Jim O’Neill is a head of Goldman Sachs Asset Management, and the man who coined the term BRICs, he has also written a Book (Amazon link): The Growth Map: Economic Opportunity in the BRICs and Beyond.
Can Europe’s Policymakers Deliver an Enjoyable Christmas?
So it looks, once more, that there is only one topic that is going to influence the mood of investors, policymakers and much of the rest of the world. That will be next week’s meeting of EU leaders to, yet again, try and solve the crisis surrounding the EMU. While there are very important things going on elsewhere – growing evidence of an improving US economy, and China shifting to some monetary accommodation – the European mess remains front and centre. A successful meeting next weekend suggests a better mood all around as we go into the holiday season. A failed meeting suggests anything but.
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It seems so clear what the consequences are. This, in itself, makes it so easy to assume the better outcome. And, as I wrote about in the past couple of weeks and has been a rising theme of media commentary, you can see this weekend where the new deal would come from.
Merkel in drive on fiscal union.
This is the headline on the front of this weekend’s Financial Times. There are a number of similar articles around the international press this Saturday. Speaking to the Bundestag yesterday, the German Chancellor repeated her comments of the past fortnight that she now believes there should be a Treaty change to ensure much stronger fiscal responsibility and one that works. There have been some signs that other key countries have signed up for the plan. And, while there are important differences with France on the exact procedures, it looks as though Germany, France and Italy are in broad agreement. Given that these three represent close to 70 pct of the Euro Area, this is likely to be the preferred approach leading up to Friday’s Summit.
It also looks from what I can see that the ECB is making it reasonably clear that if all the Euro Area sign up to the German plan, then they will play their role in helping things get better. Mario Draghi’s mention of a “fiscal compact” suggests, thankfully, that the ECB is likely to be closely involved in events late next week.
As I have written about also before, it has often seemed to me that, for much of the past 18 months, key German thinkers have seen their chance from the crisis within the Euro Area to put in place something much closer to the EMU that many of them wanted in the first place, which they made clear back in the mid-to-late 1990’s before it actually started. It has also seemed to me that once the crisis engulfed Italy; we were close to some kind of end game. To repeat specifically, I can’t see the existence of the EMU without Italy in it. Furthermore, I can’t see Italy surviving with 10-year bond yields above 7 pct. So, while it has all gotten a lot more dangerous, it has also become more exciting. And, for those that are capable of figuring out the immense politics, brink theory and policy reaction functions, there are big investment consequences.
What are the key issues to think about ahead of next Friday?
There will be an ECB meeting ahead of the Summit next Thursday. While it is unlikely that they will unveil too much of their intentions, in addition to a further rate cut and the extension of their liquidity support to the beleaguered European banking system, it is likely they will give a flavour of what they expect and hope for.
As far as the Summit is concerned, the German position is quite clear. Merkel is suggesting that a closer, more enforceable fiscal union is what they have to agree on, even if a Treaty change is necessary. Such a treaty change itself is a major challenge, as it would require ratification from all members, and without some particularly skillful Brussels footwork, ratification in all 27 EMU member countries, not just the 17 members of the Euro zone. This creates significant additional challenges, especially involving the UK. In order for the Summit to claim success, there will have to be some commitment to an eventual Treaty change, even if it might take considerable time. If all key participants sign up for this goal, then the meeting will be a success and the markets will cheer it in the days afterwards.
Ahead of this meeting, according to weekend reports, Merkel and President Sarkozy from France will meet in Paris Monday to try to narrow the key remaining differences. While Germany has signaled the need for a new authority to have budgetary oversight with automatic clear sanctions, although it has shifted its stance, France appears to still have a more nuanced position on some key aspects. In particular, France seeks a deal that will only require support from the 17 member Euro Area countries and one that Brussels won’t be the main arbiter of active decisions. Sources say that there is no planned press conference, but there is no doubt that hints about any further narrowing of differences will be leaked.
What will happen once the dust settles?
So, if one makes the assumption that a new stronger more disciplined EMU is agreed, and the ECB plays ball, is this finally the end of the EMU crisis? It will probably seem like it for the holidays, but of course, deep underlying issues stillremain. This week, I attended a small meeting with a group of leading civil service policy advisors from various countries around the world here in London, including a couple from major European nations. Much of the discussion about the world ended up to be about Europe, and much of their commentary was not related to any of the above, but the underlying issues of competitiveness, or lack of it. In particular, how can all these 17 countries stay in a permanent monetary union with no source of competitive improvement through currency adjustments? As one well-known person mentioned repeatedly, ultimately it is really a matter of arithmetic. Countries would have to undertake much more forceful supply-side reforms and, controversially perhaps, Germany and the other stronger northern members provide some kind of transfers. Otherwise, it will be tough to see the EMU survive. I actually suggested that, as part of this, Germany and other stronger northern members might have to deliberately seek slightly higher inflation than the others, even within the ECB’s 2 pct or less inflation mandate, in order to make such a long term transition less difficult. The discussions didn’t seem to be too optimistic as to where we might end up.
All this being said, these are more important medium-term issues. And, if we can’t get a positive resolution from Friday’s Summit, then they will be probably irrelevant.
A Lesson from Switzerland.
I spent 24 hours in Zurich Thursday and Friday, primarily to participate in the annual December GSAM Swiss client conference. I also presented to a large group at one particularly large client, one the largest managers of private client money in the world. I was especially interested in hearing their views about things, especially the Swiss Franc. I also met with a couple of Swiss friends of mine, some of which I have known since my early days working for a Swiss bank in the late 1980’s.
At the two events I spoke at, I surveyed the audience as to what they thought of the Swiss Franc and where they believed it might be by the end of 2012. I asked for a show of hands, first below 1.20 against the Euro, i.e., fresh strength of the Euro and that the Swiss National Bank (SNB) policy since August wouldn’t succeed, and second above1.30, i.e., success. At both events, the show of hands for less than 1.20 was conspicuous. In fact, just one person raised his hand. At the GSAM event, about 1/4 raised their hands for above 1.30 and, at the specialist client, around 1/3 raised their hands. This meant that the majority at both events believed that it would stay in a range of 1.20-1.30 (or, as I joked, they had no interest or had fallen asleep during my speech).
I also chatted about the whole issue with some people individually, and it is my impression that the SNB is expecting, in the event of a positive outcome to the EMU Summit, that the Franc will naturally weaken further as the safe haven status of the Franc recedes. In the event that the Franc doesn’t weaken, either because there is bad ending to the Summit or the market doesn’t weaken the Franc, the possibility of further specific actions by the SNB will rise. All in all, I return with even more belief than before that there is no such thing as a real safe haven, especially when policymakers are clear and determined. And I expect further Swiss Franc weakening.
One other important point for Berlin, Brussels, Frankfurt and Paris. The Swiss authorities appear to have achieved the success they have since August without actually spending any money. By making their intension so clear and being so decisive, especially with the use of the word “unlimited”, they have achieved quite a lot so far. Of course, this doesn’t guarantee persistent success, and one shouldn’t count one’s chickens, but it is a clear lesson.
More Good Signs in the US.
On Friday, the US payrolls were close to expectations, but the surprise was a drop to 8.6 pct in the unemployment rate. Many commentators suggest that this was a fluke, and the details suggest it happened purely because of a decline in the reported labour force for the month. As I have mentioned some time ago, the trend of weekly job claims for much of the past year or so would actually equate with a lower unemployment rate than has been persisting, and it might just be that while this month’s unemployment release was due to the reported labour force drop, perhaps it hadn’t really risen as much as was apparently reported earlier. In any case, this better news for Obama came on top of earlier betterthan- expected releases, especially the all-important monthly ISM survey. A number of forecasters are becoming less pessimistic about the near-term trend of the US economy, and I continue to think that there is good chance that the consensus will need to raise their forecasts for 2012 closer to 2.5 pct before they are done.
China Moves Towards Easing.
China showed more signs of a weakening economic cycle with their monthly PMI dropping below 50 amidst lots of talk –and some evidence – of further slowing of exports. All of this is ultimately quite good news as, along with the slowing cycle, Chinese inflation is going to ease further. This will create the scope for an end to monetary tightening and certainly more reductions in the reserve ratio for banks. Chinese-related equity markets continue to price in some fears of the worst, seemingly worrying about a hard landing, and while this is possible, once policymakers start to see real evidence that GDP growth might slip beyond 7 pct, they will start to ease financial conditions in earnest.
It seems to me that general developments in both China and the US are quite encouraging, and we just now need to see signs that Europe’s leaders want everyone to have a happy Christmas.
I will be away next weekend, so you may be pleased to read that there will not be a Viewpoint, although pending what happens in Brussels, I might write something early the week after. Otherwise, I shall be back the weekend of the 17/18, which will probably be the final piece of the year.
Chairman, Goldman Sachs Asset Management
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Jim O’Neill is the Chairman of GSAM, which is a separate operating division and not part of the Global Investment Research (GIR) Department. The views expressed herein by Mr. O’Neill do not constitute research, investment advice or trade recommendations and may not represent the views and/or opinions of GSAM’s portfolio management teams and/or the GIR Department. Copyright © 2011 Goldman Sachs. All rights reserved. Please visit our website for additional disclosures.
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