I don’t know exactly how this happened, but I have become widely known in financial circles as “the Muddle-Through Guy.” I began using the term in 2002, when I was forecasting that we would be lucky to do more than 2% for the entire decade. It turns out I was an optimist – we did only 1.9%. Likewise, I think we will be lucky to average 2% in the US in 2016.
In general, recent data has been trending down (with the obvious exception of the employment numbers). I am concerned that the US will be much closer to 1% growth than 2% for 2016. I know plenty of folks who expect the US to go into recession this year. They may be right, but if so that downturn will be due to some kind of external shock. But at a 1% growth rate, which is close to economic stall speed, it wouldn’t take much of an external shock. I can see three real possibilities that we will need to keep an eye on.
The first is Europe. Longtime readers know that my base forecast is that the euro survives, but only if the eurozone nations mutualize their national debts. The euro is not an economic currency; it is a political currency. And it will take the political solution of creating a fiscal union to maintain it. Given the level of debt of most of the major members of the eurozone, a fiscal union can occur only if every country – read Germany – agrees to mutualize debts,.
Up until recently I believed that you could get a majority of eurozone voters to go along with the pro-euro elite politicians’ extraordinary intentions to actually mutualize debts under the balance sheet of the European Central Bank (or another organization that would be created in the midst of crisis).
I now think that a political solution is at serious risk because of the immigration crisis. You can almost feel whatever sense of political unity existed in Europe disintegrating right in front of us. The recent tragic events in France and Germany are exacerbating the problem. I think getting a majority of voters to go along with the idea of giving up national sovereignty over their own budgets (which is what a fiscal union and the mutualization of debt would require) is becoming increasingly unlikely. As more and more people begin to demand that their countries control their own borders, the entire Schengen agreement is in jeopardy. And without that agreement, the next national debt crisis (beyond that of Greece – Italy? France? Spain?) will call into question the unity of Europe.
As country after country in Europe begins to close its borders, the flow of refugees will not slow but will actually increase. If you are in a failed state in the Middle East or North Africa and you think the doors to Europe are closing, you’re going to go now rather than wait. The refugees will find ways into Europe through those countries that don’t have the resources to control their borders (think Greece). Europe’s ad hoc approach to border control simply won’t work. It will only serve to demonstrate the true impotence and incompetence of Brussels and EU bureaucracy. And it will provide political fodder to nationalist groups that are beginning to hold sway in a number of major European countries.
No matter what you think of economic austerity in Europe, that concept is going to come increasingly under political fire and will be discarded. European borders are becoming less transparent, and Europe is increasingly economically vulnerable. A recession in Europe will cause a recession in a US economy stuck at stall speed.
I am flying over China (from Hong Kong) as I write this paragraph. I have just been a speaker at a conference sponsored by Bank of America Merrill Lynch, with some 60 major investment representatives sitting around a large table, for a very wide-open conversation. There were multiple hundreds of billions of dollars of funds represented around that table. Now perhaps it was influenced by two days of significant losses in the Chinese stock market, but the overall mood was decidedly bearish. Only a few people were actually talking hard landing, but the large majority of Chinese growth projections were decidedly lower than government forecasts.
Further, there seemed to be general agreement that the renminbi is headed down. I was particularly impressed by the Merrill Lynch Chinese analyst from Shanghai who pointed out that if the wealthiest 3% of Chinese moved just 7% of their money offshore, we would be talking close to $1.5 trillion. Money is literally flying out of China, in a variety of legal and questionable ways.
The Chinese government has been manipulating its currency higher for many years. That is now getting ready to change. Andy Xie, a well-regarded China analyst who sat next to me during my presentation, would not rule out a 30–40% devaluation over time. Admittedly, his is one of the more bearish forecasts, but few in the room were arguing that the renminbi would get stronger. Andy in particular was bearish about China over the next two years, though he remains an undaunted China optimist over the longer term. He truly believes China will rule the world within a few decades. In what was a very multicultural room (as you would expect in Hong Kong trading and investment society), it was interesting to watch the crowd’s reaction to Andy’s sentiments.
China’s slowing down more than forecasts anticipate – or, God forbid, a hard landing – would definitely deliver a shock to a still-weak US economy. We will have to pay close attention to China this year.
While everybody thinks of the Middle East in terms of geopolitics and military conflicts, the economic consequences of low oil prices will have far more problematic effects on the stock markets of the world. We are talking about sovereign wealth funds holding multiple trillions of dollars having to liquidate a portion of their assets in order to maintain their governments. These vehicles were created as the ultimate rainy day fund, and it is raining hard right now. My personal view is that we will see oil in the $20s before we see it back in the $50s. By a kind of perverse logic, the cure for low prices is low prices. It won’t happen overnight, but oil will reverse. In the meantime, low oil prices mean that sovereign wealth funds have to liquidate.
But let’s examine that concept for a moment. Many sovereign wealth funds are invested in very long-term and illiquid projects. Rightly so – that is what you should be doing with that sort of money. But that means when you have to liquidate, you sell what you can, not what you want. And that means funds will be selling liquid stocks and bonds. By the hundreds of billions of dollars’ worth. That is a lot of selling pressure, much of it in dollars and much of it in the US.