At Davos, I felt there were some ‘elephants in the room’ – big issues that need to be recognised but which people pretend are not there: the shadow banking industry, global imbalances and the US budget deficit.
While the German pursuit of a hard-line may make sense from a domestic perspective, there is no easy way out of the euro area’s problems. Policy statements cannot replace economic reality. The periphery faces deep recession. Debt rescheduling is inevitable.
It is vital for the world, for Asia, as well as for China that it addresses its inflation challenges now. This is no time to wait.
In our view, the world economy is in a super-cycle: a sustained period of high economic growth, lasting a generation or more.
John Mauldin had written an interesting post on 29th January 2011, the day after the US Government released its fourth quarter GDP numbers. The US reported 3.2% annualised GDP growth in Q4. This was despite a 3.7% contraction from inventory investment. So, every one thinks that it stores up an upside rebound in the next quarter. But, here is the rub (paraphrased from his post):
It is important to note why inventories subtracted 3.7% from growth. It is because the deflator for imported goods went up. Why? The price of crude oil shot up 10% in Q4 alone and that is 40% annualized. Remember that the USA reports GDP growth on a QoQ annualized basis.
As the price of crude oil rises 40% annualized in Q4, the import price deflator jumps, real imports get marked down and, importantly, the existing inventory of crude oil gets marked down in price too. Therefore, inventory is valued less and it reduces growth!
But, note here that this is offset by a 3.4% positive contribution from net exports because real imports get marked down due to the jump in the Deflator for imports!
There is no conspiracy theory here but just a statistical explanation.
Needless to add, I warmed up to this observation of his:
I just see a bubble in complacency. The market is going up, so all must be right with the world.
‘Truth and Beauty’ (Eric Kraus) has posted another of his racy and well-written investment letters. The introductory text whets one’s appetite, as usual:
The degree of complacency among investors is truly impressive, as the Middle East – a region which has long produced far more history than could be consumed locally – threatens to become suddenly interesting again. The effects of expansionary monetary policy, and commodity price inflation, can show up in the most unexpected places… Beware those emerging economies sitting on socio-political fault lines.
Meanwhile, with the US desperately trying to keep the bubble inflated, an increasing number of countries are biting the bullet and withdrawing stimulus – with China hiking for the third time in five months, some of our strategist peers are scurrying to get out of the way, reallocating from the EM to the DM just as fast as their little legs will carry them. [Full letter here]
Now that I could put in one blog post observations on complacency by three financial market participants, not including TGS, it is not possible to say that not many saw the (next) crisis coming. TGS will have more to say on Raghuram Rajan’s post on the matter of economists missing the last crisis totally.
Originally published at The Gold Standard and reproduced here with permission.
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