Francisco Azuero's List: Coyuntura mundial 2011

• THE price of oil has had an unnerving ability to blow up the world economy,  and the Middle East has often provided the spark. The Arab oil embargo of 1973,  the Iranian revolution in 1978-79 and Saddam Hussein’s invasion of Kuwait in  1990 are all painful reminders of how the region’s combustible mix of  geopolitics and geology can wreak havoc. With protests cascading across Arabia,  is the world in for another oil shock?

   

  There are good reasons to worry. The Middle East and  north Africa produce more than one-third of the world’s oil
• A rule of thumb is that a 10% increase in the price of oil will cut a quarter of  a percentage point off global growth. With the world economy currently growing  at 4.5%, that suggests the oil price would need to leap, probably above its 2008  peak of almost $150 a barrel, to fell the recovery

• Given the Chinese economy’s long list of risk factors—including an older  population, low levels of consumption and a substantially undervalued  currency—the authors suggest that the odds of a slowdown are over 70%.

• We can see that Asian currencies have lagged the strengthening trend of  currencies in other regions following the crisis of 2008 to 2009
• Brazil has among the highest nominal and real rates in the world
• differently, Brazil local markets currently compensate an investor  substantially more for inflation and currency risk than do traditional G-3 fixed  income markets
• Yet despite these strengths, Brazil is forced to pay investors a higher rate of  interest for three main reasons. First, the government has massively increased  the level of subsidized lending channeled to its development bank BNDES (Figure  3). This low cost of funding allows BNDES to lend money not at the benchmark  overnight rate set by the nation’s central bank (currently 11.75%), but at its  own much lower non-market rate of interest of 6%. The more c
• that flows into the economy at these subsidized rates, the higher the clearing  rate that the central bank must set for interest rates on the rest of the  economy to contain price pressures. In other words, with BNDES pricing credit at  an artificially low rate, the market clearing level for Brazilian rates moves to  an artificially higher level.
• The second main reason rates are so high in Brazil relates to concerns of fiscal  slippage and a pro-growth policy that heightens inflationary pressures and puts  an increased burden on the central bank to aggressively tighten monetary policy  to contain inflation
• investors have to contend with heterodox policy and the threat of increased  taxes from the finance ministry
• large mispricing that existed in sovereign risk for many years between  developed and developing markets has now disappeared
• The developed world is still suffering from large headwinds to growth from the  balance sheet damage inflicted by the crisis of 2008.

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• We expect systemically important emerging economies to maintain their
• Australia and Canada will constitute the analytical battleground  as elements of the new normal come head-to-head with those of the old normal.  Our sense is that the two countries’ exposure to the dynamic components of  global growth – through direct trade links with Asia and the commodity angle –  will likely outweigh the drag from the legacy of household leverage (Australia)  and the economic links to the U.S.
• We expect systemically important emerging economies to maintain their
• The same cannot be said of Europe and Japan. The former is in the  midst of a fiscal deflationary drag, with vital questions multiplying about the  very makeup of the eurozone and its supporting institutions over the longer  term. The latter will face increasing demographic and debt headwinds that will  inevitably drain even further the already weakened drivers of sustainable  growth.

• On growth, we stressed the prospects for considerable differentiation  among regions and countries. Specifically:

   

  We expect systemically important emerging economies to maintain their  development breakout phase, including a gradual broadening of the engines for  income and employment creation.
•  
  • U.S.: Gradual deleveraging and financial rehabilitation to occur in   the   context of lower medium-term growth, greater  regulation, deteriorated   public     finances  and an eventual inflationary bias down   the  road;  
    
   
  • U.K.: Also stuck in a world of lower growth and poor public   finances,   but with  greater vulnerability to domestic and external financial     instability;  
    
   
  • EU: Deflationary bias and growing core/peripheral frictions and    tensions;  
    
   
  • Japan: A constantly encumbered real economy due to demographics and    public finances; and  
    
   
  • EM: A bifurcated world, with key economies (including China)   maintaining their development breakout    phase . 
• • U.S.: Gradual deleveraging and financial rehabilitation to occur in   the  context of lower medium-term growth, greater regulation, deteriorated  public   finances and an eventual inflationary bias down  the road; 
    
   
  • U.K.: Also stuck in a world of lower growth and poor public  finances,  but with greater vulnerability to domestic and external financial   instability; 
    
   
  • EU: Deflationary bias and growing core/peripheral frictions and   tensions; 
    
   
  • Japan: A constantly encumbered real economy due to demographics and   public finances; and 
    
   
  • EM: A bifurcated world, with key economies (including China)  maintaining their development breakout  phase 
• • U.S.: Gradual deleveraging and financial rehabilitation to occur in  the context of lower medium-term growth, greater regulation, deteriorated public  finances and an eventual inflationary bias down the road;
    
   
  • U.K.: Also stuck in a world of lower growth and poor public  finances, but with greater vulnerability to domestic and external financial  instability;
    
   
  • EU: Deflationary bias and growing core/peripheral frictions and  tensions;
    
   
  • Japan: A constantly encumbered real economy due to demographics and  public finances; and
    
   
  • EM: A bifurcated world, with key economies (including China)  maintaining their development breakout phase.
• As discussed in last year’s Forum, when looking out over the next three to five  years, the global economy has embarked on a bumpy journey to a New Normal
• Through a series of transitions, collisions, and trade-offs (the journey), we  are heading to a world that is re-regulated, de-levered, and growing less  rapidly in the industrial countries (the destination
• In reaffirming the conclusion, we also refined the characterization of  both the journey and the destination based on additional information,  research and analysis.  

  Our Forum again points to the changing historical context – a  regime shift that is occurring at a time when the global economy as a whole (and  industrial countries in particular) is operating with reduced tolerance for  policy errors, political accommodation, and market accidents.
• The world is on a journey to an unstable destination, through unfamiliar  territory, on an uneven road and, critically, having already used its spare  tire(s
• regulation
• the last 12 months, the world has experienced a strong cyclical bounce… though,  notwithstanding massive budgetary and monetary stimulus and a robust inventory  cycle, most industrial countries remain below pre-crisis levels of GDP, wealth  and employment
• Several of us at PIMCO question the robustness of the handoff in industrial  countries from temporary sources of growth (stimulus and inventory restocking)  to sustainable drivers of growth and employment (final private sector demand).
• We worry that the cyclical bounce has not translated into the type of job  creation and corporate investment that would be expected based on historical  relationships, and we see significant structural headwinds on the horizon, some  of which are already being felt
• These concerns are playing out in real time in Europe. Due to the rigidity of  the eurozone occasioned by the single currency/monetary policy structure, debt  and deficit differences among countries have created significant frictions and  disruptions
• however, the U.S. faces large and mounting structural headwinds.
• The country’s public finances have taken a serious turn for the worse that will  not be corrected anytime soon. Private sector credit creation remains hampered  and the banking system will become more utility-like. Meanwhile, the household  sector is still burdened by excessive debt, suggesting that further deleveraging  lies ahead. Unemployment is high and will likely remain so for the foreseeable  future, accentuating concerns about skill erosion and loss of labor market  flexibility
• there is no clarity yet as to where the balance will be struck between  effective regulation and bad

• More than anything, the story of the last few years has been one of serial  balance sheet contamination. Initially, private sector balance sheets were  expanded well beyond sustainable levels, aided and abetted by financial  innovation, the degradation of lending standards, and short-termism.  Subsequently, too many balance sheets deleveraged simultaneously, threatening a  global depression and forcing governments to step in with their own balance  sheets to arrest an increasingly disorderly process.
• As societies start to worry even more about public finances – and this is  inevitable – it will become even more difficult to sequentially deploy new  balance sheets in order to sustain the levels of debt and deficit that currently  prevail… that is, unless there is yet another healthy balance sheet that can  stealthily take on this debt for a while
• am inclined to side with the second group in warning against the long-term  implications of additional steps to turn monetary authorities (with revolving  balance sheets) into fiscal agencies (with more permanent exposure to dubious  assets).
• This potential evolution – from disinflation to inflation – will likely proceed  at different speeds in different parts of the globe. It is already well in train  in emerging economies and will remain so. Over the medium term, the U.S. will be  next, with Europe and, even more, Japan lagging
• is a world where several of the old simplifying adages that once brought  comfort to investors – such as industrial country governments constitute  interest rate risk while emerging economies involve credit risk – require  considerable refinement;
  

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• Based on previous episodes of debt reduction, it reckoned that once deleveraging  began, countries would on average spend the next six to seven years whittling  those debt ratios back by around 25%.

• Italy, France and Japan entered the recession with  low household debt but high levels of government borrowing. France has  implemented a fiscal consolidation plan; Italy’s cabinet approved one on June  30th. French growth is picking up but Italy’s continues to lag behind and  Italian bond yields have risen lately as worries about peripheral European  solvency spread. The earthquake and tsunami in March have disrupted both Japan’s  recovery and its hopes of reducing its enormous debt burden.
• American households have already chipped their debts down to 112% of annual  disposable income, according to Haver Analytics, from a peak of 127% in 2007.

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• Many central bankers, including Ben Bernanke, the Fed’s chairman, think it is  time for fiscal policy to do more. He gave Congress a scolding at Jackson Hole,  arguing that politicians need to address the medium-term fiscal mess while  leaving room to cushion the economy now.
• European politicians are unlikely to cough up more, so much discussion behind  the scenes is about how to lever up the rescue facility. Daniel Gros of the  Centre for European Policy Studies and Thomas Mayer of Deutsche Bank think the  EFSF should be registered as a bank and allowed to borrow from the ECB, using  the government bonds it buys as collateral.

• An alternative, quietly touted by some North  American officials, is to tempt investors into buying bonds by giving them  access to non-recourse loans from the ECB. The model is another American  innovation from the financial crisis—the Term Asset-Backed Securities Loan  Facility, or TALF. Soft loans from the Fed were designed to tempt investors into  buying securities; the Treasury promised to take the first tranche of any  losses, thus protecting the Fed. In a European version, cheap, non-recourse  loans would encourage investors to buy Italian or Spanish bonds and bring down  yields. The ECB would provide leverage, but any initial losses would be borne by  the EFSF. The facility’s resources would be magnified, private investors would  be drawn in and the price of bonds would still be set by the market.

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• For Bank X, the most pressing issue is a freezing of funding markets as  investors ponder the potential impact of losses that banks may take on their  holdings of euro-zone government bonds.   

   
• American money-market funds have almost completely withdrawn dollar funding from  European banks over the past few months
• This is forcing them to sell dollar assets.
• Some of these transactions will do no harm to the sellers: there are buyers at  reasonable prices. But Bank X is also cutting traditional banking activities  denominated in dollars. Some of these include critical functions such as trade  finance.
• Bank X is trimming euro assets, accelerating plans to cut the size of its  balance-sheet. Other lenders are doing the same. That risks driving down asset  prices, forcing lots of banks to mark down equivalent assets and erode capital.  Deleveraging also means a reduction in lending activity.

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