The Road to Redemption

The global outlook is dire as we enter 2012. At best, Europe is on the brink of a severe recession. At worst, it could be on the verge of financial meltdown. Asia is slowing down, encumbered by the fiscal and monetary excesses of the past four years. Singapore, the canary in the coal mine, is trimming down its growth forecasts for this year. South Korea is reporting the worst manufacturing data in three years. Latin America is drifting aimlessly. The southern cone countries, which are more exposed to the European and Asian markets, are losing momentum. The economic woes are accentuated by the tightening of global credit conditions. In addition to the end of the Fed’s Quantitative Easing (QE) programs, European banks are shrinking their balance sheets. In addition to selling off assets, they are slashing lending programs. This is sending reverberations throughout the global economy as disparate sectors, such as shipping and property development, are denied access to credit. The situation in Eurasia is not much better. Political instability in Russia and Kazakhstan is sparking capital flight. Huge current account deficits in Turkey and Ukraine portend future balance of payment problems. Fortunately, the U.S. economy is the bright light in the dark sky. After four years of economic adjustment, the U.S. private sector is showing signs of life. North American firms are armed with strong balance sheets, highly competitive work forces and declining domestic energy prices. Employment is on the rise, allowing for an improvement in U.S. consumer confidence. Likewise, the housing market is on the mend. Almost five years of stagnation allowed much of the excess housing inventory to be absorbed. Foreign investors also played an important role, as Latin Americans, Europeans and Asians made forays into the U.S. property market to pick up bargains. The revival of the U.S. economy bodes well for Mexico, Central America and the Andean Region. For sure, all is not gloom and doom. There are reasons for optimism.

In the same way that the U.S. was able to find its way after the collapse of 2008, Europe is at a pivotal turning point. Last year marked an epiphany for Europe. The region came to grips with economic reality when it could no longer pull any more rabbits out of its hat. Through more than a dozen summits, European leaders made grand gestures and statements that were full of bravado but devoid of substance. Europe’s inbred notion of entitlement came crashing down as its banks went down in flames. As the U.S. learned four years ago, anything is possible when there is ample credit. The U.S. was able to enjoy an enviable lifestyle, support its foreign military adventures and fund a huge government spending program, as long as it had an infinite source of financing. However, the onset of the U.S. financial crisis brought the reverie to a close. The halcyon days of reckless spending were replaced with massive layoffs, grim budget cuts and the devaluation of the currency. The same is happening to Europe.  Technocrats are now at the helm of Greece and Italy. Their mandate is to get their houses in order. These individuals have no political aspirations or dreams of re-election. That is why they are implementing unpopular, but necessary, reforms. Spain is also taking important steps to bring its fiscal accounts under control and make its economy more competitive. The same is happening to the European financial sector. While the ECB keeps its banks on life support, it is forcing them to recapitalize in order to strengthen their balance sheets. These are the measures that were sorely missing. European leaders thought they could bluff their way in order to avoid the pain of adjustment, but they realized that the only way out was to atone for their previous mistakes.

A message of austerity was clearly delivered by most European leaders during their various New Year’s addresses. German Chancellor Angela Merkel and French President Nicolas Sarkozy warned that 2012 was going to be tougher than 2011. Italian President Giorgio Napolitano urged his countrymen to make the necessary sacrifices to meet the fiscal targets. This year, indeed, will be difficult. The brunt of the credit crunch will be felt as banks harbour their resources to meet amortizations. Banks were not able to raise all of the $560 billion that they have coming due in 2012. This means that very little of the LTRO funds that were provided by the ECB will be channelled into the economy. Likewise, the peripheral European governments have hundreds of billions of euros in amortizations this year. It will be a difficult proposition to roll over these obligations without a significant commitment to further adjustment. Fortunately, Europe has finally recognized that the only road to redemption will be through greater sacrifice, and this is a reason for more optimism.