Credit Writedowns

Lakshman Achuthan, co-founder of the Economic Cycle Research Institute, was on “Bloomberg Surveillance” this morning repeating his claim that a US recession “began around the middle of last year”.

The core of the issue is not whether the country could see one, or even two, quarters of positive performance, but whether any faltering recovery will be sustained out into the future, through 2014 and beyond. It is here that all the old doubts really emerge.

The European Union released figures for Q4 2012 GDP today and they were awful. GDP fell by 0.6% in the euro zone and 0.5% in the entire EU. Stock markets are getting clobbered on the news and the euro is selling off. This is not unexpected and I expect sovereign bond markets to converge to this reality.

In the links this morning, I linked to a Handelsblatt interview with the head of Austria’s social democratic EU parliamentarians. The overall gist of his comments were that he believed the EU budget was ‘catastrophic’ because it was in deficit. However, he was arguing for additional revenue to support better infrastructure and increased employment. This is the standard social democratic political position in both Austria and Germany. But, as the EU budget wrangling has begun it is the intervention for austerity by British Prime Minister David Cameron that has won the day.

My thesis these past few years is that a fiscal retrenchment to reduce deficits in the US was likely to lead to a shortened business cycle. I have been saying since 2013 began that politics favoured the United States going into austerity mode this year because deficit hawks have finally been able to galvanize support for their framing of the fiscal debate. Increasingly, this appears to be an accurate view.

As you may have heard already, the jobs numbers for the US came out and they confirmed that the US private sector continues to create 150-200,000 new jobs each month. This is consistent with moderate and does not indicate any signs of recession. The US can only fall into a recession because of fiscal cuts that ricochet back onto the private sector.

US GDP contracted at a 0.1% annualised rate in Q4 of 2012 according to preliminary estimates announced by the US government earlier today. This contraction was well below consensus estimates and comes as a shock to most of the analyst community. Nonetheless, most macro analysts are not concerned because consumer spending in the US still seems to support continued recovery.

As I have been predicting since the beginning of the year, I believe the Republicans will be able to force through some form of austerity before the budget battles in Washington are over this quarter. As the year began, we saw the fiscal cliff showdown end in a Republican defeat with taxes being raised. WHile the payroll tax hike was the biggest drag on growth, these tax increases were not likely enough in total to throw the US into recession.

While Germany’s numbers for Q4 2012 were poor, showing a contraction of 0.5%, I noted in my last post on Germany that this does not mean recession. The contraction was due to export and capital investment figures, which look to rebound in Q1.

The last post predicted a recession in the United States for Q2 as a result of the fiscal standoff in the United States. However, as I have been largely upbeat about the underlying fundamentals in the United States, this call is predicated almost entirely on the outcome of that standoff. This post is just a reminder of what data points we should be looking for as clues to where the US is headed.

Last Tuesday I said then that the debt ceiling fight would come first but that default on US public debt would be a step too far – and so Republicans would capitulate, forcing them to put their efforts into the sequester cuts. The biggest change since then is that default looks to be off the table, making cuts during the debt ceiling standoff more likely.

This is going to be a quick hit. But I thought I should put this out there now that the Platinum Coin idea has been rejected, something that makes this downside scenario more likely. The idea here is that we are in an interregnum period similar to the 1933-1937 period that will unfortunately come to an end. I’m going to spell this out briefly because it highlights my guiding macro thesis for the past few years on the US.