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Jan 09 2012

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Three Issues That Will Decide Election Day

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Destiny Beyond Our Control?

While we are focused on political developments in New Hampshire, the eventual Republican nominee and the coming horse race between that candidate and President Obama, the issues that will shape next November’s decision are in play now outside our borders, and largely outside the control of President Obama and his team or his GOP rival.

Will Europe Fall into Recession?

Despite all the high level summits and decisive-sounding statements of 2011, the sovereign debt crisis that began in Greece in 2010 remains real, potent and unresolved.

Many of the Euro-nations, including, notably, France, will have to refinance billions in national debt in 2012. The market reaction to those sales, represented in the interest rates necessary to attract capital, will speak tangibly to the shortcomings of European economic diplomacy thus far.

In addition, stricter capital requirements imposed by the EU on commercial banks will run headlong into the rising level of troubled loans on bank balance sheets, threatening a solvency crisis. Banks will hoard capital, not lend it.

The sovereign debt crisis and the halting EU reaction to it makes economic turbulence, if not outright recession a strong possibility.

The Euro zones growth figure for the fourth quarter of 2011 won’t be published until February, but according to the Wall Street Journal, data and surveys suggest the EU economy contracted in the last three months of 2011.  Specifically, ING estimates that the euro-zone GDP fell by 1.75% in the last three months of 2011 (Economists consider a recession in place when there are back to back quarters of negative growth).

Looking at current data, the European Commission’s economic sentiment indicator fell in December for the 10th straight months to its lowest point in more than a year. Also, data released on Friday showed that unemployment hit a fresh high; 16.3 million people were unemployed in Europe, the highest figure reported since records for the 17 nation union were first compiled in 1995.

The debt crisis and negative growth feed on each other in an economic Catch-22.

Short-term fiscal retrenchment, necessary to bring debt and spending under control,  runs headlong into negative economic growth, which has a regressive impact on profits, and thus taxable revenue available to the government, necessary to meet agreed budget targets (and re-assure stock and bond markets). At the same time, an explosion of unemployment places enormous pressure on governments to increase social spending to meet the needs of their citizenry.

The challenge for the US economy in this situation is two fold.

First, the web of integration between US and EU banks means that any serious liquidity crisis in Europe would have impacts in the US. In addition, a “sovereign default”for a nation such as Greece would have a domino impact throughout the EU, generating waves onto US shores.

Second, the US exported a quarter of a trillion dollars in goods to the EU in 2011, an increase over 2010. A recession in Europe will eat into that export number as demand craters. Third quarter earnings reports from major US exporters highlighted this future challenge as companies missed earnings targets based on lessening European demand. A prolonged downturn will have ramifications for US manufacturers as well as the financial sector.

Will China’s Economy Slow Down or Slip Into Recession?

Nicholas Lardy, and economist at the Peterson Institute cites three warning signs on the Chinese economy.

First, Europe’s slump has weakened China’s trade. Europe buys 20 percent of China’s exports. Second, signs that China’s emerging housing bubble is deflating, which cascade impact across the economy. And third, China’s financial tools to deal with a potential downturn (like 2008) are more limited as the nation’s debt rose from 26 percent in 2007 to 43 percent of GDP in 2010, after deploying an enormous stimulus to cope with the 2008-08 financial crisis.

Nomura, the Japanese securities firm sees a one in three chance of a “hard landing” for the Chinese economy – a drop in growth from its current pace of 10 percent annually, to 5 percent or less.

While 5 percent growth would represent a renaissance for the US economy at China’s current state of development, and with its giant population, a swing to growth only 5 percent growth or less would roughly equal – in Chinese terms – the US decline in the 2007-09 recession, according to the Washington Post’s Robert Samuelson.

Such an outcome would have global repercussions considering the pivotal role that Chinese economic growth played in preventing a much harsher world-wide downturn after the market crash in 2008. Specifically to the US, a Chinese slump would jeopardize the nearly $100 billion in exports from the US to China. Indeed, a Chinese slowdown could kindle protectionist pressures that would have a more wide-ranging impact on US investment and exports with China, with spillover impact on the US economy.

Iran and the Bomb:

The US is rapidly approaching a point of no return with Iran.

All incentives and blandishments proffered by the Obama administration and the Europeans have only served to provide more time for the Iranians to finalize preparations to build a nuclear weapon.

The November 2011 International Atomic Energy Agency (IAEA) report lays out, in chilling  detail, that the Iranians have developed a sophisticated program that is consistent with an intention to develop nuclear weapons.

Yesterday, an Iranian diplomat reported that Iran had made a secret uranium enrichment plant operational outside of the holy city of Qom, deep in a mountainside to prevent damage from any potential attack. The action flies in the face of international efforts to scale back Iran’s nuclear program, and is additional proof that the Iranians are seeking to purify uranium to a level consistent with that necessary for a bomb.

In the face of Iranian obstruction, Team Obama and select European countries have decided to place economic sanctions on Iran, which are apparently causing real distress in the Iranian economy, resulting in current Iranian saber rattling, and today, the death penalty ruling against an American in Iranian custody.

Is this enough, or two little too late?

It is official US policy to prevent Iran from manufacturing or possessing a nuclear weapon. But if diplomacy and sanctions fail, the options left to enforce this policy become ominous and costly.

Military strikes on nuclear sites might achieve a short term goal of delaying Iranian acquisition of a nuclear weapon, but unlike Iraq in 1981, it is unlikely that Iran will sit back and take no action if attacked by the US or a coalition of allies.

Iranian action could take the form of conventional military action such as closing the Straits of Hormuz.  While the US military has trained for 30 years to counter this contingency, an additional US action would increase hostilities between the two nations and would most certainly have a shock effect on oil prices.

The Iranians could also strike asymmetrically, through Hezbollah in Lebanon, with attacks on Israel proper, or through the use of terror against American targets abroad or at home.

Thus the only way to ensure a non-nuclear Iran, and to limit a potentially prolonged, global proxy war, is regime change. That remains an ugly expression in American political circles, and particularly in this White House (though Libya was regime change by another name).

But it is the only path out.

It is also the most costly and uncertain, meaning general war with Iran at a time when the US has departed Iraq and is downsizing its commitment in Afghanistan. In addition, there is enormous uncertainty regarding the impact such a forced change in political leadership would have on countries with large economic investments and interests in Iran’s current regime, most importantly, China.

Hanging over all the increased tension with Iran are oil prices. Even without a shot fired, the loose talk and rhetoric are having an impact on oil, which has a symbiotic relationship with global economic growth.  Greece, Italy and Spain are major importers of Iranian oil Should the Iranian challenge grow in the coming months, its economic side effects will impact the EU and China and the rest of the world, doubling down on economic uncertainty.

On January 27th, the Commerce Department will release US Q4 GDP. Most economists estimate that growth was more robust than the 1.8% from Q3 – perhaps 3 percent or more. That encouraging sign, coupled with better hiring numbers point to a growing stability in the US economy, if now outright recovery.

And while fact checkers can easily expose manipulated good news (such as the faux “drop” in unemployment to 8.5%), Americans as a rule reward President’s for good economic progress and punish for bad. If the circumstances are bad, but getting better – as they were for President Reagan in 1984 – President Obama will be the beneficiary of that good will, complicating the task for the Republican nominee.

But that nascent stability in the economy is subject to forces beyond Team Obama’s control in Europe, China and Iran.

What happens in those countries will impact the US economy.

And that is where the election will be decided.

 

 

 

 

 

 

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