulate small and medium businesses and consumer spending, not more infrastructure and high end apartments.
The most recent data suggest that the slowdown in real estate development has had a profound impact on overall growth in the country. Real estate development in the fixed asset investment data fell to an 18.7% year on year growth rate in April from 23.5% in March. Given that eleven of the twelve months are the same data and we find no denominatoritis (problems with the year ago base) this implies substantial month on month weakness – as building activity which would normally ramp up in April did not. This is consistent with the weak credit numbers in January and February, leading to a late swelling of credit in March as the authorities reacted. It also explains the weak trade data, as raw materials imports for construction supplies production were also depressed. Finally, our closely watched electricity production measure collapsed from an already low 7.2% year on year gain in March to 0.7% in April. As most electricity in China is used in manufacturing – especially of high energy demand materials like aluminum and cement – this is consistent with the plunge in industrial production from an 11.9% year on year gain in March to just 9.3% in April. Bottom line, we feel we can trace a substantial part of the soft Chinese data in April to a miserable start to the year for the construction industry – which is precisely what the government was aiming for.
Now the pertinent question for the Chinese economy is whether a 9.3% growth rate in industrial production — with much less construction activity — is good or bad for the economy. If, as we suspect, much of the excess construction activity was both inflationary and primarily lined the pockets of the wealthy, than its disappearance would be a benefit for the overall economy. One can hardly argue that a 9% growth rate in factory output is too low. PPI is now negative as materials prices are correcting from inflated levels. If the drop in energy production is because aluminum and cement plants are offline, then the brownouts expected this summer are less likely to occur. Bottom line, correcting an inefficient use of scarce resources is disruptive in the short run but beneficial to longer run growth. China is doing with construction precisely what the US is doing with government spending – paying a short term price in the form of weaker than expected economic growth to get the long term trend back on a sustainable path. We should all be commended.