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Strategic Update:

How Do You Spell Economic R-E-C-O-V-E-R-Y?

by Mary Miller, Director of Research


Resisting Economic Challenges Or Voicing Exaggerated Rally Yahoos

My apologies, but I could not resist the temptation to spell out something that makes about as much sense as the January reports coming from global financial leadership and economic analysts.

Following reports of a rally of the U.S. dollar and improving jobs data, one analyst wrote, “If the future is uncertain, today’s economic problems seem to be improving gradually.” Really?

Another report from the same day cited “conflicting U.S. jobs data and mounting concerns about debt defaults overseas that threaten global economic growth and triggered a worldwide wave of stock-market volatility amid fears that the improving U.S. economy could unravel.”

Perhaps it is not the spelling of R-E-C-O-V-E-R-Y, but the definition that requires our attention. But first, a review of what lies behind the pendulum swings between optimism and pessimism as the financial reporting of 2010 begins.

U.S. Jobs Data

While speaking with small business owners in Maryland, U.S. President Barack Obama downplayed the published in-crease in jobs statistics saying, “These numbers, while positive, are a cause for hope but not celebration, because far too many of our neighbors and friends and family are still out of work.”

He continued, “We can’t be satisfied when another 20,000 have joined their ranks and millions more Americans are underemployed, picking up what work they can.” Obama’s doublespeak to the positive numbers we are not celebrating may indeed be caused by the fact that the numbers are not accurate.

Amid the positive report in the growth of the number of jobs available is the revision of last year’s numbers. January’s report from the U.S. Department of Labor found that 600,000 more workers lost their jobs last year than first estimated.

Put in perspective, this revision means that 8.4 million people have lost their jobs since the recession officially began in December 2007. Unfortunately, this is not a complete picture either.

Heidi Shierholz, a labor economist at the Economic Policy Institute (a liberal policy-research group) added, “This number, however, understates the size of the gap in the labor market by failing to take into account the fact that simply to keep up with population growth, the labor market should have added around 2.6 million jobs since December 2007. This means the labor market is now roughly 11 million jobs below what would restore the prerecession unemployment rate.”

In her analysis of January’s numbers, she concluded that in order to fully fill in the 11 million-job gap in the labor market within three years—by January 2013—employment would have to increase by more than 400,000 jobs every month between now and then. This is definitely not the definition of recovery in the jobs market or the American household.

So while optimism reigns in the Administration because new jobs are being created and some Americans are going back to work; the pessimism lingers because the numbers required to achieve full recovery appear out of reach.

Rally of the U.S. Dollar

As 2009 came to a close, analysts were targeting new highs in value for the euro, the Australian dollar, and the yen with a resurgence of the British pound. The dollar, however, remained on the “most-hated” currency lists. That trend changed as 2010 rolled in. The euro lost 7.5 per-cent against the dollar in just eight weeks under the weight of Europe’s economic issues. However, most analysts proclaimed the rally of the U.S. dollar is not due to the economic recovery of the U.S.; it simply isn’t in the hot seat of currencies at the moment.

Decline of the Euro

Analysts are watching Europe closely. One of the key developments in moving toward a global economic platform was the implementation of the euro. However, problems within the Eurozone (European countries using the euro) may present a major threat to the euro’s existence.

The “euro” was possible because European countries established a common monetary policy and currency. However, fiscal policy would continue to be determined by the individual countries. To monitor these fiscal decisions, the European Union (EU) created the Growth and Stability Pact which established two key operating criteria: 1) deficit spending by member countries cannot exceed three percent of GDP, and 2) total government debt cannot exceed 60 percent of GDP.

The euro and Europe’s monetary policies are in trouble because a “one-size fits all monetary policy doesn’t give the member countries the flexibility needed to stimulate their economies.” The function of Europe’s Central Bank is to control inflation, not growth. Europe’s weaker economies are far from recovery. In fact, they are close to collapse.

PIIGS Are Not Healthy

This is not a good time to be one of the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) in the Eurozone. These nations are in danger of defaulting on their sovereign debt and full financial collapse. Despite attempts, especially in Greece, to make politically disastrous budget cuts, investors remain wary. The prices of credit default swaps (essentially the insurance policies against possible default on government debt that are traded by investors) increased to record levels for both Greece and Portugal in early February. Investors are asking higher prices than ever to insure government debt.

The status of the PIIGS is putting the entire Eurozone under a microscope. Greece and Portugal are viewed as the beginning of the domino effect of failing economies that will quickly knock down Spain, Italy and Ireland and then possibly moving on to Austria, Belgium and even France.

As investors watch, rumors abound. What remains to be seen is the answer to a tough question—do these countries receive a bailout or are they allowed to collapse to rebuild from the ashes?

With the strongest and most stable European economy, Germany is the big brother in the European monetary bloc. While European Union (EU) leaders scramble to develop a potential EU “bailout” by funneling monies through existing programs or issuing EU-wide Eurozone bonds (despite explicit rules prohibiting the issuance of such), Germany is entertaining the idea of allowing Greece to depend fully on its ability to solve its own crisis through debt reduction.

Without investor confidence, the rising cost of funding Greece’s existing debt could scuttle its best plans for budget cuts and debt reduction. Unfortunately, for the Eurozone, the PIIGS will overshadow all semblance of economic recovery for the first half of 2010. (The economic and political ramifications of this situation will be discussed in greater detail in next month’s “2010 and Beyond: The European Union.”)

The IMF – In Name Only

The monetary crisis in the Eurozone brought the purpose of the International Monetary Fund (IMF) into question. The IMF was created after World War II specifically to prevent situations such as exists currently in Greece. Conceptually, the Fund is supposed to lend money to countries in trouble to spread budget deficit reductions over time. This allows the restoration of investor confidence and acts as an external seal of approval on a government’s credibility.

However, the Managing Director of the IMF, Dominique Strauss-Khan, recently stated that while the Fund stands ready to help Greece, he knows it is wishful thinking. Some of the reasons provided as to why this help is not forthcoming:

• “Going to the IMF” brings with it a great deal of stigma. European governments are unwilling to take such a step as it could well be their last.

• The IMF is supposed to provide only “balance of payments” lending. That doesn’t fit well when a country is in a currency union such as the euro.

• Would the Europeans really want the IMF and its some-what cumbersome rules to get involved—this would be a huge loss of prestige.

• Does the IMF really have enough resources to backstop all the PIIGS?

• The IMF could play a constructive “technical assistance role” alongside the European Commission. This could, however, break the power of Europe on the international stage—perhaps a good thing, but not at all what the European policy elite is looking for.

Essentially, the IMF cannot, or will not, help in any meaningful way. It appears Europe is being squeezed into many tough choices while the world simply says, “We are here to help.” What was touted as the road to economic recovery in 2009 is visibly showing its potholes in 2010.

The Demise of G-7

The Group of Seven (G-7) represents the finance ministers from seven industrialized nations. It has been meeting several times a year to discuss economic policies since the group was formed in 1976, when Canada joined the existing group of France, Germany, Italy, Japan, the United Kingdom, and the United States. However, the group’s February meeting may well be its last. The primary issue for discussion is not the development of financial regulation or global imbalances, but the efficacy of any further meetings.

It is a sign that the 21st century is truly the Asian century as these countries recognize a world increasingly dominated by the emerging economies of China and India. This sentiment was underscored with the comments of Jean-Claude Trichet, president of the European Central Bank: “The prime grouping for international cooperation is the G-20. It is no more the G-7, at least in this format of ministers and governments.”

The Group of 20 (G-20), which includes up-and-coming economies including China, India and Brazil, now accounts for more than three-quarters of global output. In view of the fact that the G-7 economies were at the center of the recent financial crisis—a fact China is quick to point out—the G-20 countries want a greater voice in the direction of global economic policy and recovery.

Up or Down

U.S. Treasury Secretary Timothy Geithner smiled in an interview as he said, “We have much, much lower risk of [a double-dip recession] today than at any time over the last 12 months or so… We are in an economy that was growing at the rate of almost 6 percent of GDP in the fourth quarter of last year—the most rapid rate in six years. So we are beginning the process of healing.”

While Mr. Geithner is optimistic of the signs of recovery for the U.S., analysts are reporting the global economy is bracing for another major shock coming out of the European Union.

As the financial reports continue to span both sides of the recovery equation, perhaps it is easier to say economic recovery occurs when someone else is in trouble and we are off the hot seat. Or simply, economic recovery occurs until B-A-I-L-O-U-T is no longer an option.


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