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2018-01-11Macro `n Cheese

2018 Outlook Politics

In this first blog of 2018, Roger puts out a call to arms for 2018. Politicians in general and European ditto in particular, he says, must now take responsibility for a continued strong and equitable growth. Is Roger really anything but a spectre haunting Europe, we ask?

- Where do I begin?

For as long as I have been in the forecasting industry, January has been a time of tremendous activity (and some personal anxiety) with a host of (mainly sell-side) commentators releasing economic and financial outlooks for the year ahead trying to raise some contrivance that sales can use to push clients out of their current positions, and into something – anything – to generate transaction fees and next year’s bonuses.

Truth be told, it always did feel a bit odd to coerce fundamental factors into changing sufficiently every holiday season to warrant an orthogonal economic and financial interpretation come January. This year, and now that the shackles have loosened so I can move closer to the fire, I couldn’t resist the opportunity to try out another perspective of the shadows dancing on the wall before me.

So, where do I begin? – After reading tons of fine, and mainly reassuring, analyses during my holiday, I have started to suspect that the best place to see more clearly connects to Politeia. Let’s start this year’s dialogues there.

A short retrospect

The Global Financial Crisis (GFC) of 2007/08 shook the very foundations of the world economy and economics. However, the tremors were not confined to economics, but rather amplified within politics 1. Ever since World War II global order has rested on trade and cooperation of liberal democracies. Since from around the time of the crisis, the world has gone from being "a concert of nations to a cacophony of competing voices", as Ian Bremmer and Nouriel Roubini fittingly framed it a couple of years ago.

1 You can find a fine introduction to the economics behind political developments in the aftermath of the GFC here.

In the graph below, I demonstrate the very different trends in global trade volumes before and after the GFC and use the (World Bank) relative cost and time to import vs exports (net of production dittos) as an indicator of protectionism. (Another, more straight-forward, way to show the increase in protectionism post-GFC can be found here.)

Macrobond Document Macrobond Document
Graph 1 & 2: Internationale ”Ordnung muss sein, sagte Hans, da brachten sie ihn in das Spinnhaus”

Of course, these changes to the international economic and political order have reverberated regionally and nationally with increasing political polarization and mistrust of institutions. I do not think these problems will be resolved by one “lucky” election in France, but rather by politicians managing to address the underlying (mainly economic) dysfunctionalities with inequality or, perhaps more importantly – unfairness – (however defined) being the most pertinent.

Chart 2: It has been a long time coming
Source: VoxEu: “Economics of the populist backlash” by Dani Rodrik (3 July, 2017)

The year ahead in politics

For a long time, long before President Trump took office, US politics has become increasingly gridlocked. On the international scene, nonetheless, and despite the insidious rhetoric, the Trump administration has pursued a fairly conventional foreign policy, executing on almost none of the threats to global cooperation expressed during the campaign and early stages of the administration. Trump’s difficulties in uniting the Republican party around even hallmark Republican issues and policies suggests that exits from, or sweeping changes to, international agreements and treaties that large cohorts of the Republican party support (such as NAFTA), are unlikely2. Even if the inapt handling of the North Korea situation poses a risk also in the short-term, its main effects are probably more related to the long-term standing of the US as a strategic Asian partner in the face of a more assertive Chinese leadership than anything else.

Domestically, the passing of the Tax Cuts and Jobs Act (TCJA)3, will do nothing much other than add an aggregated USD 1½ to 2¼ trillion (equivalent to between 7½ and 11¼% of 2018 GDP) to the deficit over the next decade, and add an additional 5-10 percentage points (p.p.) of debt to GDP in excess of baseline scenarios. In terms of effects on demand, the proposal is “front-loaded”, and for 2018 available estimates point to an immediate GDP-effect of ½ to 1¼ p.p. that wears-off with time. By and large, these estimates seclude any Ricardian reactions which is probably fine, at least when judging the very near-term impact of the TCJA.

2 Not to mention if the decision is even Trump’s to make. Under any circumstances the ongoing NAFTA talks will surely yield some volatility.
3 All numbers are collected from non-partisan organizations: Congressional Budget Office, Joint Committee on Taxes, Brookings Tax Policy Centre, U Penn’s Budget Model, and “others” (OK, I admit, “others” is the anything but reliable Wikipedia. In this particular instance, though, I think they have produced a nice run-through)…

Taken together, in 2018, US politics is set to remain in a stalemate. The ongoing recovery is expected to continue, which, solidified by the TCJA, suggests that Trump-administrations economic performance will not be all too bad going into the mid-term elections held on 6 November 2018. Possibly, (potentially excessive) FED monetary policy normalization can foil Republican hopes of retaining both chambers of Congress. Or perhaps, quite simply, the all too frequent indiscretions of President Trump will eventually become the liability of the Republican party that Democratic-leaning commentators want to transform it into?

Chart 4: Trump approval ratings are improving. Is it just temporary?

Meanwhile, in Europe, the promise of reforms from the newly elected French President, Emmanuel Macron has emboldened not just French companies, but also Europhiles all over the continent. And a friendly face in Palais de l’Élysée is sorely needed for the weakened German Kanzlerin, Angela Merkel (CDU), who is poised to form a hard-bargained grand coalition with the Social democrats (SPD) and CSU4. From what we hear, a CDU/CSU-deal with the SPD is hinging on increased spending (and possibly some tax cuts) double the estimated fiscal space for the next four years, i.e., around EUR 100 billion (approximately 3% of GDP).

4 Bavarian counterpart in “die Unionsfraktion”.
Chart 5 & 6: Can Macron fill the European leadership void?

While the political situation in Germany and France seems stable, at least from an economic perspective, the chaotic situation in Spain lingers on. Catalan pro-independence parties retained a slight majority at the regional elections in December and we hear that Carles Puigdemont will be re-appointed as President of Catalonia, setting the stage for another showdown with Madrid in a not too distant future. That said, the popular vote in Catalonia is still not for secession, which will hopefully suffice to keep financial market nerves in order, even if another confrontation was to occur. But the stakes are undoubtedly high.

As if Spain was not enough to keep the European input in geopolitical suspense, we will soon (4 March 2018) need to digest the result of the general elections in Italy, the country with the world’s third biggest bond market (and a 133% government debt to GDP ratio to match). Admittedly, none of the main parties – including the see-sawing Five Star Movement – are still advocating an immediate Euro-exit5, but most of the viable party constellations are, if nothing else, adhering to economic policies utterly inconsistent with both Italy’s economic realities6 and EU recommendations. Temporarily, hopefully throughout 2018 at least, a care-taker government or less than amicable coalition of Forza Italia (yes, him again) and the currently ruling Democratic Party can maintain some form of political stability.

5 With the Northern League (LN) as possible exception. Many of the parties, including the Five-Star Movement (M5S), nonetheless, remain outspoken Eurosceptics and continue to suggest that a referendum on the Euro is a possibility.
6 Link to IMF’s article IV report. Do read the debt sustainability on page 40.
Chart 7: How can this possibly end well..?

By now, it should be clear that the European political outlook remains extremely difficult with the situation in Italy being especially cumbersome7 in the near-term. And another leg in the Euro crisis, propelled by the world’s 8th largest economy and 3rd biggest bond market will have global consequences.

However, as long as the Euroland recovery remains intact, a renewed existential crisis for Europe should be on hold, which leaves me thinking that we might be able to survive most, if not all, of 2018 without any major crisis.

7 Note that Italian support for the Euro is by far the lowest in the Euro Area, and the trust in the European Union among the lowest in the EU! Cf. Eurobarometer 88.
Chart 8: Political risks are on the rise. A rise in economic risks would make 2018 look nasty.

Are there other risks to the outlook? – Of course! Egypt, Brazil and a number of other countries are also host to important elections scourged by populist politicians. And in Europe we still have the continued woes of Poland, Hungary and Brexit to fend with. However, my guess is that the local, regional and global political risks will only manifest themselves during 2018 if the economies would again relapse into recession. Of this there are, thankfully, and as most of my colleagues seem also to assert in their economic and financial outlooks, few indications.

– Alas, things change and we will indeed put the light on a few things that are ripe for change; i.a., real interest rates and some aspects of the Chinese economy, in coming blog posts!


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