By Thomas Collimore, CFA
Crushing any residual optimism amongst delegates after Wolfgang Münchau’s cautionary forecast at the Fifth Annual European Investment Conference, Felix Zulauf, president of Zulauf Asset Management AG, highlighted slowing growth in China as a portent to a global economic crisis that will strike every single region. Zulauf indicated that “excessive” booms always lead to a bust, and China’s will be no exception. He stated that recent Chinese growth was actually far closer to 3% than official reports of nearly triple that level. In his view, market commentators underestimate the problems in China. Consequently, public growth forecasts for Australia, Latin America and other natural resource countries are too high. He also believes that Chinese authorities could implement “timid stimulus” after the coming leadership change but without much effect. In short, a “credit boom in reverse” seems imminent.
Zulauf argued that the U.S. government will find further fiscal stimulus unaffordable, as debt has risen from $10 trillion to $16 trillion and $25 trillion is in sight within four years at this pace. He argued that fiscal restraint is needed, even if at a short-term cost in growth, and added that “Obama has no plan” and that Republican vice presidential candidate Paul Ryan’s plan is “implausible.” Minor fixes are the likeliest case, resulting in economic stagnation. Zulauf’s only good news was that households appear to have completed deleveraging.
The eurozone is on track to be the shortest currency union in history, Zulauf said, with the possibility of federal union the only alternative to breakup. Additional temporary measures risk aggravating social conditions, with local rioting leading to broader civil unrest. In his view, the crisis is imminent and does not require a specific event. After six to nine months, the markets may suddenly wake up and react powerfully to some seemingly minor event.
He added that investment options in the intermediate term are grim. While the equity markets may thrive in the coming year or two, the seven-year equity cycle will turn in 2015 or so and “buy and hold” strategies will turn out to be painful for those with a three- to four-year horizon. Although the coming bust will be bad, Zulauf thinks it will not be as serious as the last.
Zulauf fears competitive devaluations, pushed initially by the United States. He foresees current firmness in the euro to the U.S. dollar ending soon and parity or even a discount to the U.S. dollar as quite probable, for political reasons. As with equities, bonds are subject to a downward cycle, hyperinflation is possible in deeply troubled countries, and central banks in other countries would welcome modest inflation, which would be likelier in asset prices than consumer prices. He added that these bankers sold gold at the low point, questioning why anyone would trust them to manage the process competently.
When questioned on the possible “muddle along” scenario, Zulauf suggested that only moderate inflation offered such an escape potential but doubted that once started, the central bankers could manage to avoid the 5% to 7% inflation that would trigger a bond crisis. He concluded that while a supply-side focus on increasing productivity and lowering economic barriers could help in principle, governments are “heading in the other direction.”
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