Soaring food prices driven by the rise in soft commodities has seriously dented the purchasing power of the world’s poor. The resulting explosion of discontent spread by internet around the Mediterranean basin has now reached Bahrain, Saudi Arabia, Yemen and, in particular, the dictatorship of Libya. The Web-informed populations of these countries cannot comprehend why, with billions in foreign exchange reserves, their governments should let them go hungry. Libya accounts for just 2% of global oil production and there is more than enough surplus capacity. But even so speculation has pushed the price of crude to $115 a barrel, creating sufficient drag to slow the global economy. All of a sudden the recovery is starting to look uncertain again. Coffee, cocoa, soybeans and other agricultural produce are similarly rocketing. Last summer, taking advantage of already high prices a hedge fund manager nicknamed «Chocolate Finger» cornered the market in cocoa and squeezed short-sellers. Just like in the good old days. Nothing has changed.
There are encouraging signs in the US that consumer credit and job creation are turning up. This and the rally in equities are fostering a bit of a «feel good» effect and thus providing scope for steady economic growth in 2011, despite the continuing slump in construction. The Federal Reserve, having nearly completed its collection of long-term Treasury securities, will have to start raising short-term rates gradually to encourage savings and deter speculation. We saw the damage on Alan Greenspan’s watch that zero interest rates can do. It is high time the Fed slammed the lid on speculative borrowing. With companies awash in cash, traditional loans are rarely used these days. The bonds of all levels of government—federal, state and municipal—are dangerous. Only good-quality corporate issues look reassuring.
Pimco’s well-known fund manager Bill Gross recently announced he had sold his position in US Treasuries. When can we expect the credit ratings of many governments to be downgraded to AA or A? Moody’s, Standard and Poor’s and Fitch clearly rely on well-polished rear-view mirrors. With a new US presidential election approaching, the Obama administration will focus less on reforms and more on recovery. But where will it find the money? The changes to banking recommended by the Volcker Commission will be minimal, paving the way for the same kind of gambling that caused the collapse of Lehmann Brothers in 2008. That story is now ending with the government and the SEC afraid of losing their case against Richard Fuld, Lehmann’s former CEO, accused of balance sheet manipulation. Fuld, protected by a phalanx of lawyers, may be able to contemplate a peaceful retirement.
The Brussels summit is an opportunity for EU leaders to try and further the cause of solidarity. But Angela Merkel, worried about her party’s election agenda, is reluctant to say anything that might anger German voters. Nicolas Sarkozy, likewise concerned about his approval rating, is trying to grab the spotlight. In the meantime Portugal is struggling not to capitulate, Spain is raising €15 billion to shore up its savings banks and Ireland adamantly refuses to stop undercutting its EU partners with a rock-bottom corporate tax rate. European convergence is a long, painful process. A unified fiscal policy will not be adopted overnight, although the most glaring excesses will eventually be smoothed out. The euro has firmed up against the dollar because of America’s difficulty in capping its public debt at all levels. But given the likelihood of renewed turbulence in the euro area, the EUR/USD exchange rate could easily retrace to 1.32. The Swiss National Bank is trying to dampen speculation on our franc. But apart from creating a dual market for real and virtual transactions, what can it do? As in America, the situation in Europe remains foggy indeed.
It is too early to gauge the consequences of the disaster that has just struck Japan, but two things are sure. In all forthcoming elections the safety of nuclear power plants will be challenged by environmentalists. And although Japan’s damaged infrastructure will probably be rebuilt sooner than we think, the country’s already bloated public debt will be stretched further.
In the emerging regions, rapid economic growth is offset by social instability. This has been illustrated yet again by the fairly large pullbacks in the emerging stockmarkets. We had warned our readers about the additional premium commanded by emerging equities and bonds compared with the assets of developed countries. The «emerging tilt» of many pension funds (including France’s Social Security) proves that these markets are anything but undiscovered. That said, they have not fallen enough to offer a major buying opportunity.
In conclusion, bonds and emerging assets are both heading south rather predictably. The developed stockmarkets are not following suit for an obvious reason: their advance in recent months has been unspectacular and even plodding. Thus, the fundamental uptrend driven by QE2 is probably not over yet. The shares to watch for investors looking to wade in are core holdings that embody large assets and pay a hefty dividend. Only companies like these can weather crises. We would advise lightening up on mid- and small caps in view of their run-up last year.
Gold is a good lamp to light one’s way through the fogbank we are crossing.