This is Jim O'Neill in about the most pessimistic light that his genetic makeup, not to mention GSAM employment contract, will allow him:
What Was the Most Important Thing This Week?
So once again, what a week. To most people, there has only been one thing that has mattered, Italy. I have been conducting a small poll throughout the week as I went about my usual crazy schedule. Since Wednesday, at all the events I spoke at, I asked, “There have been two really important things that happened this week, what were they?” Italy came up immediately as the most popular first choice. In many cases, angles on the Italy issue came up as 2nd, 3rd and 4th too. For the second issue, there were a host of options, with one person amusingly suggesting the debate about whether England’s football team should be allowed to wear poppies on their shirts in the probable embarrassment against Spain this weekend. Seriously though, as only one participant answered correctly, the second important event was Chinese CPI inflation.
China: The Latest Data and the BRICs.
This week, we saw the usual monthly release of most of the important data in China, which again showed signs of slowing momentum in the economy. The data also showed slowing inflation and signs of a continued narrowing in the trade balance. Also important was the monetary data. While M2 showed further softening, the data also contains hints of stabilization and more high frequency signs that suggest monetary signals are shifting. While many debate whether China’s “soft landing” will allow monetary easing, at the margin, it looks as though they are already tinkering.
China’s trade surplus widened over the previous month, but by a much lesser degree than expected. Moreover, with 10 months reported, the annualized trade surplus is not much over 2 pct of GDP. Exports are weaker than expected and imports are stronger. In my view, this continues what appears to be a relatively clear trend. It continues to baffle me why so many Western commentators and policymakers seem to ignore pretty strong evidence that this “global imbalance” has turned significantly for the better.
The latest inflation data confirms what most forecasters have believed. Some of the pickup in Chinese inflation earlier this year was highly likely to reverse as base effects from late 2010 diminished. Together with a turnaround in some domestic food prices and the consequences of a slowing economy, Chinese inflation is heading back below 5 pct, possibly even close to 4 pct by year end, and back below in early 2012. As I have written about repeatedly since the Summer madness in markets, this development is extremely important for both China and the rest of the world. If inflation continues to ease, then the likelihood of a soft landing rises, and China will be able to achieve a shift more towards domestic consumption-led growth. As I am fond of saying to people, in 2011, the change in China’s nominal GDP in US$ will be the equivalent of creating three new Greek economies. In the context of the above question and what is important this week, I realized that, along with the other three BRIC nations, the probable change in the US$ value of their combined GDP in 2012 is likely to be close to $2 trillion. They will effectively create the equivalent of another Italy.
This is what the BRIC countries can do to help the world, and especially troubled Europe, way more than any specific steps to invest in European beleaguered bonds.
On Friday morning, our money market team hosted a client breakfast about China and I was joined by the head of our Chinese asset management business, Wang Yi, to lead the discussion, which turned out to be very interesting and quite broad. We discussed all the usual issues and many more. And, as I said in concluding, Yi and his team have a very exciting future ahead of them and for us.
The US Appears to be Doing Just Fine Too.
Another reason why I have been more sanguine than many about the European mess is my views on the US. Although the US economy has turned out to be much softer than some optimists, myself included, believed at the start of 2011, it is actually stronger than most concluded by the time the mayhem broke out in August. Amongst many useful coincident and leading indicators, this latest week’s drop in job claims to 390,000 is as good as many pieces of evidence I could cite. It seems to me that, while there is considerable focus on the budget issues, it wouldn’t take much in terms of successful policies to turn the housing market around. And, if it did, then it wouldn’t take much for people to start thinking more optimistically about the US economy.
An “ok” US, together with a Chinese “soft landing,” is the key to world equity markets in my view, and it will take a lot of persistent bad news from elsewhere to avert this. Unfortunately, the Euro Area keeps trying hard to provide it.
Italy and a Highly Troubling Week for EMU.
For a couple of days this week, it actually felt as though Europe’s post-war project was nearing the end of the road and, as a result, emotions have been running high. For those that never believed it was a good idea, some have been expressing a mood of jubilance. For many involved in its creation, this has not been a good week. I got more caught up in the middle of this than usual as a result of a newspaper interview, where the headline distorted what I had actually said, claiming that we were predicting a break up. While this was not a fair reflection, I did say that some major issues were now on the table and needed to be recognized. The EMU, as created, has not really worked and needs to change. It is quite clear that many countries should not have been allowed to join. It is also clear that the Growth and Stability Pact has not worked. Policymakers need to be more open in at least acknowledging this, and then doing something about it. If all of this wasn’t enough of a challenge, Italy’s issues have become front and centre. Italy is no Greece. Indeed, although the BRICs can create another Italy in 2012, Italy is close to 4 times the combined size of Greece, Ireland and Portugal. Its total debt is close to 25 pct of the Euro Area GDP. Quite simply, Italy cannot be allowed to stay in the position it found itself this week.
On top of this, Italy is an important historical player in creation of not just the EMU, but also the EU. Italy was the first country that I was allowed to analyze professionally some 30 years back and I have retained a lot of affection for it as a result. (I’ve not enjoyed some evenings in Milan and Turin watching United getting a good occasional lesson over those years though.) When it came to EMU in 1998, it was quite clear to me that, despite many objections, the EMU couldn’t start without Italy, primarily due to its size and the key fact that large swathes of Northern Italy are just as competitive as parts of Germany and France. This remains the case today, and it is tough to see the persistence of the EMU without Italy involved. So, while I can see the case for an EMU without some others, and despite all of Italy’s complications, I can’t see an EMU without Italy. At the same time, I can’t see Italy sustaining life with 6-7 pct 10-year bond yields. So something has to give. Let’s see what Italy brings over the weekend, and how Frankfurt, Berlin, Brussels and the rest of us all react.
A Moment on Mexico.
I had a pleasant diversion from all the European madness with a visit from a Mexican delegation. While they didn’t quite go as far as some Mexican policymakers and recommended that BRIC become BRIMC, they were highly intrigued about our “Growth Market” concept and, of course, the fact that we included Mexico. Listening to their views on a couple of critical issues, it added to my suspicion that the decade we have started could be a better one for Mexico than the past one. At the core of this suspicion is the issue of the RMB and Chinese competitiveness. This conversation adds to my belief that Mexico is getting back something that was lost to China in the past. And of course, a certain Chicharito is from that country, which helps…
Anyway, let’s see what the next twist and turn brings. Good luck!
Chairman, Goldman Sachs Asset Management