As we enter the second half of the year, here is a quick rundown on how the bullish and bearish forces align.
Persistent optimism: the prevailing belief that the consequences of failure so dire that leaders will have no choice but to take the right action.
Risks of EU contagion will force leaders to print money as needed and fund the GIIPS to prevent EU, and possible global, banking and economic collapse.
They must find a solution – so they will. The optimism comes from pure hope and from the assumption that those in charge know what to do and will do it.
We question that, particularly regarding the big Euro-zone threat.
Bets are that Germany will keep abandoning stated positions to prevent and EU collapse, even if it means ultimately accepting responsibility for GIIPS nations’ debt.
The US version of the above is that because the cost of failure (recession or worse) is so high, Congress will overcome partisan bickering that we saw in July 2011 and reach a deal that prevents the US hitting the feared year end “fiscal cliff”.
This is literally an economic precipice created by legislation in the summer of 2011, of expiring tax cuts and onset of $1.2 trillion in spending cuts.
It is feared that these would send the US plunging back into recession.
China: growth slows but stays relatively robust.
EU crisis is deteriorating, no solution in sight:
There is no real evidence that EU leaders agree on what to do, are able to act if they do agree, and have enough time left to do it.
In brief, that means that they cannot agree on how to set up a “United States of Europe”, its regulation, funding, banking rules, etc., in the time remaining before Spain, Italy, or even France is at risk of default without a bailout, for which there are no funds available.
While Germany has softened its stance in the past, it has yet to show that it is willing to seriously risk its own credit rating or economic well-being by committing to fund GIIPS nations’ debt or even make substantial further contributions to help them.
While Merkel agreed to use the EFSF (European Financial Stability Facility) and ESM (European Stability Mechanism) to fund Spain, the EFSF is underfunded and the ESM is unlikely to be functioning at all until some point in 2013.
Moreover, its powers and regulations are yet unknown.
That means that Merkel has agreed to possibly write checks on accounts without adequate funding or that aren’t even operational.
US hits fiscal cliff hard:
Congress could once again be deadlocked when dealing with raising the US debt ceiling and simply defer rather than solve the US’s excessive deficit issues.
On one hand, the impending election in November pressures Washington to produce results.
On the other hand, neither party can afford to be seen as harming the interests of their voter base.
Persistent weakness or contraction in all leading economies:
With the US, EU, Japan, UK, and China all struggling, the odds favor more downside than upside.
If the EU gets hit with multiple sovereign or bank defaults, the global economy would be too weak to resist contagion.