It seems that yesterday’s piece on the IMF left more questions than answers. The point of the IMF moving to break the adverse (negative) feedback loop in the economies of Europe and the impact of austerity budgets results in greater deficits as the economy affected experiences negative economic growth rates, which creates greater deficits. As my readers are well aware, budget deficits can increase by slowing growth as well as increased expenditures. The IMF economic models have used a 0.5% impact on proscribed fiscal retrenchment. The IMF has used that 0.5% number for 30 years. As the IMF has studied the European nations and other countries during the recent Great Recession, it seems that the organization’s models are flawed and the impact is far greater, resulting in ever greater deficits amid less economic growth. The IMF believed that for ever 1% drop in government budgets the result would be a drop in GDP of that beloved 0.5%–the multiplier that the models use.
The newest research reflects the possibility that the multiplier’s impact may be 0.4 to 1.2% higher, resulting in a much greater downward slide in economic activity. If a government budget was $100 million and it was cut by 1% the result would be a 0.5% negative impact on GDP. If the actual result was three times greater, the GDP would be much more significant. This is why the IMF World Economic Outlook is so significant. The EU was pushing for very large budget declines for the debt stressed PIIGS thus creating a far greater drag on economic growth and creating a vicious downward cycle. Greece, Spain, Portugal and Italy cannot possibly undertake enough austerity without imploding.
This call for austerity is coming at a time of already very high unemployment so the devastation on the local social fabric is more than any democratic government could shoulder. The importance of the IMF research is the possible outcome for allowing Spain and Greece to get some relief from the strictures of CONDITIONALITY. Ms. Lagarde has entered the discussion in a direct fashion and will need to use the power of the IMF coffers to alleviate the austerity demands of the Jens Wiedmann led Bundesbank. How much monetary support from the IMF will it take to buy the support of the Bavarian Burghers? This is the issue we will be dealing with going forward.
***Equity markets reacted favorably to the IMF issue of fallibility. If the demands of austerity are lessened it should buy time for debtors and result in enhanced short-term liquidity, especially with the ECB and FED on standby alert for any fragmentation in global financial markets. It’s interesting that gold, silver, grains and many other commodities continued their recent slide even on a day of risk-on for the equities. Even the bond market failed to go into risk-on mode and closed virtually unchanged around the globe. Gold should have rallied today in the light of the IMF pushing for looser fiscal standards but it seems that the market is taking some profits from the GOLD’s recent rally and is willing to put some money into more equity based investments.
I think that gold will need to hold the lows that were made on September 12 and 13–the days of the FOMC meeting that introduced QE3. As a corollary, the S&P also needs to hold their lows of those days, otherwise I will be nervous that we are heading into some time of correction on all highly rated risk assets. That does not mean long-established trends are over. It only means that we are going into correction mode as the markets take profits heading into the unknown darkness on the edge of the fiscal cliff. This is merely an observance that today’s risk-on profile has a few breakdowns and did not measure a perfect one on the algo scale … just something to think about.
***In today’s Financial Times there was an oped piece by correspondent Edward Luce, “Mexico is the forgotten story of the U.S. election.” My readers know I have pushed a bullish theme on Mexico for more than two years and this article just adds a little color to the argument I have made. If I had a pool of capital at hand I would be buying up the Maquiladoras factories along the US-Mexican border. Also, HXM, a stock that I have owned on and off for a long time, is a moderately priced homebuilder owned by Sam Zell. If Mexico begins to really develop, its middle class housing will be in demand. The stock has traded up to $70 from an initial IPO price of $17 in June 2004 but is now at $13.60. If the Mexican story improves this may be a play on middle class development. I am not touting this stock just pointing it out as a possible indicator of economic growth.