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Wednesday, December 31, 2014

A New Year of Existential Moments


by Roy C. Smith
Dec. 31, 2014 
This is the time of year when resolutions and predictions are made. The resolutions are rarely achieved and the predictions, even short-term ones, are often wrong. Nevertheless, here are some for 2015, listed in terms of their existential urgency to the societies involved.
First, Russia.

This will be the year that Mr. Putin comes under the greatest amount of domestic political pressure since unexpectedly taking office on New Year’s Eve, 1999. There were a number of anti-war protests in Russia in 2014, adding to others that have occurred under Putin’s rule. In December, anti-government protests were staged in Manezh Square, and popular Kremlin critic Alexei Navalny was detained for attempting to participate. These sorts of demonstrations, however, have been harmless to Putin so far, but things may change in 2015 as acute economic pressures begin to eat into the economic gains middle class Muscovites have accrued over the past 15 years.  Russia’s GDP growth, never above 2% since 2008, has dropped to zero after the 50% collapse of oil prices and the ruble, but the added effects of US and European sanctions, soaring interest rates, a 44% drop in stock prices offer a bleak outlook for 2015 GDP growth of minus 4% to 5%.

Putin’s national approval ratings (reported by the government) may be high due to his machismo in the Ukraine, but do they resonate in Red Square? His political bullying and increasingly kleptocratic regime now resemble those of Viktor Yanukovych, the Putin supported, strong-armed President of the Ukraine who was suddenly deposed a year ago after protests in Maidan Square by thousands.  No one expected that: what goes around in public squares, can come around.

The pressure of all this presents Putin with an existential moment: He might avoid the worst by withdrawing forces from the Ukraine and acting in such a way as to get the sanctions, which are the only variable he can control in his current situation, removed. These sanctions, particularly those that restrict financial transactions and access to the Euromarket, have been very potent and may just be enough to tip the balance against Putin. As such, they may represent a new non-military tool that can be applied effectively by Western democracies when they can act together against aggressive or troublesome regimes. Better sanctions than armies.

China

Twenty-five years after Tiannamen Square, and after nearly that many years of soaring economic growth, China too may face an existential moment in 2015 as its growth rate continues to fall to around 7%, significantly below the 8% minimum that Chinese officials have thought to be necessary to prevent widespread social protests by the newly enfranchised middle class and the hundreds of millions of unregistered job seekers flocking to the cities. Communist Party General Secretary Xi Jinping, still largely unknown to the West as he maneuvers forcefully to secure his power and position in China, faces a dilemma. Flood the markets with cheap money and bank loans to reverse the economic decline, risking a financial bubble and collapse not unlike the Japanese in 1989, or tighten the belts and weather the economic adjustment but risk another Tiannamen Square event. So far it appears that the former path has been selected; increased liquidity has driven stock prices up by 36% just since March, despite an economic slowdown that will continue in 2015.

A market crash in China would reveal massive amounts of unreported bad loans to state-owned enterprises, municipalities, real estate developers and others and the shock effect could be enough to halt China’s twenty-year run of exceptional growth. Such an event also would surely awake the dragons of political protest.

Europe

Having survived (for now) a sovereign debt crisis, the Eurozone (EZ) was only able to stumble across the finish line in 2014 with growth of 0.8%. The EU was only a little better at 1.1%, nowhere near in either case what it needs to be to lower widespread unemployment or to support the enormous social safety net that still exists in Europe.  Growth forecasts for 2015 are slightly better, but unfolding events could actually make the European economic future worse. Coming up are elections in Greece that could produce a government mandated to improve the terms of the bailout or end the country’s participation in the EZ; an urgent need, according to the IMF, for labor market reforms in France, Italy and Spain that seem impossible to achieve; and a likely indefinite dependance on market-distorting “quantitative easing” by the ECB as a last ditch effort to secure minimal growth in the euro area. There is also a growth-killing EU financial transaction tax scheduled to begin on Jan 1, 2016.

Popular confidence in the EU/EZ system, its “single market” and “single currency” is fading fast. Never a Federal system like the US, at best European economic integration resembles the ineffective Confederation Period in US history (1781-1788) that was replaced out of necessity by a federal Constitution. Thus Europe too faces an existential moment when it will be required to choose between serious political integration along federal lines, or to give up and revert to the status quo pre-euro. Until it meets this moment, Europe’s slow growth and high unemployment condition is likely to remain in place.

Emerging Market Countries

There are a few Emerging Market countries that produced growth in 2014 above 5%, though all were in Asia (China, India, Indonesia, Malaysia, Philippines and Viet Nam).  In Latin America, Chile, Colombia and Mexico are showing the benefits of having invested in institutional infrastructure, but Brazil, with 2014 growth of 0.8%, Argentina 0.3%, and Venezuela (despite its oil) minus 2.8%, lag behind because they haven’t. 2015 promises an existential moment for Cuba, which will need to make significant domestic reforms to survive as an economically independent state. Now that Cuba and the US have announced a rapprochement of sorts, market and political forces will put a lot of pressure on Cuba to move things along faster than they want to.  

The US

 Despite years of talk about losing its grip, the US has been the economy to beat going into 2015.  Third quarter growth of 5%, low inflation and interest rates and a strong dollar suggests that the US has finally pulled itself out of the ditch it has been in since 2008. The US private sector, the world’s largest by far, is less affected by government action than other economies, but it has still suffered from over-regulation, aggressive government litigation and a generally anti-business administration. Corporate America, however, has adapted to these pressures, improved productivity and profitability, and is in good shape for the future. The American public sector, on the other hand, suffers from financial distress in the States and large cities, and in their pension funds, but elected officials are beginning to deal with them. Recent elections may resolve some of the gridlock problems in 2015.

The last few years have reminded Americans of two important lessons ingrained in the country’s economic history: without free-market capitalism there cannot be enough economic growth to provide the social system the people want, and free-market capitalism  can only operate a democracy with the consent of the people. Perhaps these are grounds for compromise between Democrats and Republicans. Lets hope so.

Happy New Year


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