Monday, November 14, 2016

Financial Market Snapshot November 2016

Financial Market Snapshot November 2016

Top Macroeconomic Themes

Trump wins U.S. presidential election
Donald Trump surprises the world as he wins the U.S. presidential race. The candidate of the Republican Party can count on a majority of his party in the Senate and Congress. The polls were wrong again. Uncertainties grow.
The now president-elect promised many drastic measures during his campaign. Yet the expectation that his victory would lead to a sell-off at the stock market did not happen. However, the rise of the interest rate that has been going on recently gained a new momentum.
The major policy measures of Trump’s agenda include the protection of America’s manufacturing sector and massive investment in infrastructure. Both of these items will lead to an increase of the interest rate as they can hardly be realized without a rising price level.
There are also fears that the next president will interfere with the independence of the American central bank. It is unclear how he could manage the deportation of millions of illegal residents as was promised.
Furthermore, despite many formal declarations of both sides, the Democratic opposition will not lightly give in. The dispute between the two major American parties is not free of bitterness and will poison the discourse in years to come. 
There is reason to expect more turmoil.

Profound Changes Ahead
The major concern for the financial the markets will be that the period of falling interest rates is coming to end. The United States will turn more inward and become more protectionist. The role of the United States as the dominant world power is coming to end. This change will first become manifest in the global role of the U.S. dollar.
Many of the ailments of the U.S. economy that were pointed out by Donald Trump in his election campaign are the result of the position of the U.S. dollar as the world’s major reserve currency,
The global role of the U.S. dollar brings with it the temporary advantage that deficits do not matter – neither of the government budget nor of the current account. Because the dollar serves as the major reserve currencies, foreign countries and foreign investors are more than eager to finance these deficits.
The dark side of the story is that absorption exceeds production. With imports cheap and easily to finance, domestic production is exposed to a permanent process of erosion. The structure of the U.S. economy thus has become highly lopsided with the side effect of growing inequality of income and wealth. Such a trend cannot go on forever. In the case that the change is not made in a voluntary way as it is the intention of Trump, it would have come anyway, and in this case by necessity.

Global Scenario
   Macroeconomic policies will change
  The period of expanding debt and extremely low interest rates in the major industrial countries is coming to an end. Rising interest rates are looming. Fiscal crises will become more frequent on an international scale because rising interest rates in the industrialized countries would have a global impact. Such a perspective would imply that it cannot be excluded that the world is moving towards a new international debt crisis. It is not hard to imagine what the combination of higher interest rates and U.S. protectionism would mean for the world economy.
    Protectionism on the rise
   The problem with protectionism is that it does not remain limited to a country but tends to spread even more so when the United States as the world’s largest economy acts as the pioneer of protectionism. Protectionism was already a horrible tendency in the 1920s and 1930s; in the 21st century, protectionism would be fully catastrophic. It remains to be seen whether the insight comes to the U.S. leadership that the international trade imbalances are not the result of free trade but have come about to the United States as the erosion of its manufacturing base because of the role of the American dollar as the international reserve currency.
   New role of the United States
  American isolationism would leave a gigantic vacuum in the world. When a great power recedes from its role as the hegemon, it is common that a host of new contenders will appear. The fight for succession is never peaceful. In the case of the United States as a global hegemon, its demise of this role would put the whole world under the threat of worldwide conflicts.
    Europe must strengthen its position
   As a consequence of U.S. protectionism, Europe must redefine its role in the world. Since the end of Second World War, Europe has prospered under the guidance of the United States. The North Atlantic Treaty Organization (NATO) was the common organizational structure of this system. In so far as the new American administration puts the role of NATO into doubt, Europe must find a new anchor. As of now, the European Union specific defense initiatives have been scanty. This will surely change in the future. An ironic consequence of both the Brexit and the Trump election could thus be a strengthening of the European Union. 

    Emerging Markets Scenario
  Right after the announcement that Donald Trump has gained the U.S. presidential election, the Mexican peso began to fall drastically. The deportation of millions of so-called “illegal immigrants” – most of them Mexicans – was a central part of Trump’s campaign. The incoming president, who will officially be inaugurated on January 20th, 2017, has also announced that he would renegotiate the North American Free Trade Agreement (NAFTA) with Mexico. Should the new president really pursue his announcements, Latin America might reconsider its international economic position and move towards own trade arrangements which might even lead to a strengthening of the MERCOSUL.
  Brazil’s economy is not yet out of the woods. It is not just a cyclical downturn that is happening. The fall of the economic growth rates is rather a symptom of deep-rooted structural distortions. The standing of the present transitory government that came to power after the former president was ousted, is too weak for a forceful structural change. As of now, the activity of new government is limited to install some measures of fiscal restraint. Fiscal adjustment is a necessary but not a sufficient condition for economic recovery.
   China builds a global network
   Irrespective of the political turmoil in American, the ongoing bloody conflict in the Middle East and the refugee crisis that afflicts Europe, China is steadily working on its global trade and investment network – the New Silk Road that extends from Western Europe to South East Asia. The world’s economic center shifts from the West to the East. Step by step, China is extending its sphere of influence and its path to prosperity seems to be unstoppable. Different from many other  take-offs of developing countries, the rise of China is not only based on the mobilization of labor and capital as factors of production but also on a rapid acceleration of its capacity for technological progress.
   A growing part of Africa falls into the sphere of interest of China. Africa’s space and natural resources attract Chinese business interests. Free of the stain of a colonial power, China is welcome in many parts of Africa as the chosen partner of industrial development.

 Antony P. Mueller
November 14, 2016

Tuesday, October 11, 2016

Financial Markets Snapshot October 2016

Global Economic Overview October 2016
Top Macroeconomic Themes
British pound continues to plunge
Preparing her nation for the Brexit, British Prime Minister Teresa May faces a divided Conservative Party.
The British pound suffered a severe “flash crash” when the Prime Minister pushed for a more populist agenda at the Conservative Party’s congress in Birmingham on October 2nd.
With the prospect of even more disunity among the Conservative Party members, the likelihood of a Labour victory in the next Parliamentary election is on the rise.
Labour Party leader Jeremy Corbyn would most likely resurrect the policies of “Old Labour”.
In the meanwhile, members of continental European countries of the European Union close their ranks and will confront Britain’s exit negotiations with strict conditions, most of all that there will be no free British access to the European single market without a free movement of labor.
British banks depend to a large extent on the continental European business and the potential loss for the British finance industry would be enormous if access should be denied.

As of now, new foreign direct investment to the United Kingdom have virtually stopped and foreign resident companies consider moving their business out of the country. 

Dark shadows cloud the world economy
The global economy moves further into unchartered territory. Negative interest rates in the major industrialized countries have created the perverse situation of extreme asset valuations in combination with almost no and even negative yield.
Despite the continuation of massive monetary stimuli, the prospect of higher economic growth rates has diminished. Consequently, the US Federal Reserve has not raised its policy interest rate.
Severe uncertainties come also from politics where neither of the two presidential candidates can count on a solid support among the voters. There is even talk that the candidate of the Republican Party, Donald Trump, should resign from the race. 
There is global debt overhang that will becomes a serious problem if growth should not return.
The current troubles of the Deutsche Bank are symptomatic of the precarious financial situation of global banks. Faced with a huge fine because of illegal market transactions, Deutsche Bank faces a massive fine that could wipe out its capital.
As Deutsche Bank is also very active in the market for derivative financial instruments, a collapse of Deutsche Bank would have global repercussions.

Global Scenario
    Macroeconomic policies hit the wall
    With fiscal policies blocked because of the high public debt levels, and with monetary policies having reached the end of tis capabilities as interest rates have become zero or even negative, macroeconomic policy is paralyzed for the year to come. Likewise, high consumer debt burdens, limit private consumption. The stimulus of low interest rates has little effect on business investment in an environment of generally weak consumer demand
    Germany’s exports power ahead
    After a short phase of weakness, the export performance of the German economy is on the rise again. German products are highly competitive not only because on their traditional quality, but for years now also because of their relatively favorable prices. This is the result that the euro currency is underperforming because of the troubles in the Southern periphery of the euro area. This means that Germany enjoys an undervalued currency. As a result of this imbalance, Germany’ economy is at risk of overextending the export sector of its economy.
    U.S. twin deficits
    While Germany registers a high current account surplus and a government budget surplus, the United States suffers from a persistent current account deficit and rising public debt. There are signs that America is on its way of having to confront a situation of declining willingness and capability of foreign creditors to finance the U.S. deficits. China is reducing its exposure to US financial assets and the oil exporting countries face drastically diminished return because of the falling price of oil
    Expect more troubles to come
    Stock markets in the industrialized countries, particularly in the United States and Germany, have reached extreme valuations – mainly due to the lack of alternative sources of revenue. The risk is rising that some singular event -  for example the collapse of  a major bank -  will provoke a stock market crash. Beyond this possibility, it must be taken almost for granted that global financial markets will suffer severe decline when finally interest should rise. Such an increase of interest rate may actually also happen without a move by the central banks when price inflation returns and nominal market interest adapt accordingly. 

    Emerging Markets Scenarios 
    A hard landing of China?
    China’s debt to gross domestic product is rising fast. At the same time, China’s foreign exchange reserves are falling rapidly. Both trends point to trouble. Rising internal debt comes with mounting non-performing loans that will put China’s banking system at risk. The global effect of a severe domestic financial contraction would in this case come form a fire sale of China’s foreign exchange reserves that still are in the range of three trillion US –dollars.
    Brazil on its way to recovery?
    Brazil’s economy continues to shrink. Industrial production in particular is falling. Unemployment is on the rise. Public finances are in severe conditions, especially at the state level. There is not green light in sight. Foreign demand for Brazilian goods, particularly for commodities, will remain weak, and there is no indication in sight that domestic demand could rise. Additional uncertainty comes from politics where the corruption investigations encompass not only prominent politicians but also major companies
    Venezuela is a lost case -  hopeful signs in Argentina
    Venezuela is moving towards hyperinflation and total economic collapse. The countries neighbors could soon be confronted with a severe refugee crisis.
    The change of government in Argentina has lifted the prospects for this country. Nevertheless, the economic policy errors in the past were so severe that it will take many years before Argentina could again prosper
    No way out for the Middle East
    The Middle East and North Africa are moving ever deeper into war and destruction and have become a hot bed of terrorist. Over the past month, both Russia and the United States have increased their stakes in the region. Russia is still a military superpower and is forming new broad coalitions while America’s NATO allies are increasingly hesitant to join in
    There is hope for Africa
I   In a relatively quite way, an increasing number of countries in the African heartland push forward free market reforms and benefit from foreign direct investment, particularly from China. There seem to  a trend in the making that could surprise many observers in the future. 
    Antony P. Mueller October 10, 2016

Tuesday, September 6, 2016

Financial Market Snapshot September 2016

Global Scenario September 2016


Economic growth remains fragile
Neither the United States nor Japan nor Europe show robust growth. Expectations of a rate hike by the American central bank have receded. The expectation that there will not be an imminent rise in interest rates has given a boost to the stock market, driven bond prices higher and slightly weakened the US-dollar. 

U.S. -employment in ambivalent situation
While the unemployment rate has fallen in the United States, there has also been a deterioration of the overall employment situation as it is shown by the fall in the labor participation rate. This fact reveals that a significant part of the labor force has given up looking for work and is no longer part of the active labor force. This rings the alarm bells for the future in the case that the economy should finally strengthen at some point. Rising wage rates would be the consequence along with a rising price level to follow - leading to the scenario that scope for a strong and broadly based recovery of the US economy will be limited.

Deflation fears plague central banks
Over the past eight years, since the onset of the financial crisis, the major central banks have tried to prevent deflation in a desperate attempt to reflate the economy. Despite a massive policy of quantitative easing, which drove base money to extreme heights, neither inflation nor a vigorous economic rebound has been achieved. It is more an act of despair than a well thought-out strategy when central banks fabricate negative interest rates. While the effect is largely nil for output, financial assets experience a boom that will inevitably end in a bust when monetary policy will change.   

Europe feels the Brexit blues
The shock of the British Brexit vote has given place to a widespread feeling of low mood – not only in Britain but also in the whole European Union (EU). There are fears that other countries may follow the British example and leave the EU. Yet the British move has also shown that leaving the Union is not easy. In fact, the British government has not yet made the decisive move to trigger “article 50”, which would mark the start of the process of separation. Uncertainty about the future of the Union paralyzes the decision-making bodies of the EU at a time when decisive action would be required – from the refugee crisis to the ongoing economic problems of Europe’s Southern periphery.


G20 meets in China
The “Group of Twenty” (G20) which is composed of the 19 major economies of the world with an extra seat for the European Union that is represented by the European Commission and the European Central Bank, holds its annual meeting this year on September 4 and 5 in China. The group, which represents roughly 85 % of the world economy, will meet under the theme: “Towards an innovative, invigorated, interconnected and inclusive world economy”. Additional areas of discussion that require a global response include climate change, migration, and the refugee crisis.

Brazil concludes impeachment and removes President Dilma Rousseff from office
The long-lasting uncertainty about the Brazilian government has ended with the definitive end of the presidency of Dilma Rousseff and the take-over of the presidency by Michel Temer who is said to hold the office until the next presidential election in 2018. It remains to be seen whether the government will succeed to re-establish confidence and move the country out of its deep recession.

The economic crisis in Venezuela deepens
Without a regime change, there cannot come an improvement of the Venezuelan economy. The inflation rate has hit more than 180 %, the annual growth rate stands at a negative 7.1 % and the currency is in a free fall. At any moment, the ongoing political unrest could lead to a confrontation at the scale of a civil war with consequent effects for the whole of the South American subcontinent.

China on the rise, despite temporary slowdown to the Chinese economy
The slowdown of the rate of growth of the Chinese economy from over ten percent in 2010 and 2011 to the current rate of 6.7 % is a move to a more sustainable level. Inflation is under control, the unemployment rate low and the currency relatively stable.

The Middle East and North Africa hit by unrest and war
The Middle East and North Africa are stuck in the turmoil of war, social unrest, and terrorism. After the failed military coup in July of 2016, Turkey’s incumbent president Erdogan could fortify his power by establishing an authoritarian regime. While Turkey’s role as a regional player will increase, the economy will suffer.

Antony P. Mueller, September 6, 2016

Sunday, July 10, 2016

Financial Market Snapshot July 2016

July 2016

-         Brexit vote shocks markets
-         negative interest rates are here to stay
-         macroeconomic policy hits the wall

Brexit vote shocks markets

The result of British referendum about of leaving the European Union (EU) has hit financial markets like a shock. The so-called Brexit has brought market turmoil and will bring uncertainty to the international arena for years to come.
As if the series of other worriers has not already been enough, Brexit will weaken not only the position of the United Kingdom (UK), but the European Union as a whole.
The immediate fallout has been a drastic fall of the British pound (see chart. At the political front, Prime Minister Cameron declared his resignation and the opposition leader in the British Parliament suffered a vote of non-confidence. The independence movement in Scotland is gaining new momentum.
Some of the longer-term consequences for the economy of the United Kingdom are already visible:
-          Consumer confidence has started to plunge
-          Investment spending is on hold
-          Import prices are on the rise
-          Real estate prices have begun to contract
-          Banks cut hiring and plan to move staff to other locations

Chart 1
British pound/US-dollar December 2015 – July 2016

Are negative interest rates the “new normal”?

Official interest rates in the United States, Japan and the euro area are close to zero or already negative. How long can this go on and what are the effects?
The low interest have come into existence because of the policies of “quantitative easing”, which means that central banks buy financial assets in exchange for money. Asset prices rise and consequently returns tend to fall.
The secondary effect of quantitative easing is an asset bubble. This, in turn, leads to a deterioration of wealth distribution.
Negative rates will exacerbate the situation. Along with accelerating the drive for riskier in search of return, negative rates on government bonds will also motivate the accumulation of more public debt.
An unsustainable situation is in the making.
A return to normality - with interest rates in the industrialized countries at their historical rates of the second half of the 20th century - would require a massive downward revaluation of financial assets and of property.
Central banks rightly fear the effect of higher interest rates. Yet by postponing any correction, they make matters worse.

Chart 2
Negative interest rates of the German 10-year government bond

Macroeconomic policy hits the wall

With interest rates at historic lows and with public debt at critical levels, the conventional policy measures of monetary and fiscal stimuli have reached their limits. In many countries, private debt, too, is close to becoming unsustainable. Steps to promote more free trade also meet obstacles. The Brexit campaign in Britain and the presidential election process in the United States indicate a surge of populism.
International political tensions are also on the rise. Relations of Western countries with Russia have reached a new low point, while China is on its way of asserting itself not only commercially but also in the monetary area and militarily.
For investors, there are no safe havens. The so-called BRICS-countries, first of all Brazil, have disappointed as the potential new motors of the world economy.
The euro area suffers from the weakness of its countries at the Southern periphery, including Italy. Almost unilaterally is it up to Germany to accumulate the surpluses of the other countries’ trade deficits.
With the proposed exit of the United Kingdom from the European Union, additional factors of concern have come into play. For years to come, uncertainty will tend to hamper any substantial economic recovery – not only in Britain but throughout the European Union.
Economists have begun to talk about the coming of a period of “secular stagnation”. Strong headwinds confront the world economy. Even in the United States, productivity rates have slowed down.
A gigantic mass of international liquidity is desperately on the search of returns. A large part of this financial capital exists in assets of pension funds. Large parts of the population depend on the returns of these assets for their retirement. While low interest rates favor the financing of debt, they represent a huge burden for the savers. As the positive effect of low interest rates on the valuation of stocks may diminish in the time to come, the return of financial market assets will come under even more pressure.
Monetary and fiscal policies have run out of options. As a sign of their desperation, macroeconomic policy authorities have begun to discuss even more extreme measures irrespective of the fact that their earlier unconventional policy measures such as the so-called “quantitative easing” have failed to bring about a solid economic recovery.
With plans to extend the program of central banks of purchasing financial asset on the open market beyond high-quality government bonds, the trust in the present monetary system will continue to erode.

Antony P. Mueller
The Continental Economics Institute
July 11, 2016

Monday, February 15, 2016

Financial Market Snapshot January 2016

Things to consider for 2016

-        End of Bretton Woods II
-        Contraction of China’s economy
-        Economic implosion of Brazil
-        Economic collapse of Greece
-        Dissolution of the Euro Zone
-        Global deflationary depression
-        Negative interest rates
-        A new cold war with Russia
-        Massive terrorist attack in Europa and the US
-        Did I miss something?
-        Ah, 
yeah, the US election
-        and 
yes, of course, buy gold.