By the beginning of this year (2015), Europe (the ‘Eurozone’) was in such desperate economic shape it needed to be rescued again by its Central Bank to the tune of a $1.3 Trillion stimulus package. But more importantly, its persistent state of economic stagnation, coupled with its unwieldy financial and political structure, has spawned a tidal wave of frustration and rebellion that resulted in the election of a far left government in Greece. To us this is akin to a hand grenade going off in an armory storeroom full of much larger ordinance. There are ticking political and debt time-bombs in neighboring countries of France, Italy, Spain and Portugal and others. The recent developments in Greece have the potential of blowing the Eurozone and the global economies apart, in spite of all parties trying desperately to prevent such a seemingly inevitable and explosive outcome. A rebellion has been started by the Greek people against the unbalanced and structurally flawed economic model that has been employed over the past six years, and it will spread to other countries (European and non-European) which are in similarly untenable indebted positions. The global Central Bank led solutions are not fixing the severe economic and the resulting social problems of the vast majority of the populations in most countries, where unemployment is still in the double digits, and youth unemployment is in the range of 50% or more. These struggling countries battered by the last crash and now wallowing in unpayable debt, make up the bulk of the current Eurozone. If Greece is successful in renegotiating its debt from its creditors, other heavily indebted countries will follow suit. That will unleash waves of volatility in the financial markets, further rocking an incredibly shaky boat.
In a normal democratic country it is very difficult for one government to rule effectively, due to incompetence, corruption, competing demands of vested interests, and the usually fractious and uncooperative opposition parties they have to contend with. In the Eurozone there are 18 countries with the Euro as the single currency, and 28 overall member governments, plus all their opposition parties that together have to maintain enough of a consensus for the Eurozone to operate semi-effectively. It is entirely admirable how the Eurozone has been able to come together and not only hold together all these years, but in fact become a desirable organization to join and expand. But these last few years of extreme economic stress has brought to the fore the serious shortcomings of a partially integrated political, economic and financial system. The Chart below gives an idea of the political complexity of the Eurozone, and though dated, the political volatility depicted is quite representative even now.
Source: Deutsche Welle
The negative and constraining aspects of a single currency for such a culturally and economically diverse body have become quite a problem, especially for the struggling southern Eurozone economies. Without the ability to devalue their individual currencies to adjust to their true internal weaknesses, these countries and economies are at a serious disadvantage in this time of contracting international trade markets, both in the Eurozone and outside of it. This unwieldy structure is holding them hostage in a time of painfully needed economic and currency adjustment, where they need maximum freedom to maneuver individually, but are instead locked into a ‘collective’. The net result is, the southern European countries are finding the prolonged agony of contracting economies, the need for recurring bailouts, the resulting imposed austerity measures by their Northern members, especially Germany, crushing debt, staggeringly high unemployment - especially amongst their youth - and severely eroded lifestyles, all quite unbearable. This prolonged and ever growing pain is fostering radical political and ideological shifts, nationalism, racial intolerance, and political radicalization, resulting in fringe political parties coming to the fore, and to power. All these seemingly intractable problems are spawning a backlash and resentment in the populations of these countries, which the fringe parties are exploiting. The anger is growing against the lack of economic improvement, imposed and painful austerity measures, the North – South economic divide and the ongoing suffering. This growing resentment, in the hardest hit Southern economies, may result in the ultra left or ultra right wing nationalist political parties coming to power, on a platform to break away from membership of the Eurozone, and free themselves from the constraints and inflexibility of a single currency, and the dictates of the bureaucracy that runs the Eurozone from Brussels.
Since the rapid rebound in 2009, the Eurozone has barely managed to stay above water, with its GDP slipping back into negative growth territory in 2011 (Chart below) and barely coming up for air in 2014. In January 2015, the Eurozone (EU18) is barely above negative growth territory at about 0.03%.
Besides the economies stagnating, the Eurozone is also fighting a losing battle to the forces of deflation (Chart below), forcing the European Central Bank (ECB) to propose an aggressive One Trillion plus round of stimulative action through sovereign bond purchases of its member governments.
Today, Europe is inundated with a number of economic and political problems that are serious enough to threaten its very structure as the Eurozone and its single currency, the Euro. Its internal economic and political problems are being exacerbated by its confrontation with Russia’s aggression and the resultant drop in trade exports and energy imports from that country. In fact Europe is embattled by external and internal conflict that may not go away anytime soon and may lead to a disaster for the Union.
The other growing threat to global economic stability is deflating China. Bereft of the seemingly endless voracious global consumer demand for its manufactured goods, China is sinking in serious overcapacity, years of mal-investment, and significant corporate, local government and State owned enterprise unproductive debt. Its government is desperately working all its control strings to try and engineer a ‘soft landing’ as its economic growth rate decline accelerates. The targeted 7.5%+ growth rate has long been discarded, and the new 7% target is also an illusion as its true rate of growth is probably in the vicinity of 5% or less, and heading lower. The required turn inwards, towards internal consumption, to compensate for the drop in Western consumption, will take years if not decades to be adequate enough to help boost China’s GDP growth rate into the double digit range again.
China will probably settle down to a more moderate rate of growth as its economy matures, and it faces increasing competition from less developed rivals that are further behind on the development curve. At this time almost all indicators are pointing down in China, and in our view it will not reverse this trend anytime soon.
Source: The Wall Street Examiner
Apart from a slowing economy, being pushed down by the decreasing global demand and increasing global competition, particularly in manufacturing (as every struggling economy tries to boost its exports, which is just about everyone at the expense of China), China’s real estate and credit markets are posing an ever growing financial threat to its over bloated, over mal-invested financial system. Between the slowing economy, declining asset markets (factories, land, overdeveloped real estate, and stock piled commodities - already paid for), its famed local State and corporate shadow credit markets, and wide spread corruption, which in spite of a much publicized crackdown is endemic to the system, in our view, even China’s powerful government is facing a few too many challenges to be able to control everything and land it gently. The odds are certainly against it.
China also faces external geopolitical-economic threats and shocks that could upset its plans for a controlled soft landing. Like all major economies it is exposed to competition (especially the Yen and the South Korean Won), risks in global currencies (especially the US dollar), and any major correction in the global debt/stock, real estate and commodities markets. In its current economic state China is particularly vulnerable.
Most experts, economists and analysts have tremendous faith in the political and financial power of the Chinese government to avoid any real problem to its economic, financial and political system, and therefore cannot see any possibility of a crash or a hard landing. They may be right; the Chinese government has tremendous power internally, and a fair bit externally. But we do not have such faith, as we know along with its strengths China also has tremendous weaknesses, economic and political, internal and external. To us, China today is a combination of an earlier version of the economically infallible Japan, and the once all powerful political and military superpower, the former U.S.S.R. And given the right conditions, in fact evolving right now in the geopolitical economic global arena, we believe China is heading for significant economic difficulties as the kaleidoscope of global economic and political readjustments shift to China’s disadvantage.
The tremendous cushion of foreign reserves that China holds is vulnerable to a U.S. dollar collapse, hard as it seem to envision at this time. China is more than aware of its vulnerability and has been aggressively divesting its U.S. dollar horde by investing in hard assets abroad, encouraging trade deals in Yuan, and in purchasing and stockpiling gold. These measures cannot compensate for the shrinking global demand and internal financial and social problems that China is facing today. Therefore, we can see problems both on the economic and political front plaguing China in the coming years and hence China contributing to the growing global volatility, while itself being increasingly affected by the current external global economic weakness, and the escalating geopolitical turmoil.
To us, it seems Japan is beyond redemption. Abenomics, as applied so far without the long required reforms isn’t enough. The required social and economic reforms needed to correct what ails Japan have not materialized for over two decades. Japan is locked in an endless static state of negative rates, limitless money printing, dramatic yen devaluation, a stagnant economy and rapidly worsening demographics. The Abe Government and its ultra-supportive Central Bank have pulled out all the stops in flooding the financial system with liquidity, but its economy stubbornly continues to sag. Of course, as envisioned, its aggressive drive to continuously weaken the Yen till the elusive, and until now, always out-of-reach target of 2% inflation rate is discovered and captured, is predictably triggering rounds of currency devaluations from competing countries, in a downward spiral in the zero sum game of international currency wars.
Recently, the US Government has appealed to the G-20 Finance Ministers to not engage in currency devaluations as a means to boost economic growth. In a steadily deteriorating global economic environment, where every country is increasingly for itself, and desperately needed exports are required to support growth, even in the US, we think there is little chance any Finance Ministry, particularly Japan’s, is going to heed the US’s admonishment and show too much restraint, if it means their economic well-being is at stake. The Charts below show the dangerous divergence of the current dramatic ballooning of Japan’s debt, versus its actual current economic performance.
So far Abenomics has failed. As is well known Prime Minister Shinzo Abe went to the polls and got a strong mandate from the Japanese people to ‘carry on!’ And he has. The Bank of Japan has pulled out all the stops in printing money and devaluing the Yen, in its attempt to boost inflation. The same model as most every other Central Bank is using, only far more turbocharged. In fact so turbo-charged that no country has quite gone into this “full-speed-ahead!” and “damn-the-torpedoes!” mode, in quite such a fashion. In our view, Japan will still fail in its desperate attempt to break out of its deflationary trap as it faces a declining world market demand, currency wars, global competition, corruption, crony capitalism, static internal demand and sharply worsening demographics. Additionally, most of Japan’s largest companies have a significant portion of their manufacturing situated in foreign countries where they are not helped by a devalued Yen, but are affected by the local business and political environment, and the values of local and international currencies. All these factors present too many strong headwinds for Abenomics to overcome, in our view. These factors mean that Japan will continue to struggle till meaningful reforms are undertaken.
Currently the Russian economy is imploding due to its ill-timed geopolitical strategic play in Ukraine, with all the resultant negative consequences such as western world sanctions, capital flight, the destruction of the ruble and the resulting high interest rates. Additionally, all these negative consequences have run into a devastatingly inopportune and ruinous oil price collapse, triggering a virtual crisis in its primarily energy based economy. The Russian people are once again facing economic ruin as their economy gets battered by external and internal forces outside of their control. President Putin (the supreme oligarch) is determined to bring back some of the power Russia enjoyed in the glory days of the U.S.S.R., while also pushing back at the hemming in of the current Russia by the Western Alliance (NATO).
With its former industrial might shattered, and scattered, as it lost its satellite eastern European countries, the Russia of today is economically diminished, handicapped and overly dependent on its natural resources. The Chart below shows its declining growth rate, as lack of global demand pushes down commodity prices. The western sanctions, but more so the steep international oil price decline, if it holds, will seriously hurt the Russian economy in 2015, probably a lot more than the Chart indicates.
Oil price collapse in 2014
Ruble collapse - interest rate spike = RECESSION!
While the oil prices have recovered a bit, we do not see any quick resolution to Russia’s economic and geopolitical problems. It is not possible for Russia to escape its vulnerabilities to low oil prices, or to diversify its economy any time soon; it is also not possible for President Putin to back down on his much internally promoted - ‘international restoration of Russian power and pride’ - Ukraine power play.
In both instances President Putin is in a corner, with no easy and internally acceptable way out. Being pressured internally by a collapsing economy, and externally - primarily by the NATO Alliance (Europe & the US) - President Putin becomes altogether far more dangerous now than before. While nobody knows exactly what he will do to extricate himself and Russia from the potentially face-losing economic straight jacket, or the geopolitical face-off with the West that has developed under his singular leadership, one thing is reasonably certain, Russia will not be contributing anytime soon to global economic and political security.
At the moment Putin seems to be brow-beating and out-maneuvering the US led NATO Alliance, gaining territory in Ukraine, and gaining influence in Europe and the Middle East. So far he is winning and racking up geopolitical and territorial gains. These successes may encourage him to expand his end game in the face of a hesitant, seemingly fractured and weak-kneed Western Alliance. Therefore the end result over the near term will be rising geopolitical tensions, instability, and significant financial volatility.
Nobody wants to contemplate an actual war between the West and Russia, but these days almost anything seems possible. Putin has already laid down the gauntlet of a possible conflict and warned the West of Russia’s significant nuclear power and capability. Using that ultimate threat and his absolute control over Russia at this time, Putin is in a position to gamble more than any opposing Western leader can. In 2015, the possibility of a major and globe threatening war should be unthinkable, but there we have it, an unthinkable possibility, however remote.
Additionally, Putin is reveling in the new found center stage role he has created for himself. Rising from life-long obscurity he is not going to give up that attention soon.
Feeling increasingly isolated Russia is attempting to sow seeds of disunity among the Eurozone members to lessen the effectiveness of their opposition to its current acquisitive and strategic ambitions in Ukraine. Redrawing the lines of geopolitical spheres of influence and drawing-in its ideological partners (dictatorial regimes), China, Syria, North Korea, Egypt and even the recent economically disaffected, the left leaning and disenchanted Greece, Russia is increasing its international geopolitical heft.
President Putin is playing the old cold war game effectively (being a former KGB expert), and in our view though ultimately contained, as the West has too much economic heft and fire power, and China needs the consumption of the West far more than Russian oil at this time, he will nevertheless show a few more daring moves before he is done. Those moves will add to the already heightened geopolitical economic risks that the global environment is seething with. A cornered Putin is dangerous, and that is precisely what is scaring Germany’s Chancellor Angela Merkel, as she is from the former East Germany and therefore is familiar with the mentality of such Russian KGB operative elite. In our view, we can only expect more short term economic and political grief for the global economy from Russia. It has become an increasingly ‘one-man’ State. Putin is a man who obviously has an insatiable appetite for personal power that he is unwilling to share or relinquish. He has the ruthlessness to be serious when he challenges the West with his nuclear armed war machine, to try to push back NATO’s ever encroaching missile defense systems in near neighboring countries.
Vladimir Putin set out to be the undisputed power in Russia (he has accomplished that) and secondly to restore Russia to some of its former geopolitical power, and in trying to do so he has been and will continue to be completely ruthless with his own people, and the outside World. Having effectively silenced or eliminated all opposition within the Country, and convinced the Russian people into believing in him as Russia’s savior, Putin has also closed all exits for himself and Russia, and has no choice but to threaten, bluff and browbeat the West into backing off.
See #25 for the start of this report & #27 for the conclusion...
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