Debt certainly dominated the headlines in August, with fear gripping the markets on concerns the indebted European nations together with the US debt issues, would derail the already stalling global economic recovery.
This all came to a head with the downgrade in US credit rating by Standard and Poor’s to AA+.
Global markets are driven by fear, greed and trust and while fear dominated most of August, we thankfully didn't see the complete breakdown in trust that led to the GFC. Bernanke's promise to keep US rates at zero until mid 2013 and his indications that they could look to another round of money printing, the so called QE3, calmed the markets - although the issues of debt and the stalling economic recovery, have obviously not gone away.
Despite our share market (ASX200) being down around 10% and one stage, based on market closing prices, and even more if we focussed on the intra-day, our share market closed down just 2.9% for August. While not a good result, it was certainly much better than many would have expected earlier in the month.
There's been a lot of comments on government debt, but one I particularly liked was by US money commentator David Ramsey who said, "If the US Government was a family, they would be making $58,000 a year, they spend $75,000 a year, and have $327,000 in credit card debt. They are currently proposing to reduce their spending to $72,000 a year. These are the actual proportions of the federal budget and debt, reduced to a level that we can understand."
As we all know, the US government is NOT a family - and governments are indeed different to our families. Let's quickly review the roles of the players in this global debt game.
Governments have a perpetual stream of tax receipts to spend and can borrow large amounts by selling bonds, provided others are willing to buy them (i.e. until there is a crisis in confidence).
The Eurozone is a committee of 17 governments under a common currency that unfortunately doesn't have control over the fiscal decisions of individual members. Given that it is a committee of 17, decision making can be painful but there is the financial muscle to get through these issues, provided everyone wants to play together.
Reserve Banks can print money with the limit related to the potential inflationary effects, provided they issue their own currency. The European Central Bank can print money for members of the European Union, but not for the individual member countries.
Companies can raise extra capital from the share market or borrow, provided their future looks viable. Importantly, their activities can be across many countries. For example, is Apple a US or global company.
Banks provide the cash and finance to enable consumers and companies to go about their business. They are forced to hold reserves, and even more under the Basel III requirements, but can get financially stressed when companies and/or consumers are unable to repay and/or the value of assets used as collateral (particularly real estate) fall.
Consumers usually have relatively fixed financial resources. They can't raise capital like companies, they can only really borrow against assets and they certainly can't print money (although a few have tried!). Furthermore, we should really break down consumers into employed, unemployed, dependants, independent retirees, pensioners etc.
Looking at the global economy in these terms we see that governments in most developed nation (with the exception of Greece) are not quite at the crisis of confidence stage and are working to at least stabilise their debt. Although US government debt is now rated only AA+, lower than some US companies, the downgrade didn't cause as many problems as some were suggesting. Emerging nations such as China, India, Brazil etc and indeed the world, continue to buy US government treasuries, ensuring that the US can continue to fund their activities at very low interest rates.
The Eurozone, which represents a major slice of the global economy is more problematic, although it's probably unrealistic to expect a committee structure to act decisively. Many people are suggesting the issuance of Euro denominated bonds by the ECB which would rate quite highly and could effectively solve the funding crisis on the weaker nations in the Eurozone. The politics of this is controversial and makes such a radical step reasonably unlikely.
Inflation is still not a huge concern so reserve banks can, and are, still injecting money into the system by buying assets. In effect, the ECB’s purchase of government bonds in Greece, Ireland and Spain is virtually the same as the so called quantitative easing in the US.
Companies around the world are in reasonable shape having recapitalised, or in some cases, having been rescued by a government. Banks outside of Europe also look to be in reasonable shape, which leaves just you and me - the humble consumer. In the big developed economies, consumers need to spend to get economic growth humming and unfortunately the US consumer is still struggling with unemployment levels, a falling property market and lack of confidence. Australians are saving more and spending less.
On a more positive front the strength in the emerging markets continues with China's economy still growing at a rate in excess of 9% per annum.
Overall, our view is still in the “muddle through” camp in terms of global growth, provided the players mentioned above stick to their typical game plan. Certainly the risks are high and it makes sense to have a reasonable allocation to defensive assets. The world looks scary and volatile. This will no doubt continue as the world digests the issues of Government debt, US growth and European politics. Expect more volatility and look closely at the roles that the players continue to play in this evolving debt game.
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