Friday, November 28, 2014

The Uptick’s Downside

RIO DE JANEIRO – Since late last year, a series of positive developments has boosted investor confidence and led to a sharp rally in risky assets, starting with global equities and commodities. Macroeconomic data from the United States improved; blue-chip companies in advanced economies remained highly profitable; China and emerging markets slowed only moderately; and the risk of a disorderly default and/or exit by some members of the eurozone declined.

Moreover, under its new president, Mario Draghi, the European Central Bank appears willing to do anything necessary to reduce stress on the eurozone’s banking system and governments, as well as to lower interest rates. Central banks in both advanced and emerging economies have provided massive injections of liquidity. Volatility is down, confidence is up, and risk aversion is much lower – for now.

But at least four downside risks are likely to materialize this year, undermining global growth and eventually negatively affecting investor confidence and market valuations of risky assets.

First, the eurozone is in deep recession, especially in the periphery, but now also in the core economies, as the latest data show an output contraction in Germany and France. The credit crunch in the banking system is becoming more severe as banks deleverage by selling assets and rationing credit, exacerbating the downturn.

Meanwhile, not only is fiscal austerity pushing the eurozone periphery into economic free-fall, but the loss of competitiveness there will persist as relief at the waning prospect of disorderly defaults strengthens the euro’s value. To restore competitiveness and growth in these countries, the euro needs to fall towards parity with the US dollar. And, while the risk of a disorderly Greek collapse is now receding, it will re-emerge this year as political instability, civil unrest, and more fiscal austerity turn the Greek recession into a depression.

Second, there is now evidence of weakening performance in China and the rest of Asia. In China, the economic slowdown underway is unmistakable. Export growth is down sharply, turning negative vis-à-vis the eurozone’s periphery. Import growth, a sign of future exports, has also fallen.

Similarly, Chinese residential investment and commercial real-estate activity are slowing sharply as home prices start to fall. Infrastructure investment is down as well, with many high-speed railway projects on hold and local governments and special-purpose vehicles struggling to obtain financing amid tightening credit conditions and lower revenues from land sales.

Elsewhere in Asia, Singapore’s economy shrank for the second time in three quarters at the end of 2011. India’s government predicts 6.9% annual GDP growth in 2012, which would be the lowest rate since 2009. Taiwan’s economy fell into a technical recession in the fourth quarter of 2011. South Korea’s economy grew at a mere 0.4% in the same period – the slowest pace in two years – while Japan’s GDP contracted at a larger-than-expected 2.3%, as the yen’s strength weighed down exports.

Third, while US data have been surprisingly encouraging, America’s growth momentum appears to be peaking. Fiscal tightening will escalate in 2012 and 2013, contributing to a slowdown, as will the expiration of tax benefits that boosted capital spending in 2011. Moreover, given continuing malaise in credit and housing markets, private consumption will remain subdued; indeed, two percentage points of the 2.8% expansion in the last quarter of 2011 reflected rising inventories rather than final sales. And, as for external demand, the generally strong dollar, together with the global and eurozone slowdown, will weaken US exports, while still-elevated oil prices will increase the energy import bill, further impeding growth.

Finally, geopolitical risks in the Middle East are rising, owing to the possibility of an Israeli military response to Iran’s nuclear ambitions. While the risk of armed conflict remains low, the current war of words is escalating, as is the covert war in which Israel and the US are engaged with Iran; and now Iran is lashing back with terrorist attacks against Israeli diplomats. The Islamic Republic, with its back to the wall as sanctions bite, could also react by sinking a few ships to block the Strait of Hormuz, or by unleashing its proxies in the region – the pro-Iranian Shia in Iraq, Bahrain, Kuwait, and Saudi Arabia, as well as Hezbollah in Lebanon and Hamas in Gaza.

Moreover, there are broader geopolitical tensions in the Middle East that will not ease – and that might intensify. The Arab Spring has produced a relatively favorable outcome in Tunisia, where it started, but developments in Egypt, Libya, and Yemen remain far more uncertain, while Syria is on the brink of civil war. In addition, there are substantial concerns about political stability in Bahrain and Saudi Arabia’s oil-rich Eastern Province, and potentially even in Kuwait and Jordan – all areas with substantial Shia or other restless populations.

Beyond the countries affected by the Arab Spring, rising tensions between Shia, Kurdish, and Sunni factions in Iraq since the US withdrawal do not bode well for a boost in oil production. There is also the ongoing conflict between the Israelis and the Palestinians, as well as strains between Israel and Turkey.

In other words, there are many things that could go wrong in the Middle East, any combination of which might stoke fear in markets and lead to much higher oil prices. Despite weak economic growth in advanced economies and a slowdown in many emerging markets, oil is already at around $100 per barrel. But the fear premium could push it significantly higher, with predictably negative effects on the global economy.

With so many risks in so many places, investors, not surprisingly, will eventually prize liquidity in their portfolios, while shunning riskier fixed assets again when these tail risks materialize. That is yet another reason to believe that the global economy remains far from achieving a balanced and sustainable recovery.

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    1. CommentedJonathan Lam

      Gamesmsith94134: Free-Trade Blinders

      “The experiment is based on somewhat of a false premise, because it speaks to an American audience where the lower class is currently the one facing the most challenges from free trade.”

      Since I do not have the figures to knick around, and I would explain Dani Rodrik’s experiment for its natural scientific reasoning like ones I wrote above my paradigm on the wealth circuitry in economical and social growth that supports and balances both accumulated wealth and consumable wealth; and it created a “Z” shaped financial development running both on the diminishing demand and diminishing return; which is based on the assumption, the route above the standard of living equal in length with the one below the standard of living is in agreement of its living standard to sustain a viable growth; and Societal changes due to the democracy on globalization. In assimilation, the shift of wealth circuitry make the redistribution of wealth from the developed nations, like US, EU, to the emerging market nations like China, India or Brazil. It would show how the wealth circuitry globally settling the living standard inequality to balance itself through the diminishing return as in welfare states or communistic position, and the diminishing demand as in capitalistic position when each maximized it top or bottom setting to its extreme. Since the ladder of growth with those defined the value and price expanded and extended its living standards in either ways, it develops a newer term of demand or supply to shift the advancement of living standard after inflation or deflation.

      Perhaps, it is observable that American turned welfare state that its economy turn anemic with some 1% loaded with wealth and 99% struggle to strive above the living standard that held itself to a diminishing demand. In reverse, the diminishing return states like communistic China benefits its labors after the globalization; their living standard rose after 20% increased salary and so is the demands of goods internally and externally. Now, Asian purchased 50% of the luxury good EU produced. Then, it is how the Capitalist turns communist, and communist turns capitalist; as much of the inequality of the living standard of the two combined to merge, the expansion of the global economy may reverse itself that a cycle of accumulated wealth circuitry is completed and the standard of living is moving with the strength of the frequency of the flow of wealth that is kept in it wealth accumulated circuitry in a long run. Perhaps, it is not “The question of who wins and who loses is always important, but it's not always the educated and wealthy who win in free trade and it's not always the poor who lose in free trade. All those manufacturing jobs going overseas?” as you said when these inequality living standard make the world goes around with globalization and free trade.

      In conclusion, there are deficiencies of both capitalism and communism in handling the accumulated wealth because of the agency and structure in societal developments due to a fact of the productivity model that each bounded to a death end for either a diminishing return or diminishing demand. We may always laugh at the communists for it insufficient supply; but if we understand better of our recession to depression for its lack of demand too. It is not the dogma that kept its economy stood still, but the accumulated wealth makes the world goes around.

      Perhaps, democracy and free trade is the motion of the cash flows in politics for its populace and they do affect nations of wealth globally. To-day, topsy-turvy is the diminishing return and diminishing demand are marginally reversing themselves when the all living standard merging themselves in creating the globalization and democracy setting in motion to make fee trade in balancing the outcome. When I ask why should US dominate the higher profitable in trading the high tech if it aborts its blue collars workers, or did it turn itself into welfare state by giving the rich ones another break? If US is not attempt to make its appropriate living standard for its people in lesser welfare state, the globalization and democracy will downgrade its status as developed nation to underdeveloped whether it will sustain its free trade environment or not. God bless America.

      “But democracies owe themselves a proper debate, so that they make such choices consciously and deliberately. Fetishizing globalization simply because it expands the economic pie is the surest way to delegitimize it in the long run.” Said Dani Rodrik.

      And, may the Buddha bless you too?

    2. CommentedJonathan Lam

      Gamesmith94134: Dr. Doom Warns Wall Street and Washington---- Heed Karl Marx's Warning!
      Mr. Gert van Vugt,

      You make the best description on the theory on the economical growth Paradigm that the economic change seems like Malthusian’s diminishing return, and I agree. However, Mr. Roubini makes his point on the social disruption reverse itself through the diminishing demand. If we can put away the elements like the Ponzi scheme and benefactors in social caused deficiency or defects to growth. Corruption by capitalism and the dependency by socialism among societies both caused failure in the economical and societal development.

      Perhaps, we focus on the circuitry on the accumulation of wealth and consumable wealth that runs the economy. It seems both the capitalism and socialism ran short and proven wrong in the economical model or social model that became self-destructive; eventually, the economy runs from diminishing demand to diminishing return, or vice versa. So, if we use the living standard as the equilibrium position to the supply line of the circuitry of wealth balanced by both of the diminishing return and diminishing demand.

      How about I call my paradigm on the wealth circuitry in economical and social growth that supports and balances both accumulated wealth and consumable wealth; and it created a “Z” shaped development running both on the diminishing demand and diminishing return; which is based on the assumption, the route above the standard of living equal in length with the one below the standard of living is in agreement of its living standard to sustain a viable growth, which contains;

      • The base line as the diminishing return where the societies kept peace with its populace that consumable wealth that cause economical displacement like with its negative growth or no growth; it provides entitlement or social programs with non-productive individual citizens for example, 27% of its population on welfare with add-on with subsidies to sustain a standard of living.

      • The top line as the diminishing demand that ended with accumulated wealth favors of concentrated wealth owned by individuals that ended with profitless, 1% holds 27% of the global or national wealth, plus those with extra wealth is not in production yields to no growth.

      • And the diagonal line that connected to both ends is the support of the price and value in the middle is the standard of living which contains the most of the productive individuals who is moving up and down the ladder of growth.

      If more of the wealth accumulated than the wealth consumed, then it causes saturation of the wealth. The diminishing demand under the standard of living agreement made the demand idle because of the shortage of consumption. In the process, the standard of living will go down to meet its demand after the deflationary measure to make it consumable. In reverse, the wealth consumed is over the wealth accumulated, as it is less profitable. Then, it triggers the inflationary measures to aggregate demand to accumulate more wealth in its diminishing return mode; eventually it will balance itself again with the agreement of the standard living with a viable growth.

      It is not the supply and demand. It is rather the circuitry of wealth under the spells of the lower living standard that diminishing demand is being part of the deflationary measure. If the accumulated wealth became saturated, then it means the lower living standard that made the demand finite like lesser demand in loan of dollars in ECB.
      I am certain I am not being introspective; I may twist the theory a little; but the proof of the lower living standard in Europe made it plausible.

      May the Buddha bless you?

    3. CommentedLuis A. Guerra

      I am not so sure about the growth anymore and further, I have become sceptic about any official data. In turn people like Mr. Biderman here make sense.

    4. CommentedPaul A. Myers

      Roubini has provided an excellent tour de horizon of the many risks facing the world economy. Against this we should state a contrary case to understand the investment potential available to investors. Above all world markets increasingly prize stability. If the world economy has reasonable stability over the next couple of years, investment returns could imaginably be above trend.

      First, problems in the Middle East. There are many but it is quite possible that since there are so many problems crowded into this space that there is a self-canceling dimension to this mare's nest of problems. If there is an oil price spike, buy on the correction? If oil goes up gradually, it moves the world economy towards more efficiency, probably a better thing. Vindicates everyone's alternative energy strategies. Last point for this region, except for the export of oil, the economies of these countries are of almost no statistical significance to the world economy (which is what a lot of the anger is all about).

      Europe is muddling, but one suspects as the year goes on there will be some real action on putting some money into the periphery to get growth going again. The austerity arguments, like a long staying mother-in-law, are wearing out their welcome (and politicians are going to start losing elections because of this; so where reason fails, elections will start to tell).

      The US economy is very strongly grounded in private sector job creation. So like the the tortoise, it may be slow but it will be quite sure at delivering real results. Housing will be a bluebird to the upside--eventually! Obama's reelection is looking like a dead certainty--and this man radiates stability, the tonic needed.

      China and Asia? A valuation problem, I think. Just how large and significant are the nonperforming loans and unproductive investments? No idea. But a 40 percent savings rate buries a lot of mistakes. If the worldwide emerging market countries are going to carry a bigger load for making prosperity happen, then possibly those economies are going to have to gear down and put more horsepower into each percentage point of real growth. So as an investor, are we overpaying today to get into these investments or are we paying a fair price? Don't know. Time to dollar-average-in over the next 24 months, methinks.

      How about those seas of liquidity? Yes, a real problem if eventually the money stays on the table and inflation rises. In that case I think the place to be is as the owner of a worldwide portfolio of productive assets, not a holder of depreciating short-term obligations.

      The productive economies almost everywhere are going to be more powerful than the paper-based governments.

    5. CommentedLuke Ho-Hyung Lee

      I have different views and analysis on the global economy.

      Geometrically progressive market changes have already been made by the rapid growth of synergy software applications over the last 20 to 30 years. Yet, the market results made through the market paradigm (or process) that comprised existing functional market systems could only have produced arithmetical changes.

      As market changes could only be satisfied through the existing functional market paradigm, “a structural gap” has existed in the market. As I show in detail elsewhere [ ], this is the real cause of the economic and social malaise which currently afflicts us.

      I believe the only viable remedy for this structural gap will be by intentionally inducing synergistic (or geometrically progressive) market results in the market paradigm (or process).

      Until then, there will be no balanced and sustainable recovery.