Thoughts From the IMF
This week, the IMF put out two interesting reports…one on the world economy (an update) and another about financial stability. Here are some of the interesting things I read (and some of their charts) followed by my thought for the day:
1. The weak global recovery has shown signs of further weakness. Even emerging markets are not hitting their targets. See chart.
2. The IMF lowered their world growth forecast. But, even these lower assumptions are based on (A) Euro financial strain easing; (B) emerging markets gaining traction; and (C) the US solving our fiscal cliff issue.
3. The IMF predicts that US GDP will grow 2% in 2012 and 2.3% in 2013. Realize that this level of growth will not lower our unemployment rate.
4. Q2 developments have been really weak. See chart below for Purchasing Managers’ Index.
5. In Q2, money flowed into the least risky securities. Bonds issued by Germany, Japan, Switzerland and the US were seen as safe havens.
6. Because some of the safe havens were in Europe, this prevented a steeper fall in the euro (a bigger drop in the euro would have helped European exports but would have hurt investor confidence).
7. Notice that U.S. equities have significantly outperformed other major indices. See chart below.
8. Commodity prices are 25% below their mid-March high. This resulted from weaker global demand prospects, lessened concerns about Iran and over-production by OPEC.
9. The most immediate risk is that delayed or insufficient policy action will further escalate the euro area crisis.
10. The main short-term risk to the global economy is fiscal tightening in the US, given recent U.S. political gridlock.
11. Another risk is that the U.S. and Japan will make insufficient progress in developing credible plans for medium-term fiscal consolidation. This risk is currently mitigated by the flight to safety in the bond market.
Global Financial Stability Report
1. Risks to financial stability have increased since April. Sovereign yields are higher. The investor base is eroding. Elevated funding and market pressures may result in tighter euro area credit.
2. Uncertainty about the asset quality of banks’ balance sheets must be resolved quickly. Capital injections and restructurings are needed. See chart below showing sovereign bond spreads and credit default swaps on European banks.
3. Weak growth in advanced economies makes them less able to deal with spillover from the euro area crisis.
4. Money is flowing out of Spanish and Italian banks. See chart.
5. Most markets are not yet pricing in enhanced fiscal risks for the U.S. U.S. credit default swap spreads have increased, but remain at low levels. The consensus view is that the fiscal tightening will be deferred until later and that the debt ceiling will be raised.
Thought For the Day
Everyone is saying the same thing about the U.S.: resolve the fiscal cliff and then put in a credible plan for fiscal consolidation. I think that this is easier said than done…and that’s not just a comment about our political system. It’s a comment about our fiscal gap. The fiscal gap represents the amount that we need to either reduce spending (as a percentage of GDP) or increase taxes (as a percentage of GDP) in order to maintain our current debt-to-GDP ratio. I’m not saying we’ll improve our already-too-high ratio; rather this will just maintain it.
Under the most realistic scenario (known as the alternative scenario), our fiscal gap is 8.7%. See chart below. In other words, we have to decrease spending or increase taxes by 8.7% of GDP immediately. Our tax revenue is approximately 18% of GDP (and normal spending is slightly above 20% of GDP). So you’re talking about either increasing taxes by 50% or cutting spending by approximately 40%. The Fed and the IMF make it sound too simple when they say that we simply need a credible plan for fiscal consolidation. We need a huge game-changing plan that will greatly change our society. There’s not an easy answer for that.
Have a great week.
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