Farewell, Fragile Economy — Hello, 2012

Few will mourn the passing of 2011 into the financial history books. From an apparent economic recovery at year end 2010 and high optimism in the financial markets, a succession of natural disasters, economic disappointments, and government failures led to the most volatile year in stock market history. Today there is broad skepticism that the modest improvements in the domestic economy can be sustained in a global banking system that is clearly troubled. “Fragile” has become the most common description of our positive economic momentum as we exit 2011.

The largest single threat to the global financial system and the U.S. economy remains the European debt crisis. Despite numerous “summits” European leaders have proven incapable of forging a believable rescue package for its heavily indebted members. Until late October the crisis centered largely on the failure to stabilize Greece’s finances. Since then, the crisis spread rapidly to Spain, Italy, and most recently, France. Europe is now faced with an acute systemic debt crisis which threatens the solvency of their largest banks and therefore, the global financial system. What heretofore was a debt crisis affecting a few small members on the periphery of the Union has become a twin crisis holding the financial system of the industrialized world in its grip.

The catalyst for the rapid deterioration of Europe’s debt crisis was the failure in mid-October to construct a comprehensive program to contain the spreading crisis. It became painfully obvious that the European Financial Stability Facility, created in 2010 to guarantee debt of Greece, Ireland and Portugal, simply did not have the resources to support the debt of Italy and Spain also. In addition, Italy and Spain were original contributors to the EFSF, and would effectively be guaranteeing their own debt. Rating agencies and the bond markets quickly rejected the plan. Interest rates rose on all European debt except Germany.

Many economists believe that for the monetary union to survive in its present form, the European Central Bank will have to purchase government debt as a lender of last resort. With good reason, the ECB has resisted this controversial step. Monetization of the debt is potentially inflationary, anathema to Germany, and reduces the incentive for countries to discipline their financial management. The economic and financial deterioration is ongoing. It is clear that there is absolutely no way for Greece and others to meet their interest payments, let alone pay back their debt. Furthermore, the severe austerity measures and tax increases forced upon them have plunged the weaker nations into deep recessions, and the gap between the prosperous and poorer nations continues to widen. The probability of a breakup of the Eurozone in some fashion is increasing. An exit by one or more countries or a breakup of the Union itself, would likely lead to a series of defaults and write down of assets by European banks. Until recently it was hard to see how the European Central Bank would let this happen, but the possibility is increasing as time goes on.

The unfolding train wreck that is Europe today is the primary cause of the volatility in the financial markets, especially the stock market, and the aversion to all risk-based assets generally. Despite extreme statements by some observers about the threat to U.S. banks and financial base from the sovereign debt crisis, the vulnerability of our banks to the crisis is minimal. U.S. banks are in far stronger financial position today than before the housing collapse of 2008. The exposure of U.S. banks to European sovereign debt is very low, and the extent of bank lending to European businesses including banks is extremely small, if at all. With respect to the much feared threat of credit default swaps, it is hard to believe that U.S. banks would again engage in dangerous levels of cross border insurance with the painful memory of 2008 still fresh, thereby mimicking the folly of American International Group. Also, in many ways the Federal Reserve has made known its vigilance and concern about the crisis in Europe. Recently, six central banks led by the Fed agreed to provide cheaper access to European banks for swapping euros into dollars, a mainstay of trade finance arrangements. While none of this preludes another MF Global situation but it does provide some comfort that the debt crisis in Europe can be contained.

By contrast, the U.S. scene appears almost tame. The U.S. economy is entering the new year on a moderate uptick. Estimates of Gross Domestic Product growth in 2012 have been consistently ratcheted up and now center around 3.5%. If so, the fourth quarter will be the strongest of the year. While the trend is welcome, some sectors remain depressed and are holding back a more robust recovery. Single family homebuilding, usually an important early contributor to a recovery, remains at low levels, and housing prices generally have not recovered. The excess of houses for sale and reduced level of household formations have kept a lid on a positive turn in housing. The deterioration in housing appears to be over, however, in the light of recent trends. Both housing stocks and permits rose in the latest month. Importantly, single family starts have improved for two months. If confirmed in coming months even a modest upturn in housing will have a noticeable impact on our economy. At some point, the low level of home construction relative to demographic demand will impel housing to stronger growth. This will occur only gradually as joblessness is reduced and family formations rise.

The labor market is clearly on the mend. New jobless claims have declined steadily for several months and private sector jobs are growing. The employment numbers have been revised upward in each of the past six months. The silver lining in rising employment is that national income also increases. The improved employment and income pictures are confirmed by rising tax receipts, which are up 4.8 percent at the third quarter, and healthy retail sales over the Christmas holidays. The effect on the average consumer of an elimination of the temporary payroll tax deduction is substantially mitigated by the sharp decline in retail gas prices. Other indications of economic stability and moderate growth are evident in rising production levels, strong manufacturing trends, positive international trade and exports, and improving consumer and business sentiment surveys.

The year 2011, soon to be history, has had more than its share of extraordinary natural and man-made havoc. The greatest failure of government domestically is the inability of several Super Committees to agree on even modest reductions in government spending, or to take any steps to address unsustainable increases in entitlement programs. Faced with a national election in 2012 no solution to these long term critical weaknesses will be agreed to this year. Aside from possible small fiscal steps and continued aggressive monetary policy, government policy will be quiescent in 2012, despite heated rhetoric. Economic growth in the U.S. will continue at a moderate scale into the new year, and accelerate later in the year as housing and employment continue their modest uptrends. Supported by historically low valuations, rising earnings and dividends, and fortress balance sheets, U.S. financial markets will again be favored over foreign markets, including those of emerging Asia, as was so evident in 2011.

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  • ggroebner

    ‘Despite numerous “summits” European leaders have proven incapable of forging a believable rescue package for its heavily indebted members…. Europe is now faced with an acute systemic debt crisis which threatens the solvency of their largest banks and therefore, the global financial system.’

    Blackmail and balderdash. A darn good scam: go into debt big-time, and then convince the governments of said country that the country will sink unless my private bank gets bailed out.

    Iceland didn’t all for it, and they’re doing fine. The Greek “failure” was planned by Goldman & Sachs, with fake bookkeeping that allowed Greece into the European Union in the first place. And then when the EU actually had a plan worked out that would have resolved the Greek situation, the S&P downgraded Greece’s status by an unprecedented amount. Then, government bonds picked up on the cheap.

    Yes, what we are seeing may be a financial crisis, but the causative agent is the triumph of the Jewish culture in banking, and the hegemony of this culture over the public sector. “Privatize the gains, socialize the losses.”

  • lkeebler

    I don’t like to make comments of “worldly” wares on a “Spiritual” forum but this goes to the moral and ethical core of the problem as (not) addressed in this article here.

    We are being (spiritually) herded and slaughtered like cattle and don’t even see it, the greed and corruptions are so insidious and the lies and deceptions so demanding that only God can help us… may I say carefully but not cautiously that we can not climb out of the steep hole we are clinging precipitously by the sides to on our own by some sort of economic manipulating. Leviticus 20 tells us in Wisdom how to prosper, and obviously it is not to exact specifications to what God’s Will is for us today, still we must note what God says: (22 “‘Keep all my decrees and laws and follow them, so that the land where I am bringing you to live may not vomit you out.) NOTE: KEEP ALL MY DECREES AND LAWS AND FOLLOW THEM…

    Our “crisis” and what is “fragile” is not determined by the economic trials and errors of the so many all powerful masterminding economic “Kings and Queens”, but it is instead the firestorm of lust and corruption which is spread consuming some or all Wisdom of the people to “follow” God (that we may not be vomited out).

    Like in the movie “Pinocchio” when the “boys” who were tricked into thinking they could wallow in lust and corruption at “pleasure island” looked in the mirror to find themselves looking like donkeys growing donkey ears and tails and ready to be taken and used as slaves… they exclaimed in horror: “I have been duped!!”