Lombard Street Research (Dario Perkins) the three big problems for the world economy: Europe, US fiscal cliff and the problems of China

Dario Perkins was in our office today to sell the gospel of LSR, Lombard Street Research. LSR is a little more optimistic than normal by only seeing three big problems (Europe, the fiscal cliff of the US and structural plus cyclical downturn in China).

All in all they still believe in the US in the long run and there is optimism about Japan that will grow because of reconstruction spending.

Why so optimistic about the US?

 The US is so flexible, innovative and business has done the deleveraging that was needed, households have to do only a bit more and government is not that much of a problem on the long run. The financial sector is not that big that it will create problems (unlike the UK, Spain, Italy etc.). The US $ is now competitive, even versus China.

The short term is more of a problem in the US: the fiscal cliff will come into force in January and take 4% of growth. He thinks half of it will be repaired but with big risks: maybe the lifting of the debt ceiling will not be managed in time (because of elections there is only about one month left to arrange things, that is way too short as we saw in 2011) and with big disputes.

China: LSR is the most negative on China in a decade: there are structural problems (the mid income trap that caused a growth pause in 85% of the countries that got from poverty to that middle income level), the transition from investment/ exports to consumption will be difficult. They cannot increase market share in exports with the old products now wages have become too high.

Short term cyclical problems: stop and go problems cause way too little growth of M3 now. Credit growth too low for high growth, government stimulus a problem. GDP growth is clearly lower than official statistics indicate, only about 6%.

Europe: the frog will be slowly boiled

Europe is repeating the errors of the US in the 1930s/ Japan in the 1990s. Bigger austerity is working out counterproductive.
Further decline of house prices in Spain, Italy etc will increase the problems of banks while the banking sector is too big in several economies.

He sees underestimation of the probability of bank runs (Greek banks already have 50% less saving deposits)

Politics Greece: right wants lower taxes, normal parties at best 45% of votes, extreme parties 55%: so  a big majority will be for no more fiscal austerity = quarterly help for Greece will get less support in the rest of Europe, the core will throw Greece out of the euro.

Biggest problem of Europe: Europe has no growth policy, no credible policy how to get out of the problems. No ECB that helps enough, that prevents deflation/ depression thinking

ECB: no targets yet for bond yields Spain Italy at say 6% because of opposition from core Europe: sustainability will force this over some time.

FED: Bernanke has done a very good job with avoiding deflation expectations to get hold, he needed unconventional policies that had no majority in any central bank. He got it and radicalized against the will of the hawks. Because of diminishing return of QE etc the US needed more and more radical things and that happened. He still is limited because he doesn’t want to enter the history books that blew the monetary policies with unconventional measures.

 Fiscal policies: Europe will start taxing profits of business that are hoarding too much. That will not happen in the US and the UK.

All in all are big parts of Europe sinking away. What happens with France will be critical. The help to the PIGS is unsustainable (5 to 8% of GDP of the Eurozone every year). Their wages have to become competitive with Germany. The euro will remain too strong because the market expects that the weaklings will leave the euro and the strong countries will remain in the euro. So European governments will not get rid of their high debt/GDP ratio with more austerity, banks will go down the drain because of very bad real estate markets especially in countries with too big banks, bad real estate markets and a lot of government debt.