Mega-trends and their impact in 2012

To arrive at an outlook for the year ahead we first need to analyze the big trends that endure for decades and in some cases even longer.

Population growth and food resources

The number one dynamic over the last century has been the exponential rise in global population. It took 123 years for the world population to grow from 1 to 2 billion (by 1927) and only 12 years to grow from 5 to 6 billion (by 1999). Growth, however, is now slowing and we are predicted to rise from the current 7 billion to a peak of 9 billion in the 2050s.

At the same time we are faced with increasing scarcity of food and water. Advances in technology have improved crop yields, but increased meat consumption in China and other Asian economies will reduce overall output. The area of land required to produce an equivalent amount of edible protein from livestock is 4 to 5 times higher compared to traditional grains and legumes, and up to 10 times higher for beef. Diversion of land use for ethanol production will also restrict food output.

Global warming, whether man-made or a natural cycle, may also contribute to declining food production — through droughts, floods and depleting fish stocks.

Depleting natural resources

We are also depleting global deposits of ferrous- and non-ferrous ores — as well as energy reserves of crude oil and coal — as global industrialization accelerates. Commodity costs can be expected to rise as readily available resources are depleted and we are forced to dig deeper and endure harsher conditions in order to access fresh deposits. Deep water ocean-drilling and exploration within the Arctic and Antarctic circles are likely to increase.

As energy resources are depleted, nuclear energy production is likely to expand despite current safety concerns. Development of technologies such as thorium fluoride reactors hold out some hope of safer nuclear options, but these may be some way off. Wind and solar energy are likely to remain on the fringe until technology develops to the point where they are cost effective compared to alternative sources.

Global competition

Competition for scarce resources will increase tensions between major economic players, with each attempting to expand their sphere of influence — and secure their sources of supply. The Middle East, Africa, South America, Australia, Mongolia and the former USSR are all potential targets because of their rich resource base.

Trade wars

In addition to competition for scarce resources, we are also likely to see increased competition for international trade. Resistance to further currency manipulation — initiated by Japan in the 1980s and perpetuated by China in the last decade — is likely to rise. US Treasury holdings by China and Japan currently sit at more than $2.3 Trillion, the inflows on capital account being used to offset outflows on current account and maintain a competitive trade advantage by suppressing their exchange rate.

Rise of democracy

Another factor contributing to instability is the rise of democracy in some parts of the world. The Arab Spring is still in its infancy, but the development has no doubt caused concern amongst autocratic governments around the globe. Food shortages and rising global prices will act as a catalyst. The likely result is increased suppression in some autocracies and a rapid transition to democracy in others, like Myanmar. But the transition to democracy is never smooth — especially in countries with clear fault lines, such as language, religious, racial or cultural differences — and can lead to decades of conflict before some degree of stability is achieved.

Decay of Democracy

On the other hand we are witnessing the decay of long-standing, mature Western democracies. Undue influence exerted by special interest groups with large cash resources — such as banks, big oil, and armaments manufacturers — force politicians to serve not only their electorate but their financial sponsors. Aging populations pose a new threat: large voting blocs who are not participants in the economic workforce will wield increasing influence over distribution of social welfare payments such as Medicare and Pensions. And politicians are increasingly guilty of over-spending, running up public debt and debasing currencies, in their attempt to keep voters happy and secure re-election.

The long term hope is that we evolve a more consensus-based form of democracy, along the lines of the Swiss model, and away from the excesses of the current winner-takes-all system.

Global debt binge

The decay in Western democracy resulted in a massive debt binge over the last 3 decades, with private debt often growing at double-figure rates, accompanied by burgeoning public debt levels. The massive debt bubble far outstripped GDP growth, effectively debasing currencies and causing soaring inflation of consumer and asset (housing and stock) prices. The GFC marked the peak of the debt expansion and was followed rapid contraction as the private sector diverted income to repay debt. Debt contraction is catastrophic, however, and can cause GDP to fall by up to 25 percent as in the Great Depression of the 1930s.

The response has been a massive expansion of public debt as governments run deficits in order to offset the private debt contraction. Overall debt levels hardly faltered as government spending programs filled the hole left by private debt contraction. While this succeeded in plugging the gap, many Western governments are left with huge public debt and increasingly nervous bond markets.

Central banks such as the Fed and BOE stepped into the breach, purchasing government bonds with newly-created money. Apart from putting gold performance on steroids, central bank asset purchases had little impact on inflation because the effect was offset by the deflationary debt contraction. But cessation of the debt contraction would let the genie out of the bottle.

Outlook for 2012

Here is how I believe these big trends will impact on 2012. I do not claim to have a crystal ball and it may be amusing to review these predictions at the end of the year:

  • Further debt contraction
    Contraction of private debt and constraints on government borrowing will strengthen deflationary forces.
  • Further QE
    The Fed and BOE are likely to expand their balance sheets to support public borrowing. The ECB may make a limited response because of constraints imposed by member states such as Germany.
  • Low inflation
    Deflationary forces will outweigh the inflationary effect of QE by central banks.
  • Low global growth
    Debt contraction and a euro-zone banking crisis will ensure low growth.
  • Euro-zone banking crisis will require further bank rescues
    Placing further stress on public debt levels, and pressure on the ECB to act.
  • China “soft” landing
    A second massive stimulus focused on low-cost housing and quelling social unrest will restore economic activity, but export markets will remain flat and the banking sector inundated with non-performing loans.
  • Easing of commodity prices slows
    Massive stimulus from China will support commodity prices.
  • Further social unrest amongst autocratic regimes
    The Arab Spring will continue sporadically across a far wider area.
  • Crude oil prices remain high, aided by further conflict
    High crude prices will also contribute to low growth.
  • US current account deficit shrinks as yuan rises
    Increased pressure from the US will prevent China from expanding its Treasury investments causing the yuan to strengthen against the dollar.
  • Dollar strengthens against euro
    A euro-zone banking crisis will ensure that the dollar preserves its safe-haven status.
  • Gold bull-trend when QE resumes
    Resumption of QE by the Fed would ensure that gold resumes its bull-trend against the dollar.

I wish you peace and prosperity in the year ahead but, most of all, the good health to enjoy it.

Regards,
Colin Twiggs

The Dismal Outlook for 2012 | The Big Picture

Dr. Peter T Treadway is principal of Historical Analytics LLC: ~

It is a core view that I have elaborated on in prior letters that democracies with universal suffrage have a long run tendency to spend their way into fiscal bankruptcy and degrade their currencies along the way. Investors have to recognize this phenomenon. The so called advanced West has reached that point of bankruptcy now. Politicians pass measures to please the majority that elected them, regardless of whether the country can afford it or not.

via The Dismal Outlook for 2012 | The Big Picture.

Debt and deleveraging: The global credit bubble and its economic consequences | McKinsey Global Institute

Empirically, a long period of deleveraging nearly always follows a major financial crisis. Deleveraging episodes are painful, lasting six to seven years on average and reducing the ratio of debt to GDP by 25 percent. GDP typically contracts during the first several years and then recovers.

via Debt and deleveraging: The global credit bubble and its economic consequences | McKinsey Global Institute | Financial Markets | McKinsey & Company.

Mark Carney: Growth in the age of deleveraging

Today, American aggregate non-financial debt is at levels similar to those last seen in the midst of the Great Depression. At 250 per cent of GDP, that debt burden is equivalent to almost US$120,000 for every American (Chart 1).

US Debt/GDP 1916 - 2011

…..backsliding on financial reform is not a solution to current problems. The challenge for the crisis economies is the paucity of credit demand rather than the scarcity of its supply. Relaxing prudential regulations would run the risk of maintaining dangerously high leverage – the situation that got us into this mess in the first place.

As a result of deleveraging, the global economy risks entering a prolonged period of deficient demand. If mishandled, it could lead to debt deflation and disorderly defaults, potentially triggering large transfers of wealth and social unrest.

Managing the deleveraging process

Austerity is a necessary condition for rebalancing, but it is seldom sufficient. There are really only three options to reduce debt: restructuring, inflation and growth. Whether we like it or not, debt restructuring may happen. If it is to be done, it is best done quickly. Policy-makers need to be careful about delaying the inevitable and merely funding the private exit.

……Some have suggested that higher inflation may be a way out from the burden of excessive debt. This is a siren call. Moving opportunistically to a higher inflation target would risk unmooring inflation expectations and destroying the hard-won gains of price stability.

…..With no easy way out, the basic challenge for central banks is to maintain price stability in order to help sustain nominal aggregate demand during the period of real adjustment. In the Bank’s view, that is best accomplished through a flexible inflation-targeting framework, applied symmetrically, to guard against both higher inflation and the possibility of deflation.

The most palatable strategy to reduce debt is to increase growth. In today’s reality, the hurdles are significant. Once leverage is high in one sector or region, it is very hard to reduce it without at least temporarily increasing it elsewhere.

In recent years, large fiscal expansions in the crisis economies have helped to sustain aggregate demand in the face of private deleveraging. However, the window for such Augustinian policy is rapidly closing. Few except the United States, by dint of its reserve currency status, can maintain it for much longer.

…..The route to restoring competitiveness [in the euro-zone] is through fiscal and structural reforms. These real adjustments are the responsibility of citizens, firms and governments within the affected countries, not central banks. A sustained process of relative wage adjustment will be necessary, implying large declines in living standards for a period in up to one-third of the euro area.

…..With deleveraging economies under pressure, global growth will require global rebalancing. Creditor nations, mainly emerging markets that have benefited from the debt-fuelled demand boom in advanced economies, must now pick up the baton. This will be hard to accomplish without co-operation. Major advanced economies with deficient demand cannot consolidate their fiscal positions and boost household savings without support from increased foreign demand. Meanwhile, emerging markets, seeing their growth decelerate because of sagging demand in advanced countries, are reluctant to abandon a strategy that has served them so well in the past, and are refusing to let their exchange rates materially adjust. Both sides are doubling down on losing strategies. As the Bank has outlined before, relative to a co-operative solution embodied in the G-20’s Action Plan, the foregone output could be enormous: lower world GDP by more than US$7 trillion within five years. Canada has a big stake in avoiding this outcome.

Mark Carney: Growth in the age of deleveraging.

Comment: ~ One of the most important papers I have read this year. Mark Carney, Governor of the Bank of Canada and Chairman of the Financial Stability Board — established by the G-20 in 2009 to further global economic governance — maps out the hard road to recovery from the current financial crisis.

The Black Swan of Cairo: How suppressing volatility makes the world less predictable and more dangerous

Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate beneath the surface. Although the stated intention of political leaders and economic policymakers is to stabilize the system by inhibiting fluctuations, the result tends to be the opposite. These artificially constrained systems become prone to “Black Swans” — that is, they become extremely vulnerable to large-scale events that lie far from the statistical norm and were largely unpredictable to a given set of observers.

….Preventing small forest fires can cause large forest fires to become devastating. This property is shared by all complex systems. In the realm of economics, price controls are designed to constrain volatility on the grounds that stable prices are a good thing. But although these controls might work in some rare situations, the long-term effect of any such system is an eventual and costly blowup whose cleanup costs can far exceed the benefits accrued.

….Humans simultaneously inhabit two systems: the linear and the complex. The linear domain is characterized by its predictability and the low degree of interaction among its components which allows the use of mathematical methods that make forecasts reliable. In complex systems, there is an absence of visible causal links between the elements, masking a high degree of interdependence and extremely low predictability. Nonlinear elements are also present, such as those commonly known, and generally misunderstood, as “tipping points.” Imagine someone who keeps adding sand to a sand pile without any visible consequence, until suddenly the entire pile crumbles. It would be foolish to blame the collapse on the last grain of sand rather than the structure of the pile, but that is what people do consistently, and that is the policy error.

The Black Swan of Cairo: How suppressing volatility makes the world less predictable and more dangerous
By Nassim Nicholas Taleb and Mark Blyth

Colin Twiggs: ~ This is a must read for those who want a deeper understanding of why complex systems fail and why we are continually blind-sided by unforeseen political and economic events.

Quick Overview

Looks like something positive is brewing in Europe, but I don’t want to jump the gun. China looks weak, US probably through its worst, Europe still faces plenty of pain even if fiscal reform and euro-bonds introduced. Game changer would be QE/asset purchases by Fed and ECB.

The scourge of government debt – macrobusiness.com.au

A report on a talk by Yanis Varoufakis, author of The Global Minotaur, gives some nice history of how we got here. The Minotaur is a marvelous metaphor for what governments have allowed to occur in the global financial system. Now they, and all of us, are being skewered by its horns:

“In the immediate post-war era, Varoufakis claims, “the Americans begin to take seriously the redemptive mission to save capitalism from itself.”

But in doing so, against its apocalyptic competition with the Soviet Union, America spread itself too thin. Or too thick. By the time it was funding LBJ’s Great Society reform programme, alongside the dire weight of the Vietnam war effort, America stopped being a surplus nation. It went into deficit.

What followed was a worldwide project to balance everyone else’s books in line with the Americans own – what Paul Volcker, American economist and head of the Federal Reserve from 1979-1987, called the “controlled disintegration of the world economy”…..

Towards the end of his speech, Varoufakis claimed: “The Left and Right miss the significance of this current juncture. It is not terminal for capitalism, but it has ended the conglomeration of illusions in how we viewed the world. It ended the illusion we had that we had something called free market capitalism.”

via The scourge of government debt – macrobusiness.com.au | macrobusiness.com.au.

The Weekend Interview with Peter Brabeck-Letmathe: Can the World Still Feed Itself? – WSJ.com

Recent decades have seen “the creation of more than a billion new consumers in the world who have had the opportunity to move from extreme poverty into what we would call today a moderate middle class,” thanks to economic growth in places like China and India. This means a billion people who have “access to meat” for the first time, Mr. Brabeck-Letmathe [Chairman of Nestle] says.

“And the demand for meat,” he says, “has a multiplier effect of 10. You need 10 times as much land, 10 times as much [feed], 10 times as much water to produce one calorie of meat as you do to have one calorie of vegetables or grain.”

via The Weekend Interview with Peter Brabeck-Letmathe: Can the World Still Feed Itself? – WSJ.com.